Published by the Canadian Venture Capital Association in Private Capital
There has been plenty of talk about the state of Canada’s venture capital industry over the last few years; Are returns improving? When will fundraising levels increase? Are more deals getting done? Although the industry, like many others, moves in cycles, there are some things that seem constant: the gap between the expectations of venture capitalists and how entrepreneurs approach fulfilling these requirements is a good example.
In times of limited capital, bridging this gap to establish the necessary common ground for an investment to occur is critical, particularly for entrepreneurs. The great divide may be as simple as this: entrepreneurs often focus on building technologies, while VC’s focus on building companies. Although both aspects of the equation are required in order to capitalize on a market opportunity, why is it so often a zero sum game?
While entrepreneurs are busy perfecting existing technologies, developing new ones, and perhaps focusing on securing support for ongoing research and development, venture capitalists are focused on assessing investment opportunities in terms of key business fundamentals: Product, Market, Management, Financial Requirements and Potential, and Exit Strategy. VC’s focus on all of these areas, as each one is integral to building a business to capitalize on a market opportunity and generate growth to the point where a successful exit can be achieved. Many entrepreneurs, however, concentrate their efforts on one or two of these areas, most often the Product category. Is it any wonder that so many transactions fail to occur?
The very fact that this gap still exists makes it worthy of a fresh look. The crux of the issue is the opportunity that is lost when an investor and entrepreneur simply are not on the same page, each having different expectations and requirements in order for a transaction to occur. How often have venture capitalists mused “great product; but they just don’t have a clue about business…”? In cases like this, they might as well be speaking different languages (and, in fact, they probably are).
Entrepreneurs need to do their part; by taking the time to increase their level of business and financing knowledge and to actively listen to what a VC requires in order to move forward. Expecting the process to change and balking at the requirements is not realistic or constructive; not as long as VC’s have the money. Entrepreneurs need to make a conscious decision in terms of whether or not they are truly committed to fulfilling the requirements of the financing process and stick to it.
Venture capitalists, on the other hand, may not have the time or resources to address the areas of development within a potential investee company; and it is not typically their role to do so. However, there is much that a VC can do to positively influence and expedite this process.
Recognize the language gap: Venture capital is a complex business, and it does not take much to confuse those who do not work in the industry. Given that many entrepreneurs lack knowledge of the financing process, they can quickly become “lost” in discussions with potential financial partners. A VC might think they have been clear in their expectations with an entrepreneur and may be surprised to learn that only a small percentage of their message was actually heard. Although it may sound simplistic, making a conscious effort to communicate expectations in a plain and straightforward manner increases the likelihood that the message will be both heard and understood.
Demonstrate the fundamentals: Many entrepreneurs wonder what it is exactly that venture capitalists are looking for in an investment opportunity. Although the final analysis may be in the eye of the beholder, as much as things change, the fundamentals stay the same. Articulating the fundamentals in a clear and concise manner is much easier for an entrepreneur to absorb and fulfill. A simple table, such as the one shown here, not only can help an entrepreneur to better understand the requirements, but also to identify the areas where assistance is needed.
|Fundamental Area||Items to Address|
|Product||Proprietary technology (i.e., patents, etc.); stage of completion (i.e., market readiness); sustainable competitive advantage; future product development opportunities and capability|
|Market||Demonstrated market need for the product; identification of primary and secondary markets; competitive landscape; strategy to get the product to market (i.e., pricing, advertising, promotion, distribution)|
|Management||Management team members; qualifications; roles and responsibilities; gaps in management team and how they will be addressed; board of directors/advisory board members; advisors under contract|
|Financial Requirements & Potential||Current and projected financial results (including Income Statement, Balance Sheet, and Cash Flow); schedules and key assumptions; sensitivity analysis; estimated valuation; amount of financing required and use of funds|
|Exit Strategy||Industry life cycle/outlook; timeline; key milestones; and exit approach|
Provide clear action items: After meeting with a VC, an entrepreneur might walk away with the basic understanding that they “need to improve their business plan” in order for an investor to take the next step. In practical terms, what does this mean? Although the VC might have made reference to particular areas, the entrepreneur may simply be at a loss in terms of what they need to do to fulfill the requirement (or simply, how to start). Providing clear action items (i.e., “develop a table that summarizes competitors in the following categories”, etc.) can help create the “to do” list for an entrepreneur to fulfill what is being asked of them. Examples can be particularly helpful.
Suggest practical, hands on assistance: At the end of the day, some entrepreneurs lack the experience and focus to address the needs of a venture capitalist. Utilizing an experienced business advisor who understands both the early stage financing process and building a business can be an effective way to bridge the gap and a valuable resource when the going gets tough. An advisor with this type of experience understands both sides of the coin; in terms of where the business needs to “get to” in order to meet the expectations of the VC, and how to work with an entrepreneur to get the job done. This role can also be the translator between those who speak the language of venture capital and those who do not.
Is it worth the effort? Sure it is. Aren’t we all looking for that one great deal?