Fishing for Venture Capital
Researching VC firms, getting ready for their questions and practicing
on B-list players clear the way for landing the right investment partner.
- By Edward O'Connor
- September 01, 2006
Luring venture capital is a lot like fishing: You need to know what kind
of fish you're after, the best time for fish to bite and, most importantly,
how to get them to bite. While last month we covered the basics of venture
capital (see Part I, "What
Makes Venture Capitalists Tick
," August 2006), this month we
turn to the tactical, offering practical advice on everything from choosing
your target to the best ways to reel in your catch and seal the deal.
Step #1: Know Your Bait
How do you determine your best VC prospects? One technique is to
see the world through the eyes of your fish: the ideal equity partner.
Take a hard look at your firm as an investment target, and ask yourself
the questions investors are likely to ask (an exercise you'll need to
perform anyway to prepare yourself for the pitch phase).
Here's a list of potential questions to get you started:
What differentiates your firm from its competitors? Be
sure to look at this question from all angles, including management team,
products or services, historical or planned market and financial performance,
and go-to-market strategy and tactics.
What are the problems -- strategic, operational, in development, delivery,
and in marketing and sales -- that your firm has encountered, and what
have you done to resolve them? Has your firm done everything it could
to address them? What challenges remain and what will be done to reverse
What are your firm's strategic plans for growth? Is the strategy cogent
and attainable? What is your intended path to investment exit? What challenges
do you foresee and how will you handle them?
How much capital do you need to execute your strategic plans?
What historical and competitive benchmarks can you cite to support your
case? Is the amount of capital sought appropriate to achieve it? Is it
in line with your historical financial performance, or are you stretching
for big bucks when your market position indicates that your appetite outpaces
your aptitude and resources?
What will you give? How much of an ownership stake
in your firm are you willing to give up in exchange for equity investment?
How much of a strategic and an operational say in your firm are you and
your management team prepared to cede? Are you and your management team
prepared to exit the firm, should the equity firm decide that it's in
the firm's best interests that you do so?
Answer these questions as if they were posed by your target equity investor
and do so until your management team can respond in a confident, detailed
and bullet-proof fashion.
While you're doing this self-assessment, refresh your understanding of
environmental factors. These include the macro-economic environment, market
conditions in your geography, competitive context and what the big players
are doing in your sector. Avoid the tendency to get too highfalutin' here:
The issue that matters is not really the big picture, but how the prospective
equity investor views the big picture.
Step #2: Identify Your Catch
Now that you understand the lure you're working with from an investor's
perspective, it's time to familiarize yourself with the market of equity
investors. You can do this yourself or hire a firm or individual to do
it for you:
- Start a list of firms by searching the Internet, consulting phone
books, checking with regional chambers of commerce, and asking friends
and associates for references to equity investors in your region or
those in other regions that invest outside of them.
- Identify successful firms in your sector or in adjacent sectors that
have had equity investment. Identify the lead investor and supporting
investors, and put the supporting investors on your list. While a lead
investor isn't going to want to place two big bets in a single sector,
a supporting investor might be willing to get behind another company
in a bigger way.
- Conduct due diligence on all firms on your list. Focus on their management
teams, investment criteria, portfolio companies, news articles and press
releases about successful exits, and sectors in which they invest.
Once you narrow the long list of equity investors down to, say, 30 firms,
make a short list of about half as many that are most likely to invest
in your firm. Do this by considering environmental factors and preparing
your investment apparatus. This entire research process should take you
only a few weeks.
Equity investor Web sites tend to reveal little about what specifically
the firms want to invest in and how they actually work. You need to learn
to read between the lines and test any hypotheses about your short-listed
targets before you approach them.
Not only do you need to understand the sectors in which firms say they
invest and those in which they actually do invest, you also need to understand
their perspective on the sector. This means the upside and threats they
see, the sort of strategies that they think work and the attributes of
successful firms in the sector where your firm plays.
Few firms uniformly think alike; rather, it's the partners and principals
in the equity-investment firms that matter. So narrow your due diligence
on the prospective equity investors down to the partners and principals
in your short list of firms that seem to think most in accordance with
your own views. It's likely one of them will consider your pitch and,
if the equity investment is made, it's one of them that will sit on your
firm's board and will be the main person you'll work with during and after
How do you pare your list? Fortunately, again, the Internet is extraordinarily
helpful: Consider the companies in which each of the partners or principals
have invested and on whose boards they sit. Identify the sectors that
are harmonious with the one in which your firm plays. Search on the seemingly
most amenable partners or principals in all such equity-investment firms
to find blog, seminar or conference, or article references that will help
you get to know how they think as it relates to your situation.
Do as much of this research as you can to get the best understanding
of these various equity investors-personally and professionally-in order
to break your short list into two categories: A-list and B-list targets.
Even though your A list will be your preferred investors, you're going
to start with the B list first (more on why later).
Step #3: Prep Your Lure
Before you start contacting either A-list or B-list equity firms,
you first need to know what you're going to say to them. As you're doing
your own due diligence, you'll begin to compile the sort of information
that you will need to stitch together for presentation. Doing so is by
far the most time-consuming part of the process. Items to prepare include
the 20-second verbal presentation known as the "elevator pitch,"
an executive summary of the business plan, a list of reference customers
and a presentation of 10-20 slides. This information is almost universally
sought by equity investors.
In terms of information to prepare, most equity-investor
Web sites list what they need. You should plan...
...An executive summary of a business plan as well
as the plan itself. These should clearly, succinctly
state and substantiate the following:
- the nature and focus of the business as well as
a summary of the sector
- the business stage and strategy, products or services
and competitive differentiation
- the management team's experience for this business
and the corporate governance structure
- a detailed description of the technology and its
- the business model, target markets, go-to-market
strategy, plus the historical and projected financial
- a "capitalization table," which reflects
the percentage of ownership of your firm by all stakeholders
while indicating the pre-investment valuation based
on the criteria that are relevant to your sector
- the amount of investment being sought and the intended
use of funds that aligns with the strategy
- an indication of the firm's strategic exit trajectory
and timeframe, and the specified path to achieve it
...To prepare a list (on a separate sheet of paper)
of five to 10 reference customers with their contact
...A formal presentation -- ideally 10 to 15
colored slides -- to the equity investor and a demonstration
of your product or service.
...To craft a 20-second "elevator pitch"
about your firm -- what it does and how well it
does it, how it will dominate its target market, how
much investment capital it needs and what its exit trajectory
is -- that you and everyone on your team knows by
Now that you've gotten everything together, it's time to practice stating
and explaining everything about your firm. From the top-line summary to
the most granular details, make sure that you and every member of your
management team can articulate the inner workings, market potential and
growth trajectory of your firm.
In the course of due diligence, your prospective equity investor will
want to talk with every member of the management team to ensure that your
stories are consistent. Your junior people are not immune to this probing,
so be sure that every employee can summarize the firm's strategy. Nothing
derails a due diligence exercise like learning things from an employee
that contradict the management team.
In the materials you develop and prepare for your target investor, there
are several common mistakes to avoid. They include:
- Don't over-sell but do over-deliver: Make sure your milestones are
achievable and your financial projections are realistic.
- Be confident -- not peremptory -- in your assumptions and presentation:
Assume your targeted equity investor has seen better plans and that
he's smarter than you about the market, business models that work, as
well as the particulars of your plan. This is likely not true, but it's
best not to come off as cocky.
- Be cautious -- not paranoid -- in your representations: Demonstrate
that you are an expert in your sector and your business, but qualify
things properly-such as your firm's strengths and weaknesses, and the
likelihood of your firm's success in achieving its strategic objectives.
- Be attentive to detail but keep in mind the big picture: Dwell on
the key issues that matter about your firm (capabilities, potential)
and to your investor (opportunity, exit), and support your points with
- Be aggressive but not hasty: Your target equity investor is in no
hurry to write a check without covering all of the points in its due-diligence
checklist at least twice. Don't be perceived as being in too big a hurry
yourself, but do state reasonable timeframes for each step in the process
and follow your target's lead on tasks and timeframes.
- Be perceived as a partner -- not a time-sink liability -- to your
target equity investor: There's give and take in any working relationship,
and this one is very important. Make sure you always leave the impression
of someone with whom this principal is going to want to work.
Note that you needn't be deferential, afraid or in awe of your prospective
equity investor. But it's a business relationship. So make sure that your
numbers are correct. Avoid one of the most common mistakes: Do not over-value
your firm. Learn what the right multiple is for firms in your sector -- a multiple of earnings, discounted cash flow, etc. -- and how other firms
in your sector have been valued on a sale.
Plan accordingly, and don't set unrealistic expectations for yourself
where the only justification for the valuation is your gut feeling as
opposed to what the industry standard is and what is indisputably fair.
Be fair to your firm and to your prospective equity investor in establishing-and
justifying-a proper valuation of your firm that will be used in setting
its worth before and after the equity investment (also called pre- and
post-money valuation, respectively).
When your investment apparatus -- business plan, investor presentation -- is complete, and you and your team can fluidly present and explain
it in summary and in-depth (rehearse again and again on some third parties),
then it's time to go fishing.
Step #4: Reel 'Em In
Among the first things to note on equity investor Web sites -- besides all the pictures of happy, thoughtful people and big buildings -- is that firms seeking funding to submit their business plans either
on the Web site or with an e-mail message to some address. Don't do it!
Your submission will likely be reviewed by a very junior person who simply
checks submissions for pre-defined criteria. If all of the criteria are
not met on this initial pass, the submission is deleted and the submitter
is rarely notified.
Rather, in your network inquiries to identify particular people at each
of your target equity investors, you will have found someone who knows
someone who knows the most promising investment professional there. Now
is the time to line up the introductions, whether through that person
or, ideally, from the executive in one of his portfolio companies with
whom you spoke. If you can't get the introduction, let your fingers do
Start with the last equity-investment firm on your B-list and, with a
firm determination to be brief -- respect his time -- get the guy on the
phone. Chit-chat for a split second. Then segue into your elevator pitch.
If he's interested, tell him you'll e-mail your executive summary or business
plan, whichever he wants to see, and while you're on the phone, schedule
a time in a week to 10 days to get back on the phone or to have a meeting
about it. If he's not interested, scratch the firm off the list.
Work your way up your B-list until you find a taker. Landing a meeting
with this big fish is your formal dress rehearsal. What you learn in this
meeting will be very important for your intended meetings with your A-list
firms. Most importantly, ask a lot of tough questions to gauge how well
the equity investor understands your market and about the equity firm's
investing process and investment resources.
Your Equity Partner
Sample questions for a meeting with your equity partner:
Does he understand the market, your sector and the
place and potential that your firm has in each?
Is he up on your competition and levers as well as
inhibitors to your intended growth?
Specifically, how will his firm help yours to achieve
What other portfolio companies have he and his team
similarly helped, and will he broker a call or meeting
for you and your executive team with them should you
both choose to go forward together?
What is the status of their investment fund--how
How many deals done in the past two years?
Whats the amount of the average round and when
was the last time they closed a round?
What is the average timeframe for an investment to
be made in a prospective portfolio company?
Where do they stand on the issue of follow-on rounds,
if needed, for working-capital bridging (mezzanine)
or growth-capital purposes?
How do they traditionally exit investments?
How much equity do they seek in firms such as yours
and based on what valuation?
Your equity investor counterpart will ask you what other firms you're
speaking with, to which you should reply that his firm is among the first.
Depending on his reaction -- an "OK" could signal indifference,
a "don't talk to any others" could signal envious interest -- you will get a sense of where you stand. Don't fall into the trap of being
fished for with salesmanship tactics that they might employ to get you
not to cast your line elsewhere. This posture takes some getting used
to, but you will get comfortable with it. The right equity investor will
respect your strength. Not only are you executing this fishing excursion
in a responsible fashion, but you're laying the groundwork for future
success with the equity investor should the firm decide to invest in you.
Repeat this exercise, working up your B-list until you find a firm that's
very interested. When you've done that, jump to your A-list and go for
the big fish.
In all these meetings, ask this essential question: Would this equity
investor put up all the money or would it seek to syndicate the investment?
If it's the former, you have a clear path to funding if you don't blow
it or if the firm doesn't walk away. If it's the latter, do what you can
to fast track your conversation to the point that the firm brokers a meeting
with its co-investors.
When you have found your likely investor, then you're in a position to
make your final pitch that will result in the equity investor's offering
you a "term sheet," a list of terms for its making an investment
in your firm either on its own or with other firms. This is often a happy
time, even if the terms are less in substance or more in procedural restrictions
than you might have hoped.
Don't despair or respond hastily -- everything is negotiable. Mull
over which terms you and your management team can and can't live with,
and be optimistic that you can persuade your equity investor to see things
your way. After all, you have lead the firm up to this point.