The path to successful venture capital financing

Requirements for a venture capital investment

A venture capital company expects clear indications that a business idea works and thus a significant increase in value can be achieved. Such milestones will differ depending on the phase of the company, e.g. with regard to the functionality of a technology (Proof-Of-Technology) or the general customer benefit (Proof-Of-Concept). Overall, necessary requirements for an investment by venture capitalists are scalable business models, large markets and a convincing management.

Venture capital companies expect that a start-up has the growth potential to achieve a company valuation of several hundred million euros in a few years. Venture capital fund volumes have grown strongly in recent years, and more and more capital is available. Venture capital partners thus tend to be in a position to accompany larger financings and often participate in several financing rounds.

Plan and execute a venture capital financing round

The venture capital business is 100% a game of outliers — it’s extreme competition.

Marc Andreessen, entrepreneur and venture capital investor from the United States

It is essential for a start-up to stand out in order to receive venture capital. Therefore, good preparation is definitely necessary. The venture capital funding process can be very time-consuming and takes about three to six months, depending on urgency and preparation.

Approximately 30% of all venture capital investments occur because investors proactively seek contact with attractive start-ups, e.g. at special start-up events and networking events. To be successful there, you not only need a professional pitch deck, but above all a well thought-out “elevator pitch” with story-telling elements and a personal touch, so that the company remains in the listener’s mind.

Most start-ups, however, have to be proactive in their approach themselves. The main issue here is to find the right venture capital company and to observe its investment criteria. These include investment amount, phase of the start-up (seed, early stage, expansion), geographic focus, business model and industry. The information can be found on the corporate website of the venture capital provider, information platforms such as Crunchbase or available open-source investor lists (such as the COVID-19 European Investor Status List, provided by Kanso.io).

When searching for and approaching venture capital investors, it is a great advantage to have access to an existing network of angels, entrepreneurs, professors as well as friends and acquaintances. Regional institutions for entrepreneurship and start-up networks (e.g. BayStartUP, StartHub Hessen, StartUP Berlin, Hamburg-Startups) can also provide support in finding and approaching investors.

Many venture capital firms are literally flooded with new investment opportunities. Pitch decks sent in cold via email are often ignored; according to a Harvard Business Review survey, only 10% of all venture capital investments are generated this way.

A personal connection to a venture capital investor is key

More than 30% of all deal leads come from current and former work colleagues. 20% of deals come from referrals from other investors and 8% from referrals from existing portfolio companies.

However, only a few companies already have contacts in the venture capital market. For larger financing rounds starting at about €5 million, an experienced corporate finance advisor with an extensive network can add significant value. This not only helps to identify suitable venture capitalists, but also guides the young company through the entire process of capital raising.

In pitches and discussions with potential investors, founders have to face critical questions, but the exchange should not be too one-sided. Good and confident founders, and these are the ones venture capital companies want to invest in, want to understand, for example, what value contribution the investor can make and how the cooperation will be structured.

The valuation of the start-up is not everything!

When choosing the right investor, one should not focus exclusively on a high company valuation, but also on which investor fits the start-up on a personal basis and can promote it strategically. In addition, the choice of the first venture capital company can influence future financing rounds and the reputation of the company. The venture capital industry, especially in Germany, is relatively small and a known, cooperative partner for equity capital can greatly simplify future financing.

Often founders have too high valuation expectations and focus on published venture capital investments that circulate in the market. Such valuations are exceptional cases and can often only be applied to companies with enormously high growth. Furthermore, details of the VC financing and the terms are not known, these factors can also have a major impact on the company valuation and are often forgotten by external market observers.

Term sheet and due diligence

A term sheet is always non-binding, with the exception of a few clauses such as confidentiality. Make sure that not only the valuation is defined in the term sheet, but also other conditions such as liquidation preferences, possible anti-dilution protection, veto and co-determination rights, transactions requiring approval, minority protection rights and founder’s vesting. With the term sheet, the investor expresses a clear interest in the transaction, but this is not yet a guarantee for closing the deal, but paves the way for risk assessment (due diligence) and negotiation of the detailed contract.

In due diligence, the investor reviews all relevant documents, tries to better assess the team and the technology, and will often hold meetings with customers as well as experts. For larger financing rounds and data volumes, necessary documents are stored in a virtual data room. Many founders underestimate the effort to prepare all necessary documents, as it is often noticed during the preparation phase that important documents are missing.

If the preparation is inadequate, the due diligence phase can demand a lot of time from founders, and this time is hardly to be found in addition to the day-to-day business. In the same time, it is essential for the start-up company to pay attention to the achievement of the operational goals it has communicated. The financing process is an extra burden for the management team and leads to less time being spent on product development or customer relations. Failure to meet goals can lead to a loss of investor confidence. Particularly outstanding events should be communicated to the potential investor, such as winning a major new customer or early success in product development.

After the successful risk assessment and final negotiation, there is nothing standing in the way of signing and closing the shareholder agreement.

After VC financing is before financing

Collecting venture capital financing is only the first step; it is now important to use the new capital correctly and to implement it in profitable measures. Depending on the phase the start-up is in, the financial support can be used for product development, market launch or for new employees.

It is now necessary to define clear goals with the new investor and to establish efficient controlling and management processes. A regular exchange with the new investor, including monthly reports, is essential for the future cooperation. The newly acquired expertise and experience in dealing with investors will significantly help the company to move forward.

A good venture capitalist will work to scale potentially successful business models quickly and possibly internationalize them. Slow, but profitable growth is not desired. A founding team must be aware of this and be willing to play by these rules. When it comes to growth and the rapid occupation of markets, successful start-ups will need further usually much larger rounds of financing. In case of success, the first venture capital investment is only the beginning.

If you are planning a larger financing round, Quantum Partners will find the right investor and guide you through the entire venture capital raising process. Call us for a confidential exchange of ideas. We look forward to discussing our approach, our industry expertise and references for our work.

Achim Lederle
Managing Partner
lederle@quantum-partners.de
+49 89 414144 352

About Quantum Partners

Quantum Partners GmbH, headquartered in Munich, is a specialized corporate finance advisor that supports clients in company transactions as well as in finding financing.

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FAQ

A venture capitalist (VC) finances young companies with equity capital, i.e. receives a share in the company in exchange. A distinction is made between private VCs, corporate VCs – which belong to a larger company – and governmental and semi-public VCs.

A venture capitalist provides start-ups with growth capital from an investment fund and receives shares in the company in return. The venture capital provider often participates in several financing rounds and intends to exit within three to ten years.

In order to obtain venture capital, start-ups usually have to actively approach venture capital companies. Furthermore, regional networks, start-up events or business plan competitions can be useful. In case of a larger financing round or when approaching international and strategic investors, professional corporate financiers can support advisors in finding the right venture capital donor.

Venture capital typically describes the provision of capital to young, not yet profitable companies that are seen by the VC investor as having very high growth potential. Private equity covers a wide range of equity investments typically made in already established companies. Some private equity firms can invest sums in the billions, and mid-double-digit million investments are quite normal.