Venture capitalists (VCs) raise funds from external institutions with a mandate to put those funds in relatively high-risk, high-return investments. The life of a venture capital fund is usually 10 years, meaning that they have 10 years to find investments, invest in a new venture, exit from the investment and return the capital and profits to the institutions that provided the initial capital for the fund.
Venture capital partnerships take a percentage of the profits and a management fee for their services. Because of the timeframes under which they operate and the returns they are seeking, venture capitalists typically look to invest in companies that have the potential to get really big, really fast. These investments are typically risky and therefore there are often a number of failed companies in an investment portfolio – but the model is such that the big successes (such as Google) should pay for the many failures.
In a business plan, Venture Capitalists are looking for:
1. Value creation.
Above and beyond everything else, they want to know that the enterprise they are investing in has a realistic chance of being worth substantially more in five years time than when they invest in it. VCs and angels characteristically invest in technology related businesses which can generate the returns they seek. They recognise that value within a technology business comes from one of three things: strong cash flow (think of Microsoft when it first started), patented technology (such as biotech start-ups) or the development of a very large user base (Facebook). A business that has more than one of these three elements will be worth even more. Therefore, if you are preparing a business plan to attract venture capital investment, you would be advised to focus on how you plan to create significant value through these three mechanisms: cash flow, patented technology and/or a large user base.
2. Exit options.
Venture capitalists and angels need to know that there is some way they can liquidate their investment in approximately five years time. The two most valuable ways to exit an investment are a listing on the stock exchange or the sale of the company, usually to a larger corporation. If you want to make VCs and angels interested in a business, you need to allude to the likelihood of a valuable exit in approximately five years from the time they invest. You cannot be explicit about the exit in the business plan, but you do need to be aware of this and make passing reference to exit possibilities.
3. Technology versus people.
The preference for all VCs is to invest in a business with world-class technology managed by world-class people. But if they can’t have both, different VC firms will have different preferences. Some prefer to invest in strong people, believing they will figure out a good product over time; others opt for investing in strong technology, believing they can hire good people to help manage the business. It is important for an entrepreneur to find out the investment preferences of a VC and to emphasise the right things in the business plan. The way to find out what these are is to look at the VC firm’s portfolio of investments and how those were managed after they first invested in them. Were new people quickly brought onboard or was the entrepreneurial team left alone to figure out a product over time?