According to the National Venture Capital Association, “Venture capital and private equity firms are pools of capital, typically organized as limited partnerships that invest in companies that represent the opportunity for a high rate of return within five to seven years. The venture capitalist may look at several hundred investment opportunities before investing in only a few selected companies with favorable investment potential. Far from being simply passive financiers, venture capitalists foster growth in companies through their involvement in the management, strategic marketing and planning of their investee companies. They are entrepreneurs first and financiers second.
Do you have an idea for the next big thing in the high-tech industry? You might be thinking that a venture capital fund should be your next step to find the cash you need to get your company up and running. Before approaching anyone about financing, you need to understand the intricacies of the venture capital marketplace. Venture capitalists are not waiting to deliver the Midas touch to every idea high-tech idea that comes through their doors. They are shrewd business people with money to invest and expertise to lend, but only for companies that pass muster and prove themselves based on solid market research, strength of their management team, and a promise to return on the investment within a specified timeframe, usually within seven years.
“The broad definition of venture capital is any kind of capital associated with high risk enterprises such as company formation and early stage company growth,” said Robb Smith, managing principle for Millennium Three Ventures and Nevada Ventures, Reno-based venture capital firms. Smith added that different venture funds will look to provide funding at different stages of a company’s growth — from the seed stage of company formation to what is called the mezzanine stage, just prior to a company going public. “The difference is the risk-and-reward profile for that investment,” said Smith. “The earliest-stage companies are the highest risk, and for that investors expect to get the largest return for their investment.”
According to Smith, the first step in finding venture capital is knowing if you really need it. “Ninety percent of companies seeking venture funding don’t need it. If a company is well-designed and pursuing a market with paying customers, growing without the intrusion of outside equity is an excellent choice for many smart entrepreneurs,” he said, adding that Millennium Three Ventures accepts less than 1 percent of all companies that apply for funding.
Michael Thomas, executive director of the Tech Alliance, urges companies to do their homework before approaching venture capitalists, because they need to make their first pitch their best pitch. “You won’t get a second chance,” he said. Assuming you have done your research and found a venture capital fund that invests in companies in your industry and at your stage of growth, the next step is to make contact. However, you cannot call up the fund and exclaim, “Have I got a deal for you!” Venture capitalists are a cautious group and generally only look at companies referred to them by people they trust. Smith cautions against cold-calling a venture capital firm or sending an e-mail with your business plan attached, unless you are specifically asked to do so.
“We look at over 500 deals a year,” said Smith. “Our first screening process is the credibility of the person who has suggested we look at it.” He added that this is a more difficult process in Nevada. Due to the newness of the venture capital market in the Silver State, venture capital firms cannot find the same number of credible referrals that they can find in California. “There are very few people here who have done it successfully,” he said. However, the Reno market is expanding rapidly, and Smith says his company has participated in roughly $55 million in Reno-based venture capital financings in the first two quarters of 2001.
The next step in the process is for the venture capitalist to look at your company’s marketing and business plan. According to Peter Kingman, chairman of Southwest USA Corporation, the holding company of Southwest USA Bank, the discipline of creating a business plan is an important one, because it forces a company to be focused and deliberate about what it is doing. “I’m not interested in talking to an entrepreneur until he or she can provide a business plan,” said Kingman. “That’s where the review begins, because then I can get a glimpse of the company, the management, the technology involved and the deliberative process gone through to write the business plan.”
When venture capitalists evaluate a company’s marketing and business plans, they are looking for some specific benchmarks for assessing a company’s ability to deliver on its promise of high returns for their investment. First and foremost, they are looking at the experience of the management team. They also want assurance that a company knows its market inside and out. An unsubstantiated belief that products will corner a certain percentage of the marketplace is not sufficient. “No prototype, no major customer beta test — no venture capital,” Smith said. “An entrepreneur can’t possibly understand his or her market at the level required by venture capitalists unless he or she already has tremendous domain expertise or has gotten dirty with a real product in a real beta test.”
When all the pieces are in place, according to both Kingman and Smith, the next step is for the company to come in and make a detailed presentation to a handful of the general partners for the fund. This, said Smith, is where research can really pay off and why it pays to have someone refer you. “Individual venture capitalists are just people. They have their own set of biases, likes and dislikes for presentation style and background. An entrepreneur going to seek funding should look at not only the character and history of the venture fund itself, but should also look at the individual partners of that venture fund and say ‘Does this sound like something he would be interested in?’ and ‘What kind of presentation style do I think he’d be amenable to?’”
If the partners like what they see, the process enters the due diligence phase. The venture capital fund will check the backgrounds of all principal players, talk to industry experts about the anticipated financial returns of an investment, even do market and customer research to test out the viability of the company’s products. Kingman said venture capital firms are looking for several hallmarks to measure the potential success and determine the valuation of the company. These hallmarks allow them to effectively gauge the level of investment they are willing to make in a given company.
Even if all the t’s are crossed and the i’s dotted, there is still one element to a venture capital deal that is crucial. There must be compatibility between the company’s management team and the individual partners who will work with them during the course of the investment. “Typically, venture capitalists are very involved. We not only operate at the board level as directors, but we also work hand-in-hand with the senior management to do strategic and operational work,” said Smith. “Whether it’s arranging lease financing and other follow-on financing, recruiting key executives, or making introductions to customers for the product, it’s strategic in nature, but it’s still hands-on.” Smith added that he has seen several venture deals “blow up” because of a bad fit between entrepreneurs and venture capitalists.
Michael Thomas of the Tech Alliance added this is one reason venture capital funding is not the correct avenue for everyone. He stressed that entrepreneurs need to ask themselves if they are willing or able to give up control of their company in exchange for being able to grow and expand it more quickly than they would on their own. If not, he suggested they look at other avenues to achieve their company’s goals.
The final piece of the venture capital puzzle is exit strategy. Venture capitalists typically expect to see their investment pay off within seven years. “Because we are stockholders, our return comes when someone else is looking to buy that stock,” said Smith. “That usually happens in one of two ways: either a larger company comes in and purchases the company outright in a private transaction, or we take the company public.”
Though the venture capital market has an allure and, in recent years, it seemed as if anything with a “dot-com” attached to it received funding, it is still a hard-nosed business environment where Thomas Edison’s adage still holds true. Success, he said, is 1 percent inspiration and 99 percent perspiration.
Venture Capital Conference Announced
Technology leaders in Nevada and California – the Sierra Angels, Golden State Capital Network, Tech Alliance and Nevada Technology Council – have formed a partnership to launch an annual Silver and Gold Venture Capital Conference and Entrepreneur Expo each fall in the Tahoe region. The inaugural conference is scheduled for October 14-16, 2001 at the Resort at Squaw Creek, in Squaw Valley, Calif. According to Michael Thomas, executive director of the Tech Alliance, “This conference is an important step in continuing to grow Nevada’s technology industry. This is a unique opportunity to give companies and investors a chance to build partnerships that stretch over state lines, which will benefit both regions in the long run.”
The conference will feature a series of workshops related to growing start-up and early-stage technology companies, panels featuring angel investor groups and venture capital funds, and keynote presentations by industry and public policy leaders. After a competitive recruitment and selection process, up to 75 Nevada and California companies currently seeking investment capital will be given a chance to make presentations to the investors. Nevada companies looking to hone their presentations can participate in a series of workshops sponsored by the Tech Alliance prior to the conference. Contact the Tech Alliance at 775/829-3700 or visit their Web site at newnevada.com.
