Venture Capital: Comprehensive Guide

Assuming that you have not been living on another planet for the last decade, chances are you will have heard the term “venture capital” by now. You may even know a fair amount about this popular funding option, but are perhaps not fully aware of how exactly to go about raising financing for your company from venture capital investors. If so, then read on…

With the information technology (IT) sector enjoying particularly explosive growth in recent years, the venture capital industry has frequently hit the headlines for providing the financial assistance to propel new business projects into global, all-conquering unicorns (firms with a valuation of at least $1 billion). Indeed, tech firms have dominated this space, with venture capital firms committing astronomical numbers towards supporting innovative new businesses in the likes of Silicon Valley and other tech hubs.

As such, if you have a new business idea, or your company is focused on developing a proprietary new product, leveraging new technologies or introducing a disruptive and profitable business model into an antiquated sector, venture capital funding may well be just what you need for your company to flourish.

What is Venture Capital?

A form of private equity, venture capital is typically provided to start-ups, early-stage companies or later-stage companies with strong growth potential over the long-term. A venture capital firm typically does this by pooling funds from accredited investors (known as “limited partners”) to acquire an equity interest – most commonly a minority stake – in your business, as well as possibly a share of your future profits.

You will continue to retain much of the control over business decisions, along with your existing management team. That said, venture capital firms provide more than just funds - they can also help with crucial guidance for your business, access to valuable resources and an extensive professional network to help expedite your expansion should you so require.

Dealing with start-ups every day, venture capital firms are on hand to provide a deep well of expertise as and when you need it. It thus makes sense to view venture capitalists as partners in your business that have a vested interest in ensuring that your venture ultimately succeeds.

The Main Stages of Venture Capital Investing

Whether you have a brand new start-up and are wanting to gain market traction with a small cash injection, or whether you own a late-stage company dominating your local market and are now pursuing global expansion, venture capital can help your private business with the capital to fund significant growth and development.

Venture capital firms commit varying amounts of funds depending on which stage of development your business currently lies:

Pre-Seed Stage – investment to help your venture at its earliest stage, pre-seed funding is small in amount – usually not more than $300,000 – and is issued to:

determine the viability of your idea
begin developing your concept
support advancing your minimum viable product (MVP, the very earliest blueprints of your product)

Pre-seed funding often comes from “micro venture capital” funds that specialize in this very early stage of financing, as well as from friends and family and angel investors.

Seed Stage – the first formal stage of equity funding, the seed stage can help if your company is still pre-revenue but you now have a scalable idea, a business plan, a product prototype and, ideally, perhaps even the first signs of customer traction.

At this stage, venture capital investors will provide you with the first significant amount of funding to improve your growth trajectory, in exchange for shares in your company. The seed funds, meanwhile, are commonly used to market and launch a product, expand the workforce and conduct further market research.

But with a lack of demonstrable evidence of success, the seed stage still represents a high risk to investors and as such, venture capital firms will invest limited sums of money (around the $0.5-$2.5 million range) compared to the later stages. They will also typically require a sizeable equity stake in your business, often between 10% and 20%.

Series A Stage – This stage is very much about proving to venture capital investors that your company has what it takes to scale up and sustain a profitable business on the long-term.

At this stage, your company will have already begun generating revenue, but is unlikely to be profitable yet. You should also now have a business plan for generating long-term growth, profit and possibly even scalable expansion into new markets.

In return, venture capital firms will typically commit much larger sums of money at this stage – around $5 million to upwards of $15 million – with a good chance that a handful of firms will lead the funding round, including a single lead investor that helps to draw in others.

Again, venture capitalists will acquire a minority stake in your company at this stage – around 15% to 30% - in return for the funding.

Series B Stage – having demonstrated consistent growth, and a successful product with a market edge that is gaining traction among customers, Series B funding is designed to further expand the presence of your business in pursuit of greater market share.

With robust growth and cold, hard earnings figures supporting your business at this stage, moreover, venture capital firms will be willing to commit large amounts of money to your business than in Series A – anywhere from $25 million to upwards of $50 million – to facilitate further growth, and again in exchange for a minority stake in your business (15% to 30%).

And while a Series B round will often involve many of the same venture capital firms that participated in your Series A round, it will also welcome an additional set of investors that focus more on later-stage companies.

Series C Stage – With your company now widely regarded as successful, and with an established position in your core market, Series C funding can help you develop new products, expand into overseas markets and initiate further scaling towards global success.

At this stage, you might even be mulling the acquisition of a less successful competitor within your sector. Series C funding is also commonly used to prepare for an Initial Public Offering (IPO), should you be thinking about taking your company public.

And with a longer track record of success behind you, late-stage venture capitalists and other institutional players will be keen to hop onboard in this round, such as hedge funds, private equity firms and investment banks.

Exit Stage – normally the final stage of venture capital investing, whereby venture capitalists will either sell their stake in your company to another company, or complete the sale via an IPO, when you offer shares to the public for the first time and raise a potentially substantial amount of capital to enable the investors to cash out their equity holdings.

How to Obtain Venture Capital Financing

From the outset of the fundraising process, it is worth being crystal clear that venture capital firms will only invest in companies that have a high growth potential and can thus deliver a targeted rate of return to investors. This applies regardless of the stage of investing (as above) that your company requires.

For investors, venture capital financing can be a risky strategy with few early-stage companies having the requisite track record behind them to ensure they can be successful. That said, sustained growth that can sizably improve your valuation will generate substantial rewards for both your company and the investors.

With that in mind, you should aim to demonstrate to prospective venture capital firms that the risk profile of your proposition is not excessively high, and that your company can deliver the projected returns investors are seeking.

That all begins with being as prepared as you can before you even approach the first venture capital firm.

Researching Meticulously and Preparing Well

No matter which stage of funding your company is currently seeking, preparing as thoroughly as you can is a non-negotiable prior to even thinking about approaching venture capitalists for finance.

As far as de-risking is concerned, it is worth assessing whether any part of your business can be improved for eventual presentation to potential investors. As an early-stage start-up, for example, that could mean having a prototype of your product ready to show investors rather than simply having a theoretical blueprint on paper.

If your start-up is in the tech sector, moreover, such a prototype (or, say, a beta release) can be hugely influential in convincing a venture capital firm that you can successfully leverage the latest technologies to bring a successful working product to market. And the more evidence that you have gained customer traction the better.

In terms of preparing well, it depends on which stage of funding you are seeking as to what you will need to do. Supposing you are going for Series A funding, it is worth:

verifying the venture capital firms that are most active in this early funding stage, as well as any specialist investors for your specific business sector
seeking advice from your professional network – the opportunity to consult with others that have undergone similar fundraising can be invaluable
preparing your pitch for potential investors, and understanding which exact metrics and information venture capital investors are seeking from comparable firms at this stage
adjusting your expectations accordingly such that if you are approved for a Series A round, you will know the likely ballpark figures and terms of the financing you will receive
being willing to give up shares – most likely a minority stake – and a percentage of profits in your company
demonstrating that you have a sound operating history thus far, with internal processes in place
ensuring you have a skilled team in place that can competently cover all potential bases
determining how your business operation will be scaled up

2. Pitching to Investors

When pitching to venture capital firms, a common format is to catch their eye initially via an investor pitch deck – that is, a presentation that clearly communicates what your company does, what problem it solves, and what your solution entails, thus helping potential investors learn more about your business – before progressing with in-person meetings with venture capitalists and their limited partners.

Pitch Deck - An effective pitch deck will be concise – venture capitalists are busy people, and it is highly likely that yours will not be the only pitch deck they will read that day.

If you want to progress to having actual face-to-face meetings with potential venture capital investors, your pitch deck must clearly convey everything in about 10 slides that can be understood in just a few minutes or less.

As such, presenting this information in a clear, uncomplicated is essential for making a memorable impression on investors. Assuming again that you are seeking Series A funding, investors will want your pitch deck to answer the following questions:

What is your vision, your main product(s) and your value proposition?
What is the problem your business intends to solve?
How will your business solve this problem and how will customers use your product(s)?
What is your business model and how will you generate revenue and/or profitability, including proposed sales and marketing strategies?
Does your management team have the requisite skills and experience to deliver growth?
Do you have solid financial and credit histories to date, and do you have realistic forward estimates for the coming 3 years as a minimum?
Do you have a clear plan for how you will use investor funds?

Pitch Meetings - Should you nail the deck and impress the venture capital firm, you will progress to the next stage of meeting potential investors in person to pitch your proposal in more detail. This could easily take the form of two or more meetings – one being a 1-on-1 interaction, before you pitch to more potential partners.

In both cases, be prepared to expand on your pitch deck and demonstrate confidence that your vision will succeed. Remember, you are the business owner, so make sure you embody determination – someone that can go the distance and build a successful, profitable business in the long run.

Much of the meeting is likely to revolve around the following matters:

Your business case, your goals, and a clear plan for how you will use investor funds
A clear path towards profitability and realistic financial projections
A strong, passionate management team that’s motivated, able and willing to deliver the business’ goals
An ability to generate income and maintain a low debt-to equity ratio
A strong future outlook for your business through a sizeable addressable market, with identifiable potential risks being addressed and minimized

If you are not the best at public speaking, practice your pitch over and over until it becomes second nature, such that you can convey all the important concepts with ease.

And to reiterate, a successful pitch is often the difference between just having a good idea and securing the funding to transform that idea into a world-beating enterprise. So, do your best to convince investors that your business is well-run, well-managed and has enormous upside to capture in the future.

The Financing Process

After capably addressing all investor queries, the venture capital firm will decide whether to proceed with an investment in your company, in return for an equity stake. If so, you will then negotiate terms for your funding facility - again, researching the amount of financing you can typically expect to receive will be useful here.

Once you reach agreement, a legal, non-binding document called a “term sheet” is issued to confirm the terms of the deal. After the venture capital firm completes any further due diligence on your company and is ready to move forward, both parties will sign an investment agreement to confirm the funding issued by the investors in exchange for becoming shareholders in your business.

It is important to then continue furnishing your venture capital partners with regular information about the growth and performance of your company. With startups often taking several years to hit their growth projections, it becomes important to keep issuing frequent updates, as well as to absorb the advice and guidance from the venture capital firm. This will do much to solidify your relationship with your investment partners and build your credibility for potential funding engagements in the future.

And be aware that venture capital investors will want to realize their returns when later exiting from your business and selling their shares. You should thus prepare accordingly for this to occur smoothly when the time is right.