- Make sure your plan has all the information the investors want to see, and put it where it´s easy to find.
I´m amazed at how many would-be investment plans I see that have buried or ignored the key investor concerns. These are:
- How much money you need and how much ownership do you expect to give. This goes to valuation, and if your valuation is unrealistic you aren´t credible. Always discuss valuation.
- Why you need money. Investors want to invest in growth, not owner peace of mind. Always show the use of funds.
- Who else is involved, and to what extent. Specify details of founder shares, employee options, and investor shares. Know and say whether your plan includes later rounds of more investment, and how you´ll handle dilution with those.
- How they get their money back. It´s called an exit strategy. Investors make money by putting it into your business and getting a lot more money back out of your business a few years later. They don´t care about your long-term business health.
- Who is in charge. Present the management team with useful information about background, references, etc.
People think of investors as venture capitalists (VCs), but in reality, venture capital is limited to a few hundred professional firms investing in a few thousand companies per year. This is rarified air at the very top of the pyramid. Most of that investment goes not to seed new start-ups but to add more capital to growth companies that have already established themselves but are still too small to go public. To have a shot at venture capital, you and your business must run quite a gauntlet.
Don´t think for a second that sending a business plan with a cover letter gives you a shot at venture capital. Yes, you do, without exception, have to have a business plan ready before you start, but the process is much more difficult than just the plan:
- Finish your business plan first, then finish your summary memo, then polish your pitch. Be ready with all three before you start the process.
- Your business plan should be readable and concise. Make sure the highlights are in the executive summary. Use charts. Cover all the standard bases, plus valuation, investment offering, exit strategy, and return on investment.
- Your summary memo is a 2-10 page document offering highlights of your plan. Write like a news story, the most important information in front and then in descending order. Make sure the investment opportunity is obvious. Keep lots of white space and make it easy to read. You´ll send this to a VC after you have an introduction. They´ll use it to decide whether or not they want to know more.
- Your pitch is a 10-20 minute presentation with PowerPoint slides. Stick to the highlights. Credibility is critical.
- Don´t bother with VCs unless you need at least $3 million, you have a proven management team, and you have a believable shot at paying them back 50 or 100 fold in 3-5 years. If you don´t meet all three of these conditions, look for angel investors instead (following). Important update, May 2007: Things are changing in Web 2.0 businesses. VCs are investing less money in smaller deals, on occasion, because web 2.0 start-up costs to validation are smaller.
- Select your target VCs carefully. Most VCs focus on certain technologies, geographies, and stage of business. Don´t waste your time with untargeted VCs. Do your homework first. You can find VC profiles on the web, or in directories.
- Get an introduction and talk to the VC. Nobody sends business plans to VCs anymore; they have way more deals than time. Connections are very convenient and getting introductions is hard, but if you can´t get through this step you´re not a candidate. Be prepared to talk quickly and well. This happens occasionally via email, but that´s the exception, not the rule. – If you get through this first filter you´ll be asked for either a summary memo. If the VCs like the summary memo, they´ll ask for or a pitch and a business plan. If they´re still interested after that, make sure you have experienced attorneys.
- Expect VCs to want other VCs in the deal. That´s why the deal has to be $3 million or more )see the update above, however) because VCs want to invest in groups of three or more firms, and the work involved isn´t worth investing less than $1 million.
- It isn´t that each VC demands a majority of company ownership, but VCs are rarely comfortable with less than 50% of the ownership controlled by the combination of different VCs involved. They want to make sure investors´ interests are protected by substantial ownership.
- Don´t let positive-sounding put-offs fool you. VCs will normally reject a pitch with a maybe instead of a no. Obviously the vast majority of start-ups don´t meet the VCs demanding criteria for investment.
Fortunately, there is a lot more investment going on at the second level, done not by VCs but by “angel investors. They might be wealthy individuals, companies, groups of local people united in a club or association, or some combination. There are tens of thousands of them in the United States. It is hard to find and identify them because there are so many, but web searches, local business groups, and business schools will help.