You’re a starry-eyed entrepreneur or business owner with big dreams, intriguing ideas and promising growth prospects. You’ve got the potential, but you need the funding. In that case, it’s time to hook a venture capitalist or two.
Before you move into the market and start networking, you need to consider things carefully and ensure that you can work the nuts and bolts of venture capital financing.
Venture capital (VC) is a form of financing with the medium to long term objective of growing capital by taking a degree of ownership in a business. The venture capitalist will get a stake in the company by making a healthy capital contribution in return for equity. Unlike when buying shares in the company, the equity acquired by the venture capitalist is not easily tradeable on the open market, they will not receive regular dividends and there is no interest earning as there is with regular loan financing.
The utility of ownership in the company will be an immediate and ongoing benefit for them, but their ultimate goal is to receive appreciated capital later when the company has grown (largely owed to the capital injection) and is, in one scenario, looking to sell.
Who / what would the venture capitalist finance?
They are looking at start-ups who are keen to get a foot in the door or well-established businesses intending to scale or increase operations.
The nature of your venture will determine the type and amount of capital needed. VC is appropriate for start-ups because it is interest free and there is no obligation to pay ongoing dividends, which is friendly for unpredictable cash flow. The negative for you is that you need to give away a fairly large ownership stake in the company. Unfortunately, you can’t have it both ways!
What will it look like when you have the venture capitalist on board?
Legal processes aside, their role will mainly consist of checking under the hood of the car (pre-investment) and to monitor and protect their interests (post-investment).
They will not be stepping into the shoes of executive management of the company so they will leave the day-to-day operations to you and your team. However, depending on the size of their equity pie, they may have lots of leverage to negotiate certain veto rights in respect of policy or management decisions.
What would venture capitalists like to avoid?
Mismanagement of risk.
Generally, there is no security for them if things go sour with your business. Their exposure to liability is much higher than in other types of financing.
Start-ups have little to no track record and the venture capitalist will be venturing into the unknown with you. Established companies will be less risky, but the return may not be as rewarding as it is with a unicorn start-up. So, if you want to grab the attention of venture capitalists, you need to assure them that you will pay meticulous attention to risk management and mitigation.
Some tips on risk-mitigation for all parties:
- Entertain constructive criticism of your business plan
- Be transparent regarding your management team and professional advisors
- Have solid finance controls in place and deliver regular financial reports and information
- Keep it objective and think hard before asking for VC from friends and family
- Be honest and realistic about the prospects of success.
If the odds fall in your favour and you’ve onboarded your funder, you will need to formalise the relationship by negotiating the rights and interests of all parties, putting protective measures in place to keep your ideas and intellectual property your own, and by getting the paperwork done. We are here to help you with that, so feel free to get in touch.