Venture capital is money provided by an outside investor to finance a new, growing, or troubled business. The venture capitalist provides the funding knowing that there’s a significant risk associated with the company’s future profits and cash flow. Capital is invested in exchange for an equity stake in the business rather than given as a loan, and the investor hopes the investment will yield a better-than-average return.

Venture capital is an important source of funding for start-up and other companies that have a limited operating history and don’t have access to capital markets. A venture capital firm (VC) typically looks for new and small businesses with a perceived long-term growth potential that will result in a large payout for investors.

Venture capitalists look for businesses that have the potential to grow quickly to a significant size, yielding a significant return on the VC’s investment in a relatively short period of time. VCs are not just interested in start-ups. Your company’s current size is less important than its future aspirations and growth potential. A target company for a VC is one that may be capable of becoming a large market leader in its industry due to some new industry opportunity and competitive advantage. There’s no single determinant for a successful portfolio company, but a VC tends to focus on the following factors:

The first professional investor to a deal at the start-up stage is referred to as the Series A investor. This investment is followed by middle and later stage funding – the Series B, C, and D rounds. The final rounds include mezzanine, late stage and pre-IPO funding. A VC may specialize in provide just one of these series of funding, or may offer funding for all stages of the business life cycle.

There are some excellent alternatives to venture capital that you should also explore in your search for funding sources. One such alternative is an angel investor – a term for an investor that takes you under its wing and lifts you up to the next level of growth. Angel investors typically do not have deep pockets so the average investment tends to be smaller than that of a VC, typically hundreds of thousands of dollars rather than millions. For that amount of capital, proceed with caution if you’re considering giving up some control over your company.

The exit strategy is the VC’s way of cashing out on its investment in a portfolio company. A VC often hopes to sell its equity (stock, warrants, options, convertibles, etc.) in a portfolio company in three to seven years, ideally through an initial public offering (IPO) of the company. The company becomes liquid through the sale of its stock to the public and the VC sells its stock to reap its return.

The first step in approaching a VC is to submit a business plan. Once the VC has received your plan, it will discuss your opportunity internally and decide whether or not to proceed. This part of the process can take up to three weeks, depending on the number of business plans under review at any given time.

A term sheet is a document that sets out the basic terms and conditions under which the VC will invest in your company. Work completed in the due diligence phase of the funding process is used to draft this document. The term sheet is generally non-binding and is used as a template, along with further due diligence, to draw up more detailed legal documents.

You might be thinking of asking a VC to sign a non-disclosure agreement (NDA) before you tell the VC your brilliant business idea or present your innovative technology. However, it’s not advisable to ask a VC for a NDA, and may even risk stopping your potential VC deal in its tracks.

Venture capitalists may review hundreds or thousands of business plans in any given year. Even if you think your ideas are proprietary, they may be just similar enough to another entrepreneur’s that the VC takes on the added risk of legal action against it just by signing your NDA. Also, for the VC, accepting NDAs adds the administrative burden of having to keep track of which NDA covers what entrepreneur’s ideas.