How Venture Capital Works for Startups and Small Businesses

With almost limitless opportunities that advancement in technology is creating over the past two decades, many startups and small businesses today tend to seek capital that could lead their dream business to success. While there is a wide range of financial sources they can turn to, most of these entrepreneurs are hesitant to borrow money from banks and financial lenders because of the risks involved. But the good thing is that they have found a good alternative and that is by raising venture capital from venture capitalists or venture capitalists.

Definition

Venture capital is the amount of money that venture capitalists will invest in exchanging property in a company, including a share of equity capital and exclusive rights to run the business. In other words, venture capital is the financing that venture capital firms offer to companies with high growth potential.

Venture capitalists are those investors who have the ability and the interest to finance certain types of businesses. Venture capital firms, on the other hand, are registered financial institutions with experience raising money from wealthy individuals, companies, and private investors – the venture capitalists. The venture capital firm, therefore, is the mediator between venture capitalists and capital seekers.

Requirements

Since venture capitalists are selective investors, venture capital is not for all businesses. Similar to filing for a bank loan or applying for a line of credit, you must show proof that your business has high growth potential, especially during the first three years of operation. Venture capitalists will ask you for your business plan and examine your financial projections. To qualify for the first funding round (or initial round), you need to make sure you have that well-written business plan and that your management team is fully ready for that business launch.

Process

Because venture capitalists are the most experienced entrepreneurs, they want to make sure they can get a better return on investment (ROI), as well as a fair share of the company’s equity capital. The mere fact that venture capitalism is a high-risk, high-return investment, smart investing has always been the standard model of trade. A formal negotiation between the fundraisers and the venture capital firm puts everything in its proper order. It begins with the pre-money valuation of the company seeking capital. After this, the venture capital firm would decide how much venture capital to invest. Both parties must also agree on the participation in the capital stock that each will receive. In most cases, venture capitalists get a percentage of equity that ranges from 10% to 50%.

Financing strategies

The financing life cycle typically takes 3-7 years and could involve 3-4 rounds of financing. From start-up and growth, to expansion and public listing, venture capitalists are there to help the company. Venture capitalists can reap the returns on their investments generally after 3 years and eventually earn higher returns when the company goes public in the fifth year onward.

The chances of failure are always there. But the strategy of venture capital companies is to invest in 5 to 10 companies with high growth potential. Economists call this venture capitalist strategy the “law of averages,” in which investors believe that large gains for the few can outweigh small losses for many.

Any company seeking capital must ensure that its business is profitable. That is, before approaching a venture capital company, they must be confident that their business idea is innovative, disruptive and profitable. Like any other investor, venture capitalists want to reap the rewards of their investments in good time. They expect a return on investment of 20% to 40% in one year. Aside from venture capital, venture capitalists also share their technical and managerial skills to shape the direction of the business. Over the years, the venture capital market has become the engine of growth for thousands of startups and small businesses around the world.