Preparing Your Business for Venture Capital Investment

By B. Kay Carel | THE JOURNAL RECORD, September 28, 2000 | Go to article overview

Preparing Your Business for Venture Capital Investment


B. Kay Carel, THE JOURNAL RECORD


For the small business owner, raising capital can be a never- ending process. After funding initial operations with cash from friends, family and personal credit cards, many entrepreneurs seek capital from outside sources.

For a business with no sales or established operations, careful planning and the assistance of experienced professionals will pay off when soliciting third-party investments. Seed capital of less than $1 million is typically solicited from individuals who have had financial success in the entrepreneur's industry who have an interest in investing in other businesses. In addition to providing cash, these "angel investors" can provide meaningful introductions to sources of financing, credit or vendor relationships, and can help you hire new executives.

While there are directories of angel investors available on the Internet and through investment seminars, the best resource for referrals is your securities lawyer, accountant and banker.

Following the seed round, investments of $1 million or more are generally solicited from professional venture capital companies that are normally small firms led by people experienced in small business investment. These funds are capitalized by investments from large institutional investors, such as insurance companies, pension funds and large corporations. Before investing, both angel investors and venture capital companies will want to know something about your company. The first step in soliciting investors is to draft a sound business plan that includes, among other information:

* The reason for the financing and the anticipated use of proceeds.

* A detailed description of the management team, their business experience and their compensation.

* A summary of the business, the industry and the company's entry and growth strategies.

* A description of the company's customers, market size, trends and competition.

* A statement of the economics of the business including gross and operating margins and break-even analysis prepared by your outside accountant.

* Tax returns, profit and loss forecasts, pro forma cash flow analysis and balance sheets prepared by your outside accountant.

* A reasonable plan (including a timetable) for providing investors with a return on their capital.

The required internal rate of return on each investment will depend upon the venture fund's investment strategy. There are three basic types of venture funds -- early-stage funds (that typically invest in start-up companies); traditional venture capital funds (that generally invest in pre-profit operating businesses with good growth opportunity); and later-stage or "mezzanine" funds (that invest in more mature businesses). Because of the high risk of investing in start-up companies, early-stage funds will require a return on investment of 50 percent or more to achieve a 25-35 percent internal rate of return for the fund. …

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