Venture Capital
What is Venture Capital?
Venture capital (VC) is financial capital raised to create a venture capital fund. The VC fund then gets invested into exceptionally high growth potential startup businesses. The structure of the deal can vary significantly with hybrid securities like a convertible note or preference shares regularly used.
In simplistic terms, the VC is typically looking for equity in the business and the venture capital fund makes its money from the capital gain of the equity value when the business is sold.
Venture capital is typically provided as growth funding for the expansion stage of a business and would typically come after early seed funding or angel investor funding rounds.
What type of investments do VC’s make?
Venture Capitalists (VC’s) are very selective in the investments they make and typically make investments of $1,000,000+ in return for ownership and influence in the business. In Australia, VC’s tend invest between $1,000,000 and $5,000,000 (but may be slightly lower or significantly higher) in a single business and VC’s would typically take 10-40% ownership in the business.
Only extremely high growth potential startups will gain venture capital. It’s typical for VCs to invest in only 1 out of every 100 opportunities they see. In addition to just providing financial capital, the VCs themselves will have deep knowledge and connections within their industry and will often take on advisory and directorship positions within the startups they invest in.
Early stage businesses (even in a growth/expansion stage) are still very high risk and many will fail entirely or fail to provide a valuable exit. Because of this, Venture Capitalists look for exceptional investment opportunities with extremely high growth potential in order to balance out their failed investments and provide the overall financial returns needed for the fund. Like Angel investors, Venture Capitalists require an exit, a liquidity event where they can sell their equity (or other security type) in the business and achieve a capital gain of typically 5-10 times return (or higher) on their initial investment. VCs typically look for a 3-7 year timeframe to exit.
Most VCs operate in innovative technology industries like Internet, IT, Software, Cleantech and Biotech which are likely to produce very high growth businesses, but a VC may operate in any industry which provides sufficient opportunities. Each venture capital fund has a detailed criteria list that determines what opportunities they can and will invest in. These are likely to include:
- Industry type, sub-types and specific markets: An individual VC fund will generally operate in only one or two industries (although Australian VC’s are typically more general) and often will further break down the industry into more focused growth market areas it targets. For example, rather than just targeting very high potential startups in the software space, it might be very high potential startups that are B2B cloud based software, globally scalable and operating in a market without any clear leaders. The venture capitalists themselves are likely to have deep industry knowledge and experience in their chosen target areas. The will use this knowledge when evaluating the potential of the startups.
- Business stage: The investment criteria of the venture capital fund is also likely to specify the business stage of the startup. Seed stage would generally be too risky for a VC, great opportunities at early stage will be looked at, but expansion stage startups are typically the sweet spot. Most VCs are looking for a startup that has confirmed its product/service offering, its business model and the market response is very positive [demonstrated by happy customers or users]. As such, the startup isn’t still looking for a product/market fit. It’s already got that worked out and is now looking for growth funding from the VC in order to expand and scale very quickly.
- Funds required and equity offered: The capital required by the startup must match the preferred venture capital investment size of the VC fund. If the startup is looking for $1,000,000 and the VC fund only makes investments of $5,000,000+ the deal is not going to happen. The VC also needs to have a very clear understanding of exactly why the startup needs funds and how the funds will be used by the startup. In addition, the deal structure, amount of equity on offer, the type of equity, the specifics of the company structure, directorships and control will be reviewed closely and must suit the VC’s investment criteria.
- Management team: A VC is looking for an experienced management team they connect with. The entrepreneur(s), key management, advisory team and board of directors are vital to the success of the business and are thus viewed very highly by VC’s. If the management team isn’t experienced enough or there’s a personality clash between the management team and the VC this will need to be addressed before any deal can go ahead. An strategy that is often used for startups seeking to raise venture capital will be to bring in experienced advisors, directors, and C level executives to raise the profile of the management team prior to approaching the VC’s. A larger and strengthened management team also reduces the risk to the business of any damage caused by the loss of any key personnel.
- Shared Vision: The management team (particularly the controlling shareholders) and the VC must have a shared vision for the future of business. When investing in a business the venture capitalist is looking for extreme growth of the business then a clear path to exit in a defined timeframe and this vision must be shared by the management team.
- Location: Typically VC’s require that the startup needs to be geographically located near to them, generally the same city. They want to be able to physically meet with the key management regularly without travel.
How do I raise venture capital?
Review your startup business closely: Is it an extremely high growth potential startup, does it have a proven business model, is now looking for expansion funding in order to scale, looking to raise capital in the range of $1,000,000+, with a likely exit event 3-7 years providing returns of 5-10+ times? If you don’t match these broad criteria, venture capital probably isn’t suitable for your startup. Read more other business funding options.
However, if your business fits within the broad criteria, venture capital might well be a viable funding source.
If you’re looking for VC funding, there are two key things you need to do:
1. Get Educated
2. Get Connected
1. Get Educated.
Raising venture capital is a complex exercise. VC’s are very selective. Months before approaching any investors or capital raising advisors you should begin educating yourself on the capital raising process, systemising processes, reviewing and de-risking your startup, building out a more complete management team and generally getting a detailed education about raising venture capital. For the entrepreneur seeking venture capital, even if using an advisor, being highly educated about venture capital and the capital raising process is vital.
iPitch.com.au is in the process of creating educational material on this topic and establishing partnerships with existing credible educators. Until we update this article, contact iPitch directly for recommendations on education sources for venture capital raising.
2. Get Connected.
Obviously you need to know who the venture capitalists are and then determine which ones make investments in your type of startup. Your best chances of approaching a VC successfully is through a warm introduction from a trusted connection of the VC.
Another good idea is to introduce yourself and your business to a VC well before you decide you need to raise. This helps to build a closer working relationship. Ideally an entrepreneur should make forecasts to a VC in these early meetings and then show the results in future meetings to build credibility.
Experienced corporate advisors with a successful track record in your industry are often the best method to lead the capital raising for your business. Not only do they bring significant knowledge, experience and connections they also allow the management team to focus on running the business throughout the capital raising process which might be a lengthy time period.
If you are looking to engage a corporate advisor, don’t hesitate to contact iPitch directly to get our opinion on a corporate advisor that has the capabilities and experience your situation requires.
