Venture Capital is one widely sought-after resource for emerging entrepreneurs. But it’s sometimes hard for them to understand what it is and how to gain it while they balance and maintain their new enterprises.
So, what are the basics of VC funding and how can you determine what the right funding option is for your company? Here you can learn what you need to know so you can put yourself out there and begin pitching to investors:
Is Venture Capital Funding the Right Option for Your Company?
The structure of VC deals varies between startups and VC firms. You might find that VC-funded companies typically have the same characteristics which include:
High Startup Costs: Startups that need funding to maintain their operations and grow often rely on venture capital. Companies that don’t need much money to grow their options generally have other financing options.
High-Impact Companies: These organizations expect to make millions in revenue, be a major competitor or disrupter in their market, and also end with a successful exit. VCs wants to invest in companies that scale quickly, acquiring a lot of customers in a short timeframe. For regional mom-and-pop businesses who don’t plan to expand or go public, venture capital is not a good investment.
Innovative Projects: Venture capitalists also want to fund innovative projects that could change and revolutionize a market segment. A great example of this is how First Round Capital invested in Uber because of the expectation to transform the transportation market — which they did!
Each company is unique when it comes to seeking the right type of capital. Some people attract VC investors with only an idea, while the majority of deals occur when a company has three major things: founding teams, customers and a minimum viable product (MVP).
But companies need to ensure the products are viable, that they have an economically-sound business model and that their businesses are scalable with large markets to service. As a company, you should ensure your management team can grow the company and that you have initial customers, sales and analytics to show that people are adopting your service.
The 5 Steps to Getting VC Funding
If your company is mature enough then VC funding may be the right next step. Now it’s time to prepare for the funding process which includes five crucial steps:
1. Foster a Great Idea
First things first: your company needs a great business idea to succeed. A great idea that gains VC funding is highly-scalable and dominates a market in its early stages. Think AirBnB and Facebook. Businesses that have ideas that serve specific regions should probably consider other investment options.
2. Create a Pitch Deck
Pitch decks are the first materials that you’ll share with a VC firm. Many businesses cold-email them to firms, but the best way to pitch your deck is to have a mutual network connection kindly introduce you to the VC. Early-stage pitches are often concepts and ideations, where full-on decks are more complex and geared for later stages of funding. They may feature KPIs like engagement, traffic, and revenue. Sometimes, entrepreneurs prefer to demonstrate their prototypes in the first meetings instead of a pitch deck, but when VCs show interest almost always plan on bringing a traditional pitch deck and/or business plan.
3. Secure a Meeting
Solidifying financing requires meeting and networking with VCs. The best way to network is to create a target list of VCs that will align with your business. A great resource is CB Insights’ extensive database of VC investors. You can use the database to search for specific financiers, conduct outreach or use a network of referrals. Another great resource is Pitchbook’s database but, it comes with a high price tag so find a friend in finance who already has a subscription.
Securing a meeting varies for each company, so it’s important to grow your network and solidify a great idea that will appeal to investors. Some companies may get meetings within a few weeks. If you don’t have many contacts, securing a meeting can take longer. It may be best to target specific partners at different firms and then search through LinkedIn connections to find direct contacts. Another great idea is to network with other recently funded startups in your space and see if they can make introductions for you.
4. Due Diligence
If your initial meeting with a VC proves successful, additional meetings will require a series of due diligence steps before they offer you a deal. During the process, they’ll review the founding team members, the product, the industry, target markets, your company’s earning power and financial viability. Many VCs take a phased due diligence approach which means they review these steps in three phases.
Even if your deal seems like a sure thing, due diligence is necessary for all VC firms. They’ll fact check and assess the data and assets along with any potential risks to decide if the deal is a good option for them.
5. Term Sheet & Funding
After a VC confirms a deal, they will send over a term sheet that reviews the details of the proposal. Both teams can negotiate the details and both must agree and then sign off on the document. After it’s finalized, then the company will receive funding. It’s not always a straight road to funding, so remain patient during the process!
As an added note, some entrepreneurs think that they will get a deal within 90 days, but it can take much longer than that. Six to nine months is a more realistic time frame to raise capital, but it varies for each company. So make sure to give yourself plenty of time. In the end, it can be very rewarding!
The Three Tiers of Early Stage VC Funding
Another thing to keep in mind is that most funding occurs when companies are early-stage startups. Financing has three stages:
Pre-Seed Startup: Pre-seed investment can help finance startups when they are just setting up. It allows them to grow past the general idea and implement product development. Pre-seed financing often comes from friends or family, loans, business incubators or angel investors.
Seed Round: This is when institutional VCs first invest money into a startup. It can be a modest investment ranging from $10,000 to $2 million and it’s often used to develop new products while the company tests the market. At this point, the company generally hasn’t started any large, commercial operations.
First-Round of Funding: This stage can be called First-Round or Series A investments. When companies have developed the product, team and marketing strategy, they’ll receive this round of funding which will help them scale to commercial manufacturing and sales.
If you believe in your idea and meet this criteria, then go for it. While there are plenty of funding options other than VC, it can certainly help get a burgeoning idea off the ground and into a promising market.