Understanding venture capital funds (VCs)

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Are you getting ready to launch one or more fundraising rounds with investors and venture capital (VC) funds? It is important to first have a good understanding of certain basic rules.

Structure of venture capital funds

Do you understand how venture capital funds are structured? Acquiring this understanding is essential for:
• grasping how they think and analyze prospective investments
• determining which VC fund you should approach with your project

VC funds are subject to internal restrictions on the types of investment they are allowed to make.

Maturity level of the start-up company

In addition to geographic restrictions and thresholds of concentration, almost all VC funds invest in start-up companies that have reached a specific maturity level. Some get involved very early in the company’s development (series « seed » or series « A » financing), while others get involved later in the investment chain or will rather specialize in start-up companies that are about to go public or to be acquired.

This specialization of VC funds allows them be more effective in the support they provide to the start-up company. It is therefore very important to reach out to funds that correspond to your company’s level of maturity. Otherwise you will lose time and could even jeopardize future opportunities to reach out to such funds. You only have one chance to make a good first impression!

Start-up company’s business sector

VC funds often invest in specific business sectors. It is your responsibility to conduct the necessary research to ensure that the expertise of the fund you are thinking about is compatible with your company’s business sector. If this is the case, you can then confirm that there will be compatibility between the fund managers and your team of founders.

Value added by VC funds: expertise and support

Studies have shown that the value creation brought by VC funds comes mainly from the expertise and support they provide to businesses during the life of their investment (particularly as a result of their presence on the board of directors). This is why it is recommended that you ensure that the vision you have for your company is compatible with that of the VC fund’s management team. It must be understood that how the fund managers perceive the company’s founders and their vision is a major factor in their decision to invest in the company.

Their decision to invest is often based more on their evaluation of the company’s founders than the actual project or product being sold or marketed by the company. The fact that the VC fund requires one of its representatives to sit on your board of directors should not be perceived as a threat or a desire to take control of your company. On the contrary, this presence, even if only as an observer, should be welcomed – through it the VC fund manager will be able to help you grow your business quickly.

Investment timeframe

VC funds have a specific investment timeframe. They are generally structured to have a maximum life span of 10 to 12 years from their first fundraising with their own investors. Their objective is therefore to liquidate their investments in a timeframe of 5 to 7 years. This structure allow them to offer some liquidity to their investors who want to make sure they can recover their capital within a certain timeframe. They therefore seek to invest in companies that allow them to generate the desired return within this time.

Your planning must include the moment to approach funds with a view of being able to guarantee them a sufficient return over a timeframe of less than 5 to 7 years. Otherwise, even if your growth plan may be of interest to an investor willing to commit its capital in a longer term, you risk not being able to attract interest from VC funds.

TO KEEP IN MIND

The support of a VC fund in a start-up company’s capital should not be seen merely as a financial support, but rather as the emergence of a mutually beneficial business relationship. It is therefore essential that you take the time to fully inform yourself about the characteristics of this fund and its management team and that you make an informed choice about the fund your company will work with. You should not make the mistake of choosing the investor fund only on the basis of the size of its cheque.

Guillaume Lavoie