Whether you’re a new business needing funding to get up and running or you’re looking to scale and need a cash injection to support your growth ambitions, you may be considering equity finance options like venture capital.

But what is venture capital, how does it work, and how do you go about attracting investors? We explore all that and more, outlining the advantages and disadvantages of venture capital and suitability factors for businesses to consider.

What is venture capital?

Essentially, venture capital (VC) is a business investment made by firms that seek to invest in lucrative opportunities in exchange for equity and a degree of control in the company. You can get capital from venture capital firms to fund your growth plans, selling equity to these investors. As a business owner, this means giving up part of your ownership, along with some voting rights and a proportion of future profits (or losses), in exchange for the investment. 

VC firms typically invest in new or fast–growing companies in the hope that they can earn a return when the company grows and achieves success. Returns are, of course, never guaranteed, due to uncertainties and changing market conditions, but when investments work out, VCs and business owners can reap the rewards.

How does venture capital work?

VC firms gather money from various sources, such as companies, pension funds and wealthy individuals, into a fund to invest in different businesses. Once they find companies to invest in – after going through the necessary checks and due diligence – they’ll negotiate how much to invest and for how much equity. 

Once agreed, funds are released to the business all at once or, more commonly, in rounds. In some cases, the VC firm will take an active role in managing and growing the company.

There are various ways for VCs to get their money back (plus profit), including shareholders buying them out, another business buying the company or going public and floating on the stock exchange. Whatever the exit strategy, VCs usually try to make good on their investment in 3–7 years.

Understanding the difference between private equity and venture capital firms

While private equity and venture capital firms both raise money to invest in companies, there are some notable differences in how they conduct business. 

Here are the key components to differentiate these two types of equity finance:

• The people: Private equity firms tend to consist of individuals with a background in investment banking, while those working at venture capital firms usually have a more diverse range of professional backgrounds.
• Maturity of business: VC firms often gravitate towards exciting and innovative businesses, while private equity firms like to invest in more established organisations. 
• Ownership: VCs are likely to ask for a smaller percentage of the company for their investment, while a private equity firm may seek a majority stake.
• Diversification: VC firms dilute risk by investing in lots of companies. So, if some fail, the overall impact isn’t as big. Private equity firms usually invest in a smaller number of companies, sometimes one at a time.

Check out this handy venture capital vs private equity graphic for a quick glance comparison of the two equity finance options: 

Key advantages and disadvantages of venture capital

Entering an agreement with a VC firm is a big decision, so it’s important to understand the advantages and disadvantages of venture capital before you decide on whether it’s right for your business.

Advantages of using venture capital firms

Let’s start with the advantages of using venture capital to grow your business and the benefits beyond simply capital investment:

• Getting access to significant sums of capital: VC funding can enable you to access a large amount of capital that you may not be able to get with other finance options, like business loans or debt finance solutions.
• Gaining knowledge and expertise: VCs tend to focus on specific industry sectors and, therefore, can be a great source of knowledge and expertise in your field. This can be particularly valuable for start–ups lacking experience.
• Leveraging new connections: VCs have various connections within the business community. Working with a venture capitalist offers access to this network, helping you build new connections to support business growth.
• No monthly payments: Unlike a loan, there’s usually no requirement to repay any of the amount invested, meaning no ongoing debt burden.

Disadvantages of using venture capital firms

While it all might sound great, there are certain drawbacks to consider. Here are the disadvantages of venture capital you should be aware of to judge suitability:

• Loss of control: While you don’t need to repay funds, there is a cost. In return for investment, a VC takes an agreed amount of equity from your company. This also means giving up a degree of control, affecting business decisions and direction of your business, depending on the agreement.
• Lengthy funding process: From developing a pitch and presenting your business plan to receiving an investment, the VC funding process can take a while, typically between a couple of months to around 6 months.
• Potential conflict: By giving up some control, equity and voting rights, there’s potential for conflicting views and brand principles/priorities evolving over time. This can cause friction at the ownership level and with employees and customers. So, ensure vision is aligned.
• Pressure for rapid growth: Venture capitalists typically aim for significant returns within a set timeframe, often shorter than with private equity investment. This can mean an aggressive growth and exit strategy, which can come with risks, pressure and cultural shifts that can be unsettling.

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How to apply for venture capital funding

Traditional lenders often see new businesses as too risky. Many business loan providers have a minimum trading history threshold in their eligibility requirements. Therefore, venture capital can be a viable funding option for start-ups or newer businesses.

Securing VC funding isn’t easy, though, as firms receive many applications, but understanding the process can help you stand out. You need a compelling business plan backed by extensive research and forecasting, and a clear strategy for growth and returns. 

A detailed business plan should outline things like:

• Funding needs
• Timelines
• Targets
• Sales strategy 

If a VC shows interest, they’ll conduct due diligence on your company and, if satisfied, issue a term sheet, which is a non-binding agreement that signals serious intent to invest.

How can I find a venture capital investor?

One of the easiest ways to find a VC investor is to start with online databases. That way, you can do some research on who they are, what they’re looking for and whether they’d be a good fit for your business. Industry bodies such as the British Private Equity and Venture Capital Association can be a great place to start.

As well as going it alone, you can also hire a VC consultant who can help you find an investor that matches your business needs. They’ll guide you in your search and support you in assembling and presenting your pitch for investment.

Typical steps in the VC funding process include:

• Initial pitch and meetings – you’ll present and discuss your business plan and vision to VCs.
• Term sheet – where you’ll receive a non-binding offer of investment terms, which you can negotiate.
• Due diligence process – VC firms will review your financials, operational history, legal details and current market position.
• Final agreements/signing of contracts – this is when legal documents are drawn up and signed by all parties involved.
• Funding – once everything is agreed, funds can be transferred and the partnership becomes live.

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Alternatives to venture capital

Venture capital funding can bring many benefits and has enabled countless start-up companies to achieve growth and success. However, every business is different, and VC investment may not be the right solution for every entrepreneur or business.

There are various alternative funding options to consider, including other equity finance arrangements or flexible loans that don’t have many of the restrictions that other debt finance agreements may have. 

Below are some alternatives to venture capital to raise the funding you need for your business:

• Angel investment: High-net-worth individuals who invest their own money in exchange for equity. They often bring valuable mentorship, contacts and experience besides the funding. Business angels often offer more flexibility than VCs and suit early-stage companies seeking capital and guidance.
• Friends and family loans: A common first step for start-ups is relying on personal networks for funding, including friends and family. This can be quicker and more flexible than formal finance, and may be interest-free loans, depending on the agreement. It’s a good option for smaller funding amounts. However, there is a risk of straining personal relationships if the business struggles or you miss agreed-upon repayment deadlines. 
• Crowdfunding: Raising money from a wide range of investors, in the form of donations, rewards or equity. Popular for market disruptors, crowdfunding platforms allow businesses to validate their idea with the public while raising crucial funds for growth. They are ideal for tech start-ups and consumer-facing products/services with a strong hook or problem to solve.
• Grants: Non-repayable funding for businesses, typically offered by government bodies, local initiatives or development agencies. Business grants are highly sought after but often offer smaller amounts than loans and have strict eligibility criteria, such as requirements to be in certain industries or locations. Ideal for startups working on innovative projects, typically in tech, clean energy or social/community development. 
• Flexible business loans: Usually unsecured loans from digital lenders, which offer fast access to funds and options for businesses with limited track records or assets to use for collateral. While often having higher interest rates than traditional, secured loans, due to increased lender risk, flexible business loans can unlock sizable amounts of capital with tailored repayment terms, aligned with cash flow, with the flexibility to repay early.

Weigh up the advantages and disadvantages of venture capital and the alternative options available, before choosing a finance solution that’s right for your business.

Exploring flexible funding from iwoca 

Iwoca’s Flexi–Loans are unsecured, flexible business loans for SMEs and newer companies requiring funds to fuel growth and manage cash flow. You can borrow between £1,000 and £1 million for a few days, weeks or as long as 60 months.

Applying is quick and easy, and can be completed in a matter of minutes, with funding decisions provided within 24 hours, and successful applicants can access funds on the same working day. Monthly repayments are affordable and tailored to your needs, and you only pay interest on the funds you draw down. Also, we don’t charge for early repayment, so you can save on unnecessary interest fees as your financial circumstances change.

Find out how to apply for a loan with iwoca or check out our business loan calculator to work out your likely repayments. 

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More from iwoca on equity finance and funding business growth: 

• Equity finance options
• Start-up funding options
• Financing business expansion
• Mezzanine financing
• Accessing growth capital

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