Venture capital offers an ideal source of capital funding for innovative startups and small businesses that are past the seed funding stage and primed for growth. This form of equity funding plays a key role is supporting the development and expansion of small business in the United States. Its impact is easily judged by the fact that, in 2010, there were approximately 460 active venture capital firms managing over $175 billion in invested capital; the average amount per firm was roughly $149 million.
What is a Venture Capitalist?
Venture capitalists provide equity funding to small businesses and startups that they believe have high growth potential, with the goal of making a profit. In exchange for their injection of growth capital, venture capitalists receive a percentage of a startup's stock. They help the young enterprise grow, and then liquidate their holdings when the stock has reached a market value that offers them a good ROI. Most companies who receive venture capital funding do not qualify for traditional financing due to their lack of credit history, track record, or assets. Many firms are limited partnerships between several venture capitalists who oversee a large pool of money invested by other sources, often between $25 million and $1 billion. They typically develop a portfolio of investments by working with multiple start-up companies.
What do Venture Capitalists Expect?
Venture capitalists invest in only about 1% of the prospects who approach them, and prefer to minimize their risk by partnering with start-ups where they have confidence in the people, the product, the market opportunity, and the company's valuation. This confidence is obtained through a thorough due diligence. Venture capitalists do not want to take over a business, and most will expect only a 10% to 20% stake in the company, and a seat on the board. A venture capitalist is not after a controlling interest, as they do not want to run a small business on a daily basis; they want to keep an eye on their investment and ensure that everything is running smoothly.
How to Find a Venture Capital Firm
There are several ways to go about locating venture capital firms that may be interested in investing in your small business or start-up. Usually, these firms focus on a particular industry and niche, so it is important to tailor a search towards your company's specialty, and investigate and identify several venture capital firms that match your goals. Since many venture capitalists only work with companies they are familiar with, or that have been referred to them, start your search by talking with your business contacts such as your lawyer, accountant, other entrepreneurs, even friends and family, to discover if they know anyone on your list. If so, ask for an introduction. A small business owner can also open a dialogue with a venture capitalist by commenting on their blog posts regularly, or by starting an email conversation. Other useful tools are the many online directories that list venture capital firms. In your search for a venture capitalist, keep in mind that your company is looking for investment partners, conceivably for a five to fifteen year period; it should be a two-way relationship that will help your company realize its full potential.
How to Pitch to a Venture Capital Firm
Most venture capital firms consider hundreds, if not thousands, of potential prospects every year, so their time is limited and valuable. Arranging the opportunity to meet with a venture capitalist can be a major hurdle, and a smart small business owner will not waste it by being ill prepared when they present their funding appeal.
In preparation for a meeting with a venture capital firm, it is important to develop a well thought out business plan and executive summary detailing the experience of the company's key contributors and employees. Plan to use a power point presentation, and keep it simple and easy-to-understand. Describe the uniqueness of your business, its competitive edge and why it stands out from the crowd. Other points of your presentation should be your team, your company's market size, your marketing strategy and what stage of development your business is at. You'll need to provide believable projections that ideally target the $50 to $100 million growth stage to make them attractive to a potential investor. Mention the dollar range of funding you are seeking. Be authentic and honest, and expect to be questioned and tested; a well planned presentation should lead your audience to ask questions that you came prepared to answer. Remember that you are selling yourself and your company, and look at the venture capitalist as if they were your most valuable customer.
The Term Sheet
If you have caught the interest of a venture capitalist and they want to learn more, they will investigate and evaluate your company, and then discuss terms based on their valuation. The basis for the discussions will be a term sheet, also called a letter of intent, that outlines the responsibilities and obligations of both parties. Most experienced venture capitalists will ensure that the sheet states that it is non-binding. The amount of investment and any securities the venture capital firm will receive in exchange will be covered, as well as securities required from the company owner, such as a personal guarantee. If the funding is to be advanced in stages, the term sheet will discuss the necessary milestones. The investor's stock conversion, anti-dilution and redemption/repurchase and dividend rights and their rights in the event that the company is dissolved will also be covered. The venture capital firms rights regarding voting and board representation are included, as well as all representations, warranties, covenants and other agreements between the two parties. It will also cover what will take place in case of a default by either party, and will list what conditions must be met prior to signing closing documents. Both parties sign the term sheet after negotiating and fine-tuning the details.
When negotiating, keep in mind that a venture capitalist's valuation is ultimately a reflection of the market and what someone is willing to pay for a stake in your company, with its future worth factored in. Flexibility in ironing out the details will take you to closing, and then your small business or startup will have the capital funding needed to grow and expand.
Get funding to grow your small business
Let us help you find the best financing option for your business needs.
Stay up-to-date with our small business newsletter
Subscribe to our weekly digest that features the latest in small business funding news along with helpful tips to guide you in our business financing needs