Venture capitalists represent the most glamorous and appealing form of financing to many entrepreneurs. They are known for backing high-growth companies in the early stages, and many of the best-known entrepreneurial success stories owe their growth to financing from venture capitalists.
Venture capitalists (VCs) can provide large sums of money, advice and prestige by their mere presence. Just the fact that you've obtained venture capital backing means your business has, in venture capitalists' eyes, at least, considerable potential for rapid and profitable growth.
VCs make loans to--and equity investments in--young companies. The loans are often expensive, carrying rates of up to 20 percent. Unlike banks and other lenders, venture capitalists frequently take equity positions as well. That means you don't have to pay out hard-to-get cash in the form of interest and principal installments. Instead, you give a portion of your or other owners' interest in the company in exchange for the VCs' backing.
The catch is that often you have to give up a large portion of your company to get the money. In fact, VC financiers so frequently wrest majority control from and then oust the founding entrepreneurs that they are sometimes known as "vulture capitalists." But VCs come in all sizes and varieties, and they are not all bad.
Venture capitalists typically invest in companies they anticipate being sold either to the public or to larger firms within the next several years. Companies they will consider investing in usually have the following features:
- Rapid, steady sales growth
- A proprietary new technology or dominant position in an emerging market
- A sound management team
- The potential for being acquired by a larger company or taken public in a stock offering
Venture capitalists seek very high rates of return; a 30 percent to 50 percent annual rate of return is typical. To generate these returns, they look for firms with proprietary technology, distribution systems or product lines that other companies might want to possess.
Small Business Innovation Research (SBIR) grants aim to stimulate technological innovation among small businesses. They let small businesses propose research projects designed to meet the federal government's R&D needs. If approved, the research projects may receive grants of up to $75,000.
Direct Public Offerings
Direct public offerings (DPOs) allow you to sell stock directly to the public without the registration and reporting requirements of an initial public offering. DPOs are specifically designed to let small businesses access the public capital markets with less cost and complexity than is involved in IPOs.
DPOs typically raise amounts of less than $1 million, but you can raise up to $25 million with a DPO under certain circumstances. You can also advertise and promote the sale of your own stock if you hold a DPO, something other public companies are forbidden to do.
DPOs' main limitation is the lack of a secondary market for securities. That means the stock of a DPO company is illiquid, so shareholders may have difficulty finding buyers for their shares in the event they want to sell. That is not necessarily bad for you, but it can be a deterrent to investors.
Small Corporate Offering Registrations (SCORs) let small companies raise money by issuing stock directly to the public without the help of an underwriter, as is used with IPOs, who buys the stock and resells it to the public. SCORs feature much less complicated regulatory oversight and document filings compared to standard IPOs and can be used to raise amounts of up to $1 million.