Ian Gotts, CEO of venture-backed software company Nimbus, takes you step-by-step through the process of raising venture capital money.
The best time to raise investment is when you don’t need it, for three reasons. First, you can walk away from any deal which is not right for the company. Second, raising venture capital takes longer than you think. Plan on six months, no matter what VCs tell you is the ‘fastest deal we have ever done’. Finally, you can negotiate a better deal if you are not desperate.
I’ve outlined the key elements in the process of raising venture capital below:
Determine your requirements
Once you have decided to go ahead, you need to decide what you want. The obvious answer is money, but a venture capitalist can provide far more: access to technology partners, introductions to new clients, “adult supervision” and support to a young company, a source of senior level hires, or the experience and contacts to expand overseas. Be clear what you want and need: that will rule out some finance providers from the outset.
Finding a VC is like internet dating. You can specify your criteria – size of investment, industry space, geography – which will give you a shortlist of VCs to chase. And I do mean chase. This is a long term structured sales process. You can hire an advisor but this will cost you a fee and a percentage of the funds you raise. Be sure you really need the adviser and you understand all the costs.
The process of raising venture capital is fairly straightforward compared with other corporate transactions, but who is actually going to manage it? It’s likely that all senior people in the company will want to get involved, but this is a bad idea because closing a VC deal at a decent valuation requires the company to be hitting or beating the revenue targets in your business plan, particularly in the last four to six weeks. You can’t let the entire management team take their eyes off the ball.
A winning business plan
Your business plan should be realistic, credible, concise and delivered by introduction rather than emailed cold. You need to work your network of contacts to get introductions. There is plenty written about business plans and I’d recommend you read The Art of the Start by Guy Kawasaki.
The term sheet
A business plan should prompt meetings and discussions with a number of VCs. The aim of this ‘dancing around the handbags’ is to get to a term sheet. A term sheet is an offer by the VC and should set out the key principles of the deal: amount to be invested, valuation, liquidated preferences and other terms and restrictions. Once you and the VC have signed the term sheet there is normally a period of exclusivity where you work with the VC to close the deal. You cannot talk to any other VCs so your ability to drive a competitive process is diminished.
The biggest mistake I see is that entrepreneurs take no legal advice when reviewing and negotiating the term sheet. This is not an avoidable cost. Once the term sheet is signed the principles of the deal are set and there is limited opportunity for negotiation. And if the entrepreneur changes his mind once the implications of the fine detail are understood, he is faced with a couple of unattractive options: going ahead anyway, or scrapping the whole deal, which can have a cancellation cost or fee associated with it, and more importantly means that vital time has been wasted incurring a hefty opportunity cost.
Once a term sheet is signed the clock is ticking for both your lawyers and the VC’s, but you will pick up the tab for both sets of legal fees. So aim to get the fees capped. You must make sure you are squeaky clean, making the due diligence as quick and easy as possible. Clearly getting your company ready for the investment due diligence is something you should be doing as you are writing the business plan.
Closing the investment round
The final weeks of the process are critical. The VC has got to know you and your business plan but they probably don’t really understand your business. Any deviation from the business plan can spook them and cause them to ask more questions and revisit the financials, so keep the team focused on hitting the numbers.
Last minute gotchas
Quite often in the 59th minute of the 11th hour, the VC will come back with ‘just one small change’ to the legal documents – i.e. the terms they are investing under. This often happens if you have missed your numbers in the weeks or months running up to closing the deal. The other reason is that this is a cynical pre-meditated ‘professional foul’. They know you want the investment and they’re looking to make one final turn of the screw. I am explicit very early in the process that they confirm there will be no last minute changes or the deal is off.
Due diligence should also be a time when you are evaluating the VC. Check out references of other companies they’ve invested in. Be prepared to walk away. Don’t get sucked into a mindset whereby you end up taking the investment whatever skeletons in the cupboard you discover.
The VC Deal Done
So you’ve closed the deal. You’ve got all the signatures on the legal documents and a pile of cash in the bank account. Spend it wisely. Think of your company as still bootstrapped but with more money on the balance sheet.
Then consider how you work with the VC post-investment through the honeymoon period and beyond, as it’s still vitally important to get it right.
Working with a VC is like having children. The best bits are better than you imagined, and the worse bits are worse.