101: Venture Capital

By Gregg Schoenberg Wednesday, May 9, 2012

Over the past few weeks we’ve created a timeline of sorts for raising capital for your entrepreneurial business, from friends and family to crowdfunders and on to angel investors. If you have successfully completed an angel round—or you hope to do so in the future—but find yourself in need of additional funding, then venture capital is your next step.

Like angel investors, venture capitalists (VCs) invest money into early stage businesses in exchange for an ownership stake and will usually exert some influence over those businesses after becoming shareholders.  But there are a few important differences between VCs and angels.  While angels typically invest their own funds, VCs usually invest on behalf of a pool of investors that could include pension funds, foundations, sovereign nations, corporate investors and high net worth individuals. Generally speaking, VCs can provide substantially larger amounts of capital, and take a much more active role in managing the company as well as prescribing the long-term strategies. Typically, VC firms will demand one or more seats on the company’s Board of Directors as a control factor and take a prime chunk of the common stock, one whole series of preferred stock, and lots of options and warrants. In fact, many VCs firms wind up controlling, or at least shaping the board of directors, so you need to be prepared to give up a significant amount of control if you accept venture capital.

Speaking of money, venture capital is a big business, with nearly 500 active firms in the U.S., which invested about $22 billion into more than 2,700 companies in 2010.  VC firms are looking for young companies with excellent growth potential and truly innovative products. While technology companies have always been their favorites, recent years have seen a lot of interest in the renewable/alternative energy solutions. But venture capitalists will also invest in firms in a variety of more traditional industries from financial services to consumer products. The common theme they are looking for, no matter the industry or nature of the product or service seems to boil down to growth prospects, innovation, capable management and a strong intellectual property position.

If you own an innovative high-growth business and you want to attract venture capital, the first area you’ll want to focus on is your management team. You may have your team already in place. If you’ve hired senior personnel who have successfully built companies in the past, you’ll have an advantage when seeking VC funding. At the very least you’re going to need to show that you have an experienced, focused, and flexible team of senior managers.  Flexibility is your biggest challenge because VCs may require you to make significant changes to your company’s management structure.  This may mean that one or more of your favorite early-stage associates will get pushed aside. It may even mean you’ll get pushed aside, as Apple’s Board once did to Steve Jobs. It happens.

While you will be giving up a great deal of control, you’ll be getting a lot more than just money in return.  VCs are professionals in the field of making successful major companies out of start-ups. As experienced business-builders, venture capitalists take a hands-on approach to helping their companies with everything from research and development, to sales and marketing, to building connections with other leaders in related fields.  In addition, VCs will typically make multiple rounds of investments in their portfolio companies, assuming that the companies meet agreed upon milestones when it is time for a fresh round of financing.  VCs will also openly plan an exit strategy so that they can realize a gain on their investments and move on to new opportunities. The question is, where will you be then?

If it sounds like venture capital might be a good match for your business, you’ll need to do some research to find out which VC firms are most likely to be interested in a firm of your size and in your industry.  And it should go without saying by now, but if you do get a meeting with a venture capitalist, you need to be ready to demonstrate a rock-solid business plan, a unique competitive advantage, and a realistic path for high growth and the ultimate exit of your VC partner.

A great majority of VCs predominantly use Delaware Companies as the legal structure for their portfolio companies. If you’re just starting out, and want to look really smart, incorporate in Delaware with one class of common stock and one class of “Delaware Blank Check Preferred” stock. For more information on this topic, simply request our White Paper Report “Delaware Blank Check Preferred Stock,” by calling or emailing us. There is no charge for this research report if you request it right away.

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