The 4 Secrets of Raising Venture Capital

Abstract

Early-stage technology entrepreneurs often need substantial amounts of capital to fund and grow their companies. Although venture capital is the traditional source of funding for high-growth technology companies, many entrepreneurs are unprepared and unfamiliar with how venture capital really works.

The discussion addresses the steps & secrets necessary for an entrepreneur to effectively raise venture capital. By following these steps, entrepreneurs can more effectively raise capital, thus potentially creating greater value for their company and greater wealth for themselves and their managers.

The First Secret - Understand How Venture Capital Firms Work

Many entrepreneurs who have never raised venture capital (also referred to as “VC”)don’t understand how it works. As a result, these entrepreneurs often make serious mistakes that cost their companies needed funding. Understanding how venture capital firms work is a key first step.

Venture capital is a form of private equity capital generally invested in risky companies with the objective of achieving a large return on successful investments. This is sophisticated money, managed by professionals who hope to achieve outsize gains relative to the overall market.

VC firms invest in companies that have the ability to grow extremely rapidly and achieve a successful liquidity event (either being acquired or reaching an initial public offering) in a certain time period. These investors do not invest in companies that expect to generate healthy profits and dividends forever.

Each VC firm has a different profile for its investment portfolio based on factors such as: company stage, size of investment, type of company, geography and other factors. Targeting firms that have profiles matching the company’s profile is of utmost importance.

The Second Secret  - Understand What Venture Capital Firms Look For

Entrepreneurs who don’t understand what VC firms look for in a company will waste valuable time chasing capital that is not a fit for their company. Understanding what VC firms look for helps reduce the inefficiency of a process that is enormously timeconsuming. The goal of VC firms is to make a large return on their investment in a certain period of time. They do this via liquidity events (also called “exits”) of their portfolio companies when these companies get acquired or complete an IPO.

Typically the companies a venture capital firm invests in have a compelling solution to a large business problem. These companies are able to scale rapidly and achieve high valuations upon exit. Typically these companies have a competitive advantage based on a proprietary technology or processes. VC firms understand and appreciate the importance of management in running a company and executing on the business plan. It’s this business execution – achieving sales goals, meeting product development timelines, managing cash, etc. – that drives enormous value in a company.

Raising venture capital is difficult and only a very small portion of companies that try to raise VC money actually achieve that goal.

The Third Secret - Understand How to Sell Yourself and Your Company to a Venture Capitalist

After understanding what venture capital is all about and what VC firms look for, then an entrepreneur can properly prepare to seek their funding. There are literally hundreds of venture capital firms managing billions of dollars of capital in the U.S. alone. No entrepreneur can pitch every firm, so it’s imperative to qualify firms to increase the likelihood of success. Qualification factors include, among other items: company stage, size of investment, type of solution and geography. Then, after qualifying firms and creating a “short list”, entrepreneurs should seek a warm introduction to the VC’s they want to meet. Once a discussion with the VC is arranged, getting and keeping the attention of the investor is imperative. A discussion about business execution (e.g. your experienced team, customer traction, proven sales and marketing model) rather than pure technology is preferable for most investors.

Following our process called the J1X Method, an entrepreneur will prepare several documents to help convince a venture capital firm to invest in the company:

• Executive summary
• Investor pitch presentation
• Business plan
• Financial model
• Organization chart

Throughout discussions with investors, an entrepreneur will continually validate (ideally using third party evidence) the existence of the problem, the size of the market, the value of the company’s solution and the team’s ability to execute.

The Fourth Secret - Understand How to Negotiate with a Venture Capitalist

Like any negotiation, an entrepreneur wants to get the best terms possible for himself and his company. Negotiating with a VC is no different.

Understand that due diligence is a 2-way street. A VC will thoroughly investigate a company, its management team, its technology, its customer base, etc. prior to making an investment. At the same time, an entrepreneur should investigate the venture capital firm too. Both parties want to ensure the potential relationship is likely to be a productive one.

If a company and venture capital firm both survive each others’ initial due diligence, then the investor will prepare a term sheet which outlines the basic terms of their proposed investment. Most aspects of a term sheet are legally non-binding, but create a blueprint for the final transaction.

Negotiating the terms of an investment is similar to negotiating any commercial transaction with a third party. The entrepreneur determines which terms are most important to the company and which are most important to the investor. Having multiple alternatives to the proposal helps maximize leverage in a negotiation. And of course, having good counsel, seasoned with these types of transactions, is hugely valuable.

If all goes well, your company receives not only capital from a VC firm, but also invaluable strategic guidance, operational expertise and a rolodex of important connections to help grow the business.

Conclusion

Raising venture capital is a difficult and time-consuming process. Only a very small percentage of companies that try to raise venture capital are successful at it. Understanding “The 4 Secrets” and following the J1X Method will increase an entrepreneur’s likelihood of raising venture capital.

Source : The Tech Start-Up Group is a boutique advisory firm that works with entrepreneurs and executives at start-up and early-stage technology companies to accelerate their businesses.