Fed Fund Rate Cut Won't Affect VC Funding

The cuts in the Fed fund rate – the rates banks charge each other for short-term loans, is good news for you if you have a revolving line of credit or other loan that's tied to the prime rate. But if you're trying to take your business in a new direction, you're probably looking for venture capital, which follows a whole different set of rules.

For starters, the venture capital market reacts more to general business conditions than it does to rate changes - and the general business conditions right now are uncertain. That's the bad news. The good news is, if you've got a successful business, you have a huge advantage when you're out looking for VC money

Venture capitalists basically look for three elements in a business plan, and they're all equally important.

·   "Secret Sauce." That's whatever it is about your idea, your process or your distribution that poses a high barrier to entry for potential competitors. In high-tech firms, for example, it's often software that would take competitors more than a year to duplicate.

·   Market size and growth potential or CAGR (compound annual growth rate). No matter how brilliantly your idea solves a problem, if that problem only applies to a small number of people or businesses, it's not very interesting to VCs. The reason is simple mathematics. VCs typically lose money on four out of five deals, so number five has to pay for a lot of bad guesses.

·   Experience. The third element – the one where you have a huge advantage – is the track record of the management team. If you have a going business, you've already established that you know what it takes to be successful. Don't under-value that asset when you think about your options for the future!

The bottom line: While getting VC money isn't easy, it is possible. You need a good elevator story, a great presentation, numbers that look good, the right team, and the stamina to go through the process, which can be arduous.

I'll write more about this topic over time. But if you're looking into financing, check out our own Mary Sullivan's blog on start-up financing and the very interesting article on start-up financing statistics by Scott Shane of Case Western Reserve University to which it refers. Some tidbits from the Shane article: 72 percent of the start-ups funded by VCs were in either high-tech or biotech, and 53 percent of small companies under two years old turn to debt financing to expand.