How Do I...Get Some of That Venture Capital?

The owner of a start-up recently told me that he went to a local bank for a loan, but left empty-handed. The bank's message? "Sorry, but we've got our own problems," -- or was that loan problems?

That's no surprise with what's been happening on Wall Street -- a number of banks have gotten tangled in the subprime mortgage mess -- but it's obviously not a good sign for the economy.

A September poll on small business optimism by payroll provider SurePayroll found that only 44 percent of small business owners are optimistic about their future; the first time that figure has fallen below 50 percent in the annual study. Small business owners also have mixed opinions about whether the government's efforts to bail out Wall Street will help or harm small firms.

More than 70 percent of voters say the health of the economy depends on the success of entrepreneurs, and 80 percent want to see the government use its resources to actively encourage entrepreneurship in America, according to a study (pdf) released last week by the Ewing Marion Kauffman Foundation. The same study found that 56 percent of respondents said they trust small business owners to guide the economy compared with only 14 percent who said they trust members of Congress.

In this new economic climate, many entrepreneurs are looking for alternatives to banks for their funding needs. I posted an interview last week with a venture capitalist who specializes in investing in consumer products, services and small retailers. In this second installment, I ask an expert what a business needs to know if it wants to pursue venture capital.


Melissa Carrier of the Dingman Center for Entrepreneurship connects investors with small firms. (Photo courtesy University of Maryland)

Melissa Carrier is the director of investments and social venturing at the Dingman Center for Entrepreneurship, part of the University of Maryland's Robert H. Smith School of Business. She counsels start-ups and small businesses in their efforts to connect with private investors.

Small Business Blog: What are the job duties of the director of investments and social venturing?

Melissa Carrier: I manage a program called Capital Access Network. It's dedicated to connecting D.C. metro area entrepreneurs with private investors. (CAN helps firms in Maryland, Virginia, Delaware and D.C.) We help firms seek the right amount of capital and find the right types of capital whether it's equity investment or friends and family, and we help them pitch their business. Once [a company has] decided to seek outside investors, it's important to know how to prepare your business for outside scrutiny; you've got a lot of opinions coming at you.

SBB: I interviewed the head of a VC consumer fund recently who said venture capitalists are "almost like ice cream. We come in all sorts of different flavors." If you're a small business, how do you know if you want the rocky road or the peppermint stick?

Carrier: You have to go through an education process -- be smart about how you approach outside investors, look internally, look at business operations and try to decide what it is you really need in terms of funding and expertise. Some companies don't need a lot of money, just some. What they need is a strong experienced investor to give them strategic introductions to business partners. Those companies would be better to go toward angel investors. But if you're looking at doing drug discovery in biotechnology, you're going to need tens of millions of dollars. You're going to be better targeting VC funding.

SBB: Many entrepreneurs are confused about the difference between angel investors and venture capitalists.

Carrier: Angels are high net-worth individuals. They typically are cashed out entrepreneurs or ran start-ups previously. They want to invest their own money. They either want to give back to the entrepreneurial community or be part of that start-up experience, but some want to make money. We've found they invest on average about $33,000 per deal. A venture capitalist is an institutional investor. They're making bets on high growth companies that they hope will have a sizable return. They're investing at much larger amounts - usually $2 million and up. VCs are also investing other people's money such as funds from limited partners like pension funds or institutional investors.

SBB: Is there a particular type of company that should seek out one or the other?

Carrier: About 90 percent of all early stage investment comes from angels. Venture capital is not for everybody -- it's really for companies that have a scalable strategic growth path that allows them to take a large market share in their industry with the vision to either be acquired by a bigger player or to go public. Entrepreneurs who want to grow their business to $2 million in annual revenue and want to run their business for cash flow would not be good candidates for venture capital. [For VCs], you have to demonstrate that your business model can reach $15 million in three to seven years.

SBB: Have you seen much interest from VCs in industry sectors other than technology?

Carrier: There are many specialty funds. There are a few VCs specializing in the organic food industry. There are funds that invest in retail businesses, particularly retail where it looks like an entrepreneur has two locations for their business and it's got such a great model that it could be franchisable. Baskin Robbins had to start somewhere. VCs like to see something that you can take national.

SBB: How do you convince someone that you're not a fad, but a trend?

Carrier: You're going to have to find the right investor who believes in you as an entrepreneur. What one person thinks is a fad might be a tremendous opportunity. As a start-up, you might pitch to 75 investors before you find the right one. There's no real magic to it, just continue to do your homework...It's about finding the right connection.

SBB: How does a group like CAN help?

Carrier: At CAN we spend a lot of time coaching companies. We go through a business plan and look at their investor presentation. We offer advice and guidance, give them tricks of the trade. Sometimes it's a simple thing like if you're presenting a market data number. Is it really a measurement of what you need? We help entrepreneurs think of the relevancy of the information they're presenting. So many entrepreneurs think they need $1 million in funding and might say they need it for marketing and sales but offer no details. Could you get away with using $500,000 or is $1 million not enough and you actually need $3 million?

CAN is like the Match.com of the investor community. It's up to them to close the deal, but once you have an investor on board, you're married to that person. There's got to be working relationships that have elements of trust.

SBB: How should an entrepreneur or someone looking for funding begin the process?

Carrier: Get out there and begin networking. Attend as many events as you can to start to understand the investor community. Potomac Tech Wire offers a daily e-mail listing events. There are also tech events by the Northern Virginia Technology Council. The [Center for Innovative Technology] Gap Fund hosts good sessions and several law firms like Morrison and Foerster host dinner series for entrepreneurs. There's also the TIE-DC program and the [Massachusetts Institute of Technology] forum. A lot of the local tech councils are great resources. The Maryland Tech Council hosts monthly morning sessions to learn about investing, how to grow your business and how to raise capital in turbulent times.

SBB: When you meet a potential investor, perhaps at a networking event, do you really need to have an elevator pitch ready? A venture capitalist recently told me he was wowed by someone who managed to print his pitch on the back of his business cards.

Carrier: You better have your elevator speech ready. You need 60 seconds to tell anybody about what your business does and what it means for you. It needs to grab anyone's attention.

SBB: Do you have any advice on how to make that pitch sound coherent and compelling?

Carrier: It's tough, absolutely. Choose your language carefully and don't be too wordy. Focus on a few points like what's the market, why you are in the business, are you solving a program and how are you solving it.

If you can't articulate what the problem is in the marketplace, you don't have a chance to be successful. We have five points that we teach entrepreneurs on the investor pitch:

What's the problem and who has that problem?
How big is it?
What is your solution?
Why are you going to solve it?
Is it viable? Can it profitably grow?

We don't want to go back to 1999 [when many tech firms were given money despite not being able to answer those questions].

By Sharon McLoone |  October 6, 2008; 7:02 AM ET How Do I... , Q&A
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VC Experts.com offers a great resource to educate individuals on Venture Capital.

Posted by: Michael | October 6, 2008 9:48 AM

Just attended the excellent MassTLC unConference in which mutliple VCs and Angel investors discussed how to land your first round of funding: http://www.thoughtlabs.com/blogs/2008/10/06/getting-the-first-round-of-funding-the-venture-capital-process/

Posted by: Cappy | October 6, 2008 2:17 PM

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