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Why VCs Often Turn Away Promising Investments

Why VCs Often Turn Away Promising Investments
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True story: My VC firm just had a fantastic meeting with a potential investment. The company is in a sector we target; it has strong growth potential and a seasoned management team. Yet the meeting ended with us turning them down.

In VC speak, the reason behind the rejection went like this: "Our second fund's vintage necessitated a later-stage investment with liquidity prospects that better matched the LP-contractual investment and harvest period."

Translation? We need investments that are going to pay out sooner rather than later.

This sort of thing happens all the time. Entrepreneurs with great ideas seek out VC firms that appear ideally matched to support their business model, only to be told "no thanks."

Often, they don't understand how the money flows. A common misconception is that VCs simply tap a massive slush fund for their investments. In fact, traditional VCs manage multiple funds, usually with a 10-year span between the time their clients invest and the time they get their money back, plus profits.

Here's how it breaks down: The first five years of a fund's life is known as the "investment period," the time when it's considered active and is invested in startups. The next five years is known as the "growth" or "harvest" period, and it's when a fund is usually considered inactive.

A quick search online for news about recent early-stage investments is a good indicator of whether the VC has active funds available; this will allow you to cull the list of firms you hit up (saving you time and heartache).

The age of your company also has enormous implications on whether an active fund is able to invest. As a fund grows older, the VC has less time to liquidate its assets (the equity stakes in startups) to funnel a return to investors within the 10-year window. This is why early-stage startup deals often happen in the first three years of a fund's life. After that, the investment window dwindles significantly--businesses without a specific three- to five-year liquidation strategy need not apply.

So if you are rejected, don't automatically assume it's your business plan that's the issue. It could be the firm's approach to its fund's investment cycle. If you're not sure, just ask the people involved. They'll appreciate--and remember--the fact that you want to understand what they do.

Sam Hogg is a venture partner with Open Prairie Ventures, a Midwest-based venture-capital fund investing in agriculture, life-science and information technology.

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This article was originally published in the April 2013 print edition of Entrepreneur with the headline: Window of Opportunity.

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