What you need to know about venture capital before you seek funding
Venture capital is a viable form of funding, particularly for companies in high-growth spaces such as technology, energy and biotech. And for some companies, recruiting venture capital makes sense.
But the funding method is not right for everyone. Although there are countless VC firms looking to invest money in up-and-coming companies, that doesn’t mean you should pursue VC funding at all costs.
How can you determine if VC funding is right for your company? You must first develop a crystal-clear picture of your company, where you want to take it and the circumstances that surround it, and do so before seeking any funding.
“The most essential thing to understand is what type of capital you should be seeking,” says Jennifer Hill, who was a venture capital attorney before co-founding foreign language vocabulary tool Sixty Vocab. “Are you in a high-growth space? Are you willing to sell off part of your company in exchange for venture capital? Can you get funding from other sources? You should be able to answer all of those questions before you go after venture capital.”
Some venture capital firms fund startups, some fund smaller companies that are past the startup phase, and some only play with the big kids, funding later-stage companies worth $30 million or more.
In any case, finding venture capital funding can be difficult, with lots of dead ends staring you in the face before you find the right match. It can be a lucrative path for companies positioned properly but a frustrating and fruitless road for companies that would have been better off taking another route. Determining which category defines your company can have a profound effect on its long-term health and survival.
Businesses looking to the venture capital space for funding need to know one thing: When you bring a VC firm aboard, you are selling part of your company, and thus selling part of the control of your company.
If you run a smaller company that has been primarily funded by family and friends who are willing to let you run the show, this is a critical thing to remember. Selling to a VC firm isn’t all that different from offering public stock, in that you’re giving up part — or all — of your control in exchange for the security provided by a powerful new funding stream.
When you secure the funding of a VC firm, a representative of that firm will sit on your board and help direct high-level decision-making in a way that is in the best interest of the VC firm. If its goals are divergent from your goals for the company, that can create some serious problems that aren’t easy to resolve.
“That is probably the biggest downside that can come out of courting venture capital funding,” Hill says. “You’re losing some control when you sell to a VC firm. You’re involving another entity in shaping your company. That’s why it’s imperative you find a firm that is a good cultural fit for your company.”
If you’re going to pursue VC funding, it’s essential to find a firm that is enthusiastic about the space you’re in and that wants to advance the mission of your business, not just make money from it. Don’t partner with a firm with a dissenting viewpoint on how you run your business, or even a neutral one. Instead, partner with a firm that is active in guiding your business to expansion and further profitability.
“If losing total control is the biggest downside of VC for an entrepreneur, the guidance and partnership of an experienced, enthusiastic venture capitalist is the biggest upside,” Hill says. “It needs to be about more than just the investment dollars. You want a firm that’s jazzed about your business and about what your business could become. You want to partner with folks who can help guide you. If you can find that kind of alignment, the partnership can become something really special.”
And how do you do that? Through lots of research and conversations. Meet representatives from various venture capital firms face to face and gain a thorough understanding of their goals and objectives as a firm. Learn about the firms’ portfolio of companies and why they’ve invested where they have.
In addition, talk to other companies that have partnered with the firms you’re considering — and, if possible, companies that ultimately turned down investment opportunities from those firms.
“Entrepreneurs tend to be the most honest with each other, I’ve found,” Hill says. “So if possible, seek out companies that have turned down investment from the firm you’re considering and see why. That’s not to say you should turn down opportunities based simply on what they say, but the more people you talk to, the more realistic picture you’ll be able to paint.”
Understand what you need
A significant amount of prestige is attached to successfully recruiting venture capital funding. If VC firms are interested in your business, that means you’re an appealing target for big-time investors.
That allure can make it extremely tempting for companies to pursue partnerships with VC firms, even if doing so isn’t necessarily the right path. But if you chase VC funding without really needing it, the negative consequences can outweigh the prestige many times over.
Many companies — particularly startups or those early in their life cycle — simply don’t need the type of funding provided by the venture capital space. In most cases, the simplest and most straightforward path to funding is the best one.
“Part of understanding your company is understanding the amount of funding you need,” Hill says. “It’s one of the first questions you should answer, and be able to answer truthfully.”
If you need $25,000 in funding to get a business or project off the ground, you don’t need the help of a venture capital firm. There are many other, more readily available sources of funding for that amount of money.
“For $25,000, you can go to a bank,” Hill says. “You might be able to raise that amount through friends and family. If you’re looking to raise $20 million, you’ll more than likely need professional investors. But if you honestly don’t need that type of money, you don’t need to involve that caliber of an investor that will take a portion of your company from you. Be honest and take the temperature of your company to see what you really need in terms of funding.”
Hill says entrepreneurs in start-up mode or early in their company’s life cycle should look inward first to determine if it’s possible to self-fund via bootstrapping methods. If you have to look outside the business for additional funding, friends and family should be the next source. Beyond that, numerous government and private programs offer grant money and loans, or you might be able to secure that amount via a bank loan.
“It’s kind of a scaling process,” Hill says. “By the time you need to seek venture capital, you’re likely well established in your business, or at least well established as an entrepreneur with a number of successful ventures under your belt. That’s when you start looking for the firms that have open checkbooks and expertise in the industry you’re in.”
It takes time
If you decide that venture capital is the way to go, don’t expect to have a stampede of would-be investors beating a path to your door. In much the same way that you should be selective about who you partner with, VC firms are extremely selective about where their money goes. Even if you develop a positive initial relationship with a VC firm, it could take months or years before that relationship involves dollars and cents.
“Being totally honest, it takes lots and lots of meetings to make something like this happen,” says Bob Lentz, entrepreneur-in-residence at Northeastern University’s Center for Entrepreneurship Education in Boston. “You usually have to have hundreds of meetings with many different potential venture capital firms or angel investors before you find one that is interested in your product and niche, and that is ready to commit money to it.”
But if you can find the right venture-capital match for your business, the benefits can be significant and long-lasting. If your venture capital partner brings a set of skills and competencies to the table that you or your team don’t possess, it can make the company much stronger, positioning it for levels of growth that it couldn’t have attained otherwise.
“Entrepreneurs often get focused on the end goal and might not realize when a strategic shift is needed to stay on path to reach that goal,” Lentz says. “If you partner with a good investor, they’re going to be able to see the signs that a strategy shift is necessary. If they’re experienced, and particularly experienced at dealing with companies in your industry, they’re going to be much more astute when it comes to identifying the signs that a strategic shift is needed.”
Even though it might be your idea, your company or your product, don’t hesitate to bring people aboard who are more knowledgeable about your space than you are.
“Every person running a business needs people on board who bring different strengths to the table,” Lentz says. “It doesn’t mean they’re smarter than you, it means they have more experience and can serve as an extra set of eyes to help you watch for certain situations that could develop. If you find the right investor match, it can benefit your company in many different ways, and you should embrace that.”
But you can’t force-feed that type of relationship into existence. Lentz echoes Hill’s words: If you don’t have the time to invest in finding and developing a strong relationship with the right kind of VC firm, or you don’t have the capital investment needs to warrant the involvement of a VC firm, look at other options first.
“Bottom line, you need cash to grow your business,” Lentz says. “And there are often many different ways to get that cash. If you don’t want to give up a portion of control in your business, or you don’t need the type of capital that a professional investor normally provides, don’t look at venture capital. It’s not going to be worth it, for you or them.”
Ultimately, you should pursue venture capital investment because it’s practical, not prestigious. Always follow the path of least resistance first.
“It’s very hard to raise money in the world of business,” Lentz says. “It takes a lot of time, no matter the route you go.”
Things to remember
- Venture capital firms are usually attracted to businesses in high-growth sectors, such as technology and biotech.
- Different VC firms will fund at different levels, from startups to tens and hundreds of millions of dollars.
- In order to find the right match, you’ll need to do extensive research on many firms.
- Developing investor relationships can be a long and difficult process. You might wait months or years before finding an investment firm that believes in your company enough to invest money in it.
- The simplest resolution is often the best, so if you can more readily solicit investment dollars from friends and family, or via a traditional bank loan, consider that before pursuing venture capital investment.
- When you bring a VC firm aboard, you are selling a portion of your company in exchange for financial backing. That means the firm will have a seat on your board of directors and be able to exert influence on the direction of your company, which makes finding a philosophically aligned VC firm of critical importance.