Financing is a vital requirement for all companies looking to expand beyond the idea phase. There are several options to access financing such as loans, personal investment or bootstrapping (where the entrepreneur starts small, makes a profit and invests that profit to expand). With these options, however, development has the potential to be slow and unsure. In the case where an entrepreneur or company wants to expand quickly, venture capital is a great source of funding to investigate.
What is Venture Capital?
Venture Capital is a method of providing financing for companies that have the potential to grow rapidly but have a difficult time getting traditional financing such as a bank loan due to the risk. A dedicated investment company known as a venture capital firm establishes a fund and uses the money gathered to invest in a cadre of companies on behalf of the investors who contributed to the fund.
This form of financing is not a loan, rather it is an investment in return for shares within the business and the firm is looking for a high return to compensate for the elevated level of risk involved.
Who invests in a Venture Capital Fund?
The contributors to venture capital funds include companies that make huge profits or gather money and are looking to invest these monies in assets such as stocks and bonds, real estate, to develop a profit. These include banks and other financial companies, pension schemes and mutual funds. Government may give incentives such guarantee of principal sum invested and 100% tax credit on the yield from the investment for investment in certain types of businesses.
What is the Venture capital Process?
A fixed set of money, for example $20 million, is raised and placed in a fund. All of this money is then invested in businesses approved by the venture capital’s board.
Within seven to ten years, the company(ies) will be sold or offered on the stock exchange with the hope that the venture capital firm would have made a profit on the original sum invested, which will then be distributed to the original investors proportionate to the rate they invested in the fund, less agreed upon expenses incurred in operating the VC fund. Alternatively, the entrepreneur can purchase the venture capitalist’s shares in the company and retain sole control of his/her company.
Stages in Venture Capital Financing
Most Venture Capital Funds are dispersed in phases in line with the state of development of the product/idea.
In the early phase of the financing, there are two major stages:
Seed Stage A product/idea at a somewhat premature stage of development is presented to the venture capital board to request financing. The Board will then decide based on a feasibility study of the project whether they will extend financing to the company. This initial financing will be used to develop the business and implementation plan and the initial structure of the company including the management team. A member of the Venture Capital Board takes a seat on this new team.
The Start-up stage At this stage the Business Plan is presented to the VC firm in earnest and the new company starts to take shape. The product/idea is being developed into a prototype and according to the rate of development, initial customers are attracted for sales. The funds realised at this stage contribute to a preliminary marketing push.
The funds at this early phase are not guarantees that you would get further funding from the firm.
In the expansion phase of financing, there are four major stages:
The first stage The financing at this stage shows that the Venture Capital board is satisfied that the product is proven and can start full-blown production and marketing in earnest.
The Second Stage At this stage the company is in full-blown production and the funding is to expand marketing reach of a business that does not generate enough revenue to take care of its growing needs.
The Third stage The capital provided at this stage is to enable the company to expand within the market through acquisitions and product development even the introduction of new products.
The Bridge/Pre-public stage The funding at this stage is to help the company prepare for an Initial Public Offering (IPO) within the following year. Alternatively, the entrepreneur can prepare to buy the Venture Capital’s shares in his/her company.
How to approach a Venture Capital Firm?
Here are some things to consider before approaching a venture capital firm:
- Make initial contact with the board through a mutual connection who can “put in a good word” for you or build your esteem in the eyes of the venture capital firm.
- Know your product A company would be very hesitant to invest in a company if the entrepreneur seems unsure of the intricacies of the project.
- Don’t make your presentation too complicated Your product may be sophisticated and technical, however, you need to present why your company deserves funding without confusing the board by allowing your presentation to be cumbered with technical terms and overly sophisticated language. A sharp ppt presentation is highly recommended.
- Don’t beat around the bush Get to the point of the presentation your company’s unique value proposition (the unique contribution of your product or service to the market that is different from your competitors) as quickly as possible. The last thing you want is lose the attention of the venture capitalist by making your presentation too long and full of unnecessary information.
- Be honest about the risks involved in your projects. Downplaying the risks may sound like a good way to convince the investors; however, it can easily backfire once the venture capital firm does its own feasibility study of the company.
- Be clear about market segments and targets and your objectives for market share and growth.
- Do thorough research on the venture capital firm: the kinds of companies they support; the expertise of the persons on the board; the application process for gaining funding. This helps one be as prepared as possible and confident when approaching the board.