VENTURE CAPITAL 101: THE BARE FACTS ABOUT VENTURE CAPITAL Growing a business takes serious money. When you've reached the limit on your own bank account (not to mention that of your family and friends), where do you turn? If your firm is growing rapidly, in a growth market, and could offer a great return on investment, it's a candidate for Venture Capital . Simply put, Venture Capital is money brought into your company by professional investors. When you receive Venture Capital , an investor (or investment company) obtains a portion of your firm in exchange for funds. Often, the Venture Capital firm will partner with your firm, adding management and working closely with you to minimize the risk of their investment. Last year, $6.6 billion was invested in United States companies via Venture Capital. Those firms which obtain Venture Capital have the potential to grow into significant competitors in their market space. While a government-backed Small Business Loan might ensure steady development, good initial growth, and stability, a Venture Capital investment can support rapid change and growth. If you're looking for Venture Capital, you're in good company. Not only the newest Internet companies can attribute their success to Venture Capital. Digital Equipment Corporation, Apple, Federal Express, Compaq, Sun Microsystems, Intel, Microsoft and Genentech were all Venture Capital backed corporations at early stages in their development. What is a Venture Capitalist? At his or her essence, a Venture Capitalist is someone who wants to realize greater returns on investment that are typically available in traditional markets. That's why Venture Capitalists look for private and rapidly growing companies-they want to be in on something that's moving fast, and they want to put their investment into the firm at the beginning of that growth in order to get the best return on an investment. The kinds of relationships you have with a Venture Capital firm vary. Some Venture Capital firms might simply purchase equity in your company. More likely, they will become active in management of the firm, sitting on your board and assisting with the development of products. Most Venture Capital firms are not interested in simply investing-they want to become active partners in developing your company. Venture Capitalists understand risk and are willing to take risk. However, the greater the risk presented, the greater the payoff needs to be. How do I connect with Venture Capital? The key which will open the door to Venture Capital is your business plan-and more importantly, your Business Plan Summary, or Executive Summary. This is a brief (7-10) page document that outlines and defines your business in a compelling manner, and calls the Venture Capitalist to action as an investor. Read our document on creating a winning business plan elsewhere in the Knowledge Center. Of course, while the Executive Summary is the proof of your concept, the way to get your plan looked at is through networking. Venture Capital firms are extremely busy, and receive hundreds, and often thousands, of plans a year. If you're looking for investment, go out and press the flesh. Make meetings, go out for drinks, play phone tag. Double the size of your Rolodex. When you're a known quantity, it will be easier for others to trust your business acumen, and easier for a Venture Capitalist to pay attention to your business plan. Your company probably already has a business plan, but no matter how astounding it is, without a powerful Executive Summary, it won't be read. Venture Capitalists on average receive 1010 proposals a year. They invest in 7 to 10 of these. The business plan, and personal recommendations, are the main two criteria they have for deciding which companies receive investment or not. Part 2: The Basic Executive Summary A basic business plan summary includes these sections: Overview of the company. A one-page explanation of your firm-who you are, what you do, why you do it, where you want to go, and what you'll do once you get there. Put your vision into 6 paragraphs--you can fit it all onto one page, but it takes time. After the one page summary, explain further your growth plan, describing corporate goals and anticipated stages for growth. Also address investment considerations, specifically addressing the primary Venture Capital question: "Why should I invest in this company?" Products and services. Describe what you do, and what you plan to do. Put your best foot forward, explaining the range of your firm and the unique capabilities and philosophy that makes your products and services what they are. Key to address here is the revenue model of your business - what people will be willing to pay for your product/service, and why. Market and competition. Demonstrate that you know your competitive market-not by insisting that your firm can take down any competitors, but by intelligently and clearly assessing all risks. What could happen that could take down your firm? If your firm is dependent on government contracts, could you lose them? If your firm is dependent on buyer behavior, could that behavior change? Remember, Venture Capital is all about risk-and if you show that you understand the risks, and are willing to face them without denial, then you'll earn the respect of the pe rson reading your Business Plan. Competitive advantages. Now, take the competition on headfirst. Demonstrate that your firm can handle challenges, and that your firm has a strategic lead on the market. Prove that the competition is behind your firm, and demonstrate how you will keep a firm grip on the market leadership position. Best of all is to demonstrate some barrier to entry into your market, some technical or other advantage that keeps competitors at bay. Management. The quality of management is incredibly important to Venture Capital firms. Show that your senior staff is experienced and capable of taking on challenges. Demonstrate that they're flexible and have met difficulties in the past and thrived. Above all, demonstrate that your management will be good to work with. Venture Capital firms want to work with vibrant, experienced, challenging people, not with naysayers and perfectionists. Financial Summary and Contact Requirements. Give a complete financial picture of your firm, including your expenses to date, number of customers, and average value per customer. What are your Capital Requirements? Define the amount of money needed, and the "burn rate," or rate of expenditure, for that money. Chart out your financial future, and explain your methodology in doing so. According to Capital Connect, nearly 50% of firms invest $1 to 3 million. Very few invest less than $1 million. About 40% of Venture Capital firms are willing to put in more than $3 million into your business. In terms of human resources and time spent, it costs a Venture Capital firm as much to make a small investment as a large one, so most firms would rather invest in a few companies over the course of a year. Keep this in mind when requesting financing. Contact information. Make certain that the Venture Capital firm can reach you easily. Provide phone, fax, and email addresses. Part 3: After the business plan After you've submitted your business plan, you need to be ready to discuss your business at length with Venture Capitalists. Have a 15-minute presentation ready to go, defining your business clearly and with maximum impact. Review your financials so that you can repeat them by heart-you need to make it absolutely certain in the minds of your potential investors that you are fully involved with, and totally committed to your business. What kinds of Venture Capital firms are there? There are endless variations of Venture Capital firms, and they range in size from a capitalization of a few million dollars to one of billion. Like any business, each firm expresses the values and beliefs of its founders. However, there are three ways to define Venture Capital firm within Venture Capital market. First, Venture Capital firms are defined by where their money comes from, by specialty industry sector, and by the stages of investment they are interested in making. Other issues to consider include length of investment-usually 3-5 years-and the expected return on investment. Capital Source Venture Capital firms are capitalized three ways: Private Independent Firms are privately held firms which make use of capital from their principal partners to fund other companies. This is the most common form of Venture Capital firm, and usually the most willing to take on large amounts of risk. Subsidiaries. Some Venture Capital firms are subsidiaries of other, larger corporations, like investment banks and brokerage houses. Government Affiliates make use of SBIC (Small Business Investment Company) funds, from the Small Business Administration, to make investments. There are also quasi public entities in most states. Here is Massachusetts, there is the Massachusetts Technology Development Corporation. Venture Capital Markets Different firms focus on different markets. Of particular interest right now is the technology market, especially in regards to the Internet. At the same time, other firms might focus on product-based markets, or on genetics research of pharmaceutical research. Investment Stages Different Venture Capital firms are interested in entering into companies at different times in the growth of those companies. There are 4 main kinds of financing: Early stage or Seed stage financing is focused on finding companies still in the "incubator" phase of their development, and with seeding those companies to ensure growth. Expansion financing allows small companies with real growth and profit potential to expand quickly. Acquisition/buyout financing, the investor gains control of the firm by purchasing 50% or more of it. Leveraged buyout means that an investor outside of the company uses market pressure to acquire the firm. Part 4: 12 Things to Watch Out For If you're considering going after Venture Capital, you need to tread lightly. Here are 12 key issues to track as you prepare your business plan, make phone calls, and try to get your foot in the door. Asking for money, not partnership. Venture Capital firms don't simply want to write a check and sit back. They want to be involved in your business, making decisions and working with your senior management. Make certain that your business plan identifies a place for the Venture Capital firm in management. Offering low ROI. The numbers differ, but Venture Capital firms usually want at least 40% back on their investments. If you can't match that, then you don't have a fast-growth company. Weak analysis of competition. You will have competitors, and they will be smart and fast. Underestimating them is a fatal flaw in your business plan. If anything, you should overestimate the threat from existing and potential competitors. Strong competition. If your firm is up against entrenched, firm competition, then you're doubtful to obtain backing. If you have a great new computer operating system, even if it's the best in the world, it's going to be hard to go head-to-head with Microsoft. Right now, your firm may not even be on its competition's radar-but Venture Capitalists don't want to build a company only to see competitive marketing destroy it. Unrealistic projections. Wishful thinking gets you nowhere. Even if it feels like your company will be worth a billion in 5 years, unless you have hard numbers and proven methodologies to back it up, it won't fly. Stay conservative. Overvaluing your company. An overvalued company is a poor investment for a Venture Capital firm-it diminishes the amount of equity they obtain for their investment. Assess your company according to market standards. Kill the eye candy. Venture Capitalists don't need 3D charts and color graphics to make their decisions. They're looking for a compelling argument, intelligently stated. If you have a 2-dimensional chart, keep it in two dimensions-don't use Excel to make everything leap off the page. That said, make sure your Business Plan looks professional and is visually consistent. No connections = no response. Like all of us, Venture Capital firms prefer to business with people they know. To get a good response, make sure your business plan comes recommended. Now is the time to network, make phone calls, and call in favors. Non-profitable If your company isn't profitable, it's less interesting. This is different, of course, if you're an early-stage startup-but companies that have been around for a while need to show that they're capable of making money. Suggesting "market skimming." Many companies introduce their market summary by saying, "we'll be part of an $100 billion industry-so if we get 2% we'll be worth $2 billion. Be ambitious. Venture Capitalists want to invest in market leaders-otherwise, the risk is to great. 5 year return. Most Venture Capital firms want return on investment in 3-7 years, with 5 as median. If your firm can't turn a profit in that time, they won't take your plan seriously. Non-disclosure faux-pas. Many businesspeople want to protect their ideas, but if you lead a relationship with a Venture Capital firm by insisting on a non-disclosure agreement, you're likely to damage the relationship beyond repair. Venture Capital firms like to do business first with handshakes, then with contracts. Look for other ways to build trust, and make certain that the Venture Capital firm members you're working with understand where your ideas are entirely new and competitive. And, if you can, do business with people who are personally recommended. Look to build a relationship-not just to raise funds Garage.com http://www.garage.com Information for Startups from Guy Kawasaki. Directory of Venture Capital http://www.amazon.com/exec/obidos/ASIN/0471122831 A thorough guide to the entire spectrum of Venture Capital firms-essential for those looking to do a strategic review of firms. The Red Herring on Venture Capital http://www.redherring.com/Venture Capital A standard technology industry publication takes on the Venture Capital world. Winning Strategies for Capital Formation : Secrets of Funding Start-Ups and Emerging Growth Firms Without Losing Control of Your Idea, Project, or Company http://www.amazon.com/exec/obidos/ASIN/0786308923 Practical advice for the young company. The Ernst & Young Guide to Financing for Growth http://www.amazon.com/exec/obidos/ASIN/0471599034 Clear, well-thought out advice for businesses. Venture Capital Handbook http://www.amazon.com/exec/obidos/ASIN/0139415017 Focused on creating a great business plan. Derby Management 399 Boylston Street, Boston, MA 02116 Tel: 617-292-7420