What a Venture Capitalist Looks for in an Investment

You have developed your Business Plan and Investment Overview, and now you are prepare to approach Investors about funding your Company.  But before doing so, it is important to know what the Investor is looking for and take in the Investor’s perspective.  This article lists a host of variables an Investor considers when looking at a business investment opportunity, as well as, ways to make your investment opportunity more attractive.

• Market Driven Company: Market, Sales and Profits are more important than the Technical and Technological aspects.
  • Short payback Period.
  • User’s Benefit more important than Product Innovation.
  • More importance placed on Market-Driven verses Technology-Driven.
  • Market Penetration:  If an Investor is convinced by your Marketing Research and Penetration Strategy then he or she sees your Financial Projections as Realistic and Achievable.
• Your  Funding Business Plan should show How and When Investors can Cash In (Exit Strategy). Surprisingly in my experience as Business Coach, I see companies that don’t have a proposed exit strategy or actually thought much about it. The investor wants to know early on what avenues there are for cashing in on the investment.
• When a Venture reaches 50% of its financial goals, the investor is usually happy.
• In general, Investors are looking for a Return on Investment in the 40-60% range, dependent on Risk and other variable determinants.
• Investors Manage Risk by looking at the Management Team and Product Status.
  • A fully developed Product and proven Management Team should yield a Return on Investment in the 35-40% range.
  • Incomplete Products and Unproven Management Team should yield a Return on Investment of about 60%.
• Typically at the five year mark the investor will calculate the value of the business to see what equity degree percentage will bring their expected rate of return.
  • Example Scenario 1: Developed Company
    • Developed Company projected to yield a 35% Return on Investment per year.
    • Investors want 4.5 times their investment over five years.
    • In Five Years the Company has $20 Million in Revenue with a Net Profit of $1.5 Million.
    • Assume 10 times earnings:  Company would be worth $15 Million in Five Years.
    • Company wants $1 Million in Venture Capital, so the Company should grow to 4.5 Million in Five Years to satisfy Investors.
    • Company is worth $15 Million in Five Years, so Investors would require an Equity Stake of 33%, before Inflation.
  • Example Scenario 2 : Undeveloped Company
    • Return on Investment Outlook of 60%, you will need a Net Profit of $15 Million in Five Years.
• Companies with an Accepted Product, in a Proven Market, with Competent and Experienced Management, win the Investment Funds at the Lowest Cost.
• Traditionally, Investors Gauge Performance by looking at Financial Projections compared to Performance, but they more oftentimes look at Management’s Milestones in its Strategic Plan, its achievement of success and adaption, as the Process to determine whether and how much to fund the next stage in a Company’s Growth.
• The Entrepreneur (Founders) must be Reliable and Driven.
• Entrepreneur has a Successful Track Record. Experience is Key.
• The Entrepreneur should know his or her Money Needs at specific time intervals. Set up a schedule to track Progress with the Venture Capitalist so it will coincide with your Funding Needs.
• Entrepreneur needs to look at ways to Reduce and Mitigate an Investor’s Risk.
• Demonstrate Credibility to an Investor by using a Network of Influential Mentors and Contacts.
• Consider using a combination of Equity and Debt to entice investors.
  • Venture Capital Firm receives part of their funds in interest payments, which are Tax Deductible to them.
    • VC recovers Tax-Free Cash when the Loan Principal is repaid.
    • Convertible & Preferred Debt provides easy Liquidation.

This article is written by Frank Goley, Business Plan Consultant for ABC Business Consulting. Frank has also written articles on  How to Write a Strategic Plan.

Related articles

• Silicon Valley VCs Reach Highest Confidence Levels in Two Years (nytimes.com)
• Venture capitalists step up investments in 2010 (knoxnews.com)
• Why it Makes Sense to Invest With Someone Else’s Money (smallbusinessbranding.com)
• Venture Capitalists Failure to Make Money is a Problem for Entrepreneurs (openforum.com)
• Alicia Morga: Where Are the Women Entrepreneurs? (huffingtonpost.com)
• Facebook investor: I wouldn’t take LinkedIn public now (finance.fortune.cnn.com)

Related posts:

1. The Investment Overview Document is Important for Raising Venture Capital
2. Investment Criteria of Venture Capital
3. US Businesses Dependent on Angel Investors for Finance & Venture Capital
4. Raising Venture Capital
5. Flexibility the First Rule of Venture Money