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

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.

Many new entrepreneurs have a skewed view about venture capital funding. Some believe that a great idea and lots of passion and enthusiasm are all one needs to convince a VC firm to become partners in a new business venture. However, VCs particularly scrutinize fresh entrepreneurs – especially if you don’t have funding and a track record already.  

To separate fact from fiction, a VC firm will not lend any money to a new company that does not already have some form of small business funding.

If you read that correctly, then yes, you need money before you can get money. VCs want to know that you are taking a financial risk yourself.  Of course, all entrepreneurs start by bootstrapping, but you still need more business capital before you approach a VC to ask for more money. 

Self-Funded Capital

Where can you get it? There are many forms of startup business capital. The top three self-funding capital types are:

• 401(k) – Either through your 401(k) or other types of retirement fund, you can take loans against the funds to invest in your start up.  Though it’s not recommended, you could even withdraw a portion or all of your fund to get startup capital.

• Savings – If you have substantial savings, this is a good way to show investors you believe in your business idea.

• Friendly Loans – Also known as “Friends and Family,” or F&F loans, these are also a common way for start ups to get their seed money.  If you can encourage the people close to you to get onboard, VCs might take a second look at your idea.

Third Party Funding

Other forms of small business funding may come from other outside sources before you approach a VC firm. Here are the top three you might consider:

·      Corporations – Though the last few years have been modest, corporations are known for investing money into startups. They know that VCs can make a substantial return on their projects – and so can corporations if they invest wisely. Approach corporations in the industry of your new startup. For instance, if you have a technology idea, you might talk to Dell, Cisco, or Microsoft for a stake in your new business.

·     Angel Investors  - “Angels” are similar to VC firms, except they are typically wealthy individuals who make it a point at helping startups. Angel funding can certainly be a good step toward obtaining venture capital funding, especially since angel investors are well suited for funding smaller amounts of capital. 

·     Incubators – This type of initial investor is one who may not invest cash, per se.  However, you could get valuable technical or business consulting, bookkeeping or accounting services, donations of office or research space, and even networking help.

To get to the next step of business capitalization, you need to have investors and/or your own money on board. Get to these types of initial business funding and then take your new venture to the VC firm.

Once you have successfully presented and interviewed with a venture capital firm, you may undergo a second round of qualification in order to be considered a “finalist” for venture funding.  In this process, one of the important steps a VC firm must take is valuating your start up business.

What is business valuation? And how does a VC firm valuate a company that is not yet earning revenue?

Below are a few ways that a VC firm analyzes your product, people, and markets to determine whether a business capital investment is a good choice. Here are a few steps you’ll encounter in the valuation process:

Comparables

A start up company with no documented revenue history may be valued much like real property – through comps or comparables. A VC firm may determine a business investment opportunity by looking at other existing companies with strong similarities to the one they are considering. They will talk to other investment analysts and specialists, examine 10K reports, and perhaps even research public documents to find good comps.

DCF or NPV Method

Whether a company is earning revenue or not, a VC firm may perform a discounted cash flow (DCF) or net present value (NPV) method to determine current value. By taking the projected cash flow for the next three to five years, a VC firm can adjust cash flow factors, risks, and assumptions to determine if the company is a good business investment opportunity.

Size of Market

VC firms will definitely take a look at the size of the potential market. Knowing whether a new start up company can capture a percentage of an existing market share could give them insight into current venture funding valuation.

People in Your Company

It’s not just the product or service that makes your new company successful – it’s the people too. This is actually one of the top factors VC firms will use to valuate a company. If a new company has an exceptional management team, it is more likely to succeed and meet projected financial targets, and thus, this factor increases the value of your start up. 

Product Qualities

Of course, a good business investment opportunity will solely rest upon the product in question. Your new business idea or product will be heavily scrutinized about its uniqueness, intellectual property or patent potential, and even brand strength.

Be prepared to be flexible and sharing with your information if a VC firm wishes to valuate your company. With your cooperation, you can be sure that a VC firm can make a valid venture funding decision.

As a matter of need, entrepreneurs with a great business idea and a start up company want money immediately to continue on the journey to success. However, a venture capital firm who is willing to invest in a new start up company also has a need to be thorough in its due diligence. Thus, there exists a division of practicality between the wants of an entrepreneur and the needs of a VC firm.

Entrepreneurs who fail to understand this practical funding timeline also are likely to fail in their business. Budgeting time for venture capital investment funds to arrive to the bank can prevent many mistakes along the road to capitalization. How can a new business survive if existing capital is almost on empty before applying for venture funding?

After getting an approval from the VC firm, how long do you wait before obtaining venture capital funding? The answer is always, “it depends.”  

If you ask an entrepreneur how quickly they expect VC funding to arrive at their bank, the answers are not surprising. According to a poll conducted by the authors of the book, Inside Secrets To Venture Capital, entrepreneurs answered:

Time to Closing       Entrepreneurs’ Response

Under 30 days           22%

30-60 days                  25%

60-90 days                  20%

90-120 days                15%

120 days or more       18%

In contrast to the answers provided by entrepreneurs, the same question was posed to VC firms about how long entrepreneurs should expect the funding process to take. Here are the results of their responses:

             Time to Closing        VC Firm Response

Under 30 days             1%

30-60 days                  18%

60-90 days                  45%

90-120 days                26%

120 days or more       10%

You can see the chasm separating entrepreneurs’ expectations and the VC firms’ closing reality. Almost half of entrepreneurs expect to receive funding in 60 days or less, while the actual average funding time is between 60 and 90 days.

However, when VC firms were asked about their quickest funding time, 80% responded that they were able to fund in less than 60 days, and 41% were able to fund in 30 days or less.

The point is clear. Entrepreneurs should budget plenty of time to obtain venture funding. Never wait to the last minute to approach VC firms. You never know when you’ll receive a “yes” answer, and then you can expect at least 2 months or more before funding arrives.

How far has your start up company developed? Are you ready for an IPO on the stock market, or are you still in a product development and information-gathering stage? Knowing your stage of company development can be beneficial in understanding where to look for venture capital start up financing and raise capital that is needed to advance to the next stage.

Below is an overview of the typical venture capital financing stages and how you can determine which stage your company fits. With this in mind, you can more directly focus your venture capital search for VC firms that specialize in your stage of development.

Seed Stage or Concept Stage

This is the beginning stage of a company. You might consider this stage as the point where an entrepreneur/founder/inventor has a business idea in mind, but has not yet even made a prototype. There is no management team assembled yet.  The company has much product research and market research to perform before it is ready to advance to the “start up” stage.

Funding for this stage is rarely found with venture capital firms. A company needs to have more than just an idea to get close to VC firms. For the most part, seed stage companies find start up financing from friends, family, and possibly angel investors.

Start Up Stage

At the start up stage, a new company has at least the founder/entrepreneur working full time on the company. He or she has other key management personnel filled, but the management team is not yet complete. The product is realized and is at least at a prototype stage. With a product and a focus, the company probably has a legal business entity formed and a business plan.

Start up financing from venture capital firms can happen at this stage, but it is rare. Only a few VC firms usually are interested in an early-stage company financing.

First Stage

The new company at a first stage has a product ready for market and may be earning revenue. The management team is fully assembled and the infrastructure of the company is in place.

Most VC firms will usually get involved with a new company at this stage. Venture capital financing will be used to help boost sales, cut production costs, and perform additional market research.

Second Stage

Second stage companies are in full swing, and their product has penetrated the intended market. Companies at this stage find venture capital to help expand into larger markets, such as national or international markets.

Third Stage or Established Stage

Third stage companies have been operating successfully for at least three years and are poised to capture an even bigger market share. VC financing helps make plant improvements or expansions necessary to create higher production.

Mezzanine Stage or Bridge Stage

This stage is when companies have proven their ability to increase sales and are ready to start the process of going public. Venture capital at this stage helps that process and prepares a company for an IPO.

Turnaround Stage

This stage is not where a company wants to be. A company in a turnaround stage is usually suffering from financial losses and is underperforming. Restructuring is necessary. and venture capital at this stage is used to help get a company with potential back on its feet. Though there are few VC firms who fund the turnaround stage, a company can still find financing help from a VC firm specializing in this stage.

When you get the nod from a venture capital firm for start up funding, your work is still not done. A simple “yes” answer is not the end of the road for your search for capital. Subsequently, you must sit across the table from your venture capital firm and negotiate the terms of the deal.

Should you do this alone? Or should you have someone trained and experienced in legal business entities and capitalization on your side?  Most entrepreneurs are not experienced in business partnership negotiations and are new at obtaining capital. It would reason, therefore, that having an attorney on your side during your venture capital negotiations would serve you best.

Why would hiring an attorney be beneficial? After all, it’s just another expense – and not a cheap one. However, an investment in an attorney may be worthwhile, as he or she will look out for your interests and attempt to negotiate the best terms for you.   

However, this does not mean that you must have an attorney sit with you at the negotiation table. Although some entrepreneurs might choose this option, simply having an attorney available to review the proposed term sheet and offer negotiation advice would work as well.

Here is what an attorney might help you with:

Compliance

One of the most important jobs an attorney will perform for you is to assure that every term you and your venture capital firm decide upon is within state and federal regulations and securities laws.

Realistic goals

Your attorney will help you see reality through your dreams. Most entrepreneurs want to keep full control over their start up company, but start up funding requires that some control be given away to the venture capital investor. An attorney will help advise you of your choices for outside capitalization and keep your feet grounded.

Fairness

An attorney will ask, “is this transaction fair?” An experienced litigator might be able to spot an unfair deal and advise you of your possible reactions.

Explanations

Do you know what an antidilution clause is? Or a conversion provision? An attorney will help explain the terms with which you are unfamiliar and their implications to your business.

Are the rewards of an attorney worth the cost? Most likely. Having an attorney on your side can help you get the best deal possible. Whether an attorney is at your side during negotiations or just available to review and offer advice, this legal specialist is a good investment for your start up company.

While every potential venture capital deal hinges on various factors, there are three important valuation factors that fit across the board for venture capital firms. Here is a look at the top three valuation factors that could give you an edge when approaching a venture capital firm.

1. Management is Everything

In a poll conducted by the authors of Inside Secrets to Venture Capital, venture capital firms were asked to rate the factors they use to determine the value of a potential investment. By far, the top rated factor was the quality of management.

VC firms were asked to rate the factors on a scale of 1 to 5, with 5 being the highest importance. The numbers were overwhelmingly in favor of the management team, with nine out of every ten VC firms rating this factor a 4 or 5. Seven out of ten rated this top factor a maximum of 5. The average rating for management team was 4.5, and no other factor even came close.

What does this tell you? Make the effort to recruit and attract the best possible people for your company. VC firms know the value of a management team who can weather storms and guide a small business to big success.

2. Size of Market

The next most important factor in the poll was the size of the market. The average rating for this factor was 3.8 out of 5.  30 percent of venture capital firms rated this as the highest importance. Thus, it is important for you as an entrepreneur seeking start up capital to find a market that is sizable, yet penetrable.

3. Product Qualities

Product quality was actually third on the list of top importance to venture capital firms. Only 25 percent of respondents said this was top importance, and the average rating (out of 5) was 3.7.

Along with product quality, venture capital firms look at the product’s uniqueness, the brand strength, and potential patent and intellectual property assets.

With these factors in mind, now you have an inside look at what venture capital firms are seeking. Be sure you design your new company with these top factors, and you will stand a better chance of getting a “yes” for venture capital.

Since the slump of the economy starting in late 2007, companies funded by venture capital firms also have seen a decline in the number of initial public offerings.  Stock investors are simply not putting money into new companies, but 2010 may see a return of new IPOs from venture capital-backed companies.

During a recession, skittish stock investors tend to act conservatively with their money, selling stock to put funds into more safe investments that will help retain value, such as gold or government issued securities. Putting money into a new, untested stock company is just another risk that investors are not willing to take.

What 2010 Will Bring

However, according to a recent article from the Wall Street Journal, 2010 looks promising for newer, small company valuations. In fact, the end of 2009 showed a more fair valuation in stock prices than over the last two years.

What does that mean for stock investors?  Stocks are realizing a more accurate valuation, which means that investors are placing their trust and funds back into equities.  Thus, with a higher risk tolerance this year, stock investors may be more attracted to buying stock in new VC-backed IPOs, especially since IPO stocks are typically discounted as a compensation for investor risk.

In addition, venture-backed companies who issue an IPO are typically considered small or mid-cap investments. There is a wide range of investors who do want to invest in these types of stock categories, including mutual funds and larger corporate investors like insurance companies. Small to mid cap venture-backed companies will be of interest to them as they seek to increase the value of their stock portfolios in 2010.

The Growth in IPOs This Year

Just how many new venture capital-backed IPOs could we see in 2010? 2009 saw only 8 such IPOs, according to information from Dow Jones VentureSource. But according to the WSJ article, one expert projects 30 to 50 new IPOs could happen this year. In fact, the Dow Jones VentureSource already has 33 venture capital-backed IPOs filed with the SEC.

So far in 2010 no venture capital-backed companies have made an IPO showing. However, if the data is correct, 2010 could actually see the return of the IPO for venture capital investment companies.

“Your mission, should you choose to accept it…”

Although your mission for your startup business doesn’t have to be impossible, it should inspire venture capitalists to learn more. 

Understanding the Mission Statement

A mission statement is often overdone and misunderstood.  Some businesses tend to focus on rhetoric and bullet-point statements that try to state every value and objective of the company.  Unfortunately, a poorly written mission statement does very little to help a company and does even less in helping obtain VC financing.  A business without a mission statement, or a poorly written one, will have a more difficult time convincing VC firms that they are on a mission to make money.

Rather, you should have a mission statement, but one that is succinct and states your company’s main objective or goal.  Your mission statement should be no longer than one or two sentences, which is no easy task. 

The Value of the Mission Statement to Venture Capitalists

Why do VC firms consider well-written mission statements important?  First and foremost, the mission statement succinctly summarizes the ideas contained within the business plan.  Reading these few sentences can prompt the venture capitalists to read more or simply move onto the next company.   

In addition, developing a powerful mission statement can be very beneficial to the entrepreneur and the management team.  In obtaining VC funding, having a clear goal is of the ultimate importance, and a mission statement can help you refine your ambitions into a profitable, achievable endeavor. 

Make sure your mission statement is incredibly clear.  A business who wants to “penetrate the medical technology industry” does not adequately describe how it will serve the industry or its customers.  A broad mission statement will not only bore venture capitalists, but will close the doors to your funding potential.   

Make it easy for VC firms to know what your business hopes to accomplish.  Write and re-write a constructive mission statement that highlights the main point of your business. 

Use your mission statement as a hook for gaining the attention of VC firms.