It doesn’t have to be hard to get funding from a venture capitalist. With small business financing, it’s about knowing your options and how to qualify. The same goes for venture capital. It’s about knowing what type of startup company a venture capitalist wants to invest in. Your startup company has to qualify for venture capital. It starts with your startup company management team. According to the report How Do Venture Capitalists Make Decisions?, venture capitalists attribute the likelihood of a successful investment to the company management team. A competent company management team is more important to them than the company product, service or technology for sell. That’s only the beginning. What else do you need know? Keeping reading. I’ll educate you on what venture capitalists do and how they identify a potentially successful investment. By the end of this blog, you’ll know if a venture capitalist will invest in your startup company or send you packing.
What is a Venture Capitalist?
That question may seem “elementary”. Yet many aspiring entrepreneurs don’t know the answer. Simply put, venture capital is private equity. Private equity is business funding invested in private companies, in return for a percentage of ownership. Investors with a high net-worth invest in privately owned companies that they expect to yield a high return in a short amount of time. There are also “institutions” of investors that partner up to form a venture capital firm (VC firm). These investors pool their money together to create a venture capital fund (VC fund). The money in the venture capital fund is for investing high growth startups. Just like the startup company you plan on launching.
A venture capitalist shouldn’t be mistaken for an angel investor. Most venture capitalists pool their money together in a venture capital fund to invest. Furthermore, they prefer to invest large amounts in privately owned companies. An angel investor is usually an individual (or small group of investors) that invest smaller amounts of money into startups. That’s the biggest difference between the two— how much they invest. Angel investors are the people you go to when you need less than $2 million for a startup company. That amount of money is too small for a venture capitalist. Just ask the founders of Google. They received their first $100,000 investment in Google from an angel investor. A Stanford professor by the name of David Cheriton. If a venture capital investor is what you seek, you better need more than $2 million and own a startup company worth the investment.
Will a Venture Capitalist Invest in My Startup Company?
Last year one of my business associates partnered with a venture capitalist firm to launch their business incubator in our area. I remember him promoting the business incubator on Facebook. He received a lot of interest from aspiring entrepreneurs. None of them offered the type of investment opportunity the venture capitalist firm was looking for. The problem was that most of them had Main Street business ideas. They wanted to open up daycares and grocery stores. While there’s nothing wrong with these types of businesses, a VC firm will not see them as an investment opportunity (in most cases). Businesses like daycares are microenterprises. Microenterprises are small, local businesses that usually have no more than 5 employees. If your business falls into the category of a microenterprise (or Main Street business), a venture capital investment is not right for you. Examples of Main Street businesses include local retail stores, bars, clubs, lounges, and mom and pop shops.
What Type of Startup Company Do Venture Capitalists Prefer?
A venture firm invests in innovative, low to high risk businesses that also come with high rewards. These are the “Wall Street” businesses of the world. (Wall Street is the opposite of Main Street). A venture firm is seeking high returns in the shortest amount of time. The types of businesses a venture capitalist firm can get high returns from include companies like Amazon, Apple, Facebook, Microsoft, and Google, etc. All these companies have something in common. Their company founder came up with a good idea but didn’t have the money to fund it. That’s what a venture capital investor does— funds a good idea. Another thing these companies have in common is they are in the “tech sector.” They also all went public at some point. But having a good idea and being in the tech sector isn’t enough (unless you’re dealing with a Silicon Valley venture capitalist). A Silicon Valley venture capitalist likely prefers to invest in tech businesses.
How Do Venture Capitalists Select the Businesses They Invest In?
The reality is that venture capitalists select the businesses they want to invest by focusing on other factors besides “industry”. The report, How Do Venture Capitalists Make Decisions?, was completed using a survey of 900 VC firms in the venture capital industry. Based on the data obtained from the survey, venture capitalists focus on the following factors when selecting a business to invest in— (ranked in order importance)
- Management Team Experience
- Business Model
- Company Valuation
As you can seem from the list above, “industry” ranks fifth in regards to importance. This is true for early stage financing. For later stage financing, “company valuation” ranks third. What does this mean? It means that if your startup is an early-stage company, you need an experienced management team, exceptional business model and great product to be considered for early stage financing. There also has to be a market for your product. If these are not intact, it’s time to go back to the drawing board.
How to Approach a Venture Capitalist
Venture capitalists are usually introduced to businesses in need of funding through a network. A venture capital database like VCPro is a network that can help you connect with venture capitalists that may invest in your early-stage company. There are over 5,000 investors listed in this venture capital database.
Before you begin seeking a venture capital investment, you should prepare. Preparation includes developing your business plan, marketing plan, financial projections and a pitch deck. You should also practice your 60 second pitch. Venture capitalists may first ask you to do a pitch. In this case, your 60 second pitch and pitch deck will come in handy. If they like your pitch, they may ask to see a full business plan. If you have all these things ready and you meet the selection criteria I outlined in the earlier part of this blog, you may be ready to approach a venture capitalist for funding.
What Can a Venture Capitalist Help Me With Besides Funding?
According to the report How Do Venture Capitalists Make Decisions?, venture capitalists help the companies they fund in different ways. Based on the data obtained from the 900 VC firms that were surveyed, here’s what they help with the most—
- Post-investment Strategic Guidance
- Connecting Investors
- Connecting Customers
- Operational Guidance
- Hiring Board Members
- Hiring Employees
Venture capitalists don’t just invest in businesses, they build them. The services they provide to businesses are what make them successful. When working with venture capitalists, you can expect receive more than funding. You’ll have a venture partner as well. You (and your team) won’t be in business alone. Venture capitalists want the biggest return on their investment in the shortest time possible, so they help your business where needed.
Sources: Investopedia, http://www.investopedia.com/articles/financial-careers/09/private-equity.asp, Harvard Business Review: How Venture Capital Works, https://hbr.org/1998/11/how-venture-capital-works, Forbes: Professor Billionaire: The Stanford Academic Who Wrote Google Its First Check, http://www.forbes.com/sites/ryanmac/2012/08/01/professor-billionaire-david-cheriton/#3d83c3914b05, How Do Venture Capitalists Make Decisions? By: Paul A. Gompers, Harvard Business School – Finance Unit; Harvard University – Entrepreneurial Management Unit; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI), Will Gornall – University of British Columbia (UBC) – Division of Finance, Steven N. Kaplan – University of Chicago – Booth School of Business; National Bureau of Economic Research (NBER), Ilya A. Strebulaev – Stanford University – Graduate School of Business; National Bureau of Economic Research, August 1, 2016, Stanford University Graduate School of Business Research Paper No. 16-33, European Corporate Governance Institute (ECGI) – Finance Working Paper No. 477/2016, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2801385.