Is Venture Capital Financing Right For You?
How will you find the money to turn your dream business into a reality? Fortunately, we live in a time when financing possibilities go far beyond the standard bank business loan. Whether you’re contemplating a start-up or ready to expand your already successful business, research all your options so that lack of planning doesn’t cost you more in the long run. One of those financing options is through a venture capital firm.
Venture capital firms use the money of high net worth investors (sometimes called “angel investors”) who want to significantly increase their return by putting their money into riskier ventures for a higher return on investment. The funds are professionally managed and are typically reserved for potentially profitable emerging growth companies with the potential to reach $25 million in sales within five years. Some venture capitalists may require an equity stake and an active role in your business as a condition of joining. An active role may include a board position, sales and marketing planning, or decisions related to corporate governance. The amounts you can borrow vary, but the average is $500,000 to $10 million. Getting money from a venture capital firm is not appropriate for all businesses. Each firm adheres to an investment profile, limiting the types of businesses in which it invests. This allows members of the company to become more conversant in a particular field, subsequently improving the chance of successful investing.
Venture capital firms take on risky investments that banks may reject; therefore, it is difficult to obtain financing if you have not carefully prepared your business plan. Also, be prepared to pay a higher interest rate than you would for a bank loan.
Once you’ve researched the risks and rewards of partnering with a venture capital firm and decided to move forward, here’s what to expect:
•VC members review their business plan. If your business meets the VC criteria for business type, stage of development, etc., members will meet with you to take the next step, which is…
•Perform due diligence. This is perhaps the most important step in the process, as it can make or break your chance to get financing. Great attention is paid to the numbers behind your plan: your company’s financial statements, details about your management team, and corporate governance documents, to name a few.
•Make an investment: Once VC members have decided to go ahead with financing their business, a term sheet is drawn up. This sheet outlines the terms and conditions under which the money will be awarded. If you agree to these terms and conditions, the money is invested and you, in return, provide agreed shares in your company, mitigating the risks to the VC. The money is paid in installments based on milestones set out in the agreement.
•Going out of business: Venture capitalists cut ties with companies at some point, usually within four to six years. This typically occurs through mergers, acquisitions, or IPOs that are made possible by the VC firm’s business ties. This is also the time when the initial loan is paid off, with interest, and the money is returned to high net worth investors. Sometimes redemption through shares is also acceptable.
Although it is sometimes considered that the stakes are higher, going into business with a venture capital firm can be a valuable strategy for some companies. For others, there may be more beneficial financing options. It is vital that you research and use the advice of professionals who specialize in the practice of legal matters for your business.