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How does venture capital work?

If you’re a business owner, then you would have heard about venture capital, a form of private equity that can help fund emerging businesses for growth. But it is a big world, with plenty to consider when looking at possible venture capital investment for your business.

To understand the world of venture capital better, we went to in-house experts who know the industry inside and out.

Imche Veiga, Co-Founder of Outset Ventures and Jo Wickham, Partner at Icehouse Ventures, sat down with us to explain how the world of VC works.

What is venture capital?

Just like bootstrapping or building your own revenue, venture capital is a form of funding the growth of a business, start-ups in particular.

Venture capital can be seen as an option when revenue is a “bit far off”, or you want a lot of growth in a short amount of time.

“It’s a way to fund the growth of your company, but it’s only one way, it’s not the only way,” says Veiga.

Unlike borrowing, venture capital is an investment, meaning the venture capital firms gain equity in the company in exchange for the funding they provide.

The money is raised in funds from high net worth individuals, institutions and other wholesale investors who are interested in what the venture capital firms invest in, which could range from deep technology, fintech, retail, new brands and so much more.

Does my business fit venture capital?

Venture capital is best for businesses who are finding it difficult to find capital and fund their company from the beginning.

“They can’t go and get bank debt because they’re so high risk, so for them, it’s a way to really turbocharge and supercharge their growth and their ambition,” says Wickham.

Wickham says many venture capital firms are looking for start-ups or businesses with high-growth potential or with a really large market.

“[We’re] looking for outlier companies and returns. There’s this concept in investing were we’re really looking for those few companies that just exponentially grow and do really well,” she adds.

“For every 10 companies that we invest in, we kind of expect maybe six or seven not to make it, not to survive. And that’s very much a part of the innovation process.”

Both Veiga and Wickham say venture capital is an interesting form of investment that fits for specific types of companies, so for founders, they must think carefully and research a lot about this.

Read more: Ten tips for raising capital in a challenging climate

How do venture capital firms have the money to invest in a range of companies?

Some funds can range from $100k to tens of millions of dollars, but a common Google search is, how do they get the money?

Similar to start-ups looking to raise capital, venture capital firms need to raise money from investors.

Veiga reveals that firms come up with an ‘investment thesis’ that convinces investors to invest in the fund.

The thesis can say “here’s a market opportunity, here’s an under-served market, here’s an under-served opportunity” and much more.

Venture capital firms pitch their investment thesis to investors who can be privately wealthy individuals, larger more mature funds, institutional funds, or other fund managers.

“We go out and we go and pitch to high net worth individuals, and we go and pitch to institutions for investment. We say we’re going to raise $30 million, we will invest that in the most promising early-stage deep technology companies, and we will give you all your money back and all the profits that those companies or that value that the companies build,” explains Veiga.

“Typically for fund managers, we need to repay all of our investors first before we can get any profits or carry as it’s called.”

Venture capital firms make money in a ‘2 and 20 model’. Two percent of the entire fund goes to management fees for day-to-day operations for the fund and 20 percent is the carry, while the remaining 80 percent goes to investors.

“We make money raising and managing a fund, and then we make money when the companies that we’ve invested in make money,” adds Veiga.

As a start-up, how should I get involved with a venture capital firm?

There are many different ways for venture capital firms to operate when it comes to creating a relationship with start-ups and businesses.

For Icehouse Ventures, a soft referral through their network is the best way. However, for those without a connection in the network, getting in contact shows initiative, especially for firms like Icehouse Ventures who receives thousands of pitch decks.

Veiga says that start-ups shouldn’t be bound to having a relationship with just one venture capital firm and should branch out and talk to everyone to see what fits their business best.

She adds that it is all about research.

“It’s like getting married and you need to make sure that the person that you’re getting married to is someone that you feel you can work with for the long term,” she says.

Attend events, read newsletters and understand what is going on in their firms’ world in terms of investments and how companies are growing.

For start-ups and businesses interested in venture capital, what are some tips they should know before diving into the world?

Wickham advises that many firms often say no, but “it might not be no forever”.

If you get a no, Wickham says they shouldn’t give up but rather “keep the conversation going” to allow firms to continue to watch and follow the business.

“You’re in a much better place when you go to raise capital if you’ve done all of that sort of background work, which I know it can be really hard to do at the same time as building a company, but if you can manage that, keep both of those sort of fires burning, I think that puts in a much better place to fundraise,” she says.

Bernadette is a content writer across SCG Business titles. To get in touch with her, email [email protected]

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