Acquiring Venture Capital: A Realist’s Survival Guide
So you’ve come to the conclusion that it’s time to raise venture capital for your business. My strongest suggestion, then, is that you take an extremely realistic look at what lies ahead and how you can best prepare yourself and your team for success.
I have prepared the following comments in the hope that you will find them to be exceptional guideposts along your journey – for a journey it is. While every funding pursuit has its own unique twists and turns, there are certain rules and philosophies that should be adhered to in every company’s quest for venture capital.
By way of qualification our company, VC Intermediary LLC (VCI), reviews some 2,500 executive summaries and business plans on an annual basis; of those, less than two percent pass muster. We turn away many good businesses because they do not possess the attributes sought by venture capitalists. The first question to address is a relatively simple one: Is my business “venture fundable?”
Let’s start with a description of the term “venture fundable.” What are VC’s looking for? The answer to that question comes in several flavors, depending upon what type of VC is right for your business. Those VC’s who like to roll up their sleeves and dive headlong into a business side by side with the founders may have different requirements as regards the strength of the current management team, for example. They may actually be encouraged that you need to fill several holes in your management team, for this is one of their primary functions. In contrast, later stage VC’s generally want to see a fully staffed management team with individuals aboard who’ve been there and done that. The key is to know your strengths and weaknesses intimately and use both to your eventual advantage.
Another important gauge of your probability of acceptance by the venture markets is the potential return on investment (ROI). Venture capital is the most expensive money in the world, so you’d better be prepared to face some pretty stiff dilution when acquiring a VC partner. VC’s aren’t looking for a return of two or three times their investment; they seek a return of five to ten times the invested amount, and more. Understanding that venture capital investing, in truth, is simply well-calculated gambling will give you a good glimpse into the mind of the venture capitalist. They know that not all investments will pan out – but they are willing to take the calculated risk that a few of their portfolio companies will be home runs which will offset the losses suffered from the others. Take a good, hard look at your company’s growth prospects over a four or five year period of time. If a venture capital company invests $5,000,000 into your firm in exchange for 50% of your company’s equity, will that VC reap $25,000,000 or more via a sale or IPO of the company down the road? If you can honestly answer “yes,” you may have a venture fundable company. If you have any doubts, you need to address this seriously and question whether or not venture capital investment is really the proper capitalization route for your firm. There are plenty of great, organically grown companies that are not well suited for the venture markets. Considering all of the above, don’t fool yourself by putting growth projections into play that can’t be substantiated; you’ll be wasting your time and the truth will surface rather quickly.
Now let’s address four areas of primary importance to the VC: Market Risk, Execution Risk, Technology Risk and Exit Strategy.
Market Risk can be defined rather simply; will the market you are addressing buy your product and/or service in volumes sufficient enough to cash flow the company and eventually provide extraordinary ROI? We have had clients whose previous companies have been funded by venture capitalists, and who have made outstanding returns for venture capitalists – but who still face, with their new venture, the same scrutiny under the VC microscope that first-timers also face. VC’s that get far enough into due diligence on your deal will call on experts and advisors within your particular market sector in order to determine if what you are intending to sell is needed and wanted in the market. Be prepared to offer to the VC a list of such industry experts that they can call upon for an unbiased opinion of your business strategies, products and services. They will have their own list to call, as well, but it is always best to be prepared to assist in every aspect of the due diligence process.
Execution Risk is defined as management’s ability to carry through on the proposed business growth, as set forth in your business plan. Do you have what it takes to make the business a success? If the answer is “probably,” then you need to remain open to management changes as proposed (and often mandated) by your new capital partner. Many very intelligent and capable men and women start off as the CEO of a startup only to find themselves in an advisory (or lesser) role down the road, if the VC determines that what is needed in that particular role is “more experience running large enterprises” or “more connectivity within this niche.” The greatest of plans are laid to waste due to egos run rampant and unchecked. Your goal is to move the business forward with the best team possible in order to create a greater likelihood of success for all concerned, so if you find yourself being asked to step into another role, stop and think about why this is being asked of you before reacting negatively to it. It may be the best move you’ve ever made.
Technology Risk is a concept that cannot be misunderstood: If the technology you have developed actually works beyond question and there is no chance that the technology will become obsolete in the near future, then there is no technology risk. However, most deals come with technology risk simply because the technology itself has not been proven to perform in the market it is intended for. For those technologies showing great promise, this is of little consequence; after all, VC’s are (calculated) gamblers and they are most often willing to work with an early stage firm to prove out the technology if they believe strongly enough in the work performed to date. This is especially true in the healthcare markets, where early stage medical device and therapeutics deals almost always include technologies and therapies not yet approved by the FDA and still requiring trial after trial after trial. All VC’s have unique levels of tolerance as regards technology risk – another good reason to know your audience.
Exit Strategy is what is all comes down to; after all, the VC is not investing in your business for a lifetime but, rather, for a period of time known in the industry as the “horizon.” A VC’s horizon may be two years, four years, five years, seven years or more; this often depends upon the age of the VC’s current fund. For example, if a VC launches a new $250 million fund in January 2007 and their typical horizon is five to seven years, they expect to liquidate their 2007 investments between 2012 and 2014. Therefore, investments made in 2009 out of this particular fund would have a three to five year exit horizon, and so on. I have counseled potential clients on this issue time and time again; typically, I will simply ask the entrepreneur where he expects the business to be in 5 years and what he plans to do with it. I get answers that range from, “I’d like to build all the value we can and then look to sell the company outright for a large profit” (correct answer) to, “At that time I will be ready to retire and I’d like to pass the business on to my sons” (wrong answer). When discussing the opportunity with a company, VC’s come prepared with many “loaded’ questions – the exit question is just one of many. Be prepared to answer VC questions and do so honestly and without hesitation.
This brings us to our next topic, How to Work with VC’s and What to Expect from Them. Not all VC’s are the same, as discussed above. They target differing sectors; they seek deals at different stages and their criteria are many and varied. That said, there are a few basic guidelines to share that will assist you when engaging a venture capitalist in discussion and due diligence.
The initial approach to VC’s and the resultant presentation of materials are the keys to actually attracting an appropriate and synergistic capital partner. It’s not all about the money, because you need to consider your capital partner a “true partner” in every sense of that phrase. If you wouldn’t have them in your home for Thanksgiving dinner, don’t accept their money. It’s that simple.
VC’s like to review deals that are brought to them by known (“warm”) sources; attorneys, accountants, current and former portfolio companies and various financial intermediaries. Once a deal is submitted and initial interest is elicited, the next step is usually a call between the VC and the introducing party (either you or your intermediary) to ensure that the VC understands the deal’s makeup; management, intellectual property, competition, barriers to entry, product and service explanations and the proposed amount to be invested along with a justification for that particular amount of capital. If the VC likes what he or she hears, the next step is usually a request for additional documentation. After reading that documentation and obtaining the answers to the initial questions relative to the data presented, the VC will either take a pass on the deal or agree to present the deal in the firm’s next management meeting. This is often referred to as a “partner’s meeting” and every VC has one at least once a week, usually on Mondays. This meeting is the first hardcore test of the deal’s viability as concerns this particular VC. If your deal passes muster in the partner’s meeting you can expect the VC to request a conference call to include your team and those individuals at the VC firm who would potentially carry the workload in due diligence on your deal. Most entrepreneurs do not understand that simply getting a deal into a partner’s meeting review is a major accomplishment; getting a positive review coupled with the VC’s desire to learn more is extremely rare and getting through due diligence and out of closing with a check in hand is almost akin to a miracle. It takes time, and it takes an enormous amount of effort, because VC’s have thousands of deals to choose from at any given moment in time. Prepare yourself for rejection after rejection after rejection; this does not mean that your deal won’t get funded; it simply means that your deal was not right for that particular VC at that particular moment in time. Getting funded takes a mixture of good timing, proper representation, an outstanding, unique and disruptive offering – and the patience of a saint.
Be prepared. Don’t leave any stones unturned. Be willing to learn from the VC and accept possible changes to your plan. If they are trying to describe for you a different view into your firm’s growth strategies they are probably interested in assisting you in implementing those changes – so be flexible at all times and open to positive changes. As an example, if you are convinced that operating your own manufacturing facility is the way to go, but the VC is convinced that outsourcing the manufacturing would be a smarter strategy, give that person his or her time at the podium to espouse their views and you may be surprised at the outcome. Be forthcoming at all times; know your own business, the market it resides in and the competition you face.
What about timeframes to funding? Entrepreneurs often come to me with what they truly believe is the greatest deal in the world. I enjoy this enthusiasm and I believe that every true entrepreneur exudes it – but this enthusiasm must also be tempered with realism. Many times I have had companies approach VCI looking for assistance in acquiring the proper capital partner only to hear, “And we need the funding within sixty days, at the outside.” Enthusiastic, yes; realistic – no, not usually. While the time it takes to go from the initial introduction to the closing table can vary widely, a good rule of thumb is six months to one year to acquire the proper capital partner. We work with one German venture capital group that averages nine to twelve months on every deal; conversely, we work with an information technology VC in New York City that can get a deal done in only sixty to ninety days. The quickest deal we’ve ever done took 78 days from introduction to closing. Remember, these timeframes refer to that period of time from the initial introduction to closing – but it may take you a year just to find the proper VC to begin the process. Many of our clients have their data reviewed by 100 to 200 VC’s before the proper capital partner is found; this is the norm, not the exception.
As mentioned above, be prepared. In the venture markets, you will never get a second chance to make a great first impression. Prepare an executive summary, business plan, historical financials if applicable, a five year pro forma financial breakdown and a PowerPoint presentation for conference calls and in-person pitch meetings. If you have a business plan in place today, it is most likely not in a form that would be acceptable to VC’s. We recommend to all of our clients that they produce their business plan using professional business planning software, such as BizPlanBuilder from JIAN. BizPlanBuilder is cost effective - $99 – and those who have used it have raised more than $1billion in venture capital. In our experience, it is the preferred format for VC’s and we know the software well, as JIAN is a client of ours. In order to purchase the software, simply go to www.jian.com. The software is intuitive, simple enough for a 10 year old to master and, in our considered opinion, the best on the market today. If, instead, you’d prefer to hire an expert in the creation of business planning materials, give us a call and we’ll refer you to a colleague of ours who has been producing such materials for more than 30 years now.
Most companies come to us completely unaware of what it takes to navigate their way through the venture capital maze. This is normal; in every industry, there are professionals available to guide the uninitiated. Business consultants and financial intermediaries are more often than not indispensable to a firm seeking to acquire the proper institutional capital partner. The personal VC relationships these firms bring to bear are what get your deal in the door; the guidance and insight they can offer while you are engaged in VC discussions and due diligence are immeasurably important. VC funding is usually not quickly obtained; it takes a lot of hard work and a lot of research to acquire the correct capital partner. Know your intermediary; obtain and check references and study the firm and its people to see if you believe they are professional and worthy to represent your initiatives.
I hope that this information proves useful to you. I am available to field comments at hintz@vcintermediary.com or via telephone, at your convenience. I sincerely wish you the best in your quest for the proper venture capital partner for your business.
Christopher S. Hintz
Founder & Senior Partner
VC Intermediary LLC