How Venture Capitalists fund Start-ups

How Venture Capitalists fund Start-ups

According to the MoneyTree Report, in 2015, Venture Capitalists (VC) invested $58.8 billion in start-ups across the U.S.

1Venture Capital is a very important source of funding for start-ups that don’t have the requisite capital. Venture Capitalist firms essentially pool cash from wealthy investors, high net worth individuals, and loan it to start-ups and small businesses with long-term growth potential. These investments entail high risk and high returns. In exchange for funding, Venture Capitalists assume large equity positions in the start-ups and also help with managerial or technical expertise.

The Funding Process

The funding process consists of the following phases:

  1. Business Plan Submission

During this phase, the founders submit the business plan to the VC. The business plan includes details of the opportunity, its market potential, existing and potential competitors, financial projections, and the company’s top management.

  1. Evaluation of Business Plan

After a thorough analysis, the VC decide whether or not they’d want to fund the project. If they plan to go ahead with funding the project, they meet with the founders for a detailed discussion. The founders may need to respond to VC queries regarding customer references, product and business strategy, and so on.

  1. Term Sheet and Funding

After successful completion of due diligence, the VC provides the term sheet, a document that contains basic terms and conditions of the investment agreement. When the term sheet has been agreed upon by all parties, funds are provided to the founders.

Not all VC investments pay off. The failure rate can be quite high. 20% to 90% of the companies may fail to generate returns on the VC investment. On the other hand, if a VC does well, a fund can generate returns anywhere between 300% and 1000%.

Trends in VC Funding

  • More investors are seen investing in smaller companies, choosing to encourage the culture of innovation. Apart from the financial gains, they are able to clear some of the public perception around there being more risks in funding innovative projects.

  • As per Bloomberg, most of the VC funding goes to companies founded by men.
  • On an average too, companies founded by women receive lesser funding, $70+ million compared to $100 million for start-ups founded by men.
  • Among cities in the U.S., San Francisco stands out for having the most women founded start-ups.
  • It has been witnessed that when it comes to financial performance, female entrepreneurs are outperforming male-only teams by a huge margin.
  • As per data, the number of founders who are school dropouts is more than those who have graduated from top universities. Out of the list of founders who graduated from top universities, the most founders are from Stanford University.
  • The maximum number of founders who are MBAs are found running financial services start-ups. These start-ups received the highest average funding.
    • Internet organizations have the most number of dropout founders. These start-ups received the second highest average funding.
    • On the other hand, more than 50% of the founders of pharma and biotech companies have PhDs.
    • Over 20% of the founders have graduation degrees from universities outside the U.S., mostly from India.
    • Regardless of where start-up founders graduated from, most of them set up companies in California, followed by Massachusetts and New York.
    • 57% of all start-ups are bought out and acquired by larger companies.The most notable amongst these was the acquisition of Whatsapp by Facebook.
    Woman in home office with computer using telephone smiling 

    Opportunities for Tech Entrepreneurs

    Following are some of the start-up trends that present opportunities for tech entrepreneurs:

    • There is increased focus on Virtual Reality, Internet of Things, and Cloud Client Computing. Big Data and Machine Learning are being used to make business intelligence more about predictive
    • There is also growing preference for building full-stack start-ups that create end-to-end products, relieving clients of the trouble of coordinating working with multiple vendors.
    • Another huge trend has been start-ups focused on identifying when and where data breaches occur to define the process to be adopted for damage control.

    – Rashi Kapur :

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