MONEY

Are You Ready for Venture Capital? How to Tell

Landing VC money is one thing. Using it wisely is another.
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Much has been written about the similarity between marriage and the tie between a venture capitalist and an entrepreneur. But as difficult, complicated, and emotionally draining as divorcing your spouse may be, it can actually be simpler than divorcing your venture capitalist. Once you sign a term sheet and accept funding from a VC, you are typically bound to that firm until your company achieves an exit.

Assuming you perform the necessary due diligence before you sign on with a VC firm, your investor-investee marriage will probably be harmonious, fruitful, and full of fond memories. If, on the other hand, you hastily choose a firm, or accept venture capital before you or your business are really ready for it, you might come to regret the ball and chain now securely attached to your ankle.

How can you be sure that you’re ready for marriage--the financial kind?

5 Prerequisites to Accepting Venture Capital

For VC money to be truly valuable, your business must be ready to use it and prepared to answer tough questions if it doesn’t do so effectively. Before you even think about accepting outside funding, make sure you have a good answer for each of the questions below:

1. Is your product uniquely valuable? In other words, is your product really different from everything else's on the market, and do you have a truly compelling value proposition and competitive advantage?  

2. Is your economic model attractive? Investors will want to see that you can attract customers who bring in more revenue than it costs to acquire them. Simple. If it’s too early for your business to have a proven economic model, you need to have identified proven economic models from related companies that indicate your model will be successful, too.

3. Is your business scalable? Many companies are capable of successfully serving a niche market. Is yours also able to grow into something that is 100 times larger than it is today?

4. Is your management team capable of growing with the company? Though not absolutely essential to accepting venture capital--you can always build your management team down the line--it will make your business more attractive if your team can grow your company for at least the next two to three years.

5. Do you have any momentum? This is a critical question. Have you built a concept into a real product? Have you achieved market validation (i.e., your customers use and like your product)? Is your product being used more and is your number of users increasing? Are you driving revenue or revenue growth? VCs like to see that your operating and economic statistics are going up and to the right. 

You don’t need to be able to answer positively to all these questions to find a VC, but the more questions to which you can answer yes, the more likely you are to be ready for venture capital.

Other Factors to Consider

Aside from these basic prerequisites, it’s also important to assess whether you--as the founder or owner of your company--are really ready to expose someone else to your business.

Ultimately, a VC will need to review your financials at least quarterly, and most will want to become members of your board. Some VCs will want to find ways to help you grow your business through some level of active involvement. In addition, your VC may eventually want you to:

  • Find someone else to take over as the company’s CEO
  • Replace some members of your management team
  • Assemble a more formal board of directors that will have some power to dictate the company’s strategic direction
  • Explore new ideas that you might not agree with

Are you really ready for that?

Ultimately, the best investor-investee marriages are built upon a common set of values and goals that support an overarching vision. The best partnerships are when both partners are sure that they will be able to work together to achieve those goals, overcome the obstacles that present themselves along the way, and work together in a way that is best for the business.

IMAGE: Frank Cezus/Getty
Last updated: Feb 20, 2013

SCOTT MAXWELL | Columnist

Scott Maxwell has worked in venture capital since 2000. In 2006, he founded OpenView Venture Partners, focusing on expansion-stage tech companies. He graduated from MIT with a Ph.D. in engineering and an M.S. in management.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.



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