You may be an early stage or growth small business searching for investment capital. If you have not heard the adage “proven” teams with “proven” technology in a “proven” market get ready for the difficult challenge of identifying your company as one in order to approach venture capital firms for private equity venture capital funding, or VC funding. The problem is, when you are starting out, or even if you have been in business a short time, the Catch-22 principle applies. In other words, your intended outcome is to raise investment capital to produce revenue, and the venture capital firms (VCs) are using revenue criteria to qualify you in order to raise capital!
Preparing and presenting to venture capital firms , in what we call road shows, and the due diligence that ensues, take a tremendous toll out of senior management, and their direct reports, often times taking their eye off the daily operations. In all cases of the effort to raise capital, you will find a transition to short term thinking, decreasing revenues, and more operational problems resulting. And the chances of securing VC funding may seem analogous to playing to the odds of leaving
However, understanding the expectations of venture capital firms will go a long way towards creating a cogent strategy. One of the advantages of securing VC funding will be to force you to validate the authenticity of your business, to articulate your plan and to understand your desired objectives.
I have been working with venture capital firms for several years in my current investment banking role of due diligence and capital raise for energy technology companies, and there are specific criteria which serve to weed out the 99.9% of business plans that come across their desks everyday.
In reviewing a business plan, a majority of venture capital firms will look to add value (in terms of advisory or management expertise) to the small business under consideration in addition to capital. First, most of the larger, established venture capital firms will make a quick determination whether your operation represents a validated business model that can demonstrate a reasonable chance of achieving $100+ million annual turnover within 3 years; whether through organic growth and/or acquisitions. Here are some key attributes VCs look for in investing in businesses are:
- OPERATOR –The small business owner and/or members of his executive team have a previous successful track record in small business development and profitability; Executive leadership has a strategic plan ; can envision , see the patterns, establish the order, and can clearly articulate the plan ; they can navigate beyond the technology; an absolute killer team that possesses the skills, passion and connectivity in their industry to execute the business plan and meet the priorities of all their stakeholders and most importantly, you have chemistry with them.
- INTEL – The entrepreneur has established connectivity in their industry; they have a clear identification of customer’s pain; there is a clear identification of competition; they must be able to identify and detail - barriers to entry; What is their Product/Service similar to?
- UNFAIR ADVANTAGE – there must be a clear identification of the customer’s pain (fulfilling a perceived need in a customer segment and understanding how the customer needs it to look and act) ; articulating a sustainable advantage in relieving pain better than anyone else; i.e., A clearly differentiated business model (a better mousetrap and why);
- SKIN IN THE GAME – You have a vested interest in your business - not just sweat equity;
- SUSTAINED REVENUE - Has trailing 12 months of revenue with cash flow and must generate significant revenue by delivering their products or services within 6-12 months of funding. A clearly defined and proven (albeit on a small scale) repeatable and sustainable revenue model.
- EXIT STRATEGY You absolutely must know how you will cash out and get the big upside from building the business. You must be willing to do what it takes to get upside – consolidate, merger, IPO. VCs should look at 10 xs upside in 5 yrs.
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