Venture Capital Funding
This article does not cover “angel venture capital.” This term refers to private capital that comes from a single individual or a small network of investors, rather than a venture capital investment firm. Typically, with angel venture capital, each individual investor makes his/her own decision on what to invest in, whereas in a true venture capital firm, the firm pools investments and makes the decision on behalf its investors (also known as limited partners.) Angel venture capital is most commonly called simply angel capital. See the separate article entitled “angel capital.”
Chances are you will not receive true venture capital funding, for the following reasons:
According to Wikipedia, “every year there are nearly 2 million businesses created in the USA, and only 600-800 get venture capital funding.” This understates the impact of venture capital funding. According to the National Venture Capital Association 11% of private sector jobs come from venture backed companies and venture backed revenue accounts for 21% of US GDP.[ Yet the fact remains, very few young businesses receive venture capital funding, for the following reasons:
First, venture capital firms have grown in size over the years. According to the U.S. National Venture Capital Association, the average VC firm has grown from about $50 million in 1990 to about $350 million in 2005 and larger now. The reason for this is that VC’s by definition are re-investing funds provided primarily by institutions (such as corporate investment funds, pension funds, university endowments, and very wealthy families.) The amount of capital available from such sources has rapidly increased.
As a result of this growth in fund size, the amount of money VC’s must deploy has increased in size, so that as a rule of thumb, minimum venture capital funding investments are $5,000,000 to $10,000,000 and above. In fact, according to the U.S. National Venture Capital Association again, the average amount of capital deployed per company over all rounds of financing rose past $30 million in 2005 and larger now. (There are exceptions in early stage venture capital and startup venture capital, which are discussed below.) So your company and its market potential must be worth this large size investment before most VC firms will consider an investment. Most readers of this article present smaller though still valid opportunities. For readers with smaller opportunities, in need of “angel venture capital”, see the separate article entitled “angel capital” and refer to the comments below on early stage venture capital and startup venture capital.
Another difference between the two communities of investors (angel venture capital and true VCs) is that true VC’s usually prefer a 7 to 10 year exit (to conform to the life expectancy of their funds) whereas angels increasingly seek an early exit of 3 to 5 years. If you are not willing to wait 7 to 10 years for a return on your investment as a company founder, you should probably not be seeking venture capital funding. There are exceptions to every rule of course. There is a growing secondary market for private stock in venture funded companies. For example, many of the founders of such high-fliers as groupon and facebook have been able to sell some of their private stock in advance of the public offering. If you’re considering such an exit from a VC-funded company, you should look into the private secondary market and see what kinds of firms are presently able to attract buyers of their stock in this market. This kind of research can make a huge difference in how your life as an entrepreneur unfolds!
We are not trying to discourage you from seeking venture capital funding, only to be aware of the issues. For example, since most VC’s prefer exits in the 7 to 10 year timeframe, in order to achieve the desired rate of return (say 20%), VC’s will frequently block the sale of an invested company until it achieves a large enough size that can be sold for a very large multiple of the original investment, say 30 to 50 times the original investment or more. The VC needs the large multiple on exit to compensate for the fact that 80% to 90% of the VC’s invested companies may never pay back the original investment at all. As founder, you may be happy with an exit at year 5, but your VC may not be happy exiting until the company is much larger. This may result in your being forced out of a management role and forced to wait an additional 2 to 5 years or longer before you see any liquidity (cash from your stock.) The secondary market for private stock discussed earlier may be of some comfort.
High-end investment angels leading to venture capital funding
There is another consequence of the larger size and longer timeframe of true venture capital investments: angel network investments are rarely followed by venture capital investments, as discussed in greater detail in the article on “angel capital.” However, if your company is truly venture-capital fundable, but it needs to get started with a smaller investment, we suggest seeking individual high-end investment angels — wealthy individual with experience in the same domain as your company. The best way to locate such an investment angel is among executives who recently sold stock in a winning company in the same business domain as your opportunity.
Private equity venture capital
It should be pointed out that most venture capital funding at this time falls into the category of private equity venture capital. This refers to second and subsequent rounds of funding needed to grow already-successful firms to much larger size and to achieve the possibility of an IPO or large buyout. (Technically, all venture capital is a form of private equity, but in common usage, private equity usually means later-stage investing.) In such private equity venture capital, risk is reduced and therefore the portfolio of invested companies can be smaller in number. Private equity venture capital is therefore a different category of investing which is not relevant to most of the early stage innovators who are reading this article.
Early stage venture capital and startup venture capital
For entrepreneurs with innovative products, another possibility is to present to early stage venture capital and startup venture capital firms. These are typically the smaller VC firms in your area, or they may be specialized divisions of a larger VC firm. The ranks of such firms are growing now after a decade in which it was hard to find small firms with capital to invest in early stage ventures. It’s important to understand that most VC firms, particularly early stage venture capital and startup venture capital firms, limit their investing activity to companies located within the same greater metropolitan area, so there is little point to presenting to firms outside this distance, unless there is a very close match in preferred investment types (technologies or markets they prefer.) For lists of VC firms including early stage venture capital and startup venture capital firms, see WWW.VFINACE.COM, WWW.ENTREPRENEUR.COM OR WWW.NVCA.ORG.