Getting the most from the venture capital process
You have a brilliant business idea; you are entrepreneurial and want to be your own boss but you need investment to grow your business. Is venture capital the answer?
2015 saw record venture capital funding in UK tech start-ups. The UK's technology businesses raised more than $3.6bn investment in 2015; a 70% increase on 2014.
Evidently, there are people and organisations ready to invest. Venture capital can encompass seed and start-up capital right through to expansion and growth stage funding. Different firms will have different investment criteria, some focusing on a specific stage, some with geographical constraints, and others with sectoral preferences. You need to find the right investment partner for your business.
Choosing the right investors
It is vital your investors see the same potential as you do in your business so find one that you can relate to. Their portfolio companies usually act as good reference points.
Start with a well-structured and coherent business plan. Highlight your vision for scale. Draw attention to the strength of your management team, the large and growing market opportunity and the quality of your product or service, particularly if it's disruptive. Provide detailed financial information (historic as well as projected) and explain how value for all shareholders will be created.
If you do get the chance to pitch to a VC in person then grab their attention but avoid gimmicks - credibility is key.
If investors like your plan then they will commence due diligence. This usually entails researching the market opportunity, growth potential, and risks and sensitivities facing your business. Potential investors will build a financial model to help structure the proposed investment and assess the financial sustainability of your business. This helps validate the investment opportunity and can form the basis for initial negotiations on deal terms.
Be open to negotiations
When you have nurtured your business idea from initial brainwave to full-blown proposal, your protective instinct might be to resist negotiation and stick to your own firm view on valuation. Remember that in making an offer, the investor will have assessed the technology, market, financial history, projections, management and anticipated future value of the company. Their investment terms will be based on their due diligence findings, on their investment experience and on comparable deals. Negotiation over terms is usual and ultimately, you must decide how much equity you are willing to give up to enable your business to scale.
It’s not all about the money
It is important to consider the whole package, not just the sum of investment being offered. A good investor should have a proven track record of working effectively with entrepreneurial management teams. The best venture capital investors bring significant additional value in the form of knowledge, experience and contacts coupled with practical hands-on support.
Most investors will take a seat on your board and build a positive relationship with management, helping with the company’s strategic and commercial development. Don’t reject this assistance; it is in everyone’s best interests that the business succeeds, so be prepared to work closely with your investors towards this mutually beneficial goal.
Frequently consider the future direction of your company. Where do you see your business in five years’ time? Even from the early stages of your venture capital investment, you need to map-out an exit strategy as your investor will need to realise a return on their investment.
The appropriate time and roadmap for the exit will be influenced by the stage at which you receive funding. Seed stage businesses typically take longer to exit than later stage, more established companies but in all cases an exit must be carefully planned.
A sensible approach is generally to be patient and to grow the business until it makes strategic and financial sense to run a sale process or consider IPO - this can often take 4-5 years from initial investment.
Whatever the exit strategy, there should be no surprises. It is important for investors and management to maintain an open dialogue on exit plans throughout all stages of the investment process, from initial appraisal to eventual exit. In the end, the deal should reward your hard work and represent the value you have built in your business.
Paul Neeson is an Associate with Scottish Equity Partners focusing on new deal generation in Scotland, portfolio monitoring and deal support.