You have a great idea or are onto something big. You need money to get to the next level, where do you turn? Bank finance, crowd funding, friends and family, angel investment or venture capital? If you are thinking about going down the venture capital route read on.
What is Venture Capital?
In simple terms venture capital companies manage capital funds that they invest in promising businesses in order to help them achieve their potential and make money from an eventual exit. The people funding the funds so to speak are looking for strong returns so the venture capitalists job is to seek out and invest in businesses with serious growth potential. Venture capital is in itself risky, nobody out there has a crystal ball, so the venture capital team invests in a portfolio of companies in the hope that most will be successful and maybe one or two may turn into a spectacular successes or unicorns as they are known.
Venture capital is risk investment where the venture capital company invests in your business in return for a share in your business. Businesses, especially those with huge potential inevitably need money to grow. Traditionally businesses are initially funded by the founder or founders and often family and friends. As the business grows the business owner may need more cash to fund expansion. Unlike traditional bank lending where a bank lends the business money in return for repayment of capital plus interest venture capitalists do not lend money. They are a shareholder and gain if the business does well or lose if the business goes bust. If your investment needs are modest, in the tens of thousands of pounds or early six figures then angel investment may be more suitable. Very briefly angel investments are usually ´smaller´ investments from private investors who like the business and provide some cash and often guidance and contacts. Many times angel investment is a great stepping stone to venture capital.
How does venture capital work?
Think of venture capital company like a record label, they are not so far apart in terms of what they do. A record label scouts for talent, “the next big thing in music”, they sign a band or artist, invest money in the artists development, music videos, album production etc and then recoup their investment plus their profits from record sales. In much the same way the venture capitalist is looking for the next “hit” or big thing. They invest money into the company to help fund the growth and also provide guidance. Instead of making their money back through sales and profits they make their money back typically through the eventual sale of the company or through the company going public.
Is venture capital for me?
This is a very important question and should be seriously considered before even beginning the search for a venture capital company. You must first be clear about what your long term goal is. If you are building a business to hand over to your children and grandchildren and don´t plan to sell then venture capital may not be ideal. If you want to grow your business fast, go international and sell for hopefully a large sum of money then it could be for you. Let´s look at this in more detail. Once you have a venture capital company on board you are joined at the hip, the venture capital company has a vested interest in your company and also on an exit, this will be the moment where they get their money back plus their profit, typically about 5 years on average. Therefore if selling the company in the near future is not what you want then your interests may not be aligned. This is not a hard and fast rule but generally true. If on the other hand you are uber ambitious, have a product or service that has huge potential, want to rapidly grow the value of your shareholding and exit then venture capital could be perfect for you. In this situation yours and the venture capitalists interests are better aligned. You are both aiming for the same goal, grow fast, maximise potential and sell the company for a lot of money further along the road. As you will appreciate there are many variables and the above will not always hold true but in most cases it´s probably close to the mark. Venture capital companies also bring experience, high level contacts and guidance to the table. For younger or inexperienced entrepreneurs this guidance could prove crucial and perhaps help to avoid making the major mistakes that first time entrepreneurs often make in their first businesses. More seasoned business people do learn from their mistakes but these mistakes are almost always costly in terms of time, money and in the worst case the death of their business. The venture capital company can bring this experience to your business and help you to avoid potential pitfalls. Once the venture capital company has invested they are along for the ride no matter how bumpy it gets!
What do venture capital companies look for?
Venture capital companies are looking for businesses and brands with serious growth potential and businesses with innovative products or services that could create a new industry or disrupt an existing industry. Venture capital companies look for businesses led by a founders who are true entrepreneurs with a vision and the tenacity to see a project through to the end. Venture capital companies are not looking to run a company so they need to be confident that the founders / managers are capable of executing a plan and if things get rough be able to navigate the company successfully. Generally serial entrepreneurs with a top track record or senior management coming from well known companies will more easily get the ear of the venture capitalist but that shouldn´t put you off, Mark Zuckerberg of Facebook is a great example of a young person without a corporate background successfully raising VC funding. Using the record label example again, a venture capital company is investing into multiple “artists” with the hope that at least one will provide a hit that makes a profit and also covers losses of the artists that didn´t do well. This means the “hit” needs to be big. As a general rule of thumb the venture capital company will be aiming to get at least a 10 fold return on their investment and ideally more so the potential has to be big to make it worthwhile for a venture capital company to invest. Before going for big money be sure that the market you are entering is capable of delivering the kind of exit that will sufficiently reward the venture capitalist.
How much money could I raise with venture capital ?
There is no hard and fast rule and there are many factors to consider, sector, policies of individual venture capital companies, state of the market etc. To get a rough idea, the least you are likely to raise via venture capital will be somewhere between 100,000 – 250,000 GBP, that really is the lower end of the venture capital scale and more typical for a seed level investment or an investment from a small VC. On the other end of the scale you could raise 10m – several hundred million if you are sitting on the next Facebook or Uber. As a rule of thumb if you have an idea and are looking for some seed or start up capital you could raise a six figure sum, if you have passed the seed capital stage and are in a growth phase you could be looking at seven or even eight figures if you are onto something really hot!
How do I get venture capital?
This is where is gets more tricky, if you thought I was done with the record label example then think again! Again the similarity between the venture capital company and the record label is strikingly similar. The record label gets sent demo tapes and most artists never hear from the label. The labels have scouts out there looking for artists at live gigs rather than sitting around waiting for the next big thing to walk through the door. In a similar way venture capital companies get thousands of requests from businesses looking for funding and mostly they are not interesting ,suitable and has not come to them from a known and respected source. Like the record labels the odd demo sent in the post may lead to a record deal just like an enquiry to a VC firm may lead to venture capital investment…but the odds are extremely slim. What the majority of venture capital companies do is get their prospects via known and respected professional contacts like accountants and lawyers, via introductions made by companies already funded by the VC company or introductions made through known contacts. Keep this in mind when starting to look. Very importantly before you make contact do some homework, look into the venture capital company, what other businesses have they invested in, are there any competitors or similar companies? How much do they typically invest? What sectors do they invest in? If they have invested in a competitor then they are probably not for you. Study their website and read what they are looking for, what is their investment criteria. A bit of homework and preparation will serve you well and avoid wasting the venture capital companies and your time. If you have a really good idea, product or service then get yourself out there and use whatever means you can to get your project in front of a handful of well selected venture capital companies that match. I would also advise that you get a feel for the venture capital company, do you like their style, their ethics, their style of doing business? It will be much better if you do. There is no point in getting investment into your company from a venture capital company that does not gel well with you or does not match your personal goals. This is a two way street and you need to be sure you are happy with the venture capital company and people running it before signing on the dotted line.
Be prepared to spend considerable time on fund raising and away from your businesses
Fund raising takes time and considerable energy, whether you are raising angel investment or venture capital investment you will need to invest considerable time and this will mean you are taking valuable time away from your core business. If you are a group of founders or already have employees working everyday then it may not impact you as much. If however you are a single founder or a couple of people working at your project without any employees then you will find it tough as you will end up focusing a lot of your time and energy raising the funding. If you are successful then it probably won´t matter too much as the extra cash and input from your new investor will most likely make up for the lost time and some. If however you are unsuccessful you will have lost a lot of valuable time, maybe some money in travelling costs and any professional fees you may have paid to prepare documentation. Typically timewise you are looking at somewhere around eight weeks from start to finish. Factor this time in before going down the fund raising road. If you can afford it then ask your lawyer or accountant to help you secure the funding while you work on your core business. In general you are best advised to do your research, be realistic about being able to raise investment and reach out to the right investors to increase your chances of success.
Europe or the US of A?
The venture capital industry in the United States is far more mature and historically more willing to take risks, in comparison the European venture capital industry is relatively smaller and generally more risk averse. I once read somewhere that Silicon Valley venture capitalists will not invest in a company that is not within cycling distance. In general the venture capital company will prefer to have companies in their portfolio nearby. This is not a hard and fast rule but again is probably true in most cases. Whether to seek venture capital in Europe or north America really depends on your business and your target market, it´s not easy to generalise. If you are based in Europe and your product or service is selling in Europe then you are probably better off looking for funding in Europe. London, Barcelona, Amsterdam or Berlin are key hubs in Europe, especially for the tech sector. Being close to one of these cities could be advantageous. If you do not find success getting VC funding in Europe and North America could be a significant market for you then you could try looking there but keep in mind that you are at a disadvantage. There are locally based startups seeking funding and they will get preference unless you are offering something truly unique or are prepared to move over to the United States and base yourself there.
Venture capital has played a significant role in the growth and success of many of todays biggest and most well known brands. Todays global icons like Apple, Uber and Facebook perhaps would not be where they are today without the injection of venture capital at crucial moments in their business. Get it right and you could be the next!