Venture Capital Funding: Does Your Start-up Really Need it
All brilliant ideas start while we are finishing our daily chores or are busy with other such mundane activities. And as you would already know, the biggest companies start operations from a garage and have grown into Fortune 500 companies. And, at every stage of this growth, we know, they must have been looking for funding.
There are specific types of funding required at each different stage of growth. It would be venture capital, required at the very early stages of the company. Private equity capital while in the middle phase. An IPO or initial public offering, for the next stage. And the list goes on.
In this blog, however, we are focusing on the very early stages, i.e. the venture capital stage.
What is Venture Capital?
Capital requirements funded by the private investors (or the venture capitalists) or specialized financial institutions (development finance houses or venture capital firms) are called Venture Capital. Sometimes, it may also be termed as risk capital. Because such investments are typically high-risk/high-return opportunities.
Venture capital is the type of funding that is provided for a new business or a start-up. Generally, it comes from venture capital houses that specialize in building high-risk financial portfolios.
With venture capital, the development house gives funding to a start-up company in exchange for its equity and stocks.
This is a very common feature in high growth technology industries like biotech and software.
Who is a Venture Capitalist?
A venture capitalist usually works for a venture capital firm.
The firm typically has one or more investment holdings. And are owned by a limited partnership. The financial institutions are investment funds managing the money of investors who seek to invest in private equity of a start-up that has strong growth potential.
They back these high-growth companies in the early stages. That is how many best-known success stories owe their growth to financing from venture capitalists.
What do Venture Capitalists Look For?
These angel investors are individuals having a high net worth and money to invest. They, usually, prefer to invest in sectors with which they are familiar. As Venture capital funds invest in a portfolio of companies, they understand that some will be successful enough to repay them for their investments even if some businesses fail. They will first look at your business plan to decide if it has potential. They will examine your plan thoroughly with due diligence before deciding to invest.
They work with a long-term investment horizon and are patient, giving you time to you grow your business. Besides providing capital for your business, they may also want to have a say in the running of the business. For example, they may want to be on your board of directors.
Let’s first check the possible reasons, why VC would invest in your Company Registration.
1) Have a Unique Product
Your products or services must be unique. Or, at least, proprietary. All VCs look for the next big thing. They look for companies with the potential for revenue making. Do you have that kind of product? Something that creates barriers to copying by the competition? In such a case, their interests could be protected. So, if you have a product that could be registered and patented, VCs would love to invest in your big idea. Alternatively, you could have a unique service model, with something so unique that is difficult for the competition to easily copy?
The VCs would take comfort in the knowledge that your start-up will deliver them revenue within a certain time frame. Therefore, when trying to attract VCs to invest in your entity, you must be prepared to show them how your product or service could not be easily replicated. And that the market will remain exclusively yours for at least some duration.
2) Presentations Matter
With VCs, you should be able to show them how their money will benefit your business. You must be able to present the growth potential of your business. That this business idea is sustainable and can sail through.
This would be the most important feature of the discussion. So you will have to show them, how their money, once invested, is going to increase your company's sales. When speaking to a potential investor, business owners, often, get so wrapped up in presenting their products or service model that they forget pitching their business as an investment opportunity. At the time of the presentation, it is easy to lose focus on the purpose of the conversation.
But you must never forget that goal. Rather, once you have shown them how your product or service is difficult to replicate. You must be ready to showcase how VC's money will increase your sales exponentially.
The case may be that you have already marketed your product well enough. And had to forego some orders you could not fulfil and capital is required to increase production infrastructure to satisfy existing orders. Or, the capital from VCs would infuse the marketing efforts that have been limited, so far. And that, with funds, you will be able to start and implement some better marketing strategies and increase sales.
Whatever the situation, you must know how to show that their money will increase sales and revenues. And be able to, intelligently and methodically, present the plan, in numbers and statistics, to secure the investment. The less uncertain the plan is, the more chance you have of getting the funding.
3) Prove Yourself
To show the statistics and the future demand, you may need to use existing sales as evidence.
Not everyone may have a unique and proprietary product or service model. When that is the case with your entity too, you must be able to show the VCs, that your product or service is being received well in its relevant market. And, in such a situation, what better proof is there than sales statistics? It is very important that there exists a huge market for your product, also. That way, you can achieve your goals even with low market penetration.
Even, in some instances, a patented product may not have demand. Let's say, you take a patent on the latest version of an impressive mechanical device. And that you have been selling it for two years, but, have only sold 100 units for Rs. 1,000 each. This shows that there is not much market for your product.
Real sales are the best evidence of consumer demand. This is what should be shown to the VCs. So be ready to discuss how good your goods or services are. As well as, submit data on consumer interest and validation in the form of numbers.
4) Meet the Selection Criteria
Venture firms are highly selective. They mostly pick only a few companies each year. Therefore, they try to not falter on these investments. This also means that they would be willing to risk a good deal in the present, for the potential of a bigger win in the future.
Now you, on the other hand, are fully invested in just one company.
VCs understand that most of their bets are bad investments. They also know that it is all about providing high-speed fuel to the good ones. This can't be predicted, obviously, at the time of investment. But as soon as an investment starts showing signs of weakness a VC may decide to withdraw from that.
This may not hold true for all venture firms. There have been situations where the owners of one bad performing firm might start the next big thing. Still, there is a clear tendency to grant support and attention to the winners.
5) Exit Strategy
Lastly, always keep in mind, a VC's main objective is to make money. By investing in your business, his purpose will remain the same. That is, how is he going to make money from investing in your company? To be fair, anyone would want to make money on their investment. But this issue is what gets ignored by many start-up companies. You'll need to convince the investor, in precise terms, that your company is the one they want to invest in.
There are generally two ways a VC will earn returns from investing in a company. One is that their investment drives an increase in sales. Thereby, within a few years, their initial investment doesn't only get paid back but the VCs then also reaping additional benefits above and beyond their initial investment due to the continued sales. Secondly, and often the preferred strategy, the business gets sold within a few years of investing in, providing them their returns.
Now that we understand what these venture capital firms are looking for, we can take a look at some of the common behaviours in the industry and the impact these have on your start-up. This will ultimately define when to raise VC money for your Company Registration and when to stay away from it.
Know Whether You Need to Raise Venture Capital Funding
Raising venture capital is certainly not all difficult. And there have been many great cases for VC investments. Most importantly, there would have been a number of companies and products which may not have existed without vast amounts of capital, as the funding has been the key to the success of their business.
So in order to understand when to raise VC money and if venture capital is what you need to boost the performance of your business, here's a list of questions you should ask yourself before looking for outside investment.
1) Does your Start-up Classify as a Potential Winner
If you are looking to raise money, you better be ready to meet the following approximate criteria:
- 10x return:
Unless your business can turn Rs. 100 into Rs. 1,000, why would VCs believe it can turn 10 lakh to 1 cr? To build a business that may attract VC funding, you need to be able to create a value of this scale, at least.
- Growth Rate:
What would be the velocity of your growth? How fast can your business and sales grow? There is a huge difference between getting to Rs. 1 cr annual revenue in 6 months or 6 years. This matters for two reasons: 1) Investors will deduct your future growth rate from the past performance, 2) When you’re raising venture funding, you’re, essentially, building your business with someone else’s money. And it cannot come for free.
VCs are looking for fast return investments. Start-ups with clear long-term assets have more value in their eyes. Because their investment would be locked-in for quite a long time, make sure you build a business, not a single product.
2) Is Your Start-up Scalable
You need to ask yourself a lot many questions like this.
- Would adding new clients turn your business into a complex model?
Too complex a model will make your start-up less attractive. And, thereby, cause investors to lose interest and start looking for other options.
- Would adding to your client base result in a relatively low additional cost or not?
- What if you have to take the product to different locations?
- Would your business be able to handle the branching out?
- How easy your product is to understand?
- Do you have a product that is quite the D-I-Y type?
- Is your product ready?
- Or is it in a certain stage of development?
- Is funding the only thing that is blocking your company from getting market share?
3) Are you Competitive Enough
As a founder, you are laser-focused on solving the challenges directly in front of you. While it’s critical to “stay in your own lane” to some degree, you can’t afford to ignore these three critical competitive dynamics, if you want to be venture-funded:
- Being Proactive
Nobody thinks further from achieving success. But once your brand is well established and the products are selling well, what is to stop others from attempting to imitate your success formula?
Once your venture is running well and profitable, you will, most likely, have some formidable competitors who will arise in your space. And you need to keep at the front of the race, else you will lose out on investor money.
No VCs will fund your business if you plan to be on the rank of 4th or 6th amongst the competition. In fact, you can ask the same question to yourself and even you won't put your money on the 3rd or 4th horse. That’s how your competitiveness gets evaluated. Not in the first year or the 3rd year. But for 8-10 years, on a perpetual basis.
- Peer effect
Once VCs get interested in you and you start raising money, you will be part of a bigger group. There must be other companies that have been funded by them or are vying to raise capital. Now, you will face peer pressure on a day-to-day basis. Everything, whether it is the number of employees, revenue, products, and services, you name it, will be compared. The only way to stand out in a weekly VC partner meeting will be the performance. Performance in terms of not only revenue, but the team, market, and defensibility will have to be that much more impressive.
That’s why you are advised to stay within the group where you can compete effectively.
- Sector preference
While some sectors are generally attractive, the reality is that VCs will typically focus on the most profitable sectors. If your business belongs to sectors that have structural risks, like health care or education, it may be tougher to close the investment.
This is also a good reason that sector-focused funds are becoming a lot more common. Therefore, no need for you to get discouraged just because you are in a less competitive funding sector. You can take advantage of both of them and of strategic or sectoral investors within the industry you operate in. They can be of crucial help in navigating hard-to-open sales doors with their industry connections.
How would you like to give away control?
Do you prefer to go solo in whatever you do? Would you not mind attending meetings just to report on the work status etc. to professional investors?
Not every company has a board of directors, but if you raise venture capital it will be a necessity to create one before the VCs invest. And then they will expect to have one board seat of their own. Having a board will by itself mean that you as the CEO would now be reporting to someone else.
Not all investors are the same, but their concerns may not exactly be aligned with yours.
While you may want to grow at your own speed, VCs would push you to grow as fast as you possibly can. It may even result in the capital ending very quickly. They may want you to race so that your business is far ahead of the competitors. VCs may not let you take things slowly and risk being beaten by someone else.
But the attempt to grow at breakneck speed may not always end well. Running such a business would mean you’re constantly stressed. You need to decide for yourself what speed you want your business to grow at before you decide what kind of investors you want to support you.
There's been a lot of hype surrounding venture capital in the last decade. Inspired by the successes of companies around the world, a lot many entrepreneurs try to follow in the footsteps. These entities that managed to raise billions of dollars in venture funding have added value to the industries they operate in.
It creates a significant impact, proving to be a turning point for the niche players, and turning them into multi-billion dollar unicorns.
But venture capital is not a magic wand. It is of crucial importance that you stay honest with yourself and answer these questions sincerely. Whether you actually want a business that should mould according to the wishes of VCs. So, while some companies may benefit greatly from having this access to capital, its uses are limited. Raising venture capital can be a necessary step for many companies who need to spend a substantial amount of money to get off the ground, but it is not compulsory for every business. There is always the option of taking a business loan. Especially if you have dedication of work. And you are ready for hard work and face some ups and downs.
This blog has been shared with an aim to prompt you to take a good look at your priorities. It has been written by Reema, a content writer with FinBucket. India's top portal for professional help related to finance, such as Working Capital Loan, Business Loan, and Invoice Financing, etc.