Given the current economic and financial climate, you might be forgiven for thinking that venture capital funding is almost impossible to obtain. While there is no doubt that venture firms are taking a much more critical view of investment opportunities, and perhaps putting more of their funds aside for their current portfolio companies, they still want to invest in exciting start-ups. Many of them already have their own capital raised, and are being pushed by their limited partners to deploy it, even if they are worried about how quickly they might be able to raise the next fund, as availability becomes restricted by market turmoil. But don’t believe anyone who tells you not to try.

This article is intended for those companies looking for their first round of venture capital funding, but also pushes its readers to consider what options there might be before setting off down that path. For many, the process might appear to be a potential quagmire, and many will have heard of the horrors of term sheet conditions which appear to be tantamount to giving away the store. However, as with all things, the right preparation, taken together with a strict project management process will get you the best results, and ensure that there are few surprises along the way.

Thinking About Your Options

Of course, venture funding isn’t the only way to go. Make sure you consider some of the alternatives before you take the leap.

• Bootstrap
  You’ve probably done a lot of this to get to the point you are at currently. You’ve put off moving into offices and are still working from home, communicating with your colleagues using IM and conference calls, and maybe you’ve still got that other job, or you continue to delay hiring the next developer; and you’re dipping into the last round of savings. Whatever the financial climate, it can always be a good idea to do this for a little longer. The greater your revenue, the stronger your order book, the more tested your product, the higher the value you will be able to put on your company when you eventually get to that point with prospective investors.
• Debt
  Sounds like a dirty word, but it can be the perfect direction to take at certain times. Many of the venture banks won’t provide financing unless you have venture capital backing, but there are other firms with a higher risk tolerance who might be able to provide term loans, even if this is at a high level of interest (oh, and they’ll almost certainly want some warrants in your company!). The advantage of this option is that you’ll give away less of your company’s stock, even if the expense is relatively high. You’ve more chance of getting this type of backing if you have a good level of receivables that you can use as collateral (otherwise known as factoring), or if you have a clear way to value your IP. And of course, you can always go to your own bank to see how they can help you with Small Business Administration (SBA) loans, or a traditional loan using a personal guarantee.
• Angels
  There are many groups of “angel” investors in most States, usually a collection of wealthy individuals who get together to look at interesting opportunities, and then take collective decisions to invest, or a small number of the group might invest separately. They are likely to invest in smaller amounts than venture capital firms, but they could be a very suitable option. Just type “angel investors” followed by the State, into Google and you’ll get a number of leads for where to go. Angels are normally a little easier to work with than VCs, although they will still be diligent about where they put their money. The bonus might be that they take a personal interest in your business and they can help you with contacts and good advice.
• Venture Capital
  After considering all of the above, you might still want to move forward to raise funds from venture capital, either because you need larger amounts than you can obtain from other means or you don’t have the collateral that is required for banking relationships. If you are totally new to this you can get a lot of information from the National Venture Capital Association website, but you might find that you need a consultant to help you or a savvy board member who has been around the block before. The most important thing is to be prepared for the process and make sure that all of the right parts are in place.

Being Prepared

There are three things you absolutely must have before you target your first VCs: an Executive Summary, a slide presentation and a financial model.

• Executive Summary
  The first thing an analyst, executive or associate in a venture capital firm is going to need is a short executive summary that tells the whole story in 2 or 3 pages (or sometimes only 1!). It will have to provide a description of the company, its products and services, the marketplace, the business model, a short summary of the intellectual property, the go-to-market plan, and short biographies of the management team. You’ll also have to give details of location, amount raised to date, amount you are looking to raise, professional relationships (accountants, attorneys etc) and your exit strategy. Lastly it should include summary financials for at least the next three years. Having this in short form is a good exercise to complete, as it focuses the mind on who you really are. On the other side of the coin, it allows the reader to understand quickly whether or not you fit their profile, so that you can get a quick yes/no decision.
• Slide Presentation
  This can have the same or similar information as the Executive Summary, but will allow you to have that first conversation with a prospective investor, either over the phone or in person, with the right prompts to make sure you give the whole story. If you can add a succinct demonstration of your product or technology within this presentation you’ll get bonus points!
• Financial Model
  This won’t be needed at the first contact, but if there is any interest it is likely that this will be required immediately so have it ready to go (and, of course, make sure it corresponds to the summary numbers you have already provided!!). You can provide some explanation of assumptions to go with it, but most VCs will have an analyst who knows his or her way around an Excel spreadsheet better than any of the rest of us, so they will work it all out very quickly! Make sure you know how to build in “collapse” features that make it easy to review by year as well as by month and allow for it to be printed easily.
• The Business Plan
  While it is a good idea to have a full business plan available should the venture capital firm request it, it is quite possible that it will never be requested, as the firm very often relies on detailed discussions with the company and the due diligence of various documents that they will ultimately need. Instead, you might consider preparing a longer form Executive Summary, something of approximately 10 to 15 pages. This will provide more detail of the market, marketing and sales plan, technology and operations than was provided in the first document, but doesn’t need you to spend day and night writing a comprehensive book on the subject.

Here are some other preparation ideas:

• Prior Financial Statements
  Once the decision has been made that your company is interesting to the VC, you will almost certainly have to provide your previous financial statements, so make sure these are ready to go!
• Due Diligence Materials
  The more information you can have packaged the better. Once you get a due diligence request things are looking good, so being prepared for it will earn you even more kudos! Detailed information might include market research reports, board minutes, product specifications, technology white papers, management resumés, and sales pipeline reports.
• Board and Advisors
  Have you thought of what your board should look like? Having some semblance of a board makes you look prepared! Maybe you will look even more professional if you have list of advisors.
• Consultants
  If you are worried about doing this all yourself, especially given that you still have a company to run, consider the use of consultants. You should expect to pay some retainer, but you might also be able to defer some of this, or allocate some stock in the company as part-payment. This might seem to be a comparatively large expense, but, if the consultant knows how to prepare the information in the right way, it will prove invaluable, especially if he/she also has some “friendly” VCs!

The Funding Trail

If you’ve been through this before you might have some good contacts, but the chances are that you don’t have much of a clue as to where to start. Use board members or advisors who have got contacts, but also consider the use of consultants who are expert in the process and have lists of contacts, as well as some idea of the best fit for your company and its technology.

Because of the diversion that the investment process can entail, and depending on the size and shape of your organization, you should consider who needs to be involved, so that your normal business operations won’t be taken off track. If you have a CFO, this person can project manage the process for you, leaving you to get involved in presentations or feedback and Q&A sessions only when you need to. Again, if it’s only you who will be involved, consider bringing in outside help to project manage everything. The cost will almost certainly be cancelled out by the time saving benefits!

Be prepared to change your presentation, executive summary and financial model based on feedback received, but take care not to go too far with this. Almost all potential investors have a different view of the world, depending on the discipline from which they originate, so they will all have a different take. One might think that you should talk about the market earlier in the presentation, whereas another might think you should explain the unique selling points of the product. Listen to the ideas and possible criticisms, but don’t necessarily change everything, the next listener might think the opposite!

The Term Sheet

The day has arrived – you’ve been told to expect a Term Sheet from an investor!! How exciting! But when it comes it includes a number of items that have never been mentioned before and are impossible to understand. Here are a few things you might see:

• Convertible, redeemable, cumulative, participating preferred shares!!
  Preferred – they rank ahead of common shares on a liquidation or winding up! Convertible means the shares can be readily converted into common shares at a triggering event such as a sale of the company or an IPO. Redeemable means that, at some point in the future the investor can take back cash (with accumulated dividends) instead of converting, usually at a specified date. Cumulative – there is a compounding dividend rate attached to the investment, such dividend being convertible also into shares. Participating - in the event that a sale of the company occurs (and usually in the event of an IPO) the investor will have the right to share in the distribution of proceeds based upon its share of the company following the conversion of its preferred shares and following distribution of the liquidation preference (see below).
• Liquidation Preference
  Before there is an allocation of the distribution of proceeds to the common shareholders, the investor usually requires payment of a liquidation preference, which is likely to be a multiple of its original investment, plus accumulated dividends. Clearly, this protects the investor’s downside. Following distribution of the liquidation preference, the balance of proceeds is usually then distributed in accordance with the percentage shareholding that each party holds. Make sure you understand this, as your own percentage holding is only relevant after reducing the value of the company by the liquidation preference!
• Tranches
  The proposed investment might be staged into two or more “tranches” or phases, with follow-on tranches only invested once pre-conditions are met.
• Pre-Emptive Right
  This allows current shareholders to maintain a proportionate ownership of the company by purchasing the relevant number of new shares issued.
• Board Membership
  Depending upon the amount of investment, the investor is almost certain to require a number of board seats.

The Aftermath

When you have finally completed the seemingly endless number of agreements that comprise the investment documents, and racked up a larger-than-you-expected legal bill, you should expect some changes to how you operate going forward with venture capital partners in tow. Expect to meet with your board every month at first and to prepare monthly board packages. Talk to your VC board members regularly and make sure they get no surprises at the board meetings!

Attempt to understand how each of your board members, and any others that form part of the VC “watch”, operate and how they can help. They will always tell you that they can provide operating help, but you will want to focus their help in areas that they are strong. Remember that this is still your company to run, but be mindful of their advice when they give it……you might have to go back for further funding sooner than you think!

Summary

Raising funds is hard work. It takes time away from your everyday business objectives and strains relationships in your management team. Find a member of your team to project manage the process and if this person doesn’t exist, consider hiring a consultant to help you get to the end result. Having a great product in an accelerating market, with a great business model is the backbone of your success, but being prepared and professional is an important way of highlighting your business advantages.