How to get VC funding for your company

Conditions, documents, procedures

Welcome to my second post! Let’s not waste any time and go in-depth of how to approach getting money for your company from Venture Capital firms.

The first thing to do before reaching out to VCs is to know your KPIs, you unit economics, your Business Model and your financials inside out.

Second, perform due diligence on your desired VC firms. You need to know how many deals have they made already this year, when was the fund started, and how many more deals are they looking to make before closing it. Timing is key. If you start talks with some VCs that appear very interested, but that have just closed their fund, good luck waiting for 2 years before they close the next fund to get your next round.

Third, VCs do not respect cold calls and emails. You need an intro. Or you if you don’t have one, stalk them. Some VCs have shared that occasionally they accidentally happen to travel from one airport to another with an entrepreneur sitting next to them, who happens to have a pitch deck in hand. Clearly, this is radical, but you get the point.

If a VC tells you they are not interested, it’s a no and don’t ask for referrals. What you can do if you have established a good relationship is ask why the answer is a no, but respectful. Also, don’t be a solo founder. As with crowdfunding, it means that you are unable to collaborate with people and learn from them and no VC will ever invest in you. Having said that, if you have patents, don’t overemphasize them, except if your business model is not built around patents. What you really need are paying customers. Oh, and never ask for an NDA.

Ok, you got your first meeting.

Now you have to prepare an executive summary. In the first meeting they will get familiar with your business and your team. A phrase that flies around often is “We (VCs) invest in teams, not in products”. So expect as many personal questions as business ones.

Next, you hand in your business plan (BP) and a process of clarifications takes place before you are offered a term sheet that contains the main specifics of the deal. Bear in mind, that a term sheet is not a legally binding document. So, even after you are offered one, your VC firm will continue doing extensive due diligence about your company and your market. Only after your VCs are sure of the opportunity are they going to start preparing the final contracts.

There is room for negotiation for some of the terms as well as the valuation in the Shareholder agreement. Usually VCs use a standard term sheet, but some like to screw with you big time. Be careful and don’t trust them blindly. What you can expect to see are weighted anti-dilution, non-participating preferred stock, pay to play, right of first offer, tag-along, good/bad leaver, employee stock option plan, founders vesting, getting someone on your board, information rights and maybe anti-embarrassment. What you should not see, is participating preferred stock (double dipping) or even a liquidation preference of up to 2x (5x is too high), a drag-along right to sell, and a veto right. In any case, these terms vary depending on your market as well as your company, and might change, so get a good lawyer. A very good lawyer…

There are 3 ways in which your company can be valued. The VC way, First Chicago or Golder, and Fundamental. Also they will perform a “reality check” in which they will calculate your pre- and post-money valuation as well as the carried interest (the value created for shareholders from previous rounds). VCs are going to decide how much equity they need on an IRR basis. Let’s say that they invest 1M in your company, IRR=40%, exit is in 5 years. 1M*(1.40⁵) = 5.37M. In 5 years the valuation of the company will be 20M. So they need a bit more than 25% equity.

I hope you enjoyed the reading and it was useful. If you’d have any comment, please drop one below.

Also, check out my third post from this series on MBO, LBO and Search Funds.