Venture Capital can serve as medium to long term working capital financing option for start-ups and early-stage small businesses. However it is not necessarily a solution for well established businesses and listed entities.
The finance option you choose for your medium to long term Working Capital funding will depend on the type of business you have and its current stage of growth.
Long term working capital options:
Long Term Loans and Lines of Credit
It is extremely challenging for start-ups and early stage small business to secure long term loans or lines of credit as lenders are typically risk averse and are cautious of extending credit to new businesses. They base their loan approval decisions on the historical financial performance of the business, the credit worthiness of the owner and the value of any assets belonging to either the business or the owner (to use as collateral).
While they review the cash flow forecasts in their review of the financial statements, they don’t base their decisions solely on the projected future growth of the business. Debt financiers are in the business of making guaranteed returns on the money they lend.
Re-investment of Profits
On average there are no significant profits made in the first three years of a start-up business. While an early-stage business that has consistent revenue and well managed cash flow may be able to fund small growth requirements such as taking on an additional team members, typically it cannot afford to fund large scale growth needs until it is properly established.
Equity or Venture Capital Finance
If your start-up or early stage business has the potential to scale then Equity or Venture Capital is a funding option to investigate. This option requires you to sell shares in your business in return for growth capital.
This this option fundamentally changes the ownership structure of your company, you need to carefully consider the pros and cons to decide whether this option will work for you.
Venture Capital Funding (Equity Finance)
Venture capital is a form of financing that is provided to early-stage companies or growing small businesses that are believed to have high growth potential. The capital is provided by well–off investors, finance companies managing venture funds, investment banks and other financial institutions.
Venture capital investments typically involve a substantial element of risk on the part of the funder but have the potential of high returns. The investment deal often includes more than just the capital injection and can also incorporate additional benefits such as technical support, access to networks and managerial expertise.
Equity Finance is Different from a Loan
Equity or Venture Capital finance is very different from a loan. A loan has to be repaid with interest against agreed terms but in the case of a loan you retain full ownership of your business.
With venture capital funding, the money given to the business does not have to be repaid but you will have to relinquish some shares in your business in exchange for vital working capital. Considering that early-stage businesses usually struggle to qualify for business loans, equity finance is a great option to consider to raise working capital.
If you have a business that you believe can easily scale and will interest investors then venture capital may be a good route to explore.
As a business owner you have to ask yourself whether it’s better to hold on to 100% of a company that is struggling with cash flow and has no working capital or whether it’s wiser to consider giving up a minority ownership stake in exchange for the vital capital needed to build the significant value your business has the potential to do.
Financing for Start-ups
Venture capital is often regarded as one of the most attractive and sought-after sources of financing for start-ups, and rightly so, especially due to the range of value-added services that a venture capital firm can provide to help the start-up grow and succeed. But remember, along with the cash you are also getting the venture capitalist and his/her team, so make sure you are choosing well because a bad match could cause a nightmare.
If you can find a good investor you would enjoy working with and who could provide your business with smart money i.e. money plus networks and management expertise then the trade is usually worth it. It’s far better to own 80% of a successful growing business than 100% of a failed enterprise.
Typically finance is provided for a 5 to 7 year period and the expectation is that on exit, the Venture Capitalists will earn anywhere from 25% to 40% on their initial investment. It stands to reason that Venture Capitalists only invest in small businesses that they believe have the ability to rapidly scale and gain a large enough market share to generate the required profits.
Pros and Cons of Venture Capital
There are significant benefits to accessing venture capital to fund your working capital needs in order to realise the potential of the business, especially for an inexperienced business person. The advantages of professional mentoring and business support from seasoned experts and getting access to established channels to market to sell your products or services can be invaluable.
On the other hand, there is also a danger that your business does not achieve its projected revenue targets within the agreed timelines and you have to raise additional rounds of funding which further decreases your ownership stake and you possibly lose decision making control of the business.
To raise Equity or Venture Capital finance you need to fit the strategic objectives of the finance company.
Is Venture Capital Right For you?
Before you make the decision to raise Venture Capital, ask yourself the following questions.
- Do you have a business model that can scale to a large market/s?
- Does your business fit the strategic objectives of the Venture Capital investor?
- Can their team add useful expertise and access to market linkages that will help you scale the business?
- Would you be happy to work closely with their team and share the decision making?
If you answer Yes to most of these questions, then Venture Capital could be an excellent choice of finance to see your start up thrive and scale.