When it comes to getting your startup off the ground, Venture Capital firms and Venture Capitalists in general will often play an absolutely fundamental role. In terms of startup lingo, Venture Capital certainly comes up at the top of the list of key terms and conversation talking points for entrepreneurs and experienced business owners alike. But what’s the deal? From The Startup CFO, your expert in all things related to startup financial management, we are going to take you through the 5 essentials when it comes to approaching a Venture Capital. After all, could you really explain what venture capital means at a dinner party or over beers with other entrepreneurs?
Let’s get started!
The importance of VC funds: Why they are essential for your startup
First, it’s important to remember that Venture Capital doesn’t tend to be aimed at long-term projects. Venture Capitalists generally get behind new businesses or startups which show the potential for promising growth in their first years of operation. Venture Capital is ideal for ambitious and driven entrepreneurs to really get their startups moving in the right direction with opportune and optimal funding by investors looking to earn returns and share their knowledge.
Remember that in order to have a venture capital firm or angel investor onboard with your project, you’ll be giving up equity. You heard that right. Giving up equity and elements of control are part and parcel of any project involving VC, but if you know how to manage this risk correctly, you’ll be in to win and reap the rewards.
Having VC funding onboard for your startup tends to boost your business in a range of areas, many of which are far from simply financial. You’ll be given access to a whole world of expert guidance, knowhow and expertise related to your business area and a whole array of support that a good relationship with your investor brings. Improved technology which is essential for SaaS environments, more honed acumen and a bigger picture perspective on the business environment as a whole are just a few of these potential benefits.
How do Venture Capital firms work?
It’s essential that you know a bit about how a VC firm’s structure works. Inside a VCs organizational structure, you’ll typically find general partners, limited partners, investment analysts and operating partners, among a host of other roles. Whilst general partners tend to receive most attention and might be the professionals that spring to our mind when we think about reaching out to a VC firm, the other parts that form the firm have a key impact.
While limited partners (LPs) are key due to their role in the direct investment, operating partners provide a significant amount of backup. These roles could be considered as expert strategists who create key gameplans in order for a startup to improve on its opportunity areas and make maximum returns for LPs.
Investment analysts tend to take a “behind the scenes” role, doing a great deal of groundwork in order to make the most intelligent analyses aligned with achieving investment success for all parties involved, providing a wide range of business expertise.
VC funds are structured under the assumption that the fund will invest in startups over the course of their first 2 to 4 years, before deploying nearly all capital within 5 years and returning all capital and profits to investors within a 10-year window.
How do Venture Capital firms make money and pay out?
As the funded startups begin to bring in the cash, LPs will start to make returns on their equity. One thing is crystal clear: success on the startup which was pitched and the success of a content LP as a result makes or breaks the success of the VC for said project.
What is a management fee and what is carry?
It’s here that we reach perhaps two of the most important concepts when it comes to the world of VCs. These two concepts tend to function in a 2/20% rule.
- Management fees can be considered the operating budget for a VC firm on an annual basis and tend to focus on the management and operating of all key services provided by the firm. These tend to sit at around 2% of AUM.
- Carry is a figure generally resting at around 20% which describes the profit-sharing structure of a VC fund. Let’s say a $10M fund returns $20M. The initial $10m is returned to the LPs. But, what happens to rest? Fund managers would receive 20% of the other $10m, which would be funneled through to employees and different parts of the teams such as OPs, depending on the agreements at each VC. LPs would then receive the rest, an additional $8M, making $18M in total.
It’s important to bear in mind that the more money returned and the more the LPs make, the more money that’ll be funneled through not only to fund managers but also the wider VC firm’s team, which is a guaranteed way to incentivise them to work harder for your startup’s success in the long run.
Tips for dealing with Venture Capital: how to get the most out of your relationship
As a budding entrepreneur, it’s important to think about the relationship you wish to build with your investors should you decide to use the VC route.
We’ve already looked at the importance of pitching in previous posts. However, when it comes to approaching VCs, you should be striving for more personal connections, points of common ground and conversation rather than just presenting an idea.
Relationships and bonding are everything. This might seem obvious, but it just can’t be stated enough. It’s a great deal more important to analyze who you’re going to integrate into your board and give over equity to. Make sure you know who you’re working with and if they are on the same page. Ask yourself what makes them tick.
Thoroughly investigate the types of startups the firm you are approaching has worked on, how specialized they are in SaaS environments, their track record and the type of fund they are most comfortable managing.
Excellent reporting is the key to success
When it comes to kicking off your journey in the world of startups and seeking investment, reporting is key. After all, tangible and rigorous reporting of key information on a monthly basis will provide investors and the VC firm as a whole with peace of mind, guidance and motivation to keep working for your startup’s success.
At The Startup CFO, we specialize in the most dynamic, thorough and forward-thinking reporting for all of your startup needs. Get in touch with us to have a more in-depth conversation about how to approach investors and how we can guide you in expert and crystal clear reporting.
Also, if you want to learn how to prepare these reportings, sign up for our startup finance course at The Startup CFO Academy!