What does VC mean?
In short, VC stands for venture capital, a type of financing where investors purchase ownership stakes in high-risk, high-reward companies.
The truth is, most startups don’t need to think about venture capital. This sort of funding is the exception rather than the norm, with fewer than 1% of companies raising VC dollars.
That’s because VC firms are interested in business ideas capable of creating or disrupting entire ecosystems, businesses like Uber or Airbnb. Most companies, even successful ones, won’t reach that level of market power.
If you’re curious about what makes VC finance so unique, and what your startup should know about it, keep reading.
What Is Venture Capital and What Makes It So Unique?
Out of all the different styles of investment, venture capital is the highest-risk. As such, VC-backed businesses are uncommon for both investors and entrepreneurs.
Unlike other types of investments, returns to VC investors follow a Pareto distribution. In layman’s terms, that means a tiny number of companies account for the overall performance of their investment portfolio. It’s like the 80/20 rule, where 20% of your actions account for 80% of your results, but scaled to something like a 99:1 extreme.
Harvard business school found that 75% of all venture-backed companies never return cash to investors. That means VC firms invest in a portfolio of startups expecting nearly all of them to fail!
VCs are looking for homeruns; investments so wildly successful that the failures are more than compensated for.
From an entrepreneur’s perspective, getting VC funding means you are under no obligation to be profitable any time soon. Amazon, for example, didn’t turn a profit for the first nine years it existed.
These companies sacrifice short-term profitability in exchange for long-term growth. As long as belief in the future of the business remains high, founders can turn to VCs to raise the necessary capital to remain in business.
If you’re considering seeking VC funding, it’s important you understand the fundamentals of business financials first. Check out our full guide on accounting for startups to ensure you’re up to speed.
What Kinds of Companies Receive VC Backing?
The most important characteristic of a VC-backable startup is that it must be hyper-scalable.
As you’ll notice in the below breakdown of 2022 VC-funded startups, a lion’s share of last year’s VC funding went to business in various technology-related industries. The sector is attractive to VCs because reproducing a digital product, once developed, is much easier to scale than products that require a lot of ongoing capital.
|Artificial Intelligence & Big Data
You’ll find tech companies such as Doordash, Stripe, and Instacart on the lists of the most valuable VC-backed companies in the US. These in-demand tech platforms have lower long-term overhead and are highly scalable, making them ideal for VC funding.
Other considerations VCs look for are:
- The competency and experience of founders and their advisory teams
- Unique competitive advantages compared to the existing market
- Demand for the product
- Potential market size
How Venture Capitalists Work
In some cases, people will use the noun form of VC, meaning venture capitalist. This is a general term for investors who provide funding to these high-risk businesses.
Venture capitalists prefer the high-risk, high-reward style of investing. They raise money from institutional organizations and wealthy individuals to put toward promising startups.
Once raised, VCs place the money in a common pool and invest it as a block. The model is similar to that of a hedge fund, where managers take a percentage of the total market capitalization of assets under management as fees. The lifespan of such a VC fund is ~10 years.
VCs fall into two basic archetypes:
- The industry expert
- The successful entrepreneur
The industry expert seeks out startups that they will help fund, and they’ll also take on an advisory role for the company. They know the landscape of the industry and will teach their chosen founders how to successfully navigate it.
On the other hand, the successful entrepreneur is someone who has grown a startup of their own, likely sold it, and now has substantial capital to work with. They want to give back and find a natural fit, helping startup founders coming up behind them.
What Is An Angel Investor Vs. Venture Capitalist?
You may have heard the term “angel investor” in relation to VC. Both terms refer to people who invest money in promising startups. But there is one significant difference:
A venture capitalist raises and invests money through a pooled fund, while an angel investor typically invests their own money.
What Are The Stages Of VC Funding?
VC funding is divided into several stages, each with its own range of investment amounts and equity exchanged. Specific amounts vary depending on context, but the further along in the funding stages a company is, the more capital will be exchanged.
This is the ideation stage. Founders bootstrap or borrow from people in their network while they search for proof of concept. They sometimes have revenue but often do not. A particularly promising company may attract the interest of an angel investor and receive upwards of several hundred thousand dollars.
This is typically when VCs first get involved. The company demonstrated market validation during the seed stage, proving they have potential for considerable growth.
Funding ranges from $1-15 million and founders are now benefitting from the expertise, as well as the money, of their VC backers.
The company now has significant revenue, but the founders want to continue growing and need more money for operating costs and investment. Funding rounds at this stage are typically between $10-30 million. The Series-A funders may sell to the new cohort or choose to wait for a better exit opportunity.
From here, startups can technically continue onto a series C, or D, and so on. But it’s rare. After Series B, most founders and VCs want to exit by going public with an IPO or being acquired by a conglomerate.
Venture capital is a unique sector of finance. The high-risk, high-reward field produces cutting-edge innovations and spectacularly high market capitalizations, at the cost of a considerable number of unremarkable failures.
If you’re considering working towards securing VC funding, be certain you’ve got the right financial advisors backing you up. Indinero’s fractional CFO services can connect your growing startup with the right financial experts for your business size and industry.