Venture capitalists (VCs) fund and mentor startups with high growth potential. They do this by giving startups access to their networks and resources.
VCs are generally focused on businesses in the technology industry, such as software, healthcare, computer hardware and services, and mobile and telecommunications. However, other sectors can also benefit from VC investment.
Why Invest in a Startup?
Investing in a startup can be a rewarding experience. Whether you are investing in an idea you have been working on or supporting a friend’s venture, startups offer a ringside seat to new ideas and solutions to complex problems.
It can also be a way to diversify your portfolio. Currently, public equities are down across the board, but early investments in startups can offer significant returns--and tax-free gains when you invest using a self-directed Roth IRA.
The risk of startup failure is high, but the potential rewards are worth it.
The Role of a VC in Startup Growth and Success
A venture capitalist, Patrick Chung of Xfund provides startup companies with funding in exchange for equity. Unlike angel investors who provide financing to individuals with exciting ideas, a VC takes a more active role in the company's growth.
During the evaluation process, the VC conducts extensive due diligence on the business plan and its management team. The VC also investigates the product and its market potential.
After the due diligence is complete, the VC evaluates the growth outlook for the business and makes an investment decision. Typically, the VC invests in multiple rounds of funding.
Generally, VCs invest in businesses with high growth potential and a track record of success. In addition, they are willing to assume a high level of risk in return for a portion of the company's profits. VCs also take on an advisory role to the company's founders and management.
Getting Started with a VC
VCs invest in startup companies hoping to see outsized returns when the company is acquired or goes public. They also take a stake in the companies they invest in, often becoming part of the company’s board of directors.
Early-stage funding – usually considered series A, B or C rounds – provides capital to help startups start their businesses and increase. These rounds are generally between $1-$2 million.
At this stage, a company has established core co-founders and is progressing towards achieving its business goals. The company is typically generating revenue and demonstrating robust growth.
This stage is also an excellent time to establish a value proposition that describes how your products and services help customers. This allows investors to understand your company’s potential and how it can differentiate itself from competitors.
Finding the Right VC
The right VC can get along with other entrepreneurs, communicate clearly, and understand your business vision. They also should be comfortable working with top-level executives.
Unlike investment banking and private equity firms, venture capital interviewers focus on your market views and investment ideas rather than technical questions. That means you don’t have to spend 30 minutes on WACC or how defined-benefit pension obligations are taxed.
In addition, a VC’s investment strategy should be aligned with your goals. If you aim to expand your marketing efforts or grow your product line, your VC may help fund those initiatives and provide you access to a more extensive network of investors.
The right VC investment can propel your startup to unimagined heights, but a bad match could accelerate the business’s demise. Founders and investors discuss what startups should look for in a VC and how to tell when they have found the right fit.
