With almost limitless opportunities that the advancement of technology has created in the last two decades, many startups and small businesses today tend to seek capital that can make their dream business a success. While there is a wide range of financial sources that they can tap into, most of these entrepreneurs are hesitant to borrow money from banks and financial lenders due to the risks involved. But the good thing is that they have found a good alternative and that is to raise venture capital from venture capitalists or VCs.
Definition
Venture capital is the amount of money that venture capitalists will invest in exchange for ownership of a business that includes an equity stake and exclusive rights to run the business. In other words, venture capital is the financing offered by venture capital firms to companies with high growth potential.
Venture capitalists are those investors who have the ability and interest to finance a certain type of business. Venture capital firms, on the other hand, are registered financial institutions with expertise in raising money from wealthy individuals, companies, and private investors: venture capitalists. The venture capital firm, therefore, is the mediator between the venture capitalists and the capital seekers.
Requirements
Because venture capitalists are selective investors, venture capital is not for every company. Similar to applying for a bank loan or line of credit, you must show proof that your business has high growth potential, particularly during the first three years of operation. Venture capitalists will ask for your business plan and discuss your financial projections. To qualify for the first round of funding (or seed round), you need to make sure you have that well written business plan and that your management team is completely ready for that business pitch.
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 capital. The mere fact that venture capitalism is a high-risk, high-return investment, smart investing has always been the standard model of trading. A formal negotiation between the fundraisers and the venture capital firm puts everything in the right order. It begins with the pre-money valuation of the company in search of capital. After this, the VC firm would decide how much VC they are going to put up. Both parties must also agree on the equity that each will receive. In most cases, venture capitalists raise an equity percentage that ranges from 10% to 50%.
financing strategies
The funding life cycle is typically 3-7 years and could involve 3-4 rounds of funding. From startup and growth, to expansion and going public, venture capitalists are there to help the company. Venture capitalists can reap the returns on their investments typically after 3 years, and eventually earn higher returns when the company goes public in the fifth year or so.
The chances of failing are always there. But the strategy of venture capital firms is to invest in 5 to 10 potential high-growth companies. Economists call this strategy of venture capitalists the “law of averages,” in which investors believe that big gains for a few can offset small losses for many.
Any company seeking capital must ensure that its business is bankable. That is, before approaching a venture capital firm, they must be sufficiently sure 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 an ROI of 20-40% in a year. Aside from venture capital, venture capitalists also share their managerial and technical skills to shape the direction of the business. Over the years, the venture capital market has become the growth engine for thousands of startups and small businesses around the world.
