It's not as easy as coming up with a good elevator pitch, putting together a compelling PowerPoint presentation, and then saying, "Show me the money." Venture capitalists most often require something in exchange for handing over much-needed cash. They want a percentage of your company. They often want at least one board seat. And they want an eventual exit strategy – an initial public offering (IPO), an acquisition, or some other event that promises a return on their investment.

Even if you're willing to give up all that control, venture capitalists are still quite picky about what companies they'll invest in. "One of the first hallmarks we look for is whether this is a high growth area or does this company have the potential for exceptional growth – growth that's higher than you see in the typical Fortune 1000 company," says Maha Ibrahim, a general partner in Canaan Partners, a venture capital firm with offices in the U.S., India, and Israel. "We want to invest in companies that will grow by leaps and bounds over the next five-to-ten years so that it justifies going to the public market or provides an exceptional exit that creates enterprise value."

The sections below will review what type of business is ripe for venture capital investment and how a business can get in the door and raise money from venture capitalists.

How to Raise Venture Capital: Businesses that VCs Will Back

Venture capitalists are in the business of making money for their investors – and to get a high rate of return they often have to take risks. While the rates of return to investors peaked in the late 1990s and have since fallen off, billions of dollars are still flowing into venture capital investments each quarter. During the first half of 2010, VC investments totaled $1.4 billion into 1,646 deals, according to the MoneyTree report from PricewaterhouseCoopers LLP and the National Venture Capital Association, based on data provided by Thomson Reuters.

Technology and life sciences are the sectors that have recently been receiving the most VC investments. During the second quarter of 2010, investment in the clean technology industry – made up of companies that worked with alternative energy, pollution and recycling, power supplies and conservation – doubled over the first quarter to $1.5 billion. Meanwhile, investment in biotechnology and medical device companies combined rose by 50 percent to $2.1 billion.

"There are a number of areas we've identified as ripe for venture capital investment – digital media, enterprise software, semi-conductors, and some service plays," Ibrahim says. There are other sectors that VCs tend to avoid, including consulting or professional service-oriented companies, which are based more on people and human resources, and less on technology and scalable intellectual property, she adds.

Once a company is chosen for VC backing, it can make a world of difference in business prospects. "A successful financing can be one of the single most important milestones that propel your business toward its long-term goals," says Mike Dinsdale, vice president and CFO of DocuSign, an electronic signature service that has received several rounds of venture capital investment.

How to Raise Venture Capital: Getting In the Door

If you've decided that your business is in a sector that VCs tend to back and likely to experience exceptional growth, it's time to prepare your company, your management team, and your pitch for approaching VCs.

"As with any sales pitch, you need to carefully research the market before reaching out to potential investors," says Dinsdale. "As they say, you only get one chance to make a first impression."

Prepare very clear and succinct answers to the questions that all potential investors ask. In addition, develop a PowerPoint presentation 20-30 pages long that can help guide you through an hour or 90-minute presentation that answers the following questions:

  • What is your business plan? Detail your product, your market and why you have the competitive edge. "We're usually investing at such an early stage that there isn't a Forrester report on it or public analyst writing about the space," Ibrahim says. "Through our contacts at various companies, we recognize this is an area that has the potential to be big."
  • Why are you raising capital, and how will you invest it? Provide concrete numbers regarding how much investment you need and what you will be using that money for.
  • Who makes up your team, and why will they succeed where others may have failed? "Most venture capitalists say they invest in people and management teams, first and foremost," Ibrahim says. "Their investment is essentially a bet that your team will win in the marketplace."

Target Investors
Targeting the right investors can make or break your funding campaign; each firm has a different investment philosophy, Dinsdale says. Some invest at the early stage of a business, while others only participate in later rounds.

Do your homework. Research firms and the companies they have backed. Talk to everyone you know who has been through the process of raising venture capital. And then tap into both your own and the extended management team's networks to find personal connections with your targets.

"Being an entrepreneur means you're a good networker anyway," Ibrahim says. Once you find VCs to target, do some due diligence on them. Explore their websites to see the companies they have backed and speak with as many people you can find about their experiences with these investors – what they are like on boards, how they collaborate with management, what strategic value they bring to the firm.

"These are people who are going to be your partners hopefully through thick and thin over the lifetime of your company," Ibrahim says.

Initial Presentation
The first meeting you have with potential investors is a chemistry test, Dinsdale says. Tell them what type of investor the company is seeking.  "Don't go in desperately looking for money – one of the biggest mistakes a CEO can make is to deal from a position of weakness, appearing as though you need the money to stay afloat, rather than thoughtfully wanting funding from the right partner in order to grow your business," Dinsdale says.

Bring your product, if you have a prototype or a working model. One of the ways DocuSign was able to convince VCs to back the company was by using the electronic signature service throughout the funding process to facilitate electronic – rather than paper – signatures on various documents. "Not every company has such an obvious way of demonstrating its product during the funding process, but the same ingenuity that helped you form your start-up will likely be able to devise a similar demonstration," says Dinsdale.

The Due Diligence Process
After the presentation and the introductory meeting, the courtship begins as interested VCs begin to conduct due diligence. This step presents another opportunity to impress them with your preparation. Use this opportunity to compile a due diligence binder to present to potential investors, including your articles of incorporation, bylaws and operating agreements, and all documents furnished to shareholders and directors, any information about previous securities that have been issued, and all your financial information, from audited financial statements since inception to a summary of all bad debt.

Due diligence is not a one-way street. "Company leaders need to determine how each potential investor views its role with the company," Dinsdale says. "Don't be shy about asking for value-add from your investors. It should be a competition to earn the right to invest in your company.  At the end of the day, their value-added involvement only makes their investment more valuable."

Some companies perform due diligence on the product itself, hiring experts to examine the product or its market either from a technical standpoint or reviews from customers or potential customers.

Term Sheets
The next step in your courting ritual with venture capitalists comes if they are still interested. That's when they issue a "term sheet," in which they make their financing offer. "How the term-sheet stage is managed is key to getting the best deals possible," Dinsdale says. "Ideally, multiple investors will submit their term sheets around the same time. This benefits your company because competition means better company control; when there's only one investor interested, they control the negotiations."

The term sheet will spell out the following:

  • The dollar amount of the investment the firm wants to make.
  • The level of ownership – basically a percentage of the company – they expect in return.
  • Other terms the VCs need to protect themselves, whether that includes board seats or conditions such as that the company cannot be acquired without the investors' approval.

Term sheets are usually presented to the company in person by VCs. After reviewing and evaluating term sheets, it's time to close the deal. "The key here: always keep your options open," says Dinsdale. "It can be difficult to say to a potential investor you've decided to go elsewhere for funding, and it helps if you can have a Plan B in place, if your Plan A stalls during the closing process."

Maintaining the Relationship with VCs
Most VCs stay in touch with the company on a regular basis after the documents are signed, and funding has been granted. "We tend to be involved in our companies but we don't want to micromanage," Ibrahim says. "It's a delicate balance." Companies should expect to make regular updates to investors, oftentimes done at board meetings. "Always keep honest communication open," Dinsdale says. "As long as you are diligent and they don't have to chase you down to get information on their investment, they'll be happy. If some aspect of the business isn't working well, they'll work with you to fix it. If business is going well, they'll expect you to continue to do what's working."


Recommended Resources

National Venture Capital Association

Made up of more than 400 member firms, the NVCA is the trade association that represents the U.S. venture capital industry and tracks industry data.

Startup Junkies
An online resource center for start-up entrepreneurs by veteran entrepreneurs.

The Kauffman Foundation
One of the largest foundations in the United States devoted to entrepreneurship.

StartUp Nation
The three most important elements of an elevator pitch to investors.

Canaan Partners Pitchbook
Venture capital firm's online tutorial on pitching a business concept to potential investors.