Obtaining venture capital financing generally follows a normal process that takes anywhere from three weeks to six months, but normally requires six to eight weeks from start to finish. First, locate one or several venture capitalists to contact. Then, submit a letter with a summary presentation and a formal proposal. If the venture capitalist likes your summary and business proposal, he or she will contact you, ask some questions, and then arrange a face-to-face meeting at his or her office to discuss your business.
If the investment looks promising, the venture capitalist will begin a process of due diligence, investigating your company and the industry in much more depth. At this point in time, the VC may issue a commitment letter, making an initial promise to fund your company. Once the venture capitalist completes the due diligence process, the lawyers become involved and begin drawing up the legal papers that close the deal. Let’s discuss each of these steps in more detail.
Finding Venture Capitalists : Locating venture capitalists to contact is surprisingly easy. Though most companies are private partnerships, the venture capital community is very well organized. The most frequently cited source for locating venture capital is Pratt’s Guide to Venture Capital Sources, from Venture Economics, a division of Securities Data Publishers. Pratt’s Guide contains an introduction discussing the venture capital industry and a list of just about every venture capital fund in the United States and Canada, including their area of specialization.
Another source of information is Galante’s Complete Venture Capital and Private Equity Directory. Similar to Pratt’s, Galante’s also databases most venture funds and their areas of expertise. A directory titled Small Business Investment Companies (SBICs) can be obtained from the Associate Administrator for Investment at the U.S. Small Business Administration. The National Association of Small Business Investment Companies (NASBIC) and the National Venture Capital Association (NVCA) will also provide lists of their members.
From these directories, select several venture capitalists who specialize in your industry and are located near your place of business. Venture capitalists prefer to invest in companies located nearby so that they can minimize their traveling time and maximize their contact with the companies in which they invest. Working with a venture capitalist from your city or state will also save you a great deal of money that would otherwise be wasted making trips to the VCs office. As a rule, you should only broaden your search if none of the venture capitalists in your area specialize in funding businesses in your industry.
Once you have identified several venture capital firms as potential investors, you may want to carry out a little due diligence of your own to ensure that they are reputable companies. Contact other entrepreneurs who have done business with the VCs to gain a sense of their business ethics. Do a credit check and contact the venture capitalist’s bank to ensure that the VC has a solid financial history and plenty of money to invest. Beyond finding capital, you are selecting a business partner. It will be vitally important to choose a firm that shares your goals and with which you can develop a strong professional relationship.
Initial Contact : Your first contact with the venture capitalist usually comes in the form of a cover letter and summary presentation attached to a proposal. VCs may receive a 100 proposals a week, of which 10 or less will actually be read. This fact alone places tremendous pressure on the entrepreneur to produce a first-rate summary presentation that will entice the venture capitalist to read and study the proposal. The summary presentation should be a three-to-five page overview written with brilliance and clarity that articulates the most important points of your business and seduces the venture capitalist into exploring a tremendous investment opportunity.
An effective summary will include
- (1) a description of your business and its product;
- (2) an introduction to the management team, emphasizing the experience of its members;
- (3) an explanation of the amount of funding you are requesting;
- (4) an explanation of how the capital will be invested;
- (5) financial projections for the next five years, and
- (6) an explanation of how the venture capitalist will exit the investment.
You should treat the summary presentation as a selling document that excites the venture capitalist and moves him or her to invest in your company. It should be professionally finished and cosmetically refined because it may be the most important document you compose.
Proposal : This is where the rubber meets the road. If your summary convinced the venture capitalist to read your proposal, then you have a legitimate opportunity to obtain venture capital based on the merits of your business and the potential of the investment. If you present a solid, well-written proposal, then the venture capitalist will be able to read the document and make an informed investment decision before even meeting you. It will shorten the process by reducing the amount of due diligence he or she must perform and limiting the number of meetings required to close the deal. As the name “proposal” suggests, this document should convince the venture capitalist that your company is an attractive investment opportunity. It should be succinct and to the point, only discussing topics pertinent to the venture capitalist.
Unlike a business plan, which may run to 100 pages or more, the proposal should only be 20 to 30 pages in length. It should discuss how the business will succeed, omitting details that are less relevant to the performance of the company. Your objective should be to convince the venture capitalist that your company possesses a unique product and has a competent and experienced management team. It should also prove that your company will grow substantially over the next five to seven years and will give the venture capitalist an opportunity to exit the investment and recognize significant capital gains. In his Venture Capital Handbook, David Gladstone (1988) discusses the summary presentation and proposal at length, providing an effective format for composing these important documents.
Meetings : If the proposal impressed the venture capitalist, he or she will call you to arrange a meeting to discuss your business and a potential investment. The first meeting will most likely take place at the VCs office. The venture capitalist will want to learn more about the business, evaluate you in person, and “cut a deal” if all goes well. The VC will question you at length about your assumptions and projections, and may even inquire about your personal life. The venture capitalist wants to understand everything relevant to making the investment that could be discerned from the proposal.
The first meeting will probably last several hours and may be followed up with other preliminary meetings. At some point in time the venture capitalist will want to visit your business and tour the facilities, and meet your management team and key personnel. If all goes well, the venture capitalist may then issue a commitment letter, a non-legally binding initial agreement to invest in your company. It will outline the terms of the investment and pave the way toward a formal, legal agreement.
Due Diligence : Due diligence is just a fancy term for the venture capitalist’s investigation of your company, the industry, and the market in which he or she is investing. The due diligence process actually began when the VC read the proposal and asked the first question. The venture capitalist continues the investigation by asking even more questions, doing background checks on you and your management team, talking to customers and suppliers, analysts and competitors. The VC may even hire a consulting firm to do an intensive study of the industry and evaluate your company’s growth potential.
The Closing : If you’ve made it this far you’re nearly home. However, you should take several precautions to ensure that your interests are served and that the deal is executed according to the conditions you’ve agreed to. Though the venture capitalist will have a lawyer who draws up the legal documents, you should have your own attorney review them to ensure that they are both legally sound and in line with your understanding of the agreement. Then, be sure to carefully read through the documents yourself, to ensure that they coincide with the commitment letter and any other verbal transactions that took place since you began discussions.
Remember that the lawyers are not business executives, so you shouldn’t expect them to look out for your business interests. You must personally review all documents to verify that they meet your expectations.