What is Venture Capital?
Venture Capital is a form of private equity focused on small companies. It’s a type of financing that provides startups and early stage companies, who have been identified as having high growth potential, with access to funds from investors known as venture capitalists. Venture Capital investors can either act as individuals, groups, or on behalf of a firm which specialises in venture capital investing. Because investing in startups carries a higher level of risk, investors will typically require a high potential return and look for various protections. This allows venture capital investors to protect their investments and assist the strategic direction of the business. Investors must learn to weigh up the risks of investing in startups with the above-average return on a successful investment.
Venture Capital is becoming increasingly attractive for small businesses looking to raise funds and accelerate their develop and presents a readily available capital raising opportunity.
The Benefits of Venture Capital
Countries around the world are realising that high growth businesses drive employment, innovation and productivity. They have reformed laws, taxes and policies to encourage the startup sector and wider participation from investors.
Furthermore, not only will VCs inject capital into a business, they will also actively work alongside startups as coaches and advisors, assisting founders in developing their businesses and curating their strategic direction. In exchange for an equity stake in a business, venture capital investors are giving a lot more than a cheque!
High Average Returns
Investors who fall under the umbrella of Venture Capital usually represent firms or companies that pool client’s money into much larger investments with the hope of making higher returns. Because of the size and risk of their investment, VCs often curate longer-term equity financing options, conduct heavy due diligence and work actively with their companies.
The Australian Government has placed a keen emphasis on small businesses and startups to facilitate investment in innovation and entrepreneurship. This includes providing lucrative tax incentives for investments in high-growth potential startups as part of the National Innovation for Science Agenda.
Investor Ram Shriram invested $100K in Google which yielded:
In 2004 at $85 a share.
Peter Thiel, cofounder of Paypal, invested close to $500K in Facebook, yielding:
After the IPO in August 2012.
Amazon’s founder, Jeff Bezos, also invested $250k in Google, his return:
What do Venture Capital investors look for?
Venture Capital investors are often incredibly experienced in their chosen industry.
When looking for startups, there are THREE MAIN FACTORS that influence their decision.
People who are the best in their class
Venture Capital investors will often judge a startup on more than just it’s business model, forming a basis for the decision on the founder(s) and their personalities.
People with an authentic connection
Investors are drawn to people who desire to make significant change in the world, as oppposed to those who just want individual success.
Founders with real commitment
Venture Capital investors are looking for passionate founders and employees who are really committed to solving a huge problem, which will give them drive to succeed when life gets tough.
Billion or multi-billion dollar global market potential.
Successfully identifying a huge market segment with a huge problem is vital to an investor’s final decision
On trend – businesses with the right timing to solve global issues.
VCs are looking for businesses that are targeting market segment that are growing, as they know that the trend will help carry the business.
Similar market validation and competitor proof points.
Successes in parallel market areas are a great way of showing potential and validation for a risky venture.
What are your sales?
Nothing says “success” more than real (paying) sales traction. High sales that are repeatable and growing.
Who are your customers/users?
VC’s love brand names customers, as they give other customers confidence to buy and often have deep pockets to pay for solutions.
How fast are you growing?
Many VCs look for vector evidence, which is sales (and profit) growth that is trending upwards to the right.
The more information you can provide to investors during your pitch to a VC, the easier it is to confidently demonstrate your proactive business sense.
This reflects well on you and your business from an investor’s perspective!
Here’s our favourite pitch deck template, which can help you raise up to $5m.
The Advantages and Disadvantages of Venture Capital
Like any business venture, venture capital investors will always weigh up the risk-versus-reward when investing, and so should you when pitching to them.
|Access to Funds||VCs can often provide sizeable amounts of funds (upwards of $1 million) as well as follow-on funding to a approved businesses.||Given the size of the capital raise, VCs will often seek to take a sizeable chunk of your business equity and set tough conditions on founders.|
|Industry Experience||VCs should be well versed in high growth business and the industry vertical, and can pass on valuable knowledge, skills and contacts.||However, VCs are often managing many investments, meaning they are often time pressed and hard to communicate with.|
|Return on Investment||VCs expect significant ROI, and will track, help and push an investee business to perform.||On average, VCs expect around 20%+ return on their investment, so underperformance will be unacceptable.|
Venture Capital Investors vs Angels
Whilst both invest in early stage businesses, there is a common misconception that Venture Capital Investors and Angels are virtually the same, but there are many important distinctions.
Use this table to determine the right investment option for your business!
- Company or Firm
- Invest others money
- Focus on later stage capital raising Series
- Larger investment amounts ($1m+)
- May have contacts with a wide range of experienced industry connections
- Will usually require seat on executive board
- Individual Investor (or group of autonomous investors)
- Invest their own money
- Often willing to invest in early-stage or smaller start ups, as well as larger companies
- Smaller investment amounts ($25,000 – $250,000)
- Have hands-on experience in industry
- Do not always require an executive position
Tips for investors interested in Venture Capital
Innovation has become the buzz word around the world for good reason, as it offers one of the main ways to power an economy and employment. Intelligent, wealthy individuals, especially in the US, have been enamoured and investing in startups for many years given some of the following reasons:
Improved investment portfolio performances
Venture capital investments are a powerful diversification element in your portfolio, due to their low correlation with other asset classes like stocks and bonds. A recent SharesPost whitepaper concluded that setting aside just 5% of your investment portfolio to alternative asset classes like private growth companies could improve gross returns by as much as 12%!
offsets and incentives
In an effort to stimulate job growth and cultivate startup culture, Governments often offer tax incentives for supporting startups through investment opportunities such as venture capital. In Australia these include 10 years of tax-free returns for investors, and in the long term, this can help you secure your financial assets, providing additional capital for you to use, invest, or save for a rainy day!
Potential for massive return on investment
Venture capital investing offers the potential for incredible “black swan event” returns, with huge ROI possibilities. There is almost no other investment opportunity that provides such incredible upside potential. Famous venture capital returns include Amazon’s founder Jeff Bezos, who invested $250k in Goolge and cashed out with $1.6bn. Peter Thiel, cofounder of Paypal, invested $500k in Facebook in exchange for 10.2% ownership, and an enormous $1.6bn pay day.