Venture Capital, is it right for you?
First a short definition of venture capital. Venture capital is often viewed by the entrepreneur as a high interest loan. This isn’t really the case. Venture capital is just money made available to you for starting your business, in exchange for ownership in the company. In most cases the VC firm will also offer you management advice and guidance. It is also sometimes referred to as “angel financing” a term you’ll find laughable if you do business with the wrong firm.
The way it works is you approach a venture capital firm and pitch your idea to them. It doesn’t have to be a business you are starting, it can also be a business you are trying to buy .
The firm will usually have a board of seven to ten people meet with you and discuss your idea. Then they make a recommendation to the full firm, or a segment of a larger venture capital firm, and decide if they should give you the money.
Most of the cases I’ve seen the firm retains 40% ownership if you pay them what they demand every month. If you fall short a couple of payments they take 60% control of the company and you get 40%.
There will also be certain covenants when you have the majority ownership. You will only be allowed to spend a certain amount of money wihout approval from the firm.
Sound fairly straight forward right? You pitch the idea along with the amount of money you’ll need and you’re expected earnings over a five year period. You show them how you’ll increase sales, cut costs, and manage the company better than anyone else could ever dream. They in turn give you a pile of money and free advice. What a deal!.
Here’s what really happens.
You approach the venture capital firm and meet with the board. You show them how you’ve invented a process of combining milk and apples into a potion that will cure cancer, and serve as an alternate to gasoline for 3 cents per gallon.
One of the board members is very enthusiastic. She thinks you’re on to something that with a little management and marketing guidance from the firm could be really big. The other six grumble about the risk of alar and other problems associated with apples.
After a few weeks they grudgingly decide to meet with you again. The guy that was excited about your idea sits quietly and the other members have softened a little to your idea but still have serious concerns, blah blah blah. After the meeting is over your ally will come over and talk to you alone. She’ll tell you she was really pulling for you and you may have to give up a little more control or equity, but she’s in your corner and thinks she can get it done for you.
If your idea really is good, you’ll get the money. If they detect you’re not 100% confident and that you don’t possess business savvy they’ll try to control as much of your business as they can in most cases. In other cases they’ll give you tons of freedom, but watch over your shoulder and count every penny.
When you fail to make a couple of the payments (and they will be considerably higher than bank payments) they’ll take control of the company. Then they’ll run it with such a heavy hand you’ll be forced to either sell to them, or get bank financing and buy your company back at a healthy profit to the venture capital firm.
So is it really that bad? It can be. You have to research the VC firm or angel Investors [jumpstarter.Hk] investor much more diligently than you would a bank or other lending institution. You must stick to your gains and get the best deal you can. This means you’re going to have to be patient, and you certainly will want to talk to at least to other VC firms. In short, you have to play their game.
So what should you look for in a venture capital firm?
I’d recommend one that’s been around for more than fifteen years. Some of the VC lenders have became jaded since the dotcom bust, and honestly it’s hard to blame them.
On the board there should be at least one or two entrepreneurs who made their money the old fashioned way. Hard work and perseverance. If it’s full of former dotcommers you’ll probably want to steer clear. The biggest reason for this is they may have no management or real business experience. The fact that they had a great idea and were able to capitalize on it before the bust doesn’t make for the next Jack Welch. It would also be a plus if they had a senior level manager in a big company. These guys know how to work a bureaucracy and what the traps are.
If you’ve done your homework and really believe in yourself and your idea, let the confidece shine through. That doesn’t mean be arrogant. It just means, hold your ground until you get the best deal possible.