Finding ways to finance your startup is crucial. Whether you’re just starting or ready to take on growth, there are many options for funding your business. However, it can be confusing with all of the terminology that is thrown around. Understanding how venture capital works is essential for entrepreneurs considering VC funding.
Venture Capitalism
Venture capital firms pool money from individuals, corporations, insurance companies, foundations, and pension funds to invest in high-growth potential businesses. The investors, such as Brad Kern, share the profits from successful investments and may also have the option to increase their stakes at a lower price than would be available on the stock market. “VCs take significant risks in hopes of enjoying massive returns. They back startups and new technology considered too risky for traditional capital markets or banks. The industry is a rich source of innovation and holds a firm grip on the collective imagination. The popular press is full of against-all-odds success stories. But separating the myths from the realities is crucial for entrepreneurs seeking this type of funding. The costs can be significant and may involve the loss of control over the business.
Business Plan
A business plan is a written document that details a company’s goals and how it intends to attain them. The document typically includes a company description, market analysis, and financials. The company description explains the products or services offered and how they differ from competitors. It should also include the company’s mission and vision. For example, clean makeup brand Saie shares how the founders believe their product can change lives and address environmental issues in their plan.
The market analysis includes in-depth research into consumer trends, competition, and potential disruptions in the industry. It is the most essential part of a business plan if you seek investment. But even for entrepreneurs seeking strategic partners, writing the business plan can help you clarify ideas and identify areas of weakness.
The Elevator Pitch
An elevator pitch is a brief overview of a project or product idea. It gets its name from the notion that it should be able to be delivered in the period of an elevator ride, typically at most 30 to 60 seconds.
An effective elevator pitch should include the following:
- Your name and contact information.
- A summary of what you do.
- A description of the problem you are trying to solve.
You should also provide a brief background on your experience and any relevant qualifications. Whether you are trying to start a conversation with an invite or make a connection at a career fair, having a solid elevator pitch can help you get your audience’s attention and initiate a conversation. It can also speed up the process of nurturing a potential business relationship.
Investor’s Role
Invention and innovation are the engines of the U.S. economy and hold a firm grip on the country’s collective imagination. However, separating myth from reality is critical to understanding venture capital. Banks, for instance, are limited by usury laws in their ability to lend to startups and can only finance those with complex assets against which to secure debt. VCs, however, invest outside equity from professionally managed pools of funds and typically have up-side provisions (liquidation preference) that allow them to take their stake in a company down before other shareholders do. Investors aren’t just writing checks, either — they bring a wealth of direction and industry knowledge. Entrepreneurs must build an investor pipeline that includes VCs who only invest in companies at the same stage of development as their startup.
Exit Strategy
The exit strategy is how venture capitalists plan to get their money back. They must do this at a healthy multiple of their original investment and within an acceptable risk level. The most common exit strategies include secondary offerings, M&A acquisitions, and initial public offerings (IPOs). IPOs are the longest-lasting and typically involve extensive reporting requirements. Venture capitalists focus on the middle part of the classic industry S-curve, avoiding both the early stages when technologies are unknown, and market needs are uncertain. Competitive shakeouts and consolidations are inevitable in the later stages, and growth rates decline. They also try to avoid adolescent periods of high and accelerating growth, when it can be difficult for companies to scale up fast enough to meet demand. This can lead to unsustainable growth and a premature and painful exit.
