Q&A: Dealing with VCs
Article Date: Apr 20 2006Q: My business has been up and running for a while and I’m now at the stage where I’m ready to bring in outside investment to finance further expansion. Having never dealt with venture capitalists before, however, I’m unsure of their likely demands and the room for negotiation. What advice can you offer me?
Answered by Phil Verity, Mazars
It’s difficult to give specific advice for negotiating with venture capitalists, because offers are generally based entirely on the individual circumstances of the deal and the likely levels of risk and reward involved. As a general rule, however, they’ll look to secure a sizeable minority stake in any business they invest in, so something in the region of 20-30 per cent is probable. In truth it all comes down to mathematics and unfortunately that limits your opportunities for negotiation.
That said there is still some room for debate. Remember that a VC will ask questions like, ‘How can I double my money in three years?' They all do their research based around these questions and make demands of you so that they believe they can achieve their goals; this means that you can work around the fringes. For example, if you, as a business, can outperform their expectations you can ratchet back some of the value, although you do need to make these provisions from the outset.
With business angels, on the other hand, you’ll have more room for negotiation as you’re dealing with individuals, who will often be less scientific in their approach.
In terms of securing support, several things are important. It helps to have a strong idea, a good team around you and a non-executive on board with established industry credibility. The last of these can be particularly influential as it often ensures investors will consider you seriously for investment. Having someone experienced on board will give the business a better chance of succeeding in many an investor’s eyes.
The one final thing I’d say is that it’s very hard to raise finance if you’re pre-revenue as there will be very few ports of call for you. The banks won’t do it, there’s the Small Firms Loan Guarantee Scheme of course, but aside from that, where do you raise the money? Usually it will boil down to friends and family but if you can hang on until you’re generating revenues you’ll be able to raise funds more easily and you’re likely to get a much better valuation.
Phil Verity is a partner at Mazars, the international accounting and business advisory firm, and head of the mid corporate market business line. Phil works with a wide variety of entrepreneurial and owner-managed businesses, helping them tackle the challenges of growth and development. He frequently advises companies on issues such as business strategy, financial management and control, mergers and acquisitions, succession and overseas expansion.
At Connect Yorkshire (http://www.connectyorkshire.org) we assist science and technology companies on a daily basis to seek investment – and for the majority it is the first time they have approached VC’s and business angels. I have my five top tips for attracting investors….. 1) Be able to clearly and simply explain what your business opportunity is Having an ‘elevator pitch’ that is rehearsed is a must. You need to be able to explain the problem you are solving and why your approach is different to what is currently available. Investors are unlikely to be familiar with technical details of your science or technology, and you should concentrate on the commercial aspects of the business proposition. 2) Know who your target customers are and research the market Make sure that you have a clear idea of who will want to buy your product or service and why. You need to be able to demonstrate to an investor that there is demand for your idea and that the market opportunity is real. 3) Sell the experience, knowledge and commitment of your management team Investors generally back people more than ideas so highlighting your track record and drive is key if you are to make them understand the potential of what you have to offer. 4) Let a potential investor know what’s in it for them Business angels and VC’s need to make money so demonstrate that your proposition is capable of giving them a return on the cash they put in. 5) Ensure that your intellectual property is secure Before they put their money in your business, investors will need to understand the strengths and weaknesses of any intellectual property that your business relies on. That way they will know want is stopping a competitor from doing the same as you. My final piece of advice would be to reach out to as many investors as possible. Traditional offline networking and Investment events are one way, but now sites such as http://www.mydealmaker.co.uk/ offer a way for you to connect online.
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