Venture Capitalists Don't Relish Risk
Probably the key fact for entrepreneurs to remember about venture capital firms is that their names are misleading. Though the term venture capital suggests a willingness to take risks on young companies, the fact is venture capital firms have become much less venturesome. More and more have shied away from funding start-up companies and have moved instead to target more established businesses.
And even if you manage to attract their attention, you will quickly discover why they are often referred to derisively by some entrepreneurs as "vulture capitalists." They drive a hard bargain, seeking as much as 70% of a company in exchange for their investment.
One encouraging development among venture capital firms, though, has been their growing willingness to look beyond their traditional turf of high technology and become involved with consumer products, retailing, manufacturing, and service companies. This has broadened the possibilities for nontechnology companies.
Venture capital firms have also shown increasing flexibility in the kinds of arrangements they will negotiate. Whereas they traditionally took equity for their investment, some now make part of their funds available as loans, perhaps convertible into stock some years later.
As you consider approaching venture capitalists, keep in mind the following observations of Jeffry Timmons, a professor of entrepreneurship at Harvard Business School, who has extensively researched the venture capital industry:
Tough odds. "The reality of venture capital is that it is a very specialized, very focused activity in this country and it is not for everybody. Out of 100 proposals for start-up companies or expanding small companies the venture capital investors get in this country every year, they will only make an investment in one, two, sometimes three of those 100 proposals. So the real odds of raising money are very slim for most entrepreneurs."
Management focus. "In real estate you hear the saying all the time that the key is location, location, location. For venture capitalists, the thing that they are looking to more than anything else is management, management, management and, lastly, the market potential. What is the quality of the entrepreneur and the people who are trying to get this venture off the ground and grow it? Do they have the experience, the know-how, the commitment, and the real determination and ability to see this thing through and bring it to fruition?"
Grand plans.Venture capitalists are only interested in small companies that have big potential, really big potential. After management qualities, says Timmons, the venture capitalists look at market opportunity. "The ideal deal that the venture capital people are looking for. . . is a $50-million to $100-million company in sales in five years. It should be in a marketplace that might be $300 million, $400 million, or $500 million in sales at that point in time, with the potential of being a billion-dollar industry in this country. Think of things like microcomputer software, fiber optics, telecommunications."
Value added. If you do get venture capitalists interested in your company and are able to negotiate what you consider reasonable terms, your company may gain from their experience, says Timmons. Having venture capitalists involved in your company, whether on its board of directors or as advisers, "is a tremendous advantage and a tremendously valuable secret weapon in your effort to grow a substantial high-performing company." They can provide suggestions and advice, contacts with other financing sources, and contacts with potential customers.
This material was excerpted from Chapter 8 of How to Really Start Your Own Business, by David E. Gumpert.
Copyright 1996 Goldhirsh Group Inc.