What are the benefits of venture funding? Who in particular should consider this form of support? What are the risks of taking venture capital for startups? You will find the answers in this article. Read on.
How does venture capital work? – table of contents:
- What is venture capital?
- Who is venture capital for?
- The pros and cons of venture funding
- What are the risks of taking venture capital?
- Where to find investors?
What is venture capital?
Venture capital funds are a form of external financing obtained in exchange for a temporary allocation of shares in the financed business. The investor in this case is an entity wishing to optimize the return on the capital at its disposal by investing it in a high-potential startup. Thus, venture capital is an attractive form of financing for innovative startups with limited financial resources, but great growth potential.
Who is venture capital for?
Venture capital is dedicated especially to business entities with a strong business model and significant growth potential. Therefore, it is necessary that the entity applying for funding in this form has some market experience, giving investors a guarantee of intensive business growth.
Technology, biotechnology and information technology industries are often the chosen investment sectors. It is important that the capital recipient has a certain competitive advantage, being the reason for investors’ interest. It can manifest itself, for example, at the product, service, pricing, managerial or market level.
A proper structure and presentation of the project to be financed is equally important. Venture capital as a high-risk investment requires convincing the investor of the profitability of their capital commitment. Thus, a VC fund is an attractive option for companies with an innovative idea, which is often too risky in the eyes of traditional banking institutions.
The pros and cons of venture funding
Among the benefits of using venture capital, the financial aspect of the investment definitely comes to the fore. In this way, innovative companies obtain capital that is often not available to them from any other source, and which can greatly speed up the development of the company and its projects. All this without establishing any collateral, which is often a great problem for companies with limited material resources.
The financed entities are also not obliged to pay regular interest-bearing installments – as the investor receives dividends. The costs are therefore directly proportional to the profits the company earns.
Startups using venture capital funds, however, get much more than a cash injection. This is because investors are often entities with an established market position, with a broad database, know-how, contacts, infrastructure, proven logistics channels and support from specialists.The risk taken by investors leads them to care about the success of the venture – so you can count on their extensive support, which translates directly into the benefits they receive as shareholders.
The VC fund is a form of financing that guarantees stability for startups. Collaboration is established during their growth phase, which bodes well for cooperation with an investor who will probably want to continue funding the venture. Even if their stance were different, however, pulling out of the deal without agreement on both sides will not be easy.
When it comes to the costs of this type of financing, they will certainly not exceed the benefits – after all, it’s the share of the company’s profit that is the investor’s reward. The fact that they were willing to bet on a certain business builds the image of the latter as promising – this, in turn, can attract further investors. Improving the capital structure also increases creditworthiness, which can further accelerate growth.
What are the risks of taking venture capital?
Despite the aforementioned benefits of taking VC funds, there are also certain risks associated with it.This stems from the fact that the investor in this case becomes a shareholder in the company, and therefore gets certain privileges, limiting your control over the company. Thus, you have to reckon with the payment of dividends, the distribution of power in the company and the need to consult decisions with the investor.
Also, the disadvantage of taking VC funds is the time required to implement this form of financing, which is usually about a year counting from the day the parties get in touch. High risk comes with relatively high costs. The average rate of return that the investor expects in this case does not go below the threshold of 30%. The increase of the company value also translates into the price of shares, which the investor buys much more cheaply during the initial growth phase.
Where to find investors?
There are many platforms on the Internet that offer lists of investors by country or region. One of the more popular sites with a global reach is OpenVC. OpenVC is a platform that allows founders of technology companies to connect with investors. You can use the service for free or pay for a premium membership. Finding investors is quick and intuitive, and the current database includes more than 5,000 companies. Contacts can be easily filtered by target countries, startup development stages, and requirements, etc.