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When you need cash for your small business, whether it’s to get off the ground or fund a new initiative, venture capital is one option to consider. But is it the right option? Is it even accessible to small businesses? And what do you and your enterprise stand to gain or lose by aligning with a venture capitalist?
What is venture capital?
“Venture capital is the money that is invested in an early stage, high-risk company that, if successful, has the potential to yield huge returns,” says Deborah Sweeney, CEO of MyCorporation.com, a provider of online document filing services for clients who want to form a corporation or LLC. “Unlike a traditional business loan that you have to pay back, any business that has received venture capital funding gives the investors a stake in the company,” usually provided in the form of shares. Of course, when the company does well, the price of a share increases, making the investment worthwhile for the venture capitalist. But it’s a gamble all the way.
You cannot walk into a bank and simply request a venture capital loan. The stakes are much different in this funding scenario. “Venture capital investment is different to any other,” says Clinton Lee, founder of UK Business Brokers. “[Venture capitalists] appreciate that despite their careful vetting for high-growth prospects, most of their portfolio businesses will die. A few will make a decent amount of profit but nothing that hits the headlines. One or two will hit the big time and make the game worth the candle. The venture capitalist then exits with a handsome profit.”
How does venture capital work?
Banks and sources of traditional small business loans typically don’t look for anything in return for their investment other than to have their money paid back in full with a bit of interest on top. Venture capital investors have different metrics. “If you have a firm interested, be prepared to give them something in return for their early investment,” says Sweeney. “Since they will be your future shareholders, they’re likely expecting a say in how things are run.”
Investors do not dole out cash blindly—in return for their faith and generosity, they may demand a seat on the board, a say in hirings and firings, or a voice in major company decisions. It’s up to every small business to weigh whether getting the funds they want and need is worth giving up some control and influence.
“They’re looking for the next ‘unicorn,” says Lee. “They’re looking for businesses that have the idea, the intellectual property, and the founders to drive exponential growth to make a company worth many hundreds of millions, or even over a billion dollars.”
How do you get venture capital?
“It’s not so much about whether a small business should consider venture capital involvement but whether any venture capital firm would be remotely interested in the average business,” says Lee. “Venture capitalists aren’t interested in your run-of-the-mill small business. They are interested only in those businesses that have some unique advantage in the market that will skyrocket growth.”
This isn’t to say, of course, that your small business has no shot in catching the attention of a venture capitalist. “If you want to get venture capital, first and foremost you need to have a good idea for your business,” says Sweeney. While naturally any small business owner believes in their product, concept, brand, or service, that doesn’t mean investors or the general public will also have the same viewpoint. So think niche. “Most businesses that receive capital are specialized – like tech-based companies – which is why you often hear about apps or software startups being invested in,” says Sweeney.
Venture capitalists are always on the lookout for that next great startup, and they rely heavily on networks of knowledgeable contacts. So your best chance of getting noticed is by impressing someone who is part of the venture capital network. And the best way to do that is by networking yourself.
Once you’ve gotten noticed by a venture capitalist, you need to present your pitch. It should be succinct and buttressed with data—venture capitalists want to see the numbers behind your rosy projections. And you should let your enthusiasm show. No one wants to back an entrepreneur who doesn’t seem excited by his own venture.
What are the pitfalls of venture capital for small biz?
Before getting your hopes up that venture capital is your saving grace, it’s critical to determine if you even can consider venture capital for your small business. “Most startups don’t need and will not qualify for venture capital,” says William A. Price, an attorney in private practice in Illinois. “Only 11 percent of last year’s Inc. 5,000 companies started with more than $100,000 in capital versus 48 percent that started with less than $5,000, mostly using their own money,” says Price, naming personal sales efforts, credit cards, home equity loans, or retirement funds as more common sources of funding for a new venture.
U.S. Small Business Administration loans (SBA loans) are also used frequently by small businesses and, according to Price, can be a less costly source of capital than angel investors (capital from an affluent individual in return for shares or ownership equity) or venture capital finance. And, of course, there is the newest popular form of raising money for just about any endeavor—crowdfunding—whereby businesses or individuals raise monetary contributions from anyone who cares to contribute, typically via the internet.
Regardless, small businesses have a number of options available when it comes to raising capital, even without collateral, or when dealing with a credit issue, so be sure to investigate them all to discover what works best for you.