If you are new to entrepreneurship there’s a good chance you will be surprised to learn that venture capitalists have expectations that you must meet and not the other way around. You are caught up in your vision for a new service or product or business expansion and think everyone should be as excited as you about the plans. The lenders, on the other hand, are interested in the return on investment. Though applying for funding through any type of lender has similar steps, there are differences when applying for private funding such as that offered by venture capital investors.
A good example is the fact venture capitalists, angel investors, equity partners and other private lenders can establish all of the lending terms which may or may not fit traditional lending practices. Just like an entrepreneur is innovative, so are capitalists who are looking for exceptional returns on their money. A bank may ask for 5 times returns within the lending period while the venture capitalist may ask for as much as 10 times.
Meeting requirements requires being fully prepared to present a business plan that truthfully shows revenues and expenses. The investor is looking for realism in projections and will be looking at the projections in terms of the likelihood the investment returns projected are reasonable. To determine if the numbers are realistic, the investor will consider the management experience, past successes or failures of the existing company or other enterprises the entrepreneur has been involved in, and the investment return period.
If you can answer the many questions the venture capitalist will have with realistic responses there is a good chance that business funding will become available. It is important for the investor and the business to be compatible too. Like any good negotiation process, the investor and entrepreneur will have to come to agreement on specific funding terms. The terms will be laid out in term sheets that will include a statement of business valuation.
Once the term sheets are completed, negotiations for business loans or investments become a matter of agreeing on final details like where the money will be deposited and so on.
The Sweet and Sour of Deal Making
A mismatched pairing can occur when the business plan does not correctly explain the business model. Attract the wrong type of investor for your proposal and it won’t take long for the negotiation process to sour. Investors who discover the true business is different from the business plan presentation during final negotiations can put a halt to the discussions.
In other words, don’t try to hide anything the investors should know about including growth plans, market niche, product designs and even staffing plans. Any one of these issues could have a significant impact on negotiations and that means the venture capitalists have a right to know.
Valuing the Business
There are plenty of investment negotiations that fall apart at an end stage of the process only because new information comes to light. In addition, the entrepreneur and the venture capitalists must come to agreement on the value of the business. Usually, business valuation is equal to the amount of discounted cash flow plus the residual business value. The cash flows will be projected through the investment period described in the terms.
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