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.

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.

A new company started by a fresh, enthusiastic entrepreneur will often choose a private corporation as its business form.  With a start up company, the entrepreneur will not only have to fill key management and director positions, but also seek out a board of advisers. These are the people upon whom the entrepreneur will heavily rely to take his or her new business idea to the next level, as well as even help in obtaining venture capital.

The board of advisers can help transform a start up company into a viable investment opportunity for a venture capital firm. Their experience, status, and networking contacts are always a benefit, especially during the funding phases. Here are some other top qualities you need on your start up board:

Share the Vision

Does the candidate share your vision with your product or service? It’s essential that you get board members involved who are receptive to your enthusiasm for your idea.

Successes and Failures

A good board member is one who is not only successful, but has his or her share of setbacks. This kind of experience is invaluable in providing advice for the new entrepreneur in making wise decisions.

Experience with Growth Companies

If you are able to locate board candidates who have previous experience with growth companies, all the better! Their advice will be key in getting your company in front of a venture capital firm for an investment opportunity.

Specialty in Operations

Experienced board candidates will usually be executives or even CEOs of existing companies, but they should have a particular specialty. Consider your industry. The advice from a finance executive, medical operations manager, law firm partner, insurance company VP, or technical research executive could be the catalyst in getting approval from a venture capital firm.

Committed and Available

The board members you choose may share your vision, but not be able to commit to the duration of a board term. Their availability with other projects or commitments may prevent them from giving you the attention you need with your new start up.

Don’t be tempted to ask a great choice to become a board member just because of his or her status. Make sure they can commit to your business growth as well.

Be wise in your choice of board members. Your key board advisers could be the people who help your new business idea turn into the success you dream.

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.

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.

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.

How has the economy affected venture capital new business funding? According to a report released in January 2010, the state of venture capital is in a deep freeze. The study and report was issued by Thomson Reuters and the National Venture Capital Association (NVCA), and it noted that the total amount of venture capital funding was at its lowest rate in 5 years.

The Reality of 2009

The report shows that investors are becoming less interested in funding new venture capital deals. VC firms raised a total of only $15.2 billion from 120 funds in 2009, down 47% from $28.5 billion from 223 funds raised in 2008.  This was down 58% from 2007 when a total of $36.1 billion was raised from 250 funds for venture capital.

In terms of actual investments made by private investors such as venture capitalists, in 2009, only 2,795 deals were made, with a total business funding of $17.6 billion. Compared to 2008, that number is down 37% when 3.985 deals were made for a total investment of $27.9 billion.

Why Venture Capital Shriveled in 2009

Why has the number of venture capital deals spiraled downward? The economy is a major concern, and investors have certainly reduced their risk tolerance levels. New businesses, despite whether they have a great idea and top-notch management team, are slated to fail with dwindling markets. While few venture capital firms did invest in new businesses in 2009, many voluntarily stayed out of obtaining new investments completely.

Looking to the Future

However, the outlook is promising. According to Mark Heesen, president of the NVCA, “most of these firms will not be afforded the luxury of continuing to wait for market conditions to improve in 2010.” Heesen goes on to project that 2010 “promises to be a defining period as we will gain a better sense as to what the venture capital industry will resemble in the next decade. All signs point to a leaner, more capital efficient asset class comprised of firms with proven track records of delivering value to limited partners. Not all firms will make that cut, but the ones that do will be very well positioned to invest.”

And according to a poll of venture capitalists about the outlook for 2010, the respondents said they expect to see gradual increases in the total amount of investment levels. Areas of expected increase are in “green” technology companies, as well as more venture capital investment in growth companies and later stage 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. 

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.

Why do venture capital firms and entrepreneurs have such conflicting views about each other?  It could be experience or reputation.  Venture capital firms have seen all types of entrepreneurs and think they can spot a “type” in an instant.  On the other hand, entrepreneurs may hold negative viewpoints about a venture capital firm because of its reputation.  However, all these expectations cause potential conflict between a VC firm and an entrepreneur. 

If you want to avoid this type of negative imaging that may cause a loss of venture capital funding, here are two ways you can change your viewpoint.

Entrepreneurs Want Money…VCs Want Partners

Many times, conflict arises when an entrepreneur has an egotistical desire to retain control of his or her business.  They seek capital funding for millions of dollars from a venture capital firm, but then expect the VC firm to keep their “hands off” the company.

From the venture capital firm’s viewpoint, they have invested millions of dollars in a startup company.  They want to assure that their investment is nurtured and moves in the right direction for maximum profit potential.  Therefore, their perspective is that they are a partner in the business and not an arms-length lender.

New entrepreneurs would be wise to take the advice of a VC firm.  Input from a VC firm is based on experience and previous knowledge.  An entrepreneur may hold on to a specific idea, but if the VC firm is insistent that it will not work, it’s best to take that advice and move onto other parts of operating your business.

Softening Greed and Ego

It is true that many venture capital firms have been started by rich investment bankers who saw a “gold mine” in certain industries or particular geographical areas.  Those who reach financial success sometimes forget how persistence, determination, and luck are needed to become a success.  Instead, these rich new VC investors believe their way and experience is the only way to make money.  They do not give new entrepreneurs any leeway in making decisions or exploring creative options. 

If a start up business will succeed, it needs not only capital investment, but careful nurturing and guidance.  New entrepreneurs would be wise to heed the guidance of wiser venture capital investors.  And VC investors need to know that even though they do hold the money strings, it is important that ingenuity and innovation are free to take a startup company toward the riches it deserves.