There are few things more exasperating than having a tremendous idea, but not the money to put it into action. Venture capital firms can be the only hope some entrepreneurs have. However, venture capital firms do not just hand out money. You must be ready to prove your worth in order to engage a venture capitalist.
Step One Present a great idea. You cannot go to a venture capitalist and toss any idea in his face and expect to get some start-up cash.
Step Two Prepare a thorough business plan. A business plan is not just a summary of your idea and a projection of how successful it can be. You must include information on competitors, how your idea proves to be better and not only best case scenarios, but also less optimistic projections. Venture capitalists are wary of the worst case scenario. You need to address what that would be so that their imaginations do not take over.
Step Three Use 2Merge.com to find multiple VC's who could meet your financial and strategic needs. Try to do some research on which firms focus on specific types of ventures. If one firm focuses on biotechnology, do not plan on them funding your new email software. You should also check for references and conduct a background check on them. Make sure the venture capitalist is trustworthy. Remember, they usually become members of your Board and conduct monthly meetings with you and your management team. Step Four Persevere through rejection. When you are trying to find a venture capitalist, be ready to repeatedly hear the word "no." Even the best ideas can be rejected over and over. You have to match your vision with that of the venture capitalist. That can take time so do not give up. Step Five Negotiate a good deal. When you find a venture capitalist who is willing to invest you need to make sure that you do not give up your whole idea and future to them. Venture capitalists want to take as much ownership and control of your business as possible. Make sure you retain an ownership stake and control over the direction of your project. Step Six Work your tail off. Once you find a venture capitalist who is willing to invest in your idea, the work is just beginning. Now you have to make all the projections happen and make the best of his investment.
What you should know before you raise capital
Before you go on a wild goose chase on your quest to raise capital, you should first understand how a startup investor's mind really works. Unfortunately, the majority of entrepreneurs get out there and try to raise capital for their startup venture without bothering to spend any time understanding what investors are looking for.
How they think
A startup business investor is a lot like you, only with a lot more disposable income. They pool together and raise capital from several high networth individuals to form a venture fund. This pool of capital is then used to fund the startup companies that make up the investment portfolio. Since the investments are diversified in this manner, a venture capital investor can afford to lose money on a single deal or even several deals, and still make a profit in the end if the other startups perform well.
As with any type of investor, a venture capital investor is looking to make more money with the money that they already have. Sure it's nice to have the luxury of existing capital, but managing these investments is a full time job. Unlike you, this is what they do for a living, not as a side job. Early stage investors spend a great deal of time weeding through new funding proposals looking for a great opportunity--and if the planets are aligned right, they might hit the next Google.
It's like Vegas (sort of)
In the meantime, only a few of the deals that they fund will make them any money at all--most will go bust. But, as with anything, the gamble usually pays off in the end if they make more good investment decisions than bad. That means that they can't afford to make many mistakes-- this is their primary source of future income and any mistakes will cost them dearly.
To help offset some of this risk, the majority of investors will do a great deal of research and analysis before funding any venture. They can't catch everything though! So, rest assured, any credible investment company is going to thoroughly check the facts before sending any money your way. You can count on answering some tough questions and hearing a lot of the word "No", before you find an investor that is willing to take a chance on your business.
The Basic Principles of a Venture Fund
Venture capitalists are typically former executives or investment bankers who have turned to raising a private fund to make particular investments. A venture fund can be as small as $1 million to upwards of billions of dollars of investment capital. The capital for these funds can be contributed by multiple sources, including the VC's themselves, but more typically this investment capital comes from large institutions with a lot of money that they need to invest, such as universities, insurance companies, state pension funds and other types of grouped investment sources.
The Lifespan of a Venture Fund
Venture Funds aren't intended to live forever, with the average lifespan of a fund being about a decade. Many of the investments in venture funds tend to incorporate high growth startup companies that create a great deal of value in a short period of time. Therefore the fund needs to perform sooner than later in order to repay the commitments to those who have invested in the venture fund.
The VC's Cut
Ideally the venture partners in the fund will make big bets that pay big dividends. But that isn't the only way they make money. In addition to getting a piece of the upside for making good deals (usually 20%) the VC's also get a "management fee" which often totals 2% of the total amount of the fund. Over time the fund itself tends to "run out", which requires venture capital firms to raise additional funds that create additional investing opportunities, and of course, additional management fees to the partners.
Trading Capital for Stock
Unlike a bank that will trade you debt for cash, venture capitalists are most interested in getting a stake in the company, typically in the form of equity. The goal of a VC investment is not to watch the company grow for decades, it's to watch the company grow very quickly so they can convert their equity back into a much bigger pile of cash. Ideally the VC is looking for the company to move to an Initial Public Offering (IPO) or a buyout. At this point the stake in the company that the venture fund acquired will (hopefully) become worth far more than it was originally valued at.
Not for Everyone
Venture Capitalists don't invest in very many deals. By nature, they can't. Most VC firms are limited to a few general partners or associates that must personally manage and monitor each and every one of their investments. This means that a small VC firm can handle maybe a dozen or so investments, but not many more. At the same time they are being constantly barraged with investment opportunities. For this reason it's not unusual for a VC to invest in 1 out of every 400 deals that they are presented with. The likelihood that your investment opportunity will be funded by a VC is relatively low, especially if you do not meet their particular investment criteria.
Many entrepreneurs overlook the fact that Venture Capital Funds tend to focus on very specific areas of interest (their "investment criteria"). For example, a VC may focus on investments strictly in bio-technology, or only on investments based in a particular area of the world. That's because they are trying to align their investments with their expertise. All of the investors in their fund are investing their money based on their appreciation for the Venture Partner's particular expertise. If the Partners were to invest in bakeries when all of their expertise was in the aerospace industry, you would really have to question their abilities!
Go BIG or Go HOME!
The very nature of the startup game is that while most startups have high aspirations, most of them will fail miserably, taking a big chunk of the venture funds' cash with them! Therefore a Venture Firm needs to hope that the few bets that Go BIG, go really, really BIG to cover all of the losses from their other investments.
Although the number varies from fund to fund, it's not uncommon for only 1 in 20 investments to become absolutely huge while the others perform moderately or not at all. Investing in one eBay or Google makes up for a lot of losers in the pipeline.
What does a Venture Capitalist do?
Most people think that a venture capitalist is just a banker with a bunch of cash waiting to make some investments. The reality is that a venture capitalist is more of a partner to assist in the growth a startup company, and ultimately to the eventual sale or IPO of the company.
Sort out the Good Deals from the Bad Ones
Remember that for a venture fund to exist, it must be managed by venture capitalists who know how to make smart investments in startup companies that show a great deal of promise. Unfortunately most business plans are dogs, so it takes a solid venture capitalist to separate the wheat from chaff.
VC's therefore spend most of their time sifting through deals looking for the few that they want to invest in. It's not uncommon for a VC to pour through hundreds of potential investments looking for just one deal that they want to get behind.
Part of the reason a VC has to be so selective is because they only have a limited amount of time that they can invest in any one deal. Doing a venture investment is not at all like writing a check for a loan. In order for a VC to get their money back, their investment must be managed directly from inception to maturity by the venture capitalist.
Providing Direction and Strategy
Since a venture capitalist typically invests in many companies in the same industry, they often have a great deal of knowledge about what is going on across the industry. This provides a valuable resource to entrepreneurs to understand new trends and take advantage of them. The entrepreneur often gets so buried in their business that it's hard to look up and see what else is going on. The venture capitalist, by comparison, is constantly looking at other companies and opportunities, which they can then turn the entrepreneur on to. Many startup companies will rely on this insight from VC's to provide direction and strategy as they grow. It's difficult to quantify how valuable the information a venture capitalist may have.
Help recruit talent
Another valuable contribution that venture capitalists make is the effort to recruit top management talent to the company. Since VC's work with lots of other startup companies they are constantly shuffling talent from one firm to the other to make best use of their "best players". For example, if a CEO at one of the VC's portfolio companies had just sold her company she may be a candidate to join the management team for another portfolio company. It's not at all uncommon for many of the top players to jump from funded company to funded company to help get startups evolving quickly. Startups often have a very limited rolodex, often limited to the founder or a few management team members. You can think of the venture capitalist like an executive recruiter with a vested interest in bringing the top candidates to your organization.
Find Other Sources of Capital
It's very rare that a startup company needs only one round of venture capital investment in order to grow. Even a healthy first round of investment will often require more capital as the company hits significant growth milestones in the future. Venture Capitalists are key sources for finding other capital investors to put more money into the company as it needs it. That's why you often see a series of investors in a single round investment - they all want to participate in order to collectively win.
There's another strategy at work here as well - the more venture funds that have money in a deal, the more people that have an incentive to make the deal work. Finding more solid venture funds to invest in a company creates more rolodexes to tap, more portfolio companies to partner with, and more expertise to be brought to the table.
How do I approach venture capital funds?
There are many ways to go about approaching an investor forventure capital funds. Some are good, some are bad, and some are just downright ugly! Below is a guideline for some general rules to follow when reaching out to any investor for venture capital funds.
A few basic rules
Do your homework -
When looking for funding, many entrepreneurs make the mistake of reaching out to every single person whose name tag includes the word "investor" on it. This is a huge mistake because it wastes your time and also the investor's time. Just because that person is an investor, doesn't mean that they specialize in your particular industry. So do your research and investigate the investor's current investment portfolio and strategy to see that it is a good fit before making your pitch.
Whenever you are approaching an investor for venture capital funds, be sure to make your initial contact concise! Keep in mind that most investors see dozens of proposals in a day and don't have time to read your 30-page business plan. Instead, send a one or two paragraph introduction of your company and how it relates to that particular investor's strategy. If you do the proper research in advance and make your initial contact concise, you'll greatly improve your odds of at least landing a meeting with an investor. But, if you want to ruin all hope of ever being funded, feel free to give one of the options below a shot!
Here's how NOT to solicit investors
Every successful entrepreneur knows that there are certain ways to reach out to investors and there are other ways that any sane person would never solicit them. When it comes to raising capital, if you want to be a successful entrepreneur, here are a couple of things that you should never do: Mass Emails - Never send out mass emails with an executive summary or your entire 30 page business plan attached. This is incredibly irritating to potential investors. You not very likely to land funding with this method because it shows investors that you haven't done your homework on their particular firm or that you don't have the courtesy to take a couple of minutes to write a personalized email to them.
If you start by saying "it's the deal of a lifetime", you might as well save the investor the trouble and delete your own message before you even send it. We see this all the time at Go Big and we know first hand that this is a pet peave for most investors. These messages have a multi-level marketing (MLM) feel to them and aren't usually received warmly. If your opportunity is truly the "deal of a lifetime", then you won't have to use hyped-up language to promote it. The opportunity will sell itself. Many entrepreneurs try to oversell their idea with this headlines, when in fact, these messages tend to immediately turn away legitimate investors; who likely will never even read your email or ad.
Going to "trade shows" for investors is probably not the best idea for a couple of reasons. These shows are usually attended by second rate investors that may be less than ideal partners for your business. Legitimate investors tend to receive their deals through trusted referrals (free of charge). They spend their time and money going to trade shows to find funding opportunities. Also, if your business is truly fundable, you shouldn't need to pay money to attend one of these shows. You'll often be able to contact an investor directly and work from there.
Top Myths about Venture Capital Funding
Myth: Obtaining a Venture Capital Investment is all about Numbers
Boy have we heard this one far too many times! Some entrepreneurs seem to think that finding venture capital investment for their startup company is all about contacting as many investors as possible. Not so! Getting a venture capital investment is about quality over quantity. In this section we talk about how to actually limit and reduce the number of investors you talk to in order to increase your chances of landing a venture capital investment in your startup company.
How Venture Capital Investments are made
Before you start picking up the phone and dialing for dollars or spamming hundreds of poor investors with e-mails, you need to understand why finding capital isn't really a numbers game. To do this, you need to understand how venture capital investments are actually decided upon.
VC's don't make lots of investments
They make a small number of investments in very particular types of deals. Their capital investment criteria determine what deals they will even look at, much less invest in. For example, if the focus of a venture capital fund is on software technology startups, your real estate deal is not going to make it past the front door. The reason for these criteria are the limited number of resources the VC's have to work on the deals they invest in. A typical venture portfolio may have only 20 - 30 companies in it. That doesn't leave a lot of room for lots of new entrants!
Do your Homework
It's a huge waste of time to contact a venture capitalist about making an investment in your startup company if you don't even know what types of deals a VC does. 2Merge.com has a huge database of active investors and venture capitalists that we research and learn about before contacting a VC. Nothing will make you look like more of a nimrod than contacting a VC about investing your company and having no history or understanding of what that VC does. This type of introduction reeks of an entrepreneur who doesn't know what they are doing. You don't want to be that person. Instead, spend some time researching what types of investments the VC has historically done. Are these companies similar to yours? If so, you stand a greater chance of getting an investment with this venture fund because they clearly understand (and like!) the type of company you are working with. If it looks like there is just no possible connection between your business venture and the types of deals the VC has done, don't be afraid to move on to a VC that is better suited. You'll save yourself a great deal of effort in the process.
Figure it Out!
You are far better off approaching a handful of VC's with a very well-prepared presentation that explains why your business plan is in sync with the interests of the venture fund than expecting every fund to figure it out for themselves. Venture capitalists are very busy people. They don't have the time or attention to put toward figuring out how your deal maps back to their specific investment criteria. Sometimes you need to do a little bit of the ground work for these funds so that they can understand the connection. Let's face it - if you can't find a connection between what you're working on and what the venture fund invests in, you're probably in the wrong place to begin with! It's easy to find startup capital, right?
No! In fact quite the opposite is true. It can be extremely difficult to find startup capital, and there are some really good reasons why startup capital can be so elusive. For one, there are far more ideas (good and bad) than there are investors who are willing to put forth startup capital. If you think finding funding is hard, you should see how hard it is for an investor to find a decent deal in the sea of ideas that come their way. Just talk to any investor, and they can testify that they've heard it all--from the next great widget to a revolutionary new way to slice bread! You may have good intentions, but that doesn't mean that you have a good business idea or that you'll be able to pull it off even if your idea does have some merit. Look at eBay for example. If you had come up with the exact same idea ten years ago, could you have turned it into the auction machine that it is today? It's doubtful at best. Great ideas are worthless if you can't execute on them.
Finding Capital is Like Dating
It's hard because there aren't many matches - there is usually just one match in the end - it's like getting married -- you might have to do a lot of dating before you find the right person and, even then, you'll need be mature enough to make the relationship work. In this same sense, you and your business must be stable and mature enough to be positioned for a potential investment. Bringing on an investor is much like a marriage. The investor will bring many things to the table (not just capital), but will also have demands that need to be fulfilled in return. Is your management team able to handle the demands that come with the addition of an investor? If not, it's an automatic deal killer.
It Takes Time, No Matter What!
Think of how long it takes to find a spouse--it can take years and even decades in some cases. Finding an investor can often be the same way. You can accelerate the process by using tools and networks, but ultimately it may just be a matter of serendipity. Focus on becoming the "right" company by fine tuning your business model and harnessing actual customers. Do this, and you'll greatly improve your odds. Startups that are able to prove that their business model works, because they have paying customers, are much more likely to land an investment.
If I have a good idea, I'll be able to find start up capital
You may think it's a good idea, but that doesn't mean it will be good enough to secure start up capital. Millions of people "have a good idea" and frankly speaking, 99% of them aren't that good and even fewer are properly executed on. The odds are, you probably fall under the 99% category.
Is the business fundable?
The biggest deal stopper is a business that simply is not fundable. How do you tell if your business is "fundable"? A fundable business will have a scalable business model and should already have paying customers. Do you have customers writing checks to you right now? That's the easiest way to tell if it's truly a good idea.
Must have potential for a huge return
Let's be realistic here. You probably didn't just discover a "$50 billion market that's completely untapped". And even if you did, don't state it like that or an investor will probably shrug you off. With that said, your business does have to have the potential for substantial returns or it's not worth the investor's time. "Substantial" is pretty subjective, but it's fair to say that your business should have the potential to bring in at least $10 million to make sense to any investor.
It's time to execute
Can you execute on it? Do you have a track record of successful startups? There's a reason that 9 out of 10 businesses fail. What will make you execute on it better than somebody else that comes up with the same idea or takes your concept when you come to market? And please don't say a patent--a patent won't cure everything. People get around them all the time and you'll spend most of your own time trying to battle people half way across the world that have infringed on your idea. Besides, a patent won't help you execute on your business model and take your venture to the level that investors are looking for.
Myth: Early stage venture capital will solve my cash flow problem
This idea has been misleading entrepreneurs since the begging of time (well, maybe not that far back). Early stage venture capital is designed to improve the liquidity of your startup business, but it isn't designed to pay off the debt that you have already piled up. Your debt is your own responsibility and nobody is going to just hand you a check for early stage venture capital to help take care of it. Honestly. Why would anyone possibly want to pay off your debt? Early stage venture capital investment companies are interested in making more money for themselves with the money that they hand you--they're not interested in paying off your debt!
Own up to it
Your debt is your own, so don't try to lay it off on someone else. You racked it up, now pay it off and move on. Otherwise, it's going to linger around and hinder future opportunities. Many entrepreneurs seek an investment for the sole purpose of getting themselves out of debt. It may be a little counter-intuitive for some, but this will actually turn an investor away from your venture. In fact, the worst thing that you can do is attach your debt to the investment--it's like hanging an anchor off of the boat. It will constantly slow down your growth, eat up your profit, and ultimately bring the ship to a halt.
Create value, not debt
The best way to attract investors is to create value with your business, not debt. Startups that create value are much more likely to land early stage funding that may be a crucial resource needed to fuel the company's growth toward a positive cash flow situation. VCs often look for companies that are growing and have a solid business plan, but just need startup funds to take the business to the next level.
Startup investors aren't interested in assuming debt, they are only interested in making money. Funds that go toward paying off debt are funds that can now no longer be used to create other value and earn a profit. It's like throwing your investment into the trash--successful investors didn't become successful by doing this. They became successful investors because they know how to make more money with the money that they already have.
So create value, not debt. Do this by executing on your business plan and continually refining it over and over. There's always room for improvement. Improve your marketing and advertising, customer service, and especially your sales. Execute everything better than your nearest competitor. If you don't, somebody else will.
Don't Forget to Bootstrap
Don't forget to bootstrap--cut every expense that isn't critical to improving your profit. That means, you probably don't need that brand new desk that you've been eyeing for months, or that company car that you've always dreamed of. You've made it this far with what you have, so stick it out a little longer. These sacrifices will keep your debt low all while boosting the value of your company in the eyes of an investor.
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