Venture capital 101

Venture capital (VC) allows an investor to fund a company in exchange for equity, or ownership. Some of the world's newest and largest brands—including Casper, Warby Parker, and Glossier—have used venture capital to grow fast and beat out incumbents.

However, the choice to take venture capital can be a difficult one. Are you ready to give up ownership of your business? Can you match VC timelines and expectations? Are you comfortable having an investor sit on your board? In this article, we’ll guide you through some of these questions.

Key takeaways:

  • Decide how much you are raising. The best-laid plans of mice and men are bound to fail. It’s difficult to map out a dollar amount to fluctuating plans. Instead, keep a broad estimate of how much money you need. 
  • Do your research on different VC funds. The right VC can add value in ways beyond money, from opening up new distribution channels to sharing expertise on your industry. Think about what you might want from a VC and keep it in mind as you conduct your search.
  • Keep fundraising materials handy. These materials include an executive summary, a pitch deck, a private placement memorandum, and a detailed financial model—we share more information on how to create these documents in this article.
  • Before you sign a term sheet, make sure you understand its key details. Read about them on our term sheet 101.
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What is venture capital funding?

Venture capital allows investors to provide companies with funding in exchange for equity—or ownership—in their company. Typically, venture capital is provided to startups that investors believe can grow quickly and to a large size.

Venture capital can provide founders with access to capital that can be used on anything. It is typically most useful for parts of your business that will lead to high growth—like sourcing talent, scaling production, expanding to different geographies, or testing out an experimental product that might have big returns.

But the venture capital relationship is not just about money. Venture capital investors can also act as mentors, help connect startups with their network, act as legitimacy stamps, and aid with hiring. 

Funding rounds

Venture capital operates in funding cycles—seed, Series A, Series B, and onwards. Each round maps to a company’s stage and a set amount of money. The amount of money that’s tied to each stage changes often—different stages swell and shrink in size each year depending on trends. And founders with past successes can sometimes raise hundreds of millions even without a product.

Despite this volatility, funding rounds are still useful to benchmark your company’s stage against. 

Remember: venture capital is not long-term money. It should only be used until you hit your next big milestone. With each new VC round, founders experience dilution and own a little bit less of their business.

  • Pre-seed round: The pre-seed round is the earliest funding round. At this stage, founders are often attempting to translate their ideas into a product. For many founders, particularly first-time entrepreneurs, this round involves family and friends. 
  • Angel/seed round: This is typically considered the first real equity round. At this point, money is often used for early operations like market research or developing a product. Funding can come from angel investors or a seed-stage fund; it can also come from accelerator programs such as Y Combinator. 
  • Series A: By the time a company is ready for a Series A, they’ll typically have a viable business, including a working product and a tried-and-tested customer base. They’ll be able to prove that they’ve grown from their earlier stages. Large sums of money can help beat out incumbents and accelerate the development of new products that can expand the company’s research. 
  • Series B: A Series B round comes with serious expectations from investors. It's often expected that a company breaks even after this round. Series B money can be used for all of the things that keep your company growing aggressively and well, like expanding to new countries, hiring executive talent, or launching new products.
  • Series C: A Series C is often the last round before an Initial Public Offering (IPO, commonly known as "going public"). This round can boost a company’s valuation before its IPO. By this point, your company is likely profitable and has proven that it understands its customers and market. This round might even include risk-averse investors, like hedge funds and private equity firms. 
  • IPO: The IPO, or Initial Public Offering, lists a private company’s stock to the public and is the company’s first sale.
  • Acquisition: During an acquisition, another business will buy either your shares or your assets

Why would an ecommerce business raise venture capital?

Many ecommerce brands grow their businesses without outside capital. These brands bootstrap and invest their profits into their business, and have still managed to reach great heights.

However, there are many scenarios where the need for capital grows faster than the amount of money you might have—most importantly, for fast growth.

Bootstrapping isn't cutting it right now

Let’s say you run a company that sells tortillas online. You’ve bootstrapped for a year but haven't managed to grow very quickly. You're funneling any profits you make into paying manufacturers and suppliers. You certainly don't have the cashflow to take out debt—commercial lenders will ask for proof that you have the assets or cashflow to pay their loans back.

The one thing you do have is a vision and a great product. Your tortillas are made with a proprietory recipe that's 50% healthier than the most popular option on the market right now. Your small group of customers are loyal and have sworn never to buy tortillas from another company again.

Venture capital can help you accelerate your growth. Remember: Raising venture capital doesn't mean you have to adhere to new, aggressive timelines that don't work for your business. You can turn to angel investors (sometimes these are your friends and family) or look out for early-stage VC firms that can work with your timeline.

Go to market faster

Let’s say you’ve developed a new product line for your tortilla company and plan to pivot—you’re now focusing solely on healthy tortillas. You’ve developed the product and gotten rave reviews from the small group of customers you've trialed it with. However, you need more finances to bring your product to market with a splash (a problem that anyone who’s bootstrapped an ecommerce brand can relate with).

An unproven pivot might make you too risky for debt lenders—and you don’t want to reveal your secret by taking it to a crowdfunding platform.

Venture capital can help you fund everything you need for this new experiment. Plus, it’ll help you pump up your bank account so you can come out of the gate—in your new direction—as fast and as loud as possible.

Legitimacy, partnership, and marketing

The right investor can get you legitimacy and publicity through the press releases, media mentions, and Twitter conversations that come with the mere act of fundraising. Other investors can get you connections to everything from suppliers to influencers.

How do I raise venture capital?

Register as a corporation

If you’re a sole proprietor or run a limited liability company (LLC), it’s time to switch to a corporation structure. VCs tend to prefer to back corporations.

There are a suite of reasons why VCs prefer corporations, including the fact that corporations can issue separate classes of stocks with unique terms for different investors.

As a sole proprietor, your business finances are your personal finances and you can’t offer investors shares of your company. LLCs can lead to messy tax situations for investors.

If you have questions, you should speak with your business accountant or lawyer. 

Remember: Corporations can be a lot of work to maintain and aren’t always the best fit for ecommerce businesses. This is an important detail to keep in mind when you consider venture capital.

Decide how much you are raising 

The best-laid plans of mice and men are bound to fail and it’s difficult to map out a dollar amount to fluctuating plans. Instead, keep a broad estimate of how much money you need. 

  • Raise a number that will keep your company afloat until you hit your next major milestone—plan as if you’ll make no money. These milestones should map to your company’s stage and growth plan. For example, if you’re an early-stage company, your milestone might be to ship your first product.
  • Don’t raise more money than you need. If you have a new product in the works and need entirely new equipment and facilities or are pivoting to something new, calculate how much cash you will  need to get there. It’s better to raise a precise, smaller amount of funding than to hope for a larger amount that leads to an undersubscribed round. 
  • Consider how much equity you’re willing to dilute in the long-run—for example, around 10-20% dilution for a seed round is typical.

Do your research on different VC funds.

A great VC can add value in ways that you might not see from their websites. Maybe they have access to influencers that can help promote your business. Maybe they have deep expertise in your industry. Think about what you might want from a VC and keep it in mind as you conduct your search.

Never forget that the ball is in your court. If all goes well, an investor will be involved with your business for several years. 

Ask friends and other entrepreneurs: Tap into your network. Ask other entrepreneurs and investors for info. If you can, get in touch with a VC’s portfolio companies. Gossip helps.

Check out VC websites and blogs for past portfolios: This will give you a clear idea of the type of companies they invest in. It's good to remember that many VC firms don’t do ecommerce deals, and others that might work in ecommerce don’t have as good of a track record of success.

Ask yourself a few questions: 

  • Are there competitors in your industry in their portfolio? 
  • Are there businesses you could benefit from an introduction to? 
  • Have they had any notable exits?
  • Have any of their portfolio companies shut down?

Search online databases: There are lots of free and paid resources available that list out investors and their portfolios, including Crunchbase and Pitchbook.

Get details on the partners at the firm: Once you’re in touch with someone at the firm, figure out what their role is and what that means for how you approach them. Associates and analysts conduct initial research for potential companies to invest in and often just get tons of people in the door. It’s the general partners who will make the call about your investments and be involved in your company if they go ahead with it.  

It’s in your hands. Remember: The process of fundraising is in your hands. If a VC asks for long-term financial projections and you still haven't launched a product, maybe they’re not the right person to invest early-stage. Don’t be afraid to ask them to introduce you to others in their portfolio. 

Use multiple VCs to create competition: The more venture capital firms are interested in your company, the more likely your deal is to be seen as hot. Take between three to six months to raise money to keep competition high. A shorter window can show desperation and will lead VCs to think that you’ll take any deal.  

Find a lead VC. Every funding round has a lead investor, which is the source that’s coming in with the highest amount of money. Lead investors will have more rights and potentially different placements on your board. They can also help recruit other investors and set the deals for your term sheet. Take a crack at trying to find your lead VC first. If you’re successful, the other deals will fall into place 

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Manage your money with Mercury
Scale with checking and savings, custom made tools, and our entire investor network
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What materials do I need to start fundraising?

Before you've started fundraising, spend time getting together the material that VCs will ask for. The questions you answer when gathering this material will also help you flesh out your story.

Short description of your business (or elevator pitch)
: Come up with a few sentences that explain the problem you’re looking at and how your company will solve it. The elevator pitch is handy to keep memorized—you might use it when networking or write it in an email. 

Executive summary: The executive summary is like your startup’s resume. The standard length is a page. You’ll want to touch upon your idea, the problem you’re trying to solve, your solution, and why you’re best to solve it—from your experience as a founder to the team you’ve hired.

Pitch deck: The pitch deck serves as a visual representation of your business. Although you’ll find yourself presenting alongside your pitch deck, it should be able to stand alone if you’re emailing it to prospective investors. Your pitch deck should have:

  • An overview of your company, including name, logo, and one-liner of what you want to do
  • The problem you’re trying to solve
  • Your solution
  • Any traction numbers
  • The TAM
  • Your competition
  • Your vision
  • Your team
  • What capital will do for you in a few years

Most importantly, a pitch deck should have a story behind it. VCs are looking for companies with visions. 

Business plan: Business plans add muscle and context to your vision. You can choose between a traditional business plan, which describes your business and strategy from end-to-end, sets funding requirements, and establishes financial projections, or a more modern lean one, which uses charts and visuals to touch upon key metrics that can explain your business, like your plans for customer segments, channels, and revenue streams. 

Private placement memorandum (PPM): PPMs are disclosure documents that differ from your business plan in that they are not meant to pitch anything. They include risk factors, use of funds, and a description of securities, and allow you to avoid coming under fire with the SEC for making any false or misleading statements about your startup.

Detailed financial model: A financial model is a summary of existing expenses and future financial projections. It showcases how you plan to use your money. While these numbers keep changing, it’s often a good way for investors to see how you’re thinking about your business. 

Demo (or prototype or alpha): A demo is a way to present your product—an early version is fine—and give potential investors a taste of what your customers will eventually experience. 

Due diligence materials: If you pass the first few tests, investors will begin due diligence on your company to ensure that everything you’ve said is accurate. The quantum of due diligence materials varies based on the stage of the company. Typically, this will include materials that can prove your assumptions, from your books to shareholder details to any purchase agreements.

What is a term sheet?

A term sheet is a nonbinding agreement that an investor will give you when they’re considering an investment. The sheet will set the terms of their deal, including the funding amount, company percentage stake, liquidation preferences, and valuation. Your lead investor issues the term sheet. It can also set the tone for future funding rounds. Your term sheet can—and should—be negotiated before it is signed.

  • Read more about the key details to understand about your term sheet.
  • Read about other types of financing, plan ahead for your startup’s future, and get to know what type of capital might work best for you.

  • Mercury Team
    Next chapter
    The venture capital term sheet

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