Venture capital is a type of private equity funding that is offered by venture capital firms, usually banks, to early-stage, startup, and emerging businesses that have been deemed to possess high enough growth potential or that have proven high profit potential. Typically, venture capital funds are provided to companies which are expected to receive significant revenues within a relatively short period of time. The company becomes financially stable then receives shares of its stock for its equity. This type of funding is referred to as an “asset-based” funding program because the proceeds generated from the sale of the equity in the company often cover the cost of providing such financing. Venture capital firms typically do not provide equity in these companies unless they can demonstrate the company has the potential to generate significant revenue.
The venture capitalists that provide venture capital financing typically possess a wide range of investment capabilities. Most venture capitalists have a significant amount of experience in business operations and are capable of evaluating the relative merits of individual companies. Venture capitalists may be retained by a startup as an advisory board, or they may act as sole stock holders of the company. These entrepreneurs typically serve as the sole provider of much of their day to day management and must meet a rigorous level of performance in order to retain their jobs. In contrast, angel investors typically provide personal investment capital to the startups in exchange for a percentage of the profits from the business.
As with any investment, there are several advantages and disadvantages to both methods. For startups seeking venture capital funds, one of the key benefits is that the startup does not have to pay any up front fees. In some instances, a startup might have to pay an advisor a portion of his or her salary, but this should only be an option if the startup is extremely sure that the venture capitalist will make a good investment. Additionally, in most instances, angel investors receive a written letter of agreement outlining their expectations from the startup and the details of how the money will be used.
As a result of the relatively limited costs associated with hiring venture capitalists, many startups seek venture capital funding from friends and family. However, this funding source presents its own set of challenges. Unlike angel investors, friends and family typically do not have a deep understanding of the company and are unlikely to be as invested in the success of the company as an outside investor would be. Additionally, even when the investor does have a detailed understanding of the company, he or she may not be in a position to effectively evaluate the merits of the business. This factor is particularly important for newer companies whose monetary and managerial resources are relatively limited. Many new startups need to raise money quickly in order to develop payroll and attract employees.
While many startups will eventually need to find venture capital funds in order to meet payroll, finding such funding can take longer than many funding rounds. Depending on the type of business and industry, it can take anywhere from four to twelve months to find appropriate investors. Additionally, it can take several months to secure a funding commitment from an acceptable investor. This additional time can create a delay in starting operations and building relationships with key employees and vendors.
Unfortunately, because most angel investors are experienced professionals, they usually have an interest in investing alongside companies with strong management teams. It is therefore common for startups to work with multiple venture capitalists. If your company is prepared for this process, it will help to explain to potential venture capitalists the type of business you are planning to operate and why such investors are needed. Of course, it is also important for startups to provide solid information regarding their management team, financial situation, and potential for expansion. While working with a third party will limit your personal influence and impact, it is often necessary to pitch your ideas to VCs during this initial stage.
