Venture capital (VC) is a type of private equity in which Venture capitalists (both individuals and firms) provide money to ventures with high-growth potential in exchange for equity in the company.
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What Is Venture Capital?
Venture capital (VC) is a type of private equity in which venture capitalists (both individuals as well as firms) provide seed, startup, and early-stage capital to ventures with high-growth potential. In exchange, the venture capitalist or venture capital firm received equity in the company and, most often, some level of decision making and control, such as a seat on the company’s board.
Venture capital is another way to raise startup capital that can be leveraged toward the business. Although startups seeking venture capital also need to give up ownership/equity (and even more decision making and control) in their company, venture capitalists are able to provide large amounts of funding and often provide valuable guidance, advice, and network connections.
How Does Venture Capital Investing Work?
Although each venture capital firm operates differently, most VC deals progress fairly similarly. For a company seeking venture capital, here is how the venture capital process might look:
- Do Your Research - Venture capitalists typically invest in very narrow categories of companies often focused around specific industry sectors, regions, and/or stages of the company lifecycle. You will need to do your research to find venture capitalists for whom your company is a fit.
- Get on the Radar - The second step in securing venture capital is getting on venture capitalists’ radar. Venture capitalists get flooded with investment opportunities, and many will not even open unsolicited emails or read unsolicited business plans. Some may allow open submissions through their websites. However, in most cases, this means that you must connect with the right people and to the right networks to get a meeting with a venture capitalist.
- Submit a Business Plan - Prior to getting a meeting with a VC, you will need to prepare and submit a business plan. Business plans for a VC should include an executive summary, the market size, the competitive position of the company, information on the ownership and management, and financials and financial projections.
- First Meeting - If the venture capitalists are interested in the investment opportunity, you will be called upon for a meeting and an opportunity to pitch your venture.
- Due Diligence - Venture capitalists will then do their due diligence — conduct deeper research and confirm what you are telling them is true. They may evaluate your business strategy, confirm your financial position with creditors and debtors, and verify the information that you have provided and pitched.
- Negotiate the Terms of the Deal - If, at this point, the venture capitalist is still interested in investing, you must now negotiate the terms of the deal. These include the economic terms, ownership and control, governance and management, as well as liquidity and exit.
- Finalize the Documents - Next, a term sheet and legal documents will need to be prepared and finalized, with both parties agreeing to the concluding language and terms of the deal.
- Close the Deal- Finally, you will need to establish a closing process. The closing process includes signing the legal documents and the transfer of funds.
What Do Venture Capitalists Invest In?
Venture capitalists invest in high growth opportunities. The majority of these high growth opportunities are concentrated in:
- Software & Applications
- Pharmaceuticals & Biotech
- Healthcare Services & Systems
- Healthcare Devices & Supplies
- Commercial Services
- Consumer Goods & Recreation
- IT Hardware ($2.28 billion, 1.8%)
When to Seek Venture Capital
Venture capitalists invest in companies across the lifespan of their ventures, with a fairly even number of deals going to seed and startup, early-stage, and later-stage companies. However, the deals with seed and startup stage companies (6% of total VC investments) are not nearly as striking as the $100 million+ deals with later-stage companies who receive the largest share of VC dollars (63% of VC dollars).
Pros and Cons of Venture Capital
There are several pros and cons of venture capital investments.
Some advantages can include:
- Ability to raise capital to leverage for the company.
- No monthly expenses for repayment.
- Ability to raise large amounts of capital.
- Venture capitalists are often experts that can provide valuable advice, guidance, and network connections.
Some disadvantages include:
- You give up ownership and equity in the company.
- You give up some decision-making and control.
- Venture capitalists expect a high rate of return to compensate for their risk.
- An inability to meet goals and projections may lead to the loss of control of your company.
Venture Capital vs. Angel Investments
There are several key differences between venture capital investments and angel investments, including the stage at which each type of investment is appropriate, the sectors in which each is more likely to invest, the amount of investment sought, and the role of the investor(s) in your company.
|Venture Capital||Angel Investments|
|Pharmaceuticals & Biotech
|Investment Size||$25 million to $100 million+||$25,000 to $350,000+|
|Value, Guidance, Network
May require a seat on board or role in decision making
|Value, Guidance, Network
Often little control outside of equity
Venture Capital Frequently Asked Questions
Do you have to pay back venture capital?
No. Venture capitalists receive equity in your venture. They get “paid back” when the company finds an exit, with the goal often being going public (selling stock) or getting acquired. If the company fails, you do not have to pay back any venture capital.
How much do venture capitalists invest?
Venture capitalists invest anywhere from a few million dollars to $100 million+. The median VC deal size often depends on the stage of the company. The median VC deal size for seed and startup stage companies was $1.7 million in 2019. Compare this to median deal sizes of $8 million for early-stage companies and $10.3 million for later-stage companies in the same year.
How does a venture capital fund work?
Venture capital firms often put together venture capital funds. A venture capital fund is a pool of money that the firm collects from individuals, companies, and groups that wish to invest with the firm. The VC partners will then choose 10 to 20 companies to invest in. VC funds are often particularly focused on their investments. For example, a VC might raise a fund to invest in early-stage biotechnology firms that are raising Series A funding.
What do venture capitalists look for?
Venture capitalists look for several things when assessing investments. Perhaps most importantly, venture capitalists look for high growth potential, with many expecting a return on their investment of 10x or more. They are looking for innovative products and services with traction as well as some evidence of customer conversion. VCs also look at the ownership and executive team, as investors are betting on the team as much as they are on the idea.
What are the odds of getting venture capital funding?
The odds of getting venture capital funding are exceptionally small. Top VCs such as Andreessen Horowitz receive upwards of 3,000 applications for funding every year, funding only about 20 of them (about 0.7%). Considering ventures seeking venture capital are likely to speak with multiple venture capitals, estimates of the overall odds of a startup that is seeking VC funding receiving VC funding is approximately 5%.