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

If you have viewed the Oscar Best Picture nominated film, The Social Network, you may remember the powerful scene when Facebook founder, Mark Zuckerberg’s friend, Eduardo learned he was practically ‘diluted’ out of any substantial ownership of the new company. This was after a number of rounds of venture capital start up financing. The scene is powerful because Eduardo knew that with every stage of new investment, the founders’ equity in the company got smaller and smaller. Ultimately, his ownership share was diluted to less than 1%.

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

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

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

Ask How Much Dilution is Likely to Occur

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

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

Obtain a Dilution Schedule

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

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

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

Entrepreneurs looking for venture funding for their small business or start up are often approaching venture capital firms. And there is no wonder - venture capital firms can offer a staggering amount of money for expansion, marketing, and even IPO preparation.

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

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

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

An Unclear Executive Summary

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

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

Too Long

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

Unrealistic Valuation and Financial Projections

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

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

Lack of Management Discussion

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

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

For entrepreneurs and small business owners with dreams of becoming a large, nationally recognized technology company, venture capital is often an option for acquiring small business funding.

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

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

Product Development Stage

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

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

Product Acceptance

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

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

Failure to Commercialize

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

Proprietary Measures

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

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

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

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

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

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

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.

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.

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.