What Is Venture Capital? (With Steps And Benefits)
Updated 30 September 2022
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In the global economy, venture capital fuels entrepreneurship and boosts emerging companies. Usually, venture capitalists invest in high-growth start-up businesses or founders. Their valuation of the company is based on its unproven technologies or products without full commercialisation or generation of revenue. In this article, we discuss what venture capital is, understand the process of obtaining venture capital financing, look at some of the ways to do so and find out some benefits of venture capital.
What is venture capital?
Understanding "What is venture capital?" can help emerging businesses and entrepreneurs find the right funding in the early stages. Companies called venture capital firms (VCs) manage money from various sources and invest it into startups. VC firms typically own a minority stake in companies, usually less than 50%.
Investors pool their money to form venture capital funds and lend it to startups and emerging companies they believe can grow over the long run. Investing in venture capital usually involves high risk and potential rewards.
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Process of venture capital financing
Here are the steps involved in venture capital financing:
The origination of a deal is the first step in venture capital financing. Deal flow is crucial to venture capital. When approaching a venture capital firm, it is necessary to submit a business plan, which includes elements such as:
executive summaries of business proposals
analysis of the competitive landscape and opportunities and the market potential
detailed financial projections
description of the company's management
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Venture capitalists screen all potential projects before investing. They classify projects based on several factors, including the size of the investment, the technology involved, the location, the investment size and the stage of financing. Entrepreneurs who wish to participate in the screening process can provide a brief outline of their venture or be a part of an in-person meeting for clarifications.
An evaluation of the proposal follows a preliminary screening. The assessment considers factors such as the project profile, market potential, technological feasibility and profitability. In addition to the entrepreneur's skills, manufacturing, marketing and technical knowledge are also part of the evaluation. Risk management entails considering these factors followed by deal negotiation.
Having found the project to be beneficial, the venture capitalist negotiates the deal. Deal negotiations are the process of creating a deal that is mutually beneficial for VCs and founders. Ideally, both parties reach an agreement on their demands. Venture capitalists and entrepreneurs negotiate a number of factors, including how much investment they would make, the percentage of profits they share and their rights.
Post investment activity
The venture capitalist becomes a partner and collaborator of the enterprise once it receives the funding. Venture capital firms typically participate in the enterprise through representation on the board of directors or improving the quality of marketing, finance or other managerial functions. Risky financial situations usually call for the involvement of capitalists.
When a business or investment venture achieves its profit objectives, an exit strategy may also be implemented. Exit planning for venture capital investments is based on the extent of investment and the financial stake. Exit plans aim to minimise losses and maximise profits. The venture capitalist may exit through an initial public offering, an acquisition by another firm or by selling their shares to the promoter.
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How to obtain venture capital funding
It is best to familiarise yourself with the process of obtaining VC before starting. Here are some of the ways entrepreneurs can obtain venture capital funding:
Understand the early stage venture capital
An idea for a product or service constitutes the seed stage of a company. It is essential for entrepreneurs to convince venture capitalists, who are some of the potential investors in the seed funding stage, that their ideas are worth investing in. In the event that the business has a lot of growth potential, an investor may provide funding for the development of early products or services, market research and the creation of a business plan.
Assess your company's readiness for VC financing
Companies at different stages of development approach VCs at different times for investment. Although a business can attract VC partners with just an idea, the majority of transactions are closed once it has three tangible items like a minimum viable product (MVP), customers and a solid founding team. Often, venture capital companies aim for businesses with a high startup cost and a rapid growth potential. The most likely business concepts for venture capital investors are disruptive ones, such as healthcare and technology along with companies with strong management.
Build a pitch deck
It is possible to establish a productive founder-investor relationship with the help of a good pitch deck. Pitch decks present the business in an illustrative manner. With the deck, you can describe your product or service, business plan, market opportunity, financing needs and management team. Starting a VC pitch deck involves:
Address the problem you are solving: Here is your chance to explain why your solution is necessary. It is important to define what your product does and how it works, along with the answer to the question of "why?" in light of end-user benefits.
Provide a viable solution to the problem: Describe your solution, why it benefits customers and how it works. Support your projections by using industry standards, benchmarks and the success of comparable products.
Talk about your product or offering: Explain how you envision the working of the product or offering in the form of a mockup if it is still under construction. If your product is currently in development, demonstrate how it is performing so far, along with the user engagement and market traction. Usage metrics, growth statistics and other relevant metrics may be useful.
Demonstrate that you have a team: It is important to demonstrate to investors that your company recruits the right team and win customers. You can also highlight and consider your team's performance.
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Find the right venture capital companies
Venture capital firms specialise in funding certain types of companies. List the VCs who are likely to be interested in your deal, both in terms of industry and product. Also, look for firms that have invested in similar industries to yours in the past and have funded companies in the same niche.
Become familiar with the VC term sheet
Term sheets are blueprints for venture capital investments. Term sheets are non-binding agreements detailing preliminary terms of venture capital funding. Other than its formal elements, a term sheet is essentially a contract insofar as it requires confidentiality during negotiations. Some of the terminologies in a term sheet includes pre-money valuation, anti-dilution provisions, pay-to-play provisions, dividends and voting rights.
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Finish due diligence and complete the deal
As a term used in venture capital (VC), due diligence describes how an investor evaluates an investment opportunity. It is a rigorous process used by venture capital funds and other investors to decide whether to invest in a company, identify key risks and develop a risk mitigation plan.
During the process, a series of questions are asked and answered to assess the opportunity's business and legal aspects. Upon completion of the internal approval process, the investor would approve the final investment. The due diligence process includes three steps such as screening due diligence, business due diligence and legal due diligence. Finding alignment across your internal teams, the VC firm and your legal advisors is a key element of raising VC funding and closing the deal after due diligence.
Benefits of venture capital
Here are the benefits of venture capital:
Business expertise: In addition to providing a new business with financing, venture capital offers valuable guidance and consultation. It can improve the management of financial and human resources by improving business decision-making. Growing your business can require you to make better decisions in these crucial areas.
Additional resources: Young companies can receive help from venture capital firms in a variety of areas, including taxation, accounting, and personnel. This is especially relevant during a critical growth period. Among the potential benefits are faster growth and greater success.
Connections: Many venture capitalists have good connections within the business community. They can be of major help to entrepreneurs. Connections can be in the form of catching the attention of potential employees, customers and partners.
Increase in exposure: A public relations team and media contacts are usually part of venture capital firms, which can help your startup get proper exposure. Venture capital firms can provide credibility to an upcoming startup, especially for founders who have never built a successful company before.
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