Basis for Venture Capital Decisions
Venture capitalists may look at anywhere from 1,000 to 5,000 business plans per year. Out of that approximately two percent will ever get an interview. At most, a venture capitalist will spend five to fifteen minutes making a decision on whether to interview based on the documents presented, so the documentation needs to get the business idea across clearly, concisely, and thoroughly in a brief reading.
In venture capital, the standard mantra is that the most important factors are management, management, management. And what are venture firms looking for in management? Some commonly mentioned factors are expertise, experience, leadership, vision, integrity, openness and dedication.
Anyone seeking venture capital should be prepared to supply the names of a reputable group of three to four experienced people who will be an integral part of the business. Conventional wisdom points to three critical positions: a CEO or general business manager, a VP of marketing and sales, and a VP of development. However, extensive past experience is not as important as their ability to show excellence and good teamwork.
What do you do if you don’t have those skills in your management team? Hire them. Don’t be afraid to hire people who are better than you are. Constant striving to compensate for your weaknesses with better and better hires makes your company only stronger – and is impressive to investors.
In an interview with venture investors, management needs to use those first few minutes filled with small talk well. These minutes may be a critical factor in the outcome. Unlike banks, venture capitalists will be working closely with management. They are looking for a chemistry that fits with them. There is a strong human factor. While the financials, marketing and other factors need to be in order, there has to be intellectual stimulation. The venture capitalists and management need to like each other if they are going to be spending the next few years working together for the success of this venture.
After management, there are a variety of ways that venture firms assess entrepreneurial ventures. Some factors commonly cited are size of the market, product qualities (uniqueness, brand strength, patent protection), rate of market growth, competition, barriers to entry, stage of development of the company, and the industry the company is in.
Venture capital firms will judge you by how prepared you are. Critical documents are:
- Business Summary
A brief statement covering the main points that includes a discussion of management, profits, strategic position, and exit plan
- Business Plan
A detailed document that outlines what you are going to do and how you are going to do it, including a clear and simple discussion of the idea; the management team – including full resumes; business strategy; marketing plan – including sales projections, distribution, market, and competition; financials; and a competitive analysis.
The business plan should answer:
- What is the growth potential of this company or project?
- What does the company do?
- How does the company operate?
- What are the projected revenue and profit margins?
- How is the capital going to be used?
- What type of exit strategy is foreseen?
- Due Diligence
A study of the background and financial reliability of the company, management team and industry.
- Marketing Material
Any document that directly or indirectly relates to the sales of your product or service.
In an interview, venture capitalists may ask such questions as what type of business experience the management team has and how does R&D impact future sales. Give time to think through how you would respond to variety of tough questions. Also, be certain you understand and use venture capital terminology correctly. Consult a Venture Capital Glossaryand make venture capital terms an integral part of your working vocabulary.
Venture Capital Firm Requirements
Most venture firms have a position on the board of the venture and expect to be intimately involved with the company after they invest. If they are used effectively, they can be an vital part of the decision making process. They bring a broad perspective of experience based on their work with multiple other corporate situations in the same industry. This experience can be invaluable in identifying patterns within the firm and the industry which may be invisible to the startup.
Venture capitalists have been labeled “vulture” capitalists by some individuals who misunderstand their function. One of the greatest fears entrepreneurs have is loss of control of their company. Rumors abound that venture firms require as much as 80% ownership to invest. Although no hard data is available, 30- 40% ownership seems to be the most common stake. Most venture firms, in fact, will say that what they are really seeking is a fair portion of the company in return for their risk capital, but control is not what they are seeking.
It is important to remember that the venture firms want the enterprise to succeed just as much as the entrepreneurs do. Certainly an important factor in determining their control will be the ratio of what funding is needed to the valuation of the company itself. Valuation of early stage companies is more of an art than a science, but it is critical to all the other financial factors in funding so it needs very careful analysis and documentation.