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The Basics Of Venture Capital For SMEs

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Last editedMar 20222 min read

Success looks different for every small business owner. For some, success means keeping their small business small and focusing on their relationship with customers. For others, success means growth – expanding into new territories and markets, building value and ubiquity in their brand.

But growth needs to be properly funded if you’re to make the appropriate capital investments and maintain a healthy cash flow. Venture capital is one of the most common forms of investment used for fueling small business growth.

Here we’ll cover the basics to help ambitious small business owners to make an informed decision on how to fund their expansion.

What is venture capital?

Venture capital – or VC – is a form of equity financing. It involves private investors providing finance to startup companies and existing SMEs with a view to gaining a return on that investment. The TV show Dragon’s Den is as neat an encapsulation of venture capitalism as it gets.

That said, venture capitalists are not always individuals. They are most commonly financial institutions or dedicated VC firms. These funds pool capital from a wide range of sources from corporate funds to university endowment funds and the capital of wealthy private investors. This helps to mitigate the risk to any one individual, company or body.

Private individual investors, on the other hand, tend to be high-net-worth individuals who believe in a prospective business, product or service enough to bear the risk associated with investing in it.

SMEs can turn to venture capital to fund their growth by:

Hiring more employees
Developing new products/opening new revenue streams
Investing in expanding their marketing reach
Expanding their manufacturing, buying, or sales
Moving to a new physical location

How does venture capital work?

There are many businesses scrambling for the attention of investors. At the same time, investors are understandably risk-averse. As such, an introduction is often made by a third party that has an existing relationship with both the company seeking investment and the prospective investor.

After the introduction, the company owner will usually be asked to make a pitch presentation to the investor. If the pitch goes well, they will be issued with a term sheet which details the proposed offer of funding and terms for repayment. At this point this is still a non-binding agreement.

The investor will then do their due diligence on the company to ensure that it has a good chance of turning a profit and offering an appealing return. After this, a final offer will be made and the business owner will decide whether to accept or reject the offer.

Different types of venture capital

There are different types of venture capital for different stages in a company’s life cycle.

These include:

Seed finance – Seed financing requires nothing more than an idea. If it’s an idea the venture capitalist gets excited about and feels will succeed in the market, seed finance can fund initial research and development
Startup finance – Here, the project is already in early development and further funding is needed to get the business up and running (such as hiring staff, securing equipment, leasing premises)
First-stage finance – The company has already been up and running for two to three years, but needs an investment in infrastructure to increase production and boost sales, distribution and marketing
Second-Stage Financing – This is necessary when the business is already growing well but needs additional funding to expand into new products, markets or territories
Bridging finance – Not to be confused with bridging loans, bridging (or mezzanine) financing is used when an investor’s relationship with a company comes to an end. It can be used to prepare a company for initial public offering, or even to be purchased by another company

We can help

If you’re interested in finding out more about venture capital, funding growth, and managing cash flow, then get in touch with our financial experts. Discover how GoCardless can help you with ad hoc payments or recurring payments.