Getting investors – Venture Capital firms
When considering raising equity finance, most early-stage businesses would often have to turn to angel investors or crowdfunding as was explained in last week’s article.
They are the investors most likely to invest in pre-seed or seed rounds when a business only has very limited traction, whereas a Venture Capital firm would typically not invest until the business has proven itself more.
According to the British Venture Capital Association (BVCA), “venture capital is a form of investment for early-stage, innovative businesses with strong growth potential”. Unlike private investors, VCs are businesses that are run by professional staff, and they focus on businesses with strong growth potential as these are the businesses that are likely to lead to the biggest returns. This focus, however, means that they are specifically interested in technology, fintech, life sciences and other such businesses rather than more general businesses.
At the time of writing, there are 547 active VC and PE funds in the UK, and they have participated in 15,923 fundraisings. In 2021 alone, 1,320 UK companies received investment from such firms and over two million people were employed in the UK by the 5,000 plus businesses backed by funds from VCs. These statistics show the importance of investment from this source.
A number of VCs will now invest as little as £150,000 or £250,000 in companies raising funds under the SEIS scheme as some VC firms have specific SEIS investment funds. Almost by definition, the businesses raising SEIS funds are small, very early-stage businesses and so would normally not be of interest to a VC fund. The vast majority of VCs still look for businesses that are better established, even if they are now prepared to invest smaller amounts than was once the case. In most instances, small amounts will only be invested when both parties see the need for follow on investment in the future as this enables the VCs to increase their total level of investment in future rounds.
Like with any investor, obtaining funds from a VC, as opposed to any alternative funders, comes with both advantages and disadvantages. As previously stated, one advantage is that VCs are most able, and most likely, to follow on in any future fundraising activity. They are also normally focused on specific sectors or industries and so bring expert knowledge and potentially other useful contacts. This clustering effect can benefit all those involved.
They would normally play a proactive role and would insist on appointing a board member or, at the very least, a board advisor. It is worth noting that this is something that you as a business would be charged for. In addition, the level of due diligence undertaken by a VC is extensive and would be more thorough, and take more time, than due diligence for any other type of investor.
On the downside is the fact that the way that they would value an early-stage business is different to most other methods or investors, and this would mean a lower pre-money valuation for the business prior to any investment. This in turn means that you would need to sell more shares to obtain any given level of cash injection. Charges and other costs would also often be higher than when compared with other sources of finance.
All of these facts underline the need to fully understand the benefits and drawbacks of each type of investor and carefully consider what type of business yours is, how much money you are seeking to raise, and at what stage of development the business is. Only once all that has been obtained is it possible to start to decide what might be the best source of equity funding for your business.