In the first two parts of this series, I have discussed how to tell the different types of Venture Capital and Private Equity firms apart.

In this, Part 3, I will discuss how to approach VCs, what they are looking for in an investment and Six reasons why Business Plans are rejected.

Approaching Investors

Assuming you have now identified your short list of investors from the hundreds out there, here are some key questions to ask yourself.

1. How should I prepare my business information to make it attractive and digestible to the investor?
2. What do investors expect to see in a Business Plan?
3. What can we do to ensure that our deal gets attention within the firm?
4. What sort of deal are we promoting and what is the best way to structure the financing of the deal which will give existing shareholders the best chance of making a high return while still being attractive to the investors?
5. What sort of deal terms are investors likely to put forward and how are these likely to compare or vary between investors?
6. Can we handle these negotiations on our own or should we find someone to help us manage this process?

What are Investors looking for?

Management Teams

Investors invest in strong and credible management teams backed by a strong business plan (focused on a strong business proposition).  Remember that if Investors see 500 to 1000 plans a year (and they do) but they only do 5 to 10 deals a year, your odds are no better than 100-1 against.

A Clear Business Plan

The management team need to put together a strong, well laid out and comprehensive business plan which will be easy to read, clear, concise and compelling.  The whole management team must be involved in the preparation of the plan and know it backwards.  This ownership is key to being able to communicate the plan to investors with credibility.

Realistic and Honest

The plan should be realistic not optimistic.  At the same time don’t do yourself down too much and expect the investors to run downside scenarios against you.  Understand your market and its size, be realistic about the strengths and risks posed by your competitors.  Be honest and straightforward, don’t leave skeletons in the cupboard.  If due diligence subsequently reveals unexpected information, your potential investor will walk away.

A Compelling Business Case

Your plan should put forward a compelling business case for investment in your business.  You are competing with other potential deals here and your case must convince the investors that yours is the deal they want to do.

Three to Five Years

The Business plan should scope the current business but prepare a financial plan going out at least three and preferably five years.  I always recommend that you prepare a financial model on a 5 year monthly basis.  It is easier to summarise this into annual periods than to try to reverse engineer an annual plan into 12 monthly segments.

In operational terms you should be detailed about your plans for the first 24 months.  Don’t forget you are explaining where you are now, where you want to get to and the route from here to there.

50 Page Document

I will provide check list outlining the detailed structure of the financial plan in the Six Minute Strategist PRO when it launches but in essence you should be aiming to produce a word document of up to 50 pages.  The financial model can be bound separately, if you print it out.  Any bulky data sets should also be confined to the back of the document in apendicies.

Executive Summary

The front of the document should contain an executive summary which I always recommend you write once you have written the main plan.  I have never understood how someone expects to summarise a document that has not yet been written.  This part of the document must sell the deal as it is likely that this is the only part most of your audience will read initially when trying to select which deals to look at more closely.

Understand your Audience

Try to understand your audience.  Investors want to make a good return on their investment and minimise their risk of not getting their money back.  It can help to talk to management teams from their portfolio companies if you can reach out to them to better understand the style and approach of a particular house.

Six Reasons Business Plans are Rejected

1. The presentation is vague, not well researched, verbose, non specific.  Use short punchy specific sentences – like this one.
2. There are factual errors or mistakes in the financials
3. There are specific omissions – possibly hiding negatives – which are not addressed honestly.  When preparing a SWOT analysis, make sure you are candid about the weaknesses and threats!
4. The financial model is too optimistic – avoid hockey stick scenarios.
5. There are too many uncertainties and risks associated with the plan.  These may be factors outside of the control of the management
6. The returns are too low.  As a rule of thumb, Venture Investors are looking for 5x to 10x returns on early stage deals.  Private Equity investors seek to double their money in three years and treble it in five.  This equates approximately to an IRR of 30%, but remember cash multiples are key, IRRs can be flattered, particularly over shorter time scales.

In the final Part of this series, I will discuss the characteristics of a good financial plan and Six ways investors make money out of deals.

What Next?

Take a look at my FREE video Tutorial “How to Turn Your Great Idea into a Business” which is all about Starting a Business and Raising Capital.

Can you tell the difference between a Private Equity firm and a Venture Capital firm?

Before you start to think about trying to raise finance from Private Equity or Venture Capital providers you need to make sure that you are approaching the right type of investor.

Finding the right investor can be like looking for a needle in a haystack.  The British Venture Capital Association has over 200 investor member companies.  If you add non-members to this, which will include US and European investors there are over 1,000 investors (my database for the UK is currently at 1,093 possible sources of finance) who you have to screen in order to arrive at a short list of firms to approach.

So, how can you tell the difference between Private Equity and Venture Capital and then understand the different types of companies in each category?

Lets start by differentiating between Venture Capital and Private Equity.

Venture Capital

In theory, Venture Capital funds invest in companies at an earlier stage and with greater risk.  As a result they are seeking higher returns (as some of the companies WILL fail.)   The earliest stage they may come in is in a Seed Round, typically investing in the hundreds of thousands (pounds or dollars).

The next institutional investment rounds are lettered sequentially, Series A, Series B, Series C etc.  These rounds tend to increase in size and are normally done at increasing valuations (up rounds).     As the investee company matures, it may need some additional finance ahead of an IPO, a pre-IPO funding round would then follow.

Private Equity 

Private Equity Funds also have their market segments and specialisations.  My database of PE funds recognises the following categories.

1. Acquisition Finance – providing capital to assist with M&A transactions
2. Public to Private – delisting public companies from the Stock Exchange
3. Buy and Build – initial acquisition of a “platform” to which additional companies are added in a sequence of strategic or consolidating acquisitions.
4. Equity Release – providing capital to enable founders to put some money in the bank, to settle mortgages and school fees for instance
5. ReCapitalisation – providing new capital for an existing deal. A company may be struggling and need additional capital to continue trading.  This requires a reorganisation of the shareholding structure, in which the original investors often lose out.
6. Bank Refinancing – Often companies, with bank debt from an orginal deal, may struggle to meet their debt obligations and these funds put equity in to relieve the financial pressure.
7. Spin Out – the opportunity to acquire a division of a larger company.
8. Bridge Equity – where the investee company needs some short term finance to enable it to achieve a project/milestone or objective ahead of another round of financing.
9. Secondary – the purchase of a company from another private equity or venture capital firm
10. Active – inteventionist investors who come in to force boards to take a more proactive role in realising value from underperforming assets
11. Rescue/Turnaround – investing (cheaply) in companies in financial distress and where often the only other alternative is a call to the Administrator
12. Distressed Debt – the acquisition of debt in companies in difficulties, at a discount to face value
13. Special Situations – a catch all term to cover situations which may be complex or where the underlying company is in difficulty.  The additional capital can unlock the problem, releasing value for shareholders
14. LBO – Leveraged BuyOut – generally a term for larger deals where a large company is acquired using a complex blend of debt and equity
15. MBO – Management Buy Out – acquisition of the company from original shareholders by the encumbent management
16. MBI – Management Buy In – the same as an MBO except that the management in this case come from outside the company.  The hybrid of this is the amusingly names BIMBO – Buy In Management BuyOut
17. Expansion/Development – Growth capital for the expansion of the business.
18. Mezzanine – a hybrid between debt and equity.  Interest rates are often in the 12%-18% range, part paid and part rolled, often with equity warrants.  The interest cost is high but the equity dilution is low.
19. Venture Debt – this is effectively bank lending but not from a bank, from a fund
20. Junior Equity – a form of equity with a lower return and less rights than the normal equity. It ranks behind preference shares and ranks behind these shares on a return of equity.  When there are different ordinary share classes with different rights, those with the lesser rights will be “junior” to those “senior” classes with more rights.
21. Listed – investments in listed companies shares as an equity investment leading to  a minority interests.  These investments have to conform to the rules of the Stock Exchange.
22. Purchase of Quoted Shares – similar to the previous item, but more of an investment strategy than an investment in the company

Don’t forget just identifying the investor is just the start of the process, now you have to get their attention.  To do this you need to understand their investment criteria in depth and that is the subject of the next post in this series.

What Next?

Take a look at my FREE video Tutorial “How to Turn Your Great Idea into a Business” which is all about Starting a Business and Raising Capital.