William Rosellini

What Tech Entrepreneurs Should Know about the Venture Capital Process

In a downtown Austin incubator, on a warm Texas summer morning, five tech entrepreneurs swapped horror stories about venture capital firms. One of them proclaimed, ‘even the coffeeshop we’re meeting at has gotten venture capital.’ They were all searching for money sources, but none of them could fathom taking on an investment from a venture capital firm; moreover, they were so turned off by the terms of a VC offer that they would rather not accept outside capital, opting to tough it out.

For all the terrible stories out there, there’s a few that are substantially worth the time to listen. However, the Tech community is well aware of the upsides and pitfalls of venture capital. After-all, it’s now being taught in most business schools, such as Harvard, and Yale. As discussed in the Harvard Business Review, “VC’s look more like bankers, and entrepreneurs look more like MBA’s.” (see the Harvard Business Review).

With regard to whether venture capital is a viable source for money, there are two schools of thought among the Tech community: (1) VC’s provide early stage funding in exchange for hyper growth, and (2) given that most startups choke and die on the hyper growth, VC money is not a good idea for startups. (see the New York Times).

Tech entrepreneurs know the general process as containing four parts:

  1. The Entrepreneurs
    People with unique ideas who need money to bring the idea to market, but must provide a formal pitch; including, a detailed business plan and pitch deck, and a general valuation with a preliminary investment structure scenario, as a beginning negotiation point, also known as a mock term sheet;
  2. The VC’s
    A group of people who manage a large fund and invest in startups based on their firm’s criteria for each investment, which often includes investing in a specific industry. This criteria typically involves an early stage idea with huge upside potential, and a management team that can handle the accelerated growth, but who also comprehend the exit plan needed by the VC to reap a windfall profit;
  3. Private Investors
    Investors who invest in VC’s, sometimes involves only the principles in the firm, but other times brings in outside capital from third party investors; and
  4. Investment Bankers
    People who have access to public markets, who cash out the investors by taking a company public.

While the VC process is arduous and time consuming, it can also be very rewarding. As discussed above, like any business risk there is upside and downside, but VC’s are generally very hands-on in their approach to managing their investment, for example, most VC’s will have a member of their staff sit on the Board of Directors for their portfolio companies. These directors then offer advice and consulting to help the company achieve its growth projections. Most Tech entrepreneurs know this and prepare for a member of the firm to sit on their board.

While the tech community understands many of the methods used by VC’s there is an area of confusion that creates questions, such as, voting rights for board members, and VC’s who limit voting powers to the entrepreneurs, in an effort to manage risk. This is the area that usually manifests into distrust of VC’s. VC’s have very good attorneys, and most techies understand that they need to obtain the best legal counsel available, especially when working with VC’s.

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