By looking at their business plan, entrepreneurs can figure out how much capital they need to start their activity. They can also predict the ways of financing from traditional sources (bank loans, credit cards, or family resources). However, some people cannot get it this way. Therefore, financing through venture capitalists can be an excellent alternative to start and develop your project.

What is Venture Capital?

Entrepreneur pulling cash out of pocket

It is a type of financing granted to private businesses by investors in exchange for a partial portion of the company. Venture capitalists (VCs) are mostly companies like Benchmark or Bill Gurley. However, some people are independent venture capitalists. These are known as “angel investors” because they generally get involved at an early stage and take a smaller bet.

The VCs identify promising new technology, products or concepts and give the necessary funds to move the project forward. As payment for their investment, they generally obtain an action or property. While the impression may be that VC funds are quite common, only less than 1% of companies have obtained VC money.

The Difference Between VCs and Banks

Bank buildings in the center of a downtown area

The main differences are:

  • VCs invest in young companies, in early stages of development with aggressive growth, while banks only invest money in more established associations that generate more profits.
  • VCs take action. They take ownership in exchange for companies not paying the investment. For their part, banks lend money that they will recover.
  • VCs look for businesses where the risk/reward ratio is higher while banks do not want risks.
  • VCs aim at exponential growth in 4 or 6 years, while banks can be paid from 7 to 20 years, depending on what the money is used for.
  • VCs are active investors. Usually, they are involved in the management of the associations in which they invest, while banks are passive and are kept aside.
  • VCs offer more than a financial investment. Many VCs want to have a positive impact on the growth trajectory of the business in which they invest. They don’t want to give money and see the company disappear. Therefore, they want to play an essential role in helping the company be as successful as possible. This means they will assume a position on the board of directors or will at least be consulted for decisions about the business.

How does Venture Capital Work?

Venture capital funds are made up of contributions made by private investors, which may be individuals, companies, funds from pensions or public institutions. These funds are in turn managed by professionals in the sector, called partners, whose objective is to invest in projects and initiatives that involve high risk, but also a succulent return.

Most startups and new companies pose high risks due to their future uncertainty. In general, these are not considered by traditional financial institutions. That is when venture capital companies come into play.

Venture capital has similarities with other sources of financing, especially business angels. However, some aspects characterize it. Its main features are:

  • It is an activity regulated by law and under the supervision of organizations such as the MAB and the CNMV.
  • In general, it is oriented to small and medium-sized business projects, with an innovative business model, and most of the time supported by a technological base.
  • The business plan and the entrepreneurial team has more weight when approving the financing of a project, which is why its requirement in compliance with the business plan will also be more significant.
  • Temporality: they look for a high benefit in the medium term (5-7 years)
  • They assume a higher risk than traditional entities. Its capital and profits will depend on the business evolution, on which there may be higher or lesser uncertainty.
  • Funding is granted in exchange for a stake in the company.
  • If your business is within its field of interest, the ease of access to this type of financing will be higher than via traditional financing.
  • These companies will obtain benefit from the sales that happen to your business. And in some cases, they can acquire the total profits of the company for the initial months.

The Investment Procedure Done by Venture Capital

Entrepreneur presenting business idea to venture capital investor

Venture capital funds invest in different startups, innovative, and newly created companies with high growth and development potential. In exchange, they participate in their capital, which usually amounts to between 25%-30 % of the total.

Besides, they also acquire voting rights and a position on the board of directors of investee companies, to intervene and give their opinion in decision-making. This is how they can assume most of the risk. Once the business has been successful, venture capital companies withdraw their investment by selling their shares to other interested members or on the stock exchange. They can also stay on if they wish as the company keeps growing.

Takeaway: How to Attract Venture Capitalists

It is rare for a VC firm or an angel investor to doubt a new opportunity. Therefore, a young startup is more likely to look for VCs. If this is you, here is where you can potentially get them:

  • Participation in an accelerator or business incubator
  • A meeting with the VC firm
  • An official launch event

Attracting VCs requires the coverage of a launch, which is a PowerPoint presentation about the technology or concept in development. If the capitalists are interested, they can ask to see a business plan that explains how and when the company plans to make money.

If they like what they see and hear, they may offer the terms of what they are willing to offer in the investment and under what conditions. What is most striking about taking the funds of a VCs is the reputation of being associated with a recognized company. The guide offered by a business veteran in entrepreneurship is more valuable than the money they offer.

Another useful piece of advice is to make a very detailed analysis of the project and determine strengths and weaknesses. Those factors can become allies or enemies when presenting it to attract capital. The project will go through many comprehensive reviews. It will face very intense controls. Any questions that arise for investors that do not find solid and convincing answers will be factors to reject the proposal.

For many experts, the fundamental questions that investors ask are:

  • Will it work?
  • Can I make a profit?
  • Is it worth the time and effort?

You have to take care of every detail. At the very least, it will eliminate any trace of doubt. So, prepare to answer every possible question from the ones related to the product or service to market projections.

This preparation increases the confidence of the investors and finally gives added value to the product. They will see that not only as a solid project presented, but it also shows commitment and the high level of professionalism from the people who are developing.

What advice do you have on obtaining venture capital? Let us know down in the comments.

This article originally published on GREY Journal.