Frequently Asked Questions
How do I get started?
Friends and family first. Most entrepreneurs fund the initial phase of their companies with money from friends and family.
Determine which venture capital firms focus on your industry by reviewing their web sites and talking with everyone you know. This is a relationship business, and more often than not, you know someone who knows someone.
You're looking for "smart money", money that can help you, not just fund you. Everyone's money spends the same, the key that entrepreneurs must look for are investors who will be valuable in assistance, guidance and relationships.
Venture capital is money that is exchanged for equity/ownership in your company. This will be the cheapest, or most expensive, money you will ever get. Cheap in that, if you go bankrupt, you won't pay back any of the cash. Expensive in that, when you are successful, you will have given away shares valued at $10 per share, at a cost much below. However, without the initial money and the help from your investors, you would never have been able to get the $10 price.
Why are investors looking to invest anyway?
Bottom line . . . To make money.
Investors give money to make money, not to accumulate ownership in companies.
Let's look at a portfolio of 10 companies. For simplicity sake, we'll put $10 in each company. Also, we're going to look for a return of 30% per annum, and we'll say these investments will be in for 1 year only. Generally speaking 1 company will be a home run, 2 companies will be successful (30% return), 4 will be worth only the money invested in them, but will not go public or be sold, so they are as good as failed, and 3 will fail outright.
Thus, 1 company will be responsible for its own return, and the investment and return of 7 other companies. This is why investors focus on the home run. For an investment of $10, we're looking to get $104 from that company. In the beginning, every investment looks like a return of $104 or it wouldn't be made - however, as in this example, often only 1 in 10 makes it.
This is why the market potential and opportunity must be attractive for the investor. A safe investment at a low payoff is generally not worth our time, money or effort.
What are the stages of Venture Capital?
There are 5 stages of venture capital: Angel, Seed, Follow-on, Mezzanine, and Bridge Loans. The assumption is that valuation will increase through each stage and risk will decrease.
Angel Stage: Primarily friends and family members
Seed Stage (or 1st Round): First investment by professional investors
Follow on Stages (Rounds 2-x): More rounds of professional money
Mezzanine Stage: Last expected round before an IPO
Bridge Loans: Money that is loaned with the expectation of converting into equity at the next round of financing, usually with a discount to the per share price
For any company, a drop in valuation between rounds is disastrous. When valuations do not increase, it means that the management team did not execute according to plan. This also means that future investors will be less likely to invest, given that the potential of the company is now in doubt. A fair valuation at each round is critical. If you get too much in one round, you will be in a far worse situation with follow-on funding. Thus, it is important to get a fair valuation for your company at each stage.
Pre-money? Post-money? What are they?
Pre-money is the value of your company before the investment is made. Post-money is the value of the company after an investment is made.
POST-MONEY = PRE-MONEY + INVESTMENT AMOUNT
How much money should I ask for?
Look to get enough money to validate the next stage of your business. This is advantageous to both the investor, less money is at risk, and for the entrepreneur, there is less equity being given away.
How much of the company should I expect to sell?
There is a range, depending on several factors. In general, the more stable the company, the less you need to give up in terms of equity.
How mature the company is, where you are in development, and what partnerships you have established all combine to influence how much of the company we feel we require to secure our partners' investment.
Potential counts for something, but execution, and delivering on potential is what investors are looking for. The more you have already delivered, the better off you will be as a company, and the more investors will want to give you their money.
For risky ventures, it's not unheard of to give 50% of the company in the first round. For a company that has established the partnerships and validated the technology, less is possible.
Will the VC take over the Board?
Venture capitalists will want to protect their investment, especially at the high risk, early stage of the company, but even so, majority board control will be rare.
A good VC will want to protect his company, and will need the ability to make things happen. However, every VC knows that it's the entrepreneurs who run the company, not the investors.
Board size should be small -- the last thing you want is too many people interfering with the company. Ideally, a 5-member board is enough for a small company. Look for a 2-2-1 breakdown. Two people from the company, 2 VC investors and 1 3rd party who is chosen by both sides. Ideally, the 3rd party should have industry knowledge, and be the person to break the ties in the best interests of the company -- not the investors, and not the employees.