Thursday, November 8, 2012

Understanding venture capitalists

Here are five simple tenets to consider.

1.    Be Okay with No.

Insiders call it the elegant turndown. When a VC can decline a deal and end the meeting with the entrepreneur still feeling good, the elegant turndown has been achieved. The VC will rarely want to go through the lengthy process of educating the entrepreneur on why the deal doesn’t work for them. As a result, they often say things like “Our allocation for your sector is complete”, “Call me when you reach $X level of sales” or “Call me when you find a lead investor”. The real reason is rarely revealed because it will only lead to an argument and simply wastes time. Just move on.

2.    Understand their focus and that they can help you.

Most VCs have a specific target investee of a particular sector or stage of growth. Don’t pitch them if you don’t fit their investment criteria which is usually detailed on their website. Also, don’t think that you can convince them to invest outside of their criteria. The VCs are investing money that was entrusted to them by institutions and pension funds based on a funding model which restricts their investment activity. So if they fund IT, don’t bother pitching your medical device. The right VC for you is well experienced and connected in your sector. The right VC will work on your business with you. Don’t target just the cash, target cash that comes from hands that can help move the company forward.

3.    Understand their fund cycle.

The age of their fund is also critically important. Take a look through their new releases. When did they launch their fund? If it was more than six years ago, that fund is not relevant to you. Venture funds typically operate on a 10 year term. VCs generally target exits of four to seven years post investment. A fund that is now more than six years old is no longer doing new deals. At most, they will do follow-on rounds in their current portfolio companies. At this time however the VC will likely be trying to raise the next fund. If this is the case, they will start forming a watch-list of companies for the next fund which could open as early as year seven or eight of the previous fund.

4.    Understand their workload.