Venture Capital (VC) funds are investors who provide expertise and capital (called venture capital) in privately funded companies at an early stage of their life cycle. This contrasts with more traditional ‘private equity funds’ who tend to invest in companies that are more mature and have a structured business plan in place.
How venture capital works
A VC fund typically seeks, at the outset, to limit its involvement with new ventures to a set number of years in which they hope to achieve enough growth to exit – typically, with an initial public offering (IPO) or a sale. The fund works closely with the start-up to establish its business plan and help shape its first few years.
The VC fund can create a lasting legacy for the start-up by sharing its existing contacts and creating links to new networks, which can help the start-up plan for the future by identifying sources of new capital or business. The start-up can use these connections to help establish their business in the market.
Venture Capital funds are experts in the particular industry in which their investments do business. Managers of these funds can help distinguish the start-ups in their particular areas. The funds also play a key role in the business community by taking risks with companies that would find it hard to finance themselves by other means. The success of these companies can change the marketplace in a particular area or encourage others to develop products and ideas.
What to consider before going VC
Start-ups often create a large amount of intellectual property before setting up a formal company structure, and sometimes the value of the business can be contained in this intellectual property. It is important to ensure that the company into which the VC fund is investing owns the intellectual property it has created and has sufficient agreements in place.
Key employees are vital to the success of any start-up. Employment agreements should be entered into which state that the company owns any intellectual property produced by the employee. Additionally, properly drafted restrictive covenants are important to protect the business if key staff leave and want to work with competitors. A VC fund looking to invest in a company will want to ensure key staff are contracted and the company is protected going forward.
Contracts with suppliers and customers are often the foundation of successful businesses. A VC fund looking to invest will want to ensure all key business relationships are documented properly so that the company has sufficient certainty and protection.
During the period of investment, a VC fund will be exposed to the start-up’s business. It is important, before the investment begins, to have a properly drafted NDA to protect business property and intellectual property during discussions with the VC.