If you want to start a business, the first problem you encounter is the need for seed capital. That is the money you use to develop and launch your business, including the legal work of setting up a corporation, the cost of licenses, insurance, product design and manufacture, inventory purchase, facilities lease, website development and the hiring of personnel. Most entrepreneurs hit up their friends and family for money. If you have assets for collateral, you might be able to get an SBA loan. However, if you are trying to develop and launch a big company, look for venture capital.
When you enter the competitive world of start-ups vying for funding, you are actually taking the first hopeful steps toward your company eventually becoming a portfolio company. If you have already completed your friends-and-family round of funding, and you need more money, the next step is angel funding. Members of angel investment groups combine their money and choose a few companies for seed-round investment. If your company is one of these, an angel investor has given you capital in return for an ownership share of your company. Angel rounds usually raise $250,000 to $1 million. However, once your company is ready for a larger round of funding, its mezzanine round, you are ready to start talking to venture capital firms in hopes they will invest $5 million up to $100 million or more, and take your company in as one of their portfolio companies.
Venture Capital Firms
A venture capital firm manages a pool of funds by investing in promising companies. The firm is formed by a group of business experts such as investment bankers, private investors, lawyers and entrepreneurs who combine with subject matter experts such as scientists, engineers and medical specialists. They create a business plan that details the type of start-ups they are seeking for investment and present it to institutional pension funds, insurance companies and other managed investment funds such as hedge funds. Once they have enough investment capital in their pool, they start looking to invest in young companies, which become their portfolio companies.
When a venture capital firm invests in your company, it is buying a large ownership interest. Members of the firm take seats on your board of directors and often install associates in management positions. As a portfolio company, your business receives expert advice and important business contacts arranged by your venture capital firm investor. The goal of the venture capital firm is to either sell your company to a larger enterprise or take it public in an initial public offering. The money raised by selling to a larger company or going through an IPO pays back the venture capital investment, plus profits. It also pays the other investors, founders and employees who have earned shares in your company.
About a third of portfolio companies don't succeed, but those that do succeed can make considerable profits for the venture capital firms and their investors in the capital pool as well as the entrepreneurs. The standard return sought by venture capital firms is approximately 30 times their investment, but that is more of a guideline than a reality. Nevertheless, many venture capital firms are so skillful at developing their portfolio companies that they have no trouble raising hundreds of millions of dollars from institutions eager to add to their investment capital pools.
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