Reprint from May/June 1997 "Inventor's Digest"
Finding True Venture Capital
by Jeffrey M. Stoller, JD, CMA, MBA, MBT
Where is all the venture capital people talk about? It’s there; just not where most people look. The reason is that most "venture capital companies" really want to provide capital, often on a secured debt-like basis, to established businesses with profitable operating histories. That is not venture capital. True "venture capital" is capital that is used to help launch the products, the ideas and the entrepreneurs of tomorrow.
Why do so many people have so much difficulty raising funds when there are so many firms that call themselves "venture capital companies"? If you’ve raised or tried to raise capital for yourself or for others, I am sure you will relate to at least one of the following situations.
1. The risk associated with true venture capital is greater than when providing capital to an established business. Despite the best efforts and intentions, some start-ups will not succeed. That is simply part of the game. In today’s market, though, especially if dealing with highly leveraged corporations, we have seen there is substantial risk associated with well established businesses as well as with start-ups. The risk is different, though, and people providing true venture capital recognize these risk-reward trade-offs.
2. Most investors have an unrealistic view of venture capital. They expect the high returns publicized with respect to successful new ventures but do not want to take the attendant risk. Consequently, such investors go into the marketplace looking for opportunities, claiming to offer venture capital, but never finding an investment that meets their requirements.
3. Most venture fund managers come from banking, professional money management or corporate management; while some come directly from business school and have been employees of venture capital firms for their entire career. Consequently, the vast majority of venture capital company employees - at any level - have no actual "venture" or entrepreneurial experience, particularly with start-ups. A lack of experience and understanding translates into a lack of comfort with the creation phase of a business and a reluctance to invest in such deals.
4. Entrepreneurs, in general, have different goals, motivations and personalities than bankers or corporate executives, who may expect to see people like themselves as clients. These differences can often create a gap between the venture capitalist and the entrepreneur sufficient to result in a rejection of the business proposal irrespective of the merits of the business.
5. The principal source of capital for most entrepreneurs is friends and family. Once that source runs out (if it exists at all), venture capital companies may be the only alternative to obtain funding which, most likely, are small or insufficient in comparison to the cost of, for instance, building a factory or buying a profitable going concern. Few venture capital companies want to spend the time evaluating small deals when, within the constraints of their investing limits and in the same amount of time, they could participate in fewer but larger deals.
6. Three key elements to a successful new venture are (not in order of priority): a good idea, adequate capital and good management. A failure of any one of these elements can doom the enterprise. Due primarily to a lack of experience in the creation or start-up phase, venture capital companies are often lacking in their ability to evaluate and recognize:
(a) a "good idea" because ideas and the projections associated with them are so intangible, unlike - so they think - the projections of an established company;
(b) "adequate capital" for a start-up because traditional venture capital companies may not have the experience to understand whether the entrepreneur’s goals can be achieved with the capital requested or to help the entrepreneur determine the appropriate capital requirements for a start-up;
(c) the presence or absence of adequate entrepreneurial management, which can be different than that of a large established corporation; a good example of which was the changing need of Apple Computers when it replaced Steven Jobs with John Sculley.
7. Despite the fact that many fund managers will say that inadequate management is the primary reason for business failure, they will rarely devote time to assist management to help achieve a greater likelihood of success. Consequently, some investments are destined to fail from the start; and many firms use everyone else’s failures as a reason for them to avoid start-ups.
8. Many companies and individuals complain that they have money to invest in "good" projects, but none can be found. First, what is "good" for one person or firm may not be "good" for another. That definition is guided by goals and requirements of the individual investor. An older investor may be looking for income while a younger investor may be looking for appreciation. Often, those goals are unrealistic as applied to venture capital.
Are there are any magic solutions that will suddenly make venture capital flow from the sky? Of course not; but the first step in dealing with, for lack of a better term, an obstacle is understanding what that obstacle is. This author has spent years to recognize it and understand it and the best generic advice to anyone seeking venture capital is this:
Have a positive attitude but be prepared for rejection.
Have a practice meeting with a potential investor; because the things you think are important and are prepared to address may not be what the investor wants to address. Then be fully prepared.
Don’t waste your time with people who string you along. This is very hard to recognize for someone who has not had a lot of time already wasted. It’s even harder to walk away from someone who tells you they might invest in your deal. Just consider carefully the realistic prospects of working with a particular person, group or firm.
Friends and family are great and supportive; but taking their money and failing could have much greater consequences than you imagine. Be careful. Consider alternative means and channels of raising money.
©Copyright 1997 Stoller & Associates, Inc. All Rights Reserved
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