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

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

1. What is the Trend You’re Riding?

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

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

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

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

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

4. How Safe is Your Technology?

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

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

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.

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.

What makes a successful entrepreneur? An entrepreneur must wear many hats in the process of starting a new company, but one of the traits that sets an entrepreneur apart from others is the ability to successful raise money needed to get a company off the ground.

Start up capital is essential for new businesses to succeed.  Unless an entrepreneur has substantial savings to use as start up capital, he or she will need to ask for money. Raising capital for business funding is not easy. It requires a bit of diplomacy, flattery, enthusiasm, vision, as well as a host of other qualities to convince people to part with their money and invest in a new business.

What traits do venture capital firms usually see in successful fundraisers? Here is a list of skills and traits you might need to be a successful venture capital fundraiser.

1. Networking Ability – A successful VC fundraiser needs to have a large pool of potential investors in which to pitch his or her idea. A smart entrepreneur knows the law of averages and will not narrow a fundraising search to just a few possibilities.

1. Targeting Ability – Not only does a successful start up capital fundraiser need a large set of contacts, he or she needs the ability to narrow down a list to the ones who the best candidates. Rather than a ‘scattershot’ fundraising approach, efforts are focused on VC firms who fund new companies similar to the size and scope of his or her new business.

1. Enthusiastic Communication – Finding investors requires an ability to make a pitch to those investors that convinces them of the potential of the new business. An entrepreneur who has passion and enthusiasm in the way he or she communicates to investors will have a better chance of receiving funds.

1. Preparedness – An entrepreneur who expects to receive VC funding never wings a presentation. Every detail of a presentation is practiced and honed until the message is exactly right.

1. Tenacity – Rejection is rampant in the world of VC fundraising. A successful VC fundraiser accepts this as part of the job and begins again when he or she meets a dead end.

1. Patience – No entrepreneur who needs money “now” will succeed. A successful VC fundraiser knows that there is a process to fundraising, including attracting the right venture capital firm, due diligence, and negotiation.

1. Flexible but firm Negotiator – Negotiation requires the ability to be flexible, but also the creativity necessary for the give-and-take of the process. A good negotiator will also recognize a good deal and have the ability to walk away from an unfair deal.

1. Realistic – Though enthusiasm is good, knowing the limitations and risks of the business, and being able to talk about them with venture capital firms, is also essential. A VC firm will easily see through a “smokescreen” of all positives and wants to know that the entrepreneur accepts and is aware of the risks as well.

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.

Getting a “yes” answer from a venture capital firm can be an exciting time for an entrepreneur who’s trying to raise capital for his new start up business. But an approval only means progressing to the next stage of getting the venture funding: the negotiations.

Negotiating a venture capital deal can look daunting, especially to a new entrepreneur who has not “gone through the ropes” of the entire venture funding process. Most VC firms realize this fact and subsequently have an upper hand in most deals. However, you can succeed in VC firm negotiations if you follow these helpful tips:

1. Never Negotiate When You’re Desperate for Capital

If you need money NOW, you are at a steep disadvantage at the negotiating table. When you are desperate, you may be willing to give up too much in the negotiations, which means you will be left with a deal that doesn’t benefit your new company as well as you had hoped.

2. Know the Quality of VC Firm You Are Dealing With

You should always ask yourself, “Are these the type of people with whom I want to partner?”  Keep in mind that a quality VC firm provides much more than just funding, and a good partner may be worth giving up some points during the negotiations. A VC firm that can help guide the business growth process is worth its weight in the coins they invest. Ask other startup companies, and check references (they check yours…why shouldn’t you check theirs?).

3. Retain a Good Lawyer

Having a legal specialist in your corner is always a wise choice. Find an attorney who has had previous experience with venture funding. Your attorney will be able to point out potential hazards in a deal and suggest negotiating points.

4. Keep the Big Picture in Mind

It is easy to get caught up fighting for relatively unimportant negotiating elements.  Know which brides you are willing to die on, as well as the ones where you can let the water run their way.  Choose your battles, and keep the big picture in mind – and that is getting the funding you need from an investor you trust.

5. Treat Negotiations as a Partnership

In negotiations, treating your venture capital firm like a partner will have better results than treating them like an adversary. Negotiations should be friendly, but with your points stated firmly. Know that there is some give and take with negotiations. Reaching an agreement will be more satisfying when you consider that the VC firm is there to help you and your company succeed – not to take over your company.

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.

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.