Understanding Venture Capital

So you have finally locked in on a great idea! You are visualizing the endless possibilities and how game changing your idea will be. The impact seems to overwhelm you as it comes all together during your brainstorm session. In the moment you begin to see yourself in that swinging chair, doing a bit of press conferences and interviews with journalists. Then somewhere in your daydream a thought sneaks in and echoes “but where will you get the money to finance such a great idea?” Reality sets in that you are going to need a bit of funding to launch this idea and bring it to the world. Luckily for you, the headache is over as we are going to look at a great source of funding: Venture Capital.

Venture capital is form of funding where a Venture Capital (VC) firm offers private equity financing in exchange for a stake/ shareholding in the company. For example, a VC may offer a startup company a sum of say, $200,000 dollars in return for 10% ownership of the company. The amount offered varies and depends mainly on the valuation of the startup which is often driven by factors such as demand of VC’s willing to back them up and how game changing or revolutionary their product is. That said,  it is important to be realistic in valuations and take adequate an amount of money. Don’t be greedy, being over-valued can result in startups failing to meet the expected investor targets in the form of a down round.

Funding startups is risky business therefore Venture Capital firms are very picky when it comes to where they inject their money. As an entrepreneur or startup now aware of this fact, you need to ensure that your house is in order so as to get buy in from VC investors. This entails developing a killer business plan, a comprehensive go to market strategy and a great product. It is also important to demonstrate that the team has excellent technical and management prowess to catapult the startup in a potential growth trajectory. With all due diligence done on your part, VC firms in return will offer you capital in the hope that your startup will become successful and they will realize a return on investment(ROI) from it. Return on Investment usually occurs when a company decides to go public and sells its shares for the first time in what is termed as an Initial Public Offering (IPO). VC firms can also generate return when the company they invested in gets acquired by a new owner or merges with another company.

In some instances, highly valued startups (also known as “Unicorns”) will receive additional support other than financial backing from VC firms. This is done to enable the startup to reach its greatest potential, increasing its chances of success and consequently high returns for the backing investor. This additional support comes in the form of assistance in business model formulation, marketing tactics and general strategic advice. VC firms have significant control over decision making within the company and most times require board seats to be awarded to them as part of the funding agreement. Board seats enable them to offer strategic advice that serves in the best interests of their investment and the company.

So if you are starting out with limited operating history to the extent that you cannot secure a bank loan by yourself or start a capital raising initiative in the public markets, going the venture capital route makes sense. You also need to understand that irrespective of the success or failure of your business, the VC firm has a legal right to repayment of the injected capital or interest on the loan offered. Hence it is important to ensure that you take your startup’s growth seriously and work hard to ensure a win-win situation for you and your investor.