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A capital idea: what entrepreneurs need to know about VC investments.

So you have bootstrapped your business using your own money or borrowing from family, friends or credit cards. Perhaps you've even borrowed from a bank or kick-started your business with money from an angel investor you know.

Now that your company has some legs, you're looking for an infusion of serious cash so you can enter a period of major growth. Should you seek out a venture capital investment? And if you do, what are the implications? Will you lose control of your company? Will you have to sell it down the road?

Venture capital is actually a common funding source for high-growth companies. In fact, 63 current Utah businesses have received more than $550 million from venture funds within the Utah Fund of Funds portfolio, according to Matt Peterson, vice president of the fund. The total number of Utah companies receiving VC investments is even higher.

Not Without a Price

While you won't have to sell your soul, venture capital investments do come with a price. Specifically, any VC firm that invests in your company will take a percentage of the ownership in return for the investment.

Just how much of your company will the investors want?

"The venture guys will typically take somewhere between 20 to 40 percent ownership, depending upon how clean your capitalization table is and if there are any other venture firms involved," says Chris Stone, managing director of Epic Ventures.

"Sometimes we get called vulture capitalists and that is all very entertaining, but the reality is, if you are going to take our money we have to have equity in your company," he says.

By taking a VC investment, you are essentially sharing your company with the VC firm. "These people will be owners of the company. They will have a seat or seats on the board of directors. They're going to have influence in the way you run your company, and they are going to require a lot more out of you than another investor might require, because they have investors themselves and they need to be able to justify the investment to their own investors," Peterson explains.

VC influence can be a good thing--unless you are a control freak. Peterson says the VC firm can have a huge impact on your company, because they will help you find your management team and work with you on creating partnerships. They will also work with you on your money needs.

Do Your Homework

Venture capital firms come in various flavors. Some are early-stage investors like Epic Ventures, while others focus on later-stage companies. An early-stage investor may invest from $250,000 to $2 million in your company in an early round. (VC investments typically come in rounds, like A, B and C).

Part of the homework an entrepreneur should do involves researching the VC firms themselves. Most VC firms specialize in certain industries. For example, Epic Ventures specializes in hot technology areas like social networking, computing and education services. Other VC firms focus on life science companies.

VC firms generally work as a syndicate, Stone notes, meaning they like to do things with each other, so there may actually be two or three venture firms involved in any given investment. It's a way for VC firms to share the risk.

No Easy Money

Venture capital money is not easy money. Before a VC firm will invest in your company, it will conduct an exhaustive due-diligence review. Peterson says entrepreneurs are often surprised by the due-diligence process, which can last from four months to more than a year. During that time, the VC firm will call your customers, your family members, your character references and anybody with whom you have ever done business. Further, the VC will tear your product apart from top to bottom and review your financial records thoroughly.

If that weren't enough, the VC will spend an exhaustive amount of time getting to know you, the entrepreneur, personally.

"Some entrepreneurs make a mistake by thinking venture deals get done quickly, but they don't," Peterson says. "Many entrepreneurs come to the table too late. They pitch the venture capitalists when they need money today, and that's just not going to happen. When I am counseling entrepreneurs, I tell them to start raising money at least a year before they actually need the money in their bank account."

In the process of working out the details of the investment, the VC firm will create a term sheet, which dictates all of the conditions set upon your company. The term sheet will typically include conditions like who will serve on your board of directors; how much you, the CEO, will be paid; and the valuation of your company, pre-VC investment and post-VC investment.

The term sheet will also dictate the percentage of ownership the VC firm, or firms, will take, "plus a whole bunch of legal stuff," says Peterson.

Life Cycle

Entrepreneurs should understand that every VC firm invests with an exit in mind.

"Nobody gets a big payday unless the company is sold or goes public. That's how venture firms return the money to their investors," says Stone. "We're not investing so you can have a lifestyle company and work four hours a day. It is completely the antitheses of that. We are investing so you will work your butt off and make us money and at the same time, you make money. It is capitalism at its best."

Most venture funds have 10-year lifecycles. Hence, the VC firm won't want to invest in your company for any longer than six to eight years, depending on where the venture fund is in its lifecycle. Some VC firms don't want to invest for any longer than three to five years. However, early-stage VC firms like Epic typically model their investments for longer periods than later stage VC firms do.

The industry your company is in may determine the amount of return the VC firm expects to get by investing in you. For example, Stone says Epic Ventures models its investments as 10x, meaning if Epic puts $1 million in your hot technology company, the firm will expect to get $10 million out.

"Now whether that is a sale or an IPO, quite frankly, we don't care, as long as it is 10 times," he says.

By Gaylen Webb | Illustration by Mike Bohman
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Title Annotation:Focus
Comment:A capital idea: what entrepreneurs need to know about VC investments.(Focus)
Author:Webb, Gaylen
Publication:Utah Business
Date:Mar 1, 2013
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