Raising Venture Capita

Venture capital--it's the Holy Grail in the dot com world. This week, we begin what will be an increasing focus on helping you find money to make your business go.

The typical scenario is that you think you have an idea that's going to make you a player in the IPO world. (An "IPO" is the first sale of a company's stock to the public.) Usually, the first step is finding funding to jump-start your business. If you're a beginner in the venture capital world, you should be prepared to learn some new vocabulary along with a whole new way to think about money.

Basic Jargon

For the truly uninitiated, we'll start with an introduction to some of the jargon. Of course, the beauty of learning the jargon here is that you'll be fully prepared for your next cocktail party while never having to admit to anyone that you weren't born knowing these words. It'll be our little secret.

Let's start with the most basic of basics. What is "venture capital?"

According to the Florida Venture Capital website (www.flvencap.org), "Venture capital is defined as the classic investment in the illiquid equity securities of a privately held business. Classic venture capital funds are managed by institutions (usually limited partnerships), which are staffed by full time professionals. Venture capital funds are motivated solely by the goal of producing capital gains and (less often) current returns on the securities in which they invest."

The stereotype of a venture capitalist as a wealthy person funding start-ups isn't usually the reality. What we really have are pools of capital looking for a high rate of return within five or less years.

In the context of venture capital investing "high rate of return" is probably defined as at least 25 percent per year compounded. I say "at least" because 100 percent per year is probably closer to what a venture capitalist would like to see. (And you thought that 18 percent interest on your credit card was high?)

When somebody talks about "a VC," they are referring to "a venture capitalist." When they say "VC," they mean "venture capital."

In the VC world, money does not come as one big lump followed by an IPO. The more typical model has money arriving in small (clearly a relative term) chunks or rounds. Usually, a successful startup will have multiple rounds.

As a principal in a startup, you should expect to begin looking for your next round of funding before the ink dries on the paperwork for this round. Some successful startups will have one founder who does nothing but work the fundraising side. That's how time consuming fundraising can be. (Is your current job and your 401k looking better and better yet?)

The Rounds Begin

These multiple rounds have jargon associated with them too.

Many startups get their initial survival money from that tried and true triumvirate of friends, fools and family. At this stage, you may not even need a formal business plan. It's when you've tapped out the friends, fools and family that you look to your first "professional" round. (It's now time to warm up the word processor. You're not going any farther without a business plan.)

This next round is often called the "seed round." This is the earliest stage of investment. (I don't count friends, fools and family as a round of "investment" because they don't invest, they pray.) This money is earmarked for things like market research, developing a prototype, completing the management team, improving the business plan and generally getting to the point where the company can qualify for "first round financing."

An "angel investor" often provides the seed round. An "angel" is a private wealthy individual who invests in startups. An "angel round" is typically smaller than a true "first round" investment by a VC.

The hardest part about the seed round is getting and keeping a potential investor's attention long enough to convince her that your startup is worth risking an investment. Once you have an investor's attention, the next tough part is negotiating for enough to make it to the next round.

The special risks associated with seed round financing has led to the emergence of specialists who focus on seed round investing. These specialists may find it easier to stomach an incomplete management team or business plan that's rough around the edges.

After the seed round comes the "first round." At your cocktail party, you should refer to this as the first "real" round. Even a "professional" seed round doesn't "count."

The first round follows a company's startup phase and for the first time involves an institutional VC fund. This round usually involves a step-up in valuation and total size ($4 million and up is common). Typically, at this stage, your company has something that is either commercially available or far along in development.

Moving from the seed round to the first round can be a challenge. A problem many companies face at this point is a business reality having to do with development of the product or service (i.e. "It").

Often, the optimistic time and cost projections in the seed round business plan slip on the way to the first round. If "It" is late, you've missed your first key milestone.

My advice is to come clean as soon as possible. Let your seed round investors know, let potential first round investors know and then modify the business plan based on the new reality. When you're short of money, you don't want to be short on credibility too.

You can prevent this kind of problem by working with pessimistic time assessments for "It" development. Just accept the reality that "It" always takes longer than you anticipate.

After the first round comes (you guessed it), the second round. According to www.ventureeconomics.com, the second round usually provides "working capital for the initial expansion of a company, which is producing and shipping and has growing accounts receivable and inventories. Although the company has clearly made progress, it may not yet be showing a profit."

Next comes the third round. Again, according to www.ventureeconomics.com, this round is "provided for the major growth expansion of a company whose sales volume is increasing and which is breaking even or profitable. These funds are utilized for further expansion, marketing, and working capital or development of an improved product."

Last, but clearly not least, is the "mezzanine round," which is usually the last round before an IPO. Often, this round is an unplanned round, while the company waits for that "right" moment to do its IPO.

The Team

Almost every venture capitalist I've ever spoken to has made the same comment. There is nothing more important to a VC than the TEAM.

You may have the best idea in the world, but without a powerful team, you're going to find it hard to find funding.

It's an absolute cliché that a VC given a choice between an "A" team and "B" idea, or a "B" team and "A" idea will always choose the "A" team. The moral of the story is that no matter how good your idea is, you will not be funded without a great team. So, start amassing early.

Key players in your team include your CEO, COO, your key VPs like VP of marketing, Chief Technology Officer, etc. Use your network of contacts to build an impressive Board of Directors that should include experienced business people with names that VCs will recognize, visionaries and leaders. The Board might even include some of your key professionals like your attorney or on your Board

If you can get recognizable and successful leaders, business people and professionals on your Board, you now have names that you can use to help you garner the attention you need. You also now have a network of interested people sitting on your Board who can help to open the doors that you need opened.

Popular legend notwithstanding, business plans thrown over the transom, without an appropriate introduction from a respected intermediary, almost never get funded. You'll find the Lotto to be a better bet than a cold mailing to VCs.