Venture capital is an important source of funding for start-up and other companies that have a limited operating history and don’t have access to capital markets.  A venture capital firm (VC) typically looks for new and small businesses with a perceived long-term growth potential that will result in a large payout for investors.

Who is a Venture Capitalist?

A venture capitalist is not necessarily just one wealthy financier.  Most VCs are limited partnerships that have a fund of pooled investment capital with which to invest in a number of companies.  They vary in size from firms that manage just a few million dollars worth of investments to much larger VCs that may have billions of dollars invested in companies all over the world.  VCs may be a small group of investors or an affiliate or subsidiary of a large commercial bank, investment bank, or insurance company that makes investments on behalf clients of the parent company or outside investors.  In any case, the VC aims to use its business knowledge, experience and expertise to fund and nurture companies that will yield a substantial return on the VC’s investment, generally within three to seven years.

Returns for Investors:

Not all VC investments pay off.  The failure rate can be quite high, and in fact, anywhere from 20 percent to 90 percent of portfolio companies may fail to return on the VC’s investment.  On the other hand, if a VC does well, a fund can offer returns of 300 to 1,000 percent.

Partnership:

In additional to a portion of the equity, a VC expects to have a say in how its portfolio company operates.  Ideally, the VC fosters growth at the company through its involvement in managerial, strategic, and planning decisions.  To do this, the VC relies on the expertise of its general partners who may be former CEOs, bankers, or experts in a particular industry.  In most cases, one or more general partners of the VC take Board of Director positions at a portfolio company.  They may also help recruit key executives to the portfolio company.

Size of Funding:

It’s important to do your homework before approaching a VC for funding, to make sure you’re targeting the right potential partner for your business needs.  Not all VCs invest in ‘start-ups.’  While some may invest small amounts of “seed” capital for very early ventures, many focus on early or expansion funding, while still others may invest at the end of the business cycle, specializing in buyouts, turnarounds, or recapitalizations.

Investment Preferences:

VCs may be generalists that invest in a variety of industries and locations.  More typically, they specialize in a particular industry.  Make sure your company falls within the VC’s target industry before you make your pitch – a VC that’s focused on biotechnology start-ups will not consider your request for later-stage funding for expansion of your semiconductor firm.  You can often gain insight into a VC’s investment preferences by reviewing its website.

In addition to industry preferences, VCs also typically have a geographic preference.  Being in the same general location as a portfolio company allows the VC to better assist with business operations such as marketing, personnel, and financing.

Keep in mind that venture capital is not an option for all new businesses.  In fact, VCs are very selective in choosing new companies to invest in, so your company may not qualify.  They’re most interested in businesses with high growth potential that will allow them to successfully exit with a higher than average return in a time frame of roughly three to 10 years, depending on the type of investment.  Given the rigorous expectations, most venture funding goes to companies in rapidly expanding industries such as technology, biotechnology, and life sciences.

The executive summary – really just a compact version of your business plan – should concisely address the following:

1. what your company does;
2. why your product or service is unique and what opportunity you’re presenting;
3. how your management team is well qualified to execute your business plan;
4. how much capital you need and how it will be used.

Keep your summary brief – ideally, two pages or less. Think of it as everything you’d say to a prospective investor in a five-minute interview. There are some who advise that you write your executive summary last, to capture the crucial points you’ve written into your plan. Others advise that you write the executive summary first and use it as a road map to keep your business plan on track. Both approaches have merit. In either case, make sure your executive summary is professional, comprehensive, and concise.

Example:

iWidget, Inc. designs, manufactures and markets software solutions for the online gaming and desktop publishing industry. The company’s flagship product, iWidget Pro, is the leading software package for entrepreneurs seeking to start up a web business in the fast growing online gaming industry. iWidgetPro allows a user without any HTML skills to quickly set up an online gaming web site bundled with quick loading graphics and gaming technology. The company’s two accompanying software packages, iWidgetNext and iWidgetWorld, provide advanced design elements and technologies that allow users to customize their web sites. While the market is flooded with desktop publishing software, there is no other desktop publishing software company focused exclusively on the online gaming industry.

1. The Market

iWidget’s target market is the rapidly expanding online gaming industry and entrepreneurs seeking to set up gaming websites. Since its inception, the online gaming industry has experienced tremendous growth. Estimated at just over $1 billion in 2003, In-Stat/MDR expects the online gaming market to grow to nearly $4 billion by the end of 2008.

2. iWidget’s Competitive Advantage

As the only desktop publishing software maker focused exclusively on the online gaming industry with proprietary software that allows individuals to easily set up their own web businesses, iWidget is uniquely positioned to grow along with the industry and adapt to new industry developments quickly. Unlike other software makers’ products, iWidget’s products offer advanced and continuously updated technologies exclusive to online gaming. Software products offered by other software makers do not include these specialized technologies and do not offer the same ease of use or gaming graphics capabilities.

The expertise needed to design gaming industry-specific software is a significant barrier to market entry; iWidget’s management team includes desktop publishing industry pioneers with extensive knowledge and understanding of the online gaming industry and market.

3. Management Team

This is the second software venture for iWidget founders and co-owners J. Smith and R. Jones. Former classmates at M.I.T., the two teamed up to co-found iStudy, an online study system for college students that was acquired by BIG Textbooks Co. in 2002 for $8 million. Smith and Jones were among the pioneers of the desktop publishing software industry, and used their extensive knowledge and expertise to develop gaming-specific software that would allow individuals to set up lucrative online gaming web businesses. As the online gaming industry grows and develops, Smith and Jones are at the forefront of adaptive software that continues to evolve into a greater array of business options for online gaming industry entrepreneurs.

4. Investment

The capital sought in this proposal is iWidget’s third round of financing. Proceeds of the first round of $2.6 million in funding and second round of $3.5 million in funding have been used to expand the company’s highly knowledgeable team, develop new software products, and execute the company’s first software licensing agreement.

iWidget intends to raise an additional $3.5 million to develop additional software products, build out its marketing function, and successfully bring new products to the market.

5. Conclusion

First mover advantages have allowed iWidget to gain a dominant position in development and delivery of online gaming software. This early mover status, coupled with several years of desktop publishing management experience and technological expertise, will allow iWidget to continue to lead the field with cutting edge products in the fast growing online gaming industry.

The importance of a well-thought out, comprehensive business plan can’t be overstated.  VCs, in particular, review an average of 200 business plans each month.  Of the total number of plans submitted, just 0.3 percent ultimately receive VC funding.  So to even be considered, your plan needs to be thorough and engaging.

The main elements you should have in your business plan include:

• Executive Summary
• Company Description
• Product or Service
• Market Analysis and Competition
• Marketing Plan
• Management and Organization
• Financial Projections
• Fundraising and Use of Funds

Keep in mind that potential investors will judge you not just on your ideas, but also on the way they’re presented.  The more time you spend researching your ideas and mapping out your operations, the better off you’ll be.  It typically takes several weeks to complete a good, solid plan.  You won’t regret the effort because it will also help you to determine how to allocate your resources properly, address problems, and make informed business decisions as you move forward.  So take your time and write a thoughtful, comprehensive business plan that will serve you and your investors well as your business progresses.