With almost limitless opportunities that the advancement of technology is creating in the last two decades, many startups and small businesses today tend to look for capital that can lead their dream business to success. While there is a wide range of financial sources that they can tap into, most of these entrepreneurs are hesitant to borrow money from banks and financial lenders due to the risks involved. But the good thing is that they have found a good alternative and that is to raise venture capital from venture capitalists or VCs.

Definition

Venture capital is the amount of money that venture capitalists will invest in exchange for ownership of a business that includes an equity stake and exclusive rights to run the business. In other words, venture capital is the financing offered by venture capital companies to companies with high growth potential.

Venture capitalists are those investors who have the ability and interest in financing certain types of businesses. Venture capital firms, on the other hand, are registered financial institutions with experience in raising money from wealthy individuals, companies, and private investors – the venture capitalists. The venture capital firm, therefore, is the mediator between the venture capitalists and the capital seekers.

Requirements

Because venture capitalists are selective investors, venture capital is not for every company. Similar to submitting a bank loan or applying for a line of credit, you must show evidence that your business has high growth potential, particularly during the first three years of operation. Venture capitalists will ask for your business plan and discuss your financial projections. To qualify for the first round of funding (or seed round), you need to make sure you have that well-written business plan and that your management team is fully ready for that business launch.

process

Because venture capitalists are the most experienced entrepreneurs, they want to make sure they can get a better return on investment (ROI) as well as a fair share of the company’s equity. The mere fact that venture capitalism is a high-risk, high-return investment, smart investing has always been the standard model of trading. A formal negotiation between the fundraisers and the venture capital firm sets everything in the right order. It begins with the pre-money valuation of the company in search of capital. After this, the venture capital firm would decide how much venture capital they are going to put up. Both parties must also agree on the capital participation that each will receive. In most cases, venture capitalists get a percentage of equity that ranges from 10% to 50%.

Financing Strategies

The life cycle of the financing usually lasts from 3 to 7 years and could involve 3 to 4 rounds of financing. From startup and growth, to expansion and public listing, venture capitalists are there to help the company. Venture capitalists can reap the returns on their investments usually after 3 years and eventually realize higher returns when the company goes public in the 5th year onwards.

The chances of failure are always there. But the strategy of venture capital firms is to invest in 5 to 10 potential high-growth companies. Economists call this strategy of venture capitalists the “law of averages,” in which investors believe that large gains for a few can offset small losses for many.

Any company seeking capital must ensure that their business is bankable. In other words, before approaching a venture capital firm, they must be sufficiently sure that their business idea is innovative, disruptive and profitable. Like any other investor, venture capitalists want to reap the rewards of their investments in due time. They expect a ROI of 20% to 40% in a year. Aside from venture capital, venture capitalists also share their technical and managerial skills to shape the direction of the business. Over the years, the venture capital market has become the engine of growth for thousands of startups and small businesses around the world.