What’s a Venture Capitalist?
Is venture capital your business’s golden ticket or a recipe for disaster? Read our guide to find out.
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August 20, 2019
7 min read
Let’s talk venture capitalists. A venture capitalist is someone who (usually as part of a larger venture capital firm) invests money in startup businesses; in return, the venture capitalist gets company equity.
And sure, that sounds nice and neat. But before you jump into the venture capital world to fund your business, there are some things you should know. Venture capital comes with unique benefits, sure, but it also carries unique risks—risks that could lose you your company.
That’s why we’re going to give you all the details on venture capital. We’ll explain what it is and how it works, and we’ll help you figure out if it’s the right choice for your business.
Venture capitalists 101
Quick refresher before we get into more detail: Venture capitalists (VCs) are people who fund growing businesses. VC investors provide the funds, and in return, the newly funded company gives them equity.
As we mentioned, you won’t find too many venture capitalists working solo. Most of them work for VC firms, where several investors pool their resources so they can make more—and bigger—investments. And when the average VC investment comes out to about $11.7 million, you can see why they need to pool resources.1
So why do they invest so much? Simple: they expect big returns.
How do venture capitalists make money?
Venture capitalists aren’t financing companies out of the kindness of their hearts (of course, neither are angel investors or lenders). As we said, they get equity in the businesses that they fund. And with any luck, that equity will turn into a big payday.
See, VC firms like to invest in companies that have big growth potential. They hope that, with a little bit of funding, the companies they invest in will get bigger and bigger, until they can have an initial public offering (IPO).
An initial public offering (IPO) is when a private company starts selling stocks to the public, hence it’s also known as “going public” or a stock market launch.
When that happens, anyone with existing equity in the business—like the founders or the investors—can cash out by selling their shares. And that’s exactly what venture capitalists want to do. They’ll sell their shares, hopefully at a big profit, and move on to fund the next company.
Of course, that only happens if everything goes well. Some 90% of startups fail.2 And if VCs invest in a company that fails, they never get that big payout. So venture capital investments are actually a pretty risky business.
Which is why VC investors are kind of picky about their investment choices. They seek to invest in businesses that have plenty of potential for expansion, like technology and science-based companies. And they don’t want to fund brand-new companies still in the seed stage either—VC investing typically comes after a couple rounds of fundraising (perhaps with angel investors).
That big financial risk is also why venture capital investors take a big chunk of equity from the companies they give money to. After all, VC investors want to be sure they get a good return on investment if things go well. That’s why, according to estimates, you can expect a VC firm to ask for anywhere between 25% to 50% equity of the companies they invest in.3
The pros and cons of venture capitalists
So investing is probably worth it for the venture capital investors. But what about for the companies they invest in?
Well, that depends on who you ask.
Obviously, the biggest benefit of VC investing is the money. That risk we talked about earlier? It keeps most banks from lending to young startups. So for many startups, getting money through VC fundraising is one of the few ways they can raise capital.
And then there’s the matter of experience. While some VC investors just happen to come from wealthy families, many of them have plenty of entrepreneurial experience—experience they say they want to share as they choose companies to invest in. (Though how involved VCs want to be with a company will vary from firm to firm.)
In fact, many venture capitalists will ask for a seat on a company’s board of directors so they can use their experience to guide the company.
- Provide funding to startups
- May offer experience and guidance
- Require giving up equity
- Can lead to a loss of company control
And that sounds nice—but remember, these VC investors may have a huge percentage of equity in the company. With that kind of control, the gentle guidance VCs claim to offer could feel like strong-arming to the founders.
So for business owners, the amount of control they lose to investors can be a huge con. That’s why some startup founders prefer to rely on their entrepreneurship and bootstrap their way to success rather than take money from wealthy VC investors.
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How to get a venture capitalist
We asked business owners who have experience in attracting VC funding for their advice. They told us how to find and attract venture capitalists . . .
“Fundraising is exactly like a sales process: you need to do a lot of networking, outreach, and ultimately recognize you need a high number of prospects and referrals to identify the right investors who believe in your vision and what you’re trying to accomplish. Cover your bases. I went through my network for referrals, asked other entrepreneurs who’d raised money recently, and did cold outreach to investors who seemed like a good fit in order to raise our initial funding.”
. . . and how you should approach pitching your business to them.
“The key is to have a solid business plan written with the absolute lowest projections. Then when you are in the meeting with your source, you can talk about the growth opportunities and reference the business plan as the lowest possible return and worst-case scenario . . . In addition, be absolutely passionate in your presentation. You must sell you more than the idea! After all, they are investing in your capabilities.”
They also warned us that the fundraising process isn’t as quick as you might hope.
“The biggest thing is to consider the amount of time it takes to raise capital from angels and venture firms. During each fundraising period, it took us approximately four to six months, from networking and sourcing to closing the investment.”
Finally, they reminded us that venture capital isn’t a good fit for every business.
“To get venture capital funding, you must have a business that will be able to grow large enough to get the returns venture investors need to satisfy their investors. Only look for this type of funding if you know your business can be this large; otherwise look for other types of funding such as bank loans.”
In fact, less than 1% of businesses get their funding from VC firms.4 So while venture capital might be a tempting way to get the money you need, remember that it’s not the only way.
FAQs about venture capital
What’s the difference between an angel investor and a venture capitalist?
Good question. Good enough, in fact, that we wrote an entire article about angel investors vs. venture capitalists.
In brief, angel investors usually invest earlier than venture capitalists. Venture capitalists almost always invest more money, but they also demand more equity than angel investors.
What other business financing options do I have?
Well, you probably already know that there are some great small-business loans out there. Sure, you have to pay those back, but if you can qualify for them, those are a great source of financing for many businesses.
But maybe you’re looking into VC capital because you don’t qualify. In that case, you might consider crowdfunding your startup. You’ll need to have an exciting idea that gets people fired up, and you’ll have to invest plenty of time into making an effective campaign—but crowdfunding can help you fund your business without having to pay back a loan or give up equity to an investor. Not a bad option, right?
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Are venture capitalists evil?
Well, that depends on who you ask. Plenty of business owners have complained about venture capitalists swooping in, treating their company like nothing more than an acquisition, and offering poor long-term advice in an attempt to get rich quick. And there are lots of accusations that venture capital firms are hotbeds of sexism and racism.
That’s not to say that all VC firms have those problems—but enough do that venture capitalists have developed a pretty negative reputation in some circles.
At any rate, you don’t need to write off VC funding altogether. Just make sure you carefully vet whatever investor you work with to make sure they’re a good fit for your business.
The takeaway
VC investments could be a great way to finance your business and get a leg up on the competition—but they could also leave you in a precarious situation without total control over your company. Is the trade-off worth it? You’ll have to decide for yourself.
If venture capitalists aren’t right for you, don’t worry! Check out our guide to small-business funding options to find the type of financing that fits your business.
Disclaimers
At Business.org, our research is meant to offer general product and service recommendations. We don’t guarantee that our suggestions will work best for each individual or business, so consider your unique needs when choosing products and services.
Sources
- U.S. Small Business Administration, “Small Business Finance Frequently Asked Questions”
- Fortune, “Why Startups Fail, According to Their Founders”
- Forbes, “What Every Founder Needs to Know about Equity”
- Harvard Business Review, “Six Myths about Venture Capitalists”
