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Venture Capitalist Expectations and the Entrepreneur

Updated on September 16, 2011

It’s not unusual for entrepreneurs looking for venture capital or other types of business funding to have high and sometimes unreasonable expectations. The entrepreneur has a vision and believes everyone should feel the same excitement about the business possibilities. Applying for private business funding is similar but different in some ways compared to applying for business loans through traditional investors. The entrepreneur’s naiveté quickly dissipates when learning it’s the venture capitalists or angel investors who establish the lending rules whether or not they match traditional funding models.

A good example is the fact a venture capitalist may ask for 8 to 10 times returns within the lending period. A bank may only require 5 times.

The first step is to be fully prepared to convince the investor to lend venture capital or private business loans for startup funding or business expansion. The special requirements of the investors will be presented to the entrepreneur or business management, and they set the bar high. This is to be expected because the lenders goal is to minimize risks as much as possible. The venture capitalist or equity partners want to know if your business can make enough profit to repay the lender with interest and how long it will take.

The lender will also look at the track record of the entrepreneur and top management within the company or prior experience in other companies and the level of competence.

The entrepreneur who is fully prepared to respond to questions that validate probable success will attract business funding. It’s important that the private lender and the entrepreneur or managers be compatible in terms of goals and expectations. The term sheets that are prepared will provide the details of the agreement, and it’s critical that each side of the negotiations ask all of the probing detailed questions at this stage to insure there are not misunderstandings. In addition, the venture capitalist and entrepreneur will have to agree on business valuation.

There should be no room for surprises once the term sheets are signed.

Don’t Let Your Sweet Deal Go Sour

Compatibility may seem like an odd requirement for a business deal, but a mismatch of venture capitalist offering expansion or startup funding with a business can make a sweet deal turn sour. The business must clearly communicate the business model, operating philosophy, long term goals and much more. In some cases, people will inadvertently leave important information out of discussions which later leads to the discovery the lender is not a good match.

For example, the venture capitalist may have developed a specific idea about the methods to be used for planned business growth. Learning that the idea is wrong as more information is revealed can end negotiations. Clearly communicating the business plan is critical.

Valuing the Business

Normally, once the terms sheets are signed, the loan negotiations are close to being finalized. Sometimes there are some areas of contention that can derail the process. Business evaluation is one of those areas. Usually the business valuation is calculated by adding together the discounted cash flow and the business residual value. The discounted cash flow is figured for the period of the investment.

Sometimes the business and venture capitalist, equity partners, angel investors or those making business loans will have different ideas about valuation. The business will value itself higher than lenders value it. The venture capitalist, angel investors or equity partners are lowering valuation in order to insure risk is minimized. The business or entrepreneur has a higher valuation because the perspective is on growth and profits.

In the end, most negotiations between lenders and entrepreneurs will reach the terms stage and then continue to completion. The lender and business have the same goals, and each is simply doing everything possible to insure those goals are met.

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