If you’re a startup founder, then you know that raising venture capital is essential to your company’s growth. But how do you actually go about getting venture capital funding? How do you actually raise venture capital and what is involved in the venture capital process?
In this blog post, we will walk you through the process of raising venture capital funding. We’ll show you what you need to put together your startup pitch to a venture capital fund, what you need to know about pitch decks and why they’re important to getting VC funding, and what venture capitalists are looking for when they fund startups. Most importantly, we’ll show you what negotiating a term sheet is and how to get the most out of a VC funding deal.
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What Is Venture Capital?
Venture capital is the most well-known, and high-profile type of startup funding, but what is it exactly?
Venture capital is a specific type of private equity investment that provides funds to startup companies, especially those in the technology space. Venture capital investments are in early-stage companies which are, by their nature, high-risk but have the potential for high rewards if successful.
Because of the risks involved in funding early-stage, tech companies- many startups fail!-, startups usually have a hard time getting funding from traditional sources like bank loans.
So instead, venture capitalists step in and provide the funding that helps startups get through their early stages and into growth mode. Without venture capital industry, companies that are now household names like Apple, Google, Facebook, Cisco, and more would not be able to exist.
What is a Venture Capital Firm?
To be clear, “venture capital” is provided through a fund which is managed by a venture capital firm and its “venture capitalists.” Venture capitalists are the people in charge fo that firm who raise the money from investors (the “limited partners” or “LPs”) that they in turn invest in startups. Limited partners of VC funds are often entities like pension funds, mutual funds, university endowments, and other institutions as well as wealthy individuals.
This is in contrast to angel investors, who are wealthy individuals who invest their own money. Instead, venture capitalists invest other people’s money. As a consequence, venture capitalists are also responsible to those people, their own investors.
VC firms and and venture capitalists don’t just provide money, though. VC firms also provide financial and strategic advice to startup entrepreneurs. Most venture capital firms can also be potential sources of additional investment for their successful portfolio companies, as well as sources of introductions to potential customers, partners, advisors, and additional investors.
For examples of venture capital firms, visit our 15 Pre-Seed Venture Capital Firms who Invest in Early Stage Startups.
How Does Venture Capital Funding Work?
The process of obtaining venture capital funding begins with pitching your idea to venture capitalists. This involves creating a pitch deck—a presentation that outlines what the company is, what it’s about, and its vision for the future.
This will involve describing major aspects of the company such as the company’s product or service, the market opportunity, and how it can be monetized. You will also need to provide financials and plans for future growth.
Once you have presented your startup to venture capitalists, they will decide if they want to invest in your business. If they do decide to invest, they will provide a certain amount of capital in exchange for an equity stake in your company.
How a Venture Capital Deal Works: Debt vs. Equity
Yes, VC investments are investments in equity, not debt. That means that when a VC firm gives your startup money, they are taking an ownership stake in your company. The terms of the deal vary depending on the stage of the company and the risk involved.
In other words, VC funding is not a loan that you pay back over time with interest. Once a VC firm invests in your company, they will be part-owner with a significant say in how your business is run, and they will likely be around for several years.
So choose your venture capital investors well!
Why Is Venture Capital Funding Important to Startups?
Venture capital funding is essential for startups because it provides the resources needed for a startup to develop and market a product or service in its early stages. Startups, especially tech startups, require a great deal of capital in this early stage, which is usually still long before they get to any revenue, let alone breaking even.
More typical financial institutions like banks are unwilling to take such a risky bet, and the capital necessary is much more than almost any business owner can risk, either. Instead, the venture capital industry has developed to provide the financing necessary for these emerging companies to develop.
Venture investors are also important because they help startups gain access to valuable contacts and networks that can help them succeed. Additionally, venture capitalists may provide strategic advice as well as other support.
Is It Hard to Raise Money from Venture Capital Firms?
Raising money from venture capital firms can be difficult but it’s far from impossible. The key is to have a strong team, an innovative product and a well-developed business plan that demonstrates how your startup can become profitable and grow.
Raising venture money also requires building relationships with potential investors. Venture capital investors often say, “We invest in lines, not dots,” meaning they want to see how a startup and its team grow a business over time, develop, and deal with challenges before investing money.
Building relationships with those investors develops a trust relationship that makes getting final checks that much easier!
What Kind of Companies Do Venture Capital Firms Invest In?
Venture capital investors typically invest in technology startups that have the potential for high growth. These companies often have innovative products or services and demonstrate a clear path to profitability.
That means being a successful business is not enough for potential venture capitalists. High growth potential is absolutely key to getting a yes from venture investors. Because investing in early stage startups is so risky, a venture firm can only make money by investing in companies which have the potential to make huge returns on their original investment. And the only way to do that is to invest in companies that have the potential for major growth.
What Are Common Questions Venture Capitalists Ask?
Because venture investors need to invest in high growth companies in order for their own business model to work, their questions tend to center on issues that directly relate to how much growth potential a company may have.
So venture capitalists often ask questions about the market opportunity, how big the market may really be, how fast the company can get customers onboard, the competitive landscape, and how the startup plans to use their investment to fund further growth. A venture capitalist may also inquire about the future potential of the business, how it compares to other companies in its space, and whether there is an exit strategy in place.
How to Get Venture Capital Financing
Raising a venture capital round is a multi-step process which involves everything from building relationships with potential venture investors, preparing a compelling startup pitch and pitch deck, to undergoing a sometimes lengthly due diligence process and answering numerous investor questions, before finally receiving a check.
The Steps to Raising Venture Capital Funding
Raising venture capital can be a long and difficult process, but it’s not impossible. Here are the steps you should take to get VC funded:
Identify Potential Investors for Your Startup
The first step to raising money from venture capitalists is identifying your best and most likely investors, so you can building relationships with them. This is one of the keys to how to raise venture capital that people often miss.
Inexperienced startup founders will often try to raise money from any VC firm they may encounter, but this is a big mistake and unfortunately, a very common one.
Venture capitalists, and for that matter professional investors as a whole, virtually always have a specific profile of the kind of company they invest in: the particular industry they invest in, the investment stage the company is in, how much capital is needed, etc.
Even if your company is otherwise a very attractive investment opportunity, if it doesn’t fit into that profile, the venture capitalist will almost always pass. So it’s important to only target investors who are realistic possibilities for your company!
Start Building Relationships with Those Investors
Once you know which investors are a good match for your company, it’s time to startup building relationships with them so that when it’s time for you to start raising in earnest, you will already have started building trust with them.
This usually takes the form of networking: first introducing them to your company through a “warm introduction”, and then continuing to develop that relationship through advice and mentorship. Those introductions may be through a formal program like an accelerator or incubator or through more informal networking. (For more on accelerators and incubators, check out our 10 Best Blockchain Accelerators and Incubators  14 Best Fintech Accelerators and Incubators, and 5 Best Sports Accelerators and Incubators)
By building a relationship first, you make it that much more likely to an investor to say yes, because they will already be familiar with you, your company, and its growth path.
Read more about 5 Ways to Get More B2B Sales Fast.
Create a Compelling Pitch Deck
As you get ready to start pitching venture capitalists and other institutional investors, you will need to prepare a startup pitch and pitch deck.
A pitch deck is a slide deck which presents a very slimmed-down version of your business plan to investors. It’s usually 10-12 slides which present the most important aspects of your business: what it does, market information, your customer acquisition strategy, financial projections, how much capital is needed for growth, etc. (These are not the same as branding decks. For an example of a branding deck, see our Peloton Pitch Deck Breakdown.).
Distilling your whole business into a few slides and short presentation is hard! So read more for How to Create a Startup Pitch and How to Create a Venture Capital Pitch Deck. And for an in-depth examination of a pitch deck, check out our Brex Pitch Deck Breakdown)
Submit Your Pitch Deck and Start Pitching Venture Capitalists
Now, take a deep breath and startup submitting your deck to venture capitalists to set-up meetings!
You should know this now… you will get a lot of “Nos”, and you will get “Nos” for all kinds of reasons. There will be some investors who just don’t connect to you or your business, and some will not just not see the business opportunity. Others will have issues with what you present in your pitch or your business plan. And there will be some investors who don’t invest for a reason that has nothing to do with you, e.g. they may just not be in a position to invest at that moment.
Keep going, and know that it takes a lot of “Nos” to get to “Yes!”.
For examples of pitch decks from successfully-funded startups, check out:
Answer Investor Questions and Complete the Due Diligence Process
Of course, getting an investor check takes a lot more than one short presentation!
If a venture capitalist is interested in investing in your company, they will ask a lot of questions and begin what’s called a due diligence process with your company.
The due diligence process will involve going through the business details of your company, and making sure that your business really is a solid and promising investment opportunity. Due diligence will also include investigating the company’s intellectual property, combing through its financial statements, financial projections, and major legal contracts, confirming all key employment and confidentiality agreements, and interviewing all the management team and key employees regarding their industry expertise.
Negotiate the Term Sheet and Sign on the Dotted Line
Did you make it through due diligence? If so, it’s time to negotiate the term sheet!
Yes, this means that a term sheet will enter the picture, and key details of that term sheet will be negotiated. For a startup, this may be the first time that representation by a law firm will be required, so be prepared. Hefty legal fees may ensue!
In most cases, the point of greatest contention in the term sheet will be the company’s valuation. It is notoriously difficult to determine the business valuation of an early stage company, and in the case of pre-revenue company, it’s especially difficult. In negotiating the business’ valuation, be prepared to discuss the market valuations of more established companies, and how your own company may compare.
Remember… hundreds of millions of dollars could be on the line!
The good news is that once you successfully agree on the term sheet, you are well on your way to receiving your check!
Alternatives to Venture Capital Funding for Startups
Although venture capital funding is the most common way to finance a startup, there are other options available. These include crowdfunding platforms such as Kickstarter, angel investors, and government grants. Each of these sources has its own set of pros and cons, so it’s important to do your research before deciding which avenue is best for you.
Angel investors are wealthy individuals who provide capital to startups in exchange for equity. Unlike venture capitalists, angel investors usually invest smaller amounts of money and prefer to invest early in the startup’s life cycle. They are a very common source of Pre-seed Funding. Angel investors often have a network of contacts that can help startups grow, so they can be a valuable source of funding as well as advice.
Crowdfunding platforms such as Kickstarter and Indiegogo allow entrepreneurs to raise money from a large pool of potential backers. Crowdfunding, and especially equity crowdfunding, is a great way to get small amounts of funding from many people, which can add up quickly. However, keep in mind that the funds raised through crowdfunding may not be enough to cover all of your startup’s needs.
For more about equity crowdfunding, read out article Equity Crowdfunding: Everything You Need to Know.
For tech startups, government grants can be a good source of funding. Many governments offer grants to innovative companies in order to boost the economy and encourage innovation. The application process for these grants can be lengthy and complex, so it’s important to do your research before applying.
The SBIR and STTR programs are two examples of U.S. government grants are provide seed funding to technology startups.
Small Business Loans
Small business loans can be a good source of funding for startups that don’t have access to venture capital or other forms of financing. These loans can come from banks, credit unions, or the Small Business Administration. The terms and conditions of small business loans vary, so it’s important to do your research before applying.
Small Business Administration (SBA) Loans
The Small Business Administration (SBA) provides loans to small businesses, including startups. These loans are backed by the government and have lower interest rates than other types of financing. However, the application process for SBA loans can be time-consuming and complex, so it’s important to do your research before applying.
For more on SBA loans, read our article on SBA Loans: the Pros and Cons.
Startup Business Lines of Credit (BLOCs)
Startup Business Lines of Credit (BLOCs) are short-term loans that provide flexible financing for startups. These loans often have more flexible repayment terms than other types of financing. However, the application process can be complex and time-consuming, so it’s important to do your research before applying.
For more on Startup Business Lines of Credit, read our article on Startup Business Lines of Credit: Flexible Financing for Your Business.
Credit cards are another possible source of short-term financing for startups, but carry high interest charges, so it’s important to pay off the balance in full each month to avoid high interest charges and penalties.
Bootstrapping is the process of using your own funds and resources to finance your startup. This can be a great way to get started without having to take on any debt or outside investors. However, bootstrapping limits how much money you can raise and can put a strain on your personal finances.
The Bottom Line on Raising Money from Venture Capital Funds
Raising money from venture capital funds can be a daunting task, but it doesn’t have to be. Be sure to do your research, create an effective pitch deck and have a well-thought out plan before approaching potential investors. With a little bit of hard work and dedication, you can secure the venture capital funding your startup needs to succeed.