Small Business Venture Capital: Understanding the Basics
In 2022, venture capital investments in the United States hit an estimated $240.9 billion. Most people assume that those funds solely go to startups, particularly those operating in the tech sector. However, venture capital is often applied more broadly, and it can potentially help many of the 33.2 million small businesses in the United States get critical funding to support growth.
By understanding what small business venture capital is and how it works, you can determine if it’s a potential pathway for boosting your operations. Here’s what you need to know.
What Is Venture Capital?
Venture capital is a funding source that usually takes the form of private equity, financing, or another type of support for a business. It’s provided by investors who believe a particular company – including a small business – has significant long-term growth potential.
The investment may come from several sources. Individual investors may play a role, including in the form of angel investors. However, there are also venture capital firms that provide funding, and certain other financial institutions may also be part of the equation.
How Does Venture Capital for Small Businesses Work?
With venture capital deals, the investing person or entity typically provides the funding in exchange for partial ownership of the small business it’s supporting. Usually, this involves the formation of limited partnerships. Essentially, the investor gets a stake in the company, and their hope is that ongoing growth allows them to secure a reasonable return on their investment.
Returns for investors can occur in several ways. They may earn a portion of the profits based on the size of their stake. Additionally, they may get a percentage of the purchase price of the small business if it’s acquired by another company.
Pros and Cons of Small Business Venture Capital
When it comes to the benefits of small business venture capital, the main one is that it’s a way to secure funding without having to worry about interest rates or other burdens associated with a loan. Additionally, you can receive large amounts of funding, potentially more than you could secure through other means. At times, the investor may even provide guidance or support based on their expertise, which could boost your business.
As for drawbacks, the main one is giving a stake in your company to another party. Further, the process is sometimes lengthy and cumbersome, and there’s no guarantee that you’ll find an investor. Getting funding from private equity firms can be challenging for small businesses, and it’s critical to keep that in mind.
How Do You Obtain Small Business Venture Capital?
There’s no approach that can guarantee you’ll receive small business venture capital. However, there are steps that are commonly part of the process. First, you need to identify a suitable investor. If you have an existing relationship with one, approaching them may work. Otherwise, you may want to speak with other financial professionals to get a referral to a suitable venture capital investor or firm.
After making the initial connection, you’ll need to share your business plan, a pitch deck, or provide a presentation that outlines your growth potential clearly. If the investor is interested, you begin working out any terms of the deal. A due diligence review often occurs, too, and you may need to answer additional questions along the way.
Once that’s complete, an interested investor will send offer documents outlining the funding terms. At that point, you can choose to accept or continue negotiating. Once the terms are agreed to and the offer is signed, the funding is provided.
