The VC investment process is a structured, well-planned process that VC firms adhere to when investing in high-potential startups and growth-stage companies. It can be briefly broken down into several key stages from finding an investment opportunity until exit from an investment. Here is an overview of the typical VC investment process:
1. Deal Sourcing
Its refers to the process of identifying potential investment opportunities. VC firms use different sources to get to the startup companies, with such sources including networking and referrals, industry events, startup accelerators, and pitch competitions.
VC firms primarily source for deal flow from entrepreneurs, other investors, advisors, and professionals in their network.
Specialized VCs operate in particular industries or sectors – fintech, health tech, or clean energy, focusing on sourcing in these areas.
2. Initial Screening
What it does: The VC firm performs a high-level due diligence on the deal to understand whether the startup fits into their investment thesis, fund goals, and area of expertise.
How it works:
The VC team looks at the business model, experience level, and team size.
If it’s not within the firm’s criteria, then, at the screening stage, it’s out. Most deals fall at this stage due to market size, how far along the company is, or even worse, a bad fit with the industry.
3. Term Sheet Negotiation
What is it? This is the term sheet that the VC firm extends to the startup, in case due diligence is a success. The term sheet represents the non-binding agreement indicating the key terms of investment.
How does it work?
Generally, the term sheet includes valuation of the company, amount of investment, equity percentages the VC firm would enjoy, board representation, rights of investors, and liquidation preferences.
Both sides agree on such significant terms, which could be lengthy, depending on how complex the deal is and also on the bargaining power of the startup.
4. Investment Decision
What is it: Once the term sheet is agreed upon, then the VC firm’s investment committee reviews the same to finally decide whether to invest or not.
How does it work:
The deal is brought before the partners of the VC firm or their investment committee; they then vote whether or not to proceed with investment.
The investment decision most often hinges on the outcome of due diligence, deal terms, and whether it aligns with the investment strategy of the firm.
5. Signing Legal Paperwork
What is it: Legal documents that are drawn up and signed by the VC firm and the startup after the investment has been decided on.
How it works: The legal department puts together formal agreements that consist of a Shareholders’ Agreement, Subscription Agreement, and any other paper involved.
These documents consist of the rights and responsibilities of both the investors and the startup, governance structure, and other important conditions of investment.
Legal diligence is performed to ensure all the regulatory as well as compliance matters are covered.
6. Funding and Closing
What it is: This is the stage where the investment capital is transferred from the VC firm to the startup.
How it works:
Once all the legal documents are signed, the agreed-upon funds are wired to the account of the startup.
The deal is now considered “closed,” and the VC firm is formally an equity holder in the company.
Conclusion
A process in a venture capital investment refers to the journey of finding, evaluating, and managing their investments in high-growth startups. VC firms focus on selecting scalable businesses that they believe have better growth potential, fund them, guide them, and then exit the investment with great return. Each step is designed to prevent as many risks as possible while maximizing returns for investors and founders of these startups.