Answers to some questions about venture capital

This page contains several different Question & Answer sessions with Venture Capitalists.

Panel discussion of women Venture Capitalists

Venture Capital is one of the sexiest forms of financing a business. It’s also one of the most expensive. I attended a wonderful presentation last night where a panel of VCs answered questions about their business. Many of the questions were things that people ask me when considering whether and how to pursue venture money. The answers to these questions come from Karin Kissane of TTC Ventures, Marcia Hooper of Advent International, and Vernon Lobo from Mosaic Venture Partners. I am extremely grateful to them for their excellent presentation.

What do VCs look for in a business plan?

VCs are searching for a business opportunity. Your plan has to convince
them that you have what it takes to turn an idea into a breathing,
viable enterprise:

  • Management Talent
  • A good market
  • A product
  • Support networks (e.g. other VCs, professional contacts, employees, etc.)
  • Deal Structure

The biggest convincers for a business plan reader are demonstrations of your competence. If you have a management team with real experience who have successfully launched a company in the same industry, you’ll be credible. If you have customers who have paid money for your product, you’ll be credible. If you have a clear presentation of your opportunity that shows you have a deep understanding of what it will take to make the business succeed (strategically and tactically), you’ll be credible.

If all you have is a good idea, no paying customers (or just letters of intent with no money behind them), no prior experience as an entrepreneur, and a shallow plan, you aren’t likely to make it past the first cut.

But I don’t know how to put together financials. Who knows how much I’ll sell?

Your business plan isn’t a crystal ball. You aren’t expected to predict the future. You’re expected to understand the size of the opportunity. If your product is useful at most to 1,000,000 people, they will pay 10 cents for it, and they only ever buy one, the total the company can ever make is $100,000 with 100% market penetration. Not a terribly attractive opportunity.

That said, decent financials show that you understand how the opportunity will unfold and what it takes to make it happen. By all means, bring in professionals to help you do the financials if you aren’t comfortable doing them yourself.

Should I have someone write my business plan for me?

VCs understand that not everyone is good at everything. When it comes to putting together detailed financials, or polishing the actual writing, bring in help. But when it comes to understanding your business-the market, the customers, and the product-you need to demonstrate that you understand the opportunity. Look for comparables.

I’m a visionary. I don’t have time for all that business plan and market research stuff. I just have a great idea. What should I do?

Team up with someone who has the skill to do all that thinking. VCs won’t invest in a team that doesn’t have time to scope out their opportunity. You don’t need to be the research arm of an investment bank, but you do need to show that you know who your market is, how it is segmented, the size of your opportunity, who your competitors are, and why you will succeed in that environment.

I don’t know who my competitors are.

Then find out. Buy competing products and investigate the manufacturers. Do web searches. Call reference librarians. And think broadly about who your competition is. Rolex doesn’t compete with Timex. Rolex competes with Mercedes Benz. Because Rolex isn’t in the watch business, they’re in the luxury status symbol business.

But we only need 10% of the market to be profitable…why won’t they fund me?

The other 50 funded companies who are developing competing ideas also need just 10% of the market apiece. Unfortunately, that adds up to 500% of the market. Is this a market you want to enter? If so, you need a persuasive case that you have a real advantage over those other companies. Otherwise, you’re just another generic gamble.

How long a time horizon do VCs have for their investments?

It used to be 7-10 years. Then it shortened to 3-5. In recent years, it’s become 1-5. It varies dramatically. One thing is sure, though: as internet time has begun to pervade the economy, VCs are expecting a quicker and quicker harvest.

In part, it is a function of where in the fund cycle the investment is being made. If it is at the beginning, there is obviously a lot more time than if it is the last investment in the fund. Although investors are always impatient, my [Vernon Lobo’s] personal bias is not to have funds come back as quickly as you have described. If I believe additional shareholder value, (in excess of a hurdle rate) can be created by continuing operations, I’d rather wait

How big an investment do VCs make?

Bigger all the time. More people have been investing in VC funds, and they have made huge sums which they are reinvesting. With such large funds, they opportunities to invest $3-$5 million at a time, in order to keep all that money productive. If you need less money, Angel Investors may be the way to go.

In addition, it may be better if the $3-$5 million is is staged in. I find that some entrepreneurs decide to ask for $5 million because they think that is what they have to ask for to get the VC’s attention, when all they really need to get going is $1 million. In the end, it is probably better for the entrepreneur (from a dilution standpoint), to take less up front, and stage in the capital, (as long as they meet their plan).

How big an opportunity do they need?

Many VC’s now are looking for a company that can grow to become at least $100 million (if not several hundred million) in revenue, and hopefully many multiples of that in value! If it doesn’t have that kind of potential it is not that exciting.

What kind of return do VCs need?

VCs need a high rate of return. Remember their business-they have investors that they are responsible to. With NASDAQ producing 50% returns, to be competitive, VCs need to offer their investors 70-80% returns.

But the situation is even worse. VCs have their share of failed investments. Their successful investments have to pay for the failed investments too, driving the returns they need on any single venture even higher.

On the other hand, one VC takes issues with the whole ideas of “target return.“ He writes, “We don’t have a “target” return. We don’t target a return any more than the entreprenuer does. When she/he starts a business, they usually don’t lay out a target return. Our philosophy is to become partners with the entrepreneur, so our objectives are the same…. We hope to make a lot of money!”

What do VCs want in a CEO?

Sales skills, the ability to attract the right team, an understanding of customer and markets, and flexibility. The business plan will change as the business and markets develop, and a CEO needs to be able to spot opportunity and steer the business to a successful (though perhaps unexpected) conclusion.

What’s the competiton for VC funding?

Advent International receives 10,000 business plans each year. They fund 30. You do the math.

What’s the best way to submit a plan to a VC?

Personal connections. One panelist couldn’t think of any unsolicited plans that her firm had funded. Another said some unsolicited plans had been funded, but she couldn’t remember who.

In short, work your network. The impression they gave is that unsolicited plans are virtually a waste of paper. But VCs do talk to each other. If you get your plan in one door, even if it doesn’t fly there, it may get passed around to other firms who will want to invest.

Do I have to tell VCs which other funding sources I’m talking to?

Nope. Keep ’em guessing. Late in the process, they will have to know so they know who their co-investors are. But there’s no need to be too specific in the early discussions.

What if a VC is already funding a competing venture? Will they sign a nondisclosure before looking at my plan?

Nope. You have to trust them. They have incentive to Do The Right Thing; their reputation is all they have. But legally, you’re on your own. They may sign an NDA (non-disclosure agreement) if you have a compelling trade secret, or late in the due diligence process.

An executive summary is a good way to summarize your opportunity without giving away proprietary details. Since a VC isn’t likely to read a plan in great detail if the executive summary doesn’t grab them, spend enough time on the summary and if you can pique their interest without revealing trade secrets, the NDA may be possible later.

How many VCs should I bring into the deal?

More VCs mean more connections and more resources for you to draw on. Two or three is a good number to have on board.

What should I look for in a VC?

Look for personality and fit with the partners who will be on your board. Personality clashes have destroyed companies; it’s better to wait for a good fit than to accept quick money with someone you can’t work with.

It is also perfectly acceptable to ask your venture capitalists for references. Ask for:

  • a current portfolio entrepreneur
  • a past entrepreneur whose company failed
  • a past entrepreneur whose company succeeded
  • a past entrepreneur who got booted from their company by the VC

Good Luck!


Red Herring Interviews

Red Herring has published some excellent interviews with Venture Capitalists about what VCs look for in a plan. In addition to VentureCoach VC Q&A, check out:

Benchmark Capital’s Andy Rachleff interview parts 1&2:

Divine Interventures’s Mike Santer interview 1 & 2:

A Venture Capital panel discussion Q&A, by Ste…

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