Venture capitalist weighs risk vs. reward

QUESTION: I am preparing to look for venture capital financing, and would like to know what criteria venture capitalists use when reviewing business plans?

ANSWER: Venture capitalists look at two primary issues: risk and reward.

When reviewing any business plan it is necessary to get the best possible feel for the possibility of losing all or part of the investment. Statistically, venture capitalists lose money on four to eight out of every ten investments. We would all like to have better odds of winning. The key to avoiding this problem is analysis of the business plan and/or the management team. You must prove:

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* The benefit your product or service provides to the buyer.

* The market demand for your product at your price.

* A healthy gross margin.

* Your financial assumptions are solid.

* Your timeline is real.

* Why you are so novel that competition cannot touch you.

The above information must be in your business plan with a degree of clarity and confidence. While you may not be able prove all your points, you must demonstrate that you and your team have the ability and strategy with supporting facts to sustain your plan.

Now, the other half of the equation is how much money can the venture capitalist make for the investment? There are many perfectly good businesses that will never be big enough to pay back the high costs of venture investment. It used to be that venture capitalists tried to make five times their money in five years. Today, this number has more than doubled to 10 or even as high as 20 times in five years. Obviously, if your company cannot provide this kind of return, the chances of obtaining venture funding is greatly reduced.

Q: I believe I have a great plan and management team put together. However, I have not been able to get funded. How do I compete for venture capital funding?

A: You must create an immediate interest in your plan. You must not only be able to communicate your story during the “elevator ride,” but you must also be so compelling that all others fade by comparison.

At first, your plan will not be reviewed thoroughly. Even though you have labored over your plan for hours, days, weeks and even months, your plan can be “killed” in a matter of only a few minutes.

The review process was once described to me as “a guy by the door with a baseball bat.” The reviewer is commissioned to kill off as many plans as possible. No matter how many survive, the number will still exceed the number funded, so the reviewer sees no harm in killing a good plan. The only way to avoid being killed is to make sure that your plan is obvious, perfect and, above all, compelling.

When looking at a plan, the first question that I ask myself is, “Does this company fit our mission and strategy?” If I do not invest in fish companies, do not give me a fish company plan. Please understand I will not be able to take the time to track down a fund that does invest in fish companies, so it would be wasting both our time to present such a plan to me.

The second question I ask is: “Do I get it?” If I do not understand the business model, it is most likely that I will not ask for any type of clarification. Venture capitalists, including myself, simply do not have time to work on projects that you, the businessperson, cannot clearly and concisely explain to the average lay person. I may not even have time to call the person back to state that I do not understand the plan. Time is too precious, and there are too many good plans to choose from. It is impossible to give time and attention to bad or unclear plans.

Finally, I ask myself, “Does this make sense?” For me, perpetual motion machines, generic Web portals and buggy whips are out.

If the venture capitalist you approach can positively answer the first three questions, it is most likely that due diligence will be conducted. Once these questions regarding product, price, profits and market position are acceptably answered, the plan will be first assigned to a technologist who will validate the technology.

If it passes the technology test, it goes to a marketing specialist who will validate the audience for the given product or service. If it passes the marketing test, it goes to a production engineer who will validate the costs. All reviews may be supplemented with expert consultants. If, at any time, during the review, it becomes apparent that this given technology is being done elsewhere or has already been done, the plan will be immediately terminated.

Greeley resident Russell Disberger is a founding member of Tekquity Ventures LLC, a Louisville-based specialty venture capital firm investing in technology development and licensing. He can be reached at (303) 926-3990 or via e-mail at disberger@home.com.