Seeking Venture Capital? Investors Want Fundamentals
by Robert M. Freedman
‘This is the nuclear winter of venture capital.”
That lament, popularized by Southern California venture capitalist Bill Stensrud, expressed the despair of entrepreneurs and VCs alike as they watched U.S. venture and private equity investment plummet to $36 billion in 2002 from $144 billion in 2000, according to Venture Economics. Some VCs even began giving back uninvested funds.
Is it a “nuclear winter?” Maybe so, if you’re a VC whose funders want their money back. But if you’re an entrepreneur who needs to raise equity, you’re better served by recognizing it’s always nuclear winter.
Before turning to suggestions for thriving in the harsh climate, let’s seek perspective. First, this is the fifth contraction the private equity business has gone through since World War II. And during all the down cycles, entrepreneurs have persevered to raise money and launch enterprises.
What’s more, investment capital is hardly scarce. There are more than 1,000 venture and private equity firms practice in the U.S., with an “overhang” of available capital estimated at $220 billion sitting unused in their accounts.
So why aren’t entrepreneurs getting more of the money? Does the nuclear winter explain the capital overhang? Is it a case of too much money chasing too few good deals? Are entrepreneurs from Mars and investors from Venus?
Maybe all of these.
Without question, the down-cycle of the last three years has made capital raising tougher. Many slowed their rates of investment as they retreated from depressed sectors; others opted to preserve “dry powder” for the winners already in their portfolios. Some simply became more risk-averse.
But something more fundamental, and less cyclical, is also at work here.
In times past, venture investors might state they closed on one deal for every 100 they looked at. More recently, some firms have claimed to review more than 500 plans for each deal closed.
Those incredibly low “hit rates” show that the economic cycle is not the most basic reason deals don’t get funded. Selectivity is what can really turn capital raising into a desolate nuclear winter for entrepreneurs.
How do you become one of those who prevail against the odds? Obviously, your business opportunity needs to be exceptional. But beyond that, the crucial insight involves guarding against perception gaps the Mars versus Venus factor and learning to think like investors.
Gaps of perception often arise over matters of substance. Simply put: you think your deal is great, investors think it’s flawed. And with their perspective of balancing risk versus return, they may well be right. Investors will almost certainly pass on your deal if they believe you can’t see or fix its weaknesses as an investment. They may pass if they conclude that not addressing those weaknesses in advance reflects on your business judgment.
Even when the fundamentals are strong, disparities of perception can arise from communications that fail to address investors’ concerns in investors’ terms. Or, an entrepreneur may bungle the “mating dance” the process of relationship building during due diligence.
Here are some principles for “coming from the same planet” investors do:
– Be objective about your deal’s basic strengths and weaknesses. The four prerequisites to a good investment are a big market opportunity, a feasible business plan, some basis for the enterprise to be preferable over the competition, and a CEO or better yet a management team of proven accomplishment. Before seeking money, evaluate and strengthen your case in these areas. If you are the enterprise’s leader, you must assess your personal track record objectively. Investors will.
– Think risk management. Investors try to identify all the risks of a potential investment. Then they zero in on limiting those risks that are most critical. Follow that discipline yourself. Don’t gloss over the risks. Point right at them, then explain how you’ll handle them. The more risk you remove from your deal, the greater your chance of raising money.
– Frame your case in terms of long-run competitive advantage. Your plan must explain how investment will create or enhance the sustained competitive advantage of your business. This is more fundamental than showing strong financial projections.
– Put depth into your communication. Depth of insight into your business and industry demonstrates your capability; “elevator pitch” superficiality does not. Use PowerPoint-style presentations, but recognize that graphics don’t substitute for pointed analysis.
– Manage the “mating dance.” View the due diligence process as mutual education and a trial run for future collaboration. The great objective is to develop trust. Remember that the people with whom you are talking usually have a parallel conversation going on inside their firm: they are your deal’s advocates and must “sell it in.” Support them.
– Stick to your guns. In an effort to create risk/return relationships perceived as acceptable, investors sometimes condition their participation on your making changes to your business plan. Remember that you are the ultimate expert in your business, and everyone depends on you to play that role with strength. Always weigh an investor’s concerns and suggestions. But if you are sure of your plan’s soundness, keep searching for investors who are comfortable with its risks.
Robert M. Freedman is managing principal of Athena Capital Partners LLC. He can be reached at