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Understanding Venture Capital: Realistic Opportunity Evaluation

25 Jan Understanding Venture Capital: Realistic Opportunity Evaluation

Business owners often have misconceptions about venture capital while at the same time wanting to incorporate it into their business financial strategy.

Unrealistic Expectations

One of the most common misunderstandings occurs when company owners think of venture capital (vc) in the same way they think of a loan, only without the monthly payments. In other words, they think of it in terms of debt, rather than equity.

Another common misstep is to approach potential deals with the idea of achieving 100 percent financing, while also maintaining 100 percent control over the company, a scenario that is simply unrealistic but too often the expectation.

And finally, there is the all-too-common expectation among business owners that when they were unable to qualify for a bank loan, they will be able to persuade a wealthy investor to write a check without completing standard due diligence first.

Respect the Funding Source

As a business owner, if you allow any of the above expectations to creep into your search for financing, you will soon run into difficulty. Venture capitalists are sophisticated investors who are adept at analyzing potential business investments. They will know immediately if you are trying to waste their time with unrealistic funding needs. If you are working with a consultant, you are asking that professional to risk their reputation by pushing them to sell what is clearly an un-fundable deal. Few will be willing to do this because they would be risking too many future deals where financing is sound.

As a business owner, you and any consultant you involve, must respect potential investors and their processes.

Structuring the Deal

Assuming you have realistic expectations and your company has something of value to offer investors, you may turn your attention to a possible financial structure. There is no set formula for a vc deal; the goal is to adequately meet the needs of both parties. You may find your best option for the financing structure is a combination or modification of financing instruments in a way that allows flexibility for meeting the needs of your particular situation.

Considering vc is a high-risk investment, the deal needs to be structured appropriately. Sometimes a small business owner may be viewed by potential venture capitalists as at risk of obstructing growth, mismanaging the business or harming the potential to move into the next stages of funding. Therefore, it is important for the deal structure to clearly state terms which both parties agree will result in a constructive relationship and the greatest opportunity for success of the funded business.

Moving Forward with VC

Venture capital is considered risk capital, used for high risk investments typically in the form of equity. It only stands to reason, then, that vc firms are only going to consider taking that risk after extensive and thorough due diligence. High-risk investors also expect high returns on their investment.

Your business is in the best position for a vc deal if it is an established company, on the cusp of rapid growth and exceptional profits. Niche markets are particularly attractive, especially those with unusually high entry barriers and superstars for managers.

Another important consideration is that company objectives be in line with those of potential investors. Investors are often looking for a unique and exciting project or business and talented staff. It’s important that the package you present to investors adequately showcases all of these assets. It must be professionally done and offer potential investors compelling information with a call to action based on sound financial reasoning. The personal presentation should excite your targeted audience.

Keep in mind you will be selling an interest in your company. That means relinquishing a portion of that ownership, along with a portion of the control, of your business and turning it over to the investor. How much ownership and control you must exchange for the investment will be a matter of the deal’s specifics.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.
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