Preparing for Early Stage Venture Capital Deals
By Jason D. Gabbard
After two decades of successful operations, one of my clients recently decided to pursue an outside source of capital. Her decision was one founded in need and opportunity. It was now apparent that she needed to upgrade assets and add personnel in order to satisfy a business that had grown from her basement to one with global reach. Similarly, her ability to manage the growing enterprise and the network through which she was acquiring raw materials, buyers and distributions channels are both stretched thin. Only with more purchasing power, tighter controls and more reasoned strategy will she be able to maximize her ROI and realize her brand’s full value. In short, she needs capital and expertise.
The deal strikes me as one more suited for a strategic buyer/partner, but my client has several financial investors on her list of potential investors. For purposes of this article, I’m not sure that distinction has significance, but in other contexts, especially moving forward with a deal, it will. For instance, a financial investor will negotiate harder for the preferences associated with preferred shares, such as protective rights, anti dilution and registration rights, while a strategic, viewing the investment as a long-term, synergistic partnership, may be willing to drop some of those more onerous provisions.
The following abbreviated list of pre-deal issues should be helpful in this context. Assuming you have moved beyond the preliminary paper review by the investor, this list may guide the entrepreneur in his or her preparation for discussions with potential investors, and help both sides understand critical levers in the pre deal process.
Practice your pitch. Rehearse your presentation over and over. But don’t plan for your meeting to be a rote recitation. It should and likely will be a dialogue about your business. Be prepared to have a conversation, articulate your strategy and assumptions, and defend the same.
Utilize available resources. Your company accountants, lawyers, and other entrepreneurs can serve as a discerning audience to assist your preparation.
Diligence the investor. This point should be axiomatic, but it’s not. Too often entrepreneurs want to jump at the first sign of green, but the diligence process is a two-way street. Entrepreneurs need to feel comfortable with the style, attitude, track record and resources the investor brings to the table. For example, does the investor have experience in your industry? What, aside from money, does the investor bring to the table? These questions are important, as some entrepreneurs will accept less-than-ideal terms and valuations if the investor brings expertise or an expansive network. Make the investment round opportunistic and strategic at once. Many resources are now available on the Internet to assist this process. See www.thefunded.com.
In this vein, consider a diligence request list for the investor. For instance, request from the investor information as to:
- how many current portfolio companies; how many exits, their type and success; average time to exit;
- regional focus of the fund, if any;
- average size of portfolio company (do you fit in);
- examples of how the investor works hand in hand with companies; and
- aspects of the fund itself, if it is a fund (availability of follow-on financing, how much cash is available, etc.
Understand the critical challenges facing your business, including with your weaknesses. Don’t be uncomfortable with questions related to challenges and weaknesses, in fact, address them head-on. Be prepared to articulate in a reasoned manner how your business will address these issues going forward and with the assistance of your investor (and its capital). Also, preemptively identify your key competitors and differentiate your company and its strategy.
Vet your strategy. Review your strategy and business plan to confirm that you have a big and expanding market, and that there are barriers to competitors entering that market. A strong brand name helps, or some other IP, such as patents. Can you demonstrate a sustainable competitive advantage?
Don’t forget your most important resource – your human capital. Have the potential investor into your office to meet key personnel, along with the rank and file. The investment decision may very likely hinge on the strength of the entrepreneurial founder, but without a strong team and corporate infrastructure, the Company’s growth will be prematurely capped.
Formulate an exit strategy. Be prepared to show the investors how they are getting their investment and return out of the Company. When I think about exit, I think about either an IPO or a sale to a PE fund. Be prepared to stress test the potential scenarios and to provide industry-specific examples when available.
In advance of your discussions with VCs, I also suggest that the Company compile a due diligence file containing key contracts, litigation papers and financial statements and projections, at a minimum. Review that file to assure that you understand the company’s contractual position at a general level, along with potential issues. Additionally, you should think about common representations and warranties and the potential pitfalls therein – organization and good standing; intellectual property; litigation and contingent liabilities; employee matters; and taxes, to name a few. If your company will have difficulty in making any of the representations and warranties, proactively think about a strategy for eliminating your risk.
 Incidentally, during the meeting that prompted me to pen this note, my client dropped an 80-page business plan in front of me, asking for my thoughts. My personal view, and one I’ve heard echoed time and again from my investor-side clients, is that investors, especially institutional ones, simply do not have time to wade through epic-sized business plans. I prefer to keep them short. Assume you have five minutes of the investor’s time.
This information has been prepared by GC LLC for general informational purposes only. It does not constitute legal advice, and is presented without any representation or warranty as to its accuracy, completeness or timeliness. Transmission or receipt of this information does not create an attorney-client relationship with GC LLC or its affiliates. The contents of these materials may constitute attorney advertising under the regulations of various jurisdictions.