What Capitalists Want

A survey shows what nearly 300 venture capitalists look for in new and expanding companies.

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Though the idea of venture capital is as old as capitalism itself, like the proverbial policeman, it's often hardest to find just when you need it. But it is there -- if you know where to look and how to go about asking for it.

To help pin down the criteria that venture capital organizations require, and thus increase the chances of a needy company's striking a deal, 291 high technology venture capitalists were recently queried with a four-page questionnaire. (The survey results have been compiled into a directory of venture capital organizations with funds available for high-technology investments.) Although the questionnaire was directed toward venture capital funding of high-technology industries, only 10% of the respondents replied that they invested exclusively in high-tech projects. That means that 9 out of 10 are willing to consider any proposal -- given the right circumstances. Here are some questions and answers derived from the survey. A company that is aware of such data before beginning its search for financing will be that much closer to finding it.

WHEN DO VENTURE CAPITAL INVESTORS EXPECT TO SHOW A PROFIT?

The majority of venture capitalists queried -- 83% -- will invest in a company that is showing a loss. On the average they expect to see a profit within two years. If profits are four or more years away, only 14% are interested. Only 4% insist that their portfolio companies show an immediate profit.

IS THERE A RELATIONSHIP BETWEEN STAGE OF DEVELOPMENT AND PROFIT EXPECTATION?

Yes -- but there are no standard definitions of "stages" within the industry. Generally, the pattern goes like this: Investors in start-ups -- companies in the process of being organized -- expect a profit in two years; in first-stage companies -- very young concerns operating at a loss and projecting further losses -- a profit in one year; in second-stage companies -- young concerns approaching break-even and projecting profits in the near future -- immediate break-even. (A third-stage company is one for which the investment likely will be its last round of private financing.) If you've been in business for two years but think it will take another two years to show a profit, you're more of a start-up than a first-stage company in the mind of the typical venture capitalist.

HOW IMPORTANT IS THE SIZE OF THE COMPANY SEEKING CAPITAL?

Most venture capital organizations -- 83% -- have no preference concerning annual sales of the companies in which they invest.

HOW MUCH MONEY CAN YOU EXPECT?

If you're looking for a small amount, the odds are against you. Roughly 75% of venture capitalists are not interested in deals involving less than $100,000. (Since each investment requires a certain amount of effort and expense, small sums are simply not cost effective.) However, a number claim they have no upper limit. And there is always the possibility of a syndication for larger deals: Half of the firms, will act as lead investors to raise more capital than they can invest singly. The average that venture capitalists prefer to invest individually ranges from $200,000 to $750,000 per deal; the average preferred ceiling for a syndicated deal is $6.5 million. The average individual Small Business Investment Company (SBIC) prefers to limit itself to $500,000; the average Minority Enterprise Small Business Investment Company (MESBIC) to $200,000. The average syndicated deal with an SBIC leader is limited to $4.5 million.

WHAT ARE SBIC AND MESBIC GOVERNMENTAL RESTRICTIONS?

The amount that can be invested per deal is restricted to 20% of paid-in capital for SBICs and to 30% of paid-in capital for MESBICs. Further, companies in which they can invest must have a net worth not exceeding $6 million and average after-tax net income for the preceding two years of no more than $2 million. In most situations, both SBICs and MESBICs are precluded from taking a controlling interest in a portfolio company.

HOW MUCH MANAGEMENT ASSISTANCE IS PROVIDED?

Almost two-thirds provide frequent assistance. Only 8% limit their help to "occasional" assistance, or none at all. A large number stated that a quality management team is essential for the companies in which they invest. Without a team that is well rounded and experienced, a company will find it extremely difficult to raise venture capital. "But my company has a dynamite product," you say. "It can't help but be successful!" Don't be so sure. Most venture capitalists much prefer good management with a mediocre product to mediocre management with a good product. When you get right down to it, they're looking for both good management and good product.

WHAT REGIONS ARE FAVORED?

Geography apparently is not a critical factor in determining a company's chances of finding venture capital. About a third of those queried had no preference; among those with a preference, no particular region was clearly favored or disfavored. As for the venture capitalists themselves, about half came from only three states: New York (22%), California (20%), and Massachusetts (10%).

WHAT SHOULD A SEEKER PREPARE FOR A FIRST CONTACT?

Three out of four venture capitalists prefer initially to look at a short business plan or a description of the company and the deal being sought. Long business plans usually are not required initially -- only 9% of those queried request them when first contacted.

ARE CITIES PREFERRED OVER SMALL TOWNS?

No. Only 4% of the venture capitalists prefer that your company be in or near a major metropolitan area. It undoubtedly would be to your advantage, however, to locate in a region served by a commercial airline.

HOW FAR SHOULD A COMPANY GO TO LOOK FOR CAPITAL?

Keep in mind that most venture capitalists provide management assistance as well as funding, and that the younger a company is, the more likely they will insist on working closely with it. And the closer your venture capitalist is, the easier it is for him to provide assistance. Thus most newer companies and those who expect management help as well as funding are well advised to begin their search for capital close to home. But don't automatically rule out distant sources. If you can't find a venture capitalist in your area, you may find one somewhere else who is sufficiently interested in your company to recruit a nearby organization to sponsor the deal.

HOW SHOULD A VENTURE CAPITALIST BE APPROACHED?

Only a handful of those questioned preferred that the initial contact be made by a third party or another venture capitalist rather than by the entrepreneur himself. With that in mind, you'll probably find it cheaper and faster to call before sending a letter or proposal. Remember, "nothing ventured, nothing gained" is, in this case, a maxim that works both ways.