By Fiona Rotherham
Friday 1st August 2003
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1. When to approach a VC
If you have a business that addresses a genuine market need you could be a candidate for venture capital. But take the business as far as you can first because your case will be more convincing and the value assessment higher. Don't rush your approach - you generally get only one shot at the right funder. Fundraising takes three months on average. Your initial approach should be by email or telephone after researching all the VC funds - their investment criteria, size, how much money they have left to invest if you want money again in future (VCs call it re-stocking the playpen), and where they are located. Narrow it down to between two and five VCs that fit your criteria, and speak to other companies they have invested in. Find out how much money was made in previous deals by the entrepreneur, the investor and the bank.
2. What the VCs want to know
What does your product do, is it developed, and does it work? Who is going to buy it, why and when? What's the business potential? Is your competitive advantage sustainable? Have you sussed out your competitors? How much money do you want, by when and what are you going to use it for? What value do you place on your product? What's your track record in business and what are your views on an exit strategy?
Keep in mind that your product needs international appeal and the intellectual property to be patented. Private equity managers (later stage funding) want companies with potential to double their turnover and profitability within three to five years. Don't be deterred by past failure - it's not a barrier if lessons were learned. The essential ingredient is professional management capable of turning the business plan into a reality. If you don't have the necessary experience, buy it in. If you've invested your own capital in the company don't look to take your money off the table by replacing it with venture capital. And don't demand a non-disclosure agreement up front - provide the VC with enough information to assess initial interest first.
3. How to get the best from your advisors
Work out what you need advice for, be it business planning, tax or legal issues. Select advisors with experience, and check their track record. Talk to other companies that have used them, and make sure advisors come to you for discussions because their value increases the better they know your business. Negotiate hard on charges. Never put your advisor between you and a VC. And don't let them spend their time and your money on esoteric valuations - VCs ignore them anyway.
4. How to prepare a business plan
The plan should be prepared and presented by management - and reflect their passion for the business - rather than by advisors.
It should be verifiable, easy to read, free of technical jargon, and brief - 15 pages maximum. Include the company's mission statement and avoid talking about extravagant and non-productive expenditure like a company yacht. Allow your advisors to check your business plan, but don't let them turn it in to a sales pitch - it wastes the VCs time and your money.
5. How to assess the value of your business
Valuation is an art, not a science. VCs will make their own value assessments, and valuations are trending down. In the early stages companies are usually cashflow negative so VCs consider other elements such as how much money has already been spent, the value of the IP and existing sales contracts, and how much it will cost getting to market. Orion NZ Ventures' Ian McInnes says the concept or technology underlying the business probably accounts for only 10% of the ultimate value of the business; the balance rests on management's ability to execute the business plan.
VCs advise against letting a deal fall over because of valuation: be realistic and pragmatic in your assessment, and use that as a benchmark, not a given, when considering funding offers. Don't apply formal valuation techniques to fictitious cashflows - the days of the $US20 million dotcom deals are over.
VCs are likely to seek a stake in the business of 10 - 49%. Keep in mind that some VCs prefer to structure deals with agreed valuation uplifts when key milestones are achieved. Few New Zealand deals for later stage funding have been done outside of the average 5 - 6 times EBIT range, according to Direct Capital's Ross George.
McInnes says he was once told by Pete Musser, president of US listed VC Safeguard Scientific, that the valuation process should leave both sides feeling they've been screwed.
6. Don't marry for money alone
Having been screwed, remember this is just like a marriage. Value your investor as a true partner and not just a source of cash. They can guide you on strategic and financial matters, act as a sounding board for new ideas, and they have business connections and networks that can help grow the company.
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