What is a venture capitalist and how can they help grow your business?

Venture capital is a popular form of private equity and financing for startups and small businesses. Venture capitalists can provide valuable funding to organizations at all stages of growth.

What is a venture capitalist? Also known as a VC, a venture capitalist is someone who provides equity to a venture capital fund; VCs are usually wealthy individual investors, although they can also be businesses, such as banks or other financial institutions.

Venture capital is of particular interest to small businesses as it can enable rapid growth and expansion at a time when it can be otherwise difficult to grow. This support isn’t just monetary. VCs can nurture businesses with their knowledge, experience, networks, or technical expertise in a specific field.

With the right strategies and partners, venture capital can be one of the most exciting and profitable forms of investment. Learn more about what is a venture capitalist, the benefits of VC financing, and how to attract venture capitalists for your business.

How venture capital works

Venture capital works by raising funds, either from individuals or organizations, and then investing in businesses that have demonstrated growth potential. Depending on the fund, VC can be invested at several stages in the business lifecycle. For example, seed-stage funding helps new businesses get off the ground. Late-stage venture capital is invested to help established companies continue to expand. Some VC firms invest across a range of industries while others prefer to invest within a particular vertical.

Along with their financial business investments, VCs can also add value by providing experience and technical knowledge that can be of enormous benefit. For example, VCs can provide access to their network of connections, aid in the strategic decision-making process, or even participate at board level.

To ensure a return on investment, venture capital firms usually identify an exit strategy, such as an initial public offering (IPO), acquisition, or buyback.

What are venture capital funds?

What are venture capital funds? It’s essentially pools of small business funding accumulated from investors looking for opportunities to finance early-stage companies. They generally focus on companies with a high long-term growth potential but need financial backing to drive their development.

VC funds are made up of limited partners (LPs) and general partners (GPs). Limited partners constitute the core of most of these funds. These are the individuals or organizations who invest their time and money into the fund and recipient businesses. The general partner is a legal entity, usually established by the fund and employed to manage the overall partnership.

Each VC fund can set its own rules for how it operates and receives funding. Some may not collect everyone’s money upfront. Instead, they might use drawdown funds to gather capital from investors as needed. This is done through capital calls, which are mandatory requests for investors or LPs to provide a certain amount of money. Investors agree to have this money available when they buy into a fund. VCs might initiate capital calls when they are ready to invest in a new business or need to cover certain expenses.

What do venture capitalists look for in a business?

If you’re interested in securing VC funding, you might be wondering, what do venture capitalists look for in their investments? They may have strict criteria for the businesses they work with because they want to ensure their return on investment and grow their portfolio. As such, VCs might seek businesses with a:

• Strong and passionate founding team: VCs want to know that they’re working with professional and capable people who are committed to the business mission and willing to work hard to deliver results.

• Significant market value: VC firms might look for businesses that can help them enter a certain market or industry and gain a competitive edge.

• Unique value proposition: VCs might be looking for the next big thing — a truly special product or service that meets a specific customer demand or fills a gap in a niche market.

• Scalable business model: Seeking more than just a one-off fad or trend, VCs want to know that a business can scale and sustain operations for long-term profitability.

If a business meets some or all of the above criteria, they may be a potential candidate for a venture capitalist opportunities.

How can businesses attract venture capitalists?

There are certain strategies small businesses and startups can use to earn the attention of VCs and demonstrate their market potential. These strategies include:

• Developing a strong network: Build connections with investors by attending industry events and conferences.

• Establishing an online presence: Create an engaged community through social media accounts, blogging, and thought leadership content. This can help not only attract VCs but also demonstrate your ability to build an audience and grow your brand.

• Formulating a sales pitch: Have both an elevator pitch and an in-depth presentation prepared so you’re ready for any opportunity.

• Knowing your target market: Make sure you have a clear understanding of your ideal customer and their pain points — and how your product can meet their needs. Be ready to answer detailed questions about your target market.

• Creating a roadmap: VCs don’t just want to know how you’ve already grown; they want to know your vision for a profitable future. Sell them on your growth trajectory and establish a clear plan for generating revenue.

Stages of venture capital investing

There are several stages of the VC investing process. Businesses might seek investments during different phases of growth, for example, and work with VCs secure funding for specific needs.

These stages include:

• Seed stage: VCs provide funds to help create a proof of concept or develop a prototype. They might believe in the product or vision but need to help the business demonstrate its value and practicality first.

• Startup stage: Investors fund businesses that are ready to operate but have little to no revenue. Venture capital is one of the primary startup funding sources, along with small business loans and lines of credit.

• Early stage/growth: Funding helps scale operations for companies with a proven model and some revenue.

• Expansion stage: Funding helps a well-established business grow further, such as by expanding into new markets or launching new products.

• Late stage: VCs invest in mature companies nearing an exit or transformation, such as an IPO or merger.

Benefits of venture capital for businesses

Venture capital investment and support can have huge potential benefits for small businesses looking to progress to the next level.

The biggest benefits of venture capitalists include:

• Large capital investment: VCs can provide significant sums of money to help businesses cover a range of expenses and operating costs. For example, businesses might use VC funds to start or speed up manufacturing, purchase inventory, hire staff, launch new products, buy equipment, or set up retail space.

• Technical guidance: Beyond just financial support, VC firms can offer mentorship and technical expertise to help businesses navigate growth stages and make key decisions. As investors and business owners themselves, they have the knowledge and experience that many startups need to succeed.

• Access to a network of contacts: VC funds have already put the legwork in to build long-term, reliable relationships with suppliers, partners, and other industry contacts. With VC funding, new businesses may be able to tap into these ready-made networks of valuable connections.

Challenges of venture capital for businesses

As with any form of financing, there are some potential challenges and risks of VC, including:

• Loss of equity: By giving up shares to VCs, business owners will lose equity in their company. This means they may lose some decision-making power and creative control. Especially if startups bring multiple investors on board, their shares will continue to dwindle and they may have to juggle opinions from many different stakeholders.

• Change in company direction: With decision-making power, VC firms may choose to shift the direction of the business, straying from the business owner’s initial mission. For example, VCs might decide it’s more profitable to change the target audience, market, or even core offering.

• High expectations from high-value investors: Since VCs want to see a return on their investment, they might place significant pressure on businesses to perform and reach certain milestones. Businesses might even have to speed up production and meet specific goals to receive their next round of funding.

What is the difference between a venture capitalist and an angel investor?

Although venture capital firms are similar to angel investors, they are not the same. First, the meaning of angel investor: A high net-worth individual who invests their own money in a business. For example, an angel investor might’ve already built and sold a successful company, and they’re looking to use their profits to invest in new business ideas.

Venture capitalists, on the other hand, invest money that is being controlled by a capital fund or firm. While both VCs and angel investors bring expertise and support in return for a share in the business, they can have several notable differences, including:

• When they invest: Angel investors commonly invest when businesses are in the nascent stages of development and may not have earned any revenue yet. Meanwhile venture capital firms commonly invest in businesses that have generated some revenue but are looking to grow rapidly.

• How much they invest: Since angel investors are individuals who use their own money, they might invest less than VC firms, which use a pool of funding from various sources.

• How much they control: Angel investors might seek less equity and control over business operations compared to VC firms.

What is the difference between venture capital and private equity?

VC firms are similar in some ways to private equity investors. However, there are some key differences between venture capital and private equity that are important to understand, such as:

• When they invest: VCs typically focus on early-stage, high-growth companies, while private equity is generally more focused on mature companies.

• How much they invest: Private equity firms typically make much larger investments, often of $100 million or more. Meanwhile VC funds invest at lower levels, typically $10 million or less, as they are usually dealing with startups or smaller businesses.

• How much they control: The degree to which each type of investor gets involved in the daily operations of the portfolio company differs. In terms of equity, VCs typically buy 50% or less of portfolio businesses while private equity firms usually prefer to acquire the entire operation. As shareholders, VCs also take a more hands-on approach and offer support and expertise to encourage growth. Meanwhile private equity might take a more hands-off approach.

• How much risk they take on: Private equity firms generally invest in more established and stable businesses with a lower degree of risk. However, it is precisely the higher risk, with more potential for reward, that is appealing to VC investors.

• When they plan to exit: As for time frames, VCs might aim for a faster exit through either an IPO or acquisition. Private equity investments are generally made over a longer time period.

Why do businesses seek venture capital funding?

Businesses might seek venture capital funding for a number of key reasons. Depending on their current growth stage and financial needs, businesses might work with VCs to:

• Improve cash flow: Business owners might spend their initial funds too quickly, drain their savings on an emergency expense, or struggle to keep with growing customer demand as they expand. VCs can step in to help with funding.

• Gain publicity: By working with a high-profile VC, businesses can gain exposure in their industry and reach new audiences. This can help them promote their brand and boost their reputation and credibility.

• Avoid traditional repayments: Businesses typically don’t have to repay VCs in monthly installments, as they do with traditional loan options. Instead, VCs earn money from the profits as the business grows.

Factors to consider before pursuing venture capital funding

Not all businesses align with the venture capital growth model. It’s important to do your due diligence and determine whether or not this option works best for your needs.

Before pursuing venture capital funding, consider:

• How much equity you’re willing to give up: Are you willing to cede a majority or minority share of your business to cover startup costs? What percentage of equity would you like to offer in exchange for funds? How much control do you want to retain over your business’ creative and strategic direction?

• How fast you’d like to grow: Can you achieve the rapid scale that many venture capitalists desire? Are you prepared to ramp up operations and make certain changes to meet investor expectations?

• When and how you’re willing to exit: Do your business plans align with your VC’s exit strategy? Are you willing to go public or complete an acquisition in the future?

Use venture capitalists to grow your business

Starting and expanding a business can be expensive and complex. It requires not just a great deal of capital but also knowledge, experience, and strategic partnerships for long-term success. For startups and small businesses, venture capitalists can provide much-needed funding to help fuel growth and generate profits.

Still, this solution isn’t a fit for every company. VCs can eat up equity, establish creative control, and put pressure on business owners to grow and expand before they’re ready. That’s why it’s important to understand what a venture capitalist is, consider a range of funding options, including business loans, lines of credit, and other forms of investors, to find the one that meets your needs.