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Catching the eye of VCs
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June 16, 1999: 1:05 p.m. ET
Venture capitalists can help fund the growth of your small business
By Staff Writer Shelly K. Schwartz
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NEW YORK (CNNfn) - Ask any small business owner and they'll tell you: access to capital can be the biggest stumbling block on the path that leads to financial success.
For the entrepreneur with nothing more than a bright idea and a business plan, scaring up seed money can be more challenging still.
"The reason most businesses fail is because they are not properly financed," said Don Carson, a principal with The Ansley Capital Group in Atlanta, a financial advisory firm for small businesses looking to raise capital. "In today's world, increasingly the first guy to get to critical mass might be the one who wins the game."
Enter venture capitalists -- a fast-growing group of professional investors that have been bankrolling the growth of upstart firms for years. In many cases, VCs place their bets on private companies that their risk-averse counterparts wouldn't touch.
At present, the National Venture Capital Association reports there is $30 billion sitting in the hands of venture capitalists across the country, just waiting to find a promising new technology or business in which to invest.
And experts say getting a piece of that pie for your small company may be less far-fetched than you think.
"There is plenty of money out there looking for deals," Carson said. "There's not a problem in people wanting to make investments."
The investors
Venture capital firms are defined as private partnerships or closely-held corporations that invest in growth companies using money collected from their own institutional investors.
The largest investors in VC firms are public and private pension funds, NVCA reports, followed by endowment funds, foundations, corporations, wealthy individuals, international investors, and the venture capitalists themselves.
As a starting point for criteria, the association said most venture capital firms focus their investments on companies with solid business plans offering a potential for large returns within five to seven years.
"Because VC firms are managing other people's money, they are on the line to produce returns," said John Taylor, director of research for the NVCA. "The demonstrated potential for return has to be darn good."
A little history
Most venture capitalists these days establish funds that are industry-specific. For example, they may invest only in companies involved in the biotechnology or infotech sectors.
The funds also generally set parameters to define the growth stage of the companies in which they like to invest. Many target start-ups, but some choose to finance companies at the expansion stage, or only after management has demonstrated a proven track record.
For the most part, the VCs purchase an equity stake in the private companies -- usually totaling 30 percent to 50 percent.
Taylor noted, however, that venture capitalists are not just check writers. Once they bring new companies into their investment funds, they become actively involved in managing the company's growth.
Often, VCs discuss strategy with upper management, and frequently they sit on the board of directors.
"That's the whole idea," Taylor said. "They actively work alongside the entrepreneur, but typically as an involved board members."
For AmeriPath Corp. -- a pathology services company in Riviera Beach, Fla., that secured funding from Summit Partners in 1993 -- the added expertise that venture capitalists brought to the table during the company's growth years was the most important part of the relationship.
"The guidance in our early stages was related to management of the company," said Bob Wynn, AmeriPath's chief financial officer. "They were responsible for bringing in our CEO, which added significant value to the company."
AmeriPath's revenue grew to $200 million last year, from $16 million in 1994 -- helped largely by the know-how and management decisions of Summit Partners, Wynn said. The company went public in October 1997.
"This wasn't exactly a start-up company, it was an ongoing lab operation that was extremely profitable, so the funding was probably less important than the direction and guidance of the partners," he said.
AmeriPath isn't the only venture-backed company to go public in recent years.
Over the last 25 years, NVCA reports some 3,000 companies financed by venture funds have gone public, including such blue-chip giants as Microsoft (MSFT), Intel (INTC), Apple (AAPL)and Genentech (GNE).
The market
According to the NVCA, 1998 was a big year for venture capitalists.
Some 198 VC funds raised a record $24 billion, a staggering 64 percent gain from the year before. And the amount of capital invested by venture capital funds rose to $16 billion, up 12 percent from 1997.
Over the last few years, the investment community has been heavily courting the high-tech, communications and health care sectors. Computer software and services sector claimed the lion's share, roughly one-third, of all venture capital investments last year, bringing in more than $5.4 billion.
(Click here for a chart on last year's VC activity by sector)
California continues to lead the nation, as companies based there won the majority of VC investments -- nearly $6.5 billion. Massachusetts, Texas, New York and Colorado followed.
The largest U.S.-based VC firm, EM Warburg, Pincus & Co., invested $391.2 million in cash-hungry companies.
Success rates
In recent years, average returns for VC firms have been in the 30 percent to 40 percent range. But historically, returns on investment have been closer to 15 percent to 20 percent.
"VC firms have historically done much better than the public market," Taylor said. "It's the nature of high-growth capital. The participation is active and the business plans are reviewed more carefully."
With VC's, he said, "it's no-holds-barred in terms of what they look for in the due diligence process."
Carson agreed that venture capitalists aren't the risk-taking renegades some make them out to be.
"These guys don't roll the dice," he said. "They know all the right questions to ask and they know there are no assurances, but they are very tough on their front-end screens."
When and how to approach
So, how do you approach them?
For starters, Taylor said do your homework.
Get your hands on any of the various venture capital firm directories available in the bookstores, libraries or the one offered by the NVCA, which publishes its own membership directory.
Taylor said the lists should contain everything you need to know, including where the firms are located, what industry sectors they invest in, how much they have in their coffers and contact names at the firm.
Make sure the firm has the funds already in hand, though. Some accept business plans and then go scrambling to raise money for the investment - a less desirable scenario for you.
Also, if possible, try to send the bulk of your proposals to firms that are within driving distance to your company. Since the VCs will be taking an active participation role in your company's growth, they usually like to stick with companies close to home, experts say.
NVCA's Taylor said you'd also be wise to contact your industry trade association and find out which VCs have invested in your industry.
"The best way is to go directly to their Web site," he said. "They'll tell you how they want to be contacted and when. Some like a very short executive summary. Others invite business plans only when companies have produced revenues. They'll tell you what they are looking for."
He added you should be choosy, too. Look for VCs who will add value and expertise to your growth strategy -- firms that have dealt with companies in your industry before.
Sizing up the proposals
Perhaps the most important factor venture capitalists consider when reviewing business plans is the make-up of the management team - especially the chief executive officer.
"At the end of the day, they are really betting on the management team's ability to execute the business plan," Carson said.
Most often, he said, companies that come to The Ansley Capital Group for proposal-writing guidance lack a qualified financial person on staff -- either a chief financial officer or chief operating officer.
The Ansley Capital Group charges clients a success fee that ranges from 5 percent to 10 percent of the total capital raised, consistent with industry norms, Carson said. The percentage depends on the work involved in pulling together the business plan and the amount of capital raised.
Your odds
NVCA's Taylor said only 10 percent of all business plans presented get a serious look by the VC firms, and only 1 percent actually get funded.
As far as success rates go, experts say roughly one-third of the deals funded by VCs are successful, another third fail and the rest sort of glide along neither yielding huge returns nor slipping into the red.
But don't let the numbers scare you off.
"It's a small number, but it's not unusual for an entrepreneur who goes looking for money and is turned down to go back, retool their business plan and come back at them again," Taylor said. "It's not as formidable as it sounds."
He added the rejection process will usually produce helpful feedback on why your business plan did not meet the VC firm's criteria and how you can make it better.
"A smart entrepreneur will go back and present it again," Taylor said.
Get started early
Lastly, Taylor said it can take two to three months to secure venture capital - if your business plan is approved at all. But depending on your proposition, it can take much longer.
"It's never really too early to start contacting the venture capitalists once a business plan has been thought out and once you know when you are going to need the money," advised Taylor. "Don't wait until the week before you need it."
Ashley Capital's Carson said that's good advice.
"Don't wait until you are 90 days away from running out of cash to raise capital because you can't do a good job in 90 days," he said. "Also, go out and start talking to potential investors early on. These people are very, very busy and their biggest question of the day is which phone calls do I return."
Good luck! 
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