Whether you own a business at its early stage or a well-developed stage, you will always look for better opportunities to scale. And those opportunities need proper financing to take shape. Some companies require funds to run their routine operations whereas others need cash sources to expand their operations. It is important to remember that limited finances can also limit your potential to materialize goals. There are multiple capital sources you can seek no matter what stage your company is at.
While personal savings and funds from friends and family can support your nascent stage businesses, angel investors and VCs can help you scale your growth stage company. Especially with Venture Capital financing, your funding advantages are limitless. This article will guide you through VC financing, the types of VC financing and the pros and cons of VC to help you make informed decisions.
VC Funding or Financing
Every business has specific funding needs. Depending on their requirements, expectations from the business and the stages, a founder can choose an appropriate type of funding. For example, if your business needs short-term capital, you can look for money from your investments or borrow some quick cash from your acquaintances. On the other hand, some investors are not keen on returns but want the company to grow in value. VC funding is the best source of capital if you are certain of some exponential growth in the future. Read on to know why.
What is Venture Capital?
Companies with some great profit potential, at their early stage usually require capital sources to fund their operations. Venture Capital is a crucial funding source that supports such firms which might one day yield returns to them. A Venture Capitalist may be an investor with an extraordinary financial background or a community of investors from a common institution.
Also, the VCs do not always back these firms through financial assistance. They will also be involved in the technical and marketing operations to share their past experiences. Their ultimate goal is to see the company grow and make great returns quickly. And to achieve this, the VC firms will bring in insights and strategies from competitors, Market trends and their expertise. It is certainly a risky adventure to trust a company at its infant stage and invest huge amounts for the long term. But the reputation and high returns are worth the struggle.
How Does Venture Capital Work?
Whenever a company with a promising future is looking for expansion, handling heavy competition from the industry or in need of assistance in terms of investments, expertise and networking, they can approach Venture Capital firms. There are different stages at which these firms help the firms in need.
- Seed – This is when a budding company needs help with launching, market study and drafting business plans. VC firms will offer capital support to such firms if their ideas look promising.
- Early Stage – Firms at this stage may need funds to hire staff, product manufacturing and Purchasing equipment.
- Series – When a firm needs more capital to develop its business to the next level such as increasing sales, generating revenue and incorporating marketing activities, they go for a series of funding rounds like A, B, C and beyond.
Research reveals that VC investors have spent $100 million more in 2022 than they did in 2021. Even with the mass layoffs, frequent stock market crashes and collapse of digital currencies, Venture firms have managed to reach $445 billion in funding in 2022.
What is VC financing?
Venture Capital Financing or VC financing is a funding option that VC firms use to support the capital needs of firms at different stages. Business projects that need higher funding to thrive in the market while also demonstrating growth potential seek VC funding. It is also a form of private equity where the investors require you to offer them company shares in return and involve them in the decision-making processes.
Sometimes investors may also expect instruments other than equity to process their investment. They can vary from stocks to convertible debts. This is because the nature of investment may vary according to the financial needs and potential of a company. While equity-based financing requires stocks or ownership in the company to fund the business, debt-based financing serves more as a lender.
How Does VC Financing Work?
When a company at its early stage approaches a funding firm, the VC financing firm verifies and identifies the areas that need substantial funds and the returns it can yield. They take some time to analyze if the funding will provide them with lucrative returns and also how they can be part of the company’s growth. Most Venture Capitalists expect a position among the board of directors where they can be part of important discussions and offer suggestions. The investments take place at varied stages from pre-seed funding and expansion funding to acquisition funding.
Just as there are promising lucrative returns, there are enough risks involved in VC funding. Because these investments are made just with an inexplicable trust that the companies will yield good results in the future. In cases of business failures, the VCs will have to find ways to compensate for the losses by themselves. If you compare the 2021 Quarter 4 funds received by American companies to that of 2022 Quarter 2 insights, the values have dropped from $102 billion to $66.2 billion. It is certainly the result of many factors like inflation and recession. It is a perfect example that VC financing firms do not receive easy returns or quick growth.
Types of VC Financing
Now that you know how VC funding works, you might want to dive right into choosing the best investment option for your company. But before that, you need to understand what types of VC financing are available so you can weigh them and make an informed decision.
- Convertible Debt – Convertible debts are contracts that involve two parties, the investor and the borrower, expressing confirmation to pay back the funds received by converting them into shares. This is usually done to companies at their early stages where they require greater funds but cannot afford to pay them back for a while. The contract also offers a calling option to speed up the conversion process immediately after a certain financing limit is achieved. It is a preferred funding option among investors because it allocates an interest rate for the investment until the defined closure. Investors may sometimes require the companies receiving funds to add a valuation cap or discount rate on the convertible Debt notes. The former is the ultimate value after which the debt needs to be converted while the latter allows a discounted rate for conversion.
- SAFE Notes – A SAFE note is a bond that the investor and the founder of a company are part of, assuring a certain number of shares allocated to the lender at a fixed price. It is a form of security for investors. Although convertible notes and safe notes are similar in many ways, the difference is that, unlike convertible notes, safe notes do not incur any interest rate on the borrower. They also involve valuation caps and discount rates as their key elements but are less complex than convertible notes. Company owners enjoy more flexibility in this type of VC financing as it has no obligations to repay.
- Preferred Equity – Preferred Equity is a form of equity that a company offers its investors in exchange for funds. This is better than common equity because when a company’s shares are intended to be distributed, the preferred stockholders will be prioritized. This is because these investors are promised a fixed return at the early stages of the investment. In addition, preferred Equity also comes with involvement in company ownership and voting rights. Using these rights, the investors can be part of crucial company discussions. Also, It offers lesser risk probabilities to investors than those who are involved in common equity.
Pros and Cons of VC Financing
VC financing is a great way to fund your dream business. But what are the dangers of a VC funding process? Will it help you scale your business for the better? Here are some pros and cons of VC Financing to help you make the decision your current business situation requires.
Pros of VC Financing
- It is the best source of capital for companies that cannot afford to take loans and might not be able to repay them.
- Apart from monetary support, VC financing offers business expertise from industry experts which can immensely help the company with its growth.
- VC firms will serve as your gateway to many influential connections within the industry.
- There is no obligation to repay the debts you receive from the investors.
- It is easier to raise further capital if your business operation or expansion policies demand.
Cons of VC Financing
As VC financing firms may be involved in most decision-making processes of the company, there may be conflicts of interest between the founders and investors.
In cases where owners need to offer more stakes to the investors in return for more funds, the former may lose power in managing and making company decisions.
Approaching and getting approval from a VC team is not easy. The firms take longer to verify, review and make predictions of your company’s potential before they consent to invest.
Top Sectors/ Industries With Highest VC Funding
|Funding Received (in $)
|Home and Living
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