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Knocking on Venture-Capital Doors

“Knocking on Venture-Capital Doors”

How to find money to take your company to the next level.

You need money to grow your business. Venture capitalists (VCs) have literally billions of dollars to invest. Learn how to attract VC attention and get the funding you need.

Making the Cut

VC investors are notoriously picky. They typically look at more than 100 business plans for every investment actually made, and at some firms that ratio can be 1,000-to-1.

What’s more, VCs are interested only in companies capable of dramatic and sustained growth — 20% to 30% per year for the next seven to 10 years. At a 30% growth rate, a company with $10 million in sales today will be generating revenues of about $130 million in just 10 years.

A VC fund needs to set its standards high to compete for investors’ money. Investors know that venture capital is risky, and they demand a rate of return that compensates them for that risk. And VC fund managers know that, despite their best efforts, some companies will fail. So the return from successful ventures has to be truly outstanding to produce the required portfolio return.

Some investors provide financial backing to startups and companies in the very early stages of growth, after private investors or the entrepreneurs have provided the seed money to get the business started. Yet most venture funds provide only later-round financing. That’s because there is less risk backing a company that has already attracted some financing, assembled its management team, done R&D and launched its product.

In addition, many venture funds have $500 million to $1 billion that must be invested. Their managers can oversee a dozen or so later-round investments of $20 million to $100 million each. But funds don’t have enough managers to place money in increments of $1 million or less to hundreds of startups.

That’s good news for more mature companies. But if you’re looking for early-stage financing, focus your search on the few venture funds that provide seed capital. Or consider angel investors — individuals or informal groups that provide capital in smaller increments.

It’s the People, Not the Idea

A great idea by itself is not going to lure venture investors to your company. What VCs really bet on is a management team’s ability to respond quickly and effectively to changes, including the emergence of new competitors, sudden obsolescence of a key technology or some other crisis.

Equally important to VCs is management’s ability to handle rapid growth. They want to see a team that will be able to run all aspects of a much larger operation — sales, production, marketing, distribution and finance. If VCs don’t see that talent in place, or at least identified and ready to be hired, they are unlikely to invest — no matter how attractive an idea seems on paper.

More Than Money

Once they decide to back a company, the VC group invests a lot more than cash. Successful VC firms provide portfolio companies with their enormous experience in building companies.

Most entrepreneurs who come to VCs are involved in their first company. By contrast, the partners at a VC firm have been closely involved with dozens, sometimes hundreds, of companies. It is very unlikely that you will encounter a problem that your VC partners have not seen before.

Also, a VC firm that has opened its wallet to your company will also open its Rolodex. Its partners will use their contacts to attract highly qualified people to serve on your board. They will introduce you to potential customers or companies that can provide you with key technology, distribution or other services. Some of those companies may be in your VC’s portfolio or in the portfolios of other VC firms with which they have relationships.

Another intangible benefit is the "seal of approval" that VC backing brings. The fact that you have passed the rigorous due-diligence process imposed by a VC firm boosts your credibility with bankers and suppliers.

Finding the Right VC

How do you find a VC? Look for firms that focus on your industry, company size and business stage.

The Internet is the best place to start. The National Venture Capital Association Web site lists more than 300 VC firms.

Learn how to approach the VC community at Garage.com. The site focuses on helping early-stage companies get seed-level financing. It provides mentoring, research, help with developing a business plan, reference materials and direct links to investors.

Venture Capital Online is an information clearinghouse that connects startups with venture capitalists.

The Venture-Preneurs Network [now AngelDeals.com] provides online and face-to-face networking of entrepreneurs, investors and professional service providers.

Most VCs maintain Web sites that identify the kind of investments they are looking for.

Do your homework and contact only firms for which your company is a good fit. Sending your proposal off to every name you can find marks you an amateur and can trigger a negative "buzz" that will doom even a good idea.

Geography is also important. VC firms prefer to invest in companies located within 50 miles of their offices. Investors want to visit frequently to stay involved in your progress — or intervene quickly if you get into trouble.

If your idea fits the general parameters of a venture firm’s activities, your business plan will get an initial review, which may be no more than a look at the plan’s executive summary. But a business plan will get a little extra attention if it comes recommended by an attorney, accountant or banker whose judgment the VC trusts. So it may pay to get professional advice early. Make sure the intermediary you select has the experience, reputation and relationships that will open doors for you.

Corporate Venture Capital

An alternative to traditional VC groups is a little-known source: Many leading U.S. corporations maintain VC arms.

Have you developed a new software program that produces marvelous results, but taxes the capabilities of today’s fastest computers? That’s music to the ears of Intel Corp., which has set aside $250 million in venture capital to fund products that will take advantage of powerful, next-generation Intel processors. Intel now has some $8 billion invested in 350 smaller companies.

Compaq Computer thinks the demand for "rented" software (used on computers linked to the Internet and corporate networks) will soar, adding to the demand for desktop and server computers. So Compaq has committed $400 million for equity investments in application-software companies and related dot-coms. Sun Microsystems, IBM and Hewlett-Packard are doing the same.

But it’s not just programmers and Net-heads who are attracting corporate VCs. If you’ve got a bio-tech product, companies like SmithKline Beecham, Johnson & Johnson and Dow Chemical may be interested. Publishing powerhouses McGraw-Hill and Reuters back young media companies. Though not a household name, Tredegar Corp., a Virginia-based manufacturer of plastic and aluminum extrusions, was the fourth most-active corporate venture investor in 1999, behind Intel, Microsoft and General Electric.

Corporate venture capital totaled about $7.5 billion in 1999, up nearly threefold in just two years. Like other VCs, corporations are attracted by the tremendous returns a "home run" investment can produce. But they have another, equally powerful incentive. As Intel and Compaq demonstrate, corporations want to partner with small companies whose products will support their investors’ objectives. Networking hardware giant Cisco Systems has
invested in scores of companies — and eventually acquired many of those smaller players.

For the recipients of corporate venture capital, that cash may be less important than other benefits, such as having a ready market for its products and corporate officers from the larger company to sit on its board. There’s also the cachet of being in the portfolio of a big-name corporation.

But there are three reasons to be cautious about pursuing corporate venture capital:

  1. The corporation is investing, at least partly, for nonfinancial reasons. If the smaller firm’s products don’t support the corporation’s objectives, or those objectives change, the relationship could cool.
  2. Your company’s linkage to a large corporation may make your customers nervous. After all, if MegaCorp Inc. has invested in your company and is also buying a fair amount of your product, your customers may believe MegaCorp will get an early peek at your R&D efforts.
  3. Corporate venture capital can be an obstacle to attracting subsequent financing. Latter-round investors want the broadest range of exit options. Among the most attractive are an initial public offering (IPO) or the acquisition of the portfolio company in an open-market sale. When an early-round investor is a corporation, other potential investors may assume that the corporation will acquire the company if it is successful. With fewer exit options, your company may seem less attractive.

Finding a corporate venture capital investor is another matter. A few, especially technology companies, deliberately maintain a high profile to attract entrepreneurs. But often the VC function is tucked away in a corporate-development, strategic-planning or corporate-finance department.

The National Venture Capital Association’s Web site lists some corporate VC departments, as do various venture-capital directories found in libraries. Independent VC firms, which often partner with corporate investors, may provide additional leads. Also check the Web sites of likely companies, starting with those who would be likely customers, and then check with the chief financial officer.

Writer: Alexander Auerbach