The Pros and Cons of Venture Capital Funding
Many entrepreneurs and inventors have heard of going to a venture capital fund (VC) for financing. Sadly many of them are quickly frustrated with the process and walk away discouraged. Others that do receive VC funding become disappointed later when they loose control over the direction of their company or figure out that they gave up more % of ownership than they thought they were going to. From many of these experiences VCs have earned a bad reputation and are often referred to as vulture capitalists.
The reality of situation is somewhat different however, and when an inventor or entrepreneur becomes discouraged it is because they didn’t really understand the process or had unrealistic expectations of what the VCs purpose really is.
It starts to understand why VCs exist. VCs are private funds raised by management teams who are looking for a very large return on investment for the overall fund. Sometimes money being invested in a VC is institutional money, occasionally companies have their own VC funds, and finally very wealthy investors will often invest a small portion of their net worth into a VC. The fund has a responsibility to the investor to place the fund’s money where the fund management believes it has the best chance of striking gold or having an enormous return on investment. VCs are a very risky investment however, and many of them never get that home run return on investment they worked for. There are many instances of VCs closing their doors with their investors loosing their entire investment. So the first rule for an entrepreneur approaching a VC is to understand why a VC exists in the first place. It isn’t there for a social economic goal or for any altruistic reason.
Lesson 1: A few years ago, there was an informal standard that VCs used when deciding to look at investing in a company. The standard was that the marketplace the company operated must be a billion dollar market, that the company being invested in had the potential to have $100 million in sales within five years, and that the company’s market capitalization could be potentially worth $400 million. I haven’t spoken with a VC manager lately, but I suspect the current target hasn’t changed much.
Lesson 2: Every VC has a different appetite types of industries it prefers, the geographical location, the stage of company development, and a few other characteristics. When seeking out a VC, do your homework. No two VCs are exactly alike. If you have say created the next better “superglue” find the VCs that have portfolio companies or an appetite for material sciences. Don’t go to a VC that only invests in software. Believe it or not, there is at least one fund I know that only invests in adhesives and material sciences.
Lesson 3: Understand that there is an intake person at the VC whose job it is to sift through the hundreds of business plans a month to find the one “diamond” in the boulder field. This person spends a very short time reviewing each plan. He or she wants to see the value proposition, size of market, uniqueness of idea, and potential return on investment right away. Don’t bury this information on the last page. Make it your business plan’s thesis statement. It is very often a good idea to use a professional intermediary who knows exactly how the business plan should be written.
Tomorrow I will continue discussing VC funding and an alternative to VC funding.
Sam Thacker is a partner in Austin Texas based Business Finance Solutions.
You may contact Sam directly at: sam@lesliethacker.com
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EXTRA: If you have questions for Sam regarding business financing, the credit market, and similar issues, please send an e-mail. Your questions will be recorded and Sam will answer the best ones in his podcast show.
