Fourth post of a series with all you need to know about private investors for startups and small businesses.
“How should I fund my startup business?”
“How much funding do I need?”
“What’s the best source for funding?”
The short, unsatisfying answer is: “it depends”. Every startup is different, and so is the optimal funding strategy.
It is always thrilling to start a business. However, most startups lack sufficient funding for their growth. As they attempt to finalise their product or service, ramp up sales and achieve traction, it becomes more difficult for them to set aside time to raise funds for their business.
To take some strain off their finances, the startup founders often rely on private investors. So, who exactly are these private investors and how do they fund startups?
In this series of blog posts I’m deep diving into 4 sources of investment money:
- Friends and family,
- Angel investors,
- Venture capital (VC),
- Late stage venture capital.
My goal is to help you make the right funding decision – what kind of startup funding options are available in different stages, what the strategies are for pursuing them, and how founders can determine a funding path that is right for them.
In the previous post I’ve looked into raising investments from VCs, whereas this post is dedicated to raising private investments from late stage VCs.
Who is a late stage VC?
Private equity or late stage venture capital isn’t really associated with startup capital – it’s associated with growth capital. This is a type of investment typically reserved for companies that have already grown to a larger size and are looking for a specific growth path or exit strategy that isn’t available through traditional financing.
If you’re a startup with just an idea or early product-market-fit, you’re likely too early for private equity. Typically private equity firms are looking for later-stage companies that require much larger sums of money, usually at least €5 million, in businesses that already have financial traction and some sort of assets to leverage.
How does raising private investment from late stage VCs work?
As said, private equity or late stage VC is a type of investment typically reserved for later stage companies, no longer startups but scaleups.
For businesses with existing revenues or assets, private equity becomes an interesting option for business funding. Private equity is valuable to companies that have a strong operational profile, but don’t have the high return projections of a technology startup or some other trendy investment metrics like for instance exponential growth.
Private equity firms pool their money from other investors who tend to be pension funds, insurance companies, and foundations. These institutional investors invest in a private equity fund to employ a management group to seek out high yield investments on their behalf.
Unlike venture capital firms that make big early stage bets that they hope will have an enormous return when the company grows, a private equity firm bets a little less on speculative growth and a little more on demonstrated growth.
The focus is to purchase a company that they can either IPO, sell, or generate cash returns. The private equity group is essentially betting on the fact that the asset is worth more in the future than it would be worth presently. Companies funded by private equity groups usually need to exit at $1B+ (hence becoming unicorns).
There are all sorts of private equity funds, from those that do small deals at or below €5 million to those that manage multi-billion euro deals. In each case, they are looking for existing ventures that could be better scaled with outside capital.
Advantages of working with late stage VCs
Similar to angel investors, private investors such as late stage venture capitalists also come to the table with a lot of business and institutional knowledge.
They’re also well-connected with other businesses that may help a new startup, ner recruits that a startup might want to take on, and connections with other potential investors. Many VCs often run acceleration or business incubation programs that can greatly benefit all startups.
Disadvantages of working with late stage VCs
Also similar to angel investors, part of what late stage venture capitalists want in return for their investment is equity in a startup.
That means that a founder gives up part of their ownership when they bring on venture capital.
Depending on the deal, a VC may even end up with a majority stake, more than 50% ownership, of a startup. That means the founder (or small businesses) essentially lose management control of their startup.
Also, founders should be aware of VC investment cycles, as explained above, and should try to fit within their timing. Asking for an investment at the wrong stage of the VC funds often results in rejection.
Where to find late stage VCs
The first step to find late stage venture capital is to make a smart introduction to the venture capital firm the founder wants to meet. Venture capitalists rely heavily on trusted connections to vet deals and some even run their own portal to get referrals, e.g. see the portal Signal below from Point Nine VC.
Founders shouldn’t try to contact as many people as possible; they should try to find venture capital firms that are the best possible fit for their deal.
The more closely aligned the founder is with the needs of the venture firm, the more likely they’ll find venture capital firms willing to write them a check.
Founders should do extensive research both online and through existing networks ahead of time to determine what types of investments a firm makes, as well as whether or not they have any connections with that firm.
Every pitch to a venture capital starts with an introduction to one of the private investors at the firm. It helps to know the exact profile of a venture capitalist to know which level of introduction makes sense. Typically it starts with an introduction to an associate or the fund manager and then founders can work their way up to the full partnership.
Every startup is different, and so is the ideal funding path. Usually founders start by raising early-stage capital from friends and family and angel investors to validate their value proposition, build initial traction and find their first customers. This is what investors refer to as: “early product-market-fit”.
Later, the more mature scale-ups turn to VCs and private equity firms to consolidate and speed up their growth. This often goes hand in hand with their internationalization and foreign markets outreach.
Additional funding alternatives from different sources are best suited for different startup stages. Choosing the right one can give you the boost you need. The wrong one might hold you back or lead you in the wrong direction.
In the previous post I’ve looked into raising investments from VCs, whereas in the next post, I’m going to take a deeper dive into the process of raising private investments from all types of investors described in the previous posts.
Marco Torregrossa is private investments advisor for Innovation Manager Finland Ltd. Follow him at @MarcoTorreg