Small Business Financing 101: Venture Capital

Venture capital professionals shake hands with a business owner

When you’re looking into financing options for your small business, you may wonder whether venture capital should be part of your funding strategy. In this article, we’ll explain what venture capital is and the contexts in which it works best.

 

What is venture capital?

Venture capital (VC) is a form of private equity in which a person or a limited set of partners pool money from their personal reserves, pension funds, insurance companies, and other wealthy investors and invest it into small or growing private businesses. Some invest in the early stages of a promising startup, but many prefer to see a proven concept before providing the capital its owners need to succeed.

 

Why are they interested in investing?

Venture capitalists are looking for the opportunity for returns that exceed what they could earn through other forms of investment. Most often, those opportunities fall within a specific industry segment that they know a great deal about.

VC investments involve a high degree of risk, so venture capitalists receive an equity stake in the business and a say in the critical decisions that are made to penetrate the market and achieve growth. They often opt to sell their stake in the business once they can receive a significant return for doing so (usually calculated as a multiple of their total investment).

 

Should venture capital be part of my funding strategy?

Most VC firms are interested in technology and healthcare ventures over other firms in other sectors, so if your business falls in that realm, VC may be an option for you. However, you may find other venture capitalists who are interested in businesses like yours.

It’s important to note that this form of funding can be difficult to attain. Some estimate that between 0.5% to 1% of startups secure this form of funding, and many of those have a proven market, concept, and plan for growth.

Before pursuing this option, weigh the benefits and drawbacks:

Benefits

VC financing has less risk than debt-financing options because it doesn’t require repayment if the venture fails.
Venture capitalists offer experience-backed advice and counsel where other providers of capital typically do not.
Venture capitalists can connect you with angel investors, industry connections, suppliers, and partners who can help you ramp up quickly.

Drawbacks

Venture capitalists will share in your business’s profits.
Venture capitalists will have a say in how your business is run, and their style of management may not align with your own.
Venture capitalists may have priority rights to compensation in the event of a sale of shares.

Be sure to consider other sources of funding, which may include SBA loans, term loans, asset-backed loans, 401(k) financing, and other options, before pursuing venture capital. You can learn more about options for funding in our guide, Your Go-to Guide to Raising Capital for Your Small Business.

Pro tip: You should discuss your plans to pursue venture capital investments with your accountant and attorney before proceeding. If you don’t have an accountant or attorney, you can click the buttons below to connect with experienced professionals in your market:

 

How can I connect with a venture capital professional?

Often, entrepreneurs locate venture capitalists through professional connections. You may find them through fellow entrepreneurs, your attorney, your accountant, your banker, or, more rarely, online platforms.

 

How can I attract their attention?

Email introductions are perfectly acceptable, provided that you have a shared connection. Be sure to lead with who referred you to the investor and share a brief, to-the-point summary of what your business is, the traction it’s been getting, and the plans you have to take it to the next level. Attach an executive summary or pitch deck that explains the details of the opportunity and the ways you plan to use the cash you raise to accomplish critical goals.

Read: The Pitch: Keys to Winning Over Investors and Others

 

How will venture capital professionals decide if my business is worth their investment?

Most venture capitalists will examine your business model, market, and industry, as well as your capacity to bring your idea to fruition, to look for opportunities to add value and realize significant returns. Specific elements may include:

  • Your passion, commitment, and integrity
  • Your plan for market penetration and growth
  • How your idea stacks up against alternatives in the market
  • Proprietary information or intellectual property that will make it difficult for others to replicate your product

 

To understand the financial picture of your business, they will likely ask questions about the capital you’ve raised and how you’ve used it, how you plan to use new injections of capital, costs, anticipated gross margins, and the assumptions you’re making about growth. They will also ask questions about your marketing approach, customer acquisition costs, and sales cycle to understand how you’ll position your product and get it in front of your prospective customers, and they’ll ask about the people you have in place to strategize, plan, and run the business.

If they reject your pitch, it’ll likely be for one of the following reasons:

  • Your market is too small
  • They believe your product will struggle to differentiate itself
  • Your business or market doesn’t interest them, suit their area of focus, or align with their core set of competencies
  • Your location is too far from them and their other businesses
  • Your forecasts aren’t credible
  • You didn’t come across as a person who seemed to know much about your market or strategies for growth
  • You weren’t convincing
  • You approached them without being referred by someone they know

 

What are my other options for funding?

There are many other ways to raise the cash you need to start or grow your business. Learn more in our article, Your Go-to Guide to Raising Capital for an Acquisition.

Interested in other articles that can help you build your business? Log into your owner’s portal for free, personalized guidance that will help you make your venture a success.

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