VC Process and Best Practices

Venture capital plays a crucial role in helping startups scale and grow, helping to turn innovative ideas into market-leading businesses. And for investors, it offers a path to potentially lucrative returns. There’s also the opportunity to back a visionary entrepreneur or exciting business concept you really believe in.

But how does venture capital (VC) investment actually work in practice? Whether you’re an investor or a startup founder, you might find it useful to know a little about the venture capital process.

We’re here to help, with a comprehensive guide to the key stages of the VC process, from deal sourcing right through to signing the term sheet, post-investment management and the exit. We’ll also take a look at best practice in VC, to help optimise outcomes for both entrepreneurs and investors.

And if you’re a startup getting to grips with your business finances as you scale up, we’ll also show you how Wise Business could be the ideal solution.

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Key stages of the venture capital process

Let’s start with a look at the main stages involved in finding and securing venture capital investment, following the process right through to the time an investor realises a return and exits the arrangement.

Stage 1: Identifying potential investment opportunities (deal sourcing)

The VC journey starts with identifying potential investment opportunities, in a process also known as deal sourcing.

Investors find and evaluate promising startups, using methods such as networking, industry events and partnerships with incubators, accelerators or perhaps even universities.

There are also platforms available for finding investment opportunities and matching startups and potential investors. Here, it’s possible to filter investment opportunities based on criteria such as sector, stage, growth potential or other factors the investor is particularly interested in.

For startups, the sourcing stage involves building relationships and creating a network that helps them get noticed by potential investors. They may draw up a shortlist of potential VC firms and approach them directly with their pitch.

Stage 2: Carrying out due diligence

Once a promising deal is lined up, the next step is due diligence. During this phase, investors conduct a thorough investigation into the startup, looking at the following:

• Business model
• Market potential
• Financial health
• Legal standing
• The strength of its leadership team.

Known as due diligence, this stage is critical for mitigating risk and ensuring the startup aligns with the investor’s strategic goals.

For startups, this is a critical phase where transparency, accurate documentation, and the ability to clearly communicate value propositions are essential for building trust with the investor and - if all goes well - securing funding.

Stage 3: Negotiation

If the investor (or the VC firm’s investment committee) decides to go ahead with the investment, the next stage is negotiation.

The investor and startup - and their legal representatives - will negotiate on terms, valuation, and ownership stakes.

Startups should be prepared for these negotiations by understanding their value and market positioning, as well as what they need in terms of financial support.

Stage 4: The term sheet is signed, followed by the investment agreement

Once the terms of the investment have been successfully negotiated to everyone’s satisfaction, a term sheet is signed. This is effectively a notice of intent on behalf of both parties to create a legally binding agreement, although the term sheet itself may not be legally binding.

This document outlines the key terms and conditions of the investment, such as:

• The amount of funding
• Equity stake
• Valuation
• Rights
• Responsibilities.

After the term sheet is agreed upon, a more detailed investment agreement is drafted and signed.

Startups should seek professional legal advice during this stage to ensure that they understand the short and long-term implications of the deal and that they are fair to both parties.

Stage 5: The partnership begins

The next stage in the venture capital process is post-investment management. The financial aspect of the deal has been actioned (i.e. the funding provided) but the agreement may involve the investor taking an active role in the company.

They may provide strategic guidance, mentorship and support in areas such as business development, hiring and scaling. This ongoing involvement is key to ensuring that the startup has the resources and advice needed to succeed.

For startups, this phase is about building a strong partnership with investors. It’s important to maintain open lines of communication, and make sure to take advantage of the expertise and resources on offer.

Stage 6: Investors realise a return and exit the partnership

The final stage of the VC process is the exit, where investors realise a return on their investment and leave the partnership as agreed. This typically happens through acquisitions, initial public offerings (IPOs) or secondary sales.

For some startups though, there may be further rounds of VC funding where more capital is injected into the business or more investors come on board.

The timing of the exit is crucial, as it will determine the size of the return for both the investor and the startup founders.

And for startups, a successful exit can mean the culmination of years of hard work and scaling. If all has gone well, both parties have achieved their goals - for returns, growth and the establishment of a viable business.

Best practices in VC

Now let’s move onto best practices in venture capital, an understanding of which can help both startups and VCs get the most out of any investment agreement.

Clear alignment of expectations

From the outset, it’s essential that both the investor and the startup clearly align their expectations on what they’ll get out of the deal - and what each party will deliver.

This involves agreeing on growth targets, milestones, and timelines for achieving success. Investors and startups should maintain open communication to ensure that both parties are on the same page throughout the process, especially at the very beginning.

Building and nurturing strong relationships

Venture capital investment isn’t just about injecting funds into a business, taking a return and walking away. It’s much more of a partnership, where the investor helps to steer the growth and future success of a budding business.

To do this effectively, both parties need to focus on building strong long-term relationships. Trust, shared goals, effective communication and mutual understanding are all vital components of such a relationship.

As a startup, remember that your investor is a valuable resource. They provide more than just funding - they can be mentors, advisors and connectors. Startups should leverage these relationships to unlock new opportunities and take advantage of strategic guidance.

Transparency and clear communication

For both investors and startups, transparency is critical in maintaining a healthy, successful partnership. Clear communication, honesty and accountability are all important from the very start, especially during negotiations and the signing of the investment agreement.

And it’s also essential as the partnership progresses, as it’s very easy for the relationship to deteriorate if one or both parties is failing to communicate effectively.

Startups should provide regular updates on key metrics and challenges. And from the investor’s side, they should be available and accessible, as well as willing to engage in productive discussions.

Ultimately, open communication helps prevent misunderstandings and allows for faster problem-solving.

A shared focus on long-term value creation

While it can be tempting to focus on short term returns, the most successful venture capital investments are those that prioritise growth in the long term.

This of course requires patience, both for the investor waiting to realise a return and for the startup to achieve its goals for growth and profitability. Both investors and startups should focus on building sustainable value over time, rather than expecting quick exits or unsustainable growth strategies.

Diversification and risk management

Investment always involves some element of risk. This is why investors should diversify their portfolios across multiple sectors and companies in different stages of growth. This spreads the risks across the portfolio as a whole, and reduces the risk associated with any single investment.

As well as boosting the chances of a successful exit from VC investments, it can also mean a better and less pressured relationship between investors and startups.

Startups, on the other hand, should be mindful of potential risks in their own business models and work to mitigate them through strategic planning and market research.

Follow-on investment strategies

As we’ve mentioned above, VC investors and startups need to be looking to the long-term - and this means having a plan for future funding.

Ideally, investors will provide follow-on investments to help a startup continue its growth journey. This may be a further round of funding in line with targets for growth (i.e. international expansion into a new market) or profitability, or perhaps even an opportunity to bring new investors on board.

Investors should have a clear strategy in place for follow-on investments, including the amounts, timing and conditions. This isn’t something you want to be planning and negotiating last-minute, especially if the startup is in a critical phase of development.

With proper planning, investors can ensure that the startups they foster have sufficient capital to reach their next growth milestone.

Leveraging networks and expertise

We’ve already touched on this, but it’s well worth reiterating that startups should see their investors as more than just funders.

Successful investors often bring far more than just money to the table. They offer expansive networks of valuable business contacts and resources, and potentially decades of business or even sector-specific expertise. For startups, this is an invaluable asset, and definitely a person you want to have on your board of directors (even if it’s only temporarily).

So while searching for investment, startups shouldn’t only look for investors willing to provide the required capital.

They may also want to seek those who can provide introductions to potential new clients, partners or even additional funding sources. They should also be looking for investors with the industry knowledge to guide and optimise their business strategy.

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And that’s it - our comprehensive guide to the venture capital process and best practices. We’ve covered everything you need to know, whether you’re an entrepreneur looking for funding or an investor aiming to find an exciting startup to back.

After reading this, you should have a better idea of the process of finding and securing VC investment, as well as how deals are negotiated and signed. We’ve also covered what happens post-investment, including that all-important exit and realisation of returns.

One of the most important takeaways from this is to make sure you have expert legal advice when negotiating or signing VC deals. This is especially crucial if this is your first startup or you’re making your very first venture capital investment. You need to make sure you understand the implications of the deal and go in with your eyes open.

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