Receiving venture capital (VC) funding is a significant accomplishment for any entrepreneur as it takes months of hard work and negotiation. Some entrepreneurs believe that once they have secured a funding commitment from an investor, they will have carte blanche with the cash and can report back to their investors as and when it suits them.
Nothing could be further from reality. A VC will not write you a cheque for the full amount allowing you to spend it as you please.
An early-stage funder will typically fund your business in stages. This means is that you will get funding for a period of time e.g. six months, which you will need to use to achieve specific objectives for the business. VCs do this because they want to know whether you can actually execute on the plan. You’ve talked the talk, now can you walk the walk? This is why you should know what you want to achieve and how much money you need to do this, before you even talk to a potential funder. Your funder, once they have approved and agreed with the plan, will expect you to deliver on it.
Secondly, VCs fund businesses in stages to reduce their risk. Early-stage investments are high risk because many aspects, which possibly include the market, team, technology, and business model of the business are unknown. Milestones provide clear indications whether the business is on the right path or whether the company needs to adapt its strategy or technology to be successful in the market.
Providing funding in a staggered manner is a key control mechanism to allow the investor to limit risk.
For example, if a VC agrees that you need $5-million for the next 2 years and you can’t achieve the first milestone e.g. getting customers to buy your product after spending $1-million on development, sales and marketing, the VC will have saved $4-million. By not investing the full $5-million upfront, the VC has limited its exposure in the case of a burn-out.
The primary way that VCs seek to add value (and control risk) is to be actively involved with their investments. They are attracted to entrepreneurs with vision and drive, but this sometimes has to be tempered with a healthy dose of reality to keep the business in check and on track to achieving its goals. VCs tend to be hands-on investors and while they do not necessarily get involved in the day-to-day operations of the business (this is why they invest in great entrepreneurs or management teams), they are involved strategically through active board participation, leveraging their experience and networks for the benefit of the business, helping you to grow and exit your business providing all shareholders with significant financial return and in supporting the entrepreneurial team and executives were needed.
Image: Roger’s Wife