What Is Venture Capital Financing? All You Need to Know
8 minute read
A profitable business idea and a good business plan are very important, but they are not enough to achieve business success.
In order to get your startup off the ground and start hiring talented individuals, or move into an office and start working, a company needs certain capital.
And while there are different ways to amass funds that will help you get started, one of the most prominent methods is venture capital financing.
Keep reading to find out more in this guide!
Overview:
- What is venture capital?
- What are the benefits of venture capital funding?
- How to look for venture capital?
- What is the process of obtaining venture capital?
- How much capital can I get?
What Is Venture Capital? What Is Meant By Venture Capital Financing?
Venture capital is a type of private equity financing that investors contribute to startup businesses and small businesses which display long-term potential and profitability.
This capital is usually provided by established investors, investment banks, and other financial institutions. However, it does not have to take a monetary form in all cases. This support can also be provided in the form of technical or managerial expertise.
Venture capital is typically allocated to small companies with outstanding growth potential or to companies that have grown quickly and have high chances of expanding even further.
Even though investing funds in businesses that are not yet fully-fledged can be risky, it is the potential for above-average returns that matters to investors.
Venture capital funding is becoming quite popular for new companies that have a limited operating history (under two years). These businesses see venture capital funding as a sound method of raising funds, especially if they lack access to capital markets, bank loans, or other debt instruments.
It is worth noting that investors almost always get equity in the company. This means that they get to participate in a company’s decision-making processes.
Is Venture Capital A Loan?
Venture capital transactions generally involve a purchase of a company’s equity.
Some VC firms provide convertible loans, but the expectation is that the loan will convert into an equity stake in the company. The VC firm earns its money by owning a piece of the company and typically selling it for a higher sum of money.
On the other hand, a bank loan is a loan. It is a transaction that involves debt provided at an interest rate. That is how banks earn money.
Therefore, a loan is different from VC. New companies usually don’t have the assets or revenue to be eligible to take out a loan. Banks want to see assets, operating history, and revenue, just to be sure that they will get the money back.
This is exactly why some businesses can only turn to venture capital firms for funds. Once companies become more established, they often favor loans to more expensive equity transactions.
What Are The Benefits Of Venture Capital Financing?
- Firstly, venture capital provides a candidate company with an opportunity to grow and expand faster. If a company does not have enough funds to expand its operations, no significant growth can be achieved. At least not in a short period of time.No bank will allow a loan for a new business with little to no operating history and assets. In venture capital, the investors themselves are ready to take the risk as they believe in the company’s long-term success.
- Next, there is guidance. A member from the venture capital firm is usually appointed to the management team of the start-up company.This allows the active involvement of the venture capitalist in the company’s decisions. As venture capitalists have experience in building and expanding start-ups, their expertise and guidance are very useful.
- On top of that, venture capitalists have large networks of connections in the business community across numerous industries. This is a huge chance for networking. Connections are always beneficial for startups that want to grow and become successful quickly.
- Finally, there is no obligation for repayment. If a business fails, there is no obligation to repay the venture capitalist investors, unlike bank loans.
On the other hand, it is fair to mention that even though venture capitalists provide important funds to businesses, they get a stake in the equity in return.
This means that a startup that succeeds earns them decent amounts of profit. VCs generally become a part of the Board and actively participate in the company’s decision-making.
VCs will look to protect their investment and if there is a difference in opinion between the VC and the startup founder, things can get complicated, as any major decision requires the consent of investors.
How To Look For Venture Capital? How Do I Seek Venture Capital Funding?
Venture capitalists are very selective. They look for startups with significant growth potential that caters to the bigger market.
As a company, you need to embrace the go-big-or-go-home mentality. The market opportunity has to be attractive enough to make investors want to allocate funds to your cause. In other words, it is important to satisfy an investor’s return expectations when seeking venture capital.
The second most important thing is the uniqueness of your product. A good product or service that is unique can draw an investor’s attention quickly, as uniqueness makes it difficult for competitors to replicate what you offer.
Additionally, when you pitch your idea to investors, you have to back it up with data. It is of the utmost importance to back every claim with metrics and well-researched, quality data. This is the only way to appear authoritative and convince them that you know what you are doing.
These are some of the most prominent venture capitalist firms that you could use in Hong Kong:
- Click Ventures
- Golden Gate Ventures
- Arbor Ventures
- Horizons Ventures
- MindWorks Ventures
What Is The Process Of Obtaining Venture Capital?
The first step of the process is writing and submitting the business plan. Any business looking for venture capital needs to submit a business plan to a venture capital firm.
The firm, if they find the plan interesting, must perform due diligence that includes a thorough investigation of the company’s business model, products, management, and operating history. Considering that venture capital tends to invest higher amounts of money in fewer companies, this background research is very important.
Many venture capital professionals have had prior investment experience, often as equity research analysts. Others may have degrees in business administration and similar fields.
Do know that venture capitalists often focus on specific industries. A venture capitalist with a background in healthcare probably has some experience as a healthcare industry analyst.
Once due diligence is completed, the firm or the investor pledges an investment of capital in exchange for equity in the company. These funds can be allocated all at once or in rounds.
The VC firm takes an active role in the company, advising and keeping an eye on the progress before releasing extra funds.
Finally, the investor leaves the company after some time (usually four to six years) after the first investment by initiating a merger, acquisition, or initial public offering (IPO).
What Are The Stages Of Venture Capital Financing?
Now let’s take a brief look at five key stages of VC financing.
Seed Stage
Venture capital financing starts with the seed stage.
This is the stage when the company is little more than an idea for a product or service that has the potential to develop into a successful business in the future. This is the time to convince investors that the idea you have is worth investing in.
Startup Stage
During this early stage, companies have already completed research and development and a business plan is already being created. Once the plan is created, the company is ready to start advertising and marketing the product to potential customers.
First Stage
This stage is also known as the emerging stage.
It sees financing typically at the company’s market launch. This is the period when a company first starts earning profits.
Funds from this phase of a venture capital financing typically go to actual product manufacturing and sales, as well as increased marketing efforts.
Expansion Stage
This is the period when the company starts seeing considerable growth and needs additional funding to keep up with the demand. The funds invested are used to grow the business even further during this stage.
Bridge Stage
The final stage of venture capital financing is called the bridge stage.
Companies have reached maturity and funding acquired here is usually used to support activities such as mergers, acquisitions, or IPOs. This stage is a transition to the company being a fully-fledged, viable business.
How Much Capital Can I Get?
This is not an easy question to answer. Basically, it all depends on the nature of the business and the industry. Some industries are simply more lucrative than others and hence land better venture capital investments.
Do your best to measure the potential of each VC firm you potentially deal with to see who is willing to contribute the most. Some investors are eager to provide even more than you need. But some are not and you have to be very careful when making a final decision.
How To Write A Good Business Plan?
To write a great business plan, you need to pay attention to the following factors:
- First of all, before you start creating a plan, do some research on your rivals. Be prepared to name them and show what makes you different and better.
- Prepare several versions of your business plan, one of which is for venture capitalists.
- Every claim you make has to be backed up with data and proof. Support each statement about your services or products with facts.
- You should be realistic about the time and resources. Do not be overly optimistic, but also make sure not to underestimate the potential of your business.
- Finally, think like a venture capitalist or banker and write what they would like to see. Remember, they are in it for profits too.
Wrap-Up
It is clear that venture capital is a great source for emerging startups and small businesses. This is a great chance for an entrepreneur to grow their business and significantly increase the chances of success.
When a venture capitalist realizes that you have an innovative idea which can make an impact on the market, they will be more than happy to support you.
Working with a venture capital firm is also a great opportunity to bankroll your business dream. Just remember to do your due diligence and research well before you pitch your idea.
If you are, however, interested in basing your business in Hong Kong, do not hesitate to contact us for custom-tailored help and consultancy.
