Introduction
Securing funding is one of the most critical challenges for any growing business. Venture capital can be a powerful tool for raising capital for companies beyond the initial startup phase, especially those with high growth potential. Unlike traditional bank loans, which require steady revenue and collateral, venture capital involves selling equity in exchange for financial backing, often when a company is too new or too risky for conventional lenders.
Venture capital is not just a financial transaction; it’s a strategic partnership. Investors bring not only capital but also industry expertise, market connections, and hands-on guidance that can help shape a business’s future. However, accepting venture capital also means sharing ownership, decision-making, and long-term rewards. Understanding how the venture capital process works, what investors look for, and what is expected in return is crucial for business owners considering this route to growth.
Whether you’re seeking capital to scale operations, invest in new technology, or enter new markets, venture capital may offer the fuel needed to reach the next level—provided you are ready for the expectations and trade-offs that come with it.
What is venture capital?
Venture capital is a source of funding that may be available to emerging or expanding businesses. Venture capital may be used for start-up costs, although it is generally more readily available for the growth and expansion needs of an existing business. Venture capital may come from individuals, small investment groups, professionally managed pools and partnerships, or even insurance companies. Such venture capitalists may concentrate their investments in a certain market segment, such as the computer or high-tech industry. Often, venture capitalists can supply funding for projects considered too risky by banks, but they do not take these risks unless the potential reward is significant.
What do venture capitalists look for in a company?
Venture capitalists generally look to invest in companies with the potential to make it big. There are several characteristics that may make your business more likely to attract venture capital funds. Among them are the following.
Proprietary products or services
If your product or service has a patent, copyright, trademark, exclusive distribution agreement, or other special right, you have a distinct advantage over potential competitors. An unprotected product or service can also be attractive to venture capitalists if you have a significant head start on potential rivals. In any case, your business should have some type of advantage over the competition so that you can achieve and maintain a dominant position in the industry.
Large potential market
Venture capitalists expect explosive growth in the companies in which they invest. Venture-funded companies are expected to be worth $30 million, $50 million, or even $100 million within five to seven years. This means the market must be large enough to support such growth.
Talented management team
Many venture capitalists view this as the single most important factor when deciding whether to invest in your company. They want to see proven ability among your management team, including the ability to manage a rapidly growing company and the ability to attract, hire, and retain the top people in your industry.
Exceptional returns
Venture capitalists are looking for a return on their investment. Most expect returns of 35 to 50 percent per year. You should realize, however, that most companies don’t earn this level of profit in the early years and that it may be necessary to sell your business or go public in order to meet these expectations.
How do you get venture capital?
Obtain a directory of venture capital firms
There are many types of venture capital firms, including small investment groups, professionally managed pools and partnerships, and insurance companies. Many of these firms specialize in certain types of ventures. For an annual subscription fee, theNational Venture Capital Association can provide you with online access to a directory of venture capital firms.
Create a business plan that “sells” your business
Your business plan is the hook that will reel in venture capital funding. It should be well conceived and well constructed, with a positive but realistic projection of future cash flow. Keep in mind the venture capitalists’ expectations regarding return on their investment, but don’t get too bogged down in statistics at this point. Take this opportunity to tell the story of your business and to demonstrate the strengths of the people who make your business work.
Follow up with additional paperwork
A great business plan may get you through the first round of interviews with venture capitalists, but you’re not in the money yet. If you have a second round of meetings, be prepared to provide the following:
- Complete financials on the company
- Financial statements for each of the principals
- Backup data on product development
- Current market research
- Comprehensive information on competitors
- Expert opinions, if applicable
- Patent or licensing documents, if applicable
- Inventory and equipment lists
- Outstanding loan documents
- Copies of leases or mortgages
- Documents of incorporation and partnership agreements
- Accounts payable and receivable lists
- Copies of contracts or letters of intent to purchase your product or service
- Any other documents pertinent to the operation, marketing, or success of your business
Structure a deal that is acceptable to both parties
Venture capital investments may be structured in one of two ways. The venture capitalists may take a certain amount of equity in your company in exchange for their investment. Alternatively, the deal may be structured as a loan with an option to convert that debt to equity when your company goes public or is sold in the future. The exact structure of the deal will be determined in the final stages of the negotiations. You will likely want your attorney and/or your accountant to participate in these decisions.
What will the venture capitalists want in return for their money?
Pre-investment information
Before investing, venture capitalists will generally scrutinize your company and your employees in order to minimize their risk as much as possible. Background checks will generally be necessary, as well as patent searches and other research into your company’s potential for success. They will also want to get to know you and your management team so they can decide whether they want to do business with you.
Equity in the company or the opportunity to obtain equity at a future date
Venture capitalists will want either equity in your company or the opportunity to convert debt to equity at a later date. The amount of equity that venture capitalists should receive in exchange for their investment should be calculated based on the following factors:
- Amount of money needed to achieve the desired results
- Length of time needed to achieve those results
- Annual return on investment
- Strength of your management team
- Anticipated funding needs in the future
- Method and time needed to exit the project
Participation in management decisions
As part owners of your business, venture capitalists will generally want some influence over management decisions. They may even take seats on your board of directors. This can be extremely beneficial, since venture capitalists are typically experts in their fields and may be able to offer sound advice and guidance.
What are the advantages of venture capital financing?
More capital may be available from venture capitalists than from banks
Venture capital investments tend to be larger than a typical bank loan. Few venture capitalists will consider an investment of less than $250,000, since these deals require a considerable amount of time and effort, and a small deal is just as much work as a big deal.
Venture capitalists may be willing to accept more risk than banks
Banks want to be assured their loans will be repaid. Thus, they are often unwilling to lend money to businesses that are not yet well established and profitable. Venture capitalists realize that taking risks can result in enormous payoffs, so they may be more willing to invest in a small company with a big idea.
Out-of-pocket costs may be lower
Because venture capital is typically equity financing rather than debt, you are not required to make monthly payments on the money, nor will you pay interest.
Venture capitalists may provide valuable guidance and contacts
Venture capitalists often concentrate their investments in a specific industry. They usually have a great deal of expertise in this field and may be able to offer invaluable knowledge and experience, guide your business, help you avoid common pitfalls, and provide you with contacts and potential customers within the industry.
What are the disadvantages of venture capital financing?
You may have to give up a substantial amount of equity and control
You must realize that when you receive funding from a venture capitalist, you are giving up partial ownership of your business and at least some measure of control. You’re getting money, but you’re also getting a partner.
Small businesses may have difficulty finding venture capital funds for start-up costs
Venture capital is seldom available for start-up costs. By many estimates, 90 percent of new businesses do not succeed. This is too much risk even for many venture capitalists. Once your business has made it through the initial start-up period and your chances of success begin to increase, venture capital will be more easily accessible for growth and expansion expenses.
Determining the value of the company may be difficult
To determine how much equity venture capitalists should receive in exchange for their investment, you will need to accurately determine the value of your company. This can be a difficult task in the early years of your business because expenses may be higher and revenues lower than they will be in the years to come.
Conclusion
Venture capital can offer a unique opportunity to transform a promising business into an industry leader. The financial investment, combined with the strategic expertise and networks that venture capitalists bring, can accelerate growth in ways traditional financing cannot. For businesses with innovative products, scalable models, and a strong management team, it may be the perfect funding solution to take operations to the next stage.
However, it’s important to recognize that venture capital is not free money—it comes with strings attached. You may have to give up a significant portion of equity, accept increased scrutiny of your operations, and share strategic control with your investors. Moreover, venture capitalists typically expect a high rate of return, often realized through a sale or public offering within a few years, which may not align with every business owner’s long-term vision.
Ultimately, venture capital is best suited for entrepreneurs who are prepared to scale rapidly and are comfortable with shared ownership and accountability. With thoughtful preparation, a compelling business plan, and the right investment partners, venture capital can be a game-changing resource in your company’s growth journey.
Scarlet Oak Financial Services can be reached at 800.871.1219 or contact us here. Click here to sign up for our weekly newsletter with the latest economic news.
Source:
Broadridge Investor Communication Solutions, Inc. prepared this material for use by Scarlet Oak Financial Services.
Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on individual circumstances. Scarlet Oak Financial Services provide these materials for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
