How to beat Venture Capitalists at their own Game Part 1

Putting myself in the shoes of an Entrepreneur, it is very difficult to set out to raise Venture Capital finance for the first time.

 

Inexperience means that the cards are stacked against you.

 

The experienced VCs will tell you that they don’t like intermediaries because they don’t like paying fees.  I suspect the truth of the matter is that intermediaries are rather too good at levelling up the playing field.

In this series, I will use the Six Minute Strategist methodology to try to share with you my experience of the process and help you understand what you need to know.  The key to winning this game is to know as much or more about them as they know about you.

This series will cover six areas

  • Fund Profile
  • Investment Style of the VC
  • Deal Flow
  • Process
  • Deal Structure
  • Value Added (by the VC)

Lets make a start with…

Fund Profile

Why is this important? Understanding the VC’s fund profile is important to ensure that you are engaging with an investor who is able to invest in your company because it is a fit with his fund.

Fixed Term Funds

Funds are fixed term, typically 10 year, funds.  Once the VCs have raised the fund they typically go through three phases.  In the first phase over years 1 to 4, the VCs are looking to invest in new companies, in Phase 2 which are years 5 to 7, the fund will probably not seek new investments but will reinforce their existing portfolio with bolt on acquisitions or additional growth capital.  The final phase, years 8 to 10, the fund is looking to sell its investments and realise its returns for its investors.

These phases, invest, consolidate, harvest will blend into one another so the time periods are approximate.  In order to raise their next fund, the VC needs to demonstrate a successful track record which they can only do by successfully selling some of their portfolio companies and returning money to their investors so some of the earlier investments may well be sold ahead of this timetable  Typically, VCs will tell you that they look to hold their investments for 3 to 5 years.

You should  ask the VC how much of their existing fund they have invested and how much is available for new investments; part of the fund will already be set aside for phase 2.

Equity Cheque

Fund Size determines Equity Cheques; the equity cheque is the amount of money from the fund that is invested. This is often increased with leverage from bank debt or by syndicating the deal with other VCs.  It is important to know that your deal fits the range of equity cheque that the VC wants to write.  The rule of thumb is to divide the total fund size by 20.

The reason for this is very simple.  The VC is building a portfolio of companies and typically wants to invest in between 10 and 15 companies per fund (allowing for additional investment gets you to the divisor of 20).  The rules of the fund will typically prevent the fund manager from investing more than 10% of the fund in any single company.  Management time limits the upper end of the number of companies that the VC will want to have in the portfolio. If they invested in 50 companies this would be very time consuming to screen, process, close and manage through the funds lifestyle.

You should ask the VC what is his sweet spot for the size of equity cheque he is looking to write and you should ensure that your funding round fits within this range.

Sector

Increasingly VC funds have both a sector and a sub-sector focus.  This information is normally available on the VCs website.  You should seek out investors who have already indicated an interest in your specific business sector.  This will immediately ensure that you are more likely to be of interest to the fund and they have some understanding of your business.  There are some generalist funds but you immediately have the disadvantage with them that you will need to teach them about your sector as well as your business.

Geography

This has two aspects to it.  In the broadest sense, the VC fund will normally have geographical limitations built into it.  It is therefore less likely that a Silicon Valley Fund will be able to invest in a European Country.  This however is not the most important point.  Investors prefer to invest in companies whose main business is located reasonably close to their business.  The earlier the stage of investment, the more this applies.  My rule of thumb is a radius of 100 miles or a two hour drive.  Once you move away from Venture Capital into Private Equity, this rule is less applicable.  In screening for investors, start with those who are most closely located to your business. 

Competitive Investments

This is the flip side to my 3rd point.  VCs will typically not invest in two businesses which compete with each other.  This creates conflicts of interest.  If they have a competing business, they may still welcome you in for a meeting but their agenda will be different.  They will either be keen to learn from your business to help their company or will be reviewing your business as a possible acquisition for their existing “Platform” company.

You should review the VCs website where they typically list all their investee companies, past and present, and make sure that they do not have an existing investment in your competitive space.

Note that if they have a previous investment which they have sold successfully in your space, this is a positive factor as they will know your sector and have an interest in the opportunity to replicate their past success.

Stage

VC will have their own criteria for which investment stage they prefer.  These are typically Seed, Series A, Series B etc.  As a rule of thumb if your business is pre-revenue it is not ready for a Seed round but is still seen as a Friends and Family or Angel stage.  As investment rounds tend to increase in size, the stage of investment may well be determined in part by the size of equity cheque they are seeking to write.

You should review their portfolio and see what types of investments they are making.  If this is not clear from the site, you should ask the VC what their preferred investment stage is.

On Monday, I shall publish Part 2 of this series discussing the issue of Investment Style

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.

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