In: Accounting
Many entrepreneurial ventures raise money from venture capitalists. Getting venture capital funding is a complex process of finding one or more partners to commit to back the company on its journey. The relationship between entrepreneurs and venture capitalists is important – it can be very positive and help a venture succeed, or it can be stressful and have negative implications. We will spend quite a bit of time trying to understand what venture capitalists do and how they structure deals with entrepreneurial ventures. The big question – Can venture capitalists help you and your venture succeed? Venture capitalists are professionals who specialize in investing in high growth potential ventures. They typically raise funds from institutional investors, corporations or individuals and form partnerships that deploy capital over a period of up to ten years. The venture capitalists act as General Partners and the investors are Limited Partners. Venture capital firms have two income streams. They charge a management fee based on the amount in the fund and they take a share of the profits – that share is called the carried interest. For most funds, the management fee is under 2% per year and the carried interest percentage is between 15 and 30%. Most venture capital firms have several partners and invest in multiple companies, often in separate rounds of financing for each company. Venture capital firms tend to specialize in geography, stage of investment, and/or industry. At one end of the spectrum, some funds only invest in early-stage companies. Other firms invest in more established companies to fund growth. The professional venture capital industry has existed since the 1940s though the industry remained small until the mid-1990s as the Internet revolution took hold. Total capital deployed in the industry is under $300 billion. There are several hundred active venture capital funds in the United States and around the world. Venture capital is a “hits” business. Even the best investors lose money or make modest returns on a majority of the companies they back. A few great successes generate most of the value, as was true with companies like Intel, Genentech, Apple, Amazon, Google, Facebook and more recent companies like Uber and Airbnb. A small number of venture capital firms consistently back big winners. In recent years, Sequoia, Benchmark, Accel, and Greylock have had a disproportionate number of “Unicorn” hits – these are companies that attain valuations of $1 billion or more. There is enormous variety in the industry. Some funds are small – from $10 million up to $100 million. These firms are willing to back new companies and write initial checks of several hundred thousand up to a few million dollars. Most venture funds reserve capital to make follow-on investments in companies that are doing well. Larger funds – those up to $1 billion in capital – will only invest in companies that might need tens of millions of dollars over the life of the fund. Venture capitalists are active investors. They often insist on a seat on the board of directors and they negotiate for certain control rights such as the right to replace the CEO or to approve any large capital expenditure or corporate action. Venture capitalists almost always use a standard investment vehicle – convertible preferred stock – though the exact terms depend on many factors. Some venture capitalists have been successful entrepreneurs while others have experience in large companies or finance.
What do you think about raising money from venture capital firms? How do you decide whether you should do so?
1 | What do you think about raising money from venture capital firms? | |
Venture capitalists are professionals who specialize in investing in high growth potential ventures. Thereby, they bring wealth and expertise to the company. | ||
Large sum of equity finance can be provided unlike angle investors who invest lower amount. This means that VCs can support either startup or established companies and help in their growth from seed to much later stages. | ||
The business does not stand the obligation to repay the money since the fund is not a debt finance | ||
In addition to capital, VC provides valuable information, resources, technical assistance to make a business successful. | ||
2 | How do you decide whether you should do so? | |
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’s by far not necessary for every business. It’s critical for the company to be honest about the type of company it can really become, because there’s more than one way to build a successful company. | ||
VCs want everyone who pitches them to be thinking big, big markets, big outcomes. If you think that it would be very difficult for your business to break double digit millions in revenue, you could still raise from active angel investors who would be happy making 1.5-2 times their money, but venture capital is not right for you. | ||
Venture funds have a typical life of 7-10 years. Meaning that they need to provide a return to their investors, or limited partners, in no more than 10 years. The only way for investors to get their money back is if you either sell your company for cash or liquid stock, or go public so that they can sell their shares in your company to the general population of equity investors. That means that if you have no interest in ever going public, or if you would really prefer to run your business as long as you possibly can instead of selling it to someone else, then it doesn’t make sense for an early stage investor to give you money. | ||