Using Venture Capital to Grow Your Business

Using Venture Capital to Grow Your Business

by Mary Damkot

Raising outside funding can be a daunting task. However, having a basicunderstanding of how capital markets work, what funding sources are looking forand what benefits come from raising outside funds can streamline the processdramatically. There are different sources of financing that are appropriate atdifferent stages of a company's life. Consequently, companies realize the mostsuccess if their fundraising efforts target investors whose objectives and riskprofile are aligned with their own.

There has been much attention given to the venture capital (VC) community. VCfunds typically invest money in companies that have achieved success with oneproduct or within one region and are looking to expand their business. Thisexpansion can encompass a broader geographic rollout, entrance into a newdistribution channel, introduction of a new product line or even a strategicacquisition. The specific stage at which VC firms will invest varies from firmto firm, but the majority tends to look for companies that have proven theirbusiness concept, have established a strong management team and are ready toachieve significant growth. Most VCs are willing to purchase a minority positionin a growing company and will be able to provide much more than just capital.

A good VC firm should view itself as a partner in the business. It should bewilling to help with tasks such as managing distribution channels, hiringadditional management and evaluating acquisition opportunities. VC firms are inthe business of helping to grow companies. Any firm with a track record willhave helped dozens of companies to achieve their goals. This doesn't mean thatthe company knows everything, but it does mean that it has encountered thelikely problems numerous times before and will have the experience to helpnegotiate any land mines ahead.

It is very important to select a VC firm that is a good fit with yourbusiness. There are lots of VC firms out there, and they all have differentareas of expertise and different personalities. The first step in identifyingthe best partner is to target VC firms that know your industry. A firm thatspecializes in biotech investments is not going to know a lot about managing thedistribution channels of a natural products company or how to bring a medicaldevice to market. For this reason, it is imperative that you partner withsomeone who really knows your industry and can help you navigate it.

The best way to determine which VC firms to target is to ask around. Anyonewho has raised money (or has tried to raise money) will be a good source ofinformation. These companies are in abundance at trade shows, conventions andmeetings. In addition, editors of trade magazines, lawyers, accountants,distributors and suppliers might have suggestions. There are also a number of VCdirectories that often give a brief description of the firms. Some companies optto hire a broker or an investment banker to help identify sources of capital. Ifyou decide to go that route, make sure that you get good recommendations on thatfirm as well.

The VC firm you select must not only know your market, but also be a good fitwith the stage and risk profile of your business, as well as with yourpersonality. Keep in mind, if the financing is completed, you will be spendingmany hours with these people over the next three to five years and will come torely on them for help and advice. Make sure that you like them and that youtrust them. This personal rapport is not something that will developimmediately, but you should be able to get a good feel for the people as youembark upon the negotiations and due diligence process. Trust your instincts,but also do your homework. Ask your VC firm to provide a list of executives forthe companies that it has funded. This list should include both companies thatwere successful and those that were not. Call a few people from each categoryand ask what it was like to work with this VC firm. Was the firm supportive?Fair? Honest? Helpful? A good deal is structured so that the interests of boththe VC firm and the entrepreneur are aligned. The goal for both parties is tomake money, and the partnership should be successful even if the end goal is notachieved.

Once a company decides to raise VC money and identifies a list of firms totarget, it is time to determine how to present your business. Companies have alimited amount of time with a group of people with a short attention span.Therefore, it's imperative to present your company concisely, honestly andaccurately. The key is to tell a compelling story.

Be able to explain your business. Venture investors see hundreds ofbusiness plans per year and must be able to evaluate them quickly. You must beable to explain your product or service clearly and concisely to warrant acloser look. Generally, the first opportunity to present the business is in anexecutive summary to be read by the VC firm. The executive summary shouldinclude a brief description of the business, an overview of its growth plan,historical financials and a brief description of the management team. Thebusiness plan should be a more detailed version of the executive summary, andthe in-person presentation should powerfully convey your business, yourenthusiasm and your motivation.

Accentuate your uniqueness. What is it about your company or productthat is unique? Is it better-tasting? Cheaper? Faster? Emphasize any advantage.

Be honest and clear about the company history. If there was astumbling block along the way, that is OK. Maybe it was a wrong distributionpartner or strategy, or difficulty with a supplier. We all learn from pastexperiences.

Understand how funds will be used. Know exactly what you plan to dowith the money that you are trying to raise. Will it be used for distribution?Marketing? To hire a chief financial officer? Not every penny needs to beaccounted for, but there should be a good overview about what the VC firm'smoney will be spent on.

Know your timeline. Investors need to know how long this money isexpected to last. If additional money may be needed down the road, make thatclear so investors can save some money for future rounds of financing.

Protect yourself. Proprietary technologies or processes should bepatented to establish a defensible position in the marketplace. A uniquebusiness is generally more attractive to an investor than a "me too"player.

Develop realistic financial projections. When projecting futureearnings, do a reality check. Will the company really grow to be larger than thenumber one player in the market? Or capture a 99 percent market share? Allcompanies expect their businesses to succeed, but establishing realisticprojections makes the business plan more believable to outside observers.

Start with realistic valuation expectations. Venture capital firms arelooking to make three to four times their money back on an investment.Therefore, the valuation at which they invest has to be low enough to make thisfeasible. Because there are no hard and fast rules about valuation, it'sdifficult to provide any concrete guidance in terms of valuation expectations.News articles on transactions that have taken place within your industry canoffer guidance, as can other companies who have gone through the process. Keepin mind that the valuation a company receives is highly dependent upon itsstage, the proprietary nature of the product or business, and the industry inwhich it operates. Recent valuation multiples in the natural products industryhave been in the range of one to two times sales.

Understand exit opportunities. Most venture investors look to hold aninvestment for a period of three to seven years. After that time, they expect toexit the investment via sale to a strategic or financial investor, or via aninitial public offering (IPO). Proposing viable possibilities may make it easierto support a valuation.

Stay positive! Raising money can be a difficult and time-consumingprocess. It will distract you from the task of running your business and willrequire patience and tenacity. But it's worth it! The right investor will helpyou to grow your business, providing money and expertise.

Mary Damkot is a senior associate at Sherbrooke Capital in Boston. Thisarticle was excerpted with permission from her contribution to The NaturalProducts Field Manual 2002, written by Bob Burke and Rick McKelvey and publishedby the Natural Products Consulting Institute. For more information on the book,visit www.Bob-Burke.com/fieldman.htm.The book is available at a 20-percent discount for INSIDER readers (mention thecode INSIDER). Contact Bob Burke at (978) 975-9902, FAX (978) 975-4502, e-mail [email protected].