Venture capital

For a young business seeking to grow, investment from venture capital, a form of investment that focuses on early-stage, innovative businesses with strong growth potential, could be a good next step.

Many renowned companies across the globe, including household names like Google, Facebook, and Skype, owe their initial growth to venture capital investments.

In the UK, the list of venture-backed start-ups includes notable firms such as Gymshark, Deliveroo, Innocent Smoothies, and Brewdog.

These companies leveraged venture capital during their formative stages, underscoring the importance of such funding in fostering business innovation and growth.

In this article we’ll discuss what venture capital is, how it works, and what the various benefits and drawbacks are.

Like all financial products, it’s a good idea to seek expert independent financial advice to decide whether a particular financial product is right for you and your business.

What is Venture capital?

Venture capitalists (VCs) put money into early-stage businesses to help them grow, typically (but not exclusively) in sectors such as life sciences, IT, and FinTech.

Unlike Private Equity which focuses on investing into mature companies, venture capital firms focus on young companies, many of whom are either pre-profit or even pre-revenue.

As well as money, businesses can expect strategic advice from an experienced new board member.

Often, VCs assist entrepreneurs in identifying and refining their business strategies to ensure they can successfully introduce their products to the market.

This guidance aims to help these businesses meet specific consumer or business needs, thereby creating tangible value.

VC funds often invest in cycles of between five and seven years.

They expect businesses to grow significantly during this time – and make a return for the fund.

Sometimes, funds will hold on to an investment to help the business grow even further.

How does venture capital work?

Businesses can often expect VC investment to be delivered across multiple ‘rounds’.

VCs, often in collaboration with other investors, acquire minority stakes in businesses.

Early-stage companies typically secure funding through a series of investment rounds:- Series A, B, C, and so forth.

Each round will involve either existing or new investors injecting more capital to support the company's growth and can raise many millions.

In addition to these rounds, many start-ups also gather funds (known as seed investment) before Series A through various avenues such as angel investment, crowdfunding, grants, incubators, or even contributions from friends and family.

Seed round investment is typically offered for proof of concept and can be several hundred thousand pounds.

This collective process forms what is commonly referred to as the 'innovation ecosystem'.

This system facilitates the provision of both capital and business expertise to fast-growing, early-stage companies at various stages of their lifecycle.

Venture capital firms generally retain their investments for a period ranging between five to seven years.

After this period, the company may go public (called an IPO) on the stock exchange, get acquired by a multinational corporation, or another investor like a private equity firm.

This is the typical life cycle of an investment from a venture capital perspective.

What are the main venture capital schemes?

EIS (Enterprise Investment Scheme), SEIS (Seed Enterprise Investment Scheme) and VCT (Venture Capital Trusts) encourage investment into UK businesses.

EIS and SEIS give tax breaks to investors, as an incentive to invest.

Meanwhile, VCTs help take away some of the risk of investing by pooling investors' money and spreading it across a range of businesses.

The result is more investment in UK businesses.

What are the benefits of venture capital investment?

Like all financial products, there are a number of benefits for a company looking to take on venture capital.

Relevance

Though often seen as the preserve of technology-focused businesses, venture capital is an option for a wide-range of companies.

Profit, and in some cases revenue, are often not a requirement for investment and VCs are often more interested in the strength of the business idea and the skills and drive of the entrepreneur.

Strategic guidance

In addition to the substantial capital investment, VCs bring an abundance of business acumen and expertise.

In addition, a VC can provide valuable networking opportunities to aid in the company's development and expansion.

Learn how to get support from experts and entrepreneurs with our guide.

Large injection of cash

Businesses that successfully attract VC investment can get millions of pounds to expand their business, without giving away a controlling stake.

Regional opportunities

Although London and the South East and usually hot spots for VC investment, VCs regularly travel to regions across the UK in search of investable propositions.

What are the risks to venture capital investment?

Likewise, there are a number of potential drawbacks for businesses looking to secure venture capital investment over other types of finance.

Equity and growth

There is no guarantee that your business will achieve growth as a result of the investment.

Indeed, many VC’s accept that some businesses they invest in will fail.

Competition

Venture capital investment is in high demand and the process of attracting investment is extremely competitive.

Many VCs will only invest in one or two businesses out of the dozens, even hundreds of meetings they hold with entrepreneurs.

It’s also worth flagging that many VC funds might not be looking to invest in new businesses when you’re seeking funding, further increasing competition as the amount of funding available is lessened.

Is venture capital right for me?

If you’re interested in obtaining venture capital investment for your business then its worth getting familiar with both the characteristics of a typical venture capital-backed business and the profile of the finance on offer.

About your business

• Business stage: Generally early stage, pre-revenue or pre-profit
• Annual turnover: Less than £5 million
• Sectors: All sectors, but especially suitable for companies with a scalable business proposition
• Regions: All

About the finance

• Purpose of finance: Acquisition; research and development
• Amount of finance: £1 million or more, depending on the funding round
• Duration of finance: 5–10 years
• Cost of finance: None
• Time to finance: 6–12 months

What do venture capital investors look for in a business?

There is a split between the investors whose first instincts are to identify a sector and those who look first and foremost at management teams.

Sector-led investors look for revolutionary technological change or demographic positioning.

Other VCs consider whether the founders have the vision and expertise to grow a business.

Given that the businesses they invest in are in their initial stages, some VCs adopt a comprehensive and methodical approach when assessing.

They consider not only the feasibility of the business concept but also the drive and background of the entrepreneur.

In essence, VCs are in search of innovative ideas and entrepreneurs with exceptional acumen, demonstrating a strong commitment to achieving success with their concept.

A useful tip for entrepreneurs is to think about what sector they’re in and then work out if the product within the sector is the unique selling proposition (USP) or if they themselves are the USP.

What do I need to consider before approaching a venture capital investor?

Before approaching a VC it’s a good idea to consider the following:

Board seats

VCs often expect representation on your board in exchange for funding and support.

Board representation could be a way VCs provide and deploy their business acumen to help steer the business towards growth.

Strong management team

The VC fund needs confidence in your leadership team, as with early-stage businesses there's very little else for the investors to go on.

Understand your investor

VCs look for different things, so increase your chances of success by doing your research on the fund.

This should include the types of businesses they have invested in previously as well as their overall experience in your sector.

Mentality

VCs expect some businesses to fail.

It’s a good idea to understand early on that equity investment is about relationships as much as it is about making money.

Economic cycle

Competition on funds depends on the economic climate.

Sometimes funds are not investing much at all, while at other times your business may have lots of offers on the table.

How do I attract venture capital investment?

Either you or the VC can make the first approach.

It often takes up to a year to do the deal, but this can vary.

The earlier VCs can start the journey, the better.

Sometimes an investor will talk to entrepreneurs for months or years before they actually invest.

To learn what steps you need to take to ready your business for venture capital, use our checklist.