You start thinking of outside funding. If you have zeroed in and joined the bandwagon of millions seeking Venture Capital funding (VC), you need to distinguish yourself and stand out. It is easy to talk about VC funding, but not so easy to be a VC funded business. It’s not a casino game, where luck and charm playing the pivotal part. It’s your hard-work and preparation that paves the way for it.
Phase 1: The Rehearsal (Before you approach the VC for funding)
Life is a play without rehearsals… well may be life, but definitely not so with the VC funding adventure. Rehearsals pay of here.
While in this stage, you need to be crystal clear about the following:
How much capital do you really need?
What difference does it make how much you have? What you do not have, amounts to much more.
– Seneca, Roman Stoic Philosopher– Seneca, Roman Stoic Philosopher
You have to calculate the amount you actually need. Have a clear idea of the amount you have available, and figure out the amount that needs to be raised, knowing this makes a world of difference.
While calculating the capital needed, bear in mind the following:
- Use the bottom up approach. Account for all overhead and find the amount that you need to run your business for 1-2 years. Aiming at the usual amounts being dispensed by VC’s is not the right way.
- Provide for all operating costs, including your salary.
- Give provision for a long break-even period.
- The cost and time may be double your expectation, so calculate accordingly. Be conservative and be prepared to face the worst case scenario.
What stage of capital should you target for VC funding?
Once you know the amount of capital to be raised, you need to assure the business is in the right stage for seeking VC funding. There are no perfect seasons of VC funding. But there are certain stages in the business development cycle when it is perfect to seek VC funding.
If you are still in the early stages/seed stages, and the idea is just germinating, your capital requirement should be low. Then, it definitely is not yet time to go for VC funding. In these stages, it is advisable to raise a small round of capital from your savings, family, or friends. Use it to incorporate, build your team, create your product, sell it, and make revenue, however small it is. At this juncture, bootstrapping and low burn rates are the two concepts that will help you march forward. Once you are past the seed stage and into the start-up stage, where you have a refined product, larger market share, survived market traction, commendable past performance, and see a larger growth potential, you have to expand, and this needs more funds. If your dream and excitement are still alive, this is the perfect part of the Act for the VC’s to step in.
What Sector is the VC investing in?
Do the VCs have their preferences? Yes, VCs too have their own comfort zones. Technology, life science, and recently biotech are the three sectors that have received the most VC funding. They tend to shy away from certain sectors, including consulting business and professional service centric business. The reason could be that they are more people centric, less technology oriented, and are not scalable.
What do you require?
Ask for money, you’ll get advice. Ask for advice, you‘ll get money.
Is it just funds that you are looking for? Or a bit of advice too? VC funding is not just about getting funds.
Many VCs are seasoned entrepreneurs, who have gone through the same hills and are ready to share the wisdom gained from their experience. Which investor can better understand the ups and downs of a start-up business and guide you appropriately? But not all have the time and patience. There are two types of investors-those who give you money and the others who give money and knowledge, commonly known as the strategic investor.
The advice from a seasoned investor is very critical and should be one of the reasons you target VC funding. But the final choice depends on the entrepreneur. And so keep this in mind while approaching various VC’s.
Network is your net worth, it’s who you know
You need to find investors. Now is the time to pitch into action.
Create a target list of VC’s. It is not that difficult, considering you have the world at your fingertips with the internet and advent of various communities in social media.
With the growth of social networking, you can definitely make use of professional networking sites, like LinkedIn and Palico. Sites like Angellist allow people to invest directly in start-ups. Offline networking is equally important. Lawyers dealing with start-ups can be an important source of information. You can also extend your network to VC through your industry connections. And best of all, newspapers can give you details of recent deals, and following this can be helpful. Try to meet CEOs of recent start-up companies. Having recently gone through the litmus test, they can give you lots of information.
Once the list is created then comes the question of pitching. How do you get in? Yes, the introduction to VC means a lot. VCs receive hundreds of ideas each day. So make a mark and stand out right from day 1 to get noticed. Rule out introduction through emails. VC’s are not keen on cold calls. Referencing is crucial. References from fellow entrepreneurs, industry experts, and other investors are the most effective means. That’s why it’s said that your network is your net worth.
The process of pitching to a VC is a rather lengthy one. Having a large list doesn’t necessarily mean you can contact all the VCs in the list. Be selective of the investors to be approached. Each VC has their own preference for sectors, type, stage, and domains in which they invest. This information can be researched from their websites. So before approaching, check the different VCs and select those who are specialised in your line, stage, and domain of business. This will help you shorten or, even better, sharpen your list of ‘right investors’.
Well prepared is half won…. now is the time to let your business interest take a back seat. At this juncture, you need to invest your time in getting to know the VCs on the list. In dealing with the VC, remember it is not a single person with whom you are dealing. There will be multiple stakeholders. Identify the persons who have experience in your line or stage of business, as they will be the ones with whom you can connect easily and who will play along with you during the pitch. Identifying the influencers and decision makers in each VC strengthens your defence. Get to network with them. Social meetings with recently funded entrepreneurs will help you garner such information. By the time you prepare your final list for pitching, you should be thorough with the ins and outs of each VC on your list.
A word of caution: understand the thin line between giving too much information and building relationships.
The Business Plan
Planning is the first step to any action. VC funding adventure doesn’t stand an exception. Create a roadmap or a business plan. Different VCs have different opinions on this. According to some leading venture capitalists, a well-developed plan tells you the extent to which you are prepared. It also gives an impression that you have gone through the idea carefully and meticulously.
But there is a counter view that a fifty page document would not mean anything to the VC, and most of the plans they see at this point are fairy tales, with the entrepreneur showcasing his product as a remedy for all problems in the world and how it is going to change the world. As Derek Sivers, founder of CD Baby, says you don’t wait for big things to happen to start your movement. If you have an idea, start it in the smallest way possible. It took him just a few days to build CD Baby as he had already built a website for himself.
That said, many are of the opinion that a business plan is much required. From the entrepreneur’s point of view, it gives an idea of what to expect and what is expected of you. It acts as a road map to direct you. It also helps get your point across to the VC clearly. From the VC point of view, it tells them you are prepared.
Your business plan ideally should include company overview or problem statement, industry overview, financial overview, SWOT analysis, performance review, and financial projections. It should also cover experience in the business or with the concept, your accomplishments, and achievements.
Idea vs. Execution
Great idea and great plans with a ready list of VCs to be approached – Think you are all set? Think again; you get a ‘No’ for an answer. Your pitching with the VC will be more effective and simpler if you have started, at least in a small way. This will convince the VC it is not just sweet nothings and showcases your ability to do things. But this isn’t enough for the VC. He needs to see that his money will not be idled away. What better way to show this than by starting off and putting it into action?
- Incorporate with the small amount you have saved.
- Build trust and get people to work with you or develop a team: VCs are not just interested in your product or service. They look for a persistent and passionate person with a good team. You have an idea, and if you are still not able to attract people to join your team, it shows your failure. So it is important to have a good team with different capabilities working towards a common goal.
- Develop the prototype or product: Till now, it was just an idea. You can draw the lines and wires in air and try to sell it to the VC. But for a person ready to support you with money, the VC would appreciate if you can get the prototype or beta version ready and probably test out your market readiness and make sure you are developing the right product for the right time.
- Sell and start earning revenue: Sell the product! However small the market, sell and start earning revenue. The amount does not matter much. It reflects your persuasiveness to bring your dream to reality. It also shows that you have overcome the traction.
This is not just for a start-up; it applies equally at the expansion stage when you have a new idea/ planned a new product. This tells the VC that you are a doer, and that separates you from the talkers.
The Elevator Pitch
The stage is set. It is now up to you to pull your act together. Prepare to present your idea to the VC in a way that makes the VC want to partner with you. Your presentation should be short and crisp. Keep in mind that it should answer questions like:
- Why do you want to raise money? It should clearly state the purpose of VC funding.
- Why should the VC give you money? Think from the VC point of view and explain how this is going to be feasible for the VC (exit plan).
- What makes your product or service different from that of your competitors? Explain that your product is not just another me-too product.
- What is stopping your company from doing what you are proposing? Clearly outline the progress you have made to date. It should be that you are doing your best and require the support of VC to take it to a larger level.
Phase 2: The Act (The Art of Presenting…)
The generally accepted practice of pitching is using a PowerPoint presentation, which could contain 15 slides or less. Another good rule, as proposed by Guy Kawasaki, entrepreneur, evangelist, and speaker, is the 10/20/30 rule; 10 slides, 20 minutes, 30 point font. It is also prudent to make your PowerPoint as visual as possible, and a human touch to the entire presentation is always appreciated.
Here is a guideline on data points to be included in the presentation a.k.a. the ‘Deck’.
- Start your presentation with a brief on your experience and credentials of the team, so the person on the other side of the table gets an idea of why are you in this business.
- The next slide could give an overview of your company, but keep it really simple, as you will obviously dive into the details as you advance.
- The next couple of slides can deal with the gaps in the market and your business approach towards filling that gap. You are trying to pitch to the VC that there is indeed a problem in the market, and you have the right solution to address it.
- Convince the VC investor that your product is unique and can’t be easily replicated. These slides are very important in the sense that you have a solid reason as to why you created this business. At this stage, it is advisable to show them a demo of your product, so the VC gets to visualize your product. The demo should only be a walk-through on the most gripping problems you intend to solve; do not divulge details.
- The next few slides should ideally deal with market sizing, competition, and customer adoption. A majority of entrepreneurs are stuck or so obsessed with their product that they fail to assess the market. Be specific and breakdown the market size of the category you wish to address. You need to be prepared, with the next 5 year growth projections for the industry, with reasons. Do your homework well on this section, as the VC partners may come up with several questions in this section to do back of the hand calculations. They are generally very good at this, as they see presentations day in and day out.
- The competition slide is the relatively easy one. It helps you emphasise what makes you different from the crowd and how you plan to erect barriers to future competitions.
- Last but not least, you need to discuss the financial projections of your company, time lines within which revenues will start growing, a substantial customer base will be established, expansion plans etc. Define what kind of capital you need, at what stage, how much at each stage and what your intentions are once you receive the proceeds. Give a detailed timeframe on what you will accomplish at each stage of funding.
The idea is to give the VC an understanding of how you propose to shape your business. But to end the presentation with the financials could be a little boring, so find something interesting with which to end.
A pitch is where you are being judged; it is the opportunity to make the first impression. The more you pitch, the more you learn from the process, and by the end of the exercise, if nothing else, you will have mastered Excel and PowerPoint.
All said and done, PowerPoint is just an effective tool; the deal doesn’t happen watching presentations alone. (Yes, if you’re Apple Fanboy – the Mac’s KeyPoint does the job just as good as PowerPoint).
How to deal with the dreaded question of valuation?
At some point, you’ll have to address this. What is valuation? In simple terms, it is the price at which the VC is willing to invest in your company. The amount he invests would be directly proportional to the control he would gain in your company.
Valuations require an examination of several aspects, such as future potential of the product, CEO’s past experience, credentials of the team, competitive positioning in the industry, customer base, and location of the company.
Valuations are always subjective, depending on the perspectives of both the entrepreneur and the investor. It is a compromise between the VC, who bargains for maximum equity at minimum capital, and the entrepreneur, who wants to give up minimum control for maximum capital. But it must be a ballpark figure with realistic expectations from both sides. Always remember that your time is your money. The investor can look elsewhere and has hundreds of options to create wealth, but you have just one business. Let the VC come up with a number, but let them know in a polite way that you are aware of the valuations in the market. If you have already pitched to a couple of VCs without success, don’t show your anxiety.
However, valuation is just one of the important yardsticks. The way the investors’ money is structured into your equity is of utmost importance as well. Investors, generally favour “preferred stock”, which have certain rights over common stock. Investors will also have “liquidation preference” in the terms, which simply means, who gets first access to the assets in case of dissolution of the company. Other factors, like VC’s experience and access to IPO markets, should also be considered.
Phase 3: The Fans (Dealing with fans and failures)
Timing & Luck
You might wonder what makes a VC fund certain ideas over others. Every entrepreneur has the passion, conviction, and confidence to sell his powerful business concept. Is it the chance meeting the entrepreneur had with the VC that culminated in the funding? Well, could be, but pitching to VCs also needs plenty of preparation, experience, presentation skills, and a good business plan. VCs invest in people first and ideas next. They feel ideas actually reflect the approach of the founder. So, before you qualify it as luck, next time, remember the better prepared you are, the more chances of success.
And of course, as the old adage goes, “being in the right place at the right time” also helps. You need to target the right firm and the exact partner with knowledge in the market of your choice. Each VC is different and has a liking for a certain style of pitching. It is imperative that you get as much information as possible about the VC before you pitch and adjust your style accordingly. If you are unable to collect information about the VC, take cues from early in the presentation and change.
Unfortunately, entrepreneurs fail to follow-up most of the time, usually send a single mail to an investor and that’s it. VCs too are notoriously famous for not responding, though they can’t be blamed entirely. They look at hundreds of pitches to say YES to one investment. So, if you are going to send just one email and wait for a response, then you are not worth their money. As they say, fortune is in the follow up. It is important to send regular updates on the progress of your business to the VC. When you have achieved a significant milestone in your business, request for a meeting, and explain what you have done differently.
Term Sheet – The Answer Is YES (almost)
You just received the “Term Sheet.” Yes! That’s proof enough that the venture capitalists are interested, and you have achieved a significant milestone. A “term sheet” is a letter of intent that outlines the terms on which the VC is willing to invest. But before you get carried away, wait, stop, and pause. The real deal has just begun. This is the beginning of the end…
It is important to understand that the Term Sheet is not necessarily a legally binding contract and could always be reworded. Broadly, the contents of this document include the amount the VC is willing to invest, the control you are expected to give up, management structures, and acquisition clause.
An effective approach to building relationships with investors will result in multiple term sheets at this juncture. This will not only create a level playing field for you in terms of negotiation, but help in getting better terms and higher valuations.
The VC due diligence starts soon after you agree on the Term Sheet, and the digging in your backyard almost immediately follows suit. The process of due diligence, however, will depend on whether you are an early stage company or looking at expansion capital. If you are in the latter category, then the investor would definitely want to look at your financials, distributors, and customer base and would also expect you to answer an exhaustive questionnaire. The last and final phase of pitching is “the close” (yes, the pitch is not over), which means both parties are ready for the legal agreement.
The average time for a typical close is around 45 days; however, a wait of more than 4 months can mean that the deal is at risk.
We briefly discussed terms, like valuation, preferred stock, and liquidation preferences of a VC, in the previous section. A clear understanding of option pool size, founder revesting of shares, veto rights, and board structure would also help in negotiating the deal.
The other factors to which you need to pay attention while selecting your VC would be your relationship with your partner, the partner’s experience, history of successful exits from the partner, and the VC network.
We just painted a rosy picture of striking a deal with the VC. But as already mentioned, things ain’t so easy. Borrowing the words of Guy Kawasaki, “The probability of an entrepreneur getting venture capital is the same as getting struck by lightning while standing at the bottom of a swimming pool on a sunny day.” So, what do you do when the answer is NO? Stay calm; you are not the first person to be rejected, and the one to whom you presented is not the only VC.
Keep your line of communication with the investor open. Send regular email updates to the VC on something exciting happening in your company. Let the VC know that you are hiring people, getting positive product reviews, signing deals with distributors, and shipping products. In short, be persistent, but not bothersome.
VC funding is just one way to raise institutional money. A few other alternatives to funding include:
A very important element to entrepreneurial success is to learn the art of bootstrapping. In simple terms, bootstrapping means you fund and build a business using your own finances. Bootstrapping enables you to raise capital at a much higher valuation, apart from retaining absolute control over the company. The disadvantage, however, is you are cash starved.
Crowd funding, a relatively new concept, allows small companies to accept a limited amount of money from a large number of people. Here, individuals donate funds for specific benefits, like company merchandise. The popular websites that support crowd funding initiatives are KickStarter.com and GoFundMe.com. Though it’s much easier to raise money through this method, you are going to disclose a lot of information to your competitors, even before you are actually ready with your product. (Check out this detailed resource for crowdfunding and launch your business)
Friends & Family
Family and friends are the first set of people to believe in your business and are great people to start with. The downside to this is the risk of strained relationships if the business fails.
Those in the U.S. have the advantages of SBA. The Small Business Administration (SBA) loans are considered as one of the best sources of funding. It is a US government entity, which provides financial assistance programs to small business owners. SBA acts as a guarantor for the loans paid by its partners. The SBA loan guaranty practices are subject to change, according to the economic scenario of the country.
So brace yourselves… you still hold the chance… embrace your dreams… passionately work on it… then success cannot elude you for long!