I’m frequently asked by startup entrepreneurs if their new business idea might be a good candidate for venture capital funding. It’s a good question but not easily answered in absolutes.
Unlike stock market investing which has been increasingly taken over by Quants and computerized program trading, private equity investing still relies on human judgment. That’s good news for startup entrepreneurs who are good at presenting a persuasive “story” of future financial rewards.
But there is one absolute that I always emphasize to aspiring entrepreneurs before disclosing the investment preferences of venture capitalists. Just because one or more VCs may reject a business concept for investment purposes doesn’t mean that the business idea lacks merit or is not “worth” pursuing. Rejection is nothing more than one voice at one moment in time.
Further there are many reasons why entrepreneurs don’t get return phone calls or emails that are completely unrelated to the economic strength of a business plan. For example, the VCs’ “plate” can be overloaded with responsibilities to existing portfolio company problems or the VCs could be raising money for their next investment fund. Persevere. Keep looking for funds elsewhere.
However, before you send out another batch of executive summaries, check out the following five factors that can increase your chances of getting a hearing at a regional or national venture capital fund.
1. Research industry investment activity. VCs are often called sheep because of their herd-like, follow-the-leader investment practices. After 9/11 venture funds were eager to invest in companies involved in homeland security and defense. Today, certain types of media and entertainment deals are hot.
To boost your chances of equity funding, it’s helpful to demonstrate that other VCs are investing in your industry “space.” Of course, don’t send a business plan to a fund that has already invested in a direct competitor.
2. Favor high gross profit margin products. At the seed-stage and early-stage of business development, it’s often more important to emphasize high gross profit margins instead of net income margins. High gross profit margin businesses are desirable companies to own. They have greater “margin” for error and can usually weather recessions better than low gross profit margins.
When I read business plans I’m always on the hunt for businesses with the potential to exceed the average gross profit margin of its competitors too. If you can, highlight this point within the first couple paragraphs of your executive summary.
If you are unsure of how to calculate your company’s margins and present financial information to investors, check out my new book: Start On Purpose: Everything You Need to Know and Do to Startup with Strength for point-by-point help.
3. Think big: Venture investors are attracted to businesses that one day can “scale” to reach broad national or international markets. If your ambitions are too local, venture funds will turn you down.
4. Price to sell: One of the fastest ways to kill investor enthusiasm is to overprice the value of your company. If you negotiate too hard for a generous valuation, investors will close their check book and wait for a better deal to come along. It makes good sense.
Investors have to be confident that they can buy a percentage of a company’s equity at a low enough price in order to one day sell the equity stake at a much higher price. VCs also understand that companies will likely have to raise a few more rounds of funding, which will dilute all prior investors’ equity stakes. Owning a 30 percent stake one day can dwindle down to 10% several years later. It’s a risk and reality that investors worry about.
5. Highlight specific competitive advantages: What do you have that is distinctive and valued by your customers? How hard is it for competitors to duplicate the innovative elements of your service? Just applying for a patent doesn’t always translate into extra value for investors. The longer your list of ways to tactically stay ahead of the competition, the more your business will appeal to venture investors.
Here’s another tip. Don’t ever say that your business has no competition. VCs will think that you are naive about how fast large and small companies copy first-to-market innovators.
Within my neighborhood there are now six different frozen yogurt shops. They look the same and offer practically the same experience, flavors and toppings. When too many competitors chase the same customers, prices fall and eventually once prosperous businesses go out of business.
So, how did you do? Can you answer favorably to each of these investment factors? If you have some fundamental weaknesses in your business plan, don’t despair. Venture capitalists adapt well to change and opportunity. With a few meaningful improvements to your business strategies, very soon you may be the hot company in the hot venture building space. You can do it!
Susan Schreter is a veteran of the venture finance community and entrepreneurship educator. She is the author of the comprehensive new book, Start On Purpose which provides specific action steps to start a new business, attract investors, and make any new business idea bigger, better and more lucrative. Follow Susan @takecommand