By Will Schroter. Source: Forbes.
Venture capital plays a pivotal role in the startup economy, providing vital funds to high-potential early-stage companies. Not surprisingly, it’s also a constant topic of conversation within the startup community — who’s receiving it, how much they’re getting, and how long it took them to capture the interest of VCs.
During my 19 years of experience as an entrepreneur, I have founded 3 venture-backed companies, and I know firsthand that navigating venture funding can be incredibly confusing. As the founder of Fundable, I talk to startups daily about their approach to investors. I’ve put together answers to some of the most frequently asked questions and topics of discussion amongst our community of founders. If you’re thinking about raising capital, here are a few things to keep in mind before you dive headfirst into the venture funding pool.
1. U.S. Venture Capital Had Humble Beginnings
While only a small portion of startup businesses make it to a stage where they can benefit from venture capital, venture funding has been a critical component to U.S. startup companies for decades.
In an era when venture-funded giants like Google GOOGL -0.34% and Facebook would seem ludicrous, The Small Business Act of 1958 was created to help emerging entrepreneurs by allowing the Small Business Administration (SBA) to license private “Small Business Investment Companies” (SBICs) to help with the financing and management of the small businesses in the United States. In the 60s and 70s venture capital firms were founded with the purpose of both starting and expanding companies.
The 1970s paved the way for a more organized system for venture firms, many of which became the model for today’s venture capital landscape. Silicon Valley was firmly established as a hub of startup activity, with an emphasis on technology. Venture capital firms remained limited throughout the 1980s and the first half of the 1990s, increasing by just $1 billion between 1983-1994.
The late 90s were a true heyday for venture capital, as the internet-driven economy emerged. IPOs were common and venture capital firms saw incredible returns. Since the internet bubble burst, venture funding has experienced ebbs and flows, but has never quite returned to the dizzying levels of the late 90s.
2. Venture Funding is Not the First (or Second) Step for Your Business
Often, it can seem like incredibly profitable startups pop up and are venture funded overnight, but I can assure you this is not the case. Companies have often put in many years of work before they approach venture capital firms. Typically, startup founders first approach friends and family to raise an initial seed round. This usually occurs during the idea stage of a startup. For example, a company may have a working prototype and needs funds in order to produce an initial production run of their product. This is also a time when many startups decide to crowdfund their business and pre-sell their product, or look for initial friends and family investors.
Later stage seed funding often comes from angel investors, who make their decision to invest based on a startup’s traction (sales numbers, notable press mentions, etc.), as well as an affinity toward the entrepreneur.
Venture capital comes into play when a startup has established itself as a profitable business and is seeing very rapid growth, post seed round. VCs and firms invest in companies at this time, hoping for an eventual sale or IPO so that they can make a large return on their investment.
VCs are very selective in their investments and are looking for the highest-potential companies because they must answer to their Limited Partners (LPs) — those that have invested in the fund and are counting on the firm to make profitable decisions. With 3 out of every 4 startups failing, it’s important that a VC make a significant return on those startups that do succeed.
3. Venture Capital Pairs Well with Crowdfunding
There has been quite a bit of debate recently about the relationship between crowdfunding and venture funding. At Fundable, we don’t believe that crowdfunding will replace the current venture capital model anytime soon. Crowdfunding is the perfect precursor to later funding rounds because it gives entrepreneurs the opportunity to gather the traction they need to attract later stage investors. Equity crowdfunding is a great way to gather initial investors, who in turn will continue to profit from the company’s growth — especially if the company scales to a point where it needs venture funding.
Data also shows that venture funding tends to occur in geographical silos, with the most concentrated amounts of funding committed to companies located near Silicon Valley. Because of the geographical inequality of venture capital being committed, equity crowdfunding can be a great option for companies located outside of traditional venture capital hubs, allowing them to connect with investors across the country through their online fundraise.
4. Venture Capital Isn’t For Everyone
With just over 1,000 new investments made into startups each year, there simply isn’t enough venture capital for every successful startup. Venture capital investments are still predominantly committed to technology-focused businesses, meaning that companies outside of this realm need to seek alternate paths to funding. At Fundable, we often work with companies both inside and out of the technology silo, and we’ve seen firsthand that venture capital is not the only path to grow a business.
With the legalization of equity crowdfunding, and the surge of new and innovative methods to raise startup funding, early stage companies now have more tools to raise capital than ever before. Venture capital will continue to be a driving force behind many of the most successful companies, and we’re excited to work with companies at an early stage as they start their funding journey.
As the founder of Fundable, I spend most of my day working with entrepreneurs and giving advice on how startup funding works. If you’d like me to give you a hand, I’m easy to find – firstname.lastname@example.org.