Print this articleIf you are an entrepreneur and have a company that has gone as far as it can go maxing your credit cards and begging/borrowing from friends & family, you will probably need to go find new investors. If your company is fast growing and is doing well except for the fact that it is starved for more money, maybe a lot more money in order to meet its potential, then you will need to enter into the realm of venture capital. The good news is that vast amounts of money can be found in this world. The bad news is that you have to deal with venture capitalists who often have very long, confusing and painful decision-making procedures. This blog is going inside the mind of a venture capitalist and let you know what they are thinking and what they are looking for. Learn the following 6 key steps and VCs will be showing you the money!
Step 1: Making Introductions: The Business Plan
All right so you have a company or you have a good idea for a company, what's your first step? Put in the seat time and take what is in your head and your collective managements' head and put it down on paper in a clear power point presentation. If you are like everyone else, this will take many drafts to organize and edit down to the core elements of your business plan. Essential in this process will be to have your Chief Financial Officer if you have one, or your accounting firm spell out the past (if you have them) and future financial performance for your company. Most entrepreneurs are optimists and most venture capitalists like to talk to optimists, but if your optimistic story is not backed up with solid, rationale financial assumptions about your target market/customer etc... you won't get the money.
Okay you have a good power point presentation -- who do you show it to? If you or any of your team knows a venture capitalist then its an easy call. That's not often the case however. Next ask your accounting firm or legal firm if they have any connections. Often they do, but I have to tell you these respective firms are the worst at connecting the dots. Don't expect just because they are helping you with your plan or with your company they will volunteer this kind of help. You will need to spell it out to them. If this is a blind alley, find out if there are any small, "boutique" investment banks in your community. Not to be confused with a commercial banker (the guys that say no for a living), investment bankers for a fee will take on almost any assignment. Generally if they have been in business for awhile and have demonstrated experience raising money for companies, they will be able to help you. Make sure you negotiate the fee with them, picture yourself at a souk in Morocco and give them a spirited counter offer.
Lastly, you can cold call VCs. I always appreciated the guts it takes to do this, and if you are prepared with a good plan, this will make a good impression.
Step 2: Management Meeting or Management Call
Getting to this step means the work you did on your power point presentation passed muster with somebody. Now the VC will want to either in person or over the phone hear the story and have the opportunity to ask questions. This is the chance for you and your team to show off your understanding of your customer, market, competition, industry trends etc.... Most likely this will be a phone call that lasts an hour or two. If you have a VC partner on the call, it is a good sign of early interest. Make sure you ask them about their process for making decisions and about what would be the next step and the timing on getting back to you. A general complaint from entrepreneurs is that the whole process takes too long and you have no idea how decisions were made.
Step 3: Site Visit
As mentioned above, this may happen as part of Step 2, but more likely an in-person visit occurs after a conference call has gone well. A site visit will be more of the same kind of questions and subject matter you had on the call, except now the VC will have done more work and be more precise with questions. This will also include the assumptions you have made on your financial statements. The other point of a site visit is to get a better sense of the management of the company. Who is strong and who is weak? What holes are there in the management team that need to be filled? Do we want to work with these people? Do we like them? Will they take suggestions/criticisms well? What motivates them? Will they be rationale to negotiate terms of a deal with? These are the very same questions you should be asking about them. This is a form of marriage and you should have a sense of liking these people and not just for their money! I think it is a good idea to schedule part of a site visit around a meal. This forces the situation to be less formal and allows you to talk about other topics and get a window into personalities. The more information the better to decide if the partnership makes sense.
Step 4: Due Diligence
This is the stage where things can get quite murky. Information requests will be made and weeks will go by and you will have no idea what is going on. This will be very frustrating unless you take charge. My advice is that if the VC is interested in spending the time working through due diligence (i.e. calling customers, references, third party consultants regarding the industry or sector, building financial models, etc...) you have the ability to help shape the process. My advice would be to have them break up this step. For now focus everyone's attention on doing financial due diligence with the goal of getting everyone focused on having a discussion on valuation of the company. Why waste weeks of time and have you and your business/customers hassled if at the end of the day the VC is going to offer you a very low valuation for making an investment in your company that you won't accept? Better find that out as quickly as you can, so you can move on to the next funding candidate. Besides, if you can agree on a valuation at this step, the rest of the steps should be much less stressful.
Step 5: Valuation and Terms
So now you have complied with every request and helped them come up with a financial model. This will lead to a series of discussions regarding valuation. In other words, how much money they will invest, how much of the company they will own and how much of the company you and your management team and previous investors (remember those friends and family that helped you get started?) will keep. It's important to remember that while a valuation is rooted in an empirical exercise, there are many subjective elements that go into this too. The VC will factor in a perceived risk premium that could include concerns about the completeness of the management team, competitors, technology risk, capital needs, and international threats. These concerns will manifest in both a overall value for the company, but also nonfinancial terms that will impact you. For example, how many board seats the VC will insist on or what decisions will require board approval. Often the terms will focus on what happens if the company does not perform well and needs more money. At this stage it makes sense to "lawyer up" and have them carefully review and explain to you the implications of each and every term. These negotiations will ultimately be a balancing act between what percentage of the company are you willing to share vs. what risk terms are you willing to abide by going forward.
Stage 6: Final Due Diligence & Closing
Congratulations, this was not an easy process to get through. Now the customer calls and third party consultants may get involved. Here, I think you should also be finishing up your due diligence on the VC. Have them give you a reference list of all entrepreneurs they have backed and call some of them to get a sense of what the VC is like once the courting phase is over and the money is in the company. How do they help you make your business better? How do they act at board meetings? Will they be supportive when something goes wrong? The better sense you have going in, the fewer surprises you will have. And as a general rule, surprises are a bad thing in business.
Step 1: Making Introductions: The Business Plan
All right so you have a company or you have a good idea for a company, what's your first step? Put in the seat time and take what is in your head and your collective managements' head and put it down on paper in a clear power point presentation. If you are like everyone else, this will take many drafts to organize and edit down to the core elements of your business plan. Essential in this process will be to have your Chief Financial Officer if you have one, or your accounting firm spell out the past (if you have them) and future financial performance for your company. Most entrepreneurs are optimists and most venture capitalists like to talk to optimists, but if your optimistic story is not backed up with solid, rationale financial assumptions about your target market/customer etc... you won't get the money.
Okay you have a good power point presentation -- who do you show it to? If you or any of your team knows a venture capitalist then its an easy call. That's not often the case however. Next ask your accounting firm or legal firm if they have any connections. Often they do, but I have to tell you these respective firms are the worst at connecting the dots. Don't expect just because they are helping you with your plan or with your company they will volunteer this kind of help. You will need to spell it out to them. If this is a blind alley, find out if there are any small, "boutique" investment banks in your community. Not to be confused with a commercial banker (the guys that say no for a living), investment bankers for a fee will take on almost any assignment. Generally if they have been in business for awhile and have demonstrated experience raising money for companies, they will be able to help you. Make sure you negotiate the fee with them, picture yourself at a souk in Morocco and give them a spirited counter offer.
Lastly, you can cold call VCs. I always appreciated the guts it takes to do this, and if you are prepared with a good plan, this will make a good impression.
Step 2: Management Meeting or Management Call
Getting to this step means the work you did on your power point presentation passed muster with somebody. Now the VC will want to either in person or over the phone hear the story and have the opportunity to ask questions. This is the chance for you and your team to show off your understanding of your customer, market, competition, industry trends etc.... Most likely this will be a phone call that lasts an hour or two. If you have a VC partner on the call, it is a good sign of early interest. Make sure you ask them about their process for making decisions and about what would be the next step and the timing on getting back to you. A general complaint from entrepreneurs is that the whole process takes too long and you have no idea how decisions were made.
Step 3: Site Visit
As mentioned above, this may happen as part of Step 2, but more likely an in-person visit occurs after a conference call has gone well. A site visit will be more of the same kind of questions and subject matter you had on the call, except now the VC will have done more work and be more precise with questions. This will also include the assumptions you have made on your financial statements. The other point of a site visit is to get a better sense of the management of the company. Who is strong and who is weak? What holes are there in the management team that need to be filled? Do we want to work with these people? Do we like them? Will they take suggestions/criticisms well? What motivates them? Will they be rationale to negotiate terms of a deal with? These are the very same questions you should be asking about them. This is a form of marriage and you should have a sense of liking these people and not just for their money! I think it is a good idea to schedule part of a site visit around a meal. This forces the situation to be less formal and allows you to talk about other topics and get a window into personalities. The more information the better to decide if the partnership makes sense.
Step 4: Due Diligence
This is the stage where things can get quite murky. Information requests will be made and weeks will go by and you will have no idea what is going on. This will be very frustrating unless you take charge. My advice is that if the VC is interested in spending the time working through due diligence (i.e. calling customers, references, third party consultants regarding the industry or sector, building financial models, etc...) you have the ability to help shape the process. My advice would be to have them break up this step. For now focus everyone's attention on doing financial due diligence with the goal of getting everyone focused on having a discussion on valuation of the company. Why waste weeks of time and have you and your business/customers hassled if at the end of the day the VC is going to offer you a very low valuation for making an investment in your company that you won't accept? Better find that out as quickly as you can, so you can move on to the next funding candidate. Besides, if you can agree on a valuation at this step, the rest of the steps should be much less stressful.
Step 5: Valuation and Terms
So now you have complied with every request and helped them come up with a financial model. This will lead to a series of discussions regarding valuation. In other words, how much money they will invest, how much of the company they will own and how much of the company you and your management team and previous investors (remember those friends and family that helped you get started?) will keep. It's important to remember that while a valuation is rooted in an empirical exercise, there are many subjective elements that go into this too. The VC will factor in a perceived risk premium that could include concerns about the completeness of the management team, competitors, technology risk, capital needs, and international threats. These concerns will manifest in both a overall value for the company, but also nonfinancial terms that will impact you. For example, how many board seats the VC will insist on or what decisions will require board approval. Often the terms will focus on what happens if the company does not perform well and needs more money. At this stage it makes sense to "lawyer up" and have them carefully review and explain to you the implications of each and every term. These negotiations will ultimately be a balancing act between what percentage of the company are you willing to share vs. what risk terms are you willing to abide by going forward.
Stage 6: Final Due Diligence & Closing
Congratulations, this was not an easy process to get through. Now the customer calls and third party consultants may get involved. Here, I think you should also be finishing up your due diligence on the VC. Have them give you a reference list of all entrepreneurs they have backed and call some of them to get a sense of what the VC is like once the courting phase is over and the money is in the company. How do they help you make your business better? How do they act at board meetings? Will they be supportive when something goes wrong? The better sense you have going in, the fewer surprises you will have. And as a general rule, surprises are a bad thing in business.
For many entrepreneurs who have started a company the prospect of having to go out and raise outside equity capital seems daunting. In my experience, this is true no matter if the company has $1 million in revenue or $100 million in revenue. Entrepreneurs are passionate about their business and the good ones can tell you everything about the company, sector, micro/macro trends in their industry etc... but when it comes to capital raising, it is often a blind spot. Given that investing equity in companies is something I've been doing for quite awhile, I thought it might be useful to set up this site and answer any questions about the process, give some insights into how venture capitalists and other private equity investors think and how you can make this process less painful. Recently, I was interviewed at http://www.seomoz.org/articles/pharos-vc-interview.php about the world of venture capital. Take a look and let me know what questions or comments you may have.