What is the Venture Capital Investment Process? What is the Venture Capital Investment Process?
Venture capital firms are a primary source of funding for startups and other fledgling businesses. VC firms are comprised of Limited Partners (also known as LPs) who invest different sums of money that is turn invested into startups at the discretion of a fund manager or General Partner (also known as GPs).
Key Takeaways:
- The first step of the VC investment process is most often a research process to find startups who need funding and might be a good fit for the firm’s strategy.
- There are several ways to get in front of a VC: Referrals from your advisors or partners, intake forms on the VC’s website, reaching out to the GPs directly, events.
- The VC will then meet with a startup’s founder and/or leadership team to hear them pitch their business and explain why it’s a good investment for the firm.
- The VC will decide whether to proceed with their own due diligence in determining whether the startup is indeed a good fit for the firm’s investment.
- If the firm decides to proceed with investing in a startup, they will negotiate a term sheet outlining stipulations for their investment.
VC investors provide capital for startups, entrepreneurs, and early-stage companies in exchange for an equity stake in the business. Venture capitalists typically invest in companies with high growth potential, as the potential return on investment has to be worth the high risk associated with investing in a startup. So how exactly does the VC funding process work? Below, we'll dive into the different stages of the VC investment decision making process, the difference between venture capital and private equity, the different stages of funding VC firms typically participate in, and more. Let's jump in.
What is the Venture Capital Investment Process?
As you can imagine, VCs are taking risks with large amounts of money when choosing which investment opportunities to pursue. As such, the VC investment process involves a large amount of due diligence to ensure the firm is setting itself up for the greatest possible chance of getting a return on their investment. The venture capital process will differ from firm to firm, but most will follow the same general path in discovering businesses to invest in, researching each startup's business model, meeting with entrepreneurs to hear their pitch, conducting further due diligence and internal analysis, and finally negotiating a term sheet. We'll go into each of these steps in greater detail below.
Discovery and Deal Origination
The first step of the VC investment process is most often a research process to find startups who need funding, are a good fit for the type of investment the firm is trying to make, and have high growth potential. This can be accomplished several ways including through the investor's referral network, attending startup showcases or pitch events, intake forms on a VC’s website, or even through cold calling or emailing. Many firms also use deal origination software to more efficiently target startups that meet the VC’s investment criteria.
The Pitch Meeting
Once a firm has targeted a startup for potential investment they will likely reach out to the founder or leadership team to hear their official pitch outlining the company's value proposition, business plan, and growth potential. The pitch meeting almost always involves a formal presentation by the startup team, and VCs will use this meeting to generally get a feel as to whether the business would be a good fit for the firm's investment.
Due Diligence and Internal Analysis
If the pitch meeting goes well for the startup and the VC investor feels like their business is a good fit for the firm's investment, they will do further due diligence and research into the startup's financials, market potential, intellectual property, and other legal and financial issues. This stage of analysis is used to ensure that the startup will actually be a sound investment for the firm to make.
Negotiating the Term Sheet
If a VC's due diligence confirms that a startup would be a good investment fit for the firm, they will negotiate with the startup's founders on terms of investment. These negotiations produce a term sheet which outlines details including what amount of funding the startup will receive, how much equity the firm's investors will receive, and any milestones the startup can reach to trigger additional funding from the VC.
What Are the Stages of VC Funding for Startups?
There are several funding stages that startups go through involving VC firms, with each funding round corresponding to different growth goals and generally involving a mix of funding sources. The main funding stages for startups are pre-seed, seed, Series A, Series B, Series C, Bridge, and IPO (which stands for initial public offering, also known as going public). Some of the earlier funding rounds for startups (like the pre-seed and see stages) don't typically involve VC funding while subsequent stages rely more heavily on funding from VC investors as an alternative to business loans from a bank. Some VC firms even specialize in one particular phase of startup funding.
What is the Difference Between VC Investment and Private Equity?
While the terms venture capital and private equity are sometimes used interchangeably, they are two distinct forms of financing (that share some qualities). As outlined above, venture capital investment involves the exchange of capital financing for equity. Companies that receive funding from VCs have high growth potential and return on investment in the event of a sale or IPO to offset the risk investors take in providing funding during the business's early stages. Private equity investment also involves providing capital fundraising in exchanging for an ownership stake in the company, but more typically involves businesses that are not publicly traded. Private equity firms usually invest in more established companies where their funding is used to improve operations with the goal of eventually selling the business for a profit.
If you have any questions about the VC investment process, or if you need assistance meeting your firm’s banking needs don’t hesitate to reach out to Leader Bank’s Venture Capital and Private Equity Banking team!
