This guide is based on UK law. It was last updated in February 2006.
Raising Venture Capital finance in the UK for early stage technology companies is difficult. Many point to an apparent reduction in capital available for early stage ventures – “the funding gap” – as a key factor in this. Equally important, however, is the limited understanding amongst entrepreneurs of what VC investors want, resulting in a high proportion of investment propositions failing to meet investment criteria.
Here, David Armour of Pentech Ventures sets out some tips for attracting VC investment.
Firstly, the entrepreneur must understand what drives the VC’s business. VCs operate on an investment cycle: they raise money and typically have to invest it within five years. Try to find out where the VC is in its investment cycle, because the closer the VC gets to the end of that cycle, the better chance you may have of getting a quick decision. Also find out the investment criteria.
Other things to think about include the VC's attitude and ability to provide follow-on investment; its approach to syndication; and the quality of the VC team and how they can add value to the business. Finding the right fit is crucial.
A good early stage VC will want to take an active role in the business, leveraging its skills, experience and network to the advantage of the company. If this type of relationship is not welcomed by the entrepreneur he should avoid VCs.
There is a misconception that a VC is just a more expensive bank. A VC does have high expectations for the return on its investment – but investing in early stage technology is high risk and the reward premiums must compensate for that. A VC will look for a significant equity stake in your company.
Finally, VCs don’t back lifestyle companies – they invest for rapid growth and realisation through an exit event, typically trade sale or IPO. If your ambitions are not aligned with this strategy, VC is not for you.
As a general rule of thumb, an early stage technology VC needs to be able to build a case that the investee company can, given the right growth strategy and funding, command a value of at least $50 million within a reasonable time. This requires the company to target a large market (or potential market) and be led by a management team with the ambition to build a global business quickly.
Having the best technology does not automatically lead to a successful business. There are thousands of examples of “best-of-breed” technology that never became a commercial success because the commercial exploitation of the opportunity did not match the quality of the technology (eg. Betamax). Make sure all aspects of your business are world-class.
In general, big companies don’t buy from small, early stage companies because the commercial risks are too great and existing relationships too secure – unless the business case is too compelling to ignore. The entrepreneur must be able to communicate the business benefits his technology delivers to customers and not just its features and functions.
Extending this theme further, the entrepreneur should seek to get as much evidence as possible from external sources about the value proposition. Revenues are ideal evidence. However, endorsements from relevant third parties who have evaluated the technology, conducted trials or are prepared to distribute it are also important.
Early stage investors accept that management teams will be incomplete and effort will be required to recruit key people into senior roles. Entrepreneurs need to acknowledge their own limitations and be prepared to work in partnership with the investors to plug the gaps. Accepting there are gaps, and knowing what they are, is the first step towards achieving this.
The average VC receives one new investment proposition every day (some get many more) and will invest in less than one percent of the deals he sees. Simply meeting the investor’s criteria is not enough where deals compete for a limited supply of capital and just as importantly, the investor’s limited time and attention.
So what makes a business stand out from the crowd? The simple answer is the management team, their understanding and passion for the business, their ability to adapt to changes in market conditions, their ambition and the quality of their relationship with the investor. So work on that.
See: Pentech Ventures