Many successful businesses got funded by a venture capitalist (VC) when starting-up. After all, it seems that VCs have lots of money to invest. In fact, in 2018, the value of VC investments in the United States amounted to approximately 99.5 billion U.S. dollars (Statista).
So, if can’t get enough money to get your business started, but you’ve a (really!) great business idea, then getting a venture capitalist to invest may be a sound idea…However, VCs have, just like all other funders, loaners and investors, their own criteria and standards they use to evaluate investment opportunities.
And there’s a good reason why VCs are so picky on where to invest their capital. Tomer Dean from TechCrunch not long ago interviewed a well-known venture capitalist. The VC had the following to say about the success rate of start-ups:
“Facts of life are that startups are hard. Breaking even is hard. Profits are hard. Keeping profits growing year over year (YoY) is even harder. Out of 10 companies, only two will really explode and giving our dear VCs some of their money back. The rest, as we’ll see, will fizzle out and die — or have a small liquidation event, which is pretty much the same.”
Only a 20% success rate? It’s no wonder a venture capitalist needs to be as tough as nails…
What is a Venture Capitalist?
A venture capitalist (VC) is an investor that provides capital to firms exhibiting high growth potential in exchange for an equity stake (Investopidia). Indeed, according to Mason and Stark (2004), VCs are investing for capital gain and, in contrast to the banker, they share in the success of the businesses that they invest in.
Therefore, the venture capitalist and the bank have a different perspective if they read the same business plan of a start-up. Mason (2010) shows in the table below the differences in business plans for banks and that for venture capitalists…
|Bankers (Debt)||Venture Capitalists (Equity)|
|Emphasis on collateral||Emphasis on customers' need for product|
|Negative covenants in loan agreement||Seats on board - debt warrants|
|Ratio analysis||Value of stock|
|How the bank will gets its money back||Expected return for investors|
|Owners' financial statements||Owners' background|
Whereas a bank want guarantees that you’ll pay its money back; the venture capitalist wants the get involve in your business and make heaps of money. After all, the one is a bureaucrat and the other one is a capitalist – two different kinds of beasts indeed…
Nevertheless, you need money for your startup. So let’s have a look how to approach a VC to get it.
How to get funded by a Venture Capitalist
Yes, you need a VC to fall in love with your business idea. Sadly, a VC won’t just fund your business because of love… she’ll do it 100% to make money – lots of money…
So, how do you sell your business idea to a venture capitalist?
Richard Harroch and Larry Kane in Forbes recently published the following questions that VCs are likely to ask when they consider funding your business idea:
- How good is the management? The investors will want to know that the team has the right set of skills, drive, experience, and temperament to grow the business.
- How big is the market opportunity? Most investors are looking for businesses that can scale and become meaningful.
- What positive early traction has your company thus far achieved? If your company has obtained early traction it will be more likely to obtain venture financing and with better terms.
- Are you passionate and determined? You need to be willing to grow your business and also to face challenges.
- Do you understand your business’s finances and how to measure it? You need to show that you have a handle on all of those and to communicate them effectively.
- Did you have someone that introduced you to the VC? The way to capture the attention of a venture capitalist is to get a warm introduction from a trusted colleague.
- What are the potential risks to your business? Investors want to understand what risks there might be to the business.
- Why is your company’s product great? VCs love it if your company can offer unique products that customers want.
- How will you use the VC’s money and how will it make the capital grow? Investors will absolutely want to know how their capital will be invested.
- Is the valuation of your company realistic? Often, it’s best not to discuss valuation in a first meeting other than to say you expect to be reasonable on valuation.
- Does your company have differentiated technology? An analysis of the start-up’s technology or proposed technology is critical.
- What is your company’s intellectual property? For many companies, their intellectual property will be a key to success.
- Are your company’s financial projections realistic and interesting? Investors want to invest in a company that can grow significantly and become an exciting business.
- Is Your Legal Formation Clean and in Compliance with Applicable Laws? Investors don’t want to invest in a company that has legal issues with the founders or third parties.
The big thing is to be honest about your business and yourself…
Lastly, be very well prepared should you get invited by a venture capitalist to make your business case. Beware, if you’re not in love with your business idea, how on earth will you convince a VC to invest her money in your idea?
A well-researched and written Business Plan helps to get your business started the right way.
Mancuso, J.R. 2010. How to Get a Business Loan, Simon and Schuster.
Mason, C. and Stark, M. 2004. What do investors look for in a business plan? A comparison of the investment criteria of bankers, venture capitalists and business angels, International Small Business Journal, 22(3):227-248.