Basics of Venture Capital

If you are considering raising money for your business, you are going to need to know how venture capital will work. This post is supposed to be for someone who is interested in raising funds and has a desire to learn the fundamentals of how the entire process works.

Venture capital will work in what is referred to as “Series” or "Rounds." In every round, progressively more funds are raised. These include 3 typical rounds an organization will have to go through while raising funds:

Pre-Series A - Round 1 – Angels, Family and Friends

In a Family and Friends + Angels round, you generally are raising about $500,000. As its name implies, step one includes raising money from family members and friends.

The majority of entrepreneurs discover their average contribution size in this space is around $25,000 from family and friends. The singular $500,000 investment is often a myth - The round is usually comprised of many smaller investments. Angels usually make larger investments, around $100,000 each.

Again, these are rough guidelines.

The best form these investments can take is in convertible debt. Basically, convertible debt is a loan at a low interest rate, typically around (two percent) which converts to equity as you obtain a valuation from a venture capitalist; however, the conversion will be at a discounted rate.

For instance, if the investor invests $100K, as you obtain the ‘A’ round financing and your business is valued at $1 a share, if the discount rate is forty percent, the investor is going to instead have the ability to buy stocks at $.60 cents. The $100K is going to convert into 166,666 shares rather than 100,000 shares.

Why convertible debt rather than making a valuation on the business and buying shares according to the valuation? Merely because valuation takes lots of work and is very time consuming. Some angels and most entrepreneurs instead prefer to leave valuation to the venture capitalists and instead only invest the funds now and make their money as the business obtains its series A.

Series A - Round 2 - VC Capital, $1 - $5 M

This round includes the Series A round. Usually, you will need to use a process to meet with a minimum of 20 venture capitalists, beginning with venture capitalists whom you actually do not have a desire to invest with you, ending with those with whom you do desire investment from the most.

In the process of preparing and presenting your company many many times, you will have honed your presentations to be as natural, precise, informational, and interesting as possible, by the time you reach your real investment targets.

Prior to a VC investing in you, the investors will conduct lots of research on you and your company. This might involve background checks on your executive team and on you, research into your business, audited financials, credit reports, etc. It is possible to expect to give away 20 percent to 50 percent of your business in the Series A round.

Series B - Round 3 - $5 M +

In the second round of venture capital investment, things actually are much easier. This is because, at this point, you are a vetted company and entrepreneur. Most Series B VCs will actually not do a lot of research into your company or you if you obtained investment from a reputable venture capital company for your Series A. This is because everyone knows and understands that someone else already conducted the research.

Series B is usually from $5 million to $15 million in investment. At this point you should expect to give away about 20 percent of your business.

Last Words on Venture Capital

Something to bear in mind: You must have an extremely investable business to get VC funds. You require an existing customer base, a business model that has been proven, etc. VCs generally don't take a risk on businesses still in the concept phase or which have unproven business models. Many angels will not either.

Once you have proven the idea of your company and made a little money, possess a strong business plan, and you are now requiring the funding to grow at a faster rate, this is when to search for investors. Make sure you have proven your company business model, gotten your company off the ground, and practiced presenting your information before you start searching for your investors.