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Perspectives on Raising Venture Capital

Andrew J. Sherman, Partner, Dickstein Shapiro Morin and Oshinsky LLP

There is no doubt that it is a nearly impossible time for entrepreneurs to raise venture capital. Weak public capital markets have sidelined many venture capital fund managers, leading most of these investors to focus exclusively on follow-on financings to existing portfolio companies. Only the "best of the best" new companies are attracting such funding and usually with tougher terms and lower valuations than they would have seen a few years ago. The process is also likely to take a lot longer than ever before.

Accordingly, entrepreneurs need to prepare themselves when approaching venture capitalists. Always an important factor, preparation has become critical today. Increasingly, several "must have" factors have become an essential part of the necessary preparation. In short, an entrepreneur whose goal when approaching venture capitalists is to be funded must have:

A Dress Rehearsal . You need to rehearse your presentation many times, using a "moot court," with different audiences asking different questions and replicating the actual meeting you will have with the managers of the venture capital firm. Make sure your rehearsal audiences, such as lawyers, accountants, business school professors, and entrepreneurs who have raised venture capital, have the background and training to ask the right questions -- including the tough ones -- and are able to evaluate your responses critically. Do your homework on the venture capital firm and learn what the "hot buttons" may be so you can address key issues in your presentation. As the saying goes, "You never get a second chance to make a first impression." The rehearsals will help you survive the first meeting and get to the next steps. Be prepared for the tough questions and don't be scared, intimidated or upset when the really hard ones start flying at you. If the team at the venture capital firm doesn't ask tough questions, they are not "engaged" in your presentation. If they are not engaged enough to beat you up a little, then there will probably be no next steps and no deal.

A Mentor . It's always helpful to have a venture-capitalist coach who has either raised such funding or who has advised on or negotiated venture-capital transactions. The mentor or coach can help you stay focused on the issues that are important to the venture capitalist and not waste his or her time. The mentor can reassure you during the difficult and time-consuming process and teach you to remain patient, optimistic and level headed about the risks and challenges you face.

A Detailed Game Plan . Prepare a specific presentation that isn't too long or too short -- usually 15 minutes is about right. Don't attempt to "read" every word of your business plan or put every historical fact of your company on a Power Point slide. Keep it crisp and focused and be prepared for questions and to defend your strategic assumptions and financial forecasts. Remember that every minute counts. Even the small talk at the beginning of the meeting is important, because the seasoned venture capitalist is sizing you up, learning about your interests and looking for the chemistry and the glue that is key to a successful relationship.

Your Team Available to Meet the Venture Capitalist . Don't overlook the "personal" component of the evaluation. In many cases it can be the most important factor considered in the final decision. The four "Cs"-camaraderie, communication, commitment and control (over your ego)-may make or break the outcome of the meeting. Any experienced venture capitalist will tell you that, at the end of the day, the decision depends upon the strength of the people who will be there day to day to execute and manage the company. The venture capitalist will look for a management team that is educated, dedicated, and experienced, and, ideally, one that has experienced some success as a team prior to this venture. The team should also be balanced, with complementary skills and talents, so that all critical areas of business management are covered-from finance to marketing and sales to technical expertise.

Passion, Not Rose-Colored Glasses . Many entrepreneurs fail to make a good impression in their initial meeting with the venture capitalist because they come on too strong or not strong enough. The experienced venture capitalist wants to see that you have a passion and commitment to your company and to the execution of the business plan. However, the investor does not want to be oversold or have to deal with an entrepreneur who is so enamored of an idea or plan that he or she can't grasp its flaws or understand its risks.

A Way to Demonstrate Personal Commitment . All venture capitalists will look to measure your personal sense of commitment to the business and its future. Generally, venture capitalists won't invest if an entrepreneur's commitment is only part-time or his or her loyalty divided among other activities or ventures. In addition to fidelity to the venture, the investor will look for self-confidence, a high energy level, a commitment to achievement and leadership, and a creative approach to problem solving. You will also have to demonstrate your personal financial commitment by investing virtually all of your own resources into the project before you can ask others to part with their resources. Remember, any aspect of your personal life, whether good, bad or seemingly irrelevant, may be of interest to the venture capitalist in the interview and due diligence process. Don't get defensive or be surprised when the range of questions is as broad as it is deep-venture capitalists are merely trying to predict the future by learning as much as possible about your past and current situation.

An Open and Honest Exchange of Information . One sure deal killer for venture capitalists involves your trying to hide something from your past or downplaying a previous business failure. These seasoned investors can and will learn about any skeletons in your closet during the due diligence process and will walk away from the deal if they find something that should have been disclosed at the outset. A candid, straightforward channel of communication is critical. A previous business failure may be viewed as a sign of experience, provided you can demonstrate that you've learned from your mistakes and figured out ways to avoid them in the future. On a related note, you must demonstrate a certain degree of flexibility and versatility in your approach to implementing your business plan. Venture capitalists may have ideas about the strategic direction of the company and will want to see that you are open-minded and receptive to their suggestions. If you are too rigid or too stubborn, they may view this as a sign of immaturity or that you are a person with whom compromise will be difficult. Either can be a major "turn-off" and a good excuse for them to walk away.

A Big Market and a Big Upside . Make sure your business plan and your presentation adequately demonstrates the size of your potential market and the financial rewards and healthy margins that strong demand will bring to the bottom line. A venture capitalist that suspects your product or service has a narrow market, limited demand and thin margins will almost always walk away from the deal. If your target market is mature, with a number of already established competitors, the venture capitalist may feel the opportunity is limited and will not produce the financial returns that they expect. In short, these investors are looking for a company that has a sustainable competitive advantage, demonstrated by a balanced mix of products and services that meet a new market need on both a domestic and overseas basis. Remember that most venture capitalists want a return of 60% to 80% for seed and early-stage or post-launch deals and at least 25% to 35% on latter-stage and mezzanine-level investments. An entrepreneur's business plan and presentation must demonstrate that the venture capitalists' money will be better served in your company than in other investments.

An Understanding of What Really Motivates the Venture Capitalist's Decision . David Gladstone, a seasoned venture capitalist and author of the Venture Capital Handbook, writes: "I'll back you if you have a good idea that will make money for both of us." That one sentence captures the essence of the venture capitalist's decision-making process. You must have a good idea-one that is articulated in a business plan that expresses the risks and opportunities and how your management team will influence the odds of success and survival. Then, it must make money for both of you. The venture capitalist wants deals in which both the investor and the entrepreneur can enjoy the upside and the scale isn't weighted in favor of one over the other. Finally, the "I'll back you" component reminds you that in exchange for capital and wisdom, venture capitalists expect to have some control, with "checks and balances" built into the structure of the deal and the governance of the company and protection into the documents, to ensure that their investment and ability to participate in the growth and success of the company are protected.

An Exit Strategy . The saying, "Begin with the end in mind," clearly applies to venture capital deals. Investors aren't looking for a long-term marriage. Rather, they will be focused on how you intend to get their original investment and return on capital back to them within four to six years. Your business plan and oral presentation should include an analysis and an assessment of the likelihood of the three most common exit strategies, namely: an initial public offering (IPO), a sale of the company; and a redemption of the venture capitalist's shares by the company directly. Other exit strategies include restructuring the company, licensing the company's intellectual property, finding a replacement investor or even liquidating the company.

So there you have it: a list of the 10 "musts" that you, the entrepreneur, must have in order to prepare for your encounter with the venture capitalist investor, an encounter that could be a critical factor toward setting your company on the path of considerable growth. Study the "must have" list carefully. Then gather together all the musts to assure that you've prepared properly to achieve the goal of securing funding.

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