While the sums of cash VC funds are willing to invest in growing small businesses can be ridiculously large, VC funding has conditions that business owners must be willing to accept.
Although it's well-known that venture capital funds are highly selective, few entrepreneurs understand the factors that motivate venture capital funds, not to mention the processes and outcomes the VC firm needs to perform in order to achieve its goals. Here's what you need to know about venture capital fund mechanics before you pursue VC funding for your business.
- Stage preferences. Venture capital funds are primarily interested in funding companies that are already established and poised for explosive growth. Although it's possible to fund a startup with venture capital, it's more likely that VC funds will be interested in your business after it is on its feet because it will require less time for the VC fund to receive a return on its investment.
- Equity. Venture capital funds typically take an equity position in the companies they fund. Since they aren't earning on income (per se), venture capital funds want to quickly increase the value of the companies in their portfolio, at a level that substantially exceeds their investment. Consequently, VC funds are attracted to companies that are on the cusp of developing proprietary technology or innovative processes.
- Desired outcomes. Venture capital funds earn most of their profits through the liquidation of their equity position. So it makes sense that venture capital fund partners are motivated to achieve a realization event (e.g. IPO, company sale or staged exit) as soon as possible. The longer they remain attached the company, the longer their capital lies dormant. If the business owner isn't open to an IPO or sale, they can find themselves at odds with the goals of the venture capital fund.
- Control. Don't expect your venture capital fund to simply send a check and let you handle the details of running your business. With vast sums of money on the line, venture capitalists want to be integrally involved in decision-making and even day-to-day operations. The benefit is that your business can gain the expertise of seasoned professionals; the downside is that you will inevitably lose a certain amount of control over you business. To be safe, carefully review the term sheet to make sure you're comfortable with the level of involvement the VC fund expects to have in your company.