How to Get Venture Capital: 16 Things Startups Must Do Beforehand
Startup Law ResourcesVenture Capital, FinancingRaising venture capital is difficult and venture capitalists have become very selective. Read our guide on how you can best prepare your startup for success. 9 min read
Raising venture capital is difficult and venture capitalists (often referred to as “VCs”) have become very selective about the companies in which they invest. A typical VC may finance only one or two ventures out of a hundred because, for example, the other companies were not in one of its preferred industries, the VC does not see enough potential in the business, or the entrepreneur was not referred to the VC by the right person. If you think your startup might be ready to go after venture capital here are some tips on how to make your final decision and get the process started.
1. Decide on Your Goals
What do you want from your business? Are you trying to take over the world, or do you just want stability? Do you feel strongly about being the sole decision-maker, or are you OK with sharing control?
The main goal of VC firms is to get big so they can generate big returns. If your mission is to be a small but successful family-owned business, venture capital might lead you away from that path. If you're looking to build an empire, venture capital can help you.
2. Set up as a Delaware C Corporation
If you're ready to start raising investments, it's time to make your business official. Many investors, including VCs, prefer investing in Delaware C corporations.
Why a C corporation? Although S corporations often have tax benefits for smaller companies, they have restrictions on the number and types of investors. C corporations are unrestricted and give greater flexibility.
Why Delaware? Delaware's laws and tax schedule are highly favorable to businesses. You can incorporate in Delaware even if you primarily do business in another state. Make sure you read our comprehensive guide on how to incorporate in Delaware and launch your startup.
3. Patent your Intellectual Property
If your business relies on new technology or a new and improved process, file for a patent before you start looking for investors. Read our easy guide for protecting intellectual property for startups here. Your patent attorney can help you determine if your idea is too close to something that is already patented or not unique enough to qualify for patent protection. Be aware that you could restrict or eliminate your ability to obtain a patent if you share your idea before it's patented. In addition, make sure no one else has the rights to your idea such as a former business partner or employer.
4. Consider First Raising Money from Crowdfunding, Angel Investors, or Friends and Family
Startups typically raise money in stages. The stages are commonly referred to as: seed money, Series A, Series B, and Series C.
-
Seed money is an early stage investment that may be just enough to get you started. You can read more about seed funding for startups and how to prepare here.
-
Series A investments are usually used to turn you into a more efficiently-operating business and can range from the hundreds of thousands to the low millions.
-
Series B, Series C, and later rounds are used for further growth and optimization as your business matures. Investments in these rounds can be measured in the tens or hundreds of millions of dollars for a successful business.
VCs generally look to invest millions of dollars at once, so this eliminates them for most seed money and many Series A rounds.
If you're in these earlier stages, consider using other methods such as raising money from friends and families, looking for an angel investor, or turning to crowdfunding. Your crowdfunding options include traditional platforms (such as Kickstarter or Indiegogo) or new equity crowdfunding sites that allow individuals to make small, direct equity investments in private companies (e.g., AngelList and Fundable).
5. Know How Venture Capital Firms Make Money
VCs work in a similar manner as the mutual funds you might have in your retirement account. The VC pools investor money together and invests the lump sum in growing companies.
The fund managers make their money in two ways. One is a management fee that is typically around 2 percent of the size of the fund. The other is by taking a percentage of the returns. This is called carry and is usually set at about 20 percent. The managers don't receive the carry until the investors receive their original money back.
The firm will seek to grow your company in a way that both makes their investors money and gets the managers paid.
6. Be at the Right Stage
The average age of a company receiving funding is around four years. The odds of receiving a deal after eight years are virtually zero.
VCs look at both growth potential and risk. If you're too early, you may have high growth potential, but there's also a higher chance you'll fail. If you're too late, the fear is that you've exhausted your potential for fast growth. VCs are looking for the sweet spot where you've established yourself enough to be a relatively sure bet without having fully exploited your market.
7. Prepare Documents for Venture Capitalists
When you manage to get in front of a VC, it's time to close the deal. Here are some of the things you’ll need to remember:
-
Elevator pitch: Your first step should be creating a brief elevator pitch to catch their attention. Your summary should be easily understandable by someone with no special industry knowledge. For example, Alibaba was called "The Amazon of China."
-
Executive summary: An executive summary is a one to two page summary of your business in case you aren't pitching in person. It should combine elements of your eligible pitch along with an overview of the most important technical details from your business plan.
-
Business plan: Your business plan contains full details of how you plan to grow your business, your current financial status, how you will use an investor's money, and how investors will get a return. Be sure to include summaries, headers, and a table of contents as most VCs will only skim the plan unless they're already decided they want to make an investment.
-
Presentation/pitch deck: You should create a slideshow that presents the highlights of your business plan in the form of a story and includes visuals such as charts and pictures of your products. Even if you aren't pitching in person, this is still an excellent way to make a compelling case to invest in your company.
-
Do not bring an non-disclosure agreement (NDA) to a VC: Most VCs will simply refuse to sign an NDA because NDAs can create too many legal headaches for VCs especially when a VC hears pitches from similar businesses. VCs also are much more interested in having you do the work than trying to grow your idea themselves.
8. Build a Team of Advisors
By the time you reach the venture capital stage, your business will be moving faster than you can keep up with on your own. You'll need to make many important decisions quickly that could decide the success or failure of your business. And, so, you need a good team working with you.
At this point, your team should have skilled professionals knowledgeable about the venture capital process, your general legal and accounting needs, and your specific industry. Fill in the gaps by bringing in key employees or savvy investors, or by hiring professionals on a fractional basis.
9. Learn Your Capitalization Table
Your capitalization table identifies the owners of your company, how much they own, and what kind of shares they own. It also helps you track authorized versus issued stock, granted options versus your reserve options pool, and other unvested rights. Investors want to know exactly what they're getting in return and if anything will potentially dilute their investment.
10. Select Your Target
VCs often have different focuses, such as industries, geographic regions, and company sizes. For example, a smaller VC might be looking to make ten $500,000 investments, while a larger one is looking for investments in the $5 million range. Others might focus on slightly newer or slightly more established companies.
Figure out where you stand in the market so you can target VCs that are looking for companies like yours. Avoid sending email templates and instead write custom messages tailored specifically to each venture capital website with their specific preference. The National Venture Capital Associate website has more in depth information about venture capital, advice, statistics, and lists of venture capital associations.
The best approach is to find someone who can introduce you to the VC. Networking opportunities are sometimes available through alumni and business associations, or through contacts at companies in which the VC has already invested.
11. Know Your Timeline for Growth
VCs aren't buy-and-hold investors. Their ultimate goal is to sell your company to a bigger one or to position you for an IPO. This is when the VC make most of its money.
The target date for a sale is usually within 10 years of your launch, and some VCs prefer to sell even sooner. This could put pressure on you to accelerate your growth now even if you think a slow-and-steady approach might be better in the long term.
For the best results, the milestones in your business plan should already match the typical venture capital timeline.
12. Set Your Budget
Venture capital shouldn't be seen as a prize or milestone on its own. It's just one option you have for raising money for your business.
Raise venture capital only when you don't have the funds you need to meet your next business objectives on your own. Before asking for venture capital, determine exactly how much you need to meet those objectives. Your ask should be based on that amount and not the most you think you can raise. Hang on to as much equity as you reasonably can for yourself or future funding.
13. Review the Term Sheets Carefully
As you move into the later stages of a venture capital deal, the VC will present you with a term sheet containing the full terms of the deal. This goes into the small details beyond how much of your company they'll own and how much they'll invest. Think of it like the fine print when you're buying a car but with much bigger consequences.
Some of the items that may be included in the term sheet include:
-
Valuation
-
Investor rights
-
Board seats
-
Option pool
-
Voting rights
-
Liquidation preferences
-
Founder vesting schedules
-
Founder revesting of shares
-
Veto rights
-
Preferred stock
-
Convertible notes
Each individual item contains nuances that could drastically alter your rights or the true value of a potential deal. You should always have a lawyer review a term sheet and be involved in negotiations.
If a VC says a term you're uncomfortable with is nonnegotiable, don't be afraid to walk away. Each VC has their own way of structuring deals, and another firm may be a better fit for you.
14. Prepare for Due Diligence
If a VC likes your initial pitch, it will conduct an exhaustive review of your business. Your financial statements, business structure, facilities, and key employees will all be under the microscope.
The purpose of due diligence is both to confirm what you said in your pitch and to dig into the smaller details that weren't discussed in-depth at earlier meetings. By this point, you should be operating under a formal accounting system and have taken steps to comply with all legal requirements imposed on your business.
You will be given little time to correct any lingering issues before a deal falls apart, so you should begin preparing for this review well before you dive into the venture capital process.
15. Do Your Own Due Diligence
Due diligence is a two-way street, not a roadblock to a deal. You also want to make sure a particular VC is right for you.
Even though you've done your initial homework, dig deeper into how the VC's previous investments have gone. Don't forget to look beyond the numbers to see whether founders felt they were treated fairly or were pushed out of the company. You're looking for a partnership as much as you're looking for funding.
16. Get Legal Assistance
You should rely on your instincts when making business decisions, but make sure you also have the right information. Many factors will determine whether a particular move is right for you, such as your business structure, securities regulations, local laws, and any special issues impacting your industry.
If you decide to make a deal, there will also be a ton of complex legal paperwork to complete. To get help with this process as well as general advice along the way, use UpCounsel to find an attorney with experience helping growing businesses in your area. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures and Airbnb.