By Siddharth Arora, Carnegie Mellon University
YOUR IDEA
The financial and economic devastation that the US has seen in the past couple of years has had its obvious effect on employment opportunities. This era has spawned a new breed of people who are too naive to see the obstacles that are obvious to others i.e. people we affectionately refer to as ‘entrepreneurs’.
This time presents a golden opportunity for people like these and even YOU to build on all those ideas that you’ve had in high school and college but never acted on it because you happily chose to slave away your first couple of years after college in a bank/ consultancy/ fortune 500 company to pay off your debt effectively killing your passion. That’s a well accepted/ traditional route to take in my culture and forms part of the stereotypes associated with it.
WHO VENTURE CAPITALISTS ARE?
You have an idea, something you’re really passionate about and require funding to see it materialize. Unless you’re a trust fund baby, where are you going to get the money from? The answer is Venture Capitalists. Venture capital (VC) firms provide private equity capital typically for early-stage, high-potential and growth companies in the interest of generating a return (IRR- Internal Rate of Return) through an eventual realization event such as an IPO or trade sale of the company. Venture capital investments are generally made as cash in exchange for shares in the invested company. They are typically very selective in deciding what to invest in; as a rule of thumb, a fund may invest in 1 out of 400 opportunities presented to it. Funds are most interested in ventures with exceptionally high growth potential (like biotech/software), as only such opportunities are likely capable of providing the financial returns and successful exit event within the required timeframe (typically 3-7 years) that venture capitalists expect.
WHAT DO VC FIRMS LOOK AT?
Because investments are illiquid and require 3-7 years to harvest, venture capitalists are expected to carry out detailed due diligence prior to investment. Due diligence is nothing but a careful assessment of your venture to decide whether they wish to invest in it or not. So how can YOU maximize your chances of getting invested into? Here’s a quick compilation of what I believe VC firms look at (ranked 1 through 10 in order of importance). When I say I believe, I mean the below parameters are the most for what venture capitalists have scrutinized my idea, when I have pitched it:
- Strong management: The first requirement is a strong management team, with relevant experience, drive, self-confidence, and expertise. Financial models can be cooked to represent a beautiful valuation of your business but nothing can substitute a strong management team. The catch phrase for VCs is "management, management, management".
- Market growth potential: Your idea means nothing if you have don’t have a substantial market base to sell your product. You need to understand the size of your market today, where it shall be in the next 5 years and in the next 10.
- ‘Uniqueness’ of product: What differentiates your product from what is already available out there? Does your company have a patent or other proprietary protection to forestall competitors? Why are people not aware of this yet?
- MONEY: Does your company have the possibility of growing quickly and becoming an attractive acquisition target or IPO candidate? Venture capitalists are primarily concerned with one figure- the INTERNAL RATE OF RETURN (IRR) which represents how they will realize liquidity and receive VALUE for their investment. This no. needs to typically hover around 40%-50% to get investors interested.
- Gross Profit Margins >>40%: This point speaks for itself. Large profit margins give a company room for error and enhance its attractiveness for a possible IPO or acquisition.
- "Home run" potential: The VC wants to see the possibility of hitting a "home run" by investing in your company. If your own projections show only modest growth, or if the growth of the business is limited by technology/ competitive factors, don't expect to get financed.
Good luck with your idea. Make it worth millions.
