The Truth About Venture Capital

Know Your VC

One risk that certainly is not a myth is that of unscrupulous brokers who present themselves as venture capitalists. "Anyone who asks for money upfront is not a venture capitalist," says Kluesner. To determine if you're dealing with a broker or a VC, "ask who their investors are," Kluesner says. "A VC will rattle off names and fund sizes. If they say, 'It depends on the deal,' that's a broker."

Once you've determined a VC is legit, there are more questions to ask. "Find out who they've invested in and talk to those companies," says Kluesner. "Concentrate on VCs that invest in your industry. [Otherwise], you'll spend too much time educating them in your business, you won't benefit from their advice, and in the end they aren't likely to make that jump. Remember, they're not only investors, they're also your [potential] partners."

That proved true for David Cremin who, at 29, cofounded Vis-A-Vis Entertainment, a company that amassed a library of songs for distribution over telephone lines. "We were a little ahead of our time," Cremin reflects 10 years later. Intending to solicit capital infusion from a company called DigiDesign, Cremin inquired about the company through its financier, Silicon Valley venture capital firm Draper Fisher Jurvetson. "When I explained why I was looking for DigiDesign, Draper expressed interest in financing my company."

Draper invested $450,000 in seed capital in return for 33 percent of the company. "I couldn't have found a better VC," Cremin says of the relationship that lasted until 1998, when Cremin left Vis-A-Vis to become a partner in Draper's new Los Angeles firm, Zone Ventures (www.zonevc.com), which invests between $750,000 and $1.5 million in IT companies with huge market potential and great management teams.

Edward P. "Ned" Grace III, president of Phelps Grace International Inc., an investment firm in Orlando, Florida, urges entrepreneurs to understand the character, background and motivations of investors. Many founders put a lot of time and research into starting companies, "but risk blowing it all by not knowing their investors," he warns. "These people can, in the end, control [your] destiny." Grace further advises: "Look for value added from venture capitalists or any investor. What are their contacts? What is their power base? What do they bring to the table besides money?"

That persuaded Mark Fletcher that CMGI and Bertelsmann Ventures would make ideal partners for eGroups, which now has more than 10 million users. "CMGI was the initial funder of GeoCities, Lycos and others we have synergies with," says Fletcher. "Bertelsmann Ventures gave us access to [parent] Bertelsmann AG, the third-largest media company in the world. That enabled us to enter Europe. Not to mention, they own Random House, Doubleday, 50 percent of barnsandnoble.com, and have a board seat on AOL."

If you can find an investor who shares your vision, if you've done your homework, and if both parties agree it's a mutually beneficial fit, the remaining steps should be easy: The VC firm will give you a nonbinding term sheet to review. If that presents no problem, both parties investigate each other's facts and figures before negotiating the final points of the deal. Then lawyers draw up the documents. About a month later, you receive a check, and the VC firm appoints a director to your board. You and your VC share the same goal: to see your business grow and prosper. Once you've joined forces with the proper partner, Cremin says, "Get ready for the ride of your life."

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This article was originally published in the February 2000 print edition of Entrepreneur with the headline: The Truth About Venture Capital.

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