Venture Capital Financing
What is it and the pros and cons
What is venture capital financing?
Venture capital (often abbreviated as VC) is a form of private equity financing that is provided by venture capital firms or funds to startups, early-stage, and emerging companies that have been deemed to have high growth potential or which have demonstrated high growth (in terms of number of employees, annual revenue, scale of operations, etc). Venture capital firms or funds invest in these early-stage companies in exchange for equity, or an ownership stake. Venture capitalists take on the risk of financing risky start-ups in the hopes that some of the firms they support will become successful.
What are the disadvantages?
- VCs often have short investment time horizon and often look to recover their investment in 35-year time horizon.
- Founder ownership stake is reduced: When raising a funding round, youll need to dilute your equity to issue new shares to your investors. Many companies outgrow their initial funding and have to raise additional rounds from venture capital firms. This process results in founders gradually losing percentages of equity in their company, along with reduced control and decision-making power. Founders can mitigate this risk by only raising the amount thats necessary.
- Extensive due diligence is required is this can be a time consuming and costly process and distract founders from the day to day running of the business
- Business is expected to grow rapidly: To get a return on their investment, venture capital firms need your start-up to appreciate in value on its way to being either acquired or publicly traded on the stock market. Knowing that the business needs to get there can often increase the already high pressure that founders experience.
What are the advantages?
- The ability to raise large amounts of capital that would be otherwise difficult to obtain.
- Risk management support: Obtaining venture capital can help start-up founders manage the risk inherent in most start-ups. By having an experienced team oversee growth and operations, start-ups are more likely to avoid major issues.
- No monthly payments required: When a venture capital firm invests in your business, itll do so for equity in the company. This means that, unlike small business and personal loans, there are no regular payments for your business to make. This frees up working capital for your business, allowing you to reinvest by improving products, hiring a larger team, or further expanding operations.
- Experienced leadership and advice are available: Many successful start-up founders become partners at venture capital firms after they exit their businesses. These individuals often have experience scaling a company, solving day-to-day and longer-term problems, and monitoring financial performance.
- Networking opportunities: Partners at a venture capital firm may spend up to 50% of their time building their network to assist the companies they invest in. Having access to this network can help you forge new partnerships, build out your clients, hire key employees, and raise future rounds of funding.
- Increased publicity and exposure: Most venture capital firms have a public relations team and media contacts, and its in their best interest to get exposure for your start-up. Working with a venture capital firm can add credibility to a start-up, especially for founders that havent built other successful companies. The increased publicity can lead to getting noticed by potential employees, customers, partners, and other venture capital firms interested in raising funding.