Syndicated post originally written for Xcelerate Financial, one of my clients
Make sure you consider the items below when deciding on opening a new round of financing. Your business will thank you.
1. UNDERSTAND A VC’S REQUIRED RETURN
It might be the fallacy of conviction, but founders are quick to believe that their business idea is amazing. And it very well might be. But, there’s a huge difference between an “amazing business idea” and an “investable business.”
VC firms are looking to return value to the fund’s limited partners (LPs). They also are mandated to deploy all of the fund’s cash over a four-year period, after which they go through another round of fundraising in order to raise capital and invest again. This means that VC firms are looking to invest their cash quickly, and for a high return.
All VC firms look for a multiple times return on the capital they invest. A business that returns twice the investment, while impressive, isn’t enough for a VC and its limited partners. No, these firms look for multiples of 5x, 10x, or even higher. If your business doesn’t have a chance of providing double-digit returns to a VC firm, it’s time you went back to the drawing board.
2. KEEP TRACK OF THE FUND CYCLE
VC firms, contrary to popular belief, don’t seek to invest in startups 24/7, 365 days a year. Instead, the general partners of a VC first raise capital for their fund from limited partners, and then focus on investing 100 percent of the cash over a standard four-year period. After all the capital is deployed, the general partners focus on raising more funds to repeat the cycle.
Additionally, individual VC firms have their own pace when it comes to the speed in which they invest their capital raised. It’s likely that every VC you speak with has a cap on the number of Series-A rounds it can take part in per quarter.
If you’re thinking of going the VC route, make sure that you open a round when VC firms are flush with cash and looking to make a deal. Don’t open a round in February, for example, when you know that all the major VC firms have already hit their deal quota for the quarter. In the same manner, don’t open a round when the four-year cycle is coming to an end and general partners are looking to raise money of their own.
3. IDENTIFY POTENTIAL LEAD PARTNERS
If you have an investable business and are in the correct arc of the fund cycle, the next thing to consider is potential lead partners. All VCs are made up of general partners. However, one partner always acts as the lead to an investment. The “lead partner” is the person who gets excited about your company, champions your business to the other partners, and pushes the deal through.
The lead partner usually sits on the board seat – or seats – owned by the VC firm once a round is closed. They’re the main point of contact between the investor and the investee.
Usually, partners stick to a specific vertical, industry, or “theme.” When they find a business they like within their jurisdiction, they’ll start the process of due diligence.
It’s therefore important for you to identify potential lead partners in every VC firm you intend to engage. Find out which partners are assigned to your vertical and which of them has the capacity to spearhead another deal, and approach them first.
4. FAMILIARIZE YOURSELF WITH TERM SHEETS
Every company that opens a venture round of financing desires a term sheet. A term sheet is a document drafted by a VC firm that outlines the key economic and governing terms of a potential deal. Points such as valuation, investment amount, investor rights, board seats, existing options pool, preferential rights, and others are included in a term sheet.
The term sheet is only a preliminary document, but once signed, it starts the process of drafting the actual financing documents and associated due diligence. However, term sheets outline all the components of the potential deal, and it’s important to become familiar with their makeup and design.
This way, you’ll know what to look out for in a potential deal and what you can negotiate. The end result is more favorable terms for you and your business.