Why are venture capital funds mostly for tech startups?

Any startup, be it in tech or any other domain, requires some initial funding to get going. This might be used for different scenarios depending on the use case of each company. However, the core idea behind VC funding stays the same: to provide small amounts of capital to startups that are believed to show good long-term growth.

What is VC funding or investment?

Venture capital typically stems from well-off investors or investment banks and assorts the funding based on the workflow and idea behind the startup. In some cases, this kind of funding is also provided in the form of managerial or technical expertise instead of a monetary form.

Even though this might seem like a risky gamble for investors, the returns afterward often come as an attractive payoff if the company succeeds. As for the company owners, the main downside to such a kind of investing is that since an investor has put some money in your company, they also get a say in significant decisions due to their equatorial rights.

Why do startups need VC funds?

The first reason behind this is to safeguard themselves from the uncertainty involved in the financial world. As a new company steps into business, even though they come with meticulous planning, certain things might not go as per the plan and may end up adding a sizable chunk of money to the final bill. In such a case, having some additional funding comes in handy.

Raising funds also helps startups to create a buffer that brings the attention of more potential investors. If a renowned VC investment firm is backing a small startup, it is evident that the startup must have some merit as they earned their backing.

To carry out this process, many entrepreneurs turn towards friends or family in the beginning.

But as things continue to grow, one might also want to take help from someone more experienced in the field, such as an angel investor or a venture capitalist who can afford to invest a large sum of money into the startup.

Once you have identified your key markets and introduced a bit of authority in your domain, then you can head on and start looking for funding.

How do VCs invest in startups?

VCs don’t just rely on carrying out an external valuation of the company but also weigh in various internal factors which are discussed below :

Solid management

The first requirement for the smooth functioning of any firm is management. Investors do not necessarily look for highly qualified degree holders but instead, go for experienced executives who have generated good returns in the past for other investors. The ability to quickly execute a business plan and carry out day-to-day functioning are some of the key aspects that they should master.

An organization that is looking for a venture capital firm should have an extensive list of qualified and experienced people who can take the pressure and work efficiently as the company continues to grow. If a particular startup lacks a talented manager, they should be willing to hire an outside counsel or expand their team to achieve the best results.

Size of the market

This is one of the most commonly exercised ways to catch a VCs attention. If a company targets a large demographic and shows that they can provide their services even if the revenue grows to millions of dollars, then a VC is more likely to buy-in. The reason behind this is twofold. The

first one stems from the increased risk-to-reward ratio, whereas the second one is that it allows their portfolio companies to grow their sales exponentially.

The larger the market one will target, the higher probability they have of making trade sales. This also gives lucrative pathways to VCs through which they can exit their investment. Ideally, a business plan should always include a detailed market size analysis which is presented from ‘top down’ to ‘bottom-up’. This translates to the inclusion of reviews and feedback from potential customers and the third-party estimates found in market research reports.

Great products with a competitive edge

For a startup, setting themselves apart is a highly crucial aspect if they want to succeed in their domain. A great product with a tinge of uniqueness will give them a competitive edge over others looking for investors and help them secure their customer base at a faster rate.

The goal should be to provide solutions to real-life problems which haven’t been addressed by any other startup and offering products and services which enhance the quality of life of their users. A certain product or service might sell quickly due to two main reasons:

• It is cheaper than other offerings on the market.
• It offers excellent service, which was previously missing in the market.

Hit any one of the two marks, and you are good to go.

Assessment of risks

Playing with risk is basically the job of a VC. Anyone will naturally want to know what they are getting into before investing their hard-earned money into it. VCs do not hesitate to ask any questions and are absolutely clear when it comes to putting forward the goals that a business needs to accomplish.

They also consider the factors like any legal issues in the future, the amount of money in the fund, the quality and usability of the product, the exit load and return ratio from the investment.

They try to minimize the risk as much as possible and aim to produce big returns as the companies in their portfolio mature.

Tech startups and their growth

A startup may or may not show growth during its initial stages. But recent studies indicate that the situation is somewhat different when it comes to tech startups. Let us look at the reasons why these startups grow faster as compared to the companies focused on other domains:

Reasons why tech startups grow faster than any other startup

Technology-based startups are increasing in number day by day. Their ability to offer remote jobs has turned out to be a plus factor, especially post-pandemic types. Here are some more reasons behind their rapid growth:

● Growing & Diverse culture

A tech startup involves a wide diversity when it comes to the working staff. This not only improves the work culture but also sets a higher performance bar amongst workers.

● Competition

When multiple skill sets work together to build one project, healthy competition arises between the peers, leading to the overall upliftment of the team.

● Adaptability to Situation

Tech companies can work better in pressure situations because they can quickly adapt and change their infrastructure as per the requirement. Having all the data accessible online also means that there is a lesser probability of file corruption and data mismanagement.

● Understand their Customer

A successful tech company will always analyze the ongoing trends in the market and adapt themselves so that they are able to serve the needs of potential clients best.

Understand why VC funds mainly target tech startups

With tech startups constantly updating and quickly adapting to new changes in the industry, they become an ideal choice for the capitalists who want to invest in a low-risk option. The four main sectors which venture capitalists often target are :

• Life sciences: due to its ties with the commercial sector, which can be funded easily.
• Information technology: due to the huge growth and improvement potential year after year.
• Energy and environmental technologies: as it contributes towards a greater cause and is a highly efficient resource.
• Manufacturing: due to the rapid industrialization in metro cities and beyond.

Out of these four, the IT sector is most likely to generate positive returns due to the constant updates and strides that are being made in this sector.

Trend in VC investing

Much like any other industry, trends also continue to emerge in the technology industry. The main job of VCs is to identify these trends and act on them before a particular service or feature becomes known to competition. For instance, the latter half of the first decade of the 2000s in Canada marked an increased investment rate in the startups which were aimed at solving environment-related issues, whereas the funding in other sectors declined.

This reflected the trend where both the government and public agencies wanted to invest in environmental causes. The first half of the past decade revolved around wireless technology and devices that could transfer data without physical input.

Another factor that attracted the venture capitalists is the total capital required in a particular sector to be able to generate significant results. In general, the lower the investment needed, the better.

How do tech startups fit the VC investing model?

There’s no doubt that Silicon Valley is home to a large number of venture capitalists. This is mainly due to the advanced tech industries that continue to boom to date. Here are some key features of this industry that seemed appealing to the VCs :

• A huge generational leap in terms of performance, size, energy consumption, etc. This was not only possible but showcased constantly year after year in the industry. With tech giants like Samsung and Google joining hands to create faster chips and smoother UIs, mobile devices and desktops have continued to flourish year by year. Thus, the performance improvements are not restricted to marginal ones anymore.
• The production model of these industries also involves using a third-party production model with some enhancement and change without any copyright issues. This allows small startups to be able to work on the same feature as the tech giants in their domain.
• The chips are tailored to work for specific purposes, which makes the value proposition easily understandable. For instance, the M1 chips are now custom-made by Apple based on their very own architecture to rival intel computers.

Venture capital and tech startups

As high as the reward may be when investing in a tech startup with boosted growth promises, there is always a risk ratio involved. VCs do all in their power to compare and contrast all the offerings so that the probability of making money-losing investments is almost negligible.