If you are hoping to fund your new business with the assistance of a venture capitalist, you'll want to know more about the specifics of the practice. Many of us think that venture capital funding is tied solely to Silicon Valley and the technology sector, but venture capitalists can be found throughout the U.S. providing seed money for numerous different types of businesses. Read on as FindLaw helps you understand the world of venture capital. 

Q: What is a venture capitalist?

A: Venture capitalists are individuals or companies who provide investment capital and management expertise to new businesses.  In return, they will ask for an equity position in the company, usually in proportion to their risk and the amount of their investment.  They have a stake in your company because their future returns are tied to its performance.

Q: How does a venture capitalist get involved with my business?

A: Venture capitalists effectively buy their way into the company with their investment.  That means that the company will not have to repay the capital; rather, venture capitalists expect to take their return in capital gains.  The company will have a sizeable amount of money to work with, while the venture capitalist takes an active role in managing the company to ensure it success.  After all, the venture capitalist has just bet a great deal of money that your company will be a winner.

Q: What role will the venture capitalist play?

A: A venture capitalist must be seen as a partner.  His or her active management participation may occur through membership on the board of directors, or through input into other management decisions.  The venture capitalist's goal is a high (30-40 percent per year) return on the investment over the period of his or her involvement, which is typically four to seven years.  This means that the company must follow an aggressive growth strategy.

Q: How can a venture capitalist benefit my business?

A: The resources and expertise of a venture capitalist not only bring money without the requirement of regular repayment by the company, but also provide several other less tangible benefits.  The venture capitalist shares a common desire for success with you, and should not be thought of as a lender. He or she contributes expertise, experience, contacts, and discipline.  The presence of a venture capitalist also lends credibility to the company.

Q: What is a venture capitalist looking for?

A: The strength of a company's management team can be more important to a venture capitalist than the company's product.  This year's most promising product may be eclipsed by next year's new technology, but a good management team can foresee and work through such difficulties. A venture capitalist wants to see a capable, committed set of managers who are adaptable and comfortable with growth and change. A venture capitalist is always looking for a high rate of return.  The earlier your company is in its business cycle, the higher that rate will have to be to compensate the venture capitalist for his or her risk.  This means that the company must be positioned for rapid growth, in terms of both management and product.

A venture capitalist also wants to see a realistic set of financial projections and requirements.  He or she will take a conservative view of your company's chances for profit and success.  It is helpful to emphasize financial requirements for this stage in your company's growth.  Showing a realistic reflection of the company's financial state shows discipline and the ability to plan for the future.

The owners' commitments to the business through personal financial stakes are also key.  A venture capitalist will be leery of investing money in any enterprise in which the principals are unwilling to invest their own. 

Finally, the venture capitalist will want a clear exit strategy -- how to get his or her investment and return back out of the company.  Some preferable exits are through an IPO or the sale of the company. However, other methods include management buyout, corporate redemption, forced receivership, sale of shares to principals, or sales of shares to other equity partners.

Q: What should I do to find a venture capitalist?

A: Before seeking a venture capitalist, you will need to tailor your business plan into a venture capital plan.  A venture capital plan differs in the following ways:

1.      It is a strategic document in that it not only sells a financial plan to investors, but the company's vision, future goals, and potential.

2.      It must clearly demonstrate how the company intends to repay the venture capitalist's investment, and what the exit strategy will be.

3.      It must describe exactly how much money the company wants, and what it will use it for.

4.      Additional detail is required because venture capital is riskier than traditional financing.

Q: How can I research a venture capitalist?

A: A venture capitalist typically has a preferred industry, region of the country, investment size, and stage in a company's development.  Attorneys and accountants can often refer you to venture capitalists they know or have worked with.  Extensive information about individual venture capitalists is also available on-line.  Once you find several candidates, it is advisable to research them thoroughly, including their past performance record and any referrals and recommendations from past clients.

Q: When should I approach a venture capitalist?

A: Timing well your approach to a venture capitalist is important.  As in any type of financing, you can get venture capital most easily when you need it least.  Courting a venture capitalist takes a great deal of time and effort, so it should be done when you and other key members of the management team do not need full attention on the company.  Some good times to look for a venture capitalist may be

·         At year-end, when you have an audited financial statement to show;

·         When a major contract which could substantially increase revenue is pending; or 

·         When your company's financial performance is good or improving, rather than in a downturn.

Q: What can I expect in my first meeting with a venture capitalist?

A: Ideally, your first meeting with a venture capitalist should occur after you have been introduced by a mutual contact that can vouch for you and your company.  This referral can enhance your company's credibility, and your chances.  You will need to make your proposal at this meeting, so you should consider carefully what you will say, and rehearse it.  You will need to impress the venture capitalist that he or she can help your company grow, and that it can make money for him or her as well as for itself.