I received more feedback from Part 1 of this series than any other post I have made. It seems to be something you are interested in. For this reason, I have decided to give you the mindset of a venture capitalist in this post and will talk about the “J curve” and uses of cash in Part 3.
Today, we are going to look more at your deal from the eyes of the venture capitalist.
When you, the businessman, are making your pitch, you will oftentimes say something like this to the investor:
- You should be looking to get a return of 25%.
- You will be able to double your money.
- Your money is just sitting in the bank collecting dust, invest in me and you will get a 10% return.
You are not creating any excitement with the venture capitalist. You are so used to talking to bankers and hearing interest rates of 5%-8% that you think you are doing a great job selling to the investor. You’re not.
When talking returns, a common phrase in the VC world is 5-10-20. These are NOT interest rates the investor is looking for they are multipliers they want to achieve. If you are talking to a VC, you instantly lose credibility with him when talking about his returns in terms of interest rate. You are a startup and, therefore, a huge risk. Here is how a VC will conduct business:
- An entity will be formed – oftentimes a limited liability company or limited partnership. There are limited partners as members (the investors) and general partners (the managers who can also be investors). The typical life of this entity will be approximately 10 years.
- They create a pool of money. Strategies vary but they typically will not invest more than 10% of the fund into any one project.
- They will start with a desire to get 10 times their investment as a return from any one investment. If they do not think this possible, they will take a pass. This factor can be adjusted up a little or down a little, depending on the specifics of your deal.
- A typical timeline for an investment is 7 years.
- They generally do not want to manage your company though they will have board seats so they have influence over strategic decisions.
- They will never give you all the money you need in one lump sum. Part of the deal is you have to set up milestones – typically 12-18 months apart. Once you get to these milestones, additional capital will be made available to you as long as you have met the milestone goals.
- The VC knows that historically, close to 50% of all investments will be lost. This is the reason they need the potential for high returns on all deals.
If you want money from a venture capital group, you have to think like them. Know what their hot buttons are and know where the failure points are. You need to set yourself up for success.
See you next week.