Thursday, January 31, 2013

VCs to Entrepreneurs: Stand Out, Stay Connected, Know Red Flags

So, you're an entrepreneur running a firm that has demonstrated success in one or more specific sales channels. You're making sales, hiring more people, growing the business.

What could help you grow faster - could help you push the sales/growth curve even higher?

This is the point at which many entrepreneurs are ready to consider entering into an agreement with a venture capital firm.

Venture capital firms attract investors - called Limited Partners (or LPs, for short) - who together provide a large sum of money for an investment fund. The venture capitalists, then, are responsible for investing their LPs' money into companies that will experience growth over time, and ultimately experience an exit event - a merger or acquisition, or even an initial public offering (IPO) of company stock.

There are many benefits to seeking and accepting venture capital, said Rik Vandevenne, partner at River Cities Capital Funds, which has headquarters in Cincinnati, Ohio, and Durham, North Carolina.

"Obviously, there is the money invested in the company," said Vandevenne in a public address at the CED Funding Series on Tuesday, January 29, 2013. "There's also supplementary benefits, such as the gained credibility of being a venture-backed company."

In addition, venture capitalists often open doors to a network of potential partners, can help attract top management candidates to your startup, and provide subject-area and domain expertise.

Is venture capital right for you? If so, how would you begin the process of attracting venture capital? Here's your primer on venture capital, with lessons from the first of two sessions of the CED Funding Series. Session 2 will take place on Tuesday, February 5, and provide one-on-one coaching to technology startups and entrepreneurs from experienced CEOs, investors and coaches.

Stand Out

Daniel Chalef, founder and CEO of Triangle-based KnowledgeTree, launched his company in South Africa without knowing anything about venture capital.

When the time came to scale his startup, said Chalef, "it was a baptism by fire." Chalef traveled to Silicon Valley, meeting with venture capitalists and learning the lingo. Interested readers can review Chalef's recommended steps to raise venture capital.

"Not being immersed in the local technology or entrepreneur industry" was a significant challenge, said Chalef. The process of raising capital took quite some time. KnowledgeTree did successfully raise a Series A round - it was led by a South African firm, Hasso Plattner Ventures Africa - and later went on to raise a $4.75M Series B round led by River Cities Capital Funds.

How do you set up first meetings? Chalef stressed the importance of introductions to venture capital firms through established relationships, such as the ones that an early-stage company has with its lawyers, accountants, bankers, or real estate agents. An introduction from a trusted industry insider will help you stand out from the crowd of entrepreneurs who want attention from venture capitalists.

Stay Connected

"If 'now' is not the right time [for the venture firm to invest]," said Chalef, it is imperative that "you understand why it isn't the right fit" and stay in touch after the initial meetings.

Brendan Morrissey, founder and CEO of Triangle-based Netsertive, recommends that should an entrepreneur encounter this scenario, they "ask the VC how they would like to be sold to." It's absolutely appropriate to ask how to provide updates to the venture capitalist, because each firm and each individual will want to stay in touch in a different way, said Morrissey.

If you ask, however, it is absolutely vital that you follow up exactly as asked, said Morrissey.

An entrepreneur can save a lot of time - and a lot of grief - by targeting venture capital firms that are a good target fit for their business, said Morrissey. It makes no sense for a healthcare IT firm building a mobile application for direct consumer sale to target a venture firm that specializes in SaaS companies that sell business to business.

Red Flags for Venture Capitalists

Let's say you're ready to speak with VCs. You've got your pitch reviewed by CED's fantastic PitchScrub team and you've set meetings with the Triangle's great venture capital firms. What do you need to know walking into these meetings, and what will trigger a "red flag" for venture capitalists?

"You can't go and speak to a VC if you don't know the terms that you're seeking," said Chalef, stressing the importance of knowing exactly what you're asking, and exactly what you're offering in return. 

While it's true that "there's no one-size-fits-all approach to venture capital," said Brian Carny, partner at Harbert Venture Partners, possessing deep understanding of a few key metrics can make the difference between a successful meeting and a failed meeting. 

Know the Terms. How much money are you raising, and how do you plan on spending it? Venture Capitalists are looking to maximize the revenue growth of the company, which makes it more attractive as an acquisition target. You must be able to show how you plan to "bend the growth curve in your favor by investing in your sales and marketing channels," said Vandevenne.

Know the Competitors. You're solving a problem for a particular market with an innovative product. But chances are pretty high that you're not the only person in a world of 7 billion people attempting to serve that market, or building products that solve that problem. "It's a big red flag to us if a company doesn't know their competitors," said Vandevenne. Entrepreneurs oftentimes are heads-down working on product development, but if they want to have success in their early meetings with VCs, they must be able to identify competitors and differentiate their product, service, management team, or demonstrate some other competitive advantage. 

Be Willing and Able to Show Sales Funnel. Venture capitalists are concerned with one thing - earning money for their LPs. Almost every serious conversation about venture investment in a startup will include a discussion of the sales pipeline - who is currently a customer, who is a potential customer, how is revenue being created, etc. To attract investment, you need to be able to demonstrate sales and/or revenue growth over a period of time. The famous adage is that investors choose to invest in lines, not in dots. Showing trends and traction over time is valuable, and it is what investors will look for in a potential deal. 

The CED Funding Series, "Raising the Dough," will continue next Tuesday, Febrary 5, 2013. Missed the first session? You can still register for the second session and take part in a funding assessment, get one-on-one coaching from investors and CEOs, and participate in a mock negotiation between a company and an investor, mediated by a lawyer. 

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