A Guide to Startup Venture Capital Funding

by Adarsh Raj Bhatt in August 12th, 2021
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Key Takeaways

  • Venture capital funds pool their money to invest in high-growth companies and other early-stage startups.
  • Hedge funds invest in high-growth companies that are also high-risk. As a result, only knowledgeable and hardened investors who can endure setbacks, illiquidity, and extended investment horizons are eligible for hedge funds.
  • New businesses seeking faster expansion, particularly in high-tech or developing industries, employ VCFs as seed money or "venture capital."
  • When a portfolio firm (i.e., a startup that an investor owns a stake in) goes through an IPO, merger, or purchase, then VC fund investors will receive their share of returns.
  • Top venture capital firms in 2021 include Sequoia Capital, Accel, Intel Capital, Khosla Ventures, and Kleiner Perkins.

What are Venture Capital Funds?

Venture Capital Funds (VCFs) are investment tools where people can invest their funds in recently established startups and SMBs. These really are investment funds that focus on startups that have the capacity to generate large profits. Investing in these startups, however, comes with a high level of risk. VCFs are comparable to mutual funds in that they gather funds from a number of different investors, including individuals with a high net worth, corporations, and even other funds. These are all examples of investors. A VCF is managed by a VC firm rather than a wealth management institution.

How Does Venture Capital Work?

VCFs are one type of funding available to startups and SMB-owners. A VCF will only invest in startups with strong long-term growth potential and the capacity to potentially generate large returns. Because it’s relatively startups that are being invested in, the risk is quite significant. VCFs invest in several businesses at the same time for this very reason. The entire investment strategy is broadly based on the conviction that at least a small fraction of the startups in the portfolio will be able to generate large returns and compensate for the losses experienced by the majority.

Benefits of Venture Capital

No Repayment Responsibilities

Among the most significant benefits of VCFs is that the startup is not required to repay the funds raised. Even when the business fails, the founders are not required to repay the funds invested, which would generally be a major issue with bank loans as banks require the borrower to repay the money (usually with interest).

Useful for Forming Networks and Relationships

VC firms tend to have a massive network, which may provide a startup with the marketing and advertising relationships required to help it reach its target audience.

Facilitates Future Growth

VCFs can aid a startup's rapid and exponential growth to an extent that may not be true with other types of financing.

Provides Critical Business Understanding

VCFs bring more than just money to the table -- they also offer years of useful experience. This is critical in the management of human resources, financial planning, and financial decision-making, all of which are skills that most founders lack.

When to use Venture Capital?

Founders often wonder when is the right time to raise venture capital funding for their startup. 

To begin with, ensure that you have a tested corporate model. This implies that you'll need a strategic plan which has shown to be consistent in the past. Not just that, you must also be able to demonstrate that the product/service fulfills a need that people are ready to pay for and that you can profitably sell. You must also be able to demonstrate in your proposal to VCs that the funds requested will be put to good use. In other words, you must demonstrate exactly what your startup will accomplish with the funds and how the money will aid in its growth

Next, if you've effectively managed a business before -- especially one that you founded yourself -- then you are in a relatively strong position to have a venture capital firm as an element of your startup’s overall financial situation. This is because your past experience appeals to the VC firm since it demonstrates that you already know what goes into running a business. Even if that business didn’t work out, your experience probably helped you learn from your mistakes. You're also seen as a more reasonable risk to join hands with because you'll be less inclined to make the blunders that most first-timers do.

There are certain cases when an infusion of VC funding will be needed by your startup. For instance, you might wish to prioritize the expansion of the team but are unable to persuade good talent to join your company because it's new, largely untested, and can’t promise compensation at market rates. In these situations, venture funds could be a gamechanger for you. This is because, by offering higher compensation, great candidates will be far more willing to become a part of your team. 

VCs invest their money in companies that have strong growth potential or have already proven exceptional growth. Venture capital investment is divided into stages that correspond to the phases of a company's growth. As any startup grows, it will likely go through these stages and raise many rounds of venture capital financing.

Some VC firms diversity and invest in businesses at many phases of their lifespan, while others concentrate on a single stage. Seed-stage investors, for instance, assist early-stage startups in launching, whereas late-stage investors assist established businesses in expanding. Many venture capital firms specialize in investing in a certain industry or industrial vertical.

Small businesses may frequently receive substantial amounts of capital through VC funding. Furthermore, most great investors offer value to the business that goes beyond just capital: they contribute proactively to the startup’s growth with their skills, expertise, background, insights, and networks. In fact, an investor will frequently seek to enter the startup's board of directors either as a formal board member or a board advisor as part of a VC agreement. This will enable them to sit in on board meetings which will, in turn, enable them to be more engaged in the company's strategic (and occasionally operational) choices. In this way, they'll be able to contribute much more to the startup’s success beyond money.

Steps to Securing Venture Capital Funding

VCFs are classified according to the stage in which they engage with startups. 

There are 3 kinds of venture capital funding in general:

Early-stage Funding

Early-stage funding is the capital invested to assist a startup in establishing itself and beginning to develop, sell, or distribute its products/services.

The three forms of early-stage funding are:

  • First-stage funding: Granted to startups that need money to get off the ground
  • Startup Funding: Start-up financing is offered to assist new businesses in developing their products/services.
  • Seed funding: Seed investment is a modest sum of money given to a company to help it qualify for a loan from a bank.

Expansion Funding

As the name implies, this money is available to startups that are generally past the “proof-of-concept stage” and focused on growing the business at various possible stages.

There are three forms of expansion funding:

  • Second-stage funding: Second-stage funding is given to businesses looking to expand.
  • Bridge funding: This is a type of short-term funding that allows a startup to meet short-term expenses while waiting for long-term investment.
  • Mezzanine funding: This is a type of financing that is available to help startups with mergers and acquisitions.

Acquisition funding

The following are types of acquisition or buyout funding:

  • Acquisition funding: This type of investment is used to assist late-stage startups in acquiring specific parts of another company -- or the entire company.
  • Management/Leveraged buyout funding: This type of funding is provided to assist late-state startups in acquiring another business or a product

Top Venture Capital Firms in 2021

Sequoia Capital

Sequoia Capital is located in Menlo Park, California, and was established in 1972. The firm works with early-stage startups and established businesses in a variety of sectors. It has recently shifted its focus to the internet, smartphones, healthcare, finance, energy, and web businesses. Up until December 2020, Sequoia made roughly 1,275 investments, with 365 of them yielding a profit. When they are the primary investor, their success rate rises to 63 percent. Apple, NVIDIA, Instagram, ServiceNow, and more are among their prominent exits.

Accel

Accel is based in California, London, China, and India, and was launched in 1983. Consumer applications, mobile technology, enterprise applications, and the internet are the primary areas in which this VC company invests. They've made roughly 1,350 investments, with 280 of them yielding a profit. Their success percentage rises to 55.56 percent when they function as the lead investor. Facebook, Crowdstrike, and Animoca Brands are among their most successful investments. It mostly participates in early-stage and growth-stage startups, with some seed investments thrown in for good measure.

Intel Capital

Intel Capital, a corporate VC division of Intel, was founded in 1991. This venture capital firm concentrates on the United States, China, and Western Europe. It focuses on technology companies working in fields such as artificial intelligence (AI), 5G & Telecommunications, Cybersecurity, IoT & Automation, Next Gen Computing, and more. More than 1,300 investments have been made, with Intel Capital leading the round in 34% of them. Their success record rises to 83% when they act as the primary investor. Animoca Brands, Schoology, and MongoDB are just a few of the successful brands where Intel achieved an exit.

Khosla Ventures

Vinod Khosla, the co-founder of Sun Microsystems, launched Khosla Ventures in Menlo Park, California, in 2004. This VC company has made over 700 investments, with 96 of them progressing to the IPO stage. It invests largely in China and the United States, notably in the software business. Despite the fact that the firm concentrates on a single market, it has had a great deal of success in its 16 years of operation. Square, Okta, and Big Switch Networks are a few of their famous brands where Khosla Ventures achieved an exit.

Kleiner Perkins

Kleiner Perkins was formed in 1972. Originally, the company focused on software/hardware businesses but it has since expanded its holdings to include businesses in the health, smartphone, internet, business software, and biotech sectors. Similarly, it used to engage with only late-stage growth startups but today it also invests in early-stage startups. They've made over 1,100 investments, with 240 of them in startups that went public. When they operate as the primary investor, they have a success rate of around 79% Among Kleiner’s most prominent exits are Twitter, Uber, Peloton, and Beyond Meat.

Summary

Venture capital funds are collective investment pools that handle the funds of investors looking to invest in startups and early-stage businesses with good prospects. These investments are typically described as extremely high-risk/high-reward. Previously, VCFs were exclusively available to professional VCs, but today, accredited individuals can participate in VC investments as well. VC funds, however, still remain mostly out of reach for ordinary investors.

Venture capital funds are distinguished from mutual funds and hedge funds in that they specialize in a certain sort of early-stage investment. Venture capitalists invest in companies that have significant development potential, are risky, and have long investment horizons. VCFs prefer to take on a leadership role (lead investor) in their investments, offering advice and even serving on the board of directors. As a result, VC funds are involved in the operations, management, and functioning of most startups in their portfolio.

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