If you have what you think is a sure-fire, money-making idea that needs a bit of support to get off the ground, then you may or may not have considered the possibility of seeking out venture capital. If you haven’t considered going that route, or you have and simply do not know where to start, here is what you need to know.
Why turn to venture capitalists?
Why turn to venture capital and not a conventional loan from a bank or credit union? According to the United States Small Business Administration (SBA), venture capital “is a type of equity financing that addresses the funding needs of entrepreneurial companies that for reasons of size, assets, and stage of development cannot seek capital from more traditional sources, such as public markets and banks.”
In plainer terms: banks and credit unions are not often interested in providing loans to start-ups, both because of the high risk involved and the lack of hard assets that can be leveraged against money being borrowed. Thus, venture capitalists exist to provide money for those dynamite ideas and business knowledge to help foster success. In most cases, they do so on the conditions of owning shares in your company and having a more direct line of input into how it operates.
As the Small Business Administration notes, the venture capital process commonly follows a five-point process. First, there is the submission of a business plan to a venture fund wherein discussions occur if the plan meets desired criteria.
Next, the fund will perform due diligence to ensure the viability of that in which it intends to invest — looking into everything from the management team and operating history to products and services to financial statements.
Should your plan pass the due diligence process, then the investment is made. Terms are typically determined based on what was uncovered during the fund’s research, with an eye for both benefitting the business and minimizing potential risk to the fund. After the investment, the venture fund becomes involved in the company. It is noted by the SBA that the investment and involvement stage can repeat in rounds based on milestones set out in the agreement, with more financing potentially becoming available as the company continues to thrive.
Finally, the venture fund will look to exit the company at an average of four to six years after initial investment. This is typically done through mergers, acquisitions and Initial Public Offerings.
What you can lose
The decision to involve venture capitalists is a tacit acceptance that you are willing to cede control in exchange for start-up capital. This can be problematic if your idea is one on which you are not willing to compromise, particularly in that the route of venture capital is one marked by conciliations.
According to Allan Kunigis, author of “Advantages vs. Disadvantages of Venture Capital” for The Hartford’s Business Owner’s Playbook®, the aggressiveness of venture capitalists may even mean having to give up majority ownership in your business, ultimately losing control of your idea and the direction it takes. As Kunigis points out, however, this is a disadvantage unless you are willing to accept a position more akin to that of partner in the hopes of getting your business off the ground.
Like with any form of borrowing, venture capital is not without risks. The SBA notes that investors will remain committed to a company only so long as they feel they can achieve an acceptable return on investment
What you can gain
Naturally, the biggest advantage of working with venture capitalists is the acquisition of much-needed money. The SBA considers venture capital to be “long-term or ‘patient capital’ that allows companies the time to mature into profitable organizations;” in this sense, venture capitalists are more flexible than financial institutions because it is to their benefit that your business is given every opportunity to excel.
The SBA also notes that venture capital is advantageous because your investors are looking to grow value. So long as you are comfortable with the idea of sharing leadership responsibilities — or, in some cases, entrusting others with those responsibilities — you can rest assured that your investors are working hard to improve the value of the business as much as possible. As Kunigis points out, this also entails providing support resources in areas like tax expertise and personnel, as well as utilizing business connections to help sustain and grow the business.
Venture capital is a useful avenue for actualizing your idea and turning your dream into reality. There are other viable alternatives, both traditional (loans, grants) and non-traditional (crowdfunding), that can also be effective at getting you and your business off the ground; the best choice is ultimately exploring all available possibilities and utilizing the means of acquiring capital best suited to your business aspirations.