Understanding venture capital basics for Hong Kong founders

What is venture capital? 

Venture capital is a financing mechanism wherein investors, known as venture capitalists, provide funding to startups and small businesses that demonstrate long-term growth potential. Unlike traditional financing, VC involves equity investment, meaning venture capitalists acquire a stake in the company in exchange for their capital. This form of funding is essential for startups that can't access capital markets and require substantial resources to scale operations.¹

Venture capital firms, which manage these funds, are pivotal in this ecosystem. They aggregate capital from a variety of investors, including institutional investors, high-net-worth individuals, and family offices, to invest in promising startups. The primary objective of a VC firm is to realise substantial returns on investment by transforming these startups into successful, scalable companies.

Understanding venture capital structure

The structure of venture capital is intricate, involving multiple stakeholders and layers. At the heart of this structure are venture capital firms, responsible for raising capital, identifying investment opportunities, and managing investment portfolios. These firms typically operate as limited partnerships, with general partners (GPs) managing the fund and making investment decisions, and limited partners (LPs) supplying the capital.²

Venture capital funds are structured with a finite lifespan, usually around 10 years. During this period, the fund progresses through several phases, including fundraising, investing, and exiting. The GPs are tasked with deploying capital into promising startups, supporting them through growth phases, and eventually exiting the investment through mechanisms such as an IPO or acquisition.

Investment decision process

The investment decision process in venture capital is rigorous and multifaceted. It begins with deal sourcing, where VC firms identify potential investment opportunities through networks, industry events, and direct applications from startups. Once a potential investment is identified, due diligence is conducted. This involves a comprehensive evaluation of the startup's business model, market potential, financial health, and the founding team's capabilities.³

Deal sourcing and evaluation

Deal sourcing is the lifeblood of venture capital firms. It involves identifying and evaluating potential investment opportunities. This can be achieved through various channels, including networking events, industry conferences, and referrals from other investors or entrepreneurs. Many VC firms also have dedicated teams or use technology platforms to scout for promising startups.

Once a potential deal is identified, the firm conducts a preliminary evaluation to determine if the startup aligns with the fund's investment thesis. This initial screening involves assessing the market opportunity, the uniqueness of the product or service, the competitive landscape, and the capabilities of the founding team.³

Due diligence

If the startup passes the initial evaluation, the VC firm undertakes a thorough due diligence process. This involves a deep dive into the company's business model, financials, market position, and growth potential. The firm analyses the startup's financial statements, customer contracts, and legal documents. It also assesses the management team's track record, leadership skills, and ability to execute the business plan.

Due diligence is critical because it helps the VC firm understand the risks and opportunities associated with the investment. It also provides insights into the startup's valuation and the terms of the investment.³

Negotiation and execution

Once the due diligence is complete, the VC firm enters into negotiations with the startup. This involves discussing the terms of the investment, including the amount of capital to be invested, the valuation of the company, and the equity stake to be acquired. Other terms, such as board representation, voting rights, and exit strategies, are also negotiated.

After reaching an agreement, the investment is executed. The VC firm provides the capital to the startup in exchange for equity. This marks the beginning of the partnership between the venture capitalists and the entrepreneurs.

Understanding venture capital funding stages

Venture capital funding is typically divided into several stages, each aligned with a different phase of a startup’s lifecycle. If you’re planning to raise VC funding, it’s important to understand these stages, as each carries different expectations and implications for your business.

Seed funding

Seed funding represents the earliest stage of venture capital investment, designed to help startups develop their product, conduct market research, and establish a viable business model. At this stage, investment amounts are relatively small, and the risk is high, as the startup is still in its infancy. Seed funding is often used to cover initial operational costs and to validate the business concept.²

Seed investors often include angel investors, seed-stage venture capital firms, and sometimes friends and family. The primary goal of seed funding is to help the startup reach the next stage of development, where it can attract larger investments.

Early funding

Early-stage funding, often referred to as Series A and B rounds, occurs once the startup has a working product and some market traction. This stage involves larger investments to scale the business, expand the team, and increase market reach. The focus is on building a sustainable business model and achieving significant growth. Venture capitalists at this stage look for startups with a clear path to profitability and a strong competitive advantage.²

In a Series A round, the startup typically raises enough capital to optimise its product, expand its customer base, and refine its business model. Series B funding is used to scale the business further, enhance operational capabilities, and prepare for larger market entry.

Late-stage funding

Late-stage funding, which includes Series C and beyond, targets companies that have achieved substantial growth and are nearing profitability. The investment at this stage is used to further scale operations, enter new markets, and prepare for an exit event, such as an IPO or acquisition. Late-stage funding involves larger amounts of capital and is typically less risky, as the company has already demonstrated its ability to succeed.²

Late-stage investors look for companies with a proven business model, strong revenue growth, and the potential for a successful exit. The funds raised are often used to expand into new geographical regions, develop new products, or acquire other companies.

Advantages and disadvantages of venture capital

Advantages

Venture capital provides startups with substantial funding, along with expertise, mentorship, and industry connections to drive growth and innovation. If you're looking to raise VC funding, these are the benefits you'll get from venture capital.

• Access to Capital: Venture capital provides startups with significant financial resources that may not be available through traditional financing methods. This capital can be used to develop products, expand operations, and enter new markets.
• Expertise and Mentorship: Venture capitalists often have extensive experience in building and scaling companies. They can provide valuable guidance, mentorship, and industry connections that can help startups succeed.
• Network and Resources: VC firms have extensive networks of industry contacts, including potential customers, partners, and other investors. These connections can be leveraged to help startups grow and succeed.
• Credibility and Validation: Securing venture capital funding can enhance a startup's credibility and provide validation to other investors, customers, and partners. It signals that experienced investors believe in the company's potential.

Disadvantages

As mentioned above, venture capital provides more than just funding to help you scale your startup. However, it also comes with certain expectations, particularly around ownership, which may pose disadvantages for your business.

• Equity Dilution: Venture capital funding typically involves giving up a significant portion of equity, which can dilute the founder's ownership and control over the company
• Pressure for Rapid Growth: A venture capitalist may expect high returns on their investments, which can create pressure for startups to achieve rapid growth and profitability. This pressure can lead to strategic decisions that may not align with the company's long-term vision
• Loss of Control: With venture capital funding, entrepreneurs may have to cede some control to investors, who may require board seats or influence over key decisions
• Exit Expectations: Venture capitalists typically expect a return on their investment within a specific timeframe, often through an IPO or acquisition. This can create pressure for startups to pursue exit strategies that may not align with their long-term goals

Venture capital success stories

Raising VC funds may come with risks, but there are several success stories on how venture capital has fueled the rise of technology startups and giants like Airbnb, Uber, and WhatsApp, enabling them to scale quickly, innovate, and disrupt industries, ultimately reaching multi-billion-dollar valuations.

Global success stories

1. Airbnb

Founded in 2008, Airbnb revolutionised the hospitality industry by allowing people to rent out their homes to travellers. With the support of venture capital, Airbnb expanded globally, developed a robust platform, and became a household name. The company went public in 2020 and is valued at over USD$ 100 billion.⁵

2. Uber

Uber disrupted the traditional taxi industry with its ride-sharing platform. From its early days as a startup, Uber raised several rounds of venture capital funding, which enabled it to expand rapidly into new markets and develop new services. Uber went public in 2019, with a valuation of over USD$ 82 billion.⁵

3. WhatsApp

WhatsApp, a messaging app founded in 2009, quickly gained popularity worldwide. With the help of venture capital, WhatsApp scaled its platform and user base. In 2014, Facebook acquired WhatsApp for USD$ 19 billion, making it one of the largest tech acquisitions in history⁶.

Regional success stories

In Hong Kong, venture capital has fueled the growth of startups like Klook and WeLab, helping them expand and strengthen their presence in Asia’s competitive market.⁷

1. Klook

Klook is a travel activities and services booking platform that has raised significant venture capital funding to expand its offerings and reach. The company has grown rapidly, becoming one of the leading travel platforms in Asia⁷.

2. WeLab

WeLab is a fintech company that provides online lending services. With the support of venture capital, WeLab has expanded its operations across Asia and introduced innovative financial products 7.

Alternatives to VC funding

While venture capital is a popular funding option, you may choose to avoid it due to its risks. Fortunately, it’s not the only source of funding available to startups. There are several alternatives you can explore, each with its own advantages and drawbacks⁸.

Angel investment

Angel investors are high-net-worth individuals who provide capital in exchange for equity. They often invest at an earlier stage than venture capitalists and can offer valuable mentorship and guidance. Angel investors are typically more flexible than VC firms and may be more willing to take risks on unproven startups.

Crowdfunding

Crowdfunding allows startups to raise small amounts of capital from a large number of people, typically through online platforms. This method can be an effective way to validate a product idea and build a community of early adopters. Popular crowdfunding platforms include Kickstarter and Indiegogo⁸.

Debt financing

Debt financing involves borrowing money that must be repaid over time, usually with interest. This option does not require giving up equity, but it does involve repayment obligations. Options for debt financing include bank loans, lines of credit, and convertible notes 8.

Government grants and subsidies

Many governments offer grants and subsidies to support innovation and entrepreneurship. These funds do not require repayment or equity, but they may have specific eligibility criteria and application processes.

For example, in Hong Kong, the Hong Kong Science and Technology Parks Corporation (HKSTP) provides several funding and incubation programmes that allow startup companies to receive funding ranging from HK$10,000 to HK$21.5 million, depending on the objectives⁹.

Bootstrapping

Bootstrapping involves self-funding a startup using personal savings, revenue generated from the business, or support from friends and family. This approach allows entrepreneurs to retain full control over their company but may limit the speed and scale of growth 8.

Manage your VC funding effectively with Aspire's business account

Raising VC funds is a crucial step to scale your startup. However, based on our experience, many startups struggle to manage these funds effectively, leading to cash flow issues and, in some cases, business failure. These challenges often stem from hidden financial leakages that may seem small but have a significant impact, such as limited visibility over expenses, delayed receivables, and high international payment costs.

This is where Aspire’s Business Account helps you take control of your finances. With Aspire, you can:

• Send and collect payments directly in USD, GBP, EUR, and HKD with multi-currency accounts
• Send and receive money in over 30 currencies with competitive FX rates
• Track and monitor expenses in real time with a centralised dashboard, ensuring actual costs stay within budget
• Earn 1% cashback on SaaS and digital marketing subscriptions with corporate cards

Whether you’re starting out or scaling your business in Hong Kong, Aspire gives you the visibility, efficiency, and confidence to manage your finances and focus on growth.