Most venture capital firms protect their investments from risk by investing jointly with other firms.
They prefer to have two or three groups involved in most stages of business funding. Such relationships provide portfolio diversification by investing in more deals, per each invested fund.
Investment diversification also minimizes the workload of the venture capital partners by getting other firms involved in assessment of the risks in the business.
You need to know which investors to reach out to by doing due diligence, and research.
Gather information on the investor's target investment, and ask yourself whether you need to raise equity or convertible debt in your business without wasting time on known dead-ends.
Always look for the best funding for your company's stage of growth. Look out for expertise and a proven team of investors that have the experience in your chosen business industry.
Is venture capital financing right for your business?
If your business is a startup or early-stage, what would most interest a venture capital is;
Is the business in the right industry?
Most venture capital firms tend to focus their investments on competitive industries where they have a strong understanding.
It would be hard to try and convince a venture capital firm to invest in a business in an industry they have little to no experience in.
It is important that you do your research about a particular investor you are interested in approaching for funding.
Know whether you suit their investment needs and area of expertise. For instance, a business in the construction sector cannot be suitable for a venture capital who mostly invest in the healthcare sector.
Does your business have long-term high growth or show proof of high growth potential?
Venture capital firms tend to favor high growth business opportunities due to the nature of their business model.
They always exit the company after a period of time, usually from four to six years after the initial investment, by initiating a merger, acquisition or initial public offering (IPO).
It is important for you to indicate high growth potential for your business, if you are interested in attracting investments from venture capital firms.
Are you ready to give out equity in your business?
Investment in exchange for equity stake is what interests venture capital investors most.
If you need an investment and are ready to offer an equity stake in your business, the offer may prove attractive to such investors.
You need to make sure that you are not disadvantaged by terms of any deal you sign. Due diligence is a necessary undertaking you need to exercise.
How venture capital financing works
Venture capital funding comes from institutional investors and high net worth individuals, pooled together by dedicated investment firms.
The funds are used to finance a new, growing, or troubled business, in exchange for an equity stake in the business rather than given out as a loan.
The venture capitalists take into account the risks involved with regards to the company's future profits and cash flow.
Most venture capital deals involves creation and selling of equity stakes of a business to a few interested equity investors, through independent limited partnerships established by the venture capital firms.
Some of the partnerships consists of a group of enterprises with similar operations. Venture capital tends to focus on new emerging companies looking for substantial investments financing for the first time.
Venture capital financing is funding provided to businesses and entrepreneurs at different stages of their growth.
A large percentage of venture capital investment funds is used for building business growth infrastructure such as manufacturing, marketing, sales and provision of fixed assets and working capital.
Funding is not always long-term with the intent being to invest in a business's balance sheet and infrastructure until it grows in its market valuation.
The business will then be sold to a corporation or listed in institutional public-equity markets to provide liquidity for exit for the venture capital investors.
Venture capitalist buy a stake in an entrepreneur’s idea or business, nurtures it, and then exits after a short period of time with the help of an investment banker.
An aspiring entrepreneur with an idea or a new technology but with few or no hard assets against which to secure debt, often has no other financial lending institution to turn to for funding.
Venture capital investment funding comes in handy. It is the most suitable financing option for companies and businesses with large up-front capital requirements, but with no cheaper financing alternatives available in the market.
How to apply for venture capital funding
Venture capital firms invest large amounts of funds in a few businesses after undertaking a detailed background research.
Before approaching a venture capital for funding, you need to;
Prepare and submit a business plan; This should include an executive summary of your business proposal, description of the opportunity, market size and potential, a review on the existing and expected competition, detailed financial projections and details of the company's management.
Information review, analysis and one-on -one meeting; When the venture capital has undertaken detailed analysis of your business plan and they find your project meeting their preferences, you will be invited for a one-to-one meeting to discuss the proposal in detail.
The outcome of the meeting will determine whether or not the process will move forward to the due diligence stage.
Due diligence process; After the meeting, your business proposal will be moved to the due diligence phase which involves solving of questions relating to customer references, your product and business strategy evaluations, and management interviews.
Agreement signing and funding; If the due diligence process is successful, you will be offered a term sheet which is a non-binding document outlining the basic terms and conditions of the investment you are agreeing to.
The term sheet is negotiable and must be agreed upon by all parties involved in the funding process.
Funds will be made available to your business upon completion of legal documents and due diligence.
Types of venture capital financing
Venture capital funding is for early stage, expansion, and business acquisition or buyout. The financing process is often completed after six financing stages corresponding to the duration of the business growth.
This is a low level funding for testing and improving on a new idea.
This is given to new businesses seeking funds for marketing and product development expenses.
This is provided for manufacturing processes and early sales.
This is for operational costs allocated for early stage businesses selling products, but with no profit.
This is funds for expansion of a new high growth company.
This is the final stage of financing mainly for initiating a buyout or initial public offering (IPO) process.
Advantages of venture capital financing
- Business benefits: They bring a lot of expertise and wealth to the business.
- More funds available: They offer a high amount of equity financing.
- Flexible or no repayments: Your business does not have to repay the invested funds.
- Valuable market information: They provide valuable market information, resources, and technical assistance in addition to capital, to make a business a success.
Disadvantages of venture capital financing
- Loss of business autonomy: You stand to lose the autonomy and control of your business as the investors become part owners.
- Lengthy process: The negotiation process is often long and complicated.
- Complex funding terms: The funding is uncertain in form.
- No short-term benefits: Only long term benefits can be realized from such type of financing.
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