What is venture capital? Definition, examples in Australia

Australia has become a melting pot of ideas and innovation. Unicorn companies like Canva, Safety Culture, and Airwallex (yep, that’s us!) have built a strong reputation for Australia globally, making the land down-under a magnet for entrepreneurs and investors alike. 

Of course, venture capital is a key part of almost all startup stories. None of the Aussie unicorns would be where they're today if it weren’t for a little help from our friends in VC. If you’re looking to understand how venture capital works, this guide will break it down for you – from definitions and financing stages to tips for securing funding.

What is venture capital?

Venture capital (VC) is a form of private equity (PE) funding that venture firms provide to startups and early-stage businesses with high growth potential. VC funding generally comes from angel investors, investment banks, and financial institutions, or limited partners (LPs) who want high returns on their investments. In return, VC firms get equity or ownership stakes in the companies they back. 

Venture capitalists often offer not just financial backing but also mentorship, networking opportunities, strategic guidance, and technical expertise. This support can be valuable for startups as they get their business off the ground.

Do startups need venture capital funding?

In the early stages, startups often run into financial roadblocks that make it difficult to scale, develop products, or break into new markets. That's where venture capital comes in as a key funding solution, especially when these startups can't tap into traditional financing like bank loans or capital markets, which are usually reserved for more established companies.

What are the main venture capital firms in Australia?

Australia’s venture capital market has witnessed a 11% growth from 2023 to 2024 with indications of continual growth in the next few years.²

A number of venture capital firms have established a strong presence in Australia. Among them is BlackBird Ventures, one of Australia’s most active VC funds supporting startups with a global vision. Square Peg Capital, focuses on Series A and B investments, while AirTree Ventures invests in startups from the tech sector. 

For startups targeting venture capital funding, attending venture capital events offers great opportunities to connect directly with investors and industry leaders. These events facilitate networking, knowledge exchange, and potential funding discussions, enabling you to build connections that can lead to strategic partnerships and financial support.

7 stages of venture capital financing and how it works

Venture capital typically follows five funding rounds, starting from the seed stage and moving towards later stages as the business grows and proves its viability. Each round of funding is used to fund different aspects of a startup's growth and usually involves different types of investors. Here's a breakdown of the different stages:

• Pre-seed stage

Pre-seed funding is the earliest stage of financing a startup can receive. It is so early that it is often not seen as part of the official funding rounds. This initial financing often comes from the founders themselves or family and friends. The primary goal of this stage is to help founders transform their idea into a tangible business model.

• Seed stage

During the seed stage, most businesses have a minimally viable product (MVP) and may have completed initial market testing. The goal of this stage is to secure enough capital to demonstrate early market traction to future investors. Seed funds are often used to hire key team members, fine-tune the product, and develop the business plan.

• Series A stage

At this stage, the company has proven that their product or service resonates with the market and has achieved some degree of operational stability. The goal of a Series A round is to provide the startup with enough capital to further product development, hire more employees, and prepare for future rounds of financing.

• Series B stage

Series B funding is aimed at startups that have successfully demonstrated market traction and are ready to scale their business. The goal of Series B funding is to help the startup grow rapidly and capture a more significant share of their target market. 

• Series C stage and beyond

At this stage, the startup has already established itself as a successful business with a proven track record of exponential business growth, generating consistent profit, and customer acquisition. 

After Series C funding, some companies may choose to pursue additional rounds of financing known as Series D, E, etc. These later-stage rounds are typically aimed at providing enough capital for further expansion and sustaining the company's success over time.

• Mezzanine stage

The mezzanine stage, also known as the bridge round, is the final stage of VC funding. Startups often use it to raise the necessary capital to bridge the gap between late-stage venture capital funding and the eventual initial public offering (IPO) or exit strategy. Mezzanine rounds typically attract late-stage investors aiming to profit from an IPO or sale, as early-stage investors opt to sell their shares and secure a substantial return on their investment.

• Exit stage

After several rounds of venture capital funding, the ultimate goal for any startup is to reach the exit stage, where the company's founders and investors can cash out on their investment. The most common exit strategies include an initial public offering (IPO) or acquisition by a larger company. An IPO refers to the process of offering shares in a publicly-traded company for the first time. Acquisition involves a larger entity purchasing the startup. The exit stage is crucial as it marks a major transition for a company, providing the original backers with financial returns while enabling the company to leverage new resources for further growth.

Pros and cons of venture capital you should know

As attractive as venture capital funding may sound, it's important to understand the advantages and disadvantages before seeking startup venture capital.

Pros:

• Financial support: The most obvious benefit of venture capital is the financial resources it provides to startups that have difficulty securing bank loans or external funding. This allows startups to invest in product development, hire top talent, and other key areas necessary for growth.

• Valuable guidance and mentorship: Venture capitalists can also offer managerial expertise, strategic insights, and industry experience to startups.

• Networking opportunities: VCs typically have extensive networks that can open doors for recruitment, partnerships opportunities, and developing client relationships.

• Increased credibility: Being backed by reputable investors often signals to potential partners, customers, and other stakeholders that the startup has significant potential.

Cons:

• Equity dilution: Venture capitalists typically receive equity in return for their investment, which means that founders will have to give up a portion of their ownership in the company.

• Pressure for rapid growth: Venture capitalists typically seek high returns on their investments, which can result in pressure for startups to achieve rapid growth and quick exits.

• Time-consuming process: Pitching to multiple investors and going through the due diligence process can be distracting for founders, taking away from their focus on actually running and growing the business.

• Difficulties in managing multiple VC funds: When a startup gets investments from different venture capital firms, managing funds from various sources can get tricky. If your startup is looking to tap into venture capital funding, consider using Airwallex's all-in-one financial solution to simplify your efforts in managing global funding. Check out how Aussie startup LeonardoAI used Airwallex to help receive global investor funds during their seed round.

What do venture capital firms look for in a startup?

Here are a few key factors venture capitalists and venture capital companies look for when evaluating startups for funding:

• Market traction: Venture capital firms are more likely to invest in startups that have already successfully introduced their product or service to the market and demonstrated its resonance with the target market, rather than those at the idea stage.

• Team capability: Venture partners want to see a strong team with relevant experience in the industry, as well as a track record of success. 

• Growth potential: Venture capital firms look for scalable businesses that can expand rapidly. Startups with clear strategies for capturing a larger market share, entering new markets, and addressing unmet needs are particularly attractive to venture capitalists.

How to secure VC funding for your startup

Step 1: Create the best venture capital pitch deck 

A well-structured pitch deck can increase your chances of starting a conversation with potential investors. Some key elements that should be included in your pitch deck are:

• Your business concept: This includes your mission and vision, the problem you are solving, and how your product or service can solve the problem.

• Market analysis: Provide details on the size of the market you are targeting and any relevant trends or competition.

• Product and unique selling proposition (USP): Explain what sets your product or service apart from competitors.

• Business model: Describe how your company plans to generate revenue. This could include subscription fees, advertising, or product sales.

• Financial projections: Give realistic financial projections for the next 3-5 years, including your startups’ burn rate, payback period, and P&L statements. Read our article for more key business metrics you should know about.

• Your team: Introduce key team members and their relevant experience in the industry.

Step 1: Find the right venture capital for your startups

Before approaching investors, it's crucial to research and identify venture capital firms that align with your startup's industry and goals. Some venture capital companies focus on early-stage startups while others target more mature companies. It's also important that their vision and values align with yours to ensure a harmonious partnership. You can use online platforms and databases such as Crunchbase, AngelList, and LinkedIn to research potential investors and understand their areas of interest before reaching out to them.

Step 2: Prepare your venture capital pitch

Once you have identified potential venture capital firms, it's time to prepare your pitch. Tailor your pitch to suit the specific interests and expertise of ‌venture capitalists and clearly articulate your value proposition. Be ready to answer tough questions regarding risks, competition, and market challenges. Show them that you have thoroughly thought through potential obstacles and have a plan to overcome them.

Step 3: Create the best venture capital pitch deck 

Now you’ve refined your pitch, you’ll need to show it off with a slick pitch deck! This can increase your chances of starting a conversation with potential investors. Some key elements that should be included in your pitch deck are:

• Your business concept: This includes your mission and vision, the problem you are solving, and how your product or service can solve the problem.

• Market analysis: Provide details on the size of the market you are targeting and any relevant trends or competition.

• Product and unique selling proposition (USP): Explain what sets your product or service apart from competitors.

• Business model: Describe how your company plans to generate revenue. This could include subscription fees, advertising, or product sales.

• Financial projections: Give realistic financial projections for the next 3-5 years, including your startups’ burn rate, payback period, and P&L statements. Read our article for more key business metrics you should know about.

• Your team: Introduce key team members and their relevant experience in the industry.

Step 4: Understand due diligence and negotiate terms

When a venture capital company expresses interest in investing in your startup, they will conduct due diligence to assess the potential risks and opportunities associated with your company. Once the due diligence process is complete, the venture capital firm will present you with a term sheet outlining their proposed investment terms. It's important to carefully review this document with your legal team to understand all the terms and negotiate if necessary. 

When engaging in negotiations with venture capital firms or trusts, startups should seek clarity on venture capital fees that might be incurred to set clear expectations and carefully consider how much equity you are willing to give up in exchange for the investment. 

Join our startup community

Understanding venture capital is crucial for startups looking to accelerate growth. VC firms not only offer the necessary financial support but also bring valuable expertise and industry connections. However, VCs are just one piece of the puzzle when it comes to startup growth.

Being a part of a startup community can also open many doors. Airwallex is fuelling the growth of startups in Australia through our free Airwallex for Startups program. The program offers exclusive benefits from Airwallex and our partners to help startups tap into incredible resources..

In addition to these perks, Airwallex for Startups also offers educational resources to equip startups with the financial knowledge they need to succeed, and regularly hosts community events that connect founders with like-minded entrepreneurs and venture capitalists. 

Frequently asked questions

1. What are the main differences between venture capital and private equity?

Venture capital (VC) and private equity (PE) are both forms of investment that involve buying shares in companies. However, they differ in the types and sizes of companies they invest in and their investment strategies. VC firms typically focus on early-stage startups with high growth potential. Their primary goal is to provide these emerging businesses with the capital they need to expand quickly and establish their market presence. Conversely, PE firms often invest in more mature, established companies. They often acquire a significant stake, aiming for strategic redirection or financial restructuring.

2. How can startups prepare for venture capital due diligence?

Startups can prepare for venture capital due diligence by ensuring that their financial records are well-organised and up-to-date. This includes having a complete set of financial statements, tax returns, and forecasts readily available. Airwallex simplifies this process by streamlining the entire financial management process, from invoicing and global payments to account reconciliation, enabling startups to produce precise, timely reports with ease.

It's also crucial to maintain thorough documentation of all legal agreements. You should ensure their business model and growth strategy are clearly articulated, reinforced with concrete data such as customer acquisition metrics, revenue projections, and market analysis.

3. What are the typical returns that venture capitalists expect from their investments?

On average, VC firms aim for a return of at least 25% to 35% per year on their investment portfolios. However, individual investments have the potential to yield much higher returns, sometimes exceeding 10 times the original stake.³ This is because venture capitalists often invest in companies with the potential for exponential growth, hoping that one or two successful exits can compensate for other investments that may not perform as well.

4. How do corporate venture capital funds differ from traditional venture capital?

Corporate Venture Capital (CVC) refers to a subsidiary venture capital arm within a large corporation that invests in startups. Unlike traditional venture capital firms, which are primarily focused on financial returns, CVCs pursue strategic benefits aligned with the parent company's operational goals alongside financial gains. These strategic objectives might include gaining access to disruptive technologies, fostering innovation within the corporation, or exploring potential merger and acquisition targets. 

5. What alternatives are available for startups that do not qualify for venture capital?

Besides venture capital, startups have several alternative funding options to explore. Bootstrapping involves self-funding the business with personal savings or revenue generated from initial sales. Crowdfunding allows startups to raise capital from a large number of individuals through online platforms such as Kickstarter or Indiegogo. Angel investors are high-net-worth individuals who invest in early-stage companies in exchange for equity ownership. Bank loans provide access to debt financing but require collateral and usually have high interest rates.

6. What are the common exit strategies for venture capitalists in startups?

One prevalent exit strategy is through an Initial Public Offering (IPO), where the startup's shares are offered to the public, thereby allowing investors to sell their equity. A trade sale, or acquisition, is another popular exit strategy, where the startup is sold to another company, often a competitor or a company seeking to expand its market reach or capabilities. Also, secondary sales allow venture capitalists to sell their shares to other investors in the private market. Lastly, a buyback option involves the startup's founders repurchasing the shares from the venture capitalists, providing an exit while returning ownership to the original entrepreneurs.

Sources

1. https://fundcomb.com/blog/a-list-of-australian-vcs

2. https://www.statista.com/topics/4729/start-ups-in-australia

3. https://hbr.org/1998/11/how-venture-capital-works

Disclaimer: This information doesn’t take into account your objectives, financial situation, or needs. If you are a customer of Airwallex Pty Ltd (AFSL No. 487221) read the Product Disclosure Statement (PDS) for the Direct Services available here.