Startup entrepreneurs look for investors who are willing to fund their startup’s product or idea. These startups require the capital to get their business off the ground or to realize (rapid) growth. In this article, we take a closer look at venture capital and its associated advantages and disadvantages.
What is venture capital?
Venture capital, also known as risk capital, is the money investors offer a startup business for funding with a stake in the business given to the investor as consideration. The venture capital is invested in companies that are in the start-up phase, as a result, investing in these companies entails a high risk.
Despite startups having a high-risk profile on investment, there exist today over a thousand venture capital firms across the globe. The venture capital market holds enough investors having a significant ‘dare’ to take on risk. In the world of the venture capital market, the rules are simple: ‘the higher the risk, the higher the return’, investors, therefore, expect substantial profit on their venture capital investment.
Venture capital process
The path to venture capital is not always straightforward for entrepreneurs. But roughly speaking, there is a step-by-step plan with 7 steps to make the process to venture capital.
1. The business plan
Most business plans start with an executive summary as the first chapter, a summary of a maximum of two pages of the total business plan. This is followed by the chapters, the idea, the market, the entrepreneur and his team, The financial projections and The exit strategy.
2. The financial projections
The financial projections consist of calculations of the capital requirement, the value of the company and the shareholding that an entrepreneur is willing to transfer to the investor. The more money you ask for, the more shares you have to give away.
On the other hand, it also costs time, effort and money if you have asked for too little capital and therefore have to look for venture capital for a second time quite quickly.
3. Search and find
After you have written your business plan and mapped out your capital needs, the search for an investor can begin. But it’s not a straightforward process.
Therefore, visit as many events and meetings as possible, keep an eye on the media, engage an intermediary or present your business idea on our website.
4. The pitch
You’ve found an investor. Then it is time to package your business plan in a presentation in which you show that you have an attractive proposition.
Two factors are important for making a good presentation: clear content and a logical structure.
No two negotiations are the same. Yet there are several points that you and your investor will always have to agree on: the business plan, the valuation, the deal structure and control.
6. The agreements
If you and your investor agree, the contracts can be signed. These are usually the participation agreement, the shareholders’ agreement, the loan agreement, the articles of association and the management agreement.
7. (after) the deal
It’s the day after signing the agreements. From today, the collaboration with your investor starts. Together you will work to make the company a success!
The benefits of Venture Capital
- Possibility of financing when the bank says no: The bank prefers to take as little risk as possible. They request a lot of documents that show that your company has proven itself. A start-up company or new product cannot yet prove itself. That does not mean that there is no chance of financing. Capital injection by a venture capitalist can be a good option to put your company or product on the market.
- Investor brings knowledge and experience: Some investors would like to share their knowledge and experience with the entrepreneur. That’s why it’s smart to look for a venture capitalist who is already familiar with the industry or with the type of company/product. He or she can guide you to build your business in the right way.
- It gives your company a strong balance sheet position: Venture Capital is included in the solvency of the company. This means that you can count it under your equity. This gives you a strong balance sheet position as a (starting) entrepreneur. This can be an advantage if you later want to raise extra capital from the bank or an alternative financier.
The disadvantages of venture capital
- Relinquishing shares no longer means full control: In relation to ordinary shares, these give the right to control and dividend. Financing through venture capital involves more than just money. You must realize that. A shareholder is, in fact, a co-owner of a company.
- The proceeds are distributed among all shareholders: Shareholders are entitled to a profit distribution. The amount and method of payment of the dividend are determined at the annual meeting. This can be determined per year, but can also be determined for a longer period.
- Long process before Venture Capital is completed: You cannot arrange financial space through a Venture Capitalist within a few days. You must first write a good business plan, find investors and pitch your plan. Then you have to negotiate to get a good deal. Altogether this can take a few weeks to a few months. The result, on the other hand, can certainly be worth it.
- Direct lending as an alternative: Direct lending is not an alternative to capital injection through venture capital. That does not mean that when you look for Venture Capital, you cannot get financing through a direct lender. Direct lending is another way of financing. Direct lending is a quick way to arrange a business loan. You borrow money, pay interest on it and you have to repay everything within the term. As a starting entrepreneur, it is difficult to get financing.
The advantage of a direct lender is that you have received the financing within one to three days. Curious about other benefits of direct lending? We have summarized them in this article.
Identifying capital needs
Before you start looking for an investor, there are two things you need to have in order. Number one is writing and visualizing a strong business plan. Number two is mapping out your capital needs. You can make this transparent by drawing up a liquidity and investment budget.
The liquidity budget contains the expected cash flow. You can immediately see when liquidity problems may arise. At that point, you need extra capital. The investment budget consists of all expected investments that will take place.
The required capital plus the expected investments are the total financial resources you need. It is smart to calculate a surplus of 10% to 20% on this. This way you can be sure that you have sufficient capital.
Getting the needed capital to start up a business is not an easy task, however, I trust that this article has given you possible road maps as to how to go about the rigorous process.
With every step you take, you are just a step closer to finding the right person with the potential to invest in your business. Have a smooth ride all through the process.
Frequently Asked Questions
Yes! Venture capital gives you a strong balance sheet position as a (starting) entrepreneur. This can be an advantage if you later want to raise extra capital from the bank or an alternative financier.
One of the benefits of venture capital is that it gives the Possibility of financing when the bank says no.