December 6, 2022

Benefits of Venture Capital Funding

Benefits of Venture Capital Funding
In 2021, companies backed by VC investment in the United States raised nearly $330 billion, almost double the amount of $166.6 billion in 2020.
However, amid global uncertainty, VC investments have dropped recently. According to Crunchbase, VC funding for the third quarter of 2022 totaled $81 billion, down by $90 billion (53%) year over year. 
Let’s understand how it works first and why it has been losing its charm.

What is Venture Capital Funding?
Venture Capital or VC funding is a kind of private equity funding where investors can provide funding to startups or small businesses with proven potential for long-term growth. Investors may also favour companies that have grown quickly and are looking to expand. Venture Capital can come from HNIs, a group of individuals, investment banks, or other financial institutions.
VC funding became popular among upcoming companies looking to grow. These companies could be struggling to find access to debt funds, such as capital markets or bank loans. VC funding can come in the form of financial aid or as technical and managerial expertise for businesses. However, the catch with most VC funding is that companies are expected to give up some share of their business resulting in equity dilution and accountability for business decisions.   
Generally, during VC deals, a company is divided into large ownership chunks. These chunks are sold to interested investors based on independent partnerships that are determined by VC firms. These partnerships can, in turn, consist of several similar VC enterprises.

The Process of VC Funding
Any business looking to gain funding from VCs has to first submit a business plan to them. If the business plan seems to captivate the firm or investors, they proceed to perform due diligence, which includes a thorough investigation of the company’s products or services, operating history, revenue, and business model.
After the due diligence is completed, the investor generally agrees to an investment of capital in exchange for equity in the company. The capital may be provided all at once or in rounds. The investor actively monitors the company, before releasing subsequent funds. 
Investors exit after a period, usually four to six years after the initial investment. The exit can be driven by initiating a merger, an initial public offering, or until a bigger company acquires the business.

Pros and Cons of VC Funding
Some of the benefits of venture capital funding include:
  • VC funding unlocks capital funding for companies that do not have access to traditional debt funding sources such as bank loans. It offers a win-win for startups and investors. Through VC funding, investors can procure part ownership of companies that have demonstrated growth potential.
  • Unlike bank loans, securing VC funding does not need companies to demonstrate predictable cash flow or give assets as collateral.
  • Some VCs also provide benefits beyond monetary roles by giving mentoring and networking expertise to expand talent and growth in a company.
Here are some reasons why VC funding may not be the best option for your company:
  • VC investors take at least 15% of the ownership of the company. In fact, in most cases, it is seen that VCs take between 25 and 50% of a company’s ownership. In the short-term, equity dilution may appear as a debt-free loan, but it could interfere with the long-term company vision and goals.
  • VC investors generally hold companies accountable for their business decisions in return for capital funding, which results in companies being forced to make decisions to keep VCs happy rather than focus on the growth of the company.
  • Sometimes, companies may find venture capitalists demanding immediate returns on their investments. In such cases, companies may lose creative control and have to shift their focus to meeting the required sum that has to be repaid.
Types of VC Funding
VC funding can be classified based on the growth stage of the company, receiving the investment. VC investment can be one of the following stages:
  • Pre-Seed: This refers to the earliest business stage when the founders are still trying to build a sturdy business plan from an idea. The founders may seek out VC investment for early mentorship and capital.
  • Seed Funding: At this stage, a company is looking to launch its product or service. The company is yet to see its first revenue but is looking for funding to kick-start its operations.
  • Early-Stage Funding: This is for companies that have already launched their product or services, but are looking for additional capital to expand into a new market, ramp up services to boost customer acquisition, improve talent acquisition, upgrade s to new technology, or anything that can accelerate further growth of the company. 

The earlier the stage of the business, the higher the risk for investors to fund the capital required. This is probably why early-stage funding is the most common type of VC funding. It was estimated that almost 80% of VC funds go into increasing the infrastructure of companies.
Now that you know so much about VC funding, it might be easier for you to make a choice and decide whether it is the right approach for your company. 
Remember, however, that VC funding results in equity dilution and valuation are temporary, while equity is permanent. If you are looking for founder-friendly sources of capital funding for your company, check out recurring revenue-based financing with Recur Club.