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Positioning your business for venture capital

Wednesday, 30 November 2011 | By Marc Peskett
Marc PeskettMy last article titled Four ways to get a cashed up start-up outlined the different sources of funds available to start-ups.

 

This week I want to delve into one particular source that many start-ups and small businesses often don’t adequately understand or position themselves well to obtain – venture capital.

 

The unfortunate fact is we have a limited available and active venture capital pool in Australia.

 

However, that pool is still an important source of funds for enterprises that tick the following boxes:

 

  • Businesses with a scaleable and saleable business model.
  • With superior products and services.
  • That can be sold to fast-growing, new or untapped markets.
  • Have a defensible position.
  • Can deliver a high return on investment for the risk money VCs invest.

 

Venture capitalists (VCs) invest cash in return for an ownership stake in the business and financial return on their investment.

 

Their investment usually ranges from $1 to $5 million.

 

For their risk, they typically take between 10-40% ownership in the business and require a five to 10 times return on their investment, that they expect to realise within three to seven years.

 

They will have a high level of involvement with the business and insist on agreements to ensure they maximise their return and are first to realise their return as well.

 

In addition to their initial investment, VCs may provide additional rounds of funding, dependent on the results the investee achieves and the investment preferences of the venture capital fund.

 

They may also provide skills and knowledge to the investee business on strategic and operational issues, as well as financial and technological advice, industry knowledge, recruitment of key staff, and introductions to contacts that can add value to the business locally or internationally.

 

They are also well experienced in the process of preparing a business for an exit such as an IPO or trade sale.

 

Not all venture capitalist are the same. It’s important to understand the focus of the individual fund. VCs may make their investment decisions based on a particular investment stage or product commercialisation stage the opportunity sits in.

 

They may also concentrate on a particular turnover size of business, industry or geographical location.

 

Once a business has identified potential VCs, it’s important to obtain information about their investment criteria and how your business, products, services and value proposition aligns with that.

 

One of the most important criteria they will concentrate on is management skill and capability. VCs want the assurance that a strong management team is in place, with the depth and breadth of knowledge and experience that will enable the business and the VC to achieve their goals including a lucrative exit.

 

If you’ve done your homework and identified suitable VCs to approach, you will need to compile an investment proposal to take to the VC.

 

Your proposal should be firmly focused on what turns VCs on – financial upside.

 

Demonstrate how everything you do will create a strong financial return, whether it’s your technology, process, team or market opportunity. Show how you’re going to be profitable in order to warrant being a worthy investment.

 

Your proposal should also clearly explain what’s different about your product or service and how it addresses the needs of your target market.

 

Use plain language that’s easy to understand and is free from jargon and technical terms. Also try and be as transparent as possible and proactively address any areas you think are likely to be sticking points for the VC, including competition.

 

Many start-ups believe they don’t have competitors. Most VCs won’t buy that point of view, so think laterally about your competition and identify those that offer a product or service that might not be the same, but could be a substitute. Then address what advantage you hold over them.

 

From there the investment process, which can take several months, will follow these key steps:

 

  1. The VC will review your proposal to ensure it meets their investment criteria.
  2. A meeting will be arranged with the key business leaders or management team to discuss your business plan and start their due diligence.
  3. A Memorandum of Understanding will be entered into.
  4. The VC will look at forecasts covering size and growth rates of the relevant markets. They also review competitors, entry barriers, niche opportunities, current product life cycles, distribution channels and other factors that can impact the potential of the business. This information is often sourced from independent experts, accountants and consultants and is compiled into a due diligence report.
  5. Once due diligence is completed and terms negotiated, a final investment proposal is submitted to the board.
  6. Legal documents are then prepared to address many issues including the three key ones of ownership, control and valuation of the business. These documents include a shareholders’ agreement that outlines the responsibilities and expectations of both parties.
  7. Once the investment decision is made by the VC, the cash is provided to the investee business either in a lump sum or in multiple tranches as the business achieves certain agreed milestones.
  8. Regular ongoing reporting back to the VC will then be required or the VC will often take a seat on the business’ board to track progress of their investment.

 

If you don’t proceed to these stages, don’t be disheartened. Seek feedback and approach the next VC on your list whose investment preferences match your profile and keep pitching.

 

You’ll refine your proposal and presentation with each attempt and be able to apply those improvements to the next opportunity, which might deliver the results you need.

 

Marc Peskett is a director of MPR Group a Melbourne based business that provides capital raising, grants advisory and finance lending services as well as business advisory, tax, outsourced accounting, and wealth management to fast growing small to medium enterprises.  MPR Group is a member of the Proactive Accountants Network.  You can follow Marc on Twitter @mpeskett