When investing in a startup, VC funding is provided in exchange for equity in the company, and it isn't expected to be paid back on a planned schedule in the conventional sense, like a bank loan. VCs typically take a longer-term view and invest with the hope they will see outsized returns should the company be acquired or go public. VCs usually take only a minority stake - 50% or less - when investing in companies, also known as portfolio companies, because they become part of the firm's portfolio of investments.
A VC investment by its nature is risky and takes place before a company goes public or, in early-stage companies, even before a company has an established track record. The possibility of large losses - even the entire investment - is factored into the VC's business model. In fact, VCs anticipate that they'll lose money on most investments. The odds of hitting a "home run," earning over 10X the venture capital investment, is small and can take years to realize. The calculation is that a few successful companies can pay dividends that far offset the losses.
Despite the long odds, venture capital is a major economic engine that:
The funding VCs provide gives nascent businesses - and industries - the chance to flourish. They help to bring ideas to life and fill the void that capital markets and traditional bank debt leave due to the high risk associated with limited operating history, lack of collateral and unproven business models. VC funds play a particularly important role when a company begins to commercialize its innovation.
A venture capital investment fund is a pooled investment vehicle that primarily invests in startups and small- to medium-sized enterprises with high growth potential. These funds are managed by VC firms, which raise capital from LPs, such as pension funds, endowments and high-net-worth individuals. The goal is to generate significant returns for investors by identifying and nurturing companies that will scale rapidly and eventually provide a profitable exit through an acquisition or an IPO.
Despite US VC investment falling below previous peaks, there is still more capital flowing to US startups this year than in 26 of the previous 30 years. This reflects a vibrant landscape for VC fundraising and investment, driven by a recalibration and recovery in the innovation economy. Non-traditional investors continue to expand their participation in the VC arena, including:
The latest State of the Market report tells the story of this ongoing trend, highlighting the resilience of the venture capital market despite fluctuations in investment levels.
Tapping venture capital is a logical choice. There are many sources and, as noted above, non-traditional investors are joining an already large mix of traditional VC firms. Many funds target a specific industry or sector, geography or stage of company development. Many connections are made through startup networking groups, accelerators and mentoring programs. Among the first items is to create a pitch deck and target firms that appear to be good fit for your company and business model.
If an investor is impressed by your pitch deck and business plan, they will do their due diligence to verify your point of view. This will include a full analysis of your business model, products or services, financial position and performance - now and in earlier ventures.
Suppose the decision is made to go forward. In this case, the venture investor will present a term sheet that will include:
There may be conditions you need to meet before they release their funds, including additional fundraising on your part. You should expect that VC money can be structured to come in multiple rounds over several years.
