Venture capital for startups and small businesses

Raising money for your business doesn’t always mean using traditional borrowing methods. Getting loans approved can be challenging, especially if your business is pre-profit or pre-revenue. This is where venture capitalists come in; they provide both financial support and valuable business advice. Let’s break it down.

Key takeaways

• Prepare a compelling pitch and business plan so venture capitalists can quickly understand your idea and likely returns on their investment

• Recognise it can be a lengthy process that requires networking and preparation

• Carry out thorough research on investors before approaching them with your pitch – if they haven’t invested in your sector before, you might be wasting your time

What is venture capital?

Venture capital is a form of private equity financing and a potential source of funding for your business. It involves a venture capitalist (VC) investing in a business (or an entrepreneur) during the early stages of their startup journey. While there are no specific exclusions, VCs often focus on businesses in the IT, life sciences, and financial technology sectors. 

A VC can invest not only cash but also time. Access to an experienced VC can be an invaluable resource for small businesses. Imagine facing a make-or-break decision and having a successful, savvy business person nominated as your ‘phone a friend’ option. VCs have experience of your situation, can help you strategise, and can connect you with their network - all of which helps your business move forward quickly. 

But VCs expect something in return for their time and money. Venture capital is a type of equity finance, meaning you give up equity stakes or shares in your business in exchange for funding and advice.

Read more: Ten realistic ways to raise money for your startup

How does venture capital work?

Venture capital is a high-risk, high-reward arrangement. Let’s start by looking at the process from the venture capitalist’s side:

Step 1: Fundraising

Venture capital firms raise capital from various sources, including high-net-worth individuals, government entities and known investors. The VC firm then pools this money into a fund. 

Step 2: Investment opportunities 

With a fund in place, the venture capital firm starts looking for investment opportunities. This can happen at industry events, through referrals or through existing networks. The firm then screens the opportunities it identifies, considering factors like market potential, the business model and the overall industry landscape. 

Step 3: Evaluation and risk assessment

This is when the venture capital firm conducts its due diligence. A VC typically requests business finance documentation and a business plan to assess the likelihood of seeing a return on investment (ROI).

Step 4: Investment 

If everything checks out, the venture capital firm and business seeking funding negotiate investment terms. This includes the amount of funding the VC will provide and the equity stake it requires in return. Once all parties are satisfied, a formal agreement is signed. 

At this point, the newly funded business can begin to benefit from any growth or strategy support the VC is willing to offer.

When the time comes to part ways, the VC's exit strategy is typically straightforward and involves making a return on its investment. It usually achieves this by selling the startup to another company, taking the business public on a stock exchange or selling its shares to other investors.

Venture capital funding stages

Now that we understand the VC’s process, let’s take a look at how things work from your side. Small businesses go through venture capital funding stages. The following are generalised examples – the specifics of each funding round can vary depending on your industry and wider market conditions.

Pre-seed

This is the earliest stage and usually involves the least investment in monetary terms. You’re likely still in the pre-seed stage if your business is still forming ideas and concepts. You may not have a minimum viable product (MVP) – that is, a physical product or service. You might also be seeking funding to conduct market research to refine your idea.

This stage isn’t exclusive to venture capital. You could be in this stage while obtaining funds from angel investors, family or friends.

Seed

Your business is in the seed stage when you have a refined concept that needs funding to become a reality. You may need money to hire key team members or to build prototypes. This stage is still not exclusive to venture capital, but early-stage VCs may now start getting involved.

Series A

You’re in the Series A stage if your startup has its MVP and a plan to achieve long-term profit. Startups in this stage need funding to scale or expand their operations, which may involve hiring employees or purchasing stock or equipment. As a result, businesses in Series A typically require more cash than those in the seed and pre-seed stages, so they often seek funding from venture capital firms.

Series B

Businesses in the Series B funding stage are usually identified by the fact they have high growth potential and are likely to offer a good return on investment. A business in Series B probably needs funding to grow even further, such as adding new products to its range, starting global exports or entering new markets. Venture capital firms are likely to be involved at this stage.

Series C

Businesses looking for Series C funding are likely transitioning to a large enterprise, demonstrating significant revenue growth and a strong business model.  

How to get venture capital funding 

Before approaching a venture capitalist for funding, consider a few important factors. The more you have in place, the stronger your pitch is. So take the time to prepare before diving into the process. Here are some things to put in place before approaching a VC:

• Craft a strong business plan. Whether you seek equity or debt finance, you need a strong business plan. It should clearly outline your business model, market research and financial projections.

• Build a solid pitch deck. To help with your pitch, create a concise and visually appealing pitch deck. This deck should effectively summarise your business plan.

• Demonstrate appeal and traction. If you’re trading, make sure any customer reviews are visible. Testimonials and early sales figures can really enhance your pitch.

• Do your research. Conduct research before approaching potential investors. Check if the VC has invested in your sector before and try to understand their interests. This can save you both a lot of time.

• Approach investors. Once everything is in place, you can start approaching investors. This can happen at industry events, through networking opportunities, or by email. Be sure to include your pitch deck and a strong executive summary of your business plan.

• Build relationships. Venture capital isn’t necessarily a quick fix for funding. You may need to network and build relationships over time, so be prepared for that.

Venture capital advantages and disadvantages

Venture capital isn’t right for every type of business at every stage, and like most financing options, it has its pros and cons. 

Advantages

• Access to cash. Venture capital provides funding that can help you scale up quickly and cover operational costs, product development and marketing expenses.

• Expert guidance. VCs often bring valuable industry experience and insights, offering mentorship and strategic guidance to help you navigate challenges during your business journey.

• Networking. VCs can connect you to a network of industry contacts, potential customers and follow-on investors, all of which helps facilitate growth and expansion.

• Credibility. Securing funding from a venture capitalist can serve as a stamp of approval for your business. It enhances your credibility and may attract additional investors or customers.

Disadvantages

• Less equity. Accepting VC funding typically requires giving up a significant equity stake in your business, which reduces your overall control.

• Pressure for growth. VCs expect high returns on their investments, often within a short timeframe. This might lead to a pressured environment.

• Loss of control. Investors may demand significant input or insist on making business decisions. This can further dilute your control over the business’s direction.

• Consumes time. It can be a lengthy and complex process to secure VC funding. You may spend months networking. Then, when you finally get a meeting, it often involves extensive negotiations and ongoing communication, which can distract you from running your business.

Alternatives to venture capital

There are many alternatives to venture capital. Debt finance is an obvious example. This type of finance allows your business to raise finance through borrowing. That includes business loans, credit cards, overdrafts, asset finance, invoice finance and business lines of credit. 

There are also alternative equity finance options to explore. For example, you could consider crowdfunding platforms or angel investors.

You could also consider bootstrapping, where you fund your business with your own money. You can also use grants. The government and other organisations offer these as another way to fund your business.