By Mike Sullivan and Richard D. Harroch
Startups seeking financing often turn to venture capital (VC) firms. These firms can provide capital; strategic assistance; introductions to potential customers, partners, and employees; and much more.
Venture capital financings are not easy to obtain or close. Entrepreneurs will be better prepared to obtain venture capital financing if they understand the process, the anticipated deal terms, and the potential issues that will arise. In this article we provide an overview of venture capital financings.
1. Obtaining Venture Capital Financing
To understand the process of obtaining venture financing, it is important to know that venture capitalists typically focus their investment efforts using one or more of the following criteria:
- Specific industry sectors (software, digital media, semiconductor, mobile, SaaS, biotech, mobile devices, etc.)
- Stage of company (early-stage seed or Series A rounds, or later stage rounds with companies that have achieved meaningful revenues and traction)
- Geography (e.g., San Francisco/Silicon Valley, New York, etc.)
Before approaching a venture capitalist, try to learn whether his or her focus aligns with your company and its stage of development.
The second key point to understand is that VCs get inundated with investment opportunities, many through unsolicited emails. Almost all of those unsolicited emails are ignored. The best way to get the attention of a VC is to have a warm introduction through a trusted colleague, entrepreneur, or lawyer friendly to the VC.
A startup must have a good “elevator pitch” and a strong investor pitch deck to attract the interest of a VC. For more detailed advice on this, with a sample pitch deck, see How to Create a Great Investor Pitch Deck for Startups Seeking Financing.
Startups should also understand that the venture process can be very time consuming—just getting a meeting with a principal of a VC firm can take weeks; followed up with more meetings and conversations; followed by a presentation to all of the partners of the venture capital fund; followed by the issuance and negotiation of a term sheet, with continued due diligence; and finally the drafting and negotiation by lawyers on both sides of numerous legal documents to evidence the investment.
In the rest of this article, we discuss the key issues in negotiating and closing a venture capital round.
2. The Venture Capital Term Sheet
Most venture capital financings are initially documented by a “term sheet” prepared by the VC firm and presented to the entrepreneur. The term sheet is an important document, as it signals that the VC firm is serious about an investment and wants to proceed to finalize due diligence and prepare definitive legal investment documents. Before term sheets are issued, most VC firms will have gotten the approval of their investment committee. Term sheets are not a guarantee that a deal will be consummated, but in our experience a high percentage of term sheets that are finalized and signed result in completed financings.
The term sheet will cover all of the important facets of the financing: economic issues such as the valuation given to the company (the higher the valuation, the less dilution to the entrepreneur); control issues such as the makeup of the Board of Directors and what sorts of approval or “veto” rights the investors will enjoy; and post-closing rights of the investors, such as the right to participate in future financings and rights to get periodic financial information.