Venture capital

What characterises venture capital

Venture capital is equity for young companies with high growth potential. The difference from private equity lies in the stage: venture capital invests early, often before the business model is proven, and accepts a high default risk for it. The investor's calculation is simple: out of ten investments two or three should grow so strongly that they cover the losses of the rest.

The decisive expectation follows. Venture capital does not look for a stable business but for one with the potential to grow several times over. An online shop with stable revenue and a good margin is uninteresting for this kind of investor, even when it is healthy.

Which expectations investors have

• Market size: the market has to be large enough that a multiple of today's revenue is possible.
• Growth speed: one percent growth a month is not enough. A clear multiple per year is expected.
• Scalability: effort must not rise linearly with revenue. That is why software and platforms are popular and retail with stock is harder.
• Team: what matters is not only the idea but the people and their ability to build an organisation.
• Exit perspective: there has to be a route to sell the share later, for instance to a larger provider.

How funding rounds build up

The first round usually comes from private investors entering early and serves to prove the model works. The second round follows when first revenue and repeats exist and pays for the build out. Further rounds follow when growth rises faster than income, which is the normal case in e-commerce.

With every round the founders' share falls, and that is intended. Anyone raising capital trades control for speed. The craft lies in giving up only as much as the next step needs and choosing the moment when your own share has the highest value.

What comes instead

For most online shops growth financing through venture capital is not the right route, and that is no disadvantage. Four alternatives are more common and often more fitting. A bank loan for predictable growth with existing stock. Supplier credit when payment terms are negotiable. Postponing conspicuous investments in favour of slow, self financed growth. And a share for a strategic partner who additionally brings market access.

Venture capital fits where speed is decisive, such as building a platform with a network effect. Where growth hangs on goods, stock and staff, debt works cheaper. Further basics are covered under contribution margin.

Frequent questions

• How much share do I give up? Ten to twenty five percent per round is common.
• Do I need a business plan? Yes, with figures, assumptions and a traceable calculation.
• What is the most common mistake? Raising capital without a plan for using it.