Why is VC blossoming?
In his book, The Entrepreneurial Bible to Venture Capital, investor Andrew Roman talks about what entrepreneurs must understand about the venture capital industry if they want to raise money and how they should go about attracting venture capital. He begins by talking about the venture capital market in the 1990s where the costs of launching a new business were high: purchasing software licenses and servers would require tens of thousands of dollars. But, as the cost of technology plummeted, starting a company became much cheaper. Today, $5000 is enough to get a website and a mobile app working. And yet, value creation coming out of startups is just as real today as it has been in the past. Therefore, while traditional banks shy away from funding a company that has no cash flow and no marketable product, venture capitalists appear like the best financial partner. And yet, 60% of venture capital-backed startups go bankrupt even before they get to pay back their investment. Plus, all in all, only one startup out of 10 generates a handsome return for investors.
What makes VCs tick?
The author talks about how the Venture Capital business operates. General partners and managing directors get their money from Limited Partnerships (LPs) and are in charge of identifying promising startups. In doing so, they retain a slim “management fee” of 2% and, when their investment generates a return, they keep 20% on returns as a “performance fee”. Entrepreneurs should target managing directors and General Partners, as they enjoy decision-making authority.
Attracting VC money
To attract venture capital money, the author suggests that entrepreneurs first turn to Angel investing. Angel investing money exceeds that of venture capital. Plus, Angel investors usually don’t ask much in return for their capital: they asked for no board seats nor controlling rights. Finally, many Angel investors provide numerous networking opportunities.
As many startups end up pivoting their business model, developing a comprehensive business model is not the first and foremost criteria venture capitalist will look at when selecting one startup over another. Rather, they look for well-balanced management teams made up of a visionary leader, a technician, and a salesperson.
Startups need to find ways to grow value to attract venture capital investment. Many entrepreneurs make the mistake of going on a spending spree once they secured an investment and spend too much on marketing. But entrepreneurs should really focus their efforts on developing the right innovation; that is a product that solves and addresses a real need. It also involves building the right distribution channels and finding like-minded customers. When Skype started out, they were just one of 200 startups over offering of voice over IP. They decided to launch a marketing campaign made up of banner ads on Kazaa, the music file-sharing service. The ad read: “you don’t pay for music. Why would you pay for telecom?” This ad of the free service appealed to the Kazaa community and Skype’s user base grew quickly.
How Venture Capitalists make money?
As mentioned earlier, venture capitalists make their money when they exit via an Initial Public Offering (IPO) or an acquisition. Entrepreneurs should focus on finding the right kind of buyer and the author mentions that emotional buyers make up the best target. They are typically in a stressful situation where they’re losing market share. They see an acquisition as a strategic asset to expand their business further. For example, Google diversified its revenue base by acquiring YouTube. Oftentimes, when buyers are taking too much time thinking about whether or not to complete an acquisition, startups CEOs should go on with an additional funding round, increasing the company’s valuation thereby increasing. In some cases, the acquirer misses out on the opportunity. For example, Twitter had been considering acquiring Instagram. The picture-based networking site secured an additional round of financing before getting an offer an acquisition offer from Facebook, making up twice the amount.
The author talks about drafting presentations to venture capitalists. He really mentions that they ought to prepare three versions of a similar presentation: a 30 seconds, 2 minutes and 20 minutes.
In The Entrepreneurial Bible to Venture Capital, the author talks about why entrepreneurs should learn about how the venture capital industry operates. Unlike traditional banks, venture capitalists are well versed in funding startups that have yet to develop a marketable product and that have no cash flow to show. Plus, while the costs of launching a new business have fallen, venture capitalists are backing many of the most prominent unicorns. The author also talks about how to attract venture capital: a well-balanced team, working on the right innovation serving a real need addressing like-minded customers, and drafting multiple version of the startup’s business plan make up some of his suggestions.
The author also mentions that 60% of venture capital-backed startups go bust before they’re able to pay back their investment. Plus, only one startup out of 10 generates the returns that meet the investor’s targets. Although, the author mentions VC is risky, he does explain how to assess, supervise and control startup-related risks.