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If you’re looking for funding to help get your business off the ground or to help it expand, venture capital funding is one option worth exploring. It won’t be the right choice for every business, but if you think it could work for you, here’s what you need to know.
What is venture capital funding?
Venture capital funding is a type of financing that investors provide to startup companies and early-stage businesses that are believed to have long-term growth potential.
Venture capital (VC) can be thought of as a subset to private equity. Venture capitalist firms tend to invest in promising startups that need growth capital and business expertise to help take them to the next level. Private equity firms, on the other hand, tend to invest in established businesses that might want a cash injection or new strategy to move them forwards.
How do venture capital funding investors differ from traditional investors?
Venture capital investors tend to offer financing to startups and small businesses that are likely to generate high rates of growth and above-average returns. Venture capital funding tends to come from wealthy investors, investment banks and other financial institutions.
VC firms have considerably more to invest (typically more than $250,000) compared to other investors because they typically pool funds from other investment companies, large corporations and pensions. In return for their investment, they get a large stake in the company. This means they will have a say in how you run your business, including your company’s strategy, management and trajectory.
By contrast, angel investors (or business angels) are high net worth individuals who invest their own money and will typically only invest in startups and early stage businesses. Angel investors are usually experienced entrepreneurs who can also offer their own skills, expertise and contacts to help your business succeed. However, their level of involvement tends to depend on the wishes of the business and the angel’s own inclinations.
Angel investors will invest smaller amounts, typically between $50,000 and $500,000 and the return on investment will usually be smaller too.
Steps to getting venture capital funding:
Follow the steps below to help you find the right venture capital funding:
Identify your target investor
Venture capital funding won’t be right for all businesses. Generally, it’s likely to be more suited to you if your business shows good growth potential, has a strong brand and team in place and has secure sales channels.
If you’re in the very early stages of starting out, venture capital funding is unlikely to be the best option to explore. Instead, you could be better off seeking funds from friends and family, a startup loan, crowdfunding or business angels.
Survey the market
Before deciding on the group of investors you want to target, you need to carry out some research. Venture capital firms each have their own interests, whether that’s software, fintech or green technologies, so you want to find one whose interests match those of your business.
Each firm will also vary in terms of the amount it’s prepared to invest in a business, so it’s important to bear this in mind when looking for a suitable investor. After all, there’s no point approaching a company that usually invests several million pounds when you only need an investment of $500,000. As well as wasting your time, it can also make you look unprofessional.
To help you, make sure you have a clear idea of the investment sum you require and then make a list of venture capital firms that are prepared to carry out deals within this range, as well as those interested in businesses in your sector.
You’ll then need to research these companies in detail to find out how highly rated each one is and the type of business they have carried out in the past. You could even consider arranging a quick chat with senior people at some of these companies – if you find that you’re turned away, you might want to cross these companies off your list.
It’s also important to consider the location of your selected venture capital firms. It can be sensible to look for ones located near you and those that have invested in businesses in your area before.
Create a shortlist of investors
Once you’ve researched the market thoroughly, you should have a good idea of who you would like to invest in your business. You should also be armed with lots of useful information about the investment process and what to expect.
This should enable you to reduce your list to five or six candidates. Try not to have more than 10 as this can be difficult to manage, particularly if you end up getting a lot of interest.
Keep in mind that most venture capital firms will put a member of staff onto your board and will want to keep a close eye on how you are spending their money. Remember that you will need to have a close working relationship with them so choose carefully.
Approach your target investors
If you’re lucky enough to know someone at one of your target businesses, this should give you a foot in the door and enable you to set up a meeting more easily. If you can’t think of anyone off the top of your head, get on LinkedIn and see how each firm might be connected to people you know. If you find a connection, you might be able to get an introduction.
If you don’t have this advantage, it’s worth attending events that investors might be at so that you can get networking and introduce your business.
Another option is to send an email to each VC, but this won’t always be the most effective way to get the attention of potential investors. VCs get lots of emails every day, so you’ll need to do this the right way to ensure your email stands out.
Curate your pitch and brand message
If you’re approaching a lot of VC firms, it’s important not get them mixed up in your communications and make sure your templated information is concise, but provides enough detail.
It’s important to get straight to the point and grab their attention, rather than writing a long introduction. In your email, state who you are and what your business does, as well as how well it’s performing. Also mention something about your competent and hardworking team. Avoid including a lot of data at this point so as not to overwhelm them – if a VC is interested they will get back to you and ask for the figures they require.
You don’t need to negotiate at this point either, so don’t refer to how much of your business you are prepared to give away in return for their investment.
What you do need to do is ensure each email you send is different and focuses on why you were attracted to that particular VC firm. This shows you’ve actually considered the company carefully, rather than sending out the same email to multiple VCs at random.
Once you’ve sent your emails, you’ll need some patience as it can take a couple of weeks to get a reply. Avoid chasing them up until this time has passed.
Negotiate
Once you have found a potential VC to team up with, it’s time to negotiate. Term sheets are preliminary, non-binding agreements in which the major terms of a VC investment are agreed to before anything is officially signed.
The main sections of a term sheet include:
- A funding section which outlines the financial guidelines of the proposed investment, including how much the VC firm is offering to invest and how much equity it wants in return.
- A corporate governance section which defines the distribution of power among the co-founders, VCs and other stakeholders, specifically related to the company’s decision making.
- A liquidation and exit section which covers what happens regarding owners, investors and shareholders if the company is dissolved, liquidated or acquired. It defines who gets paid first and in what order investors and other stakeholders get paid if the company gets sold or is liquidated.
Because term sheets are non-binding, it’s important to negotiate any terms you’re not completely happy with once you’ve read through them. Never accept a deal you don’t feel 100% comfortable with – you can always walk away and see if you can find a better deal elsewhere.
How do I create a pitch for VC funders?
When preparing for VC funders, you’ll usually need to prepare a business plan, pitch deck and product demonstration. Your pitch deck should be tailored to the specific investors to which you’re presenting and it should cover the following:
- The problem that your product or service solves: You’ll need to explain the problem that exists and cover how your business aims to fill the gap in the market. Try to make the problem relatable to investors, and then explain how your product or service will solve this issue.
- Market size and opportunity: Show investors the market potential that your product or service has.
- An explanation of your product and how it’s performing: Explain how your product works and try to include testimonials from customers who have tried it out. Also, show a month-to-month breakdown of its performance.
- Your team members: Talk about the people on your team, their experience and what they bring to the company.
- Market competition: You’ll also need to cover who your competitors are and what sets you apart from them.
- Projected financials: Present three years’ financial projections if you can – try to be realistic but conservative.
- Funds required: Finally, you must explain how much funding you need and how you will use these funds. Try to express this as a range rather than a fixed amount as this is more likely to attract offers.
