Venture Capital

Finding investment is one of the important issues when starting a business or launching a startup. In today's world, there are enough sources of financing, and one of them is venture companies. Let's explore in more detail what this is and what distinguishes venture capital from other types of investments.

Venture Companies: What's the Essence

The very name comes from the English word "venture" — to take a risk. So a venture company is an organization that invests funds with risk. This type of financial investment is usually sought when technical or scientific innovations enter the market, meaning the potential success of the business is high, but not obvious. Investors take the risk to achieve a higher return than the invested amount when the company acquires customers and strengthens its position in the market.

Venture financing implies long-term cooperation with the company. The scheme is as follows: the company or startup provides a well-thought-out business plan, and if it satisfies the investors, over the course of 5-7 years, the business receives funds that allow it to develop and modernize production.

A Bit of History

Venture capital is part of a private fund, so there is always a company or businessman behind it, deciding how reasonable it is to risk their money. Venture investments first emerged after World War II. Georges Doriot, a professor at Harvard Business School, founded the American Research and Development Corporation to support companies working on technological innovations. The fund raised $3.5 million, part of which was allocated for the development of X-ray technologies, which, by the way, successfully paid off. Instead of the $200,000 invested, Doriot returned nearly $2 million.

One of the first official venture companies was established in Silicon Valley by Arthur Rock and was named Davis & Rock. It financed many startups that have today become fantastically successful, such as Apple or Intel.

In 1958, when the U.S. government recognized the potential of venture funds, a law was passed to encourage businessmen to invest in developing companies. In the 1980s, after three amendments to the law, a true boom in venture capital began, allowing many small companies to realize their ideas. However, a decade later, the boom passed, but the industry had already established itself, and today venture investments are a constant source of financial inflow for both novice and experienced entrepreneurs.

What is Unique About Venture Investing

Venture investing differs from other types of investments in several ways:

• Pre-defined financial risks. Of course, investors primarily think about profit, but at the same time, investors assume they could lose money if the company fails. The higher the likelihood of success, the more investments a project receives. However, the money is returned only in the form of revenue from the sale of the existing share package. If the company is successful, its shares are valuable; if the business fails, there will be nothing to recover.
• Deferred profit. Venture investments imply that the first profit will not be received by the investor for at least 3-4 years, and during this time, they can only monitor the effective and correct use of the invested funds.
• Investor participation in project development. The investor owns only 20-40% of the shares, but understanding that the project's success directly impacts their profit, they not only monitor the company's progress but also consult and assist in solving various problems when necessary. This is why investors prefer to invest in sectors they understand. Additionally, during the project's development, the venture company may invest in staff training to enhance their employees' qualifications, thus increasing the chances of success.
• Already sufficiently successful projects. In recent years, angel investors and crowdfunding have taken on initial stage investments. If the project is already mature enough and money is needed for expansion, building distribution networks, or product lines to significantly increase sales and profits, this is where venture investments come into play.

How to Win Over Investors

Getting money is not as easy as it may seem. To convince an investor to invest in your business, you need to put in the effort.

• Innovative idea. To attract an investor, you need to offer something that truly stands out from the crowd of startups. This can be something entirely new or a modernization of an existing idea.
• Well-thought-out business plan. This point shows how well you understand the issue, whether you have studied the risks and consumer needs, and if you are aware of the strength of competition in your chosen field, among other things. Overall, it's worth paying attention to market analysis before starting to work on the project.
• Competitive product. Let's say you have a brilliant idea. Don’t rush to share it with the world; first, monitor the market for similar products. It is unlikely that an investor will be interested in yet another messenger app or improved “smart” watches — there are plenty of those in the world. A slight modification or improvement of an existing product does not constitute a reason for venture capital investment. You must clearly understand how your invention or service can attract consumers and why they should choose you over a competitor. In general, look for a unique feature and highlight it in your presentation, and then the investor will invest in your project.
• Professional team. One of the most crucial points, as the realization of any business idea depends on it. The fact is that no business can be built by one person. Besides the initiator, there must be specialists, marketers, designers, financiers, engineers — in short, all the components of the mechanism; otherwise, the entire machine will simply fall apart. If you want to be taken seriously, ensure that each person in your team is doing their job: the accountant counts the money, while the engineer constructs. Keep in mind that if you have an artist or a writer as the chief designer, and a musician as the financier, this will immediately put a damper on the most promising idea. No one will invest in such a team. It would be great if you already had industry specialists in your team who have achieved success in similar businesses or professors from leading universities in the relevant field of specialization that the startup will be built upon. This will enhance efficiency and prove that you are focused on results.

Stages of Venture Capital Investment

Since venture funds collaborate with companies on a long-term basis, money is allocated in stages throughout the duration of the project. The amounts are determined by the business plan: if it is well thought out, it includes a schedule for achieving intermediate goals, the attainment of which indicates the progress and setbacks of the business.

Firstly, this protects investors from losing a large sum of money; secondly, it allows for controlling expenditures and adjusting them as the project develops. By observing the progress, investors can cease funding at any moment if they believe the risks are too high. For entrepreneurs, this type of investment is a great incentive to work diligently and strive for business growth.

In the classic scheme, the stages are presented in the following order.

1. Pre-start investments. Initially, small amounts are invested so that the entrepreneur can prepare the technical and economic basis, purchase necessary equipment, and address initial organizational issues.
2. Creation of the initial capital. As the project develops, other investors will come on board.
3. Allocation of funds for completing developments. At this stage, a marketing campaign begins, aimed at studying the market, identifying the target audience, and assessing prospects.
4. Start of production. The company begins to produce the product, and the first profits appear, but the business is still operating at a loss or (at best) breaking even.
5. Transitional investments. The business receives working capital, allowing it to pay bills and expand inventory.
6. Acquisition of ownership rights to the company or taking the company public. This is the so-called exit strategy, where venture firms recoup their capital with profit.

Sources of Venture Financing

There are enough investment sources so that you can find the right one depending on the type of company and business specifics.

• Public funds. This organization is managed by an independent company.
• Venture capital partnerships. This is when a group of entrepreneurs comes together to invest in developing projects.
• Individual investors. When the practice of funding startups was just beginning, these investors were at its inception. Today, they contribute to the creation of initial capital and invest in quite risky projects if they have even a slight chance of success. Often, this is done by large entrepreneurs who have already achieved success and direct their capital into venture funding.
• Target capital from corporations. In the U.S., many projects are invested in by venture companies, and to pool resources, large companies merge their funds into a venture company.
• Capital from banks. Initially, such investors only invested in businesses at the later stages, but as the range of services expanded, private capital such as SBIC and MESBIC emerged.
• Government investments. In the U.S., the government has long practiced supporting young entrepreneurs. In this case, the goal of the investment is not to return profit, but to motivate ambitious entrepreneurs to grow.

Types of Companies: Which Projects are Funded by Venture Funds

Considering the diversity of venture investment forms, it's worth understanding when to approach each of them. Understanding the situation will save time for both the entrepreneur and the investor. The most common four types of projects are:

• Start up – a new company seeking financial assistance for conducting research and development as well as starting sales of ready-made products.
• Seed – a business idea needing investments for further research and producing initial prototypes. Such investments are typically made either under a serious successful team or under a company of a well-known entrepreneur.
• Early stage – a company that already has its own refined developments but lacks funds to start implementing the ready products.
• Expansion – an operating firm seeking investments to expand production and increase working capital through marketing research and product modernization.

Types of Financing

When venture investors invest in a small enterprise, they do not require collateral, but the investors themselves participate in the development and management of the business. There are several forms of financial influences when working with startups:

Commodity credit. The most accessible form, where equipment serves as insurance: this reduces credit risks for both parties.

Factoring. This is financing provided by banks, but clients can only be firms with a good reputation, solid customer base, and stable cash flow. If the business owner cannot provide any guarantees that the investments will pay off, the chances of obtaining funds are virtually zero. However, as an option, a guarantor may become a co-owner of the business and receive a share as compensation for the risky investment.

Bridge financing. This financial assistance is provided by new investors at the moment when the company has already used all available resources. At that stage, the business can offer ready product prototypes and provide results for interim goals so that new investors can see how much the startup has progressed since its launch. This type of financing not only allows for continued work but also attracts new people who can bring fresh ideas and revitalize the business if necessary.

So, how beneficial are venture investments?

Venture companies are an excellent solution if you are looking for financial sources and are willing to sell part of your business shares. This type of investment allows not only newcomers to get on their feet but also existing businesses to expand; the main thing is to create a clear, understandable business plan and arrange a bright presentation to attract investor attention.

Overall, venture investments are just one way to finance. If you are looking for funds for your business, our company specialists will help you find the optimal solution, advise on all types of financial investments, and suggest how to overcome major challenges. Contact us, and together we will make your business better!