1. What is venture capital funding?
Venture capital funding is a form of private equity investment where a business obtains long-term investment in exchange for a share of its equity.
Venture capital funding is suitable for start-ups or new businesses with high growth potential, existing businesses that are expanding rapidly or to fund management buy-outs or buy-ins, or develop new products and move in to new markets.
Venture capitalists typically invest in businesses with:
- an ambitious but realistic business plan
- a product or service that offers a unique selling point or other competitive advantage
- a large earning potential and a high return on investment within a specific timeframe, eg 5 years
- an experienced management team with a proven track record in the sector - although venture capitalists tend not to get involved in the day-to-day running of the business, they often help with a business' strategy, can appoint non executive directors to the company and board observers
2. The process
Raising venture capital is a time consuming process and it can take several months to secure the investment. It is important to allow for this time in your business plan and ensure you have sufficient cash to fund the business whilst you secure an investor.
Before approaching Venture Capitalists you should research the fund and their investment criteria in terms of the amount they invest, the sectors and geographical areas they invest in and the stage of business they support.
Some companies will also work through a Corporate Finance Adviser who helps prepare the business plan, pitch and makes introductions to relevant funds. This can ensure that you present a quality proposition to the potential investors and target the right funds for your business.
You should make sure that your business plan is up-to-date with detailed financial forecasts.
The investment process may differ from fund to fund but a typical investment process would be:
- Send out executive summaries and business plans to your target investor list.
- Meet with interested investors face to face and make your pitch.
- The investor will undertake their own analysis and decide whether they want to issue a formal term sheet. This is an agreement that sets out the terms of the investment, how much they want to invest, the stake they want in your business, the type of share and the rights attached to those shares. It is usually a high level summary outlining the main commercial terms of the investment.
- Due diligence. This is an information gathering and validation exercise on the claims you have made in your business plan. It would usually cover all aspects of the business including commercial, management, technical and IP and financial. The costs of this are usually borne by the company and deducted from the investment.
- If the due diligence exercise is successful most funds have an internal approval process that will make the final investment decision.
- Once the investment has been approved both parties will appoint a lawyer to draw together the legal investment agreements.
3. Pros and cons
- venture capital funding is committed and long term
- you retain management control of your business – investors will not get involved in the day-to-day running of your business
- no need for collateral, ie personal assets
- no repayments or interest
- equity can provide you with the capital to enable you to make a step change in your growth
- selling shares in your business
- raising venture capital is demanding, costly and time consuming
- not generally suitable for small investments
- can take a while to find a suitable venture capital investor
4. Common mistakes
You may be unsuccessful in raising venture capital finance because you haven’t made sure that you are ‘investment ready’ before approaching potential investors.
Investors will want to know if there will be an exit opportunity and that they can recover their investment and make a profit. You should be able to tell them about your business’ long-term plans and ambitions i.e. your exit strategy. This also needs to align with the investors plan for your business so choosing the right investor is critical
An experienced management team with a proven track record in the sector is essential. You can bring additional gravitas to the management team by appointing non executive directors or having an advisory board that is made up of experienced industry professionals.
5. Funding sources
- you can use the British Private Equity and Venture Capital Association (BVCA) membership directory to find venture capital investors. However, you will need to subscribe to get access
- The Welsh Government established the Development Bank of Wales in 2017 and is the successor to Finance Wales and provides commercial funding, including equity, to small and medium-sized businesses throughout Wales to enable them to realise their potential for innovation and growth
- the Business Growth Fund is a funding scheme for medium-sized companies launched by the government and the British Bankers’ Association. The fund invests between £2m and £10m in firms, in exchange for a share of the business ranging from 10% to 50%
- the Enterprise Capital Funds (ECFs) provides equity up to £2 million for companies with a turnover of up to €50 million, if they have viable business models, operate in an eligible sector and have growth potential in need of long-term investment