Having covered the general principles of a strategic business plan to attract lenders, and offered tips on what banks and mezzanine lenders will be looking for, I’m going to move on to venture capitalists (VCs). When is venture capital the best source of funding, and how do you obtain it?
What sort of companies need venture capital?
Venture capital is a very important source of funding for start-ups or small companies wishing to expand that do not have access to capital markets. Investors will provide money to such businesses if they have perceived long-term growth potential. VCs usually expect higher returns for the additional risks they are taking.
Venture capital can also include managerial and technical expertise. Most venture capital comes from a group of wealthy investors, investment banks and other financial institutions that pool such investments or partnerships. The downside for entrepreneurs is that VCs usually get a say in company decisions, as well as a portion of the equity.
What do venture capitalist investors look for in a strategic business plan?
The answer can be expressed in just two words: exponential scalability. Your business plan must show specifically how that future growth is going to happen. For most VCs, just projecting 20% growth is not enough. They will want to know how your company will scale to 100 times its size so that they can receive a 10 to 20 times return on their money.
If your business involves intellectual property, this can help you to secure VC financing. Venture capitalists are looking for businesses that have a sustainable competitive advantage, primarily based on intellectual property.
A negotiation point to remember
When you are negotiating the final venture capital transaction, be sure to negotiate an equity earn-back. This will return the equity you gave up based on the VC’s sceptical evaluation of your future performance. If they believe you are going to hit half the performance in your business plan and price their transaction return accordingly, and if you then hit your plan, they will have received twice as much return as they expected. This is not fair; they need to return the equity they took based on their scepticism.
Venture capitalists vs angel investors
Angel investors also provide financial backing for small start-ups or entrepreneurs, so they are worth mentioning here despite the fact that they are essentially the exact opposite of venture capitalists.
Angel investors are usually found among an entrepreneur’s circle of family and friends. They may provide a one-time injection of seed money, or ongoing support to carry the company through difficult times. Because they are usually investing in the person rather than the viability of the business, they give more favourable terms than other lenders. They are focused on helping the business succeed, rather than reaping a huge profit from their investment.
Next time, I’m going to talk about what you should do differently in your business plan if you have an early-stage company, whatever type of lender you are approaching. Meanwhile, please email me or call me on 020 7099 2621 if you would like further information or advice about venture capital or other funding options, or about strategic business plans.