Have you ever thought about starting your own business but the idea of initial funding got in your way? Many entrepreneurs consider this to be one of the most important setbacks they face when deciding to work on a new project. Who’s gonna pay for kicking off operations?
Funding nowadays has many possible sources. We can get access to private equity, like Venture Capital or private placements, or finance our business through a bank loan. We can use angel investing, or try to crowdfund or way into action - that means trying to get many people to invest a small amount of money to fund our project. 1 dollar is not much for 1 person, but if 100.000 people donate 1 dollar that can pave the way for future outside investments as well.
If you happen to be curious about the origins of venture capital success (VC), it is worth noting that in 1957, ARDC (American Research and Development Corporation) made a smart investment of $70,000 in Digital Equipment Corporation (DEC). This decision later paid off significantly when the company went public in 1968, as its value skyrocketed to over $35.5 million.
But the realm of Venture Capital started to expand in the last years, with many VC firms seeing extraordinary returns on investments in the last decade.
The number of Unicorns (startups younger than 10 years with a valuation of more than $1bln) in the tech industry, and not only, has multiplied considerably in the last 10 years. Their number spiked from 39 in 2013 to more than 1000 in 2023. And since many VC firms got in early on many of these deals we can understand why the hype around this type of funding is growing.
So VC firms usually offer to fund startups that have a high growth potential. Think about Uber for example. The startup got many VC fundings along its path to the 2019 IPO (Initial Public Offer) mainly due to its disruptive potential that appealed to many investors.
By accessing large amounts of money the company could finance its rapid growth and expansion in many countries. But Venture Capital funding is not necessarily money. It is a form of private equity, but besides money, Venture Capitalists can offer guidance or access to a solid and mature network of individuals. In exchange for the initial investment, the startup founders give a share of their company to the investor.
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So VC funding provides the opportunity for startups to finance their initial growth efforts and for investors to get in on a hot idea that could get a high return on investment in the future.
Startups usually get access to VC funding in their seed stage or series A of funding but investments from VC firms can be made later in the life of a startup as well, being called - expansion financing, and acquisition/buyout financing. Uber for example had more than 20 rounds of funding before 2019. However, if we started working on a new idea we are not in a good position to contact VC funding initially because of the higher risk profile we bring to the table. This is called the pre-seed stage and we are more likely to fund this period in our startup life by accessing friend and family money and possibly angel investing that might like to invest as a side hustle and like our idea.
But there comes a point where we need a more significant sum of money to finance our growth, and this is where VC funding comes in handy. We will need to prepare a pitch deck with the sole purpose of getting the attention of a VC firm and looking for money that will help our marketing efforts, product development, or growing our team.
And VCs often have a vast network of contacts in various industries that they can introduce our startup. This can be particularly helpful if we are looking to expand our customer base, find new suppliers, or seek partnerships with other businesses.
VC is much more appealing than other debt-creating options like taking a bank loan, which will mean we are in for paying the money back with interest.
With VC funding, by giving away a share of the ownership of the company, say the company fails, we are not required to give the money back to the investor. But such a scenario implies that the VC has the right to disagree with our future business strategies and have a saying in what steps we will take for the success of the startup.
So VC funding offers the possibility for new and innovative ideas to come to life. The rate of success is higher due to access to capital and mentorship but the risk is always present. At such an early stage in the life of a company, the risk of failing is very high, and VC firms know that. For this reason, they get in with a long-term mindset and do not expect to get out of a deal usually in the first 5 years. And this leads us to one of the main downsides of VC funding.
The high level of risk that VC firms are facing when investing in a new startup can translate into intense pressure for startups to achieve rapid growth and profitability, which can be challenging and stressful for entrepreneurs.
By giving up ownership in their company, founders can be facing very uncomfortable situations at board meetings when their ideas will clash with those of the investors. Not to mention that the process of securing VC funding is often lengthy and competitive, requiring a significant amount of time and effort from entrepreneurs.
Even after securing funding, we may spend a considerable amount of time reporting to our investors. This can come in handy though, meaning that we may avoid making big mistakes due to the lack of experience but more often than this is a downside of VC funding.
However, VC funding has played a pivotal role in enabling well-known companies like WhatsApp, Facebook, and Snap to expand their operations. These are just a handful of instances that highlight the tremendous impact venture capitalists can have on business growth and success.
So VC funding can be a valuable source of capital and resources for startups, but it also comes with significant challenges and potential drawbacks that we should carefully consider before pursuing it.
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