If you’re like a lot of new business owners, you are probably busy reading every bit of business advice you can get your hands on. You are also probably always on the lookout for funding. Many business magazines and online articles talk a lot about companies gaining funding through venture capital firms, but for those unfamiliar with these firms, figuring out whether or not it’s worthwhile to pursue this type of funding can be difficult. It can also be difficult to figure out exactly how you can get your foot in the door!
So what exactly are venture capital firms?
Venture capital firms are in the business of investing in young companies that have a lot of potential to become successful. They tend to focus on technology companies, but not exclusively – at the very least, they look at companies that use technology in a unique way or are leaders in a up-and-coming field. They’re not necessarily in the business of funding startups, unless the startup has an amazing business model, stellar leadership team, and a detailed plan for how the new company plans to grow over time. They tend to invest big – think amounts in the millions instead of the thousands. Because the list of requirements are very specific, venture capital firms aren’t for everyone, but if your new business checks all of the required boxes, then you may want to consider this source of funding.
There are a few tradeoffs when it comes to working with a venture capital (VC) firm, as well as benefits. Here’s how it usually works – because a VC firm generally invests in higher risk companies (companies that may only be a couple of years old, and may not qualify for other funding sources), the rates for using their money can be high. A lot of VC firms look for a 20-50% rate of return on their investment. In addition, they will likely want to do an equity buy in (i.e., they will want to purchase a percentage of your company). This can pose a problem for some business owners, because it does mean giving up some control of the company. It also means that many venture capital firms will want to be actively involved in your business, usually in terms of holding a position on the board of directors for you company.
What can venture capital firms offer my company?
These requirements listed above can be a turn-off to many business owners, but there are some positives to consider. For example, there are venture capital firms out there that are pretty hands off, leaving business operators to operate however they see fit. There are also firms out there that provide fantastic mentoring opportunities through the person or team participating as part of the board of directors, which means you will gather a lot of valuable information from their assistance. There are also firms that can give you a certain level of cache, adding credibility to your company.
Like anything you do for your business, however, you should be sure to do your research. Venture capital firms can vary, and some may not be everything they promise to be. Once you’ve gotten into negotiations with a firm, check some references – contact others who have worked with the group and ask about their experiences. If they don’t sound like the right fit for you, trust your gut and seek funding elsewhere.
How do venture capital firms make money?
Good question. It seems like these firms magically have an endless source of money, but that’s not the case. Most venture capital firms have a varied portfolio of funding sources, including (but not limited to) investments, endowments, and wealthy individuals. They also don’t enter into investments without a clear exit strategy. While they have the reputation of taking on high risk investments, VC firms don’t do this blindly – they weigh the past growth of a company, forecast what their future will likely look like, and plan for either a merger with another company, acquisition by a larger company, or Initial Public Offerings (IPOs). While they act as “long-term” investors, their timescale is still limited, with the average relationship lasting between 4-6 years.
This sounds right for me…how do I approach a company?
The very first thing you should do before you try your luck with VC firms is get your ducks in a row. You need an amazing business plan that is crystal clear on how your business has gone over the past year or two, and how you envision your plan moving forward. It has to have detailed information on cash flow, as well as information on how you plan on growing. Remember, VC firms are all about quick growth in order to recoup their investments, so you need to work out how you plan to fulfill the obligation. Be prepared to answer detailed questions about the inner workings of your company, your numbers, and your team.
You also need to be prepared to sell your idea, which may mean doing some research on technique if you’re not a natural born sales person. Remember, this pitch is not only about how great your company is and how amazing you will be in the future. It’s also about how investing in your company is good for the VC firm. Answer the question, “What can my company do to make your portfolio better?”
Once you have that information together, it’s time to start reaching out to your networking community. To get your foot in the door with a VC firm, you will likely need an introduction from someone familiar with the company, either someone who has worked with them, or someone who is on good terms with the firm’s leadership. Be prepared to shine once introduced – this is your moment to sell your vision to those who can offer you the money you need to grow!
The Bottom Line: Seeking funding from venture capital firms may not be the right option for every small company, but if you’re operating a tech company, a company utilizing tech in a unique fashion, or are a leader in an up-and-coming field, it might be something to consider. You will likely lose some control of your company, but the influx of money, along with potential benefits like mentoring resources, may make the exchange worthwhile. Just be sure to do your research before you commit.