Start-ups have the power to disrupt traditional industries and drive innovation. But to do that, ambitious founders need funding and guidance to create the company that they’re envisioning.
Enter: Venture capital.
Venture Capital (VC) is an alternative to bootstrapped funding for startups. Venture capitalists invest in startups with hopes of a significant financial reward when that startup grows. New companies will often exchange a percentage of ownership for financial, technological, and business advice.
How does venture capital work? How can you know if a business is right for it?
How Venture Capital Works
Venture capital is money invested by a private entity or firm to support a growing business with a high potential for success. Venture capital firms are investing in the ideas of the startup founder(s) to parlay their ingenuity into a viable business. Most often, VC has a price tag of a percentage of equity in the startup. Although it’s certainly not easy to secure venture capital, it’s a great way to get their concepts to market. Venture capital isn’t for every business as it comes with risks and rewards.
Pros and Cons of Venture Capital for Startups
Turning to venture capital can be a lifesaver for many businesses, but it does have its drawbacks. Below is a brief overview of the pros and cons of venture capital:
Advantages:
1. You don’t have to pay back the money. Perhaps the biggest (or at least the most attractive) advantage of using venture capital to float your business is that in the event a startup goes under, you don’t have to pay the money back. Unlike bank loans, the money you receive as venture capital is a risk on the part of the investor, not the entity receiving the loan. So, if the startup fails– as many do– the investors won’t get any funds back.
2. Venture capitalists bring a lot to the table. When partnering with venture capitalists, you get expert advice with powerful connections. Venture capitalists bring years of real-life experience and can help guide you in the big decisions of launching a new business. From recommending top talent to hire to choosing a tagline that will set your company apart, the advice from a VC is priceless. Even better, these influential folks also want you to succeed because if you succeed, they succeed too.
3. The VC’s networking game is strong. In addition to the money and guidance you get from working with a seasoned venture capitalist, you also get exposed to a new world of social networking. Your VC will likely have a few business dinners you can sit on to absorb the knowledge offered between sips of mezcal.
Potential Disadvantages
1. You’ll lose equity. When working with a VC, they typically take a substantial piece of your business, reducing ownership stake. Many startups will burn through their initial funding and need more money. Unfortunately, the new funding rounds come with giving up more stake.
2. Your eyes can wander off your prize. When a new business is in the weeds and needs funding yesterday, it can significantly distract founders from growing their business ventures. Most companies seeking VC would rather spend their time and energy perfecting their ideas, crowdsourcing innovation, or interacting with potential new customers. Instead, they’re forced to scour Silicon Valley and other VC hotspots for investors.
3. Your business can go under– fast. Working with venture capital investors often comes with an agreement that you will use the funds according to how the investor sees fit. When founders choose not to heed that advice or spend the money too quickly without moving the needle of sales or progress, those businesses are often let go. Founders can avoid this – at least to an extent– by open communication with investors and collaborating on goals.
Clarity on the advantages and disadvantages of venture capital is critical to determining whether it’s a good fit for your business. Questions to ask when you’re considering pursuing VC can include: How fast do I think I can grow my business once given funding? Am I comfortable giving up a large percentage of my company?
Alternatives to Traditional Venture Capital
If venture capital doesn’t feel like the right funding option for your startup, other successful means of funding exist. Some popular alternatives to traditional VC include angel investors, corporate venturing, incubators and accelerators, and crowdfunding.
Angel investors are wealthy individuals who fund startups in exchange for equity. These investors are different from venture capitalists because they use their wealth and not an investment fund. Angel investors are often more likely to invest in new founders who do not have a proven track record or previous success than venture capital firms.
Incubators and accelerators are additional alternatives to venture capital that provide short-term help sponsored by private companies, universities, or municipal entities. Incubators can be considered mentorship programs for businesses in the concept stage with a longer timeline (or, in some cases, no timeline) for success. Accelerators are generally short-term, with a highly-structured curriculum for businesses that are further along in their journey with prototypes or proof of concept.
Corporate venture capital is the investment made by an organization to fund an external startup via an equity stake. CVC is often considered a business world quid pro quo. The organization can give founders advice and mentorship within their industry they may otherwise not receive, while the startups give the organization insights into new technology and growth opportunities.
Crowdfunding has gained significant popularity over the past several years as a non-traditional means of funding startups. Crowdfunding is asking large groups of people online through platforms like Kickstarter to support your business in exchange for a small reward.
Want to get innovation insights from a large group of people outside of your organization? Learn how to run a successful crowdsourcing challenge with HeroX.
Finding and Pitching to Venture Capitalists
Finding the right venture capitalist can be an arduous and long-term undertaking. The first step is ensuring you have a well-researched, professional pitch deck. Your deck should be clean, concise, and informative, with the goal being that the investor can know exactly what your startup is and what you need from them. Make sure it’s engaging; after all, these investors see pitch decks all day long.
Next, start researching venture capital firms in your startup's industry and contact them by sending your pitch deck via email or submission form. Once the VC decides to invest, they will dig deep into your business financials and may request to speak to customers. This phase is called due diligence and requires financial paperwork and proof of concept completed by the founders.
Conclusion
Venture capital can provide much-needed larger-scale funding and support to fledgling businesses looking to make an impact. Even though it has many benefits, venture capital is not for every business. Alternative fundraising methods like crowdsourcing are easily accessible to any startup and can be done quickly and effectively.
Have you explored crowdsourcing as a way to solve your business challenges? Tap into the crowd for new ideas while reaching new audiences and building your brand. Ask us how!
BUTTON
