In's and Out's of Venture Capital

With the push underway to create new industries in Ohio, the bar has been lowered for smaller businesses and eager entrepreneurs with a great innovative idea to get into the venture capital game. Historically this more sophisticated form of financing was primarily reserved for companies with sales generally from $25 million and up looking for $10 million of new private equity and up. 

Investors continue to aggressively look for great ideas that can grow into a blockbuster business, with a national and international market, in a relatively short period of time - say five to seven years.

Investors will also look for turnaround opportunities of an underperforming company with great potential with the right management partners and more funding.  VC's, simply stated, are high-risk takers and will go where many others won't.  A sample VC portfolio might have thirty companies, with only 20% who turn out to be real winners and knock the ball out of the preverbal financial ballpark.  Huge in the high risk area, they will expect a lot more out of a company than what a traditional asset-based lender at a traditional bank will request.

From your perspective, venture capital and private equity money is generally paid in capital to your company with no principal and interest repayment required.  But, they will require ownership and management control in most instances. If you have one of these big ideas, you may be a candidate for one of the investment options now open.  Here are the typical conditions attached to venture capital money and a few guidelines to consider when you approach investors:

The business plan is the first step.   You will be required to provide a business plan outlining your request.  This should be a working document for your company that is used in long-term planning and not simply a sales tool to get financing.  The plan should be no more than 15-20 pages and include:

       1.    Executive Summary - Prepare a concise one page overview of the project.

       2.    Investment size and structure requested - Break out, in specific detail, how much money is needed and in what allotments.  Is all cash needed at the beginning or can it be in stages?

       3.    Description of the product or service - First and foremost - identify what makes this product or service unique.   Second, how and why is this uniqueness going to build existing market share or create new markets to generate new revenue?  Breakdown, in detail, the products or services, including: manufacturing, distribution and pricing strategies.  Show best case and worst case scenarios.  Be realistic.  Seasoned investors know pie in sky when they see it.  Show how to mitigate a worst case scenario in order to turn around a negative blip in the real world business environment.

          A.  Current financial statements and projections - Provide CPA prepared financial statements and projections.

          B.   Brief history of your Company - This important segment can demonstrate your past successes and ability to manage and grow a business.

          C.  Business and marketing strategy - What are the specific steps required in bringing your product or service to market?  What is required to launch the business?  What is required to maintain and grow market share once in the market?  This will include operations, technology, manufacturing, distribution, product development, advertising, public relations, promotion, staff development and sales/distribution training.

         D.  Competitive analysis - Analysis of the market and the competition is key to any success.  Identify both primary and secondary competitors. How will you compete against each competitor and why will it work?

          E.  Detail resumes of key management - Management expertise, credibility and integrity is absolutely vital to an investor.  Highlight industry and market expertise of your management team that would enhance the success of this new idea.

         F.  Non-disclosure agreements - Sorry.  Don't expect to have a NDA signed by most venture capital investors.  They believe they have too many requests and can't afford the legal costs that would be incurred if NDA's are part of the process.  Make sure you complete your own due diligence of the firms you speak with to learn of the character of the company before you share your next generation idea with someone.

When you begin interviewing investors, to save a lot time, select firms that specialize in the industry of the business you wish to grow.  Ask them to give you references and a reasonable expectation of what their firm's capabilities are that will be provided to your firm - other than funding - like market research, access to key people, companies, trade and government resources. 

If you and the investor wish to move forward in working with your company, expect the investor to:

1. Take controlling interest -  Be prepared to give up controlling interest in your company.  It is not unusual for an investor or investor group to ask for up to 51% ownership in your business and /or the rights to your patent or intellectual property.
2. Board position - More than likely, if you do not already have a board of advisors, a board will be created and the investor manager will be an active board member and will put into place other individuals to compliment or replace your current team.  Make sure you like and can work with this investor.  In many ways this form of financing is much more like a marriage than a loan. 
3. Provide paid in capital -   The investor will provide the paid in capital.  The investor should provide enough money to get the job done as you will be giving up a significant amount of control of your company in exchange for not having to pay the money back.
4. Management expertise - It is vital that the investor is bringing management expertise to your company that you don't have, and more importantly, can't get.
5. Coaching -   The investor manager should be a good coach to help shape and mold the company.
6. Expected rate of returns - This is subject to variables, but typically an investor is looking for anywhere between 11% to 33% average rate of return on the gross profits in exchange for the money and talent  they provide.  This, of course, only occurs when the business is profitable.
7. Over what period of time - This is also subject to variables, but typically expect the investor to want out of the deal after two to four years.
8. Exit strategy- Make sure a clearly defined and legally prepared exit plan is prepared, agreed upon and signed by all parties.  By having a clearly spelled out exit strategy, there are now surprises for everyone in the end.

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About the author: Marsha Powers is president and CEO of Powers Financial Group Inc., which specializes in helping companies secure financing for business loans, commercial real estate, mergers and acquisitions, restructuring debt and consulting services. www.powersfinancial-group.com   

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