Is Venture Capital an option for Entrepreneurs?

So what do we know about venture capitalists? Sure we know that they take calculated risks investing in viable business plans often taking a large steak in the business with the "hope" that the business will grow sufficiently fast to ensure that the the investor makes a large profit on the initial risk taken. But its not always this straight forward. Many entrepreneurs complain that once the venture capital firm comes into the business, a new business plan is implemented, giving priority to processes and formality takes over, robbing the business of the culture that once made it a potential winner. Venture capitalists will surely defend themselves by saying that they act in a professional manner in doing what needs to be done to both protect their investment and give the business the best possible platform from which to succeed.

But every entrepreneur will have a different experience. As with so many things in business it comes back to relationships and how you nurture, grow and maintain these. Some will be doomed to fail while others still leads to the huge successes that both the entrepreneur and investor foresaw at the start of their journey together.

Often these opinions are based on one individual's specific personal experience with venture capital, and often based on someone's negative experience -- as is often the case, people who have negative experiences are more motivated to tell others than people who have positive experiences.

With that in mind, I will try to provide my hopefully broad perspective on the topic.

I'll just say up front that I don't think my point of view on this is any more valid than that of any of my fellow entrepreneurs -- everyone's experience is different, and this is definitely a topic where reasonable people disagree.

My experience with venture capital includes: being the cofounder of two VC-backed startups that later went public (Kleiner Perkins-backed Netscape and Benchmark-backed Opsware); cofounder of a third startup that hasn't raised professional venture capital (Ning); participant as angel investor or board member or friend to dozens of entrepreneurs who have raised venture capital; and an investor (limited partner) in a significant number of venture funds, ranging from some of the best performing funds ever (1995 vintage) to some of the worst performing funds ever (1999). And all of this over a time period ranging from the recovery of the early 90's bust to the late 90's boom to the early 00's bust to the late 00's whatever you want to call it.

I'm starting to understand why I don't have any hair left.
The most important thing to understand about venture capitalists is that they are in business to do a very specific thing.

They raise a large amount of money -- often $100 million or more -- today, in order to invest in a series of high-risk startups over the next small number of years -- usually 3 to 4 years.

The legal lifespan of the fund is usually 10 years, so that's the absolute outer limit on their investment horizon.

They generally intend, and their investors generally expect, to have the returns from those startups flow back within the next 4 to 6 years -- that's their realistic investment horizon.

Within that structure, they generally operate according to the baseball model (quoting some guy):
"Out of ten swings at the bat, you get maybe seven strikeouts, two base hits, and if you are lucky, one home run. The base hits and the home runs pay for all the strikeouts."

They don't get seven strikeouts because they're stupid; they get seven strikeouts because most startups fail, most startups have always failed, and most startups will always fail.

So logically their investment selection strategy has to be, and is, to require a credible potential of a 10x gain within 4 to 6 years on any individual investment -- so that the winners will pay for the losers and in the timeframe that theirinvestors expect.

From this, you can answer the question of which startups should raise venture capital and which ones shouldn't.

Startups that have a credible potential to be sold or go public for a 10x gain on invested capital within 4 to 6 years of the date of funding should consider raising venture capital.

Most other startups should not raise venture capital. This includes: startups where the founders want to stay private and independent for a long time; startups where there's no inherent leverage in the business model that could result in a 10x gain in 4 to 6 years; and startups working on projects with a longer fuse than 4 to 6 years.

Notably, there are many fine businesses in the world -- many of them highly profitable, and very satisfying to run -- that do not have leverage in their model that makes them suitable for venture capital investment.
By leverage in this context, I mean: the ability to make something once (a piece of software, a chip design, a web site) and sell it (directly or indirectly) to a lot of people (1,000 business customers or 10 million consumers) -- which leads to the classic "hockey stick" revenue projection.
Venture capitalists shouldn't, and can't, invest in companies that don't hit these criteria -- not because they're not good businesses but because their own investors wouldn't stand for it.

There are also many fine entrepreneurs in the world who want their companies to stay small, or who don't want to sell their companies or take them public. That is also well and good, and those entrepreneurs should not raise venture capital.

On the other hand, a business that is built for leverage that could be sold or go public in 4 to 6 years should strongly consider raising professional venture capital, for three reasons:

First, you get the cash to invest in the business and grow it at the speed required to realize its full potential.

It's satisfying to say you don't want to deal with VCs and you want to do it on your own, but if your business has the potential to get big, in my view you should take the cash to invest to make it as big as you can, and that usually requires more capital than you can raise from bootstrapping or from angels.

Second, you get that cash from a professional investor who invests in this kind of business as her full-time job and reason for existence in the world.

Most other possible investors in a high-growth startup will be much more difficult to deal with than a professional venture capitalist.
Third, in the best case, you will get help building your high-growth business from the venture capital partner you take money from (but see more on this in Part 2).
When a venture capitalist turns you down, it isn't personal and it isn't (usually) because she's stupid. Instead, it's often for one of these reasons:
One, she can't see the leverage -- she can't see you getting to a sale or IPO with a credible prospect of a 10x return within 4 to 6 years. If she can't see this, and 10 of her peers at other firms can't see it, then you may want to revisit your fundamental business model assumptions and try to understand what's missing.

Remember, it's in her best interest to see the full potential in your business -- she is looking for high-potential startups in which to invest.
Two, she thinks that what you're doing is too early or unproven.
This is the one that drives entrepreneurs nuts. Isn't the whole point of venture capital to make risky investments in unproven technologies and markets?

Unfortunately, that's life -- sometimes things are simply too early for venture capital. In that case, develop your idea further with bootstrap or angel funding and then take it back to the VCs later with more proof points.

Three, she isn't convinced that you've assembled the right team to go after the opportunity. This usually means she doesn't think your technical founder(s) are strong enough, or she doesn't think your founding CEO is strong enough. Again, it's in her best interest to see the potential in the team if it's there -- so if she and 10 of her peers pass on your startup because of concerns about the team, then you may want to rethink your team.
There are many other reasons in addition to these that a VC may pass on your investment that have nothing to do with you:

She loves it but she can't talk her partners into it -- which happens.
She's fully committed and doesn't have time to take on a new opportunity.
It would require travelling and she can't or won't do that.
You're in a market she doesn't know much about.
Or, she had a bad experience with a similar investment in the past.
The frustrating part is that she won't always tell you why she's passing -- in large part because she wants to keep the door open to investing at a later date if things change (i.e. if it becomes clearer that you have a home run on your hands).

So where does that leave us with our understanding or belief in venture capital as a real opportunity for entrepreneurs through which to reach the dizzy highs of success. I'm guessing that although you may have found this article fairly interesting your original perception on the effectiveness of venture capital has largely been unmoved.

Venture Capital as a career opportunity

Some of you reading this blog over the past year or so may be starting to see Venture capital as an attractive career opportunity. You may be thinking, I love business, Ive written a business plan and sourced business finance myself,  I like money and I like helping others, why not join the three and become a Venture Capitalist. Well as interesting and attractive an opportunity this may be seeming at the moment, you have to realize that the competition is tight and the opportunities are few and far between. Still, being the ambitious and talented individual you are, this will, I'm sure, not put you of in the slightest. So if you are still reading this, here are a few useful steps to consider.

Find your niche market
Venture capitalists are unique for what they do. They define markets. They set investment goals and they adjust their decisions on a combined set of skills that match their insight. If you were to join an investment bank, you would most likely be asked to implement predetermined investment policies to support the company’s mission statement. Venture capital does not work like this. As a venture capitalist you would have to place money in a high risk – high growth company for a specific period of time and expect a return on your investment either by public placement or by selling the company to another owner. Therefore, you have to be able to identify new market opportunities and companies that can add value to your portfolio on a long-term horizon rather than blindly follow the investment policies of an investment company. Moreover, you would have to leverage the company’s marketing and sales policies by branding yourself effectively and remaining on the right track.

Join a start-up organization

When pursuing a job in venture capital, it is very important to have a start-up experience. If you don’t feel like starting your own company, you may join a start-up organization with full potential to give you valuable insight on what are the necessary steps in the early stages. Working for a start-up company will expose you to venture finance and equip you with all the necessary experience to become a successful venture capitalist in the long run. Besides, your personal insight and passion for the job combined with the institutional investors who will trust your instincts and will agree to take the opportunity you offer to them, can serve as a means for future success in the difficult field of venture capital. All you need at this point is to align your passion with the requirements of the particular industry you will choose to deal with to ensure the greatest long-term benefit from your start-up experience.

Network, Network, Network

Networking is extremely important in any kind of job. Particularly, when pursuing a job in venture capital, the value of networking becomes extremely essential. This is because venture capital job opportunities are rarely advertised. Instead, people who already work in a venture capital company are asked to recommend anyone who would be suitable to work for the company. It’s all a matter of trust. Venture capital companies base their recruiting policies first on trust and then on the resume. Therefore, you need to develop a networking strategy and follow it religiously, while adding value to anyone you meet and interact with. Keep in mind that building the right network can help you becoming a venture capitalist possibly in no time. Yet, maintaining your network and keep it growing is what will make you a successful venture capitalist.

Overall, you should know what you’re asking from a job in venture capital. In 2009, venture investing declined by 30%, fundraising declined by 44.5%. If you think these stats are black and discouraging, you probably shouldn’t considering joining the venture capital industry. On the other hand, if you see clearly that venture capital is still a promising market to invest with high returns, then, by all means, join.

Moreover, make sure that you know what you profile is. You may shoot for the best firm on the market, but if your profile and insight do not match the company’s positioning and investment decision making, don’t expect returns and dynamic partnerships. Even more, don’t expect to be able to define new markets and propose new strategies because soon you will find yourself to be a misfit in the firm you have chosen.

Sources:
http://www.investorsnetwork.co.za
http://tutor2u.net/business/finance/raising_finance_venture capital.htm
http://www.ehow.com/how_2363498_venture-capital-job.html

http://www.marketwire.com/press-release/2009-Venture-Investment-Declines-to-Lowest-Levels-in-More-Than-a-Decade-1105820.htm
http://www.marketwire.com/press-release/Venture-Capital-Fundraising-Experiences-a-Slow-Start-to-2010-NYS

Finding a Venture Capital Firm that suits your needs

If you look at where entrepreneurs come from then you will find that most   wold previously been in permanent employment from where business ideas, business experience and eventually a business plan may come from. Yes of course graduate entrepreneurs are becoming more commonly found today with entrepreneurship as an career becoming more and more popular and business finance becoming more readily available.

As with many things that are worthwhile doing, the field of entrepreneurship is not smooth sailing.

You have to come up with a feasible business plan before embarking on looking for funding from to enable you convert the idea into action.

Having drawn your business plan, you should shortlist investors to approach for funding since getting access to a bank loan for your start-up may not be easy

This is advisable if you are devoid of savings to pump into the business idea and choose to rely on external sources to roll out the idea.

Selling business idea

But before you start selling your business idea, you need to decide whether you want to work on the notion and grow it into a big business venture or you want to sell the idea to a business entity.

Many prospective businesspeople are often undecided on the two choices and as a result end up losing their dream of entrepreneurship.

Others come up with feasible business plans to sell to potential employers in order to secure employment.

For instance, a young entrepreneur could developed a feasible business plan of an innovative mobile technology and sell the idea to mobile phone company in return for employment or partnership.

Ultimately, this leads to loss of entrepreneurship energy as the idea owner losses control once he is offered employment.

On the other hand, selling a business plan to a rival company in search of funds has left many budding entrepreneurs in regrets as they see their business plans copied without them getting any reward.  

If you are convinced that you want to roll out your business plan and grow it into a big business venture, then the venture capital market would be your stop point.

Here, you can shop for investors interested in buying your business idea and grow it.  

Competitive nature

Owing to the competitive nature of the venture capitalist market, it is essential for an entrepreneur to do proper research and identify the right investor before packaging the business plan for implementation.

Just like doing prior research on a potential employer helps guide a job seeker on where his services could be of value, proper research guides a budding entrepreneur on the choice of the right venture capitalist.

Sending applications arbitrarily in search of funding, without proper research, is a futile effort that can never yield any response let alone results.

This is analogous to a pilot making unsolicited job applications to manufacturing firms that have nothing to do with aviation.

However qualified the pilot could be, his applications can never sell to personnel managers of manufacturing firms.

To identify the right venture capitalist firm, you need to do proper research on the following;

First, research on the venture capitalist’s industry focus in relation to your line of business.

Most venture capitalists tend to focus on specific industries or sectors and exclude others.

Try to enlist only those firms that lay focus on the industry within which your business plan is anchor to stand a chance of being considered.

The second criterion is the geographical preference and proximity to the venture capitalist.

Try to limit yourself to venture capitalists that have preference for funding business plans from your continent, country or even province.

Venture capitalists often earmark their geographical areas of concentration.

If you don’t lie within their area of preference, your application may be in vain.

Late-stage investing

Third, you need to unravel their stage-of-development bias.

Do they provide seed capital or are they only interested in late-stage investing?

If you are a start-up, its appropriate to single out venture capitalists that provide seed capital.

Fourth, what amount of capital do you need for your business plan and what is the range of capital investment of the venture capitalist?

Most of the investors have set low limits of the size of investments that they can consider sponsoring.

For instance, a firm may state that they only fund business plans that require a capital size of between R1 million to R100 million.

If your project lies outside this range, it is advisable not to approach them.

Revenue potential

You must resist any temptation to inflate the amount of capital that you require to match their capital range as you would encounter some difficulty later when you are called upon to demonstrate the feasibility of the project and its revenue potential.

Upon settling on a selected number of targeted venture capitalist firms, try to do a background check on the type of investments that the firm has made.

This can help you identify whether your business plan could be a duplication or slightly similar to an investment the targeted venture capitalist firm has explored.

Once prepared, you can now approach your targeted venture capital firms or go to a investors network event where you can start meeting business angels and venture capital partners.