A Venture Capitalist (VC) is a risk-taking investor who provides capital to companies exhibiting high-growth potential in exchange for equity in a company. Generally, VCs fall into two major groups: 1) those investing in companies demonstrating material business success or “traction;” and 2) those taking a greater risk by investing in companies whose business plan is more conceptual and major business hurdles remain. Today, we’ll talk about the common traits among both groups of VC investors.
VCs willing to take the greater risk of startups with the hope of much greater economic returns are often called “Angel” investors. Often, Angel investors enter after the entrepreneur has exhausted the ability to raise money from “friends and family.” Examples of Angel VCs are those willing to roll the dice on an investment to develop a new drug, design a new piece of software or to a develop a new medical device. VC investors wishing to take less risk may focus on companies that have already demonstrated stability and, possibly, cash flow but need additional capital for marketing or product improvement.
At the end of the day, the lines between the two groups tend to blur. All VCs hope for the “home run” deal, which confirms they made the right investment decision and produces significant cash returns. One “home run” should be more than enough to offset quite a few losses, which can be expected. VCs understand that losses are part of their risk-taking world.
All VCs, in their own way, look for the following:
- A strong management team with prior experience;
- A reasonable pre-money value, so the percentage of equity being acquired for the VC’s capital is fair;
- A well-written business plan, to which the VC can relate;
- Sufficient capital is being raised, along with cash on hand, to meet the cash needs of the business plan;
- A professionally prepared financial projection; and
- A demonstrated understanding of the plan, risks, competition and challenges.
One can step into the VC/Angel investing world by joining a small investment group or by investing in an experienced and successful private equity company. Each group or private equity company will have its own investment style and may have specific investment preferences. These groups come in many flavors. Some only focus on one type of business such as, for example, environmentally sensitive companies or pharma.
Depending on the group, you will meet bright people. You can ask questions and hear the questions of others and the answers provided by the entrepreneurs. You will appreciate the extensive due diligence required before any investment is made. Most groups require very limited membership commitment to join the group. In many groups, your willingness to assist in due diligence will be very much appreciated. The best benefit of these groups is the investment education you will secure by being a member.
If you are considering becoming a VC or Angel investor, do so with the counsel of your team of advisors. The Tax Warriors® at Drucker & Scaccetti have experience working with venture capital groups and, along with the rest of your financial team, can help you decide which group is best for you. Contact us with your questions.