You’ve just come up with a great business idea and now you’re looking to develop it and take it further. Most likely you’ll need to finance your start-up, and this is usually one of the biggest challenges.

Start-ups have expected losses for the first several years, and traditional debt financing is most likely not a viable option. Your next best option would be equity financing. This is where you, as the owner, sell shares in your company for an agreed amount of financing.

What is venture capital?

Venture capital (VC) is one of the most common sources of equity financing.

VC investments are usually done in a series of rounds. After the deal is signed, you will need to meet specific milestones that will enable you to move on to the next round of financing. The goal at the end of the day is a liquidity event, where the return on investment (ROI) is realized, either through an initial public offering (IPO) or the sale of the company. Many companies must complete a few fundraising rounds before getting to the IPO stage.

As the company grows and it demonstrates its ability to survive, two things will happen.

The value of the company increases, and the company will try to raise additional capital based on the performance to date combined with current marketplace conditions.

Also read: 5 Financial Mistakes Your Small Business Might Be Making

How does venture capital work?

Before any round of funding begins, analysts will do a company valuation. Valuations are derived from many factors, including management, proven track record, market size, and risk.

One of the key differences between funding rounds has to do with the valuation of the business, as well as its maturity level and growth prospects. These factors impact the types of investors getting involved and the reasons why the company may be seeking new capital.

The very first round is known as the ‘seed round’. This is where the business owner goes ahead to finance the unproven start-up. Seed funding helps a company finance its first steps, including market research and product development.

Businesses at the seed round usually consist of just a few people with an idea. Often the idea stems from experience coming out of the entrepreneurs’ own backgrounds. They will have worked in a specific area and seen opportunities. The idea should be well-thought and properly researched. For a deal to happen, it depends on the people and the relevancy of the target market.

This is because once the deal is signed, you’re going to be in business with each other for many years. You want to like your investors and vice versa. The human element is still important in something like this.

Relevancy means the idea will be significant enough to provide investors with enough ROI. On the venture capital landscape, a relevant plan has the potential to generate a multi-million dollar return on the initial investment.

Tips to remember when looking for a venture capital investor

In the seed round, it is very important to get the attention of a VC. Firms cannot possibly look at all the plans and ideas it receives, so relationships and key connections are very important. It helps to get your foot in the door through a trusted reference. Remember, you are going to be associated with that person, so you must be careful who you work with.

Make sure that you do enough research. There is a lot of information available on the internet –do your homework about the market. Work on your networking skills and plan how you’re going to get to the influencers.

When it comes to looking for capital, the better option would be to find someone local. Typical VC investors tend to get local investors involved because they can add value to the business.

Once a business has developed a track record (an established user base, consistent revenue figures, or some other key performance indicator), it could be ready to raise additional capital.

Rounds of funding consist of individuals hoping to gain funding for their idea or company and individuals looking to invest. Investors not only wish for businesses to succeed, but they also hope to gain something in return from their investment.

Investments made during any stage of funding are arranged so that the investor keeps partial ownership of the company. If the company grows and earns profit, the investors will be rewarded too.

Also read: Choosing The Right Small Business Accountant

The final stages of venture capital

As the business becomes increasingly mature, it tends to advance through the funding rounds; it’s common for a company to begin with a seed round and continue with A, B, and then C funding rounds.

The different rounds of funding operate in essentially the same basic manner; investors offer cash in return for an equity stake in the business. Between the rounds, investors make slightly different demands on the start-up.

Understanding venture capital and equity financing will help any business founder to finance their ideas and move their company to the next level. Contact us for more information using our contact form or by phone at 604-781-2412.