I just read the Q1 2011 report from CB Insights, which shows venture capital is back. Overall, investors put $7.5 billion to work across 738 financing deals with U.S. startups. That represents a $1.5 billion jump in funding over the same quarter of 2010 with a similar number of deals, so it clearly shows a trend to larger deal sizes for fewer startups.
To me, this indicates that venture capitalists (VCs) are looking for business, but not from first-time startups. Sure, there is always some seed funding (10% of overall deal flow), but you can bet that this money goes to entrepreneurs who have been there before and won. Angels are also moving up-stage, leaving a bigger and bigger black hole for new startups. Your friends and family are really the only answer until you have a significant revenue stream.
Back to VCs, Silicon Valley venture capital firms are still the most active. In fact, most of the most active investment firms are located there, although NY now has moved solidly into second place (ahead of Boston). That doesn’t mean that you have to live in one of these places to be considered, but it helps.
It also helps to keep track of the business sectors VCs are focusing on. Greentech deals had a breakout quarter with deals and dollars up 45% and 145% respectively vs. Q4 2010. Internet and healthcare deals stayed flat and funding actually dipped. Energy deals climbed with funding increasing significantly. Every quarter seems to have a new hottest sector, but these four will be near the top for some time to come.
So what can you do to get to the head of the venture capital investment queue? Here are some key action items that will give you some priority:
- Create an investment-grade business plan. This means build a plan that hits all the hot buttons; problem/solution, executive team, competition, business model, reasonable financial projections, and what’s in it for the investor. Be ready with a killer executive summary, investor presentation, and financial model.
- Line up a winning team. You have probably heard me say this too many times, but investors look harder at the people than they do the idea (bet on the jockey rather than the horse). They want founders who have been there and done that before, in the same business domain. Both operating executives and top advisors count.
- Timing is critical. Remember you only have one chance for a good first impression. Don’t try to talk your way to a deal before you have the documentation. Practice every step, including the elevator pitch to get the first meeting. Use friends, family, and angels, if possible, to get a product, revenue, and customers first before the VC connection.
- Identify the right people in the right firms. Mass mailing your business plan to every VC in the book won’t get you any credibility or traction. Investment firms specialize by business sectors, and each partner within the firm has a specialty. If you are in “energy,” do your homework to build a list of the top players in this segment.
- Make a personal connection, directly or indirectly. If you don’t personally know anyone on this list, talk to every professional friend you have to see who they know. Get introduced via one of the social networks, or a professional organization, before you approach a VC with a business proposal.
Overall, remember what VCs are looking for big numbers, in relation to angels or other potential investors. They are looking for products (not services) that will be "must haves" for customers, not "nice to haves," and they are looking to multiply their money by five to ten times in five years.
That means the target market must be large (at least $500M), proven and growing, with revenue potential of at least $50M within five years. Initial investment targets are usually larger than $2M, sometimes up to $25M or $50M. To make this work, you will need an initial valuation of at least $5M.
