I recently had the opportunity to participate in the Venture Capital Investment Competition organized by The Rotman School of Management. In this competition student teams played the roles of Venture Capitalists and had to evaluate two real business opportunities and negotiate a termsheet with one.
This was a great opportunity to sit on the other side of the table and analyze a business from a VCs point of view. Our team had to critically analyze the business plans, listen to the entrepreneurs pitches, carry out due diligence sessions and successfully negotiate the terms of a deal with the entrepreneur. Through this exercise, I was surprised to learn some things which at first seem counter intuitive for start-up businesses looking to raise money from investors
1. Forecasting large revenue projections for pre-revenue companies is an exercise in vain:
- All companies forecast a ‘hockey stick’ revenue growth curve in hopes that when investors look at their projected growth, they will value them higher. In reality, investors rarely value a pre-revenue company based on its projected revenue (a method of valuation known as Discounted Cash Flow). Instead investors like to see a well thought out revenue model, in which growth is based on sound assumptions and a niche target market.
2. Don’t go to an investor if the only thing he or she can offer is money.
- Money is certainly important to grow your business, but investors, especially VCs, can offer a lot more value to the company. For starters, find a VC who shares your enthusiasm for your business idea and has similar vision for the growth of the company. Also, look at what else the VC can offer in terms of networks and marketing or technical expertise. This can really speed up the growth of your company and help you find opportunities previously unavailable to you.
3. Don’t fight too hard to keep a very large share of your business.
- All entrepreneurs want to keep control and a large portion of their business. But would you rather have 10% of a $1 million company or 100% of a company worth $0. Because, in reality, a pre-revenue company is essentially worth $0. VCs decide how much to invest for what percentage of the company by valuating the business based on various factors such as the management team, market growth and recent acquisitions or investments. It is important in the negotiation to understand the highest valuation the VC will go to, so you can get the best deal. You can also negotiate on other terms to maintain control, such as board structure and shareholders rights. Eventually it is a partnership, so you want to ensure that both parties are happy on signing the deal.
Well, my team managed to win 2nd place at the competition, beating out 6 other MBA teams.
Overall what I learned from this experience was this: Making a deal with a VC is like getting into a long-term relationship; there will be ups and downs, but both parties need to ensure they understand each other well enough to get through the tough times.
Shantanu Mittal is graduate student pursuing his Masters of Biotechnology from the University of Toronto Mississauga. He is currently the communications officer for the RIC Centre, a role which has helped him understand the world of entrepreneurship and business development. With his expertise in the life sciences and green technology sector, he has been able to provide valuable feedback to clients along with the entrepreneur-in-residence. Shantanu hopes to pursue a future in business development in the biotechnology or green technology industries.
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