Venture Capital Overview

In the late 1990s, the Internet provided a new frontier in which entrepreneurs could try their hand at plying a trade or developing a new enterprise. While “start-up” madness may have subsided when the dot-com bubble burst in the first few years of the new millennium, it hasn’t gone away. Whether on the Web or in traditional brick-and-mortar businesses, entrepreneurship is alive and well, and the problem of obtaining start-up capital for new business ventures is usually topic number one when the idea for a new business is born.

The following is an overview of the venture capital process and what you can expect if you are thinking about starting a new business.

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Sources of Venture Capital

So, you think you’ve got a great new idea?  You believe that everyone would want your product, if only you could produce it.  Where do you begin?  Unlike in the past, obtaining funding today is more complex. A venture-capital funded entity, generally, will go through four stages of development.  Sources for funding will vary depending on where the company is on this timeline.

• The “Start-Up” Phase

During the early stage, appropriately called “start-up,” foundation money and seed capital funding is needed. Usually, the first line of attack during this phase is the business owners’ family and close circle of friends. It is important to get at least one financial partner from this inner circle. Outsiders often will not have faith in a project where the entrepreneur has no demonstrable faith from close associates and family. However, the entrepreneur must be sure that this first offering complies with exemptions from federal and state registration requirements. This is to assure that the business does not give initial investors any rights that will encroach upon the venture’s ability to attract other investors in the future.

Next, the “angel investor” is a remarkable boon to any company fortunate enough to attract one.  Angel investors are private investors with large net worth who have a desire to invest seed money in start-up companies. The market for angel investment is private and informal. Angels are usually found by word of mouth. However, a trip to the local council on foundations for private donor information could prove helpful. 

Finally, it may be possible to obtain funding directly from your local city and state governments. Cities have become much more interested than before in attracting new companies to their economic base. Therefore, they have become very assertive in offering creative financial packages.

• Development Stage           

The second stage of a venture capital funded company is called the “development stage.”  In this stage, the company is actively attempting to develop its main products or services. Companies in this phase typically seek investment dollars from private sources such as angel investors or venture capitalists. Due to the difficulty of raising capital at this risky stage of a company’s development, initial public offerings (IPOs) are not possible as an alternate means of obtaining funding.

• Maturity Stage           

The third stage is called “maturity.” During this stage, companies with established track records may obtain additional or “expansion” funding from venture capitalists or from conventional banks or financial institutions. Also, some investors who come in on the ground floor may establish a plan for investing that progresses in installments. After each installment is paid, the investor will wait to see that predetermined criteria are met before advancing the next installment. In addition, satisfied customers and strategic partners sometimes provide another source of venture capital at the “mature” stage. This is especially true if the company’s customers are other institutions with a desire to form a future or continuing business relationship with the new company.

• Growth Stage

The last stage, sometimes called “growth,” includes strategies for the investors to exit the enterprise, collecting their financial returns or mitigating their losses as they go. In each of these stages, conventional wisdom counsels against using a “finder.” Finders often call themselves venture capitalists, consultants, investment bankers, lawyers, accountants, or business advisers. Sometimes they will help with writing the business plan, management-team recruitment, or in establishing a Board of directors. However, they can come at a high price tag, and the work may be that which the entrepreneurs do themselves.

What Do Investors Want?

In order to find venture capitalists or other investors who are willing to invest in a “brilliant idea,” it is important to understand the transaction from the investor’s point of view. That is, what do they want from the deal? Generally, they want high return on their investment. This translates into adequate rewards for the level of risk they are willing to take. If the investor is a family member or friend, pride in the enterprise might be an intangible side benefit of the deal. Venture capitalists and other investors want a great deal of information prior to signing on to a project. They will want specific guarantees, and often will require contractual language that allows them to “take over” if the project does not proceed according to plan. In return, they contribute capital, business skills and expertise to the enterprise.           

Selling the Plan

To be able to convince an investor that a company is an economic winner, one must have several factors firmly in place: a business plan and a management team.

First, the company will need an excellent business plan that gives a clear description of the product or service offered and of the targeted purchasers.  The business plan must include market research and provide a detailed discussion of the business operations needed to reach that market.  It should include biographies of key management personnel, executive compensation schemes and option plans, as well as a discussion of other staffing needs. The assistance of an experienced attorney may be helpful when developing this very important document.

Investors also look for a solid management team and a business venture with diverse and sustainable product offerings.

It is also important to have revenues that demonstrate the existence of a real business, not simply a brilliant idea.  Investors also want to see a solid corporate entity with a committed set of business professionals already on board, ethical legal practices, and safeguards to protect copyrights, patents, trademarks and other proprietary information.

Venture Forth

In sum, when starting a business the new entrepreneur should surround themselves with knowledgeable business associates.  This will go far in preventing that original brilliant idea from being tarnished by the complexities of business financing.  In addition, legal assistance will become indispensable when negotiating agreements and will be especially necessary if the company chooses to go public.  With proper management and attention to detail, starting a new business venture can be an exciting journey.

How a Business Law Attorney Can Help You

If you are seeking the assistance of VC firms to fund your new project, speak to a business attorney today. Business attorneys are knowledgeable about the complicated details that go into funding negotiations and due diligence, can evaluate your business model, and will be able to guide you through the process. 

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