Commercial real estate investors can utilize venture capital funding to streamline high-risk, high-return ventures. To overcome their challenges, the venture capital funding process plays a significant role in the company’s success. Venture capital funding also termed “seed money” is usually used by CRE start-up firms to accelerate their business growth.
Before we dive into the types of Venture Capital funding and its processes, let us first understand what Venture Capital Funding actually means.
What is Venture Capital Funding (VCF)?
Venture Capital Funding is a pooled investment vehicle through which investors can invest in start-ups with strong growth potential. This type of investment involves higher risks, as well as high-return opportunities, and is typically open to accredited investors. Venture Capital Funding has similarities with mutual funds which means they do not make investments available to the public market.
Furthermore, a venture capitalist firm comprises limited partners, lawyers, accountants, and property managers who perform due diligence.
Moreover, real estate technologies like PropTech are also becoming more involved in this category rapidly. VCFs are a form of private equity that provides funds to startup businesses that have long-term growth potential such as real estate.
A venture capital investment earns returns for investors in various procedures. It invests in real estate, and also companies and monitors them until the portfolio company exits. This procedure takes place either through Initial public offerings IPOs, mergers, or acquisitions. The form of return comes as an IPO or rental income and is then distributed among the fund investors on a pro-rata basis.
In today’s era, Venture Capital Funding mainly focuses on an investment property that denotes investment in high-risk ventures.
Types of Venture Capital Funding
Various types of venture capital funding are available for all types of businesses. The funding types and the investors are classified based on different stages of business needs.
Depending on this basis they are classified into three categories: early-stage funding, expansion funding, and bridge funding or mezzanine funding. Moreover, investors who deal with early-stage funding are known as Series A investors. They are followed by Series B and Series C investors as they move up in higher rounds.
1. Early-stage funding
Early-stage funding is further subdivided into three categories. The earliest stage in funding is often known as “pre-seed funding”. It comes so early that it’s not counted in the venture capital funding rounds.
Generally, in this situation, the investors are less likely to make any investments. As the funders are usually the company founders, close friends, and family.
a. Seed Funding
Seed funding is officially the first equity funding stage in venture capital funding rounds. Every entrepreneur starts their business with an excellent idea but to execute that idea they need capital.
Hence, Seed funding allows businesses to raise that capital to nourish their idea into a business. It typically involves the very first money to raise a business venture.
Also, Seed funding helps a company to employ a founding team to execute and also assures financial help to conduct market research. It is not a form of a loan but rather an ownership share/profit share in the company in exchange for capital investment.
With seed funding, a company determines its final products and also its target demographic. This funding helps you to create sample products as well as covers the entire administrative set-up costs, and the mortgage payments.
To use seed funding for your business plan you must have a minimum viable product. Also, you should demonstrate that your product and idea will be successful.
b. Start-up Funding
After completion of the process in seed funding, investors move ahead toward start-up funding. It refers to the initial amount of money funded to the company to cover additional market research.
Furthermore, it involves recruitment procedure, developing the working prototype, and finalizing the product before introducing it to the market. Start-up funding also looks for the market size, product adoption rate, forecasted market growth rates, and customer relationships with the product.
As there is no growth during this stage the investors have to work hard to get this amount. Hence, if the company profits, investors make returns proportionate to the amount of equity in the start-up.
But, if the company makes a loss then the investors lose their invested money. Thus, it is crucial to make the exit options at the beginning of start-up funding. These exit options involve mergers and acquisitions, IPO, selling shares, etc.
c. First Stage Funding
Though termed first stage funding it usually comes after the seed and start-up funding. This funding is provided to those companies which show growth after two to three years. It’s also known as the “emerging stage” and the funding raised in this stage covers the company’s market launch, also to maximize productivity. Furthermore, it involves sales increase, advertising, and marketing activities.
To achieve all these the company requires a large amount of money. Hence, the amount of first-stage funding is larger than the prior stages. These investment opportunities help to increase the efficiency of the company, improve productivity, and also create brand awareness.
2. Expansion Funding
Expansion Funding is also termed Second Stage Funding, as the name suggests this funding involves the expansion of the company to a larger extent. It helps the company to grow to an extent to meet the customer’s demand.
This venture capital funding round is the fuel for enabling expansion to additional markets, along with increasing the marketing efforts. In this situation, the VC firms lend a huge amount of money in exchange for equity to enhance the production capacity.
One crucial factor to consider in this stage is to deal with the competitors. Creating new and diversified products, investing in new equipment, and enhancing marketability ensure staying at the top.
After remaining successfully for more than three years a company is eligible for expansion funding. Hence, this funding helps to increase the capacity of the business, ramps up the marketing strategy, and increases working capital.
3. Bridge Funding or Mezzanine Funding
Bridge Funding or Mezzanine Funding is the final stage of venture capital funding rounds. These fundings are the additional fundings that help a company to develop new products, along with the expansion of the business.
Furthermore, it helps to merge with other companies or acquire new companies. This bridge financing is a full-fledged transition for the business which involves financing the steps towards an initial public offering.
Bridge funding is a gap financing that acts as a temporary fix. It helps the business to cover their expenses until they get a longer-term financing solution. It’s an interim financing round that helps the company remain afloat until the next larger round.
Moreover, many companies utilize this funding stage to boost their valuation in anticipation of an IPO, buyouts, or recapitalizations. It also helps to acquire the asset of other underperforming companies, which can later be used as collateral for getting funds.
The major reason behind using bridge rounds is to get financial assistance during any short-term crisis. It also helps to accelerate the growth of the company and hit a certain milestone. For getting bridge funding proper due diligence is crucial to identify the purpose of financing.
How to invest in real estate through benture capital funding?
Venture capital firms usually look for a business that is systemized and also has a space for expansion. This criteria also adds value to the investment which is difficult to achieve in a traditional real estate portfolio. Thus, for financing real estate investment property REIT, real estate business syndications or crowdfunding are more popular options.
Real estate provides the largest asset classes in the world and makes up 13% of the U.S GDP providing boundless opportunities. Investments in this sector also provide successful exits. In July 2017 Redfin’s IPO raised 45% on its first day of trading in the public market. This success story has created long-term investors’ confidence and also enhanced the potential growth of the newer real estate tech.
The growth in this sector accelerates and the funding in this space is ample. Company profiles differ with each case study, risk levels, and maturity levels at each funding stage. With proper funding from investors, businesses can execute ideas properly and reach their dreams. With appropriate venture capital funding, the return can be 10 times its actual in four to seven years.
And if you are a real estate company then real estate venture capital can be a worthwhile option to gain immediate financing. Hence, do due diligence before each stage of investing and achieve fruitful revenue growth.