Ins & Outs of Venture Capital

Key learning from a CEO Roundtable Contributed by Bruce Law, principal and founder, Sprout Marketing

The following pointers surfaced in a recent CEO Roundtable discussion focused on the ins and outs of raising institutional money from venture capital firms.

Questions that Venture Capitalist ask themselves

• Am I going to make money?
• Does the company have a winning management team? VCs are instinctively team players and need to have confidence in the management team.
• Where is the company going?
• What’s the potential for return?
• What’s your track record? If the CEO is not experienced, does he or she have individuals on the advisory board who are?

What VCs want

• Returns of 8-10 times within 3-5 years
• The lowest possible valuation without the management team walking, in order to help guarantee a maximum return
• To quickly find an excuse not to fund a company; VCs are better off not funding a company than funding it and losing money.

When to think about raising money

• Don’t go to a VC in the hour of desperation unless you want to give away your company. Raise money before you need it.
• Allow the necessary time – it may take 6-12 months.
• Profitability is the fastest way to get high valuation. If you can survive to profitability, your chances of raising money and preserving ownership are higher.

Things to remember as you select a Venture Capital group

• Spend time researching the VCs you are targeting. Be aware of each of their portfolio companies before you pitch them. They may shop business plans to your competitors. VCs never sign NDAs.
• Look for a VC that will add value beyond just money. It is better to get credible, smart money than to receive nice angel money with no incremental value.
• Subscribe to VentureWire or VentureOne so you can speak intelligently about valuations of other like companies in your industry.

Things to remember when negotiating with a VC

• Be honest. Be willing to talk about holes or weak spots in your company or strategy.
• Commit your VC in the first round to help you raise the second and third rounds. Name brand VCs like Kleiner Perkins, Mayfield, Benchmark, and so on, can command lower valuations because of their track record and the greater potential for returns. The ‘A’ round sets the stage; take as much money on an ‘A’ round as you can. Lots of due diligence takes place in the ‘A’ round so be prepared to go the distance and get scrutinized heavily.
• Don’t get hung up on ownership percentages. The reality is, the VCs will be able to control the company anyway.
• Hire a qualified lawyer to create the Private Placement Memorandum (PPM) and have them walk it into a VC. This shows you are serious and that you do things right. Negotiate a cap for the VCs lawyer (keep it to $15,000). Split the due diligence from the document preparation

What to do as you prepare to raise capital

• Write your own business plan – you have to care that much about your business
• Spend time every day on the fundraising process even if it’s only to get outside opinions from credible sources on your business plan.
• Stay away from VC brokers. They add no value.
• Hire skilled, high quality legal counsel to get your rounds financed (expect to pay $15-30,000 for each round).

Things to remember as you start your meetings with VCs

• Get introduced at the right level from the start. This can be achieved by using a legal or accounting firm.
• Once a deal is inked, these firms become helpful allies.
• Leave the best possible impression with every VC with whom you meet. It’s a small industry and everyone talks.
• Generate buzz early; VCs like to fund companies with buzz.

Issues to watch for in a VC term sheet

• Liquidity preference – 1-3 times
• Participating preferred
• Preferred in kind (PIK) – avoid the PIK
• Option pools – make sure it’s accurate
• Ratchet clauses
• Avoid draw down strategies – take long-term runways

| 8/25/2006 11:38:37 AM | 0 Comments