Fundamentals in Procuring Venture Capital

Venture capital can be an important part of your overall financial strategy. Considered a type of risk capital, venture capital is known for its particularly thorough due diligence process.

That’s because venture capitalists are focused on selecting investments that have high potential of generating exceptional profits, as they expect sizable returns for their investments. Because of this, they tend to stick to companies that have well-established track records and those on the cusp of rapid growth.

Investors also look for companies operating in industries where they have expertise or at least a strong interest, and those in which they believe company goals can help them further their own. There are are other criteria that typically come into play. These investors often target niche markets with high entry barriers, for example.

Stand out from the crowd

If you are trying to attract venture capital, be prepared to put together and present a top-shelf proposal. That means not only do you need to go into detail, but you need something that is going to spark excitement in what you’re proposing. In addition to looking for something they can get excited about, venture capitalists will also be looking for talented management teams with a proven track record of success.

Venture capital financing differs from most other forms of financing because it requires you to give up a portion of ownership and control in your company  to the investor. This can sometimes be a stumbling block for companies that would otherwise be good candidates for attracting this segment of investors.

The amount of ownership and control you hand over will depend on the deal that is struck. Because of this, venture capital is considered to be an equity position rather than debt.

For the most part, and for obvious reasons, VC deals are more complex than other forms of financing, such as business loans. This is primarily because outside investors become directly involved in the business.

Once you find a suitable venture capitalist for your business, expect that he or she will have a list of criteria they will want to meet when making the decision whether to invest and in constructing the deal. These typically include matters of basic financial parameters as well as level of influence, amount of investment on the business owner’s part, minimizing tax consequences and ability to liquidate if the venture proves unsuccessful.

Although venture capitalists don’t typically want to run the day-to-day operations of a company, they do want assurance that the company is being managed appropriately in exchange for their sizable investment. Any deal will need to define the day-to-day operations and voting control. In fact, investors will typically expect to have the authority to change management if they feel necessary for the sake of their investment.

A “win-win” attitude is important to pulling off a successful deal since the stakes are high for both parties and both parties will need to benefit. You can expect a venture capitalist to use a range of financing instruments in putting together the deal. These might include:

  • Preferred stock, which gives the holder preference over common stockholders.
  • Common stock, which is expensive for the company owner and also the most risky overall.
  • Senior debt, characterized by its use for long-term financing for lower risk companies or sometimes in later stage funding.
  • Subordinated debenture or debt that is secondary to financing from other financial institutions.

Bottom line: It’s common for business owners to look for venture capital, but have a lot of misconceptions about how this funding actually works. Too many entrepreneurs think of VC in terms of a loan without monthly payments rather than in terms of equity. Too often, they also look at it as 100 percent financing and are less concerned about having skin in the game and more concerned about maintaining full control. This is not the mindset for seeking VC. 

Equally damaging is a thought process that if you don’t quality for a bank loan, you can just turn to some person of wealth and expect them to write a blank check without completing the standard due diligence. It’s important, instead, to realize these are sophisticated investors and you need to bring your best game to the table.

Nate Nead on LinkedinNate Nead on Twitter
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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