Guide to Gaining Venture Capital

Venture capitalists may look at anywhere from 1,000 to 5,000 business plans per year. Out of that approximately two percent will ever get an interview. At most, a venture capitalist will spend five to fifteen minutes making a decision on whether to interview based on the documents presented, so the documentation needs to get the business idea across clearly, concisely, and thoroughly in a brief reading.

In venture capital, the standard mantra is that the most important factors are management, management, management. And what are venture firms looking for in management? Some commonly mentioned factors are expertise, experience, leadership, vision, integrity, openness and dedication.

Anyone seeking venture capital should be prepared to supply the names of a reputable group of three to four experienced people who will be an integral part of the business. Conventional wisdom points to three critical positions: a CEO or general business manager, a VP of marketing and sales, and a VP of development. However, extensive past experience is not as important as their ability to show excellence and good teamwork.

What do you do if you don't have those skills in your management team? Hire them. Don't be afraid to hire people who are better than you are. Constant striving to compensate for your weaknesses with better and better hires makes your company only stronger - and is impressive to investors.

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In an interview with venture investors, management needs to use those first few minutes filled with small talk well. These minutes may be a critical factor in the outcome. Unlike banks, venture capitalists will be working closely with management. They are looking for a chemistry that fits with them. There is a strong human factor. While the financials, marketing and other factors need to be in order, there has to be intellectual stimulation. The venture capitalists and management need to like each other if they are going to be spending the next few years working together for the success of this venture.

After management, there are a variety of ways that venture firms assess entrepreneurial ventures. Some factors commonly cited are size of the market, product qualities (uniqueness, brand strength, patent protection), rate of market growth, competition, barriers to entry, stage of development of the company, and the industry the company is in.

Venture capital firms will judge you by how prepared you are.

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Critical documents are:

Business Summary

A brief statement covering the main points that includes a discussion of management, profits, strategic position, and exit plan

Business Plan

A detailed document that outlines what you are going to do and how you are going to do it, including a clear and simple discussion of the idea; the management team - including full resumes; business strategy; marketing plan - including sales projections, distribution, market, and competition; financials; and a competitive analysis.

The business plan should answer:

- What is the growth potential of this company or project?

- What does the company do?

- How does the company operate?

- What are the projected revenue and profit margins?

- How is the capital going to be used?

- What type of exit strategy is foreseen?

Venture Capital Firm Requirements

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• Due Diligence

A study of the background and financial reliability of the company, management team and industry.

• Marketing Material

Any document that directly or indirectly relates to the sales of your product or service.

Most venture firms have a position on the board of the venture and expect to be intimately involved with the company after they invest. If they are used effectively, they can be an vital part of the decision making process. They bring a broad perspective of experience based on their work with multiple other corporate situations in the same industry. This experience can be invaluable in identifying patterns within the firm and the industry which may be invisible to the startup.

Venture capitalists have been labeled "vulture" capitalists by some individuals who misunderstand their function. One

In an interview, venture capitalists may ask such questions as what type of business experience the management team has and how does R&D impact future sales. Give time to think through how you would respond to variety of tough questions. Also, be certain you understand and use venture capital terminology correctly.

of the greatest fears entrepreneurs have is loss of control of their company. Rumors abound that venture firms require as much as 80% ownership to invest. Although no hard data is available, 30- 40% ownership seems to be the most common stake. Most venture firms, in fact, will say that what they are really seeking is a fair portion of the company in return for their risk capital, but control is not what they are seeking.

It is important to remember that the venture firms want the enterprise to succeed just as much as the entrepreneurs do. Certainly an

The Executive Summary

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The executive summary is the single, most important part of the business plan. Describe the market opportunity, your product to harvest the market opportunity, your strategy for addressing and selling to that market, financial results in the first years of operation, long term objectives, and the key personnel.

This is a ”commercial” of your business plan as investors will read it first. It should be written last ensuring that only vital information is included in most clear and convincing way. As a general rule, your first paragraph should include your business name, what it sells, where it is located, and the nature and purpose of the plan. You might also refer to the keys to success, or at least summarize them briefly.

The outline of the executive summary should include:

Disclaimer page (registration number; return instructions; non-proprietary)

The Purpose of the Plan (attract investors; document an operational plan for controlling the business; test the financial feasibility of a business concept)

The Company (the needs your company will satisfy; the products or services you will offer)

Market Analysis (the characteristics and the size of your target market)

Product or Service Research and Development (major milestones; ongoing efforts)

important factor in determining their control will be the ratio of what funding is needed to the valuation of the company itself.

Valuation of early stage companies is

more of an art than a science, but it is critical to all the other financial factors in funding so it needs very careful analysis and documentation.

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The Business Plan

Background: Describe the market recent developments, market trends and the market niche for your product. Your business plan must demonstrate clearly the commercial viability of the proposed venture.

Business Concept: Provide detailed description of the products or service and implementation arrangements for the targeted types of customers:

If you are selling a product: key suppliers and your terms and arrangements with them.

If you are selling a service: which services will be provided at the business location and which will be delivered "in the field"

Marketing and Sales Activities (marketing strategy; sales strategy; keys to customer success in a competitive environment)

Organization and Personnel (key managers and owners; key operations employees)

Financial Data (funds required and their use; historical financial summary; prospective financial summary, including brief justification for sales projections; valuation and deal structure; valuation summary and methods used)

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Market Analysis

Market research (know your customer, describe your target customers, provide an industry analysis and current trends; market size, market segmentation, the market share you will capture, seasonality, unique aspects)

Competitive factors (describe your competitors: list competitors by name, location, and their strengths and weaknesses; your competitive strategy – how you will succeed against them; how they will react to your entry into the market)

Objectives and Strategies

General

Mission, e.g. to improve certain situation

Objectives, e.g. to develop products satisfying specific needs of your target customers

Keys to success, sustainable competitive advantage

Marketing

Objective, e.g. build a customer base to support your financial management objectives

Strategy, including description of the "six P's" for your business:

Product: how you will design and package your product/service

Price: how you will price your product/service

Place: how products (and related services) are distributed to the customer

Positioning tactics: explain how you are planning to position your product or service against your competitors in your prospects' mind to retie the connection that already exists

Promotion or marketing plan: what media and marketing methods you will use to generate awareness and interest about your product/service; include examples of your promotional materials (brochures, print ads, copy for radio ads, calendar of special/regular promotional events)

People: who will be responsible for marketing your product/service

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Operations

Objectives, e.g. to win customers by offering superior services

Strategy

Legal structure and why you chose it; include legal/governing documents (articles of incorporation and by-laws for corporation, partnership)

Management and personnel:

Who the key managers/owners are and what relevant expertise and background they bring to the business; include synopsis (background, relevant employment and professional experience, significant accomplishments, and educational background of each member); detail résumés may be provided in the appendix

Describe non-management positions, responsibilities/qualifications, personnel policies

Outside advisors (board of directors; legal council; accountants; bankers; consultants)

Customer service: procedures and policies regarding your work and how you will treat customers

Location and operations: your facility, including a layout, description of business image, hours of operation

Operations plan: how you will deliver your product/service to the customer, from start to finish (who does what

tasks, how long it takes, etc.)

Renovations and equipment list (including prices and condition – new or used)

Taxes to be paid, licenses required, and insurance needed

Key people: who will provide accounting and legal services, technical assistance and support

Financials

Objective, e.g. generate certain gross sales during the first year of operation

Strategy

Risk Management

Objective, e.g. identify and act to minimize risks to your company

Strategy, e.g. to develop a responsive system addressing the specific issues

Financials

Financial Forecasts (provide in Appendix)

Sources of Capital (if the business plan is aimed to attract investors, define type of capital you need, explain clearly the investor’s exit strategy and how you expect to provide them with a return on their investment; note additional expected rounds of financing needed)

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Technology / System Summary

Innovativeness (describe innovative aspects of your technology with relation to the market needs)

System Components (describe major components of the technology/system and how they satisfy specific customer requirements)

Manufacturing Methods

Competition (compare your development program with existing technologies)

Intellectual Property Rights (describe if your business is based on a proprietary technology and if the proprietary position is adequately protected)

Company Organization

Ownership at the initial stage and plans for the near future

Management: investors invest in people rather than products, so sell the management team. Describe the management team at the initial stage and plans for the near future, including coverage for the owner’s unforeseen absence (sick time, etc.) during critical periods

Location

Appendices

Issues list (acknowledge barriers to

success – list important issues and solutions to these issues)

Issue, e.g. the owner has management/technology expertise, but no experience as a business owner; the proposed business concept is unproven; equipment damage risk; longer than expected time to the market; human resources shortage risk.

Solution to each issue, e.g. use experienced consultants; take training courses; conduct preliminary field testing; sub-contract certain work; obtain insurances and develop backup systems; limit number of projects and/or develop contingency coverage partnerships.

Marketing/promotional mechanisms (list mechanisms you are planning to employ for initial marketing of your product and provide their structure and brief description)

Financials: A full set of cohesive financial statements: startup costs (provide breakdown per cost components e.g. business license, corporation filing, legal fees, equipment, office expense, supplies, advertising, training, utilities, taxes, miscellaneous); balance sheet, income statement (list all your expenses incurred so far and income generated); cash flow forecast, for a period of 3 to 5 years, including loan amortization schedule, and detailed assumptions for each line item; break-even analysis; personal financial statement for all owners, co-signers.

The Business Plan is not Just a Plan, but a Selling Document

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Only one out of 20 business plans are read by prospective investors beyond the executive summary and only 6 out of 1000 business plans get funded on an average.

The quality of the business plan is crucial for winning attention of investors, especially for a first-time entrepreneur who has no track record in managing own business. It is not only important for a business plan to have the right content, but it also must be organized into logical and clearly defined sections and presented in a way that is informative and maintains readers interest.

Your business plan should:

Provide a roadmap showing how your company plans to achieve its goals

Provide Strengths - Weaknesses - Opportunities - Threats (SWOT) analysis

Discuss your company's plans for the near and long-term future.

In writing your plan, you should keep it as short as possible while ensuring that

you cover all the important topics in sufficient detail to substantiate your proposal. Investors only give you one chance. Address every key aspect of your plan: value proposition, financials, deal structure, marketing strategy, valuation and exit strategy – everything investors consider when they decide which projects to invest in.

Refine Your Presentation

Follow the enclosed outline as closely as possible

Answer the most meaningful questions in the outline - not necessarily every one

Add information you feel is important even if it is not in the outline

Try to allocate about the same amount of time to each topic in the outline

Don’t get bogged down trying to describe products or technologies, just talk about what the technology is used for.

Try to answer the questions in the outline crisply and directly. No time for

Due Diligence Information

Due diligence is a form of research conducted by investors or prospective joint venture partners to make certain they're are getting exactly what they agreed to buy. Trust the information

you receive from the prospective partner, but it's good business practice to verify the facts through interviews with third parties. Due diligence emphasizes understanding and

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long explanations. You can elaborate later.

Don’t exaggerate.

Be as factual as possible. Be prepared to defend any claims you make if possible.

Quantify claims whenever possible. (Don’t say, “we’re going to make the best widget in the industry.” Say, “our widget will have 200% more performance than existing widgets and it will cost 30% less.”)

If you don’t know the answer to an important question, don’t be afraid to say so. No one expects you to have all the answers at this stage. (“One of the reasons we need some money is so we can answer that question.”)

Don’t use busy charts. It takes too long to explain them. You have a little

over one minute for each major topic. A good format would be to have nine charts with simple reminder phrases for each of the important topics to be addressed on each.

Use graphics, pictures, charts, graphs, etc. if they will dramatize a point. But make sure they are simple and easy to understand. Explain the graphics carefully if necessary.

Keep asking yourself, “Would I invest in this business? Why?” The audience is interested in the investment promise of your business – not the technology.

Don’t try to say everything in the 10-minute presentation. It is just an “attention getter”. You can explain the details later, assuming you succeed in creating some interest. Distill the essence of your business into a few key, memorable points.

Due Diligence Checklist

Management: Chief Executive Officer; Number Two & Three in Management; Management as a Team; Organizational Structure & Decision-making; Management Characteristics; Corporate Ownership; Documentation; Management Reports; Strengths & Weaknesses

Personnel: Corporate Organization; Employee Compensation; Profit-sharing Plan; Bonus Plan; Payroll Records; Training Program; Attitude and Morale; Record Maintenance; Reports; Motivation; Hiring Procedure; Consultants; Ratio Analysis

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quantifying the risk of the proposed deal, rather than the upside.

VC Investing in Start-up Firms

For the venture capital investment process, due diligence means a rigorous investigation and evaluation of an investment opportunity before committing funds. This investigation is conducted by the parties involved in preparing a registration statement to form a basis for believing the statements contained therein are true and that no material facts are omitted. This process includes review of its management team, business conditions, projections, philosophy, and investment terms and conditions.

Absolutely vital to making a sound

investment, due diligence verifies any business opportunities that survive the initial screening stage. For venture capital investments, as few as 10-15% of proposals make it past the initial screening stage to the full due-diligence process, and only 10% of those receive funding. This verification process consists of checking the accuracy of business plans, audited accounts, and management accounts; getting replies to warranty and other standard questionnaires; patent searches; and technical studies. Unpublished accounting information and subjective information are equally important; these data are collected by calling customers, suppliers, lawyers, and bankers, and by checking trade journals

The Valuation Process

Valuation of start-up companies is highly subjective. It is rather art than science. Proper valuation of the entrepreneurial business is the seminal

event in the corporate maturation process however and it becomes an absolute requisite when the entrepreneur wants to raise private or

Contracts: In the Ordinary Course of Business (customer contracts; supplier contracts; agency/distribution agreements, etc); Not in the Ordinary Course of Business (partnership agreements, joint venture agreements, confidentiality/trade secret agreements, etc)

Proprietary Rights: Intellectual Property Rights (IPR); Intellectual Property Agreements; Pending or Threatened Claims for Infringement or Other Violations; Suspected or Alleged Infringement by Third Parties; Arrangements for the Disclosure of Confidential Information; Agreements with Employees and Consultants; Arrangements Relating to Proprietary Rights of Employees

Marketing: Marketing People; Products; Customer Description; Customer Service; Competitive

Analysis; Industry Analysis; Marketing Strategy; Product Distribution

Production: Production Management; Personnel and Organization; Production Process; Purchasing, Suppliers, Shipping, and Receiving; Efficiency Analysis; R&D

Financial: Management, Personnel, and Organization; Cash and Investment Management; Documentation; Analysis of Financial Operations; Financial Statement Analysis; Other Assets and Liabilities; Taxes; Analysis of Projections

Reference: General information about the company; Reference List: Bank, Other Institutional Lenders; Accounting Firm; Law Firm; Suppliers; Customers; Competitors; Agents, Consultants, Stakeholders, Trade Associations, Brokers

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Is it a Great Deal?

public capital. Once the company is properly valued, then the entrepreneur can determine how much of the company can be sold for the capital injection provided by the investor or venture capitalist. No matter how enthusiastic each party seems, it always comes down to valuation.

The most common start-up business valuation approaches include:

Cost approach (uses the valuation information to restate the asset at fair market value)

Market approach (gathering data to value developing assets; uses actual market derived data, comparing and correlating subject company to market comparable)

Income approach (connects data to value of developing assets)

How will additional capital and further dilution of stock be handled?

Does the plan include early investor return of capital?

How is the premium paid for the risks involved calculated?

What other "kickers" or other incentives not necessarily monetary in nature are being offered?

Are there warrants or other options to increase equity share or liquidate early?

Have you considered the tax and legal considerations including state securities laws?

What business organizational format are you using and why? Is it compatible with the proposed exit strategy?

Are buy-sell agreements, key man insurance issues addressed, convertible preferred stock, and management contract agreements included?

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