Have you ever asked yourself what venture capital firms are looking for in an investment? If you don’t know the answer to the question and you have to ask it to find out, then your company is not a suitable candidate. It’s just like asking a car salesman how much a Ferrari costs and he would answer that if you have to ask, you probably can’t afford it.
Although some business owners don’t really know, there is a huge difference between venture capital firms and angel investors or outside investors. And most often, when entrepreneurs talk about venture capital firms they actually refer to the angel or outside investors. Venture capital is extremely specialized. In the U.S. alone, there are around 500 venture capital firms.
According to the National Venture Capital Association, venture capital does around 4.000 deals a year, while the average is approximately $20-$30 million a year. This includes both initial investment and follow up.
Venture capitalists want all the qualities angel investors want, but on a larger and improved scale. VCs are interested in high returns for high risk. As in the case of the vast majority of angel investors, VCs are not interested just in a healthy company or dividends, but rather they are purchasing percentages of the ownership of companies with the intention of later selling the percentages for 10, 20 or even 100 time more than they originally invested. They make money by exiting, which happens when they sell their share of ownership for a large amount of money.
VCs create a specific type of portfolios, by collecting the investments they make. Moreover, all the companies they’ve decided to invest in are part of their portfolio. A successful VC portfolio will grow 10 times in a couple of years. In some respect, the real money they get after their exit should be considered as growth.
And it’s a hit or miss type of business. They are fully aware they cannot always expect returns on the entire collection of companies. The ones who win will have to pay for the ones who lose. According to the National Venture Capital Association, about 40% of VC-backed companies fail, another 40% register moderate returns and only 20% are actually successful.
Venture Capitalists invest in businesses that show an outstanding growth potential. Moreover, they must have extremely strong management teams because they will have to be able to scale up – getting to high volume of sales extremely fast. They must have a unique component, something different like a secret recipe or technology that will put them ahead of the competition rather than just being bait for the big sharks.
Venture capitalists raise funds of hundreds of millions of dollars even billions about every two or three years. The money comes from larger organizations such as insurance companies and university endowment funds, enterprises, etc. Taking all this money comes with the obligation to invest it in startups that show tremendous potential and emerging businesses.
If you’re still not sure which type of funding source is right for you, take a look at our section dedicated to Finance.