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Venture capital and private equity investments offer many advantages compared to other forms of financing. In addition to the financial investment, the portfolio company receives expertise, contacts, and partnership from the investor. The success of the portfolio company is in the investor’s interest; thus, the goals of the entrepreneur, management, and investor are aligned. Venture capital and private equity investors aim for the growth-driven increase in value of their investment, which benefits all owners.
During the investment, the entrepreneur usually relinquishes most of their ownership, except for investments made in very early-stage startups. However, they often remain as an owner after the transaction. However, relinquishing often leads to greater success; a share in a company grown with an investor can be more valuable in five years than 100% ownership of the original company.
The financing provided by the investor is typically equity-based. Compared to bank loans, venture capital and private equity investments have lower priority in situations like bankruptcy, and the investment is not usually repaid during the investment period. These characteristics mean that the investor shares the business and ownership risk with the entrepreneur and management. The investor only earns returns if the company’s value increases.
Growing through cash flow is often slow, and for companies aiming for rapid growth, it can even be impossible as multiple companies try to enter the market simultaneously. Those that can grow with the support of funding and invest in future growth gain an increasing lead. The participation of a venture capital and private equity investor in the company’s financing often also facilitates obtaining bank loans.
Through venture capital and private equity investors, the portfolio company gains access to a wide range of expertise in different fields. Since investors have invested in many growth companies, they have experience and knowledge of growth challenges and shortcuts. This pool of companies is a good place to seek operational models, practices, and benchmarks, for example, for entering markets in different countries.
Startups often need 3-4 rounds of funding to finance their growth. An experienced investor can help the company assemble new funding rounds. Investors support growth companies with additional financing if needed, for instance, for larger acquisitions.
Venture capital and private equity investment in a growth company usually requires a willingness to change originating from the company. Situations where such investment is a natural solution include: the entrepreneur wants to grow and internationalize the company but needs more expertise and resources; a public entity wants to privatize a business unit; the company’s owners recognize the need for industry restructuring; or the entrepreneur wants to retire in the coming years.
An investment can enable an entrepreneur to fulfil their dream: the investor brings additional resources and expertise to the company, helping to grow it larger and more valuable and often at a faster pace than peer companies.
An established growth company can be very profitable even before an investment. With such, the entrepreneur can diversify the wealth tied up in the company by receiving a significant portion of the company’s value in cash (or the entire value if the arrangement does not include the seller reinvesting in the company). For startup owners, venture capital and private equity investment reduces the need for other financing, thereby reducing the personal risk of the entrepreneurs.
Venture capital and private equity investors typically bring a professional governance model to board work. Amid busy schedules, many early-stage entrepreneurs may neglect board work. Investors bring good governance principles into the company’s daily operations. This is also a prerequisite for the company’s eventual listing or sale.
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The article is part of a blog series based on the association’s fundraising guide for entrepreneurs. You can find the full guide here.