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How to Win Venture Capital
By Colleen debaise
THE WALL STREET JOURNAL COMPLETE SMALL BUSINESS GUIDEBOOK (Three Rivers Press).
The process of selecting, pitching and ultimately negotiating with a VC can be intimidating, especially to those not accustomed to the world of high finance. I asked Lori Hoberman, head of Chadbourne & Parke LLP's emerging-companies/venture-capital practice in New York, to explain the various steps. Here's what she said:
Pinpoint the ideal VC.
First, an entrepreneur must target the right venture capital investment fund to pitch. That requires some research. It's a good idea to attend venture capital and private equity conferences. Ask an attorney or accountant for a referral. Online databases such as VentureSource (owned by Dow Jones) provide information on the latest venture deals. And most VCs host websites that describe their "sweet spot" and existing portfolio investments, Ms. Hoberman says. Don't waste time pitching your biodiesel fuel business to a VC that only invests in software.
Prepare a "teaser" document.
This one-or two-page document that you send to VCs is your way of introducing yourself—and it's got to be memorable. Tell the VC who you are, what need you fill in the market and how that market translates into dollars. Because most VCs are barraged with investment requests and can give each one only limited consideration, every sentence of your teaser needs to "answer the question about why an investor would ever dream of putting money into you," Ms. Hoberman advises. "It forces you, as the entrepreneur, to think in sound bites." She recommends incorporating text and graphics (pictures, pie charts or graphs) into the document. "The whole idea is to tease the investor into wanting to hear more," she says.
If your teaser has done its job, a VC often will ask you to provide financial statements, including projections. If you're building out your business model and are attracting paying customers, "it's a much easier sell," says Ms. Hoberman. Show how you've gotten to your current stage, whether that's through bootstrapping, help from family and friends, or funding from angels.
Prepare your pitch.
If a VC wants a meeting after reviewing your financials, the initial face-to-face encounter will probably last less than a half hour, so use the time wisely. Don't forget the thirty-second rule, Ms. Hoberman advises. "You have to tell the investor in the first thirty seconds who you are and how you are going to make them money," she says. If you plan to show visuals, such as a slide show or online demonstration, keep it short so that there's time for questions. Demonstrate your belief in the company and your knowledge of the market or industry. "The VC wants to get a sense that you know what you are talking about," she says. When a company has more than one founder, it's also important for partners to demonstrate that they are a strong management team. "Look at each other when you talk, and show respect," she says.
Review the terms.
If your pitch was successful, you'll receive a term sheet for a first or "series A" round of financing (later rounds are called series B, series C and so on). The document outlines the deal that the VC is proposing before investing in your company. At that point, you and your advisors (specifically, an attorney who specializes in venture financing) should begin negotiations. The term sheet outlines voting rights, liquidation preferences and, more important, how much equity the VC will receive.
Figure out what you're worth.
In order to negotiate, you need to place a value on your company, which can be tough or imprecise at such a young stage. One approach is a so-called back-of-the-envelope valuation, which can be determined by deciding how much venture capital the company needs and how much equity you're willing to sell. "You try not to give away more than one-third of the company in the series A round," Ms. Hoberman says. For example, if you need $3 million in financing for your consumer product company but don't want to sell more than a one-third stake, you'd value your company (prior to receiving the capital) at $6 million.
Do your due diligence.
Before signing on the dotted line, take some time to consider the ramifications of your decision. Talk to other companies in the VC's portfolio about their experiences. Keep in mind that the VC will take board seats and expect progress reports at monthly meetings. Good VCs "understand the hills and valleys and can wait it out," Ms. Hoberman says. "The really bad ones ream the entrepreneur every time the slightest thing goes wrong." Write to Colleen DeBaise at firstname.lastname@example.org