Considering exploring the realm of venture capital? Well, you should learn the basics first.
In essence, you need to know where venture capital is usually acquired from, at which stage it matters most and what’s essential for success in the VC world.
By the end of this article, you will have enough to go on and decide if you’d like to continue your journey.
The VC world is not simple, so whenever you’re ready to learn more, keep reading.
What Is Venture Capital?
Venture capital is the endeavor of funding fast-growing, young and potentiated businesses. In essence, this means you cannot get venture capital for the established mattress manufacture franchise you’re so interested in.
Venture capitalists usually look for very large returns of at least 2x per year with investments amounting to millions of dollars. This means that your local mom-and-pop shop looking to buy more equipment doesn’t fit the average ballpark of VC funders.
And that’s not a problem. Venture capitalists take a lot of equity. It’s probably best that such businesses avoid such propositions unless the business has the potential to acquire millions in sales.
Niche VCs do exist, but most focus on the technology and medical sectors. This is where the most growth is seen, both in the market addressed and individual company growth.
The Types of Venture Capital Sources
If you’re looking to learn more about venture capital, here are some of the primary types of startup funding. Of course, these are not the only types of VC, but they are the most prominent.
Many people acquire their startup loans at regular banks. However, even with potential Small Business Administration backing, startups are usually a big risk for banks.
If the business produces impressive projected financials, has clients lined up, rich industry history, and a professional business plan, they might get a couple hundred thousand dollars.
But even then, banks like to make very restrictive entry conditions. Don’t be surprised if the bank asks to take another lien on the business owner’s home.
Family and Friends
Unless the owner is independently wealthy when working on their startup, they will usually start with funding from their family and friends. Did their college roommate invest in Bitcoin early or their aunt made money off oil stocks? Those are the kind of people they will be looking for.
Family and friends are the most empathetic to the cause. It might sound odd, but this group of people usually see the investment opportunity as a method to help you, not just make money.
Every other type of funding for venture capital is based on the promise of return.
Private Equity Funds
Venture capital funds are part of the global industry of private equity funds. PEFs only exist when individuals/entities pool their money together to make investments in private businesses/opportunities.
Venture capital is often the final step of a startup roadmap. Once the growth is seen and the product is established, a venture capital fund will usually approach the business.
Angels are the serious rendition of your family and friends. They will often come flying in the door to save the floundering businesses with their investments.
Ever seen the show Shark Tank? Well, those are angel investors. They often have lots of experience in the realm of business and offer their consulting.
Angels can offer venture debt and capital investment (in exchange for part ownership). Venture debt has double-digit rates and comes with conversion opportunities, allowing the angel to convert the investment to equity.
The Phases of Financing Venture Capital
Now, let’s take a look at the stages that a business will usually go through when looking for venture capital financing. This does not apply to all businesses, because each enterprise will have its own VC journey.
The first phase is the conceptual one. This is when you think of the service/product and start to create it. You learn about business ownership and accounting, write your plan, reach out to vendors/associates and hire some employees.
The seed phase is when the product is launched. If you have a history of business success, you might be able to acquire funding at this state. However, if you’re unable to do so, you can get funding from the sources listed above.
Another source for funding is fund via product sales. Build your minimum viable product, sell it to customers and develop better versions of the product as you start to gain traction.
Startups that grow in this manner have an advantage because they are not losing equity and not going into debt.
Venture Capital Rounds
If you did not fund in the prior state, you will go through several funding rounds to raise money. Each round will have its own valuations and benchmarks, as well as different investors.
Each round provides investors less opportunity for their money because equity is usually depleted in each round by a percentage.
Initial Public Offering
The final phase of VC funding is the initial public offering. The business hires an investment bank to underwrite an offer and then you go public by pitching your business to investors who want to buy stock.
This is a stage in which most angels and private investors are found, this is when VC funds will sell shares as well. Quite commonly, a business will get very big and the founders will have to sell shares just to pay tax on gains.
Continue Reading in Part 2: Become A Venture Capitalist