Venture capitalists, just exactly what are they. The venture capitalists definition, according to Investopedia , is an investor who either provides capital to startup ventures or supports small companies that wish to expand but do not have access to public funding.
According to the same source, an Angel Investor is one who provides financial backing for small startups or entrepreneurs. Angel investors are usually found among an entrepreneur’s family and friends. The capital they provide can be a one-time injection of seed money or ongoing support to carry the company through difficult times.
Let us briefly consider the pros and cons of angel investors vs. venture capitalists. As you can ascertain from the definitions, both of these types of investors provide capital, they both come in a start-up or they are called upon to fund growth, they both come into play when the enterprise does not have access to public funding.
The venture capitalist is interested in taking the company public via an IPO within three to five years or selling it outright. The venture capitalist will more than likely demand a seat on the board and/or introduces his management personnel. Under these circumstances, the business owner must approach venture capitalists firms with his eyes wide open, and in full agreement with the VCs vision.
Conversely, angel investors are not interested in taking control nor are they interested in taking the company public or selling it for profit. Besides close family and perhaps friends, there are also angel investors who can be approached for funding. These people will have an interest in your business sector, but they are not easy to find.
A Useful Video about how venture capitalists work.
How to Find Venture Capitalists Who Will Take an Interest in Your Business.
All businesses need capital, they need capital to start-up, they need working capital and they need capital to expand. There are three common ways to raise capital; borrow from family or friends, borrow from a bank or seek an equity injection from venture capitalists. In these difficult times, banks are taking a long hard look at small business before they agree to a loan. If your needs exceed the combined financial ability of your family and friends, you are left with venture capital as a logical solution.
However, even the top venture capitalists have tightened their belts since the dot com bubble burst in the ‘90s. When you begin your search just remember how to approach venture capitalists, with full
knowledge and agreement that, should you be entertained, you have not incurred a debt, you have gained a partner who will demand a quick turn around on his investment. Any venture capitalist will look at your business through a magnifying glass, they can even go so far as to like the business but feel your management style is sub-par, they will replace you as CEO if they feel that by doing so, the create a more powerful management.
What Do Venture Capitalists Look For?
ROI, return on investment, is a simple answer. This return can run as much as ten times their investment if they see the investment as high risk or a small investment, mid and late stage investors can look for anything between three and five times their investment, depending upon the state of the company’s finances. If the company is generating positive cash flow, the expected ROI will be lower.
Here is what you had better to bring to the table when you approach venture capitalists.
- The market plan: What you think and what a VC thinks can be very different. There is no entrepreneur that does not think his product is not the best thing since sliced bread. Be ready to support your ideas with tangible data to show that you can do your thing, cost effectively.
- Market size: The market size comprises the aggregate revenue of you, plus all your competitors. If the annual market is less than $100 million, you may have problems attracting the venture capitalist. Go prepared with data to support you assessment, as well as an assessment for a five year time frame.
- Competitive advantage: What is it? Can it be sustained? Can your product be copied easily and less expensively?
- Your management team: If you are a start-up or a relatively young company, this prerequisite is not all that important. When it becomes important is with later stage investments. Venture capitalists are by no means dumb and blind; look at Yahoo, Facebook and the likes.
Do You Think You Can Give Up the Reins?
Top venture capitalists want in, and want out. They work on a five year plan, maybe seven at tops. During that time they want the company groomed for either sale or to go public. Right from the start of your negotiations with venture capitalists, you must have your exit plan prepared. If you cannot stand the idea of giving up control, then equity finance from a VC is not for you.
What’s The Size of Your Deal?
The top venture capitalists firms will be looking for a deal of at least $1 million, the biggest firms look for deals in the range of $3 to 5 million dollars. If the progress of the company is spectacular, and they think more capital will grow the company bigger and faster, many more millions are available. If your needs are not in this range, you need to seek money elsewhere
The Stages of Finance.
Assuming you are successful in arranging equity participation by a VC, the normal cash injections are:
- Seed money: You have the idea but you do not have product.
- Start-up: capital needed in early stages, primarily for R&D.
- Round 1: Personnel recruitment, continued market research and product completion.
- Round 2: Working capital for companies not yet profitable.
- Late stage: Expansion funds when selling at a profit.
Your Due Diligence.
Venture capitalists evaluate you, you should also evaluate them. Assess their track record; do they have more success than failure? Do you like them? Remember, they will be on your board and they may also be involved with the day to day running of the company. Make sure that you and the venture capitalist fit like a hand in a glove.
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