You have successfully navigated negotiations with your venture capital firm. Congratulations!

But what happens next? After all the terms have been negotiated, the venture capital firm will draw up a term sheet that summarizes all the important items, as well as the proposed structure of the deal.

A term sheet is simply a summary, and all summarized items will be expanded upon later in the closing documents. While the term sheet is non-binding, it is still used as a document to set forth expectations of both parties until the actual closing.

Included in a term sheet you may find:

o   The total invested dollars provided by the venture capital investors

This may be a single dollar amount, or broken down into separate disbursement amounts at agreed times in the future.

o   The target date for closing the venture deal

The closing for venture capital doesn’t happen overnight. Due diligence is still required. Usually the closing is set on an average of 60 days from the date of the term sheet.

o   The division of capitalization of the company

This is where you will see who will own what part of the company after the closing occurs. For instance, a venture capital deal might require that they own 55 percent of the company, and the founders will retain a 45 percent ownership stake.

o   The type of security the venture capital firm will eventually own

If the goal is an IPO, the venture capital firm will clarify up front whether they desire to own preferred stock, common stock, or perhaps convertible debentures.

o   The number of shares

In addition to the type of stock, the venture capital firm will outline how many shares it requires to purchase up front at the IPO.

o   Dividend distribution

The term sheet may also set forth how future dividends are to be paid to the venture capital firm as stockholders.

o   Distribution of sale proceeds

If the company is sold prior to an IPO, the term sheet also will explain how final sale proceeds will be distributed to both founders and venture capital investors.

Though the term sheet is not a binding document, it is created as a reminder of the terms agreed up on in negotiations. With the term sheet, all parties have a clear understanding, and there are no disagreements up to closing time.

2009 saw a severe drop in the total number of new small businesses funded by venture capital firms. While total small business funding is down, 2010 looks to bring in more investment opportunities for VC firms in a few select areas. One of those sectors is clean technology.

The Profile of VC Funding Today

According to a report published by MoneyTree from PricewaterhouseCoopers, LLC and the National Venture Capital Association (NVCA), the 3^rd quarter of 2009 saw an increase in venture capital funding driven by the clean technology sector. One of the clean tech deals was the ninth largest venture capital deal since 1995.

Not only is clean technology getting more deals, but they are receiving business funding over the long-haul. Mark Heeson, president of the NVCA says that this type of funding is “a gradual and deliberate industry shift towards a longer term venture capital investment strategy.”

This tells us that venture capital companies are looking more toward sectors like clean technology, biotechnology and life sciences, where business funding occurs over an extended period, sometimes 10 to 12 years. These companies often have multiple rounds of venture capital financing over that time period, and they have a longer average time to accomplish its exit strategy.

This is not to say that shorter-term small business investment opportunities will be overlooked. Heesen goes on to say that the mix of sectors that VC firms invest in will become more balanced between shorter-term IT companies, as well as longer-term bio- and clean technology companies.

The Promise of Clean Tech

Clean technology includes companies that specialize in alternative and renewable energy sources, pollution and recycling, power supplies, conservation, and green transportation. These types of companies are founded to produce more energy efficient methods of producing and using electricity, as well as create fuels and electricity with fewer carbon footprints.

Clean technology is seeing an increase in the number of firms due to a variety of reasons. One is the simple fact that most people are interested in clean fuel technology and methods that help save the planet, thus creating a market for these products. Second, the U.S. government also is encouraging clean technology, with tax incentives and guaranteed loans for clean technology companies.

Clean technology is still emerging and is at a young stage. With the help of government backed financial aid and increased business funding from venture capital firms, clean technology may become the most sought-after VC investments.

“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. 

How do you convince VC firms that you are worthy of start up financing?  A brilliant idea is a solid start.  Enthusiasm will help VC firms listen to you.  However, your integrity is what VC firms will bank on to make your company a success.

Integrity is very influential.  It is at the heart of a company’s culture and values, and VC firms know that a company with high integrity has a better chance at success.

What is integrity?  And how can it influence your chances at VC funding?  Here are some reasons why.

Respect

Entrepreneurs with integrity show respect to others.  Whether or not an entrepreneur is experienced, integrity shows in how he or she respects the opinions, questions, and standpoints of VC firms.  A person of integrity will value differences and engage in constructive debate.  He or she will treat others with respect and courtesy at all times, regardless of age, sex, or business position.  Learn to show respect and you will be respected yourself for your integrity.

Trust

Know that others will want to be in business with people they trust – which holds true for customers, as well as business partners and contacts.  If you have a large network of people who fully trust your business judgment, ethics and policies, be sure to highlight this fact for VC firms.  Your trustworthiness can result in VC financing for your business.

Money Matters

Ever since the Enron debacle, every business and everyone in business is expected to have a higher integrity in regard to bookkeeping.  When approaching VC firms, be sure you have shown your integrity when showing actual sales and expenses, as well as pro forma statements. 

Be Open to Ideas

Integrity sometimes means following a goal to its end.  However, it also means being open to new ideas and suggestions.  An entrepreneur who believes his way is the only strategy to reach his goal is not likely to see any VC financing.  In contrast, one who is open to criticism and guidance based on past experience will have a much better chance at receiving VC funding.

Integrity is often an overlooked character trait, but it is a valuable one that VC firms recognize and want in their investment portfolio companies.  In your quest to obtain VC financing, be sure you prominently display your business integrity to gain the trust of a VC firm.

Entrepreneurs often complain about how much trouble it is to find venture capital funding.  Many venture capital firms are very strict about the geographical area in which they invest – which leaves entrepreneurs with great ideas and potentially successful business plans with fewer startup capital options if they are not in a “hot” region. 

So why do venture capital firms get choosy about location?  There are many reasons, and some venture capital firms may only choose one good reason to stay locally.  Here are the three main reasons a venture capital firm will choose certain areas:

Visiting Investments

If a venture capital firm invests only in local or regional startup companies, it is easier to visit and work with them.  Venture capital firms spend a great deal of time overseeing and taking an equity stake in their startup companies.  When a startup company office is driving distance, or at least a short plane ride away, a venture capital firm can be at hand to help develop the startup company more easily.

Fertile Investing Area

Some venture capital firms choose a certain area or region because it is a fertile ground for startup companies.  The best example is Silicon Valley in California.  There are more venture capital firms there per capita than anywhere else in the country.  These firms are right in the middle of one of the hottest technology regions in the world. 

The Silicon Valley attracts the smartest, the brightest, and the most ambitious entrepreneurs.  New ideas for startup companies are discussed and finalized over lunch there.  So why not establish a venture capital firm office right in the middle of that action?  With so many potential booming new businesses, a venture capital has its pick of the best.

Best Managers

Another reason venture capital firms choose a specific region is because they like startup companies with experienced and talented management teams.  If an area is hot for new startup business, it attracts workers because of the challenging job opportunities, as well as the very lucrative salaries and stock options.  A startup company will have access to these bright managers, who in turn are attractive to venture capital firms seeking start ups with experienced managers.

If you find yourself in a city with limited venture capital activity, consider relocating your startup or focusing on venture capital firms without geographical constraints to make your startup funding endeavors easier. 

How do VC firms decide to provide start up financing to one company and not another?  There is no single element that sets a startup company apart, but usually a combination of factors.  If you are looking for start up financing, here are five important ways you can position your company in front of VC firms to get a better chance at “yes.”

1. Have an All-Star Management Team

VC firms are interested in providing start up financing to new companies with experienced management.  Too often a young entrepreneur comes along with a great idea, but no experience in the industry or marketplace.  A smart entrepreneur will surround himself with experienced managers in all arenas, including sales and marketing, accounting and finance, HR, product development, and administration.  And better yet, VC firms like to see management team members who have previously been a part of a successful start up company.

2. Have a Quality Product

A VC firm will more likely invest in a startup company with a new, unique, and strong product idea.  Innovation is the key.  However, your idea doesn’t have to be a product.  A service idea with ingenuity and quality benefits can carry weight with VC firms as well.  If a VC firm believes your product or service will sell, you’re more likely to gain their interest.

3. Appeal to a Large Market

One thing that entrepreneurs must remember is that VC firms want to invest in companies with very large earnings potential.  A startup company with a great idea but only a niche market may only have potential for a few million in earnings each year.  If you want VC funding, expect that your product will eventually earn hundreds of millions or even billions on the market.

4. Have Growth Potential

As stated, VC firms like companies with large earnings potential.  Your startup may be in development and be small.  However, you will need to have the ability to easily expand when the market calls for growth.  Know and state your company’s growth strategy.

5. Large Return for VC Firms

VC firms don’t invest money to get 8% to 12% returns.  They could do that with the stock market or real estate.  Instead, VC firms invest in startup companies to get larger ROI, and certainly the risk-to-reward ratio applies to venture capital investments.  This translates into venture capital firms holding an equity position up to half the company’s value and even large stock options in an IPO.  If you want VC funding, be prepared to offer large returns for the investment you receive.

Many entrepreneurs want to start a new business and think that venture capital funding is the only way to get the capital needed.  Why?  Simply because the term “venture capital” is tossed around so frequently.  It is associated with capital for new companies.  The thought is, “if you’re venturing out on a new business, venture capital financing is the way to go.”

Although this is partially true, there is much more involved with obtaining startup financing from venture capital firms.  Entrepreneurs must know that VC firms have specific guidelines for their portfolio investment companies, and many of those guidelines are universal.  If you are wondering whether your start up business is a good candidate for VC funding, here are a few good ways to know:

You’ll Be Serving a Large Market

You may have heard the term, “find your niche.”  Niche businesses are those that find a particular market or customer segment and fill a need that is not already there.  Unfortunately for these types of businesses, they may be successful as a niche business, but not a good candidate for VC funding.  Why?  They simply will not pull the revenue numbers expected of a VC funded business. 

Successful niche companies are sure to earn millions.  However, VC funded start ups are expected to eventually earn billions.  Thus, if you want VC start up funding, your new business must serve the needs of the masses.

You Need a Large Amount of Capital

Many new startup companies need only a relatively small amount of financing to get off the ground.  A few hundred thousand dollars or even a million or two will do the job adequately.  Unfortunately, venture capital firms are more interested in investments that require millions, and sometimes tens of millions, in capital needs.  A $500,000 investment simply will not give the VC firm the return it requires.

You Need Many Rounds of Financing

VC firms are looking to invest in startup companies from the ground up, which means potentially many rounds of financing.  For instance, a startup company may require seed financing and then many subsequent stages of funding until the business is ready to even introduce a product to market.  If your company does not need heavy market analysis, product development, and market testing, you may not be a good candidate for VC funding.

Entrepreneurs need to know where the best places to look for startup capital.  If you are a wise entrepreneur, you will carefully evaluate your new business to see if it is a good fit for VC funding.  If not, you would be best to focus your efforts on other sources.

What you state in your business plan says a lot about the future success of your business.  Venture capital firms have witnessed plenty of successful new businesses that started with a sound business plan.  VC firms know what should be included in a business plan – and what should not.  They also know the qualities that a business plan should possess if it is worthy of their time and money.

What are the qualities that VC firms like to see?  Here are 10 that should be in your business plan:

1. A Brilliant Idea

No plan is complete without a nugget of a great idea.  The idea is what sparks the interest of a VC firm.  The rest will solidify their interest, but it all starts with an exciting idea.

2. Brevity

VC firms don’t have time to review every business plan that is put in front of them.  Make sure yours is brief and succinct and contains the main compelling points that are of interest to a VC firm.

3. Clarity

Be absolutely clear about what your idea is and how it will achieve success.

4. Know Your Market

Do you know who will buy your product?  What are the demographics? How will you market to them?  Let your potential VC funding firm know that you completely understand your market.

5. Show a Large Market

VC firms will invest in startup companies with a potential for big earnings – which means having a big target market.  Show VC firms that your product will fit into a large market.

6. Your Competitive Advantage

Why will your target market buy your product rather than the competition?  This needs to be addressed honestly and with crystal clear focus so VC firms know why you set apart.

7. Existing Contacts

Have you already established potential partnerships with other successful businesses?  Do you have a top industry business ready to buy your product?  VC firms like to know that you already have potential help and customers waiting.

8. Management Team

The quality of your management team will be a top priority for VC firms.  Show that you have a team assembled with the best experience and qualifications.

9. Demonstrated Product Success

If your product has already been developed and shown sales potential, prominently display your sales success. 

10. Avoid Anonymity or ‘Hiding’

Don’t try to hide information a VC firm.  Your plan will more likely be rejected.

When an entrepreneur thinks of capital funding, the first thing that comes to mind is venture capital.  However, depending on the stage and growth plans of the new company, an entrepreneur may be better suited to pursue an angel investor. 

Many venture capitalists receive proposals for capital financing from companies that just do not meet their requirements for scaling, industry, or funding amounts.  This happens frequently when entrepreneurs fail to properly research the role or expectation of a VC firm in comparison to an angel investor.

An angel investor is an individual or private company that may wish to invest capital into new businesses that need help getting off the ground.  A previously successful entrepreneur may become an angel investor as a way to help new entrepreneurs get past the self-funded stage.  Typically, angel investors will fund companies that need financing in amounts anywhere between $150,000 and $1.5 million.  Though angel investors are easier to acquire than VC, they still require higher return amounts than traditional bank loans.

Venture Capitalist vs. Angel Investor

How can you, as an entrepreneur and business owner looking for capital growth, know which investor to approach?  Here are some guidelines:

Type of company

Venture capitalists have a preference for certain industries, particularly those with high growth, such as biotechnology or software with large expansion potential.  Though angel investors like high growth industries as well, they are more apt to be a capital source for other smaller growth industries. 

Size of company

The growth potential of the company is a tremendous factor in VC funding decisions.  They expect big returns when a startup company goes national or global, is acquired by a major corporation, or offers an IPO as a larger corporation.  Angel investors, however, will look at smaller companies that do not require as much capital for initial startup or capital growth.

Experience

VC firms are notorious for picking and choosing startup companies that are lead by experienced entrepreneurs.  Experience may be within the industry they are entering or through other successful entrepreneurial ventures.  Angel investors, on the other hand, will more likely help a first-time entrepreneur.

Amount of capital needed

Whether you need only one round of capital financing or a series of rounds, if you need more than $3 million for your capital needs, you should seek VC funding.  VC firms will usually not consider startup or small companies needing less than $1 million, unless the VC firm specializes in seed capital for startups. 

Generally, if the total capital required to create a positive cash flow in just a few years is less than $3 million, an angel investor is the way to go.

If you are an entrepreneur who wants to get an innovative business off the ground with a capital inflow, consider your options carefully.  Think of how big you want to take your business, your experience, and your ultimate capital financial needs.  You may find that a VC firm is not what you’re looking for after all. 

If you’ve successfully walked through the door of a VC firm and given a presentation, your next step may be having the VC firm perform a valuation on your business.  A successful presentation is indeed a commendable feat, but before you receive a check from a VC firm, they will do their due diligence and valuate the true potential of your business.

Some call the process of valuating a business an art rather than a science.  The results can be highly subjective rather than objective when considering the value of an untested business idea or process.  Particularly the entrepreneur’s opinion of his business may be inflated due to the enthusiasm that clouds better judgment.  But conversely, a VC may undervalue a business to be ultra-conservative in estimating potential losses.

Valuation Factors

A VC business valuation must take many factors, including:

• Risk vs. Reward – A VC firm must evaluate a company from the viewpoint that it is risking its own capital to capitalize another company.  And for that risk and use of money, they deserve a reward.  The higher the risk of financial loss, the more reward will likely be asked of a potential portfolio investment company.

• How Much Capital is Needed? – A VC firm will try to assess the amount of capital that a business needs in order to succeed.  Too little capital and the business risks failing.  Invest too much capital, and the VC firm has tied up more money than it needed, thus losing other potential investment earnings.

• How Fast Will Revenues Grow? – Another factor that venture capitalists must consider is the rate at which revenues are predicted to increase until they can take out their “reward” or financial return.  Some companies may take up to five years or more before they even see a profit and are able to incorporate with an IPO.  The longer that VC money will be tied up, the more return they will ask for at their exit point.

Valuation Methods

There are many methods a venture capital firm may employ to valuate a startup business.  Most of these methods are subjective since the future is always unknown.  Here are a few of the most common methods:

• Cost Approach – This is also known as book value.  The cost approach tries to determine the future book value of a business at the exit point after liabilities are subtracted from assets. 

• Market Approach – A market approach to business valuation would try to determine what the business would be sold for on the actual market.  Sometimes this means comparing the actual recent sale price of a similar sized business in the same industry. 

• Income Approach – An income approach uses a capitalization rate, or cap rate, to determine a subjective valuation.  The cap rate is divided by the net income of a business at a particular point in the future to calculate the valuation.  For instance, if a startup company expects to have net earnings of $10 million at the projected exit point in eight years, and a 10% cap rate is used, the business valuation would be $100 million.

Business valuation is an important step for VC firms and entrepreneurs.  It must be completed to reconcile the valuation between what the business owner thinks the company is worth, and the conservative estimates of a VC firm.  If you’ve reached this stage, you’re well on your way to receiving VC funding, but be prepared to cooperate fully with a VC firm in their requests for valuation information.