When a new business is starting, it typically needs an influx of cash in order to really get it off the ground. For example, you need money for office space, business equipment, furniture as well as money to hire and pay employees to work for you. But where does this money come from? Many startups turn to their personal savings or a bank loan for this sort of money.
While these two options can work, they certainly have limitations unless you have some very wealthy individuals you can rely on in your personal circle. For those that don’t have this luxury, using Venture Capital is one of the best options. Let’s get into what Venture Capital is and how it works.
Venture Capital Firms
There are some big Venture Capital individuals out there, such as Patrick Chung of Xfund that have years of experience investing in successful startups, but how does it work exactly?
Venture Capital firms traditionally open a fund, which is essentially a pool of money that the Venture Capital firm will invest into new companies. This pool typically includes money from wealthy individuals, companies, pension funds, and other entities that have money they want to invest. The Venture Capital firm will typically put a fixed amount on the fund such as $150 million.
The firm will then take the money in this fund and invest it into a number of companies. Since the fund will have an investment profile, each fund will have different risks and rewards associated with it that investors will know about when they invest money into the fund.
It’s common practice for firms to invest the entire fund with the expectation that they will liquidate their investments within 3 to 7 years. It is also often the goal for Venture Capital firms to expect the companies they invest in to go public on the stock exchange or to be purchased by a larger company. The goal is to have the sale of the stock, or the purchase of the companies to be more than the size of the fund in order to produce dividends to the fund investors.
How It Works With A New Company
If you are a new company, this is how working with a Venture Capital firm typically works. The founders of the startup will create a business plan that shows their financial goals within the next few years. These plans are then pitched to different Venture Capital firms to see if they want to invest. The first round of money given to a new company from a Venture Capital firm is called a seed round. Most companies receive 3 or 4 rounds of funding before being sold to a larger company or going public on the stock exchange.
The company that received Venture Capital money will give up shares in the company as well as decision-making controls. This ensures the Venture Capital company is involved in company decisions in order to try and maximize profits. Venture Captial companies also provide more than just money to a new business. It provides experience, contacts, and connections to help catapult the new business into profitability.
If you’ve ever watched “Shark Tank,” then you’ve seen Venture Capitalists in action. The biggest question on that show, as well as for any Venture Capital firm is how much stock should the firm get in return for the money it invests? This answer is typically determined based on the valuation of the company. This can be a little tricky to do with a new company without any sort of track record, which is where a very solid business plan and goals can help greatly.
A Good Solution
New businesses often don’t realize all of the expenses they will incur in order to grow. Advertising costs, equipment, and employees are expensive. Most people want to be paid to work, so needing that initial influx of seed funding is essential for most startups to get off the ground. While the money is valuable, the connections and experience gained by using a Venture Capital firm are just as valuable, if not more so, as a company can gain access to tenured executives of companies past to help them move towards success.