Any small business owner or entrepreneur who is in search of venture capital has a great challenge before them. One of those challenges is speaking the same language and terminology as venture capital executives, especially when it comes to valuating your business.

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.

For an entrepreneur looking for startup venture capital funding, it is likely he or she will get plenty of opportunities to pitch their business idea. And each time an entrepreneur sits before a VC committee with the goal of raising startup capital, there will be question after question from VC firms who are expecting straight answers.

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.

In your quest to obtain startup capital for your new business, you will certainly have plenty of opportunities to present your pitch in front of venture capital firms. However, make no mistake - meetings with venture capital firms are not a 20-questions kind of interview. Venture capital firms expect you to present them with a brief yet detailed exposition about how you will make them make money.

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.

Despite a period of shrinking venture capital activity during the recent recession, the venture capital industry experienced a good year in 2010. More start up funding was distributed among growing comp businesses and more small companies successfully exited from venture capital backing through IPOs and other strategies.

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.

If you are looking to obtain money from a venture capital firm, you may be asked the question, “so what is your expected burn rate?”

The burn rate is simply a calculation of the amount of cash that a start up business spends each month. Usually, the burn rate is based on the assumption that a new business will spend start up capital at a loss for some time before profitability and positive cash flow occur.

The burn rate is a critical measurement of the potential financial health of a start up, as well as how much start up capital may be required before profitability begins.

Calculating the Burn Rate

A new business owner may simply want to say that the burn rate is an average of typical monthly costs. However, one needs to consider what other sources of cash (not necessarily revenue), are available as well.

Consider a burn rate to be in terms of negative cash flow. For instance, the following simple formula helps provide the monthly cash flow:

All sources of current and expected income or revenue (not current cash on hand) LESS: Monthly operating costs, including interest and taxes (but not including depreciation or amortization

= BURN RATE (NOTE: Cash flow will probably be negative for start ups)

If the start up does have some cash available, such as loans from family and friends or other angel investors, the “Cash Zero Date” is the date in the future when the cash runs out. For instance, if the burn rate is $50,000 per month, and there is $150,000 in the bank, the Cash Zero Date would be three months in the future ($150,000 / $50,000)

Managing Your Burn Rate

It is important to have the burn rate calculation ready to present to venture capital firms. Some firms will want to know all future burn rate expectations. For instance, when the product is ready to be promoted “live” to the public, you may be in a position to hire more people, causing an increase in the burn rate before actual revenue is expected.

Of course, it is best to learn how to control expenses and keep the burn rate as low as possible. Constantly monitor expenses month-by-month, and continually compare actual expenses to the predicted ones. If a venture capital firm knows that you are in control of your burn rate and have predictions in the future that protect their investment and lower their risk, you’ll have a much better chance of approval.

Most people in America are familiar with reality TV game shows. Survivor is probably the oldest and most common reality game show that still retains popularity today. In Survivor, the contestants are put to the test in a remote part of the world.  To eliminate the competition and get further in the contest, alliances are formed usually between two or more people.

Using this kind of comparison, you can see how an alliance with a key business may be useful to obtaining venture capital funding. While your alliances will probably not be as cut-throat as a contestant game show with $1 million on the line, a key alliance or two may be the element you need to attract venture capital as an investment opportunity.

Advantages of Alliances

What are some of the advantages to alliances? Imagine finding greater success and building more revenue to attract venture capital through:

• Additional sales channels – Utilize your alliances to penetrate additional markets and reach more sales channels you could not do on your own.

• Shared technology – Through strategic alliances, you can get access to technology you wouldn’t otherwise have. Instead of investing heavily in new expensive equipment, an alliance may be the way to utilize that technology without burning through all your seed money.

• Credibility – A strategic alliance with a very prominent or visible partner could mean added credibility to your business idea. Imagine presenting venture capital firms with your idea that includes Disney characters, McDonalds logos, or 3M technology.

Tips on Forming Alliances

You can never dream too big when it comes to finding the right alliances.  As an example, Mello Smello, a small mom and pop sticker company, partnered with 3M and Disney to create scratch-and-sniff stickers that propelled the small company into national status. 

There are different strategies you can take to form alliances, including:

·         Joint Ventures – Talk to the top management in a business with whom you want to align yourself. Sell them on your business idea, and show them the benefits they will receive by joining you in a business venture. If you can get a few good alliances on your side, it may win over venture capital firms. 

·         Go National – Don’t just think locally for your potential alliances. Think national. As mentioned, the more high-profile your alliances are, the more credibility you get with venture capital firms. 

Don’t be shy or reticent about forming an alliance or two before you approach venture capital firms. Get these types of key strategic business relationships on your side and face the unique challenge of impressing venture capital with your partnership abilities.

Obtaining start up financing from venture capital firms is never a breeze. In fact, many new entrepreneurs and inventors face rejection after rejection when they approach venture capital firms with their new business ideas.  

Getting a “yes” from a VC firm may be a question of approaching them at the right time of your product development.

How do you know when your product is “ripe” for showing a venture capital firm? Here are a few tips:

Innovative New Business Ideas

Venture capital firms like to see innovation in the startups they finance. Brilliant new business ideas that have innovative solutions are a step ahead of someone who is simply reinventing the proverbial mousetrap.

Product Development

How long will it take for your product to get to the market?  For venture capital firms, the faster your product can launch, the better. 

Of course, this doesn’t mean you should race through research and development. However, if you still need many more years of research to turn a new idea into a marketable product, a venture capital firm may give you the “pass” instead of “fund” stamp.

By the same token, don’t be afraid to show your product-in-development to a venture capital firm in order to obtain start up financing. Your product doesn’t have to be perfect. Simply prepare your product to the point where it represents a good prototype that will give venture capital firms a reasonable idea of its use and purpose.

Proprietary Status

Does your product have potential intellectual property rights? Have you filed patents? Or registered copyrights?

The proprietary status of your product or idea can have a large impact on a venture capital firm’s decision. New business ideas that obviously require patent filing, such as unique inventions or improvements on an existing product, should have a patent filed or pending before you approach a venture capital firm. Let them know you have done your due diligence in keeping innovative ideas proprietary and safe from competitors “leapfrogging” your idea.

Don’t let the details of product development be a reason to avoid venture capital consideration, nor let it be the reason for rejection. Get your product ready for presentation, and you’ll have a distinct advantage with your venture capital presentations.

Before you go in front of a venture capital firm, are you ready to explain your exit strategy with them? Venture capital firms are particularly interested in this portion of your long term plan. The exit strategy is simply the way that the venture capital firm will “cash out” its investment at the end of the investment term.

Venture capital firms know that start up financing is not a short-term investment. It is a high-risk, long-term venture, but the rewards are also high if the venture is a success. Indeed, venture capital companies know that they could lose their capital investment in a company as many as seven out of ten times.  However, the few start ups who make it are worth the payoff.

How will your start up’s exist strategy pay off for the venture capital firm?  They already expect to wait between five and 10 years to get their money out, but after that time, the venture capital firm will want to receive money or marketable securities for their trouble.

Subsequently, if you do not have a viable exit strategy, a venture capital firm is not likely interested in making the investment.

What are possible exit strategies? Here are the most common:

• IPO – An Initial Public Offering, or IPO, is the point where a new start up company takes their business public on the stock market. They offer marketable securities in the form of preferred and common stock. The venture capital firm will usually be a major part of an IPO, with a preferred stock holding in your company.

• Merger or Acquisition – An IPO is not always an option. Instead, a small start up may look to be acquired or merged with an existing larger corporation. The buyout will supply the funds to pay back the venture capital firm.

• Reorganization and Recapitalization – Sometimes a small business start up may take longer to achieve success, but the VC still wants its money back.  Therefore, in some cases, it may be necessary to reorganize and recapitalize through other investments in order to pay back the VC and continue with the product research or market saturation process.

• Liquidation – In actuality, the majority of new businesses that receive venture capital start up funding will fail. Your exit strategy, though hopeful for the best, should also plan for the worst with a liquidation plan if the venture does not succeed.

Venture capitalists are not interested in slow-growing businesses. Take heed of their advice and be ready to present a viable exit strategy when you approach a venture capital firm for funding.

New business ideas may sound great on paper, especially to an enthusiastic entrepreneur. However, venture capital firms are more concerned about the risk the product faces in a targeted market.

Venture capital firms will ask many questions about your product or service, particularly regarding the acceptance in the market.  If you’re an entrepreneur, what are some of the questions you should ask yourself about your product or service before facing a venture capital inquisition? Here are a few key things to think about and prepare to answer.

1. What is the Trend You’re Riding?

Trendy technology faces a big risk. Will the trend be a short-term fascination with the market and fail to sustain regular sales and profits?  In order to avoid being a ‘trendy’ flash in the pan, be sure your product or service offers an integrated total solution, rather than something that falls by the wayside when the next best thing comes along.

2. How is your Product/Service Different from the Competition?

Can you quantify how your new business idea will differentiate itself from what’s on the current market? It’s important to brainstorm a short sentence about your market differential.  At the same time, you should also create a full matrix designed to spell out point by point how your product stacks up to its competition. This will give you the ammunition needed to show why your idea can take the market by storm. 

3. Is the Industry Aware of Your Product/Service?

Some new business ideas are unique and have yet to fall into a defined industry category, while others are ones that have been recycled.  Be sure you are fully aware whether your new business idea is a breakthrough “revolutionary” idea or whether the product/service already exists in the market. Keep in mind that a “revolutionary” product will have a much more difficult time carving out a new market.

4. How Safe is Your Technology?

If you do have a unique technology, you need to ask yourself how safe it is from potential competitor theft. Do you have all the patents and other intellectual property protection that keeps your technology away from curious eyes that can potentially take it to market first?

Remember, venture capital firms are in the business of taking risks. Just be sure that you also know the risks involved with your new business idea.  Be prepared to show a venture capital firm that you understand and are aware of the potential acceptance factors of your product.

What is your new business idea?  Every good entrepreneur worth his or her salt is confident in their idea, which is usually accompanied by high hopes and lofty dreams of tremendous success.  

However, what is the reality of the market opportunity for the business idea? If a start up business will take a new idea to a venture capital firm to present it as an investment opportunity, the market opportunity must be significant.

Even if a new business idea is worth its weight in gold, if it doesn’t serve a sizable market, then a venture capital firm will not consider it a qualified investment opportunity. VCs know that in order to get their investment back, a business idea will need to attract a wide market, and that market must be open to the idea.

Is your idea’s market big enough for a venture capital firm?  Here are a few factors to analyze before approaching a VC:

Identifiable Market

Does your market exist, and is it easily identifiable? Don’t ever think that your new product idea will “open a whole new market.” VCs aren’t interested in a possible market opportunity – only existing ones. And remember, a small regional market is not good enough. It must be at least on a multi-regional, national, or international level market.

Commercial Viability

If the market exists and it is sizeable as a VC investment opportunity, the next step is determining whether the product or service idea is commercially viable. Will it service a current need in the market? Will it fill an existing niche?

Other factors to consider about commercial viability are whether the product will be reproduced and manufactured repeatedly, efficiently, and in a cost-effective manner? Will it sell at a price that will generate a profit?  

The same questions hold true with a service idea. Will the service sell at a price that can generate enough revenue to pay back the VC – plus profits?

Competitive Advantage

Finding an existing market and knowing the product can fill a niche is not sufficient. The new business must have an identifiable competitive advantage over existing products or services in the market. VCs will want to know that new business ideas are worth the investment opportunity. Be sure to show them why the customer will buy your product over the competition.

If you are looking to find venture capital, be sure you get your research done. Find the market, and get the proof that people will buy your product. Finally, prove that the competition doesn’t stand a chance. Then you’ll have a much better chance at getting that VC deal!