Jitendra has been selling his wallets for over a year now, thanks to his crowdfunding campaign. He is almost out of money but hasn’t broken even yet. It’s still too soon to take a loan and face the risk of debt. He concludes that he could give up some of his equity in exchange for an investment. So, he decides to bring on a venture capitalist, someone who can help him financially and act as a mentor.
It is difficult for startups and early-stage companies to utilize traditional methods of fundraising such as acquiring a business loan, since both parties are put at a disadvantage. Banks are unwilling to invest due to the lack of fixed assets to act as a surety and emerging companies often cannot afford to have debt so early on in the process.
What do Venture Capitalists actually do?
Venture capital fills this void in the market. Venture capital is the private funding provided to early-stage businesses that are considered to have high growth potential. These investments are made by venture capitalists in exchange for equity or ownership in the company. In venture capital firms, investments are collected from the various venture capitalists and are ‘pooled’, i.e. they are combined, and the total investment is divided among various startups, so as to spread the risk.
However, venture capitalists do more than just provide capital. Due to their equity ownership, they receive the authority to control business decisions. They provide valuable advice to the company in the form of mentorship, they provide guidance in financial decisions, help devise viable business plans and marketing strategies. To give you an example, in the TV show ‘Shark Tank,’ the ‘Sharks’ are all venture capitalists.
How to get funding from a Venture Capitalist
Alejandro Cremades, in ‘How Venture Capital Works’ talks about the process of getting funded by a venture capital firm. According to him, after the initial introduction and a show of genuine interest, a venture capitalist may ask you to provide a presentation, or a pitch-desk. If the partner finds the presentation satisfactory, you will receive an appointment to meet with all the partners, where you will have to address their queries. If the meeting goes well, they may provide a Term Sheet. This term sheet is not binding, it is simply a promise to provide funding. The final stage is the Due Diligence stage. It is the most time consuming as it involves all the legal paperwork but may end with the company receiving the desired funds.
The stages of funding
According to the book ‘Corporate Finance’, written by Ross and Westerfield, there are six stages of financing offered in venture capital. Venture capitalists typically join in Series A round, which occurs after the Seed Funding round. In the Series A round, the first series of preferred stock is offered to investors in exchange for equity. The funds collected are usually used for manufacturing. The subsequent rounds are called Series B, C and onwards. Series B funds are used as working capital to make the business profitable and the other rounds are used to gather funds for business expansion.
Venture capital investment is quite different from lending loans. Loan givers have a legal right to charge interest and demand it be paid on time, irrespective of the financial status of the business. Venture capitalists receive returns on their investment, depending on the growth of the business. They make most of their money when they ‘exit’ the company and then they sell their shares. Due to this reason, venture capitalists are incredibly careful while considering a company to invest in. According to the Harvard Business Review, “There is a myth that venture capitalists invest in good ideas and good people. The reality is that they invest in good industries.”
Despite the scary success-failure ratio in the business world, venture capital is an attractive deal for entrepreneurs. It gives them a slight advantage over the rest of the herd. Having a third-party invest financial resources, time, domain expertise, and knowledge in a company, while providing access to important business connections, is invaluable. Venture capital is and will remain one of the most prominent aspects of startup funding.
Author – Shweta Shukla
Entrepreneurship Development Cell 
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