How Venture Capital (VC) funding usually takes place.

January 1, 2025

How Venture Capital (VC) funding usually takes place.

1. On what basis will they inject funds into the new company?

VCs typically evaluate the following factors before investing:

• Market Potential: Is the market large and growing? VCs want companies with potential to grow enormously.
• Team: Does the startup team or team have the capability, experience, and motivation to execute the business plan?
• Product/Service: Is the product or service new, scalable, and solving a real problem?
• Traction: Early signs of success, such as revenue, user traction, or partnerships, can increase the likelihood of funding.
• Business Model: Is the business model strong and capable of producing high returns?
• Competitive Advantage: Does the company have a unique advantage (e.g., technology, IP, or market position)?
• Exit Potential: VCs look for a clear path to a successful exit (e.g., acquisition or IPO).

2. What are the bases of valuation generally for small-sized companies?

Valuation is generally subjective and based on different factors:

• Stage of the Company: Early-stage companies will be valued based on potential rather than actual figures.
• Revenue and Growth: Revenue multiples or EBITDA multiples can be used for companies that generate revenue.
• Comparables: Price can be established based on comparable sector companies that have recently raised funding or were recently acquired.
• Market Trends: Trendy industries are able to fetch premium valuations.
• Discounted Cash Flow (DCF): In the case of established companies, future cash flows can be approximated and brought back to present value.
• Negotiation: The VC and the founder will negotiate on valuation, balancing risk vs. potential.

(Noted: Majorly valuations are taken based on DCF for private nature of companies where comparable valuation cannot be extracted.)

3. Will they put money primarily into equity?

VCs will typically invest in equity (ownership stock) to fund shares. This is to say:

• Issue company shares, dilute the founder's ownership.
• They may also utilize convertible notes (taking a loan with an understanding that in the future it can be converted into equity) or SAFE agreements (Simple Agreement for Future Equity) in early times.
• VCs never lend debt except as a component of a structured deal.

4. What are the terms and conditions typically between the parties after engagement?

The terms and conditions are established in a term sheet, which includes:

• Valuation: Pre-money and post-money valuation of the firm.
• Equity Stake: Ownership percentage that the VC will hold.
• Preference of Liquidation: VCs will usually expect to get repaid first (or multiples thereof) if the firm sells or winds down.
• Board Seats: VCs might also demand a seat on the board so that they can influence decisions.
• Vesting: Founders' shares may be vested over some period of time so that they are committed.
• Anti-Dilution Provisions: Maintains the VC's ownership percentage in future rounds of funding.
• Milestones: Payment can be tied with reaching specific business milestones.
• Exit Rights: VCs may have the right to demand an exit (e.g., sale or IPO) after a time period.

5. What can be the types of exit they normally pursue, and what is the time horizon?

VCs seek exits with high returns, typically 5-10 years later. Common exit routes are:

• Acquisition: A larger company takes over the firm. This is the most common exit.
• IPO (Initial Public Offering): The firm gets listed, and shares are sold on a stock exchange ( Mostly we can see recently in Energies)
• Secondary Sale: The VC offloads its shares to some other investor or private equity firm.
• Merger: The company merges with another firm, and the VC exits through the merged firm.
• Buyback: Founder or company buys back the shares of the VC (rarely in Nepal)

So let's see the highlights:

- VCs invest in high-growth companies and look for huge returns.

- Valuation is most likely to be based on market potential, traction, and comparables.

- Equity is the most common form of investment.

- Conditions and terms are agreed upon and drafted in a term sheet.

- VCs typically desire exits in 5-10 years as acquisition or IPO.

An entrepreneur or business owner should ensure they understand the costs of VC funding, including dilution of ownership and loss of control, before proceeding. Having a legal or financial advisor get involved is highly recommended.

Summarized by

Manik Balami

Corporate Financial & Legal Advisor

Research & Development Unit

Rudolph Corporate Service Pvt. Ltd.

Contact us: hello@rudolphservice.com

Disclaimer:

The information provided above is for general informational purposes only and should not be construed as legal, financial, or professional advice. Venture capital (VC) funding involves complex legal, financial, and business considerations, and the specifics of each deal may vary significantly. It is strongly recommended that your friend consult with qualified professionals, such as a lawyer, financial advisor, or business consultant, to understand the implications of VC funding, negotiate terms, and ensure compliance with applicable laws and regulations. The author and publisher of this content are not responsible for any decisions made based on the information provided herein. Use this information at your own risk.