5/5/14 3:53 PM Venture Capital For Dummies Cheat Sheet - For Dummies

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Cheat Sheet
Venture Capital For Dummies
From Venture Capital For Dummies by Nicole Gravagna, Peter K. Adams
Navigating the world of venture capital as you seek to raise funds for your business can be scary and
confusing because of the high stakes. After you identify whether venture capital is a good choice of
funding for your company, you can begin to seek out investors. When seeking venture capital, you
need to know who the venture investors are and where to find them. You also need to take certain
steps to prepare yourself and your company for the scrutiny youll experience as potential investors
strive to learn more about your company as they decide whether it is a good candidate for venture
capital.
Determining Whether Your Company Is a Venture
Company
Its very important to figure out the type of company youre building a
venture company or a lifestyle business so that you can decide whether
you should consider venture capital in your business growth strategies.
Sometimes, determining which category you fall into is hard. Even though
lifestyle businesses can make annual revenues into the millions, other things,
like the type of business and/or the rate of growth, make them unsuitable for
venture capital investment. The rate of growth and the ultimate size of the
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company are good indicators that can help you decide.
Characteristics of Venture
Companies
Characteristics of
Lifestyle Businesses
Area in
which
you do
business
National or global Local or regional
Growth
rate
Very fast (you plan to grow from a
brand new company into a nationwide
corporation in only a few years)
Slow (you plan to
open only one new
location of your
business each year,
for example)
Nature
of
business
Generally game changing businesses
based on new technologies
Businesses that sell
or deliver traditional or
conventional products
or services
Makes
money
for
Investors, founders, and owners Founders and owners
Future
plans
To be sold to another company or to
go public, with founders leaving the
business or assuming different roles,
based on need and qualifications
To be kept in the
family for generations
or to be sold when the
founder/owner retires
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Alternatives to Venture Capital Funding
Venture capital is a unique way of getting funding for your company. Because
venture investors look for companies that are growing very quickly and can
make several times the initial investment for the investors, venture capital isnt
right for every company. Fortunately, growing businesses have plenty of other
ways to find funding. Here are just a few of the other ways you can get capital:
Debt: Many different kinds of debt are available for growing businesses:
business loans, government-backed Small Business Administration (SBA)
loans, and factoring loans that are backed by accounts receivable (in these
loans, you sell the businesss accounts receivable to a third party at a
discount).
Friends and family: Your friends and family are watching you create and
grow your business. Chances are they are proud of you and want you to
succeed. If they have the means, they may be interested in financially
supporting your venture.
Angel investors: Angel investors are like venture capitalists in that they
invest in early-stage companies to get a large return on investment. Unlike
venture capitalists, who fund businesses by using other peoples invested
money, angels work with their own money. As a result, angels have a lot
more freedom to invest in non-standard ventures.
Crowdfunding: Crowdfunding is a great way to pre-sell your product before
its ready to ship to customers. For businesses, crowdfunding doubles as a
way to get paid to market your new company or product.
Growing organically: When you grow your company organically, you take
out only what you need to survive and put the rest of your profits back into
the company as an investment. The bigger you can grow your company, the
more money it will return to you in the future.
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Preparing to Seek Venture Capital
Investors want to put their money in companies that will succeed. To select
such companies, an investor has the difficult task of predicting which
companies will flourish and which will fail. Investors like to see companies with
lowered risks. A business can lower the risk to success over time by
developing the business strategically and creating powerful relationships with
individuals and other businesses.
To make your business most attractive to investors, you must show that
you've hit milestones and lowered the risks that are inherent to start-up
companies. You don't need to have profits or even revenue yet. You just need
to show venture capital investors that you are on your way.
Key tasks to building the business
Every business faces the risk that it will fail. Successful venture companies
are founded, grown, and sold to another business, or they go public in an
initial public offering (IPO). Between the day the business is founded and the
day it is sold, a business faces several major risks that stand in the way of
success. These risks are different for all businesses, but here are some
examples:
Creating a product that is unique and that is (or will be) in high
demand: A venture company must sell a product that solves a major
problem for a lot of people or businesses. If your product is commonplace or
needed only by a handful of people, you will have a great deal of difficulty
connecting with venture capital.
Fulfilling all legal, tax, and government regulations required to sell the
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product: Venture capitalists are professional investors. They will not work
with companies that have failed to build the business legally or without
meeting all formal government requirements.
Selling the product for a profit: A popular product isn't valuable unless it
can be sold for more than it costs to make. Making products profitable can
be especially tricky in cases where manufacturing or materials are very
expensive.
Hiring a management team that can grow the business: The team is
probably the most important asset for a start-up company. A great team can
change the product, redesign the marketing plan, and make new
relationships with strategic partners. A great team can overcome most
challenges to the business.
Finding and meeting investors
When your company is ready, you can begin to connect with investors.
Venture capital investors can be hard to find. When you are ready, look for
them in the following places:
Talk with your service providers. Bankers, lawyers, and accountants can
often connect their clients with local venture capital firms.
Network and attend pitch events. Pitch events are formalized
conferences designed to connect founders with investors.
Tap into the resources of business incubators (groups that
concentrate resources in one place and often provide discounted
services and free advice to young businesses) and mentors who have
raised capital in the past. These groups will be able to point you to the
right investors for your company. To find business incubators, go to the
National Business Incubator Association at http://www.nbia.org/.
Reach out to venture capitalists through their websites. To find more
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about venture capitalists online, visit the National Venture Capital
Association at http://www.nvca.org. Remember, venture capitalists need
you just as much as you need them.
Crafting a Venture Capital Agreement That Benefits
Entrepreneurs and Investors
A venture capital investment is a partnership between an investor and a
growing company. To create a productive relationship that supports a rapidly
growing company, the partnership has to be good for both the entrepreneur
and the venture capitalist. To ensure that the agreement is fair and promotes
the interests of both parties, pay particular attention to the term sheet and to
your company's valuation.
Term sheets
A term sheet is a legal document that outlines the agreements made between
the investors and the company founders. When both sides agree on the terms
in a term sheet, the deal can close, and the investors effectively purchase
stock in the company. The term sheet contains multiple terms, but the most
negotiated are these:
The type of investment (stock or convertible debt): Convertible debt is a
hybrid type of investment. The agreement begins as debt and then converts
to a purchase of stock if the money is not paid back. Generally, both sides
assume that the debt will convert to stock at an agreed-upon time. A regular
stock purchase is a transaction in which an investor purchases a number of
shares in a company for a predefined price.
The price of the stock, which is defined by the valuation of the
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company. Determining the price of stock for a start-up company is not a
simple task. Many ways exist to determine a company's value. No matter
how much a founder calculates his or her company's valuation, the true
price of stock is the price that an investor is actually willing to pay.
Liquidation preferences for investors: Investment agreements are not all
created equal. One of the biggest factors that affect an investor's final
payout when your company sells is the liquidation preference. The
liquidation preference describes who gets paid first when the company is
sold. Liquidation can also occur when the company is dying, and assets are
sold to cut losses. People holding preferred stock typically get their invested
money back before everyone else.
Definitions for who controls the company: Investors can be given voting
rights so that they make executive decisions for the company as a group.
Also, investors can sit on the board and have a major impact on decision
making. Determine up front how much power you want your investors to
have.
Valuation
The price of your company's stock is defined by the valuation of the company
and the number of stock shares that make up the company.
Risk is a key determiner of your ultimate valuation. The value of your
company is low when you first start up, because you face many future
milestones that have yet to be accomplished. Over time, you decrease your
risk by accomplishing these milestones. As you do so, the value of your
company grows a situation that is reflected in the cost of your company
shares. Investors will have to put more dollars into the company to buy the
same number of shares.
Because no perfect formula exists to determine the valuation of an
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early-stage (pre-revenue) company, expect to spend time
negotiating with investors to make sure everyone is on the same
page about valuation and risk (both the risks your company faces
and those it has already overcome) when investments are made.
Pitching Your Deal to Venture Capital Investors
Talking with venture capital investors about your company is different than
having a discussion with potential clients or customers. Investors want to
know how you will make money for your company and subsequently for them.
To impress these investors, be prepared with sophisticated materials that
communicate your company, product, and plans for the future. In short, you
have to get across that you are the founder that investors want to work with
for the next three to seven years. Your task is to show that your team is
capable of driving your company to success through integrity, hard work, and
adaptability. You do that by creating a pitch deck.
The pitch deck is the visual slide presentation that acts as a
backdrop to your oral presentation. When you are presenting your
deal in person, the pitch deck should be clean and nearly wordless.
After all, the images (typically infographics) serve to reinforce your
oral presentation. However, you may not present your deal in
person. In that case, a pitch deck can also be a PowerPoint file that
you e-mail to investors. For this pitch deck, the slides must be self
explanatory. (Yes, plan on creating more than one deck!)
All investor pitch decks for early-stage companies should include information
about these topics:
Company overview and the problem your product or service solves
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Your business model
Your target market and marketing strategy
The risks and barriers to entry your company must overcome
The size of your industry and your company's growth potential
Your team
Your exit strategy
Your valuation story
The ask, when you ask for investment from those in the audience
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