Investor's Guide

There is no standard set of rules venture capitalists use to judge investment propositions. The following, however, is a rough guide.

 

Management

In venture capital, the standard mantra is that the most important factors are management, management, management. What are venture firms looking for in management? Leadership, vision, integrity, openness and dedication.

Most businesses are people driven, with success or failure depending on the performance of the team. It is important to distinguish the inventor/entrepreneur from the professional management team. The value of the idea, the vision, putting the team together, getting the funding in place are some key aspects of the role of the entrepreneur. An investor will insist on quality management, including a CEO to execute the idea and if necessary, who can work in a team environment. Integrity and commitment are attributes sought after. The venture capitalist may provide or contribute to the strategic vision, but the team executes it. As a famous Silicon Valley saying goes "Success is execution, strategy is a dream".

Depending on the size of the business, you should insist that three critical positions be filled with competent professional people: a CEO or general business manager, a VP of marketing and sales, and a VP of development. However, extensive past experience is not as important as the ability of the team to show excellence and cohesion.

What do you do if those skills are not present in the founding team? Suggest either a change in the team or the hiring of personnel with those skills.

 

The Idea

The marketability as well as the technical and economic feasibility of the idea are of crucial importance. As a venture capitalist you will find reassurance by the presence of a scalable marketing model. Distinctive competitive advantages must exist in the form of scale, technology, brands, distribution, etc.

 

Economic and Social Trends

As an investor you should be aware of the current economic and social trends. A technology relying on VHS recording instead of CD is obsolete.  However, a technology that could spawn many other products is desirable.

 

Business Plan

The plan must cover:

  • a clear description of what the business is about including products
  • details of the management team (and why someone's savings should go behind them)
  • financial history and projections (profit & loss, balance sheets and cash flows)
  • the market and competitive environment
  • a realistic evaluation of how much money will be needed.

The  Small Business Administration provides an excellent model for a business plan.

 

Valuation

Most deals fail because of valuation expectation mismatch. Linked to valuation is the stake demanded by the VC.

  • Entry Valuation: money is made by investors by getting the buying price right and knowing when to sell. When the VC is buying, the entry valuation is everything - typically a valuation 30% or more below an equivalent quoted company would be a good price - this discount makes up for the fact that VC cannot sell immediately and gives him a start on the way. Valuation is not an exact science.
  • Exit Valuation: The VC needs to know and believe the following:
        i. Selling his share of investment will be possible sometime in the future
        ii. An approximate  date when he will be in a position to sell 
        iii. An estimate of how much his investment might be worth then. 
    He needs this to calculate his profit. Without exit valuation, gains cannot be calculated. Exit may be in the form of a strategic sale or/and IPO and taxation issues will have to be factored in. Any VC would discuss all exit options before closing a deal including, for example, a buy back clause to ensure an exit.

 

Financial Indicators

Each VC has his favorite. A simple financial indicator is gross margin - if a business has a significant gross margin then it must have a competitive advantage or be in an uncrowded sector.

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