Venture capital (VC) is typically used for supporting startups and other businesses that have the potential for rapid, substantial growth. Earlier, Anand Jayapalan had spoken about how VC firms tend to raise funds from limited partners (LPs) for the purpose of investing in promising startups or even larger venture funds.
VC funding is provided in exchange for equity in a startup. This money is not expected to be repaid on a planned schedule like bank loans. VC firms follow a longer term view, and invest in growing companies with the hope that they would enjoy higher returns if the company is acquired or goes public. VCs generally take a minority stake, 50% or less, when investing in companies. Venture capital is known to be an important economic engine that spurs innovation, generates job growth and facilitates the creation of new business models. Venture Capital funding is instrumental in providing a chance for nascent businesses to grow and flourish. These funds especially play a major role as a company starts to commercialize its innovation.
How does venture capital works?
In the initial stages of their operations, businesses often rely on “bootstrapping,” or utilizing funds provided by the founder, friends, and family who support the venture with the hope of eventual success. However, a critical juncture arises when the emerging company needs to scale, often well before achieving profitability. It is at this juncture that founders explore more formal avenues to finance their growth. Opting for venture capital becomes a logical and strategic choice at this stage.
The landscape for venture capital funding is diverse, encompassing a plethora of sources, including both traditional venture capital firms and an increasing number of nontraditional investors. A number of venture funds specialize in specific industries, sectors, geographies, or stages of company development. Connections are established through engagement with startup networking groups, participation in accelerators, and involvement in mentoring programs. One of the initial steps in this process involves the creation of a compelling pitch deck, followed by the identification of venture capital firms that align with the company’s profile and business model.
In case an investor is impressed by the pitch deck and business plan of a startup founder, they would conduct due diligence for the business. This can include a full analysis of the business model, the services or products of the business, its financial position and performance, and more. If the investor wants to go forward after the assessments made in the due diligence process, then they are likely to present a term sheet that will include:
- The venture capital investment amount they are proposing to make
- The equity stake in the company that they expect in return
- Other conditions of the deal
There might be certain conditions the startup owner or the founder has to meet before the venture capital funds get released. Earlier, Anand Jayapalan had mentioned that VC money is often structured to come in several rounds over the span of multiple years. Many terms put forth by the VC are likely to be negotiable. However, one has to be specific and realistic when negotiating or they would run the risk of coming across as inexperienced or overly confident.