1. Prepare a Comprehensive and Well-Researched Business Plan

2. Establish Your ‘Dream Team’

3. Prepare for Your Interview(s)

A business plan and proposal letter are only the means to getting an invitation for a comprehensive interview. Be prepared to ‘wow’ a VC firm with your preparation. That means designing a 5-10 minute presentation that you have practiced over and over.  It also means being prepared with answers to tough questions about your business venture. An unprepared entrepreneur will quickly see a closed door.

4. Identify The Proper Venture Capital Firms

What is dilution and how can you avoid getting ‘diluted’ out of your proper share of a start-up company? Consider a cup of water with a few drops of food coloring. You can easily see the coloring in the water. However, after adding three more gallons of water, the color of the water is diluted so much that you can hardly discern it at all.

The same thing happens when more and more money is invested in a start-up company. The more a venture capital invests start up financing in a business, the more equity they will claim in the company and dilute the founders to a less substantial position.

What can you do to assure that you and your co-founders of a start-up company are not completely diluted? Here are a few tips.

Ask How Much Dilution is Likely to Occur

When working with venture capital firm for your start up financing, be completely upfront and ask how much dilution may occur. This is especially important if you expect at least three rounds of start up financing.

The more successful your start up company is, and the more value it gains with each stage of start up financing, the better off you’ll be. However, do realize that if your business value remains about the same or even decreases, your amount of dilution will increase at a dramatic rate.

Obtain a Dilution Schedule

It is perfectly within your right to obtain a dilution schedule. A dilution schedule is simply a matrix listing each current ownership interest, including yours, your co-founders, mangers, and the venture capital group(s).

The matrix should also list all the series of start up financing A, B, C, etc, plus any convertible notes, warrants, common stock, and any convertible preferred stock. The total amount of equity interest for each party should add up to 100%. Double check the math and be sure to discuss any dilution that seems out of the ordinary.

Your start up business may not grow at the rate that Facebook did when it first hit the market. However, even so, you need to protect your equity interest and avoid over dilution.

However, don’t get over-zealous and lay down unrealistic market opportunities. Venture capital firms want to see a sizable market, but it must be realistic.

Avoid Overstating Your Intended Market

It is very tempting to say you are entering a “300-billion a year” software industry. And simply stating that even penetrating 1/1000^th of that market will lead to riches. However, that is far from the truth. You must be clear to venture capital firms that within that market, Microsoft applications takes up a great percentage. And after bypassing all the gaming software, financial software, and other popular consumer software, your little database program aimed at the bartending industry is only a very small portion of the overall “software industry.”

Use Published Facts and Figures Pertinent to the Market

Let your venture capital investors know the particulars of your intended market and industry. Don’t be afraid to use statistical reports from reputable research companies and from name brand industry leaders such as the Dow Jones, Forbes, Wall Street Journal, or Bloomberg.

These kinds of business or industry reports can give you leveraged data to help persuade venture capital firms that your market is growing. Cite growth percentages and emphasize actual market numbers. This will help give credibility to your intended market segment.

Identify Changes and Trends

You may be able to persuade venture capital firms that a particular market is trending. By using the above strategy of published statistics and reports, you can use your power of analysis to study trends and make your own educated and professional market projections. And if you have created new business ideas to take advantage of early trends, you could score with venture capital financing.

No matter how good (or improvable) your new business ideas are, you must convince venture capital firms that a market is or will be in place. Use targeted market segments, recent reports, and your own valuable trend identification to help VC firms get the picture of your business success.

Venture capital firms are often contacted first through an introduction letter and an executive summary. If the venture capital firm wants to know more, they will usually ask to see the full business plan and set up a meeting if the plan is attractive.

However, getting that first executive summary past the initial contact stage is never easy. Entrepreneurs should be advised to pay close attention and polish the executive summary to the point that it gleams.  

What are the typical mistakes that can cost the entrepreneur any further meeting with the venture capital?

An Unclear Executive Summary

Both venture capital firms and entrepreneurs agree that the biggest mistake on an executive summary is an unclear one. Many executive summaries are verbose, lengthy, and unfocused.

A venture capital wants a clear understanding of the new startup company, and clarity can be presented in a brief fashion. Entrepreneurs must succinctly articulate their company’s purpose and mission in a few sentences, or risk losing a VC firm immediately.

Too Long

Many executive summaries ramble on through paragraph after paragraph of mental regurgitation. The executive summary is not meant to be a detailed document. By its name alone, you can figure that it should be kept as a brief and concise summary and expanded in the full body of your business plan.

Unrealistic Valuation and Financial Projections

It is easy to imagine a startup company being successful and toss in desired growth statistics to match an entrepreneur’s imagination. However, to acquire venture funding, you must be realistic in your current business valuation and financial projections.

You will lose credibility with venture capital firms with numbers that are too high on expectations, or even too low on current cash needs.

Lack of Management Discussion

Too many entrepreneurs and beginning business owners talk too much about their product, and not enough about their own management team. It may surprise a lot of entrepreneurs, but venture capital firms place a high amount of emphasis on the management team, sometimes over the product itself, as to whether a startup company will succeed.

Your executive summary is the first point of contact with venture capital firms. Make it count. Avoid these costly and critical mistakes and polish your summary so that VCs will be clamoring to learn more.

It is tempting to use a “shotgun” approach to finding venture capital firms by shooting your business plan to every VC firm in every directory. But you would do better for your new fledgling company by researching and prequalifying venture capital firms before you send them your winning business plan.

What method should you use to target the right list of business investors for your company? Here are some common ways to properly prequalify VC firms.

By Industry

While there are a few VC firms who have a broad range of diversification, most will specialize their investments in specific industries.

Why do most venture capital firms avoid diversification when conventional wisdom calls for investments in many different areas? Business investors are not like stock investors. They find that their investments do better when they specialize in certain industrial niches.

What are the more popular VC firm industries? According to the 2010 MoneyTree Report, the most venture capital money was invested in the following top 5 industries:

1. Software
2. Biotechnology
3. Industrial/Energy
4. Medical Devices and equipment
5. IT Services

But don’t let this get you down if your new company doesn’t fit in one of these segments. The report also listed the following industries popular for business investors:

By Region

Many business investors find that investing in new business in their region work well for them, especially in regions where major business development takes place. Consider the Silicon Valley where literally thousands of software and technology companies have started. Other popular regions include New York, New England, and the Southeast.

But don’t despair if your new business isn’t in one of these regions. There are plenty of venture capital firms in all other regions who like to invest locally. Research the ones in your area and find those that may be interested in your business idea.

By Stage of Business

Many VC firms like to invest in companies in a certain stage of development. Consider these stages:

• Seed financing – Companies needing to perform market research
• Start-up financing – Companies looking to begin production
• First, Second, or Third Stage – Companies open for business who have little or no revenue (1^st), some revenue and other investment sources (2^nd), or profitable and looking to expand (3^rd).
• Bridge – Companies looking to go public within 12 months

Find where your business fits and look for business investors who specialize in that stage of development.

Finding your ideal venture capital partner can be much easier if you know which ones to look for, and know which ones are looking for you.

However, venture capital firms are not in the technology industry; they are in the finance industry. Thus, a venture capital firm will more likely look at a small business in terms of market potential, executive team, and previous financial management - and not just focus specifically on technology, even if it is superior.

But that doesn’t mean you should avoid identifying and fully disclosing your technology risks with a potential VC firm. They will expect it. So what kind of risks exist? And how do you identify them?

Product Development Stage

Many small technology companies attempt to acquire venture capital way too early in the venture capital process. If your company is still in the beginning stages of product development, there is a much larger risk for both you and the investing venture capital company. On the flip side, the further along in the product development stage, the better off you’ll be.

If you have a prototype that has been tested, and even analyzed and improved an efficient manufacturing process, you will have significantly less risk and be more attractive to venture capital firms.

Product Acceptance

You may have a product with superior technology, but why will customers purchase your product? And if similar products exist, why will they purchase yours over the competition?

These types of questions must be answered. Venture capital firms love superior technology, but they also understand that it must be marketable and have some advantage to acquire a large market base.

Failure to Commercialize

If you already have a product on the market, a tremendous risk exists if you are unable to fully penetrate the market. Your product must be marketable to the point where you generate enough revenue to exceed fixed costs and earn a large enough gross margin to make a profit. And commercialization is the way in which you capitalize on your superior technology with customers.

Proprietary Measures

Do you have proprietary technology? If so, if could be at risk of competitive espionage, or simply of commoditization when other companies try to copy your superior technology.

Be sure you take all measure to protect your proprietary and intellectual property. That includes:

?  Patents - Be sure to patent and protect your technology from copycats. Register your products with the US Patent Office.

?  Copyrights and Trademarks - If you have intellectual property, be sure to protect your property and trademarks with copyrights. For instance, the Walt Disney Company vehemently protects its intellectual property. Don’t even think of placing the famous mouse or any other protected character on any of your products. And be just as vigilant with your own. No one should use your intellectual property to make money without your permission.

?  Non-disclosure agreements - If you are afraid of espionage, don’t hesitate to use non-disclosure agreements with those with whom you share information. The at least gives you some recourse should your proprietary technology be released without your permission.

Identifying your technology risks can be a challenge, but by doing so, you ensure that a venture capital firm is fully aware of the challenges you face.

Company valuation is extremely important when it comes to determining how much business capital should be invested. And if you are not familiar with the terms and language, you could face an uphill battle when it comes to negotiating the terms of your venture capital investment. Here are some important terms and methods to be aware of.

TERMS:

Pre-Money Value

This is simply a term that states the value of your business before VC investment. Both you and the venture capital firm must agree upon this figure.

Post-Money Value

This is simply the value of your small business after the business capital is invested. Simply add the pre-money value to the investment amount.

Hurdle Rate

The hurdle rate is the compounded rate of return that your venture capital firm expects to earn from an investment. Keep in mind that the hurdle rate takes into account the stage of the business. For instance, if the business capital is going toward seed funding or first stage, the hurdle rate is higher due to the greater perceived risk. Likewise, a company ready to go public will have a lower perceived risk and a lower hurdle rate.

The hurdle rate is a percentage from 0.1% to 100%, with the higher the number, the greater the risk.

Liquidity Event

This is the term describing how a venture capital firm gets their investment back, plus any returns based on their equity share in the business. Typically the liquidity event happens with an IPO, or the sale of a business.

METHODS OF VALUATION:

Comparables

One of the most used methods of valuation used by venture capital firms is the comparable method. Much like real estate is valued compared to similar properties, a business can be valued compared to a similar business.

Venture capital firms will often research other companies that sell similar products, have similar cash flows, rates of growth, and years in business. They then look at the realized earnings when the comps were start-ups.

Net Present Value

This may also be known as the Discounted Cash-Flow method. This takes into consideration your projected cash flow for the next three to five years. The cash flow is adjusted for items such as depreciation, amortization, interest, and taxes. Then it is adjusted again for the consideration of time-value of money and other risk factors. This gives a general and estimated figure of how much a business is worth now, compared to 3-5 years from now.

If you are in the final stages of talks with a venture capital firm, know the language they are speaking and how they are calculating the value of your start-up business. This will give you an edge in the negotiation process and help you get the most value from a business capital investment.

What are the most common questions from venture capital firms? Here are five of the most common but important questions the start ups should expect.

1. What is Your Business?

A simple yet deceiving question!  An owner of a start up needs to prepare the famous “elevator pitch” for this answer. Don’t spend too much time answering the question. It’s not meant to be a full detail answer. Instead, intrigue the interest of venture capital firms with a succinct answer.

2. Why Are You Raising Money?

Venture capital firms know you are in their house to access their money. They have a right to know why you want it. Be sure you have a prepared answer that tells them your growth plans and financial projections with the capital raised.

3. Do You Have a Marketing Strategy?

Of course, the answer you should give is yes!  However, venture capital firms are looking more for the details of your strategy. Do you have a chosen target market? Who is the target and why? What promotional activities have you considered? What is your timeline for your individual marketing strategies? Be sure to give confident, clear, and detailed marketing answers without spending too much time on them.

4. What is Your and Your Team’s Background?

Venture capital firms put a lot of emphasis on the experience of a start up’s founding team. It’s not enough that a team has experience.  What is it in each individual’s background that made you feel they were qualified for the job? Do any of them have previous start up experience? Have they been successful with other growth companies? Has any of your team led a company through an IPO?

Prepare to give your VC firm detailed and specific answers that will impress.

5. What Are Your Barriers to Entry?

No start up company has a yellow brick road paved before it that leads to success and riches. There are always obstacles and competition that must be overcome. Tell venture capital firms how you plan to find your niche in your industry, and your competitive advantage over similar companies.

What must you do to design a compelling presentation? Here are a few tips to keep in mind.

Design Your Slides

Your presentation will stand out with visual aids. The most common visual aid is a slide presentation using PowerPoint software. Amateur presenters will be tempted to create a plethora of slides using all the cool animated bells and whistles included with PowerPoint. But refrain from this temptation. Keep slides to a minimum, and don’t go overboard on the “effects.”

Here are a few additional tips for slides:

Stay with the main elements - Your slides should cover the main elements of your business presentation, including: use of proceeds, any special trademark, patent, or proprietary technology, market opportunities, marketing strategy, management team, financial projections, and exit strategy.

No more than 3 points per slide - Too much information one a single slide gets convoluted and confusing. Make your main point on a slide and use not more than 3 bullet points. 

Remember, a successful venture capital pitch is one where the investors remember you.  Chances are they won’t remember your PowerPoint, so think of the slides as just a simple supplementation to the main show: you!

Prepare for Technical Glitches

You want to be absolutely sure that your presentation runs smoothly. Time spent troubleshooting your computer and connecting cables is time you lose with VC decision makers. Like any Boy Scout, you must be prepared for any situation. Bring backup computers, cables, projectors, or any equipment that may break down. 

Practice For Time

Beginner entrepreneur presenters are often gung ho about their business idea, and many of them can talk for hours about their plans, dreams, opportunities, and projections.

However, know that venture capital firms want to get the basic idea of your business, and then they ask questions. Your prepared presentation should last no more than 15 to 30 minutes. Practice your speech and presentation transition so you get the flow perfectly and stay within the expected time frame.

Talk Freely

This doesn’t mean talk without ceasing. It means being prepared with answers to questions presented by venture capital firms. And it means having answers that are honest about your business, including the opportunities and the hurdles you face.

A presenter who has a prepared answer will gain much more respect, and more importantly interest, from VC firms.

While the venture capital industry had a growth year in 2010, what is in store for 2011? According to the National Venture Capital Association (NVCA), the future looks bright. Here are a few important  predictions according to the NVCA and Dow Jones survey of venture capitalists for the coming year.

More Investments

During fiscal year 2009, the venture capital industry felt the pains of the national recession. The total number of VC investments in startup companies was significantly down compared to the tremendous growth of investments leading up to 2008.

However, 2010 saw increased activity in startup funding, and according to the NVCA survey, most VC firms expect increased funding in 2011, particularly with later stage investments.  About half look forward to expanding investments in expanding companies and seed development.

IT Will Be a Hit

In previous years, venture capital has found a haven in life sciences and medical technology. However, Information Technology is making a comeback. Startup companies focusing on digital media, consumer internet, and mobile technology will likely find a favored audience with VC firms. And more specifically, cloud computing is becoming all the rage and will likely be the “favorite child” with the most investment dollars.

Medical IT

But don’t think medical technology is on the way out. Technology in the healthcare IT sector will still be on the increase, particularly in medical devices and biopharmaceuticals.

Smaller Firms Favored

According to the survey, 70% of VC firms seem to favor smaller startup companies over larger ones. Perhaps it’s a matter of diversity. Splitting more dollars among a greater number of smaller startup companies protects a VC firm from over investing in unsuccessful larger companies.

Increased Exits

A successful startup company doesn’t stay with a venture capital firm forever. It hopefully exits with a lucrative IPO or acquisition deal. And according to the NVCA survey, about two-thirds of VC firms polled said they are confident that more start ups will go public, and 81 percent said that they expect more start ups to be acquired by private-equity or other public firms.