In our fundraising series, Venture Capital is the next step up.
The key difference between Venture Capital and other fundraising options, is that you’re dealing with professional fund managers whose job it is to control other people’s money. Because of this, the checks are tougher and the investor involvement is higher. It is incredibly competitive, with VC firms receiving around 500 proposals each year. For this reason, an introduction to the firm is extremely beneficial.
Venture capitalists tend to specialise in a specific industry and each will have an expert in the field. This person will be brought in to dissect and challenge your business plan, so it must be rock solid. Companies generally raise between £250,000 and £5,000,000 using Venture Capital firms, so although the risk is high for both company and investor, the growth potential is huge.
What do you need to do to successfully raise money with a Venture Capital firm?
As discussed above, Venture Capital firms receive hundreds of submissions a year, so it is very difficult to raise money without having a personal connection. Usually, the most junior member of the firm will have a checklist and spend 5-10 minutes skimming through your business plan to assess whether you qualify for investment. You must grab their attention in this time, which can be very hard. For this reason, it is a good idea to find someone you know to introduce you to a firm instead.
- Have a look on LinkedIn, or use a company like Add Then Multiply who has connections in a firm. The most important thing is that you get an introduction to a firm, that specialises in the industry you are in.
- Ensure your business plan is thorough and detailed and will stand up against any checks they carry out. The due diligence process carried out by Venture Capitalists are very hands on, and the firm will typically engage top law and accountancy firms for this, so you must be prepared.
- You also need to have a certain amount of funds at your disposal, because Venture Capital firms expect you to pay for their due diligence and will often turn away start-ups that don’t have any cash for this purpose.
How does it work?
If you make it through the initial checks and the firm is considering your business, an industry specialist will be brought in to test and challenge your plan. If you pass this stage, you’ll be invited to pitch to one of the fund managers or partners. You’ll meet with them several times, following a pitch and Q&A format. There will be more communication and further questions to which you must provide solid answers. If they decide they are serious, they’ll hire lawyers and accounts to carry out due diligence and you will pay for it. You’ll also need to hire lawyers of your own, to get the investment and shareholder agreements documented. If you pass the final stage, you will agree upon a deal which will set out targets you hope to achieve. They will then get a member of their team on your board, who will help to drive business strategy.
Venture Capital firms will tend to invest in a very specific type of business. It may be that they invest in fintech, media, or healthcare related businesses, but their focus tends to be narrow. Bearing these objectives in mind, they will go out and raise money from a pool of investors which they will then put into an overall fund. From this fund, they’ll make separate investments on behalf of all their investors but effectively acting as the Venture Capital fund.
What kind of business can use Venture Capital firms?
Most commonly, it is early stage businesses that use Venture Capital firms. However, this tends to range in the industry; some specialise in very young companies while others require companies to have a turnover of at least half a million pounds.
Pre-revenue businesses are higher risk, but the firms take the view that they’ll get a bigger chunk of the company and therefore a better return. They might invest in 10 companies and have the expectation that 7 will go bust, one may be moderately successful and one or two may take off.
The return on the successful companies will completely outweigh the money they lost on those that failed. However, unless you are in a really hot sector you’ll need to have some establishment to your business; a turnover of half a million plus, a good cash flow, traction in the marketplace and the data to back this up. You’ll be aiming to raise between £250,000 and £5 million in the first round and if your business grows, well you’ll have access to more.
How involved are the investors?
They get very involved. Even more so than angels, Venture Capitalists will drive the strategy of your business. They’ll require a seat on your board and will devise an agreement that will give them a significant amount of power to block or pass decisions on the strategic direction of the business. Some appoint an independent chairman, as well as someone who represents their firm. They will also structure the investment deal in a way that protects their interests over everyone else, to ensure they get their money first. The way they achieve this is by structuring their investment in a combination of common stock and preferred shares, this is very technical and if you need to know more don’t hesitate to get in touch, but the main thing to take away is that they’ll have a very significant say in the business.
If things go according to plan, Venture Capitalists can be incredibly useful. Depending on the firm you are with, you may be able to go back for more money; if your businesses have grown in the way they had hoped it can be easy to raise even more money which can help you expand further and faster. If your business doesn’t deliver, however, things can get tough. The term vulture capitalists were coined because firms have been known to fire members of the board, including the founders if things don’t go to plan. They will often bring in some of their own people who will inform the firm if the business is not performing as expected. Additionally, regardless of your business success, they will always be data hungry. Monthly board meetings will take place, where you will need to report on financials, marketing activity, web traffic and so on. It will, of course, depend on the nature of your business but they will want to drill into a lot of data so you must implement systems to produce these reports monthly.
If you are successful in raising money using the Venture Capital route, you will no doubt have a seriously investable business, as these firms do not invest easily. It takes a lot to get funding, and your business is worked very hard once you secure it. However, if you deliver they can be fantastic backers.
Serial entrepreneurs who have had success with a firm can often go back and ask for more money for their newest Venture, once they have exited their previous one. These firms have deep pockets and if you perform well, they can be a great source of investment. However, if you don’t deliver on your plans it is not uncommon to see yourself moved out of the business. Although it was a more public company at the time, if you look at what happened to Steve Jobs and Apple in the 90s you can see that founders are not invincible and management firms will not hesitate to take serious action if your business does not perform.
So, if you decide to go down this route, you must ensure you are fully prepared for all eventualities. That being said, successful funding can propel your business forward in incredible ways, you just have to put all you’ve got into making it work!
Tomorrow, we take a look at the world of private equity. Until then!