Many of today’s new ventures, particularly Internet startups with their enormous cash requirements, high risk, and high potential return, require approaching the venture capital marketplace. Venture capital investors are difficult to characterize, but we can discuss what venture capital firms generally look for when they analyze a company and its proposal for investment.
What Venture Capital Firms Look For
One way of explaining the different ways in which banks and venture capital firms evaluate a small business seeking funds, is expressed by LaRue Hosmer as: “Banks look at its immediate future, but are most heavily influenced by its past. Venture capitalists look to its longer run future.”
Venture capital firms and individuals are interested in many of the same factors that influence bankers in their analysis of loan applications from smaller companies. All financial people want to know the results and ratios of past operations, the amount and intended use of the needed funds, and the earnings and financial condition of future projections.
Banks are creditors. They look for assurance that the business service or product can provide steady sales and generate sufficient cash flow to repay a loan. Venture capital firms are owners. They hold stock in the company, investing only in firms they believe can rapidly increase sales and generate substantial profits.
Venture capital is a risky business, because it’s difficult to judge the worth of early stage companies. So most venture capital firms set rigorous policies for venture proposal size, maturity of the seeking company, requirements and evaluation procedures to reduce risks, since their investments are unprotected in the event of failure.
Size of the Venture Proposal
Few venture capital firms are interested in investment projects of less than $1,000,000, and this threshold is even higher for the major firms. Projects requiring less are of limited interest because of the high cost of investigation and administration.
The typical VC firm will quickly reject on the order of 90% of the proposals received, because they don’t fit the established geographical, technical, or market area policies of the firm, or because they have been poorly prepared. The remaining plans are investigated with care. These investigations are costly, and generally reduce the candidate pool even further.
Maturity of the Firm Making the Proposal.
Most venture capital firms’ investment interest is limited to projects proposed by companies with some operating history, even though they may not yet have shown a profit. Companies that can expand into a new product line or a new market with additional funds are particularly interesting.
Companies that are just starting or that have serious financial difficulties may interest some venture capitalists, if the potential for significant gain over the long run can be identified and assessed. If the venture firm already has a large risk concentration, they may be reluctant to invest in these areas.
A small number of venture firms specialize in “start-up” financing. The small firm that has a well thought-out plan and can demonstrate that its management group has an outstanding record (even if it is with other companies) has a decided edge in acquiring this kind of seed capital.
By John Hester