What are venture capitalists looking for today? Entrepreneurs often have a hard time figuring out what venture capitalists are looking for, and when the best time it is to approach them for funding. Often, entrepreneurs complain that they just can't get enough attention from funding sources to make their idea a reality. On the other hand, venture capitalists complain that entrepreneurs are coming to them too early, do not understand where a company needs to be to be a viable investment, and have not done their homework before approaching a firm.
What are VCs looking for?
At the recent Los Angeles Venture Association (LAVA) Investment Conference, a panel of early stage venture capital firms discussed this topic. On the panel were David Cremin, of DFJ Frontier fund, Ted Alexander, from Mission Ventures, Jim Armstrong, of Clearstone Venture Partners, John Fisher of Draper Fisher Jurvetson, Brad Jones of Redpoint Ventures, and Winston Damarillo, founder of Simula Labs. Among topics that the panel covered was what a venture firm is looking for in an investment.
Ted Alexander, a venture capitalists at Mission Ventures, a venture firm out of San Diego, pointed out three things he looks for in an investment. He said they were: a well articulated value proposition, a product that is selling, and a team with a unique skill set.
John Fisher, a venture capitalist at Draper Fisher Jurvetson, commented that what they are looking for is for entrepreneurs to do their homework. They should look at a venture firm's risk profile, and do due diligence on a fund before approaching them for money. Often, what happens is that an entrepreneur will go to a venture capitalists without researching what kinds of investments that VC has made historically, and understanding what industries and amounts of investment they make.
Investments Get BiggerAnother issue that was on the minds of all of the panelists was the size of investments required, particularly by the larger funds. Brad Jones, of Redpoint Ventures, pointed out that in 1989, they had a $50 million dollar fund, so if they were able to put in $2M into an investment and get $20M out, that was a pretty good, 10 X return. However, their current fund, which was closed in 2000, is $750M in size. That means to get an equivalent return on their fund, they need to put $30M into a company, and a 10 X return would mean an exit of $300M. He commented that there are lots of companies you can sell for $20M, but not that many for $300M.
That drives two characteristics of today's venture investor. First, venture capital firms have to make bigger investments. They are no longer only putting a few million into a deal, they have to make bigger bets. Second, they need to put as much dollars into a deal (if they like it) in order to maximize the possible return. This is reflected in the deal flow by a lot more, large bets by big venture firms. As John Fisher of DFJ commented at the LAVA event, the .largest funds are elephant hunting..
On the other hand, venture firms comment all the time that with the right team, anything can be funded.even just an idea on a napkin. For those who have done it before, and have a track record, getting venture funding is much easier.
Other Investment AlternativesSo, if your ideas isn't going to make it through the qualification that a big venture capital fund does, and you don't have a track record, what are your alternatives? There are several options.
Another logical place to look is toward angel funding. Angels are high net worth individuals, who are looking to make investments in early stage companies, and often to help mentor those companies and help them grow. Usually, angels are often the founders of companies which did very well and cashed out their ownership, and are looking to continue their involvement in the high tech industry. Others come from other industries, such as real estate or the financial sector, who are interested in high tech investing. In Southern California, there are not only individual angels, but several well established and newer angel groups. One group is the Tech Coast Angels, a well organized group of over 270 individual angels, which has a formal process for applying for funding and presenting to members. Other groups include the Pasadena Angels, a group out of the San Gabriel Valley, and newer groups such as the Maverick Angels. Angel groups tend to have a similar screening process as venture capital firms; in most cases they'll want to see some traction, customers, and product shipping.
Many companies are initially funded by friends and family; that is, friends and relatives of the founders. Friends and family can be a valuable source of early capital, but it's important to think about how to structure these deals to keep family relationships intact even if a business fails, and to make sure that terms do not rule out angel or venture capital funding in the future.
Another area of possible funding is government grants and loans. One area that many high tech companies in the area have used are SBIR (Small Business Innovation Research) and STTR grants. SBIR grants are given to small businesses who are conducting research and development that has potential for commercialization. These funds are somewhat limited.for example, they can't be used to pay for sales and marketing, and the projects must have scientific and technical merit that the government would find useful. STTR grants are similar, but include the involvement of a local research institution such as a university or college.
Finally, you might also want to look at possible corporate partners or customers. Many firms find their first funding from their customers or partners, and many large corporations now run their own corporate venture capital and investment funds. Whether it's a corporate partner that is willing to help fund a business that will benefit that company, or who is looking to seed the market for their products through partners, this is another avenue to making your business a reality.