How to prepare for Venture Capital: 3 first steps for entrepreneurs

Entrepreneurs often walk into CED with questions about raising capital.

Recently, I had the pleasure of a conversation on raising capital with Triangle entrepreneur Daniel Chalef, founder and CEO of KnowledgeTree, and Ed McCarthy and Rik Vandevenne, both directors at River Cities Capital Funds.

Chalef started KnowledgeTree, a document management service for businesses, in South Africa.  Although he successfully raised the capital necessary to expand operations and move headquarters to Raleigh, he admitted “I had no idea what I was doing the first time around,” said Chalef, “we had in fact, a baptism of fire”.

Chalef learned quite a bit from this experience – so much so, that when the time came again to seek investment in order to scale operations and the product team, he was 100% prepared to secure capital, raising $4.75 million in just under seven months. The lead investor in the Series B round was River Cities Capital Funds, sponsored by McCarthy and Vandevenne, who comprise the Raleigh, N.C. office.

Together, Chalef, McCarthy and Vandevenne walked me through the three fundamental first steps that entrepreneurs need to follow in order to secure financing from venture capitalists.

Get Your Ducks in a Row

This may seem basic, but it is absolutely vital that entrepreneurs can clearly articulate their business and their market, as well as their reasons for seeking funding. This includes a detailed plan on how the company will allocate the funds.

There are three key items an entrepreneur needs to prepare prior to seeking investment, said Chalef. The entrepreneur and company must “have a cogent story,” or one that articulates the mission of the company, and the reason the company exists. What is the problem you address, and who is the person, group, or company that needs the solution? If you can’t hit this in the first two minutes of a conversation, go back to the drawing board.

Second, it is important that an entrepreneur has “milestones that have been proven out,” said Chalef. This enables an entrepreneur to understand the key areas of the business that need to grow in order for the company to expand. It also informs an investor on how an entrepreneur will allocate the funds.

Third, entrepreneurs must understand the market, and how their company can, will and does address the market, said Chalef. This includes an intimate understanding of the total market size, major competitors in the marketplace, and an idea on what may occur in this market in the future.

Once your ducks are in a row, you’re prepared for fundamental step 2.

Do Your Homework

Asking for introductions to investors becomes a whole lot easier when an entrepreneur has researched firms that tend to invest in the company’s vertical or industry.

According to Ed McCarthy, entrepreneurs must have an advanced understanding of venture capital prior to seeking investment. Great entrepreneurs, said McCarthy, also understand individual funds, their focal points, and their expertise. These entrepreneurs know to “target fundraising activity toward the right audience,” said McCarthy. For example, “if you’re an early-stage company, you’ll want to target investors who invest exclusively in early-stage companies.”

This is one of the reasons that KnowledgeTree was such an attractive investment, said McCarthy. Chalef understood the process, and understood that RCCF has demonstrated strong success with investments in other Software-as-a-Service (SaaS) companies (SciQuest, for example).

Because investors will always choose to “invest in what we know,” said McCarthy, it benefits entrepreneurs to complete extensive research prior to requesting meetings or asking for referrals to investment groups.

Ultimately, said Chalef, it is about establishing and building trust between the venture capitalist and the entrepreneur. Think of seeking investment like playing your favorite sport – soccer for instance. You’re not going to go out on the playing field alone, because there’s no way you’d be able to take on your competitors. So an entrepreneur must establish a network of trust, and gather a team of individuals who play the same sport on the same field.

When an entrepreneur researches venture capital firms, it is vital to understand what ‘sport’ they play, and the dynamics of the ‘field’ on which they perform. River Cities Capital Funds, for example, invests primarily in companies that have business-to-business products, and they tend to invest in growth-stage companies that have demonstrated products and are bringing in sales revenue.

River Cities isn’t necessarily the best group to approach if you’re building a consumer business or consumer product and you’ve only developed your MVP. It’d be like approaching a bunch of tennis players and asking them to come play soccer against one of the best competitors. Before you approach a firm, it is vital that you understand why and how they invest. The key point here, said McCarthy, is to understand the investment groups and target only those that make the most sense for you and your business. That is how an entrepreneur will be able to create the right network of investors.

Meet Early, Meet Often

According to Rik Vandevenne, “great CEOs are always networking.” You’ve probably heard the saying “always be closing.” Well, Chalef alters that saying and used it as a mantra while building his business. According to Chalef, the best mindset an entrepreneur can have is one where the entrepreneur is “always fundraising.” It may be a simple concept, but it certainly is not easy, said Chalef.

Entrepreneurs often get caught up in the day-to-day operations of their business – and rightly so. However, said Chalef, entrepreneurs need to understand that the best time to meet investors is before you are actively fundraising. This, said Chalef, “is important to do, but it isn’t always that easy to do. It is important while you remain focused on the immediate to not let yourself get into the position where the only time you’re fundraising is when you need to raise funds."

Vandevenne agreed, articulating what he sees as one of the biggest obstacles entrepreneurs face while growing their business. “One of the challenges a lot of entrepreneurs face is that they see investors as just the people with the money,” said Vandevenne. “It’s only when they have three months of cash left in the bank account that they start to worry about raising extra money.” This is a potential fatal flaw for the business. On the other hand, “great CEOs are always networking, talking with people, meeting investors, and giving them updates when things are going really well, as opposed to just when they need the money,” said Vandevenne.

If you’re able to meet early, and you effectively follow up every few months, or stay in touch when sharing company milestones, you’re building a long term relationship with potential investors and demonstrating continued growth.

When an entrepreneur decides to seek investment, if these relationships are already in place, it simplifies the process and enhances the likelihood of a meeting, of introductions to other investors, and the successful signing of a term sheet to close the deal.