Venture capital (VC): investors to boost the development of companies
Venture capital is a financing activity for startups and young companies. Concretely, investors will take a stake in the capital of a high-growth potential company. This can be through share subscription at the start or during a capital increase.
VC is part of the " private equity " investment, corresponding to " venture capital". It only concerns companies which are not listed on the stock exchange, a sector often called the "unlisted" for this reason.
The investors are generally "business angels" (individuals, often former business leaders, who gamble their own money in crowdequity) or investment funds specialized in seeding looking to participate in value creation by providing money. They plan to sell their stakes in the medium-term, bagging a good profit in return for the risk of loss taken. Their participation is often minority.
Venture capital has a significant potential gain if the company succeeds, which attracts investors. But it's also appealing for entrepreneurs, as it allows them to raise a lot of funds to accelerate their development.
It's indeed hard for a recent company to find financing. Banks usually ask for a "track record" of at least 3 years: they therefore must present 3 years of financial statements to justify the continuity of their activity. Moreover, credit institutions often ask for guarantees on the founders' own assets, which puts them at great personal risk in case of failure.
As new companies have no history, it's difficult for them to obtain traditional financing, even if the project is innovative or promising. But if their business plan is robust, they can turn to private venture capital investors.
Venture capital represents a source of financing which complements the contributions of entrepreneurs and their relatives (love money, fund raising in a restricted circle...). It can also intervene after the first growth phase for consolidation or development.
Another advantage of VC is that the new shareholders can participate in the company's strategic decisions and bring their expertise and network. This help can be invaluable at the launch of an activity to find customers, suppliers, and advice. The downside is that by giving up company shares, entrepreneurs lose some control and rights to profits. This has to be offset by a potentially higher gain.
From project analysis to venture capital financing
To take advantage of venture capital, entrepreneurs must first create a business plan and present it to the investment fund or business angels. This plan details the activity and project, provides information about the production processes, the financial history of the company, the entrepreneurs' backgrounds and so forth.
The investment methodology then usually follows these steps:
- screening,
- due diligence,
- letter of intent,
- closing.
During the screening, the entrepreneur submits his business plan to several funds simultaneously and lets them assess the viability and high growth potential of his company. The due diligence is the step conducted by potential investors during which they verify the provided information and ensure that the entrepreneur has not inflated the figures. If the project is deemed viable and presents profitability prospects, they will request to meet the entrepreneur to ask him to explain the project in person: this is the "pitch".
A letter of intent is sent to the entrepreneur in case of favorable opinion. The fund specifies the conditions of its investment in the letter, which could be subject to financial and legal negotiations (purchase price of shares and premium on issue, exit conditions of investors...). A stage in which entrepreneurs are well-advised to be assisted by a lawyer specialized in business law. The closing phase for the VC is the realization of the investment, the funds are provided to the startup which can dispose of them in compliance with the agreed conditions.
Seed, Series A, B or C: a step-by-step financing
Companies can raise from tens of thousands of euros to several million in venture capital. This depends on many parameters and their needs.
Venture capital investment funds generally specialize in particular sectors and different financing stages. This specialization allows them to provide real expertise and non-financial resources such as technical tools and strategic experience to the startup. The types of venture capital fund raising include:
- Seed, that is, start-up funding. This is the most complicated stage because the company is new ("early stage") and has no own history. Most of the time, the business model has not been tested on the market and many strategic modifications will take place before it finds its bearings. Seed funding is dedicated to startups in creation and the amount raised here is usually less than a million euros. They are used to enrich the original idea, test its real application, and develop and market a first product or service.
- Series A funding: The company has already tested its model in its market. For example, it has launched a first product or service and achieved enough revenue to consider a follow-up. Series A funding will enable it to initiate a first phase of development by increasing its production or expanding its volumes.
- Series B funding: After initial successes and a more defined business model, the company will seek additional funds to enter a development phase. This capital increase thanks to VC will open the doors to acceleration and initial economies of scale. The fundraising amounts are usually several million euros.
- Series C funding: The model is consolidated and the company can spread its wings by duplicating its model and making it scalable. This fundraising is intended to gain market share, create and launch new products or services, or set up in new markets (geographic areas, sector...).
Who are the VC investors
The venture capital sector consists of many players. Entrepreneurs can approach business angel networks, such as France Invest, France Angels... It's important to note that regions can also support companies through regional participation institutes (IRP).
Bpifrance is also a major player in company financing. This public entity manages numerous investment funds with different objectives. Its advisors can also guide entrepreneurs according to their needs.
Some financial companies specialize in the creation and management of venture capital investment funds such as FCPR (Risk Placement Mutual Funds), FIP (Local Investment Funds), FCPI (Innovation Mutual Fund), and FPCI (Professional Capital Investment Funds), some of which entitle individual investors to a tax reduction. They gather investors and search for projects in which to invest (see our list in the box).
Part of the major groups also have strategic funds dedicated to VC, such as Axa Strategic Ventures, SNCF Digital Ventures, Open CNP... These most of the time finance companies with themes related to their own activity.
Companies that need funds can also resort to crowdfunding. Platforms like Anaxago or Wiseed for the best-known ones, allow project owners to get closer to individual investors in equity, that is, through the subscription of shares (or bonds).
Lastly, entrepreneurs looking for funding can turn to companies specialized in fund research such as Finance et Technologie, Multeam conseil, MGT...
What are the risks of venture capital
Venture capital investment, as the name suggests, carries many risks for investors as well as start-ups. In case of failure, they may never realize a capital gain, and above all, may lose their entire investment. Although it is impossible to predict everything, it is important for an investor to ensure the soundness of the financial forecast and the potential of the entrepreneur's project in the market before investing.
Moreover, exit can be difficult. For a return on investment, someone has to buy back the shares. This could be another investor - sometimes even the founders themselves who take back control of the company - or an Initial Public Offering (IPO).
It's precisely for all these reasons that investors diversify the companies they fund as much as possible. This allows them to spread their risk.
By delegating part of their decision-making power to investors, entrepreneurs also take a real risk concerning the ownership and management of the company. They then need to pay special attention to the drafting of the shareholders' agreement in order to protect their status.
