How To Raise Venture Capital for Your Company
The Venture Capital Raise
Before I became an offshore banker, i was a decidedly "onshore" entreprenuer -- of varying levels of success.
While Venture Capital (or "VC") funding is not getting the press or attention it did during the last start-up and public equities boom in the later half of last century, it still exists. And, many a startup -- especially those in the high-technology and medical fields -- still require it to get their cash hungry ventures off the ground before they can realistically "cash flow"
Before I begin, my experience is as an "Angel Investor" and as an entreprenuer seeking Angel, VC and Strategic Corporate investment in the past. I never had the job of "VC", however, I've spent most of my time on the other side of the table from them. So, that affects my bias and view.
Types of Funding Available for a Startup
Before I get into talking about raising venture capital funding for your startup, I need to talk about the other kinds of funding available to you. Because, in many many cases, you can save a lot of time, money, energy, and heartache by realizing what kind of funding is realistically avaiable to you. The bigger factors in this will be business stage, overall business opportunity, and defensible intellectual property around an invention or business process.
- Bootstrapping or Cashflowing
- Credit Cards, Personal Loans, Factoring
- Friends and Family
- Venture Capital
- Strategic Investment
- Public Markets
Bootstrapping or Cashflowing
This involves the antiquated, yet sound, practice of funding short term cash flow needs out of what is available from cash on hand and profit. While "sound", there are a number of companies whose cash flow requirements are too great to be sustained out of "cash flow". The obvious example, even assuming no capital expense required, is when the entreprenuer gets a large order that he cannot fulfill given the time and capital required to produce the order would leave him bankrupt waiting to collect on the account receivable. This is when outside capital is required.
Credit Cards, Personal Loans, and Factoring
For many, this is a common way for early stage companies to get funding. The downside is of course that it leverages the financial risk that the entreprenuer is enduring as large parts of his savings and often his job/salary (if he or she is receiving one) is also at risk simultaneously.
The cost of this debt, in absolute terms can be relatively high however in relative terms can be "worth it" -- if the entrepreneur has faith in the eventual success of his or her venture.
Factoring is the act of selling your receivables at a discount to a financial institution who in turn will provide you short term liquidity. The size and credit worthiness of the customer in question will determine the depth of the discount or whether or not you are able to sell it at all.
Friends and Family
No discussion of early stage venture capital would be complete without talking about he dreaded "friends and family" round. While at times, this refers to a round where friends and family are given preferential rights to purchase private stock in the days leading up to an initial public offering (presumably at a higher price), it more often refers to the period of time when those are the only people you can convince to join you in your crazy entrepreneurial mission.
This can be a fast way to get a little bit of cash, but obviously it comes at a very high cost. Even those that truly love you might start to avoid your phone calls or start asking you hard questions about their investment when all you want to do is relax over Thanksgiving dinner.
Another more popular form of early stage funding is what is known as "Angel Funding". Angel funding differs from venture funding.
While the "Angel investor" monicker leaves one with the feeling that they have been lifted from entreprenuerial purgatory by a righteous saviour, the truth is far from that.
Perhaps more than anything the name "Angel Funding" is a triumph of marketing. It contrasts dramatically with the, often well earning, tag "Vulture Capitalist" placed on VC investors. However, the ethics, and business drive of these funding sources has more to do with the source of their funds than their demeanor in the board room. The Angel investor is assumed to be working with his own funds or those of a tight knit aligned group of like minded individuals, whereas the modern venture capitalist is usually working with other peoples' money (OPM).
What is Venture Capital?
Venture Capital generally refers to institutional money invested into early stage companies to fund growth and development.
The companies in question are often not cash flow positive yet, and many are at the pre-revenue stage. Others can be as early as just a concept stage or "mezzanine" -- which infers a bridge financing to get the organization from the filing of its intent to "go public" and the IPO.
Before I get into the meat and potatoes of VC funding, I want to talk about the last two: the strategic investment/buyout and the IPO.
While there are some companies, most notably intel corporation, that have their own venture funding arms, we will discuss strategic investment separately.
This is usually only available at a much later stage for the company seeking the investment, and since most companies are not organized to evaluate and move on such early stage investments, in general they are very rare.
However, in later stage companies, buyouts and mergers and acquisition (M&A) activity, usually sold to corporations with cash or valuable stock to trade by investment bankers is one of two "exits" for the venture capitalist -- and potentially the other early stage investors.
This is important to note, because for the venture capitalist, a company is not a "win" when it becomes profitable, or when it grows its market share, or when it provides jobs to a community, or when it creates interesting products that change the world.
The venture capitalist is successful when he can successfully extract his investment at many multiples of what he invested and move on to the next kill. More on the reasons for this, and how it effects the entire industry later.
The IPO, Selling to the Public Markets
The Initial Public Offering, or selling stock to the general market is the other obvious exit for the Venture capitalist to extract his investment. in normal times, IPO's of funded startups are rare, and in the time I was building and funding startups it was even moreso. As such, to make up for all of the startups that never acheive flight, the VC will usually demand that the few winners in his stable make up for many many losing bets. The model works very similarly to the music industry I'm told.
Becoming a VC
To understand what it takes to garner VC investment, it helps if we understand a little bit about what the VC has gone through to get to where he is, and what he must continue to do to remain in his job.
The VC -- especially at the more well regarded firms -- has generally attended one of about 5 or 6 schools. He probably has a degree in an engineering or medical field and often an advanced degree in same and/or an MBA from a top school.
The better ones have some operational experience and the really good ones have walked more than a mile or two in the entrepreneurs shoes. All of this means that VCs can command respectible salaries working for other people, and continue to demand them as VCs.
For the Venture firm to have any weight at all, they must be sitting on a fund -- monies to invest in promising young startups. While it seems enviable for the VC to be "decider in chief" with large sums of money determining whose dreams live and whose die, as the saying goes "everybody's gotta serve somebody"
In this case, the VC's must "serve" the institutional and high networth clients who have contributed to one or more of the firm's funds and continues to provide the liquidity that the fund will need to fund the startup's dreams as they run into delays in the development of their businesses and need more capital -- as they nearly always do.
So, with that background in mind, let's talk a little bit about what makes an investment VC worthy.
Is Your Company Venture Capital Worthy?
Here, I'm going to talk about what kind of companies tend to get the lion's share of venture capital investment and a little bit about the "why's". If your company does not fit the "mold", of one of these companies it does not mean that acheiving VC investment will be impossible. It simply means that you are effectively flying "against the wind" and something that is already quite difficult to do will become even moreso.
The five things that spring to mind immediately that will determine the ease with which you're able to get an audience with an venture capitalist to make your pitch include the following:
The reality is that what industry you're in determines a LOT. When the VC makes his pitch to the investors in his fund, he usually tells them what industry or "space" he will be targeting. The investors have faith he can find the winners in a given space given his background, those he hires to advise him, and the general investing public's outlook for the market in question.
If you are pitching an idea that is not in the two or three industry spaces that he has slated to target that quarter you won't even get to the "elevator pitch" stage.
If you have a great idea that only works if you build the company in Kansas, you'd better look for someone that funds deals in Kansas. Due to the scale of the VC's fund, he will usually look to only fund deals in areas he wants to or has to already travel to for business. As a result, a large percentage of deals funded by Palo Alto, CA VCs are done in and around Silicon Valley (under 1 hour driving distance). The same can probably be said for VCs located in Boston, etc.
Because VCs are dealing with large funds that must be deployed in the most efficient manner possible to enterprises that by definition take a lot of attention to grow, they've evolved into a "feast of famine" mentality.
Better put, perhaps, if we use a baseball analogy. They are interested in grand slams and strike outs. They have neither the time nor resources to be "running the bases" on solid base hits or doubles or triples.
In other words, solid, profitable, companies that will grow organically over time to a respectable profitable little enterprise are of very little interest to the VC. This is the hardest thing for many would be entrepreneurs to get their head around.
This also drives decisions of industry type. Those industries that tend rely on defensible Intellectual Property tend to attract VCs like bees to honey - perversely because they are so "binary" in nature. Either you are a huge hit, or a totally "whiff" -- Either way, it minimizes the amount of time the VC has to "waste" to find out which one you are.
If this seems "incredible" to you that they would have little to no interest n profitable little enterprises (especially those that would continue running profitably forever with no real chance of a high money buyout or initial public offering) look at what industries the majority of the VCs focus on, and/or talk to someone who has tried to submit a business plan to a venture shop that didn't meet this criteria.
To reach these improbable scales as quickly as the VC would like, they tend to look for "revolutionary" technologies often rather than evolutoinary. Guys in the early stage venture game tend to look for technologies that promise "10x" improvements in either price/performance. This is especially true in hardware based startups since the price/performance curve is a moving target and it takes time and money to get nascient technologies developed tested and adopted.
Big hits and big failures work to recycle money faster than lots of moderate successes.
For the early-stage startup this will generally revolve around intellectual property (IP) and patents either in technology or process.
In later stage companies, IP can be part of a portfolio we might call "inimitable assets" -- or things that cannot be easily knocked off by competitors. Many smaller entrepreneurs might consider their industry knowledge or company's customer service to be "inimitable" however, VCs are typically looking for things that would be hard to acquire at any price (other than through their company). This increases the chances of getting out of the gate before they get crushed by the competition and sets the company up as a more likely acquisition target.
What do I mean by this? Basically, "where did you come from"? Does the VC know you? Has he seen your work? Have you done something similar in the past or with this team in the past? Did you go to the "right" school? Have you worked for or with people he respects or trusts.
Often these guys are so inundataed with funding requests that, sadly, this has become their first level filter. In short, you will have a very very difficult time even getting the BEST idea to be taken seriously if it comes in "over the transom" as they will put it.
If however, you are a known entity, it helps. How do would be entrepreneurs get around this? Often they are forced to hire a "known" CEO who as the connections necessary to get the meetings with the VCs to make the appropriate pitches.
So What are the Mechanics of Getting Venture Funding?
While the preceding should have given you a good idea in what you need to do, I'll get specific here:
Figure out if your idea or company is really VC worthy.
It could be that you just don't fit their mold for whatever reason. If this is the case, you're much better off focusing on building your business other ways. The amount of time and energy you can waste chasing the VC rainbow can be soul sucking. If you have a great idea, in the right industry, but the wrong management team, for example, you may find yourself getting meetings, but no funding commitments...just stringing you along. The VCs are either
1. polling you for information because they are considering funding a would be competitor, or
2. they have rightfully concluded that the longer they string you along the less risk to them and their capital.
Either way, it's a really bad situation to be in as an entrepreneur as with each new meeting your hopes are raised yet again -- only to be strung along.
Once you've ensured your idea, industry and area are VC worthy, create your pitch.
Create Your Pitch
Your going to need something to pitch to these guys if you ever do get a meeting right? Part of the complexity to this is that these business plans are living breathing documents and you'll probably be updating it frequently -- much more frequently than you can even guess probably.
Rather than the traditional business plan, it's probably best to just condense it all to a "deck" of powerpoint slides and some rather complete project plans and detailed financials that include Income statement, balance sheets and cash flow statements.
It is truly important that you are able to do all three of these statements -- if you don't have accounting or finance help to help you do these, several of the commercially available business plan builders may have a template -- or you can just google for financial proforma templates in excel.
Since there is a difference between cash accounting (what some mom and pops run) and accrual accounting (what any funded startup will require) you could conceivably have a profitable company that runs out of money due to the cash-flow cycle (see above discussion related to 'bootstrapping' your business).
The powerpoint deck should suffice and it will make it easier to taylor or change parts of your presentation over time as management personnel change, as some VC tells you he'd be more interested if you went a slightly different direction, as the timeline gets extended, etc.
Work Out your "Elevator PItch"
This is what you're going to have to tell someone in person, in 15 seconds or less why you're a compelling enterprise. It's harder than it sounds.
This is what you're going to have to use in person, on the phone, in a quick email (whatever) to try to get a sit down meeting and have someone take you seriously.
Get a Meeting
You can't get funding until you get a meeting, right? Unfortunately, this is the hardest part of the exercise. The real key here is to get the right meeting.
Yes, if somebody's former frat brother's squash partner is a VC, by all means take the meeting. It's good practice and it might lead to a meeting at a firm that can actually do business with you.
However, the likelihood that this one (or two or three) connections that you have lead to a funding are remote -- unless you're already very well connected and then you don't need to read this document.
The key here is to keep in mind which VC firms you need the meeting with. Focus on:
- Area, and
The VCs are going to invest in the industries they feel comfortable evaluating. VCs that don't have medical device startups and little or no inhouse expertise won't invest. It's a practice run at best.
If you're in Kansas and you fly to Silicon Valley for a meeting, you'd better be sure that that VC is one of the rare birds that has no problem investing in Kansas -- or you'd better be prepared to move -- everyone and everything.
Certain VCs focus on a stage of development -- early stage, developmental, prerevenue, post revenue, mezzanine.
The earlier the stage, the greater the risk and the greater the potential rewards from the rare successes that make it from very early stage to liquidity event.
BEWARE: some very early stage VCs are not in the business of funding early stage businesses at all. Rather, they are sitting on a stable of proven and vetted entrerpeneurs and university engineers and waiting for an idea to poach and build their own team around. And, more often than not there is no room for you in this new organization they are envisioning.
Leaders, Followers & the Problem of the Penguins
Assuming you've done everything right, and you're getting meetings and a certain degree of interest, you'll run into firms that will tell you, "wow, this sounds great. we are really interested. let us know when you find someone to lead the round."
Here's the deal. A *ton* of firms will not due the necessary due diligence or oversight functions to be considered a "leader" of a venture round.
What do I mean by this?
Well, at any given stage in the venture capital funding cycle it is typically a conglomerate of VC funds which pool their funds and invest in a "round". More often than not, certain funds are "comfortable" investing with other funds they trust and have a workin relationship with.
However, there are precious few firms who will take the respondibilty to "lead" a venture round. Leaders are given cred, a certain swagger, and latitude to negotiate the deal and well as board oversight and *sometimes* slightly better fundin terms to compensate for the added expense. Just as often however, they invest on equal terms with the "follower" VCs.
For this reason, there are (rationally) a LOT of Venture firms which will raise a fund and get into the business of "following" one of the major VCs into a round. While very hot deals that have a good lead VC have to beat off investors with a stick, those with no lead VC are left to swing in the wind with lots of interest.
My friend deemed this the "penguin in the water" problem. According to him, penguins have been evolutionarily trained to NOT be the first penguin in the water on the chance there is something waiting below an ice hold to eat the first bird who pops in.
Therefore the penguins will shuffle shuffle slower and close until on the the penguins pushes another in and then they stream into the water afterwards with reckless abandon.
While there are no VC's "pushing" other VC's in, the "pile on" effect is palpitable as VCs who were loathe to take your call 6 months ago now act hurt that there is no room for them in the deal. In the end however, it is the lead VCs call who and for how much gets allowed into a deal they have greenlighted for funding.
The cycle for any given industry will swing widely in the venture community, and the "groupthink" will become almost maddening for the would be startup. However, there is a rhyme and reason here too. Primarily, what the VC is gauging is probable investor appetite for a liquiidty event two or three years later (depending on the development stage of the startup in question).
Unfortunately, these signals are usually late, in that if the public markets are very robust for alternative energy deals, then the early stage company will likely find a ready and willing audience of would be funders.
Of course, the cycle for alternative energy deals will probably be over the liquidity event window closed by the time the company is ready to go public, however, the VC has precious little to go on other than tea leaves, industry pundits, gut feelings, general trends, and the public's appetitie at any present time.
As a result, a chip company I was part of seeking funding in the wake of the dotcom collapse found it very tough sleddin as the entirety of the nasdaq was beaten up badly. We were forced to get our A round (first round of institutional money) from effectively a strategic investor investing from offshore.....Asia.
I hope I was able to dispell some of the rumors myths and inuendos -- and maybe even create a few new ones of my own with this hub on bringing venture capital into your company.
I know for a lot of people who have not been exposed to the process it remains a bit mysterious -- as it did for me -- and i had a very difficult time getting real information on the topic. Blogs had not become mainstream yet.
I guess the effect of having managed, institutional funds in the venture capital cycle is a two edged sword.
On one hand, the amount of capital necessary to develop some early stage projects can be quite staggering and a large percentage of people seeking such funds would never find them from wealth angels alone.
On the other hand, institutional money brings with it certain realities of quarterly reporting to investors, dissociative behaviour and disconnected decision making (that one could argue for or against), and the need to acheive tremendous economies of scale quickly. The last of these is perhaps the most damaging to would be entreprenuers who otherwise have nice profitable niche businesses.
Now that you are appropriately forewarned you can more adequately determine if Venture Capital is right for you and your business, and perhaps be more prepared for what you will encounter when you find it.
By way of reference, it took my last US based company nearly 3 years to get our first domestic venture round (and the company had been in development for several years before i joined it). We had a seasoned CEO, BS/PhD from MIT and Stanford in Electrical Engineering and it still took in excess of 100 venture meetings before we were funded.
In slow times, if you need venture funding, be prepared for a long haul and have a "plan B" if you need funding to get you from here to there.
Feel free to comment with any questions and I'll do my best to give you my perspective or clear up anything that I may have gotten wrong.
Venture Capital Cycle
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