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.

How to write a faster business plan

For many entrepreneurs, writing a business plan is a tedious process. Entrepreneurs are often more contempt with being practically involved overcoming real challenges than sitting down and writing a 30-40 page document. Unfortunately, a comprehensive business plan will almost always be a requirement from Venture Capital firms as it will allow them to get more of an insight into the issues present within the business business.

Before starting writing your business plan, do the research. Find out if there is a market for your product or service. See whether you are capable of filling that market, and that it is realistically profitable. You may discover challenges that will force you to rearrange your idea before spending weeks constructing a business plan.

Focus on Profitability

If investors and lenders are to be attracted to your business plan, you must show:

that your competition is large and plentiful, proving you operate in a large and growing industry
that you can outmaneuver that competition by niche marketing and setting up barriers to entry

Many entrepreneurs make the mistake of claiming they have no competition. This may or may not be true in your case, but investors don’t believe in one-business industries. Healthy competition is evidence that your industry is growing, which allows your business to grow within the industry.

The paradox is that you must show you can overtake said competition somehow. You can do this by proving a) you have identified and can master a niche market within that industry, and b) you have created barriers to entry (e.g., proprietary technology, exclusive information, a unique management team, etc.) This shows that your company is the only one equipped to fill the market need.

Logic is a key for a investment winning Business Plan

A business plan is essentially a logical argument for why and how a business will succeed. The logic is as follows:

1. Opportunity: There is an unmet market need.
2. Resources: Your business has the resources to fill that need.
3. Methods: Explain how your resources will be used to fill the need.
4. Results: Show how you and your investors will profit from the way your business uses its strengths to fill an unmet market need.

Financial Assumptions: Spell It Out, From Seed to Exit

The imagination of the investor is where fundraising efforts go to die. Do not let them imagine. Show your figures. Explain revenue and cost projections, from the start of your business all the way through the liquidity events that will benefit the investors. Use industry research and case studies to support your pro forma (projected) financial assumptions.

Just Say No to Format Creativity

As sure as there is grammar in an English sentence, every business plan has a standard format. That format, in this exact order, is:

1. Executive Summary, 
2. Company Analysis,
3. Industry Analysis,
4. Customer Analysis, 
5. Competitive Analysis, 
6. Marketing Plan, 
7. Operations Plan,
8. Management Team, 
9. Financial Plan, 
10. Appendix. 

Yes, you can be creative in the content of your business, and the ways in which you go about marketing and running operations. Creativity is what allows entrepreneurs to win. But the format of the business plan must be absolutely adhered to.

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Venture Capital Focus on Growing Firms Says Shuttleworth

'Venture capital is better spend on existing and growing firms' This is the opinion of South African venture capital company HBD, which is still strongly associated with information-technology entrepreneur Mark Shuttleworth. The organisation expects to have disbursed some R100-million by year-end as part of its second fund, launched in late 2006.

CEO Julia Long tells Engineer-ing News that it is currently interrogating several potential investment opportunities, mostly in high-technology companies, but not necessarily information-technology enterprises.

Its so-called ‘HBD Fund2’ will run for two years, with Shuttle-worth having made some R150-million available to the initiative. However, Long says it is possible that more than R150-million could be disbursed over the period, citing a possible investment figure of R200-million.

Unlike the initial HDB fund, or ‘Fund1’, which focused on pure start-up-type enterprises, the current facility is seeking to finance more “mature” businesses that already have products, services and customers.

Long says the idea is to fill a gap in the South African capital market by offering equity funding to enterprises that are keen to either accelerate domestic growth or embark on an internationalisation endeavour.

Given this greater level of maturity, the size of the investment tranches has also been raised to between R10-million and R25-million – Fund1’s limit was set closer to R10-million. “By contrast, the companies we financed between 2000 and 2005, when Mark set aside R70-million for venture capital, were generally at a far less developed stage, some even at the concept stage,” Long explains.

She argues that there is still a desperate need for ‘angel investors’ to support start-ups, but that, following a broad-ranging analysis of the South African environment, HBD (short for ‘Here Be Dragons’) decided there was greater opportunity and less risk slightly further up the value chain.

She says the fund is open to just about any sector, excluding direct investments into real estate and agriculture, and hints to the fact that HBD is in the final stages of a due diligence involving an investment into a leisure-and-entertainment enterprise that offers a “unique” restaurant experience. It is also interrogating an equity position in a logistics enterprise.

To date, though, capital from Fund2 has been deployed in only two instances: an investment into EDH, which develops products and services for the sport, defense and industrial- inspection markets, including a radar-based solution used by broadcasters to track and display shots made by golfers during tournaments; and an investment into a company called incuBeta, which is an Internet search-engine marketing business, with a turnover of R50-million a year.

Long says its basic criterion remains that the companies be established and domiciled in South Africa.

She anticipates that HDB will remain invested in the companies for a period of about five years, and says its partners accept upfront that HDB will be seeking to make a profitable exit at some point. These exits can take various forms, from selling the business to similarly-styled entities, through to an initial public offering, most probably through a listing on the JSE’s small- company board, AltX.

The company has already exited from some of its initial investments made during the roll-out of Fund1, but Long admits that most of these have been conducted at a loss.

“We are acutely aware of the risks involved and don’t take them lightly. But our assessment is that, if we invest in ten companies and spend R100-million in the process, just one might turn out to be core. But that core investment will offer a return that more than covers the upfront investment with a healthy return, with the balance of the disposals offering a bonus over and above that return,” she concludes.

This may be a typical move by venture capital funds in the current economic climate trying to limit their risks and increase returns from businesses already proven to be successes in the market. Despite the importance of business finance being available to this market segment it should not be forgotten that with many banks trying to do the same the investors and banks in South Africa should not forget the army of entrepreneurs hoping to bring their own ideas to the market. Both Shuttleworth and the growing firms his company now invest in was at some stage a start-up and was it not for someone investing in these businesses at early stage they to may not have been in the position they are in today.

How To Open A Business Using Venture Capital Funds

Both Venture capitalists & Business Angels are really just investors in your business. This is because the objective is simmilar to what it will be for any other investor. The business or individuals involved will normally be reviewing tons of business profiles until one is found that have some synchronicity with the values and objectives of the funder.

Venture capitalists & Business Angels will normally find you through a combination of channels. As an entrepreneur looking for business funding you may be found either through joining a network of investors, sending your business plan to investors that you know of, or in some rare cases they may find you, either through a referral or recommendation from someone else.


Once contact has been made and a background check has been done, the management team will contact the entrepreneur so a meeting can be set to talk more about the idea that was envisioned by the person. If everything sounds good, then the funding will take place similar to how a student in school is able to get a grant in order to conduct the project.
The difference here is that the Venture capitalists & Business Angels will hold a certain percentage of shares in the business. This means a team of people will be working with the entrepreneur in seeing things through. This is done to protect the investment given by the company to ensure its success in the long term.

One of the industries being funded regularly by Venture capitalists & Business Angelss is the information technology industry. Despite that, the chances of someone in another field who would like the same thing to happen is still possible because there are also companies out there looking for the next big break.

Everyone becomes a winner when VCs, business angels and the entrepreneur sign an agreement and turn that idea into a reality. This is because despite the risks involved in starting something new, the determination of the entrepreneur and the experience of the Venture capitalists & Business Angels can easily tackle the bumps on the road by steering clear from it.

Venture capital funding is when a startup business or an existing one needs funds from outside people to sustain or keep it growing. While there are banks that can help do this, it is easier to deal with private individuals since the interest rates are not that high and these supporters become strategic partners.

As an entrepreneur, attracting venture capital funding of course also holds many other benefits for your business. You only need to speak to a business owner who has been there and done that to know that VCs, not only will provide you with the funding, but as their money is on the line, you will gain, experience, valuable contacts, a much needed confidant when times are tough.

More than Just Money - What VC's can really bring to the table

South African Entrepreneurs and business start-ups benefit hugely from joining forces with venture capital firms or even look for angel funding. Once you have your business plan and feasibility study done and are confident that this business idea is the way forward for you there may be numerous avenues for you to explore to get investment for a business.

Not only is there the obvious advantage of having cash in the business for research and development, marketing, product proto-types and all the other many business processes that benefit from an inflow of cash into the business, but the the other side of the deal, and in my view perhaps the best part of it is the expertise that the the business gains from either an individual or business who have been there and done it, more often than not, on numerous occasions.

There has been a number of recent Blog threads on the issue this year.

Recently on Venture Blog, David Hornik writes in More Than Just Writing a Check, about the enormous benefits that entrepreneurs can experience from working with the right VC firm.

Recently in the web strategy blog, Jeremiah Owyang in his thread entitled Beyond the Money lists the following benefits to working with a venture capital firm:

VCs Provide Startups With A Competitive Edge by Offering Additional Services:

Thought Leadership
VCs are required to anticipate future trends, and as a result they are highly connected, obtain information from a variety of sources, and have to quickly synthesize what’s next. Some of the VCs are more active in public, and are on the speaking circuit, and are sharing their ideas. Take for example David Hornick, who does a great job at this as he discusses why and how he’ll invest the $650mm they raised in high tech. Considering the recession this fund will fuel a great deal of innovation –even during a downturn.

Strategic Guidance
Often, VCs sit on the Board of Directors of their portfolio companies and provide guidance, direction, and access to other decision makers. This not only protects the VC to keep an eye on the company, but gives the entrepreneurs a chance to bounce ideas off senior and seasoned investors.

Being Part of The Family
Access is important. When I meet with startups, it’s important to know who invested in them, as it indicates their network. If you watch carefully (real carefully) you can see that startups that share the same investor use each others products, exchange executives, and are talking to each other. They often have offsites

Ancillary Services
Some VC firms have education teams and marketing teams that provide a broad range of services to the portfolio companies who don’t have the resources to hire full time marketing staff. In fact, I’ll be doing a workshop with Giovanni Rodriguez in the near future for a VC group. Recently I held a dinner discussion with Allegis capital and Scale Venture Partners, to meet their portfolio and discuss market trends.

Umbrella Branding
Perhaps the most under utilized is the benefit of being part of the brand of a well known firm. There are certain firms that are known for investing in certain verticals, or have a track record of success that lights my eyes up. Companies often tout their investors in briefings, especially if they are a top tier firm.

Parties… eerr um Networking
Ok, that’s my polite way of saying great parties, well networking too. During the height of the economy, some VC firms flew the executives of their portfolio companies out to a one week retreat in Hawaii. Also, some of the best parties in all of Silicon Valley are at August capital –social media networking nirvana.

Recruiting and Fundraising
I added this bullet after the fact, after seeing how David Hornick has added to the conversation it’s too important to pass up. VCs offer additional services like recruiting, which I’d be so bold to say is often executive placement of the right folks. Secondly, they help with fundraising, which I would assume would be for additional rounds of investment, I would expect that this would often mean a solid reference from one investor to the next.

Entrepreneurs should weigh all benefits
Of course, with the top tier VC firms, there are certainly considerations, getting backed by a very successful VC firm may mean they have more influence over the terms, may drive the direction of your company, and ultimately, may have more equity of the company. I encourage you to think about the other services, network, and events that your VC will offer you, find out by observing or talking to companies in their portfolio.

VCs offer more than just funding
VC should continue to provide thought leadership in their space, discussing in public why they are raising money, where they anticipate market growth, and how they plan to invest. This not only attracts new investors for their fund, but gives branding cover for their portfolio, and the folks in the industry, like me, visibility on the next trends. What they do beyond the investment makes a different –I can see it.

Most of these sounds like an offer you would seldom be able to refuse. Remember though that if you do go down the road of looking for a venture capital partner to go into business with, do your homework, ask for references and check out the FAQ's on the topic on the SA Investors Network site.

How to become a venture capitalist

How do I become a venture capitalist? A common question asked by graduates, professionals and entrepreneurs who may have been through the process of finding venture capital to grow their business. Venture capital is of course not for everyone and you need to be certain of your motivations of why to enter this are of business.

If you have the money to invest and has the appetite for high-risk, high-return investments, you might consider investing in new, rapidly growing companies that have potential to bring you large returns.

People and companies that do this are called venture capitalists. They help small and fledgling companies take off by providing them capital as well as technical and administrative inputs, usually, at their startup stage.

How Does Venture Capital Investing Work
How do you become a venture capitalist? If you are an individual, you can act alone and become an "angel investor" providing low-level financing and management expertise or you can partner with another investor or become part of a group of people and institutions funding a corporation.

If you are pursuing the plan with a partner or a group, you basically start a firm first, which is usually structured as a partnership or a corporation
The venture firm, as your group will be called, will form a pool of funds by seeking capital commitments from other investors and institutions to raise a pre-determined amount of money. This happens with the firm seeking out prospective investors and sending them prospectus about the capital raising. Out of the capital commitments solicited, a fund will be created, which will become the legal entity transacting business in behalf of the investors. The process could take weeks to years. The fund is usually structured as an LP or an LLC, which has a fixed lifespan, usually up to 10 years.

The venture firm will have to decide whether it wants to invest the fund in a particular industry or area or invest across industries, in various locations and in companies at different stages of development. The venture firm might also choose to concentrate on acquisitions or helping failing companies get back to financial health (turnarounds).

The venture firm considers various investment opportunities presented to it. The firm then conducts due diligence to choose an investee company (usually among many, which could be a hundred). Typically, the firm will be given shares in the investee company and members of the venture firm become managers or directors of the company. The capital commitments will be during several stages of the company’s development.
The firm may decide to do another round of rounds of fund raising for other investments.

Venture firms anticipate investments to generate returns in three to five or seven years. Usually expected return on investment is 20-40%. The maturity of the investment is heralded favourably by an initial public offering of the company or a sale or merger, which shows it has gained enough footing to be able to attract investor interest.
As a venture capitalist, you help many companies get through their startup stage, while helping create jobs and fuelling the economic growth of the country.

If you are looking for venture capital in South Africa or want to try your hand at becoming a venture capital professional visit the investors network site and see if you can start your bright future in business investment today.

Thank you for the contribution of startupbizhub.com to this article

Venture Capital Investment: March 09

Some interesting venture capital deals that took place in March this year are as follows:

Google has joined a $5.75 million investment round for Pixazza, a start-up that hopes to profit by overlaying photos on the Web with links that let people buy the products in the images.

Audience, a maker of mobile-phone technology intended to drown out background noise, has nabbed $15 million in a fourth round of funding. Investors in the latest round include New Enterprise Associates, Tallwood Venture Capital, Vulcan Capital and VentureTech Alliance.

Flat World Knowledge, an online textbook publisher, has landed $8 million in its first round of financing. Investors in the round include Greenhill SAVP, High Peaks Venture Partners and Valhalla Partners.

HyTrust, a virtualization start-up, launched its flagship product Monday with $5 million from its backers, VentureBeat reported. Trident Capital led the round, which included participation from Epic Ventures.

Revolution Money, an online payment firm backed by AOL co-founder Steve Case, said on Monday it has received funding of $42 million from a group that includes a Goldman Sachs affiliate and earlier investors Citigroup and Morgan Stanley, Reuters reported.

Redbrick Health, a provider of employer insurance, landed $15 million in a third round of financing led by Kleiner Perkins Caufield & Byers. Fidelity Ventures, Highland Capital Partners and Versant Ventures also contributed to the round.

Mostly sourced from Venture Beat. If you know of any other interesting venture finance activity please let us know.