Venture capital (VC) firms have always been considered to be the most desired source of funding for start-ups. VC investments are usually long-term partnerships, are controlled by an individual or a small group, require a high rate of return and a significant percentage of ownership in the funded entity. In addition to financing, VC firms can also provide introductions to strategic partners and customers, as well as introductions to additional investors and significant industry players.
If a company decides to opt for VC funding, one needs more than a great pitch deck and a unique business concept. Here are a few important things to expect and consider:
Know the VC
It is important to understand that when approaching a VC, one needs to understand their objectives. VC funds usually focus on companies that have a high growth rate with high operational costs. Additionally, before approaching a VC, one should assess whether the company fits with the fund’s investment strategy or sphere of focus. For example, certain funds may be sector focused (software, education, hardware, biotech, mobile, etc.). Other factors such as the stage of company (early-stage/seed, Series A, or later stage) and geographic focus are also important to look at before approaching the investor. For example, if you are a Hong Kong-based company with market opportunities in Asia, you should approach a VC that focuses on companies scaling in Asia.
Even though disruptive ideas and successful management teams are definitely favoured by VCs, the following criteria should also be considered when approaching them:
- The management/founding team – can this team can actually lead the company to meet its objectives?
- A minimum viable product – an abstract concept of a product is not enough for a VC or any investor. The company must demonstrate the actual product and show how it works.
- Customers – it is crucial to show that there is an actual customer base or users of the product. This is known as traction.
Pitch deck and presentation
It is crucial to have a strong pitch deck to present to the VC that provides a thorough yet concise overview of the business. The presentation should clearly describe and tell the story of the product or service, business model, market analysis, and opportunities, company financials, funding needs and management’s capabilities.
Term sheets and financials
A term sheet is the primary document that the founder sees from a VC when they are considering investing. The term sheet signals that the VC is strongly considering an investment and wants to proceed to the due diligence stage and prepare legal investment documents. Term sheets usually include:
- The financial guidelines of the proposed investment – the amount of money the VC is offering and what it expects in return.
- The corporate governance section – details of the decision-making protocols of the founders and investors pertaining to the company.
- Liquidations and exit scenarios – what will happen to investors and shareholders in the event that the company is liquidated, dissolved or sold.
Valuation of the company
The valuation is typically referred to as the “pre-money valuation,” which is the valuation before the new money or capital is invested and is a critical issue for both the entrepreneur and the VC investor. There are many different ways to arrive at valuation amounts. Valuations are usually determined based on:
- The experience track record of the founder;
- Market size and opportunity;
- Technology of the company;
- Traction: partnerships/users/customers;
- The revenue of the business model;
- The capital viability of the business model; and
- Valuations of comparables in the market.
Founders must prepare well for due diligence, or the process by which investors gather all the information and assess the potential risks involved in an investment. Due diligence may include:
- Analysis of the financial statements;
- Analysis of the financial projections and assumptions;
- Sales contract and contract reviews and litigation and claims;
- Review of corporate records and legal records;
- Founder background checks;
- Review of patents and any intellectual property;
- Market and competition analysis; and
- Investment agreement analysis.
Fundraising can be a long and daunting process that is key throughout the entire lifecycle of a start-up, from early start-stage support through family and friends, VC, private equity, merger and acquisition, all the way up to an initial public offering.
To learn more, join the Startup Impact Summit in the upcoming months, organized by WHub, Hong Kong’s first startup community platform, and hear first-hand from serial entrepreneurs and successful investors, across all stages and industries.