One of the common challenges that new businesses and startups face is funding. Where will the money for operating expenses and other necessary costs come from? Even though projected profits are high for the future, how will the bills be paid right now? Even though you’re all familiar with the idea, it’s worth revisiting that fundamental question: what is venture capital?
In many cases, new entrepreneurs have found that venture capital offers a solution to these and other problems. Of course, it usually takes skill, organization and perseverance to secure enough venture capital for a fledgling company’s needs. The following information will discuss what venture capital is, how venture capital firms operate, and what you must do in order to acquire adequate funding for your business.
A Quick Venture Capital Definition
Venture capital is capital used for investment purposes with regard to new or fresh enterprises (or ventures). It has been defined as “a form of private equity and a type of financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential.” Venture capital is usually monetary in nature; however, it can also involve technical or managerial expertise, as well as the provision of a solid infrastructure within which the new company can operate and grow.
Venture capital is sometimes referred to as “risk capital” because there is always an element of risk for investors. For instance, a startup company may fail (which occurs nine out of 10 times); or the actual return on an investment may be much lower than originally projected. For this reason, most private investors and venture capital firms seek out business opportunities that offer a potential return of at least 10 times the original investment.
How do Venture Capital Firms Operate?
While private investors may provide venture capital to some startup companies, many new entrepreneurs turn to venture capital (VC) firms in order to secure funding for their enterprise. In almost all cases, venture capital firms are examining two primary factors when deciding which companies to fund: which investments have the most potential for exceptional ROI, and how much control the firm will have (or need to have) over the investment.
To illustrate these two points, imagine that there are three different startup companies in the same vertical market:
- Company A has a solid business plan in place, and an ownership group willing to cooperate with potential investors, but only projects a return of 2-3 times the initial investment.
- Company B has tremendous potential for growth; however, Company B’s owner is unwilling to relinquish any control in the business’ decision-making process to outsiders.
- Finally, Company C has both an exceptional projected ROI, and an ownership group willing to yield a measure of control in exchange for funding and technical assistance.
Clearly, for the majority of venture capital firms Company C would be the preferred option for investment.
The Hierarchy of a Venture Capital Firm
There is an established hierarchy of authority within most venture capital firms. A basic understanding of the different roles within a VC firm can help you understand how best to engage participating investors and attract attention to your company.
A VC firm may have analysts as well as interns that are in training to become analysts. As the name implies, an analyst’s main job is to examine the market and determine which new companies have growth potential, and would be a good fit for the venture capital firm. The analyst conducts in-depth market research, and may attend networking events such as conferences or trade shows. However, an analyst’s role is merely to report; he has no decision-making power within the firm.
One step up from analysts, associates in a VC firm often have a strong background in the financial industry, and are key to building and maintaining relationships with partners of the firm. Like analysts, they also do not have any inherent decision-making power. Nevertheless, they are often helpful in introducing entrepreneurs to senior members of the firm.
Principals have some decision-making power within the firm when it comes to investments. However, they do not guide the overall strategy of the firm. A principal can help you to “get your foot in the door” and be a powerful ally throughout the process of securing the necessary capital for your business.
The most senior members of a VC firm are the partners. These may be general, managing, venture, or limited. All partners have a voice in the investment decisions of the firm (managing partners also run the operational side of things). In most cases, each partner has the responsibility to raise capital for the firm, which will in turn be spent on investments.
How to Raise Your First Round of VC Funding
With the above information in mind, how can you successfully obtain the needed funding for your new company? Here are 4 steps that you should take:
- Create a business plan. In order for your business venture to appeal to potential investors, there must be a solid plan in place, backed up by convincing evidence of your company’s potential for growth. Your business plan should include an executive summary, a detailed SWOT analysis, and a financial overview with projections for at least the next five years.
- Do your research on potential VC investors and “agents of introduction.” You need to have a basic idea of which VC firms are interested in your market vertical, and how they’ve performed with previous entrepreneurs. Do they have the funding muscle that you need for your next big step? In addition, do your due diligence when checking out consultants, founders of other startups, and startup accelerators. Make sure they have the right kind of connections to meet the needs of your company.
- Make connections. Network with other startup entrepreneurs. Forge virtual relationships through social media platforms like LinkedIn and Facebook. Consider going to private clubs or exclusive restaurants where venture capitalists and those within their network gather. Be sociable, friendly, and persuasive. Focus on how your prospective investors would benefit from a partnership with your company, rather than what you stand to gain.
- Nail the pitch deck. Your pitch deck (or presentation deck) is absolutely essential in sealing the deal with an interested VC firm. It’s a tool that allows you to briefly and persuasively summarize your business plan, your vision for your startup, and why your company is a good investment (often within 10-15 slides on PowerPoint or Prezi). Your pitch deck may be the first thing that a potential investor asks for, so you should have it ready to send at a moment’s notice.
In summary, venture capital is an essential ingredient for success for many startup companies. Understanding how venture capital firms work and how you can appeal to potential investors will enable you to craft a highly targeted strategy, and persuade interested suitors to fund your company for future growth. If you’d like to learn more about how to get venture capital for your business, reach out to us today.