Venture Financing - Reality versus Rumors with Dick Brown
I belong to several “special interest” groups on the Internet, generally those relating to entrepreneurs and financing. On one of these on LinkedIn had a simple inquiry:
Where can we find investors in the United States that would be interested in helping us fund our venture?
It was late on Friday. I’d had a good week and was in a wry mood. I replied:
Go to New York. Rent a room at the Plaza. At cocktail hour go to the Oak Bar. It will be jammed with people. At least 75% of all the ones you see in this room have adequate funds available to help finance your deal. Bring your lawyer for the closing details.
Although impish, my comment was quite accurate. Even in today’s environment, it isn’t hard to find people with money that might be interested as an investor. The easy part is finding where they gather.
The trick is selling them.
There’s an old sales adage that says: “In order to sell anything, you first ask the potential customer why they’d consider buying your wares. Then you sell to them, based on what they just told you”
In earlier columns, we’ve talked a lot about many different kinds of investors. You already understand the people that comprise your “3F’s”. Few of you will require the huge capital amounts available from merchant banks. So, most of you will require funding in the ranges supplied by either Angels or VC’s. Here’s some clues on … “why do they buy?”
Angels & VC’s - What They Have In Common
They are both sophisticated investors and require that you have:
- Excellent profit potential,
- A good business plan,
- A competitive product or service,
- An excellent marketing opportunity,
- An experienced management team.
- A proprietary product or service, preferably protected by patents, trade secrets, copyrights or unique market timing, know-how and contacts of the principals in the venture.
- Growth potential: large and fast. Able: to reach $25 million to $50 million in sales in 5-10 years.
- High return on investment: at least 20% to 25%.
- Management comprised of seasoned, experienced pros with track records in successfully making money. The venture also has some members of "the club" - people who are already connected to the money community and/or its support staff (lawyers, accountants, bankers etc.)
Angels & VC’s - What’s Different between Them
1. Size of investment:
| Traditional VC Investments | Angels/Other Adventure Capitalists |
| 21% are under $2,500,000 | 90% are under $1,000,000 |
| 7% are under $1,000,000 | 82% are under $500,000 |
| Venture Capital | Angels | |
| Time to make a commitment: | Slow | Quick |
| Number of sales leads needed: | Moderate | Many |
| Whose money? | OPM | Their own |
| You meet at: | Their office | A private, secure place |
| “First Man In” Leverage: * | Very High | Medium |
| Networks: | Huge, National | Small, Regional |
| Ease of Finding: | Very Easy | Moderate to Impossible |
| Tolerance for putting in more money: | High | Moderate |
* Note: In any sales situation, the first sale is always the toughest. From that point on, the salesperson can always say: “Mrs. Jones bought one and absolutely loves it! Would you like to talk with her?” (i.e.: your “singer”)
Due to the basic characteristics of VC’s, getting one of them to commit to the deal makes it much easier to rope in the rest. As mentioned, the first-VC- in may also bring others with them as a syndication.
For angels, having your first investor is nice, but not nearly as powerful as a sales tool. The angel probably doesn’t know your first investor personally and usually doesn’t care.
Amazingly, I have had angels invest in the early stages that never even asked if anyone else was already in!
The Biggest Difference
For our sales activities, we are going to take advantage of the largest difference between VC’s and angels. VC’s belong to a very large, interlocked club. There is an enormous, day-to-day exchange of information between the members of this club. The motive of every member is to make money for their VC firm and if they find a deal to do this they act, sometimes very quickly. If not, they may refer the opportunity to other VC’s or angels in case the other parties might be interested.
This is also the reason that I urge entrepreneurs that seek funding to include many VC’s in their prospect lists even if the amount they seek is relatively small and could be fulfilled with only one. If you have a good idea for your venture, it’s possible that a mailing to VC’s may wander through a number of hands to ultimately find the VC company, angel or corporation that is very interested.
Conversely, angels are not closely linked (except for the angel clubs and associations) and they are not interested in making money for anyone except themselves and an occasional friend. Contacts/mailings to angels do not have the same potential multiplier/leverage factor than for VC’s.
Another Difference … Time To Market
The middle portion of the graph (bars) shows a substantial growth in sales, with demand outpacing supply. Most companies earn their highest profits in this phase.
The right-hand side of the graph shows the products and markets in a near-stable condition. They have reached their “natural peak” and from this point the companies that survived the earlier battles and the larger companies that entered late in the game supply the market. This market is often one in which the majority of suppliers compete solely on the basis of price. This is a tough place for the smaller competitor.
Angels like to play with companies in the left hand side of the graph: Very high risk, very high rewards. This usually terrorizes the VC’s, but sometimes they get right back in that game, looking for huge returns from a handful of investments.
VC’s favorites are still those companies that survived the early stage and are in the middle portion. It’s a lower risk, but still pretty good rewards. Angels will invest in this stage as well. On the right hand side of the graph, neither VC’s nor angels are likely to invest*, unless your company is one of the winners in the market and needs additional capital (“bridge” or “mezzanine” money) to get to an IPO.
* Exception: You might have a chance for financing if your plan has some unique idea that will position your company in a secure niche within the mature market and also make your venture very profitable due to the large, proven, active demand for products.
Market Differences
Angels will invest in anything and often for “cosmic”, not-totally-rational, reasons.
VC’s are focused and disciplined. Generally, their favorites are:
| Software | 24% |
| Medical Devices | 13% |
| Biotech | 10% |
| Green Technology | 9% |
| Internet Specific | 9% |
Your Closing Rate - Summary
One major, Northeast VC receives over a thousand business plans in the course of a year. They invest in around 10 deals. If you're trying to use this VC to raise money, you've a 1% chance of success. When it existed in the .com space, the conglomerate CMGI, received over 1,000 business plans a month.
How do you get to be one of the lucky few?
- First - Work very hard and show your venture to many, many of the potential capital sources you’ve selected.
- Next & Simple - find out what your VC community wants and then sell it to them! Use exactly the same technique with angels.
What's the single, most important thing both want?
Yet, not one business plan in 100 shows how the particular venture will make money ... and, preferably obscene profits, with a minimal investment. Ironically, many plans show how the venture will lose money until some, long-away future time when the red ink finally stops.
Show any angel, investor or businessperson how they can make a lot of money and you'll have their undivided attention!
The Odds
Let’s imagine that you decide to blindly follow all the rest of the sheep and choose only to consider venture capital financing. Further: You throw my columns away; fail to read books or follow anyone’s advice; don’t bother with a good business plan; and, insist that you’re going to trust your “gut instinct” (what you’ve read about the wild success stories of teen-age billionaires depicted in the San Jose Mercury.) You just know that the VC’s will love you and you’ll do your IPO in less than a year.
If you take this “path worn thin by the ignorant”, here are some of the odds:
- There are 10 “high-tech hubs” (Austin, Boston, Boca Raton, Chicago, Los Angeles, New York, Raleigh/Durham, San Jose/San Francisco, Seattle and Washington, DC.) Some 70% of all venture capital investments are made in or around these hubs. If you’re not in one of these markets, the VC odds are already against you … most VC’s funds deal solely in their geographical area since it’s easier (and cheaper) to monitor the investment.
- “Not even 1% of the 300,000 or so companies growing at 20%+ a year (e.g.: Inc magazine’s “Private 100”) are backed by VC’s”.
- During the .com frenzy a “swinger” VC, WIB, (Laguna Beach, CA) was shown 200 deals a month. They reported doing less than 2% of these (That’s 4 deals/month, folks!).
- The VC firm of Draper Fisher Jurvetson, based in Menlo Park, California with affiliate offices in more than 30 cities around the world gets 10,000 business plans a year and backs some 15 deals. (.15% ... That’s point 15%!)
- Only one of thirty companies that receive venture capital financing ultimately goes public.
So, based on these numbers, the odds on getting VC funding and going public is far less than 1 in 25,000.
By comparison, your odds of “Death by Lightning in the US” are 1 in 17,400.
For more information, please visit Dick's TNNW Bio.
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