The 3 Things Venture Capitalists Really Care About

By Mujir Muneeruddin

So you've successfully seeded your company and gotten operations off the ground. Maybe you've enlisted the help of a few angel investors along the way. You now have some employees and a significant stream of revenue to show for your efforts. While things are progressing nicely, you realize that in order to take the proverbial next step you will need an injection of funds and expertise. This is a classic stage in the business cycle that has played out for so many start-ups before. Yet many entrepreneurs — particularly their first time around — can find it daunting and overwhelming.

At this stage, the most appropriate source of funding is often a venture capitalist (or VC). VCs are, in theory, sophisticated and usually institutional investors who specialize in accelerating businesses by bringing capital, business expertise, and a formidable rolodex. Due to far greater demand for VC investment than supply, VCs are often in the enviable position of letting entrepreneurs "pitch" within a limited timeframe. At that point, it is very important for entrepreneurs to understand who VCs are and what they are really looking for.

1. Value

Entrepreneurs will often find this to be a major differentiator between VCs and angels: VCs are usually in it to make money. Early in the conversation, entrepreneurs can expect VCs to raise the question of current revenues. While notions of "changing the world" and "revolutionizing technology" might sound catchy, a seasoned VC is going to look right past and ask, What are your current sales like? Hence, it's fair to say VCs are more concerned with whether you have an idea with high revenue potential than whether you have a revolutionary one.

VCs are also looking for a good bargain, much of which hinges on the valuation of the company. On the other hand, founders too often overestimate their company's current valuation by putting too much weight into intangibles like "potential" or "profile." Seldom will a sophisticated VC take this bait. VCs valuations are likely to be driven by revenues – mostly current and near-term projected. Once VCs agree with you on valuation, they must also feel that they are getting enough (whether pure equity, mezzanine debt, or fixed dividend) to justify the capital they are risking. This "value" component is likely to drive a VCs decision to invest.

2. Oversight

VCs typically like to take a position on the board of a company. However, what they plan on doing with their board position is often very different than a founder. Most VCs are not interested in taking over your company or being actively involved in its day-to-day management. Rather, they usually just want some decision-making input to ensure a maximum return on investment. Founders often mistakenly expect that once a VC is on board, he/she will roll up their sleeves and begin co-building the business as a partner. While it's true that one of the key elements brought by VCs is business expertise, this expertise is brought more to board meetings and occasional phone calls than on an active and daily basis. In some cases (depending on jurisdiction), a VC may even be taking a directorial position simply to show "control" for the purposes of being exempt from onerous securities law requirements.

One scenario where this misunderstanding comes into play is where founders bring on a VC with the expectation of getting immediate access to their rolodex. While VCs are apt to play up their contacts or distribution network, remember that there is a difference between a VC "taking a chance" with their money in a company and said VC risking their reputation by taking the same company to their own contacts. The implications to the VCs reputation and long-term prospects are arguably far greater in the latter scenario.

The bottom line is that you should approach VCs differently than you would potential co-founding partners or acquirors. Don't spend too much time pitching them on synergies or what they can do once they are on board. Focus instead on financial projections and how much money you can deliver to them. Similarly, if you have the luxury of competing offers, don't give too much weight to intangibles such as contacts and distribution network. VCs may well invest in your business today without ever gaining enough confidence (or time) to take you to their network. I recall an episode of "Shark Tank" where an entrepreneur responded to Robert Herjavec's offer for 50 percent of the company by saying (all quotes may not be exact) "[well then] you better spend 16 hours a day on the business like I do!" Initially caught off-guard, Herjavec responds by saying: "I work on MY business 24 hours a day to have the privilege of hearing pitches from individuals like yourself!" Many VCs see themselves as outside investors and NOT founding business partners, so address them accordingly.

3. Exit

VCs are not usually in the business of holding a long-term position in a company. Like so many other private equity professionals, VCs are often focused on a lucrative exit — typically an initial public offering (IPO) that returns multiples on their investment. While there are usually (depending on your jurisdiction) securities laws preventing pre-IPO stakeholders from dumping their interest too soon after going public, VCs will usually look to "cash-out" as soon as practicable. Hence, VCs may not necessarily be as interested in the "long-view" of a founder if it does not fit within their near-term exit strategy. They will tend to emphasize monetization models over many of the lofty (and even noble) long-term growth and social impact motivations of founders. Put simply, at the time of investment, many VCs are already thinking about their exit. This should especially be a factor when considering whether to solicit any VC investment at all, as opposed to pursuing other modes of financing or just growing organically through revenue.

Take-Aways

It's important to take the right approach with VCs and when choosing among them. The right VC can provide a huge stepping stone by bringing critical growth capital, business acumen, and potential access to powerful networks. However, they are typically looking for very specific things so be sure to address those points, especially when dealing within a restricted timeframe.