Financing a startup is no easy feat, especially if you’re a new business owner. The right type of funding can help you get your feet off the ground in no time, but how do you know which is best for you?
If you’re a new business looking to grow, venture capital is a great option for obtaining the funds you need. Want to explore venture capital for your company? Here's how it works.
What is venture capital?
Venture capital is a type of financing that involves private investors providing funding to small businesses. These investors may include individual backers, investment banks and other financial institutions. While venture capital often takes a monetary form, it can also include technical or managerial expertise.
Funding from venture capital is a popular option for new businesses, who may not be able to access bank loans or other funding sources, to raise the necessary capital.
[Read more: How Three Venture-Backed Startups Balance Growth and Profitability]
Types of venture capital
There are several types of venture capital, which vary based on the stage of your business. Knowing which investment capital you’re seeking can help you pursue the proper channels. Here are four common types:
- Seed capital. In the earliest phases of your business—before you have a product or company —you might seek out seed capital. The amount investors will put forward, if any, is typically small at this stage. These funds can be used to conduct market research, cover setup fees or develop a sample product.
- Startup capital. Once your company has developed a sample product and has at least one manager working full-time, startup capital can help you take your venture to the marketplace. Funding can cover continuing market research, hiring additional management and finalizing your product or service.
- Early-stage capital. When your business is a few years in, with a management team and growing sales, you can seek out early-stage capital. Obtaining venture capital here can help you improve your company’s processes and bring your sales to a break-even point.
- Expansion capital. Seeking out expansion capital can help you boost your marketing campaigns and enter new markets. This type of funding is typically reserved for well-established companies looking to reach the next phase of growth.
...The less [money] you need to raise, the less you need to give to your venture capitalists down the line.
How does venture capital work?
Interested in raising venture capital funding? Here are the steps you’ll need to take.
- Evaluate how much your business is worth. Before approaching any investors, you’ll need to determine your company’s value. This number will be determined by its age, growth rate, revenue/cash flow, patents/intellectual property and the experience of its senior management. You’ll also want to do financial projections to establish a realistic return on investment.
- Figure out how much you need to raise. The amount of money you ask for is important for your company’s future—the less you need to raise, the less you need to give to your venture capitalists down the line. Consider carefully how much capital you can use immediately and effectively, the stage of your business and what you are willing to cede to your investors.
- Find a venture capital investor. Financial professionals, such as banks, CPAs and financial advisors, can offer referrals for venture capitalists. You can also attend private equity conferences or industry events to start networking.
- Prepare for your pitch, then present it to your potential investor. When preparing your pitch, make sure you can define your company’s business model and explain why it’s unique and worthy of investment. Keep your pitch concise but provide as much data as possible to get your investor on board with your vision.
[Read more: 4 Signs Your Business Is Ready for Venture Capital]
If your pitch is successful, you will land a venture capital deal. In any such agreement, investors will seek to protect their investment if something goes wrong, while also maximizing their gain if the venture is successful.
In practice, this means a venture capitalist will invest a certain amount of funding in exchange for an ownership percentage. They will also include “downside protection” in the provisions to protect the investment in the worst-case scenario. Review the terms of your venture capital deal carefully before signing.
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