Despite all of the attention that venture capital firms get in the business press, they actually finance very few businesses and it is a relatively small industry. The better venture capital firms are deluged with proposals from budding entrepreneurs, but most of them are inappropriate for venture financing.
What Kinds of Businesses Are Venture Capitalists Looking to Fund?
Most venture capitalists concentrate their financing efforts on later-stage business funding. However, some venture capitalists will consider financing a start-up. What they really want to see from any entrepreneur seeking funding is a history of start-up successes. These venture capitalists are best known for financing high-tech firms, but they do finance other types of businesses—approximately 50 percent of businesses they finance are not high-tech.
Venture capitalists prefer to cut deals that provide an exit path within five years. They look at the probability that a firm will successful enough to go public or be purchased by a larger company. They are looking for firms that have the potential to produce net income of tens of millions of dollars a year.
They also expect very high returns for their investment risk that only the fast pace of highly profitable growth will bring. They want to see a management team in place that can handle rapid growth, and one that is well balanced with all types of experience and skills represented: creative, engineering, financial, marketing, and management.
Each venture capital firm, and usually each venture capital partner, has its own deal criteria and tends to specialize not just in certain industries but also in certain deal types. Maybe they focus on early stage health care firms or start-ups in mobile hardware. Find out who covers your space and focus on them.
I have seen entrepreneurs waste their time and energy taking their proposal to venture capitalists. If your situation is not a venture capital–potential business, don’t waste your time and energy trying to make it one—there are other financing alternatives.
What Do Venture Capitalists Look for When Investing in Start-Ups?
Generally, in financing start-ups, venture capitalists are looking for a reasonable probability of being able to cash out their initial investment with a high multiple within five to seven years. The liquidity event may involve taking the firm public, or selling it out to a larger company.
If the venture capital firm doesn’t recognize the start-up entrepreneur, it looks to see what other venture capital firms have already committed to funding. Especially in funding start-up companies, venture capitalists tend to make very small commitments because even they find it difficult to judge the likely success of a start-up. They tend to prefer investing in start-ups when another venture capitalist that they respect has already agreed to make an initial investment.
The question then is: how do you get the first commitment? Well, one solution is to get at least a tentative commitment, or an indication of interest, from one of the more prestigious firms, and then perhaps go to a secondary firm for your first solid commitment.
Takeaways You Can Use
- Venture capital is only appropriate for financing a very small percentage of start-ups.
- Many venture capitalists don’t finance start-ups at all.
- When venture capitalists invest in start-ups, they prefer to be part of a larger group providing seed capital.