When starting a business, it is essential to have appropriate funding in place to cover the set-up and running of your new enterprise. In the modern lending market, there are many ways to finance this – it is all about finding the right option for you.
If, for whatever reason, your start-up is deemed ‘high-risk’, you may find it harder to secure the equity you need to launch it. Many traditional lenders are risk-averse, so you could be turned down when applying for finance.
This is where venture capital comes in. A form of equity that specialises in providing funding for potentially risky enterprises, venture capital can offer a lifeline to early-stage, innovative businesses with strong growth potential that struggle to obtain financing elsewhere.
In this guide, we will explain what venture capital is, how it works and why it could be the ideal solution for your start-up.
- What is venture capital?
- Why is venture capital good for early stage companies?
- How do I get funding through venture capital?
What is venture capital?
As already mentioned, venture capital is a form of private equity – however, unlike traditional private equity, it is aimed at early stage start-ups or SMEs with strong growth potential. Venture capital firms (also known as VC firms) will seek to invest in high-risk business ventures, with the aim of generating a reasonable rate of return.
VC firms will evaluate the potential of any business applying for funding and, if successful, will collate investment from private sources to raise funds for the enterprise. The company receiving the funds will be segmented into ‘chunks’ of ownership, which will then be offered out to investors as shares.
The key driver for venture capitalists is to get a high return on their investment. In most cases, they will expect a minimum of 25% return on any sum they give to a company. They also tend to seek an exit within five to seven years, so you will be expected to generate profitable results in this timeframe.
So, if you need funding to grow your early-stage start-up but believe you have high growth potential, you may be an excellent candidate for venture capital.
Why is venture capital good for early stage companies?
Venture capital is specifically aimed at early stage companies, but there are many benefits for new enterprises who utilise this form of finance.
The most significant advantage of venture capital is the substantial funds you can receive. As VC pools together investment from multiple sources, this can culminate in large sums of equity to inject into your company. As a result, you will have the working capital you need to fund your growth, introduce cash into your business and allow your operations to grow rapidly. Funding tends to occur in stages rather than upfront, which may also be preferable to entrepreneurs who wish to have continual investment coming in to maintain cash flow and enable gradual growth.
Another advantage of venture capital is that it offers hands-on support. VC firms are keen to get a profitable return of their investment through your enterprise, so they will work with you to ensure success. Unlike a business loan, where you tend to receive funding but not necessarily support, you will be able to get an additional layer of guidance which can be very significant in the early stages of a new company. VC firms have expertise across a range of industries, and this experience places them in a unique position to advise you on how to maximise your own results. They will be able to offer access to resources and connections that could provide incredibly useful in the long-term running of your company.
If your company does not wish to be burdened with recurring loan payments, venture capital could be a good alternative as the focus is on investment. So, rather than having to pay back a loan, you will need to offer shares in your business – with the investor receiving a return either via dividend or when your enterprise is sold.
It is also a relatively long-term solution, with most venture capitalists typically seeking an exit after seven years. It also means you will have extended access to support – both financial and otherwise.
How do I get funding through venture capital?
For early stage enterprises, venture capital may be obtained through a venture capital firm or possibly through high net-worth angel investors. A corporate finance broker or advisor should be able to refer you to an appropriate funding options including venture capital.
The hardest part of venture capital is securing it through your application. VC firms will undertake a lot of checks to ensure there is the potential for your business to grow, become profitable and provide a reasonable rate of return on their investment. As such, you will need to provide evidence that highlights the potential of your business. Things that will be considered include your management team, ability to meet investment criteria, the commercial viability of your products/services and the room for growth in your enterprise.
You will need to be prepared to give over relevant documentation concerning your business model, financial plans and any other information so that VC firms can complete their due diligence. These will need to be watertight and strongly emphasise the value that your company will be able to provide to secure approval for funding. So, be sure to spend time optimising your business plans to ensure success.
Get advice
Venture capital is one of many options entrepreneurs should consider in their mission to fund their new business. It could prove particularly useful for those at early stage or with high growth potential which may be deemed as high-risk – as long as you are able to make that risk pay off.
If you need guidance in identifying the right funding solution for you or finding a venture capitalist who could work with you, we are here to help. Our team of financial advisors have worked with many SMEs to secure the funding they need to establish their companies in a range of industries. As a result, we can find the best solution for you.