by Darrell Poole
You have the ambition, the ideas, the “friends,” the name, and the confidence that every entrepreneur needs when starting up a new business. What are you missing still? Perhaps you will need a little funding if not lots of funding in order to get this new business off the ground. Often money can be attained from an array of sources. Some sources include friends and family, a job that you are currently working at, angels, and seed funding firms. There are several ways we can fund a business and at the beginning stages of a business a lot of it will come from outside sources. One type of funding not listed is venture capitalism.
As vconline states, venture capital is money used to purchase equity-based interest in a new or existing company. The investor will give money to a company in order for that company to increase its growth, hire more people, etc. In return for giving this money the company must repay the investor in the form of equity. This usually comes in the form of stock, royalties, or even a piece of the company’s profits. The more risks that a company takes with an investor’s money, the more the company will need to return to the investor. A VC has the ability to invest a lot more than some of the other means of funding.
“There is a very sharp dropoff in performance among VC firms, because in the VC business both success and failure are self-perpetuating. When an investment scores spectacularly, as Google did for Kleiner and Sequoia, it generates a lot of good publicity for the VCs. And many founders prefer to take money from successful VC firms, because of the legitimacy it confers. Hence a vicious (for the losers) cycle: VC firms that have been doing badly will only get the deals the bigger fish have rejected, causing them to continue to do badly.” says Paul Graham, a founder of Viaweb in a 2005 essay titled “How to Fund a Startup.” That is why a VC has to see that there is a great deal of growth potential in the company that it is giving money to. There is a lot at stake on both sides of the deal. But then again another thing to note is that when you take money from a firm that is not as well known as some of the bigger firms, people may get the impression that it is only because the “better” firms rejected you even if that is not the case. However this can be overcome by the great performance of your startup which will boost the image of you and the VC.
Since venture capital is mainly for startup companies that are smaller, Wikipedia states that, “most venture capital funds have a fixed life of 10 years, with the possibility of a few years of extensions to allow for private companies still seeking liquidity. The investing cycle for most funds is generally three to five years, after which the focus is managing and making follow-on investments in an existing portfolio.”
One serious question is when a person should go to a VC about funding for a company. It essentially depends if you are at the stage where you can make the VC believe in the possibilities of your company. In order for an early approach to be successful with a VC, the founders of the company most definitely need to have impressive resumes and the idea of the company must be very easy to understand. Paul Graham continues to say that if you aren’t very well known then it is best for you to launch things off first in order to demonstrate that people like your product. If things go really well there is the possibility that you get multiple VC’s to fund you. In this case it is very beneficial not just in a financial sense but in a knowledge sense. You are being funded by them because they all want you to succeed and believe that you can. Therefore you have their advice at your disposal. The only thing is that you need to pay a bit more equity to get multiple VC’s.
Before there is funding for a company, there must be negotiations with the VC first. As noted in class, the VC has a lot more experience with negotiations than the founder does. So it is wise to hire advisors or whomever it is that can best help you with this situation. Also a potential danger with negotiating with a VC is that they already have lots of money. So if the negotiation is not good enough for them then they won’t sign the deal or delay their signing the deal in an effort to get you to bend to their will. This is because the longer it takes for you to get more funding for this new company, the more money you will lose in trying to maintain it on your own while waiting for the VC. So it is best have great advisors and if the VC takes too long to sign then you should move on to the next VC before you lose too much money.
Other things that a VC will do to further protect their own investment is request a small percentage of ownership in a company as well as a seat on the board of directors. By doing this they are able to know for sure how a company is doing. The VC becomes sort of an opponent and a helper at the same time. They become a helper in the sense that they are there to give you guidance. However if it seems to the VC that you aren’t taking things in the right direction, aren’t well aware of what’s going on, etc. then the VC will not invest.
Sources:
- Paul Graham’s Essay “How to Fund a Startup” http://www.paulgraham.com/startupfunding.html
o Used for learning more about the process of venture capital
- Wikipedia: http://en.wikipedia.org/wiki/Venture_capital
o Used for finding out what venture capital is
- vcaonline: http://www.vcaonline.com/resources/glossary/index.asp
o Used to understand the terms used throughout the other sources.
