Venture capital: how it works and how to attract it

When it comes to the world of business financing, venture capital has always been seen as a powerful yet slightly mysterious source of funding.

For small businesses and early-stage startups, however, it represents a golden ticket to rapid growth, credibility and access to networks that would otherwise be out of reach.

But what does venture capital truly entail, and is it the right path for your business? In this article, we’ll break down what venture capital is, how it works, and what makes it such a sought-after funding option.

What is venture capital?

Venture capital (VC for short) is an investment fund made up of contributions from wealthy individuals, investment firms or corporations – often referred to as “limited partners” (LPs). These funds are managed by professional investors known as venture capitalists, who seek high-potential startups and provide them with funding in exchange for equity.

Unlike angel investment, venture capital lasts longer as it usually has a 10-year fund lifecycle and often sticks with businesses from its series funding rounds to exit (IPO or acquisition).

What’s the difference between private equity and venture capital?

On paper, there is none. Venture capital is technically a type of private equity. However, there are some key differences between the two:

• Stage of investment: VCs invest in early-stage startups (often before a company is profitable), whereas PEs usually invest in companies that are already established, have a proven business model, and are generating a steady revenue.
• Size of investment: VCs generally invest smaller amounts in early rounds (e.g. seed rounds, Series A, etc.), while PE firms invest much larger sums.
• Ownership: while VCs invest in exchange for equity in the company, they don’t usually take full control. PEs, however, often have a say in major decisions and sometimes even take over management or restructuring to improve performance.
• Risk profile: the risk is higher for VCs because they invest in younger companies with less stability and have more chance of failure, while PEs invest in businesses with a proven track record.
• Return expectation: VCs typically look for a 10x return on their investment and bet on a big exit, such as an IPO. PEs tend to focus on more stable, steady returns through operational improvements, cost cutting or increasing profitability.

How venture capital works

Raising venture capital is a whole process that starts with getting on a VC’s radar and (hopefully) ends with a long-term business partnership. Here’s a simple breakdown of what venture capital typically looks like — from introductions to funding and beyond.

1. Pitching to investors

When first meeting VC investors, founders will need to present a pitch deck, which is where the startup’s vision, potential and traction are laid out. For this, you’ll need to clearly communicate your business idea, market opportunity and growth strategy. Some key components of your pitch deck should include:

• The problem you’re solving: the pain point you’re addressing and how your product/service aims to tackle it.
• Your target market: who your customers are, how big the market is, and why it’s the right time to capture that market.
• Business model: how your business plans to make money (e.g. subscription, transactional, etc.).
• Traction and key metrics: evidence that your idea has potential, such as user growth, revenue and partnerships.
• The team: the key players behind your company —investors want to know that you have the right people to execute your vision.
• The funding ask: how much you’re raising and how you’ll use the funds to scale and hit important milestones.

2. Due diligence

Before agreeing to invest, the VC firm will conduct due diligence to verify your business and evaluate the risk. They’ll look into:

• Financials: this includes your business’s revenue, cash flow and burn rate (how quickly your business is spending cash).
• Your product: how developed your product is, current traction and customer feedback.
• The current market: the demand for your product in the market, the competitive landscape, growth potential and your business model’s viability.
• Your team: assessing your team’s qualifications and experience, as well as a background check.
• Your cap table: the current ownership structure of your business.
• Legal and regulatory compliance: ensuring your business adheres to the relevant laws and regulations.

3. Term sheet

If everything checks out, the firm will issue a term sheet – a non-binding document that outlines the key terms and conditions for the investment deal. This includes the investment amount, the amount of equity the investor will receive, voting rights, and how money will be distributed if the company is sold.

Term sheets aren’t enforceable, so founders can negotiate with investors at this stage. While term sheets help investors to simplify the deal-making process, they also allow founders to fully understand what they’re agreeing to before making a deal.

4. Funding and post-investment involvement

Once the term sheet is signed, the funds are transferred to the business’s bank account, the VC firm officially becomes a shareholder, and any conditions included in the term sheet are actioned.

From there, the VC will become heavily involved in the business’s operations. For example:

• Offering strategic guidance on scaling, product direction or the recruitment process
• Board participation, often with regular check-ins and votes on major decisions
• Helping with follow-on fundraising, including introductions to other VCs for future funding rounds
• Helping position the company for acquisition or IPO when the time is right

Types of venture capital

VC firms will offer funding depending on the size of your business and what stage you’re at. Each type comes with its own level of risk, funding size and investor expectations. Here’s a breakdown of the main types of VC you’ll come across:

1. Pre-seed

This is the earliest stage of VC funding, often starting with an idea. At this point, firms will help startups build a product prototype, conduct initial market research, or start their first hires. The risk is also high because the company’s business model hasn’t yet been proven, and investors will typically take a 10%-25% equity stake.

2. Seed funding

At this stage, the business has a minimum viable product (MVP) and is looking to launch it to the market, grow their customer base and expand on their marketing efforts. The amount of equity is similar to the pre-seed stage, but seed funding stages often include a higher investment amount – approximately £250,000 to £2 million.

3. Early-stage capital

This is when a startup begins to show early traction – like user growth, revenue, or a working product. The funding is typically used to refine a business’s product, grow the team and begin expanding in the market. Founders can also combine early-stage capital with government business grants or follow-on investments from seed-stage backers.

4. Growth capital

This is for businesses that are already seeing strong results and are ready to scale further. For example, expanding internationally, entering new markets or developing new product lines. At this stage, the startup has solid traction and is shifting from early growth to full-scale expansion.

5. Late-stage capital

Late-stage funding is usually raised by mature startups that are approaching an exit, either through an IPO or acquisition. The money is often used to strengthen operations, increase market share or prepare for listing on a public exchange.

Advantages and disadvantages of venture capital

Venture capital funding comes with many advantages, offering not only a solid amount of money for your business, but also new networking opportunities, hands-on support and faster growth.

That being said, there is a catch, as it comes with giving up equity and facing pressure to grow quickly. Therefore, you should weigh the pros and cons before you decide whether VC funding is right for you. Here are the main advantages and disadvantages:

Pros of venture capital

✅ Large amounts of funding: VC firms can provide significantly more capital than bootstrapping, bank loans or angel investors.

✅ No repayment pressure: VC funding doesn’t need to be paid back. Instead, the firm makes money when your business grows and exits, not through interest.

✅ Support and mentorship: VCs also offer industry expertise, introductions to key partners or hires, and help developing a strong growth strategy.

✅ Open to risks: unlike traditional banks, venture capitalists are more open to risk, especially when they believe a startup has strong growth potential.

✅ Faster growth: the funding provided by VC firms can help grow and expand a business faster, which is crucial for fast-evolving markets and outpacing competitors.

Cons of venture capital

❌ Loss of control: getting VC funding means giving up equity in your business, and with more investors on board, you may lose some control over key decisions.

❌ High pressure for growth: VCs want a high return on investment (ROI), so they’ll often push for fast scaling, which might not suit every business model or founder.

❌ Dilution of ownership: your stake in the company gets smaller with each funding round, so founders who raise multiple rounds can end up with a minority share.

❌ Lengthy process: raising VC is time-consuming as it involves pitching, due diligence, negotiations and a lot of legal paperwork.

❌ Doesn’t suit everyone: VCs tend to look for startups with significant market potential and a scalable model, which isn’t the best fit for those that are more niche or aim for steady and sustainable growth.

Tips to secure venture capital

To bag venture capital, you need to convince investors that your startup has serious potential to grow and succeed. From building the right pitch deck to knowing how to approach the right investors, there are a few key things that can make all the difference. Here are a few tips to help you stand out and improve your chances of landing that all-important VC funding:

1. Develop a strong business plan

Having a solid business plan is important for many reasons, and that includes securing funding. For VC funding specifically, a robust business plan provides investors with a comprehensive roadmap for a business by demonstrating its market opportunity, financial projections and overall vision. It can help convince investors that a business has good potential and is worth their investment.

Need help? Check out our guide on how to write an effective business plan, with a free template included.

2. Nail your pitch deck

A pitch deck is what you use to communicate your business plan. You’ll need to make sure that it’s clear, concise and engaging to whoever is listening. Your pitch should focus on key information, such as the problem you’re solving, your solution, the size of your market and your current team.

3. Know your numbers

VC investors are going to want to see some important figures, so you should include them in both your business plan and pitch. You’ll need to be ready to talk about your revenue, growth metrics, burn rate, and customer acquisition cost. If you’re at the pre-revenue stage, you should be clear about your plan to generate profits.

4. Show traction

Venture capitalists want proof that your idea is working, or at least moving in the right direction. For this, traction can come in many forms, including user growth, revenue figures, partnerships, app downloads or strong engagement metrics. The more validation you show, the more confidence investors will have that your idea has potential.

5. Approach the right investors

Not all venture capitalists invest in the same industries or stages. You’ll need to research firms that match your business’s sector and funding stage. Before reaching out, research their portfolio, find out how much they typically invest and whether they’ve invested in companies similar to yours.

“Every VC I know is on the lookout for good-quality deal flow, and the vast majority have clear websites or LinkedIn pages describing their investment criteria,” adds Whitehead. “Do your research and target specific funds and individuals. It can be a long process, so start early and be persistent.”

What can venture capital firms offer besides investment?

Money is usually the first thing that comes to mind when people think of venture capital.

But the right VC partner can offer a whole lot more than just a cheque. From valuable advice to strong industry connections, VC firms often play an active role in helping startups grow faster. Here’s what else they bring to the table:

• Strategic guidance: VC firms can help businesses make smart decisions about scaling, hiring, product development and market expansion – and help you avoid common pitfalls.
• Industry expertise: many VC firms specialise in certain sectors (e.g. fintech, SaaS, healthcare, etc.), meaning they understand the space, the challenges and what it takes to win in your niche.
• Valuable networks: they can connect you with potential customers, partners and other investors.
• Follow-on funding: VCs often invest in multiple rounds, so if things go well, they may lead or join future raises – making it easier to secure additional capital when needed.
• Good credibility: being backed by a respected VC makes it easier to attract other investors, hire top talent and build trust with customers and partners.
• Board-level support: if they take a board seat, they’ll be involved in high-level decision-making and governance, which can be helpful for founders looking for advice on major milestones or challenges.

Summary: is it right for you?

Venture capital can be an extremely effective way to get the funding you need – whether you’re just starting a business or looking to push things further. 

The right VC investor not only puts extra cash in your pocket, but also brings valuable guidance, mentorship and networking opportunities to help get your idea off the ground.

That being said, it isn’t easy to get VC funding, and there are many hoops you have to jump through before you even get close to pocketing any cash. It’s a long process that involves a whole lot of planning, pitching and convincing, which doesn’t always lead to investment in the end.

However, with the right business plan, a convincing pitch deck, and solid proof of traction or potential, venture capital funding could fuel your startup to the next level – opening new doors to significant growth, valuable support and long-term success.