You’ve come up with a great idea for a business, gotten the plans in order, found others to help you, and the company is finally starting to have some success. The hard part is over, right? Well, maybe not. For many young entrepreneurs, the challenges are just beginning, as a new company needs funding to help meet the needs of customers and to reach growth and development milestones. Finding investors, often in the form of venture capitalists, is one way to finance these next critical steps as a business, but it’s often a process fraught with uncertainty and stress.
If you’re new to starting a business and finding investors, knowing what makes a business appealing to venture capitalists, how to talk to investors and close the deal, and when you’re better off going it on your own are things that are neither easy to learn nor especially obvious. Here, we’ll provide some help and guidance on these topics and many others you’ll run into when seeking investments that can make the process a little less scary and hopefully, a whole lot more successful.
When Do You Seek Out Investment?
How do you know when it’s time to seek out investors for your budding company? It depends on what your goals are for the future.
Tarang Shah, a VC and author, says in his book Venture Capitalists at Work that it’s a myth that the best entrepreneurs look for funding only when they need it and only raise the amount they need. In contrast, the best plan is to always be fund raising and always looking to raise more than you need so that you always have funds on hand (which can be a lifesaver in case of unexpected events). This is especially true in highly competitive areas like technology, where entrepreneurs have to scale rapidly and find a way to quickly dominate the market. But any company can benefit from funding that lets them more quickly expand into new markets or capitalize on opportunities.
Keep in mind that the top reason most startups fail isn’t because they aren’t getting funding; most falter when they try to scale too early, aren’t positioned correctly in the market, or can’t meet their performance metrics for these or any other number of reasons. So if you don’t get funding, it likely won’t lead to the downfall of your business; you’ll just need to regroup and try again.
Before you give it another go, rework your pitch, carefully research investors in your industry, develop an in-depth knowledge of your current and projected financials, and concentrate on building your business with the resources you have so you’ll have even more success to showcase when you meet with the next round of VCs.
How Do You Find Investors?
New companies most often seek out two types of investors: the ones who care about your business and their ROI — venture capitalists; and the ones who care about your business and you — angel investors. They can both offer your business some big benefits.
Angel investors are commonly friends and family, but this doesn’t mean you don’t need to be thorough in the research and presentation of your startup’s numbers. According Dusty Wunderlich, mergers and acquisitions advisor and private equity professional for DCA Partners, angel investors have a larger appetite for risk than venture capitalists, in part because they don’t have to answer to anyone but themselves.
Venture capitalists, on the other hand, know there is risk involved, but they have less of an appetite for it because they don’t answer to themselves; they answer to their clients. If you’re seeking funds from venture capitalists, then your business should be in their area of interest: the capital markets. Capital markets are where there are industry booms or new niches making major profits. These investors commonly bring more experience and knowledge to the table than an angel investor, which is a tremendous asset to have. They will freely offer their time and understanding of the business to you, especially since it is their money on the line.
But how do you hook up with a venture capitalist? This is where you’ll need to do some research. Before you ever contact a potential VC directly, find out which organizations tend to invest in the kind of opportunity you’re presenting. Look at where investors have put their money in the past and use that to gauge who might be interested in funding your company. Consider contacting entrepreneurs who’ve been funded through the company; they can let you know what kind of businesses and investment opportunities get the firm excited about contributing.
To get you started, here some VC firms in some of the major investment categories. While not a perfect fit for every business, they can be a good jumping off point when researching investors.
- Andreesen Horowitz: While relatively new to the VC game, this firm has invested in some big name companies like Pinterest, Facebook, and Skype.
- Google Ventures: If you’re like most, you probably didn’t even realize Google had a venture firm. They do, and it offers support for startups that can be ideal for newbies in the market.
- Felicis Ventures: Starting a web-based business? This firm is a smart place to start looking for investors, with more than 80 companies now on board.
- Draper Fisher Jurvetson: DFJ’s investments focus on digital and cleantech businesses. Current clients include FeedBurner, box, RedFin, Yammer, and Tesla.
- Chrysalix: This network of cleantech investment partners is the largest in the world, hooking entrepreneurs up with investment firms on a global scale.
- Nth Power: If clean power is in your wheelhouse, then consider looking into this firm, one of the earliest investors in clean technologies.
- NEA: With more than 31 cleantech and renewable energy companies in its portfolio (including solar and wind power), this firm is a smart choice for innovative entrepreneurs in the industry.
- Firelake Capital: Firelake focuses on funding clean energy and innovative environmental science companies.
- Allegro Capital: Looking to build your fashion company’s brand? This London-based firm invests in early stage brands and technologies.
- Maveron: Maveron has invested in all kinds of consumer-focused businesses, from board games like Cranium to discount sites like Groupon.
- First Round Capital: Those who want to start a web-based business, like current ventures ModCloth and Fab, may find luck in getting funding from this firm.
- BioEnterprise: Startups in the medical industry should consider this VC firm. They focus on investing in medical devices, biopharmaceuticals, and healthcare IT.
- Galen Partners: If your business is already generating healthy profits but needs to expand, consider pitching to this firm, which focuses on healthcare technology, medical devices, and pharmaceuticals.
- Radius Ventures: Radius Ventures is another firm that focuses on expansion stage businesses. Look here if you’re working with healthcare or life sciences.
- The Vertical Group: This group, in business for more than 30 years, is interested in funding medical technology and biotechnology companies at any stage both as venture and angel investors.
- Sequoia Capital: Looking for seed money? This firm, which invests in everything from energy to mobile technology, may be a good fit.
- Accel: Accel invests in an incredibly diverse range of businesses, though most are web-based.
- Khosla Ventures: From storage to consumer health to Internet retail, Khosla has invested in nearly every type of business at one time or another. What are they looking for? Startups that are highly innovative, unusual, rapidly growing, and large market focused.
What Makes Your Business Appealing to Investors?
No matter how amazing you are at pitching an idea, you won’t get far without crafting a business that gets venture capitalists excited about investing. Some of what drives interest in your business may in you and your business partners yourselves.
According to Wunderlich, a lot rides on the knowledge and skills of the team and entrepreneur.
He says investors become more interested if an entrepreneur comes from a background in a specific industry or company and has identified an inefficiency and is tackling the problem. More specifically, Wunderlich says investors are interested if an entrepreneur, “has contacts, knows the problem, and how to make it better.”
This is why serial entrepreneurs commonly have less trouble getting capital from investors, because they have been down the startup road before and have had success.”Some are very efficient in taking nothing and turning it into something,” Wunderlich added.
Of course, those who’ve never tried to score funding for a business before shouldn’t despair; if your business model is solid you should still be able to find support for your company. You just have to know what venture capitalists are looking for.
In his book, Shah interviewed dozens of ventured capitalists about when, why, and how they invest. While each firm will differ, the book makes it clear that there are common traits that VCs look for when making investments. One of the most important is that an entrepreneur’s ideas need to be big, bold, and unusual. While you might think a risky or disruptive idea will make investors shy away, the contrary is actually true in many cases. Big ideas inspire passion and that’s what you want from investors.
Your own passion matters, too. Investors want to see someone who isn’t just motivated to make money but who truly believes that his or her idea is a great one and has worked hard to hone their business plans through research and practice. Of course, you shouldn’t be alone in this. Your team, especially your co-founders, needs to be on the same page. This kind of unity appeals to investors because it shows that you have the passion and cohesion that will help you hit the ground running.
Finally, investors are much more likely to see your business as appealing if it is adaptable. This means being able to push different ideas until you find the right fit at the right time for the right customers. For many, this can be difficult because it means letting go of the original idea for the business, but in a world where trends come and go rapidly, this kind of flexibility is essential and proves you have real staying power.
What Is a Good Pitch?
The pitch can be one of the scariest parts of getting venture capital, but it’s the place where you get the shot to show off your business, what it can be, and where you think it’s headed. That can be both nerve-racking and incredibly exciting.
Jeffrey Bussgang has been on both sides of investing, both as a business owner and now as a member of Flybridge Capital Partners. In an interview with Inc., he reveals that it isn’t just the person you’re pitching to that you have to convince. “In most venture capital firms, the entire partnership needs to be supportive of the deal. As an entrepreneur, I would spend all of my time trying to convince the person I was talking to and not realizing that he, in turn, had to convince his whole partnership.”
When crafting a great pitch, this is something entrepreneurs need to keep in mind. You won’t be aiming to impress one person, but to convince an entire group of businesspeople that you’re a solid investment. This is why it pays to be incredibly prepared and to know exactly what a firm is looking for in a potential investment. Of course, you shouldn’t ignore the human factor, either.
Arjan Schutte, managing partner at Core Innovation Capital, says that it’s important to remember that VCs are people, too, and have limited time and resources to offer entrepreneurs. The faster you learn to cater to the needs of these investors, the faster you’ll find a receptive audience. “We have specific investment mandates, and we need liquidity events within the timing of our fund,” says Schutte. “If you’d like more insight about these mandates or thresholds, just ask — we’re happy to share those insights if it informs a more thoughtful pitch.”
He also recommends focusing more on execution than your ideas. While good ideas can grab attention, investors are more interested in learning about what you plan to do to act on them. To back this up, you’ll need clear financial models and to be able to anticipate the need for additional growth capital, as well as being open and honest about where you can improve and how you’ll deal with competition. Shutte says that most entrepreneurs miss these points, which can make it harder to convince investors to fund them.
How Much Do You Ask for?
As for how much to ask for, that number should come from the goals you have for your company and what you want to achieve. To get started, take the quarterly numbers since you launched the business and show the rates of increase — sales, profits, customer growth, etc. Account for all of your current expenses and add the expenses for future growth — i.e. more employees and expansion or upgrade of facilities or technology — and come to an agreement on a number.
“We look at the year-to-date financials [and] how much you need to get to the next inflection point,” Wunderlich explains. “For example, ideally we want to be out of the deal in four to seven years and receive a 35% ROI. So what do you need to drive those numbers?”
Some investors stage their investments by agreeing on a total, but only giving the money in increments. You may receive half of the agreement up front and more on every inflection point or goal reached. This method removes some of the risk for the investor.
“This forces the entrepreneur to drive the numbers on short term and long term basis,” Wunderlich said. Of course, whether or not this kind of arrangement works for you is something you and your partners will have to decide.
Is It a Good Deal?
If your first experience finding investors was successful, congratulations, but don’t celebrate just yet. Make sure that the terms of the deal are ones you can live with. Venture capitalists are in it to make a profit, not just to help you out, so make sure that a deal will ensure your business is here to last, not turn a short-term profit.
While you might be tempted into taking any funding that comes your way given how hard it is to get it and the poor economic climate, rushing into a bad deal could do more harm than good. A smart first step is to ask questions and make them specific. You need to know what the exact terms of the deal will be and how they’ll impact your business and your personal success and profits. Most investors welcome questions and will be more than happy to answer them in order to ensure everyone is starting off on good footing. If he or she is hesitant to answer your questions, that could be your first red flag that things aren’t going to go well.
There are other signs to be wary of as well. An investor should be excited about your project, he or she should make it easy to be honest about problems or issues, and should have a good rapport with you and your partners. If any of these don’t apply, you may want to reconsider as you’ll be tied to this person and his or her firm for years to come.
Make sure that the financial aspects of the deal won’t leave you wishing you had avoiding finding investors in the first place. Investment capital comes with strings attached, usually in the form of an ownership stake in your company. Give away too much and you may find yourself earning less and having less power than your investors. Before saying yes, do the math and determine what share you can live with giving away.
If your investors are offering you a great deal, enjoy your success and make sure you keep in touch regularly. You not only want to set up your company for continued growth, but you also want to keep these connections for any future business ventures that may need funding. Many investors want to play an active role in pushing your company forward (they have a big stake in making sure they get a return on investment), so keeping in touch shouldn’t be a challenge for most entrepreneurs.
Of course, you don’t just have to rely on your existing connections. As your business grows, reach out to other investors, get to know the market, and keep in touch with those who may be able to finance future expansion should you need the investment. Some investors only want to get in, make a profit, and get out, so you’ll need to build relationships with those outside of your current firm in order to ensure you’re prepared for the next round.
Building a business is hard work and growing it is even harder. But with some preparation, a little knowledge about how investors work, and a great idea, entrepreneurs can turn a meeting with an investor into the opportunity to build the business they’ve always dreamt about. It won’t be easy, but the challenge can make it all the more satisfying when you get there.