Venture Capital (VC) is the source of equity funding for many startups and also larger businesses looking for their next stage of growth.
VCs’ usually fund millions into businesses and should only be looked at when you need millions and when you have exhausted all other sources of funding.
VCs’ obtain their own funding from pension funds and high net worth individuals and look for high returns, usually around an annually compounded rate of 25% as a minimum. They will also look at a relatively short time frame to exit, usually 5 years. With such returns, VCs’ will look to invest say £20 million and get about £60m on a 5 year exit. VCs’ look to obtain funding over 5 years and then try to invest those funds into businesses that have potential high returns. They keep doing that for a fee and a share of the returns.
So what do you need to consider when looking for VC funding? Here’s a few critical areas to consider when you start talking to VCs’.
1. Solid Business Plan – as with any external equity investors, you must have a solid business plan and understand the business.
2. Experienced management team – VCs’ will always look at the team and how it can deliver the results even if the industry sector has lots of competition.
3. High returns and exit term – they are investing other people’s funds and on average only about 30% of their investments really pay off, so they need to generate at least 25% annual compounded returns. VCs’ are not long-term investors usually and a 5 years term is the norm to exit, so make sure your strategy complements that.
4. Proof of revenue – unless the plan is exceptional, most VCs’ like to see proof of concept and there’s nothing like having some revenue streams coming in already. It will also strengthen your leverage with them.
5. Passion – if you don’t have a compelling reason to be doing it, why would a VC invest someone else’s money into your business?
6. Industry sector – ensure you talk to VCs’ who have invested and are interested in your sector be it IT, biotech or other.
7. Understand the risks – identify and know the risks of the business since VCs’ will try to reduce this by possibly changing your business plan. If you know the risks and can discuss them openly, the better. Also, ensure you get confidentiality agreements signed before you discuss your plans.
8. Control – unlike angels, VCs’ may want control of your company to meet their returns and also dictate how the business is run. So large equity sums can mean loss of control.
9. Partnership – look for evidence if they will make a good partner. Running and growing a business is tough enough but you must have the right partner who can help. Make sure you speak with other entrepreneurs they have invested into to see if the match is right for you.
10. Valuation – ensure you talk to a few VCs’ and foster some competition so that when your business is valued, you can negotiate a fair share. This is more likely if there is more than one VC competing to invest and a higher valuation can help you keep more of your company with eventually higher rewards.
Finally, VC equity can be very expensive so ensure you talk to the right ones, negotiate hard when the time comes and work in partnership to make the business a success.
[Contributed by Asoka, Independent Finance Director and Management Consultant based in London. He works with growing companies as their part time Finance Director and is the Founder of AKCA Consulting, which helps companies improve their financial health.]