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How Venture Capital Works for Start-ups

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The world’s economy largely depends on innovation and invention. Often marred by overly technical terminology, raising capital can be a little intimidating for the average entrepreneur. It is worth noting that venture capital firms are the muscle behind innovation, given that they continuously support the companies they invest in.

As much as it is tough to raise funds for a start-up, venture capital funding can bail out almost every business that does not meet the criteria of traditional lenders. If you are looking to scale on a lucrative exit, this could be a solution to leverage. Here, we tell you what venture capital (VC) is and what the firms offer besides investment.

What is Venture Capital?

Venture capital finance is an investment fund gathered from companies and individuals who hand over a certain amount to a VC firm to have their investment portfolio managed. The funds are given to high-risk start-ups, whereby the funders get equity as their reward.

The investors are informed of the business their capital will be invested in, and the rewards and risks they can expect. Usually, venture capital firms target a particular sector and amount to invest in.

How VC Works?

Sometimes, a little push with capital is all an entrepreneur needs to get their business on the right path of success. As soon as the entrepreneur establishes a firm that can finance their project, they get a chance to grow and get a good share of the market.

Understand, however, the ability of an entrepreneur to capture the attention of an investor is the first test towards their business skills. From the perspective of your company’s age and mission, you can get a potential investor. With a start-up, for instance, angel investors can bail you out.

These assume a great risk by pumping a certain amount of money with the belief that it will pay off based on your business idea. These investors expect to get their money back after a period, usually accepting payments in the form of instalments as soon as the business begins to generate revenue.

For start-ups, venture capitalists are careful to invest just a small amount of funds to help the business get through the first 12-18 months. As soon as the start-up reaches a certain milestone within a specified duration, it automatically earns higher cash injections.

The Pros

Venture capital allows a start-up to gather venture funding, which then allows it to scale faster than it would on its own. When a business partners with a venture capitalist, it can make large investments. Because VC is not the same as a loan, the borrower does not have an obligation to pay back.

• Secure large funding that you would not get from any government or financial lender
• Turn the shares into money within a short duration
• Share financial risk in the expansion of your business

Cons

Although a VC may review your business idea and identify it as low risk, it can present various challenges:

• Surrender most managerial control to the firm
• Give some shares to investors
• The VC firm could take your start-up to the initial public offering (IPO)quickly
• Share your business model details with the firm

The Investing Approach for Venture Capitalists

Venture capital firms are aware that not very start-up will pay off, but they still finance believing that some will still be highly successful and not just pay off, but offset any incurred losses from the failed start-ups.

Most of them limit the number of businesses they fund to dedicate their energies and help them succeed through instilling institutional knowledge. Capitalists also work towards hooking start-ups with successful businesses and entrepreneurs to ensure that they succeed. Venture capitalists tend to favour known industries such as technology because they tend to fetch bigger returns than others. If you are looking to expand your business, venture capital finance should help.

Before accepting offers from a venture capital firm, be sure that the pros outweigh the cons. If you would like to be your own boss, try out other alternative finance that will help you stay in control.

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