The reality of inventing is that often, your idea requires a large amount of capital to succeed. After you've exhausted your resources--pestered friends and family, approached every bank, maxed out your credit cards and held numerous garage sales--you may want to look into the possibility of finding capital through a venture capitalist.
A venture capitalist is a company or partnership that has a large fund available to invest in products or ventures. Unlike banks, venture capitalists are willing to get involved in projects where there is a significant risk; however, they demand a greater return, may require control over many aspects of the enterprise and many times dictate who will be hired.
Some say working with a venture capitalist is like selling your soul to the devil. If you've exhausted all avenues of financing, however, and thoroughly understand the agreement you make with a venture capitalist, the rewards can be great. Remember, a venture capitalist also wants to make money with your idea, so he or she wants you to succeed. And being in the business of building businesses, he or she has the advantage of seeing how many businesses work and can act as a consultant to help you succeed.
Starting Your Search
How do you find a venture capitalist? A good place to start is with Pratt's Guide to Venture Capital Sources (Venture Economics). It is updated once a year, and most libraries have it in their reference section. This guide lists venture capital firms by state and includes a list of foreign venture capital firms.
Almost all the information you need to make an informed decision is included in each write-up. For example, Pratt's tells you what type of financing the venture capital firm prefers (seed capital or leveraged buyouts, for example). This is important because as an inventor, you are no doubt looking for investors who have a bias toward early-stage financing (more about this later). Pratt's also spells out what each company's minimum and preferred level of investment is and their geographic preferences. Most venture capitalists want easy access to their investments; this is important to know when compiling a list of prospective firms.
Another valuable piece of information provided by Pratt's is a percentage breakdown of each venture capitalist's current portfolio; for example, it may break down as 35 percent communications, 38 percent technology, 14 percent medical and 13 percent telecommunications. Obviously, in this example, it wouldn't be a good idea to send this venture capitalist a business plan discussing a retail venture. Send your business plan to investors who specialize in your industry.
Types Of Financing
Venture capitalists typically offer one of three types of early-stage financing: seed financing, research and development financing, or start-up financing.
Seed financing is generally given to entrepreneurs to help them prove that their invention or concept works. It's usually a small amount of money that pays for product development and market research. If the idea works, the venture capitalist will then consider providing start-up capital to further develop the project.
Research and development financing can be beneficial to both the inventor and the venture capitalist. This kind of financing has tax advantages if it's set up as product development financing. Venture capitalists can receive tax write-offs for their investments or a share of the future profits if the product is successful.
If you are far enough along that you have developed your idea and done some initial marketing, you should look for start-up financing. This type of financing is usually for a larger amount than the previous two types because the early stages have proved successful, and the venture capitalist feels his risk has been reduced.
Making A Plan
Without exception, you must have a business plan if you want to do business with a venture capitalist.
There are some strict do's and don'ts you should heed when writing a business plan. Do give a clear and simple explanation of your idea. Do have a well-thought-out sales and distribution plan. Do show that you are knowledgeable about your market. Do explain who your competitors are and how you will compete against them. Do include full resumes of your key managers. And do, if possible, write your own business plan. Pat Hamner, vice president of Capital Southwest Corp. in Dallas, says he wants to read business plans that "make sense and exude credibility. I like to see if all the sections of the business plan hang together, having been supported through well-documented statements and data," he says.
Venture capitalists notice certain red flags when reviewing a business plan. For example, don't make statements such as "there is no competition," "this is a paradigm shift for the industry," or "my idea represents a multibillion-dollar market." Al Fleener of Seed Company Partners LP in Dallas feels that the more grandiose the business plan, the harder it will be to sell. "Demonstrating that you have analyzed the market and will initially go after a segment of it is far more attractive to a venture capitalist than going after the entire market all at once," he says.
An employee list that only includes family members is another red flag. It's one thing to have friends on the list; it's hard to believe, however, that one family has all the skills necessary to make a venture successful.
Your business plan is the most important tool for communicating your idea to venture capitalists. Not only does it sell your idea, but it also demonstrates your ability to plan for, organize and manage a successful business venture.
Your intellectual property rights must be clearly represented to a potential investor. All rights should be specific, protected and properly assigned to the company being formed. Any arrangement in which you or other related parties retain the rights as individuals to the basic patents or other intellectual property under a license and royalty arrangement will not be looked at favorably. The venture capitalist does not want any other agreements in place that deplete the value of the company it is helping to fund. If you have not yet received patent protection on your idea, having searches conducted and opinions rendered by a patent attorney can be very useful to a venture capitalist during his evaluation.
Most venture capitalists will sign nondisclosure agreements. However, virtually no venture capitalist will sign a covenant not to compete. At this point, therefore, you should have already filed for a patent.
A Foot In The Door
Though you can blindly submit your business plan, the best way to approach venture capitalists is through a third party. Venture capitalists tend to look more closely at business plans that have been introduced by someone in their "inner circle."
So how do you get your name into the inner circle? Networking. If you're friendly with a successful entrepreneur who has received financing from a venture capitalist, his or her introduction of your business plan could be the foot in the door you need. Lawyers, bankers, accountants and marketing firms can also make introductions for you. Most venture capitalists have strong alliances with these professional communities. Find out with whom these professionals do business, make an appointment to see them, and sell them on your idea. If they agree that your idea is fabulous, they may provide a great introduction for you.
As a final comment, let me share with you a statistic from one of the venture capitalists I interviewed. Richard Tadler of TA Associates in Boston says he reviews an average of three business plans a day and spends anywhere from five to 15 minutes looking at each business plan before making a decision about whether to invest. That's almost a thousand business plans a year. Of the business plans he looked at in 1997, he only arranged to meet with 95 entrepreneurs. And his statistics are not unique. One venture capitalist I spoke to claimed to look at 5,000 plans a year and only picked one out of every 475 to interview. As you can see, the odds are not in your favor. Therefore, having a strong business plan and getting a third-party introduction are the most valuable things you can do to be considered for venture capital.
By G. David Doran
Names and ages: Lance Rake, 45; Deborah Rake, 40; Kermit Krantz, 40
Company name and description: The New Deal Playing Card Company manufactures and markets the Ergo Card, poker-sized playing cards ergonomically designed with a rounded, wavelike shape that fits the curve of the hand. The company also produces Kid Kards, which are Ergo Cards with colorful backs drawn by art students at the Lawrence, Kansas, Arts Center. A portion of Kid Kard's sales goes toward a scholarship fund for these students.
Based: Leawood, Kansas
Start-up costs: $100,000. "Thirty thousand dollars of that went to obtain a patent on the idea, and the rest was for manufacturing, inventory and advertising," says Ergo Card inventor and University of Kansas industrial design professor Lance Rake.
1997 sales: $125,000
1998 projections: $1 million
Hands-on training: "I experimented with a number of different curves, thinking the market for this product would be senior citizens with arthritis," says Rake. "But what I found is that my kids would pick them up and shuffle them, and they liked the way Ergo Cards felt. It's difficult for kids to learn how to shuffle--it's kind of a tricky, fine-motor coordination activity, and the shape of these cards naturally guides their hands to where they need to be so it's a lot easier to learn."
In the cards: New Deal is now marketing custom-made Ergo Cards with promotional backs featuring corporate logos and advertising slogans.
The New Deal Playing Card Company, 2620 Cranley St., Lawrence, KS 66046, (888) 268-3325.