You may have considered a range of funding options to help grow your start-up, one of them being venture capital. But what exactly is venture capital, how do you access it, what are the pros and cons of going down this particular route, and is it even suitable for your type of business?
Simply put, venture capital is a type of funding that is provided by investors to small businesses which they believe have the potential to grow and be successful. Sources for this type of capital often comes from one or more wealthy individuals – known as venture capitalists, or angel investors – but also from investment banks and other financial institutions.
Venture capitalists actively look for new investment opportunities and in addition to funding, may also offer managerial and technical support to start-ups. As a start-up, you can apply for venture capital in much the same way you would approach your bank or other lender for a loan. You explain why you need funding, specify the amount you want, and present a well-prepared business plan to support your application.
What do venture capitalists get out of it?
The main difference in seeking funding from a venture capitalist compared to a bank, for instance, is that you will be expected to give up some equity in your business in return for any investment. A bank charges you interest on the money they lend you, whereas the venture capitalist typically gets a share of your company and a say in how the business is run going forward.
How much say they have, the level of equity they hold, the duration of the deal etc., are all issues to be settled between the parties, but it’s important to be clear what is involved before agreeing to go ahead. You may decide that ceding some control of the business isn’t for you; on the other hand, you may welcome the expertise, fresh impetus and funding a venture capitalist can provide.
What else do you need to know?
A typical agreement will involve equity being transferred to the venture capital firm who then have a stake in the company. Depending on the level of investment this could be 10-20% of the business, rising to a controlling percentage of more than 50%. Venture capital tends to be focused on start-ups and/or emerging businesses that are looking for a significant capital investment.
Is venture capital your best option?
If you’re a small business with a limited operating history, you may find it hard to get funding from traditional capital markets such as banks, or the bank may not be willing to lend you the amount of money you need because of the perceived risk.
Angel investors are often wealthy individuals who recognise and encourage the entrepreneurial spirit and will invest in a start-up if they are convinced by the business plan and see the potential for a good return on their investment. Some venture capital specialise in funding particular types of start-ups, such as in healthcare, renewables, biotechnology and software, and invest in services or products they understand.
Some pros and cons
Before deciding whether or not venture capital is the method of funding that suits your business, consider the following pros and cons:
- Venture capitalists tend to have deep pockets and the means to invest in your business, including providing additional funding if necessary.
- Because they have invested money in the business, they are interested in making the project a success and will be an active partner.
- They may have the kind of expertise and experience that can be invaluable to any new business.
- They can leverage business contacts on your behalf and provide access to potential customers or markets.
- They may provide technical support, tax advice, legal advice, and give you access to other resources.
- You lose some control of your business. This may limit your decision-making powers and restrict your ability to take the company in a particular direction, including taking occasional risks.
- You have to accept that any profits will be shared.
- If you cede controlling interest in your company you may end up feeling you’re no longer your own boss – a dream that drove you to start up on your own in the first place.
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