1. VC basics
Typical VC will have a fund of £500m, with fund managers taking a 2% fee and a performance fee of c.15%. The fund size of each VC will dictate their appetitive for risk, so the smaller funds tend to be more risk averse. Note the difference between VC and VCT (Venture Capital Trust) which is a tax efficient investment like EIS. VCs will often invest low initially with the hope of investing a larger sum in a second round to increase their stake in the business (and most VCs will look to have 20-30% equity in the business). According to one partner expert, in 10 deals made by VCs, 3-4 go bust, 3-4 manage 2-3x return and the stars manage 10-20x return. Often, the decision to invest is made by the Deal Lead who you will speak to at the pitching stage. They will feedback to an internal committee and come up with questions that structure the due diligence process.
2. Private Equity vs Venture Capital
In general, VC funds invest in companies at an early stage in their development with little track-record of profitability and are cash-hungry. In contrast, PE funds invest in more mature companies with the aim of reducing inefficiencies and driving business growth through often increased margins and/or new sources of revenue growth. PE will accept lower rates of growth for steady profitable growth while VC expects at least 50% growth. US style VC is looking for unicorns that will provide the returns for therest of the portfolio, so are inclined to focus on the two most promising and less on the other 18, with Balderton and Index Ventures tending to look for 10x ROI in 5 years. Private equity typically look for 3 to 4x ROI in 5 years. BGF is the largest mid-market PE offering with a fund of £2.5 billion and a billion invested. BGF Ventures has a fund of £200m.
3. Preparing for VC
Be clear on what you want from an investor, as this will determine who you choose to work with. For example, is it just cash or do you want specific support for your business? If you don’t have a management team in place, have a plan for building one as a VC will expect to see it (in some cases it’s what the funding is for). Most VCs will expect a chairman on the board toact as theintermediary between the founder and investor. They also add structure and accountability to board meetings, making them more impactful, focused on decision making and less of a reporting function. Also prepare yourself psychologically that after taking on investment you will be focused on the next 5 years and you are ‘employed’ by the board to deliver. Be clear on how your key metrics arecalculated and tidy up your accounts at least a year before going out to pitch.
4. Choosing the right VC
Try to find a VC that truly understands your proposition and market, with a relevant network that could support you beyond investment. Members always advise talking to other members or founders that have already used the VC you are considering to get their opinions onservice and relationship. They also recommend talking to a corporate finance adviser who will have a better idea of the funding landscape and what differentiates each VC. And check where you will be in the VC’s investment cycle, whether it’s for follow onfunding or if they are likely to push for exit sooner than you planned.
5. Pros and cons of VC
There is a perception that VC is purely driven by maximizing capital value, and focusingon the exit. However, VC can help you to professionalise your businesswith stronger governance, reportingand financial management. They also help to define a goal and get everyone aligned around it to achieve the best outcome. VC can provide access to a relevant industry network and senior talent pool as well as bring in advisers to support growth.Some VCs try to install a chairman, so try to influence the decision to get someone who understandsentrepreneurial businesses and founders.
6. Raising VC funding
Before you begin looking for VC, draft a five-year plan of what the business would look like with and without an injection of VC funds to help you decide if you need it and if there are alternatives –such as extending your overdraft, invoice factoring or crowdfunding to get the capital you need. Be warned that if you are burning through cash quickly this will weaken your bargaining position when raising VC. However, the tech boom means many will be looking for the next unicorn to invest in so look at how to present a compelling story. Fundraising can be very distracting so members recommend getting an MD or COO who can run and manage the businesson your behalf. If you want to focus on growing the business, a corporate finance adviser who understandsyour objectives and can help to find the right VC.
7. Pitching to VC
When presentingto VC, members and partner experts recommend you have an FD or financially literate director in the pitch to talk around the numbersif necessary but focus on the growth story and market opportunity. A pitch deck should include the following:
- Intro to management team
- What you do, with product demo where relevant
- Market size and growth rate
- Key competitors and USP
- Customers broken down by segment and geography
- Product road map
- Units economics: cost of acquisition, churn rate, lifetime value (more relevant to SaaS companies)
- Historical revenue growth rateand projections
- Money required and what you need it for (ie taking market share)
Some advise that you include a solid financial model, with as much detail as possible onhistorical and projectedthat clearly showswhere and how the funding will impact the business growth. However, others recommend you focus on your growth story, why you are the best at what you do and why investment will help you dominate for a long time.
8. Managing VC investors
Members and partners advise being open with investors and avoid keeping things from them that will surely come to light at some point. Send investors a quarterlynewsletter outlining updates, successes, new additions, and plans. Use "we" when talking about business and "I" when discussing thought leadership or marketdynamics and trends. Have ad hoc meetings throughout the year (4/5 times) just for shareholders and send through a monthly management update with comment. It’s also worth meeting investors individually to ensure they’re onside. Some members have created a separate Investor Board to the Operational Board, but set up guidelines on who can make what decisions and at what level. Some have also found a non-exec chair with clout to manage investors and their non-execs.
9. Due diligence
Always get references on the fund.Speak to businesses that have gone into liquidation after raising with them as well as those who have been successful(If the fund doesn’t offer up names, this could be a red flag). Have the VC model out an exit for you, asthis will make it clear and setexpectations for both parties. Ensure you understand terms around preference shares and what this means on exit. VCs will contact current and churned customers to find out about your business(so if you have any disgruntled customers, manage them before you enter in the process –and you could ask for a copy of this at the end of the process to gain customer insight). They may also insist on psychometric tests on the management team to understand how they work and how they like to communicate.
At the outset, the VC will set up key milestones and not all will be financial(it could include demonstratinga path to a new market, maintain profitability of certain clients, if the management team is a little weak, hire a Chairman, etc). If you hit the milestones you are generally guaranteed reinvestment. VCs invest in teams with laser sharp focus so that they are working towards the same goal and outcome. If you take a lot of investment but aren’t hitting the numbers the VC will begin to push you to exit. For example, this could be done by them finding a new investor to buy them out(who may not be as nice to deal with). Expect to hire a CTO and Chairman within 6 months of the deal if these roles aren’t already in place. Finally, VCs on your board will be very frank and not afraid of the hard conversations, so be prepared for this.