Is Venture Capital in Your Future?
Venture Capital is a form of financing that is provided by firms or funds to small, early-stage, emerging firms that are deemed to have high growth potential, or which have demonstrated high growth (in terms of number of employees, annual revenue, or both). Venture capital firms or funds invest in these early-stage companies in exchange for equity, or an ownership stake, in the companies they invest in.
The Six Stages of Venture Capital
There are typically six stages of venture round financing offered in Venture Capital, that roughly correspond to these stages of a company’s development.
- Seed funding: The earliest round of financing needed to prove a new idea, often provided by angel investors. Equity crowdfunding is also emerging as an option for seed funding.
- Start-up: Early stage firms that need funding for expenses associated with marketing and product development
- Growth (Series A round): Early sales and manufacturing funds. This is typically where VCs come in. Series A can be thought of as the first institutional round. Subsequent investment rounds are called Series B, Series C and so on. This is where most companies will have the most growth.
- Second-Round: Working capital for early stage companies that are selling product, but not yet turning a profit. This can also be called Series B round and so on.
- Expansion: Also called Mezzanine financing, this is expansion money for a newly profitable company
- Exit of venture capitalist: VCs can exit through secondary sale or an IPO or an acquisition. Early stage VCs may exit in later rounds when new investors (VCs or Private Equity investors) buy the shares of existing investors. Sometimes a company very close to an IPO may allow some VCs to exit and instead new investors may come in hoping to profit from the IPO.
- Bridge Financing is when a startup seeks funding in between full VC rounds. The objective is to raise smaller amount of money instead of a full round and usually the existing investors participate.
How Much Capital is Available?
The amount of venture capital available has reached record amounts. The final quarter of 2017 saw US$46 billion in venture capital (VC) investment globally, propelling the VC market to a new annual high of $155 billion of investment according to the Q4’17 edition of Venture Pulse – a quarterly report on global VC trends published by KPMG Enterprise.
How Do I Access Venture Capital?
The question is how to access this source of capital and compete against other companies looking to get the attention of venture capitalists. The key is to understand your “pitch” from the venture capitalist perspective.
15 Key Rules to Help You Prepare the Perfect Pitch
Rule Number 1 – The Business Idea
- What the venture capitalist is thinking: Ok. Looked at 10 opportunities today. What am I going to be looking at for the next 45 minutes? Why should I be enthused? Is this really an innovation that has potential to define a new category?
- Rule 1: Be concise and convincing – Express your idea in one sentence. Describe a big idea that has potential to earn outsized returns and generate real wealth for investors.
Rule Number 2 – The Market
- What the venture capitalist is thinking: Is this market/opportunity big enough to yield a highly valued investment? It is growing fast? Are there changes in market structure, technology, business models etc. that are creating room for an innovator and making the entrenched companies nervous? Are there barriers to entry that will make it difficult for competitors to copy or replicate the innovator’s success and position it for sustained growth and market share leadership?
- Rule 2: Describe the opportunity you have to create revenues and margins by disrupting the existing industry, your total available market/return and what your revenue would be if you got 100% of your target customers paying what you expect.
Rule Number 3 -The Problem/Opportunity
- What the venture capitalist is thinking: Will customers care about this product and company? Are the customers significant? Do they have the power to make a decision for their company and a reputation for being friendly to startups—or are they leery of new companies and their lack of staying power? Are the customers “good” customers who will pay for product/service features and don’t just seek lowest possible cost? (Companies that sell to high gross margin customers tend to have high gross margins. Those that sell to low gross margin customers have low gross margins.)
- Rule 3: Know the problem and the opportunity. What problem are we solving for? Who is the target customer; does he/she have buying ability and authority; what problem does the customer have today; why is that a big problem, why is it his/her biggest problem? “The problem our product/service addresses is the most important problem for our customers, who are high gross margin, high growth companies in high growth sectors who move very quickly and are open to buying products from startups”.
Rule Number 4 – The Solution
- What the venture capitalist is thinking: Will it give the organization a competitive advantage? What changes in the market and buyer preferences is creating room for this opportunity?
- Rule 4: Find and articulate the solution. “We have come up with a solution that is truly innovative and value creating, which you found due to exclusive domain expertise or intellectual property that is really hard for others to match.”
Rule Number 5 – Current Status
- What the venture capitalist is thinking: Is there a lot of research and development remaining to be done or are the company’s products/services really marketable?
- Rule Number 5 – Present a factual current status. “All the risk of research has been managed and no major unsolved technical problems remain.”
Rule Number 6 – Customer Status
- What the venture capitalist is thinking: Are there customers that matter with a high willingness to pay?
- Rule Number 6 – Who has agreed to pay for the product—or is the product still in “beta test”? Describe specific customers who have provided credible evidence that they are ready to buy the product—and will work with the company to help improve it over time.
Rule Number 7 – Getting to Your Market
- What the venture capitalist is thinking: Is there a channel that can allow this company to get its product to customers profitably? What is in the way to this company reaching his or her customers? Does the company have effective sales collateral and has it armed its sales force/distributors?
- Rule Number 7 – Accessing the Customer – How will you get in front of the customer, direct, indirect, etc. “Product falls off the shelf fast, very easy, short sales cycle.”
Rule Number 8 – Customer Economics
- What the venture capitalist is thinking: Is there a channel for the product, do people care (i.e. are they paying?). Who will be the ultimate decision maker?
- Rule Number 8 – Know what customers pay, what it costs to service them and what it costs to acquire them. “We have an efficient new customer generation engine and exceptional customer retention rates that will result in compelling unit economics. Each new customer generates an attractive rate of return. We can reach a broad, diverse customer base across industries/geographies inexpensively; yet get big revenue out of them.”
Rule Number 9 – Your Key Milestones
- What the venture capitalist is thinking: How much progress will the company be able to make with the funding they are seeking. Where will this round of investment take us?
- Rule Number 9 – Set Milestones. “Tangible, big milestones will be hit quickly that prove the value proposition and indicate that the company can address its market, allowing a big step-up in value for the company.”
Rule Number 10 – Your Team
- What the venture capitalist is thinking: Is this a world-class team with relevant skills and track record to pull this off? Have they been successful entrepreneurs themselves—or just associated with innovation that others were really responsible for? Will they be able to recruit from their networks? What have they done before that is special? Have they done it before or are they learning as they go? Do I want to work closely with these people every other day for the next three years and every month for the next ten?
- Rule Number 10 – Prepare impressive profiles of the top team, with one sub-bullet on relevant past. “Done it before, recruiting is easy, key team in place, success follows all these guys yet they are hungry for a defining moment in their careers in building a world-class company.”
Rule Number 11 – Financial Information
- What the venture capitalist is thinking: What are the unit economics? How are the gross margins (how competitive), how quickly the opportunity ramps, how many dollars to profitability? Do these guys understand how an opportunity grows? Are they believable numbers—or have they “cherry picked” them?
- Rule Number 11: Last two and next two quarters, next year, two years out, three years out across the horizontal axis. Key metrics on the vertical axis: number of customers, big revenue lines, COGS, gross margin, big expense lines, net income, cash flow and EBITDA.
Rule Number 12 – Your Competition
- What the venture capitalist is thinking: How is the company positioned in the landscape with all the other companies I’ve seen? How are companies in this category valued? Do I know about competitors that these guys don’t have listed or are these guys clued in on their competition? If they are initially successful, will they face a threat from better-financed new market entrants or substitutes—who can afford to “buy” customers with cutthroat pricing?
- Rule Number 12 – Create a matrix of the competition with the variables that matter. “No big “uglies” directly with the startup in their sites, not a bunch of money already invested by other companies attacking the same space.”
Rule Number 13 – Get Specific
- What the venture capitalist is thinking: Do I believe these guys can win? Where should I focus my due diligence efforts? Do the companies assumptions and plans involve wishful thinking?
- Rule Number 13 – Be specific about the top two or three competitors, one/two-liner on their story (funding, etc.), one/two liner on why you beat them. “No one else has invested significant money yet. An underserved segment.”
Rule Number 14 – History
- What the venture capitalist is thinking: How much has been invested and did it make a difference? Did the investment in this team make a difference?
- Rule Number 14 – Create a history of achievements. What investments have been made and how far did they go? “Great return on investment in this project and in the team. Real value added to the organization!”
Rule Number 15 – Why this Project?
- What the venture capitalist is thinking: What are YOUR motivations?
- Rule Number 15 – Play the long game – Understand the company’s investment portfolio and style and where your particular project fits into company strategies and objectives. Understand what the company is good at and be realistic about how it can help your project succeed. Understand its ability to add value in ways other than providing capital, such as challenging your thinking, helping you make contacts in your market and enhancing your credibility and reputation. “The team is focused on getting the right investment, commitment and project team and is in for the long run.”
Venture capital can be an excellent way to fund the growth of your business. But be prepared to give up a significant part of your business, some of your independence and a fair amount of your autonomy.
Michael Evans is the Managing Director of the Northern California office of Newport LLC.