Most business owners and entrepreneurs have probably heard the term Venture Capital, but perhaps never fully understood the core concepts behind it. In this post, we’ll give you a crash course on what Venture Capital (VC) is, and how you may be able to leverage it to fund your business.
What is Venture Capital?
In its most basic form, VC is funding given to a business, often a startup, in exchange for equity (an ownership interest) in the company. In this context, a startup would be defined as a newer company that is expanding and in need of funding to help promote its growth. What makes the VC system of business financing different from alternatives, like crowdfunding or a bank loan, is that it better facilitates continued cash flow and oftentimes provides the new business with advisory/mentorship support.
Why Do Businesses Seek Out Venture Capital?
Over the years, business owners began realizing that traditional bank loans and debt financing were not the most efficient or profitable way to fund their fledgling businesses. This is because, typically, loans and financing do not allow for reinvestment in the company. In fact, loans and financing often result in lost earning, even when used for expansion, due to interest. Additionally, a majority of startups are considered high risk by banks due to the high rate of failure in the first few years, so that interest is also often higher than necessary.
- Receives Venture Capital?: We often hear about companies like Amazon, who received VC investments when they were just startups working out of a basement. While many VC-funded businesses are small and young with a high probability of failure, there are numerous businesses that have grown to be quite successful and expansive that still seek extra capital through VC funding.
- Distributes Venture Capital?: Venture Capital funds consist of two primary partnerships, Limited Partners (LPs) and General Partners (GPs). LPs are generally institutional investors like insurance companies, university endowments, pension funds, etc. GPs are considered “active investors” who analyze business portfolios and make decisions on how to use the money furnished by the LPs.
How Does The Funding Process Work?
Venture Capital funding is typically distributed in installments known as venture rounds. These rounds are issued in progressive stages starting at Pre-seed to Seed to Series A-F. In between each round, the businesses are generally expected to show growth in their market share, revenue, and product offerings. Usually, the pre-seed round will consist of minimal funding in proportion to the valuation and risk inherent in the business. Pre-seed and see are often used for business development stages. As the business proves to be profitable and less risky, the VC group will provide a greater amount of money. For example, Pre-Seed might be $100,000 to Seed at $1million to Series A at $10 million and so on.
When Does A Venture Capital Firm Decide Which Companies To Invest In?
GPs work to develop a profitable investment portfolio for each fund that they manage. This usually requires extensive research, due diligence, and business type diversification. To build the right portfolio of companies, the firm compiles a large database of companies they want to evaluate and receive regular updates on. This is referred to as the company pipeline. These pipelines can range from a few hundred to several thousand businesses depending on the amount of the VC fund. Generally, however, due to limited fund capacity GPs are exceedingly selective with the companies they choose to invest in. In fact, the typical VC firm will invest in less than 1% of the companies in their pipeline.
Where Can My Business Find A Venture Capital Firm?
There are many options for finding VC Firms, here are some to consider:
- Venture Capital Associations. VC associations provide tools and resources to entrepreneurs and small businesses to assist with locating the right venture capitalist. The Small Business Association, The National Venture Capital Association and The Angel Capital Association are great places to start.
- Networking. Picking the brains for other business owners and successful entrepreneurs can be a good way to find trusted VC firms. Though, as mentioned above, funding sources are competitive, so some of your counterparts may not be as forthcoming as you’d hope.
- Internet Sources. Blogs, social media, and online databases are good sources of information.
- Hire a Professional. There are many venture capital consultants and corporate attorneys available to help you find the VC that is the right fit for your company.
Remember: Finding a VC is more than a cursory google search. You want to find one that is right for your business. This means doing research and asking for references to find out everything you can about your VC options. Also, before reaching out to a firm, it is important to evaluate your business honestly, to determine if your level of profitability and growth is prime for VC funding.
We hope this article has been a useful guide for understanding the basics of Venture Capital, who the players are, and how it can help your business. Capital Partner Law has the knowledge and breadth of resources to guide you through the complicated process of funding your business. Additionally, our experience in real estate, tax law, intellectual property and more, will allow us to help you assess your business’ target valuation and properly structure your funding. Contact us today for a free consultation.
To learn more or speak with a knowledgeable Florida Business Attorney, contact Capital Partners Law today:
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This article is provided by Capital Partners Law for informational purposes only. It is not intended as legal advice and does not form the basis for an attorney-client relationship. If you need legal advice, please contact Capital Partners Law or another licensed attorney.