Business growth, especially at an expedited rate, usually isn't organic. Even with a powerful idea and world-class marketing and branding, companies require funding to reach their potential. Some businesses, in the early stages of growth, acquire funding through angel investors or venture capital (VC) firms, often in exchange for an equity stake in the enterprise.
Angel investors, for the most part, are experienced entrepreneurs and business leaders who leverage their wealth to invest in promising start-ups in hopes of earning a profit on their investment. VC firms, meanwhile, are teams of investment professionals who raise money from sources such as pension funds, corporations, endowments, high net-worth individuals, and foundations to invest in companies with high growth potential.
Angel investors usually invest less than $50,000 in startups, whereas VC firms, with institutional support, often invest anywhere from $1 million to $25 million in the businesses they fund. Companies like Airbnb and DoorDash raised billions of dollars in VC funding before going public, though this isn’t typical. Meanwhile, the VC industry has grown considerably in recent years as firms look to capitalize on early-stage, innovative, tech-focused businesses. According to FactSet, VC investment activity exceeded $612 billion worldwide in 2021, representing an increase of 108 percent from the year prior.
What Benefit Do VCs Offer Business Owners?
Beyond the obvious funding component, VCs can provide consulting services in many areas of business. Most VC firms are composed of experienced entrepreneurs who know how to navigate the various stages of business growth and may be able to connect startups with important players in their respective industries and additional sources of capital. Because they are investors, VCs are committed to the success of the startups that they fund, and they will generally provide as much support as they can to achieve a return on that investment.
What Should Owners Consider When Seeking Funding?
As important as funding is to facilitate business growth, entrepreneurs should exercise patience and due diligence when searching for the right VC partner. Startups will have a better chance at securing funding if they present VC firms with important facts and business metrics, such as product information and potential, revenue, strategic partnerships, and average customer acquisition price. Thus, it's best to wait until the business is ready for the next stage of growth, which means having stable management, a concrete business plan, solid customer base, and unique selling proposition. Proof of early success and traction in the market go a long way toward convincing VCs that your business is viable.
Though you probably are eager to start making money as soon as you can, don’t rush the process. “Go fast and break things” is a common mindset in the tech start-up world, but you can’t rush so much that you don’t have the fundamentals in place. Start small, demonstrate proof of your idea, and nail down your brand first—you’ll have more success when you begin courting VCs.
Moreover, keep in mind that all VCs aren't created equal. Some invest in specific industries, while others emphasize different stages of ventures with varying degrees of risk. Startups should prioritize VC partners with success investing in their industry. It's also good to know if the firm has enough assets to invest in follow-on rounds as this can save significant time and resources in future fundraising.
How Do VCs Assess Potential Investments?
Even the most successful VC firms lose money on some investments. In fact, the average VC firm takes a loss on half of their investments and only makes money on about 20 percent of the businesses in which they invest. However, these businesses usually provide returns of about 10 to 100 times the original investment. This is because VC firms primarily invest in promising, tech-powered ventures that, with an infusion of capital, could grow at an expedited rate.
Beyond that, VCs look for startups with a quality and experienced management team. Most firms even prioritize the management team over the company's products and/or services.
What Are the Five Stages of VC Funding?
Pre-seed funding is the first of the five primary stages of VC funding. In this stage, entrepreneurs typically seek between $50,000 to $500,000 to conduct critical market research and build minimum viable products. The other stages are seed funding, Series A, Series B, and Series C, each of which typically increases in total average investment as the startup progresses through the stages of business growth. The average Series C funding round, according to PitchBook data, is $58.2 million, for example.
Are There Any Disadvantages to Working with a VC Firm?
While VC funding can help accelerate business growth, entrepreneurs should think carefully before deciding to partner with a firm. In exchange for funding, entrepreneurs may have to give up a percentage of ownership and may not have complete autonomy in key business decisions. VCs prioritize growth over everything, but scaling too quickly can overextend and ultimately kill some startups. There's also a lot more pressure to grow and meet key metrics with VC backing.
Mark Achler, an entrepreneur and venture capitalist, once told Inc. that "to some extent" taking capital from a VC is a "pact with the devil." In some cases, investors have the power, through the board of directors, to remove management teams if they're not happy with their performance.
It’s also worth noting that most successful small businesses do not obtain VC funding, since VCs are only interested in a very small subset of new businesses with exponential growth potential. Most small businesses are financed through personal savings, loans, and other means. However, for those founders who have a potentially disruptive concept, a strong business plan, and a capable management team, VC funding can make a lot of sense.