Applying for venture capital (VC) funding is an excellent choice for most early-stage startups because the venture capitalists take on the majority of the risk, and there’s no obligation to pay the money back if your startup fails.
However, getting VC funding isn’t as easy as it sounds. There are thousands of startups out there competing for venture capital in an increasingly oversaturated market.
So, it’s important to ensure you fully understand the VC process to improve your and your company’s chances of rising above the competition and receiving startup venture capital from a VC firm, a VC fund, or angel investors.
1) Determine Your Business Valuation
The amount of venture capital funding investors will potentially give you, and your business is directly tied to your startup’s current valuation. In other words, the higher your company’s valuation, the more money you can raise.
So, the first step to getting VC funding is to come up with as accurate an estimate as possible of how much your business is worth.
There are a few different ways to do this, and methods can vary by industry and business type. But, in general, you could try and use some kind of financial model to calculate your business value.
This is easiest to do if you’re already generating some revenue. In this case, you can add the value of all your company’s net assets and subtract any outstanding debts to come up with a business value estimate.
However, many startups seeking venture capital are in their very early stages and are not yet generating revenue, so using the above method can be tricky.
Also, venture capitalists are typically more interested in the future revenue potential of startups rather than their current status.
Therefore, determining the business valuation for startups is often quite speculative.
You’ll want to factor in things like the company's age, the leadership team's characteristics, your startup’s current growth rate, the size of your product’s user base, and revenue/cash flow projections.
You can look at other similar businesses in your industry or work with a professional business appraiser to help you determine your startup’s valuation before you start talking to venture capitalists.
That being said, be prepared for the possibility of the first few venture capitalists you talk to telling you that your business valuation is off — they may suggest a different valuation based on their prior experience and expertise when you start negotiating.
2) Determine How Much Capital You Need
After you come up with your startup’s valuation, the next step you need to take toward getting VC funding is to determine how much capital you need to raise.
For this step, it’s best not to get too fixated on a single number. Instead, come up with several different figures and have actionable plans for using those different amounts of venture capital.
Start by deciding the ideal amount of money you would like to raise. The money could be used to build a new version of your product, continue paying current employees for a year, or hire new key team members to help with expansion, to give you a few examples.
Once you come up with your ideal amount and know what you will use it for, decide on at least two other sums (one above and one below the ideal figure), and lay out plans for how you would use less or more money to keep growing your business.
For most startups, there’s no “right” amount of venture capital to start looking for. The proper amount for your business depends on many variables, including your current stage, your valuation, and how much equity you’re willing to give up in return for VC funding.
Generally, the lower your business’s valuation, the more equity investors will probably ask for. So, if you don’t have a particularly high valuation and you don’t want to give up a significant stake in your business, you should be prepared to get offered less VC than you want.
3) Determine the Best VCs for Your Business
With your startup’s valuation and your venture capital target numbers in hand, you can start looking for venture capitalists to seek funding from.
There are roughly 1,000 venture capital firms in the US alone and countless more private venture capitalists, so you must narrow your options before applying left and right.
Important factors to consider when coming up with a list of potential venture capitalists to talk to include your startup’s current investment stage and funding history, location, and industry.
Investment Stage & Funding History
When trying to find venture capitalists and researching them, one of the first things you should find out is what stages of companies they invest in.
There are plenty of VC firms and funds that invest in startups from their seed stages all the way up through their expansion stages. Still, there are also venture capitalists that only focus on seed-stage companies or companies seeking Series A funding.
If your company has already raised pre-seed and seed funding, you wouldn’t want to approach a VC firm that only provides seed funding, for example. You should be looking for VCs that offer Series A funding and beyond.
A VC firm’s location and your company’s location are other important factors to consider when deciding what VCs to apply for funding from.
Some venture capitalists only work with startups based in certain countries or regions, while others invest more globally.
So, before you decide on the best VCs for your business, make sure you determine whether or not they have any geographical restrictions when it comes to providing startup venture capital.
The final factor to consider when deciding what VCs to apply with is your industry. Certain venture capitalists prefer to fund companies in specific sectors, such as fintech or health care, while others may have portfolios that cover a wide range of industries.
You can certainly find venture capital in almost any industry. Still, it’s important to ensure the investors you want to reach out to are interested in your industry before you put effort into applying for venture capital from them.
Once you identify VCs that look like a good option to contact, make a prioritized list based on how likely you think they might be to give you venture capital.
It’s possible (very likely, even) that you’ll end up contacting all of them anyway, but it’s best to work your way down the list, starting with the VCs that seems like the best fit for your startup’s business stage, location, and industry.
An executive summary and business plan are key assets you need before you go into meetings with venture capitalists.
The executive summary should be a one to two-page, text-based overview of your business that VCs can look over to quickly get an idea of whether or not it might be a good investment opportunity for them.
Remember that VCs receive thousands of applications for venture capital, so they’re not going to read over every detailed business plan they receive when conducting the initial screening of applicants.
Think of the executive summary as a shorter version of your business plan that covers all the main points in a more concise, easy-to-digest fashion. If this overview piques a VCs interest, they can then read some or all of your business plan to get all the more technical, in-depth info.
Your business plan is the most important part of any investment proposal and should contain more complete details about your company’s status and plans for the future.
Make sure to include all your current financials, your plan for growth, how much money you need to grow your business, how you will use said money, and what type of returns investors can expect.
Again, most prospective investors will not read your whole business plan immediately, so organize it well.
Include a table of contents and add summaries of main sections using easy-to-read formattings, such as bullet points and larger font. Feel free to use visuals like tables, charts, and graphics to help convey key information wherever it makes sense.
This allows investors to seek out the information that’s most important to them, and they have the option to read more details in certain areas of your business plan.
5) Build a Pitch Deck
Once you write an executive summary and create a business plan, use them to build a pitch deck that you will present to potential investors. This is one of the most important tools to have available when you meet with venture capitalists.
What Is a Pitch Deck?
A pitch deck is a multi-slide presentation that goes over your startup's potential and investment proposal.
Think of it as a mini version of your business plan — it shouldn’t be as detailed as your business plan, but it should provide a high-level overview of all the key points.
As such, you should aim to cover everything in approximately 10 to 15 slides, using large, easy-to-read fonts, bullet points, and visual assets to convey information concisely.
Each slide should present a clear idea, and you should aim for your presentation to take no more than 20 minutes.
A good rule of thumb to remember is the 10-20-30 rule: shoot for 10 slides, a 20-minute presentation, and use a 30-point font or bigger for all text.
You can also build two versions of your pitch deck: a lean one to present and a more detailed version with additional text that you can send out via email that can be easily understood without a verbal presentation.
Every pitch deck should cover the following 10 topics, ideally using one slide per topic (although you can go into more detail on a couple of them, as needed):
Introduction: Who you are and why you’re there
Problem: The problem(s) that your product/service is addressing
Solution: What is your solution to the aforementioned problem(s)
Market size and opportunity: Measurable numbers regarding the actual market
Product: A showcase of your product/service and its technical specifications
Traction: Data on your startup's current use/growth and goals for the future
Team: An introduction to key team members, such as co-founders and other executives
Competition: Who your competition is and how your company is different
Financials: Details on current revenue and/or projections for future revenue
Investment and use of funds: How much capital you’re asking for and how you’ll use it
6) Learn How To Read VC Term Sheets
If you’ve done the right preparation and started pitching your startup idea to venture capitalists, you’ll hopefully start receiving offers from potential investors. When a VC makes an offer, they typically present you with a term sheet.
What Is a Term Sheet?
A term sheet is a document that lists all the terms of a proposed venture capital funding deal. Term sheets are different from contracts in that they are non-binding. In other words, a term sheet is more of an informational document as opposed to a legal one.
Nonetheless, it’s still important to ensure you know how to read and fully understand a term sheet before deciding whether or not to move forward with a VC funding deal.
What Is Generally Included in a Term Sheet?
Most term sheets include three main sections related to funding, corporate government, and liquidation/exit terms.
In the funding section of a term sheet are all the financial guidelines for the proposed investment deal.
Essential components of this section are how much money the VC offers and how much equity they want in return for its investment.
If any other financial elements are being offered, such as royalties or lines of credit, these will also be outlined in this section.
A term sheet's corporate governance section covers the company control distribution among co-founders, VCs, and other stakeholders, specifically related to the company's decision-making.
In short, this section outlines the rules, processes, and practices for making important business decisions. It should go over things like who the board members are, how many votes are required to make a decision, and who has veto rights for certain business decisions.
Liquidation & Exit
Lastly, every term sheet also covers what happens regarding owners, investors, and shareholders if the company is dissolved, liquidated, or acquired.
For example, it will outline things like who gets paid out first and in what order investors and other stakeholders are to get paid if the company gets sold or liquidated.
The All-In-One Newsletter for Startup Founders
Every week, I’ll send you Failory’s latest interviews and articles and 3 curated resources for founders. Join +25,000 other startup founders!
7) Negotiate Your Terms
Since term sheets are non-binding, you should always try to negotiate any terms you’re not totally comfortable with after reading them.
Let’s say a VC offers you $2 million in exchange for 20% equity in your company, but you weren’t planning on giving up more than 10% equity. In this case, you could discuss the issue with the venture capitalists and offer them less equity for less money.
During this phase, the most important thing to remember is that you should never take a deal you don’t feel 100% good about.
If a VC is unwilling to negotiate the terms of the deal and there are terms you don’t like, don’t hesitate to walk away. Many more VCs out there might offer you a better deal.
Who knows, your company might end up being the next missed opportunity for some big venture capitalist out there.
8) Prepare for Due Diligence
Before any deal goes through, after you agree on its terms, any VC firm, VC fund, or angel will conduct due diligence to ensure everything you’ve told them about your company and its potential is true.
You can make this process easier for the VCs by preparing things like formal financial reports and copies of any legal contracts your company has entered into to provide to them.
You may even want to send these types of things over preemptively so the VCs don’t have to ask you for the info. This makes you look good in the eyes of investors and can help make a deal go more smoothly.
Additionally, be prepared to answer lots of more in-depth follow-up questions about particular aspects of your business, such as the team, your competition, your product development plans, and your marketing/sales plans, among other things.
During this time, you may also want to conduct your due diligence on investors, especially if the VC you’re thinking of working with is not a huge, well-known firm.
Look into information about their past investments and try to find out how things have worked out for past founders who have partnered with the VCs. You could try contacting founders at other companies in their portfolios to do this.
At the end of the day, getting venture capital funding isn’t just about the money — it’s about forming a mutually beneficial partnership that could last for many years. Hence, you want to ensure you choose the right venture capitalists to work with.
9) Seek Legal Advice
Once the due diligence phase is over and both parties are satisfied with what they found, it’s time to start putting together all the legal paperwork to formalize the venture capital funding deal.
For this step, you should hire outside legal experts to consult you and review all contracts and other documents.
Ideally, find a business lawyer with experience in your area and industry. They’ll be most familiar with local and industry-specific laws, rules, and regulations.
For instance, if your startup is in the app industry and is based out of California, find a legal consultant who has previously worked with other tech startups, particularly in Silicon Valley.
10) Close The Deal
Once all the legal documents have been created, the final step of obtaining venture capital is for both parties to sign the required paperwork and officially close the deal.
The exact number and composition of documents to sign can vary from business to business and deal to deal, as well as according to the personal preferences of the attorneys and legal teams who put them together.
In general, the documents you must sign off on to close a VC deal will cover the terms of the primary investment agreement, decision-making/voting rights, stock purchase agreements, indemnification, incorporation, legal opinion, and employment and confidentiality agreements.
Getting startup venture capital funding isn’t simple, but it can be very rewarding when executed correctly.
It’s easy enough to find a venture capitalist, but there are many steps you need to take before, during, and after applying for venture capital to close a VC deal and get the money in the bank.
But, if you follow the guidelines discussed above and have a solid business idea and plan, you should be well on your way to obtaining a cost-effective source of funding for your startup to help take it to the next level and achieve its true potential.
And, if you don’t find a venture capitalist willing to back you immediately, try not to get too discouraged. Many startup founders have to pivot on their initial ideas one or several times and keep bootstrapping their companies for some time before they finally get VC funding.