Passing the First Gate
The typical venture capital firm receives over 400 proposals a year.
Probably 90% of these will be rejected quickly because they don't fit the
established geographical, technical or market area policies of the firm – or
because they have been poorly prepared.
The remaining 10% are carefully investigated.
These investigations are
expensive. Firms may hire consultants to evaluate the product, particularly
when it is the result of innovation or is technologically complex. The
market size and competitive position of the company are analyzed by contacts
with present and potential customers, suppliers, and others. Production
costs are reviewed. The financial condition of the company is confirmed by
an auditor. The legal form and registration of the business are checked.
Most importantly, the character and competence of the management are
evaluated by the venture capital firm, normally via a thorough background
These preliminary investigations may cost a venture firm several $K per company investigated. They result in perhaps ten to fifteen
proposals of interest.
Then, second investigations, more thorough and more
expensive than the first, reduce the number of proposals under consideration
to only three or four.
Eventually, the firm invests in one or two of these.
Evaluating Your Track Record and Potential
Most venture capital firms' investment interest is limited to projects
proposed by companies with some operating history, even though they may not
yet have shown a profit. Companies that can expand into a
new product line or a new market with additional funds are particularly
The venture capital firm can provide funds to enable such companies to grow
in a spurt rather than gradually as they would on retained earnings.
Companies that are just starting or that have serious financial difficulties
may interest some venture capitalists, if the potential for significant gain
over the long run can be identified and assessed. If the venture firm has
already extended its portfolio to a large risk concentration, they may be
reluctant to invest in these areas because of increased risk of loss.
Although most venture capital firms will not consider a great many proposals
from start-up companies,
there are a small number of venture firms that will do "start-up" financing.
The small firm that has a well thought-out plan and can demonstrate that its
management group has an outstanding record (even if it is with other
companies) has a decided edge in acquiring this kind of seed capital.
Evaluating Your Management Team
Most venture capital firms concentrate primarily on the competence and
character of the
Management. They feel that even mediocre products can be successfully
manufactured, promoted, and distributed by an experienced, energetic
They look for a group that is able to work together easily and
especially under conditions of stress from temporary reversals and
competition problems. Obviously, analysis of
managerial skill is difficult.
A partner or senior executive of a venture capital firm normally spends at
least a week at the offices of a company being considered, talking with and
observing the management to estimate their competence and character.
Venture capital firms usually require that the company under consideration
have a complete management group. Each of the important functional areas
product design, marketing, production, finance, and control - must be under
the direction of a trained, experienced member of the group.
Responsibilities must be clearly assigned. And, in addition to a thorough
understanding of the industry, each member of the management team must be
committed to the company and its future.
Evaluating Your Competitive Advantage
Next in importance to the excellence of the management group, most venture
capital firms seek a distinctive element in the
product/market/process position of the company. This distinctive element may
be a new feature of the product or process or a particular
technical competence of the
management. But it must exist. It must provide a
Sustainable Competitive Advantage
What happens when, after the exhaustive investigation and analysis, the
venture capital firms decides to invest in a company? Most venture firms
prepare an equity financing proposal that details the amount of money to
be provided, the percentage of common stock to be surrendered in
exchange for these funds, the interim financing method to be used and
the protective covenants to be included.
This proposal will be discussed with the
management of the company. The
final financing agreement will be negotiated and generally represents a
compromise between the management of the company and the partners or
senior executives of the venture capital firm. The important elements of
this compromise are: ownership, control, annual charges, and final