Entrepreneurs who are looking to raise capital for their startup have options. Deciding what type of investor to pitch to is a difficult task. Fortunately Venture capital (VC) has become one of the most popular funding vehicles for startups. In 2020 alone 10,862 companies received $164 billion in funding. This marked the third year in a row that more than $130 billion has been invested in promising companies. Much of this funding has come from venture capitalists.
Understanding all of the potential investors and their role in your venture can help you decide if a venture capital investment is a right fit for you.
What is a Venture Capitalist?
Simply put, the goal of venture capitalists is to make money on their investment in the shortest amount of time possible. A venture capitalist will give a business capital in exchange for equity in the business. The company can then use the capital to grow the business. The venture capitalists rely on the hope that the business will be worth significantly more in the future than when they invested in the business.
Venture capitalists typically look to invest in companies that have developed or are developing disruptive technology. This class of investors typically are not the first investor in a startup. Entrepreneurs who are just starting their business will typically find it difficult to raise capital from a VC unless they have a proven track record of growing successful businesses. Choosing a venture capital investment is a promising way to ensure that your company can thrive in the future. 20% of all US public companies received venture capital.
Entrepreneurs need to be patient when raising funds from a VC. Venture capitalists will perform due diligence, analysis, and research on companies that they are considering investing in. This will take a minimum of 30 days. Typically, it takes at least six months to complete the fundraising process.
Types of Venture Capitalists
Today, entrepreneurs have more options when they go to raise venture capital. There are multiple types of venture capitalists.
Conventional Venture Capital Funds
The first true venture capital firms, in modern terms, came about after World War II. The American Research and Development Corporation was founded by Georges Doriot, the father of venture capitalism, along with Ralph Flanders and Karl Compton in 1946. This fund had incredible successes, such as the 1957 funding of Digital Equipment Corporation where the initial investment had a return of more than 1200 times.
This type of fund became popular in the 1980s. There are about 1,000 active venture capital funds in the United States. Venture capital funds invest actively for a period of three to four years and the capital is locked in for at least seven to ten years. Venture capital funds are selective about the companies that they invest in. A Stanford survey showed that venture capital firms only invest in one company for every 100 companies they consider.
Some venture capitalists are only involved passively, while others get directly involved in the business. Venture capitalists can provide their investment companies with marketing, human resources, and office space. This could be potentially invaluable for startups that are still working through growing pains. Venture capitalists have experience working with other companies they have invested in and can help other startups navigate issues that they have seen previously.
The popularity of traditional venture capital firms has led to the rise of alternative venture capitalists. Companies whose main focus is not venture capital have gotten into this area of funding.
Corporate Venture Capitalists
Corporate entities are now investing in startup companies. Large organizations looking to hedge their long-term bets have become venture capitalists. The most innovative companies in the world, such as Google and Apple, are investing in startups. These companies are looking to maintain their position as leaders by investing in companies that may be their competitors in the future.
Corporations may have different goals and requirements as compared to other venture capitalists. They also will likely have more product and technical knowledge than the typical venture capitalist. Subject matter experts may grill your business about your technology. This type of investor typically falls into one of three categories when they invest in startups:
This type of corporate venture capitalist operates similarly to institutional venture capitalists. Their goal is to utilize the corporation’s capital to scale their portfolio and generate massive returns. This type of corporate investor will have full-time teams dedicated to this effort. Companies may want to seek investment from this type of company to help them open up revenue streams.
Corporate venture capital funds are not always driven by returns. Technology companies have to stay on top of the most recent technology to stay competitive. Many corporations are focused on investing in new technologies that can improve their product offerings.
Large corporations who are just beginning to get started in venture capital typically lack experience and proper systems. This type of corporate investor moves slower than the other two types and typically does not have a full team dedicated to investing. They also likely do not have a dedicated venture fund in their balance sheet.
Entrepreneurs should understand what type of corporate venture capital they are working with. Startups can benefit from corporate-backed venture capital by leveraging the company’s industry expertise, brand name, network, talent, and more. Corporate venture capitalists may eventually purchase the startup that they have invested in.
Solo Venture Capitalists
Individual venture capitalists raise outside capital, but they operate alone. Solo VCs can decide independently to invest in a startup without permission from anyone else. This type of investor has long been part of startup investment, but the size of the check has recently increased dramatically. Playco announced its $100 million Series A funding in September 2021. Unlike other funding rounds, one of the co-lead investors was Josh Buckley, a solo VC.
These solo VCs can make deals quickly because they have deep connections and are desirable partners to startups. This group of investors is typically willing to offer entrepreneurs better terms and valuations than other investors. Solo venture capitalists do not need buy-in from other partners or team members Which allows solo VCs to move faster than traditional venture capitalists. Additionally, these venture capitalists can spend their time helping founders of companies, instead of dealing with partners and team members.
Alternatives to Venture Capital
If you cannot raise capital from venture capitalists, all hope is not lost. There are other methods and institutions that entrepreneurs can utilize to raise the capital they need to take their businesses to the next level.
Private equity firms and venture capitalists are similar. Both types of financial institutions require significant equity in your business in exchange for capital. Private equity funds typically focus on more stable companies, while venture capital focuses on early-stage companies with the potential for massive growth. However, private equity funds do invest in startups.
Special Purpose Vehicle
A special purpose vehicle (SPV) is another way that entrepreneurs can raise money. This type of funding is similar to a venture capital fund in the way that they are structured. However, an SPV is used to pool money from a group of investors to invest in a singular company.
SPVs are typically a short-term commitment as compared to traditional VC funds. Venture capital funds can use SPVs when the investment opportunity falls outside of their traditional investment philosophy. SPVs provide affordable investment opportunities to accredited investors.
Special Purpose Acquisition Company
Special purpose acquisition companies (SPAC) are companies with no operations that are created purely to raise capital through an IPO. A special purpose acquisition company is also known as a ‘blank check’ company. SPACs have recently exploded in popularity, with more than $80 billion in funding raised in 2020. Startups have been utilizing SPACs to take their companies public.
Similar to SPVs, SPACs are created to only invest in one company. Startups can avoid the traditional IPO process by taking the SPAC route to go public. This is potentially advantageous for multiple reasons. The traditional IPO process takes up to 18 months, meanwhile, the SPAC process only takes 4-6 months. This means that your startup can raise the funds that you need in a shorter period of time.
Another potential alternative to venture capital is crowdfunding. Startups can reach more investors than ever with social media and the internet. Entrepreneurs raise money from a pool of small investors, who typically only invest a few dollars or a few hundred dollars. In exchange, investors receive equity, gifts, and/or products.
Media for Equity
In Europe and India, a more common alternative is for investors to provide advertising and media coverage in exchange for equity. Startups often do not have the skills and expertise to get the word out about their technology or service. This type of investment can be used to bridge the gap between rounds of funding.
Choosing the type of investment that is best for your business can make or break your business.
What Type of Venture Capitalist is Right For Me?
Deciding what type of venture capitalist you should be looking for is not an easy task. You may go to try and raise funds from traditional venture capitalists, but find that a corporate venture capitalist is the way to go. As an entrepreneur, you need to be open to all potential sources of funding.
More Than Just Capital and Prestige
Entrepreneurs often only aim to raise the most amount of money when going to raise venture capital funding. Raising the most money possible is a costly mistake that entrepreneurs have fallen victim to. Targeting the biggest venture capitalists can have its benefits, but also potential drawbacks.
You will have a long-term relationship with the venture capitalist who invests in your company. You need a venture capitalist whose long-term vision and goals align with yours. If you have different versions of what your company looks like going forward, then you will run into serious problems.
A venture capitalist’s record with similar companies can help you make a decision. Study companies that have received funding from the VC firm you are considering. Talk to other founders who have taken capital from the investor. This can lead to valuable insights on how the firm works with founders who have taken investment, whether the insights are positive or negative. The venture capital firm you choose to work with is your business partner for the next five to ten years. This choice should not be taken lightly.
Expertise is important when targeting venture capital firms. Choosing a VC firm that knows the industry that you are operating in can help you navigate your industry. They will have connections and know-how to help ensure that your business continues to grow. A VC firm that does not have experience in your industry, but is looking to invest in your company could be a potential red flag.
Although entrepreneurs will likely take financing from anywhere in the world, choosing a VC firm that is located closer to home can impact your decision. If your VC firm is just a short drive away from your business, you can receive input faster when you need it. Taking long flights across the country or the world is a massive time investment that can take your focus away from growing your business.
Venture capital funding is hotter than ever before as investors try and cash in on the next big company. If your company can raise enough capital, you can potentially be the founder of the next unicorn company. Venture capital can help your company grow through the money and resources that VC firms have.
Ready to start fundraising? Sign up for one of our info sessions to learn more about the Newchip accelerator!