Evaluating a Venture Capital Firm

What is the best way to approach and work with a venture capital firm? What do venture firms look for in evaluating a new company? How should the entrepreneur go about evaluating that firm and any financing it might provide his company?

Venture firms are as different as entrepreneurs. There is thus a wide range among these firms in terms of their industry expertise, business experience and, most importantly, their ability to work effectively with you.

Your process of selecting a venture firm is, therefore, much more analogous to the selection of key managers in your company than it is to the selection of a bank for a loan.

· "With a banker, the appropriate question is "How much money will he give me?"

· "With a venture firm, the right question is "How much money will he make me?"

This is because your venture firm, if used effectively, will be an important element in the continuous decision making process of your company. The venture capitalist can bring a broad perspective of experience to your corporate problems based on multiple other corporate situations in your industry with which he has been involved.

This experience enables him to recognize patterns within your company and industry niche which may be invisible to you. For example, he would be aware of external factors beyond your control which are already influencing other market niches in your industry and which your company will either capitalize on or be limited by.

When you select a venture firm, you are likely to be embarking on a relationship that will last five to ten years or more and which can be a pivotal factor in turning your company into a major enterprise. Because of the rate at which a high growth venture company encounters new challenges, decision making times can be greatly shortened. Therefore, the relationship with your venture firm can be critical.

A talented venture firm reinforces management's naturally good instincts on solving corporate problems and discerning industry directions. The less experience you have in some matters, the more you may need to rely on your venture firm's advice. The more experience you have, the more you will appreciate the quality of the advice.

The venture firm's investment makes it uniquely dedicated to your success. Venture firms only succeed; if you succeed and this frequently depends on their ability to persuade you to do what is in your own self-interest.

Therefore, the key question to ask in evaluating a venture firm is: do you believe that you can develop a relationship with the firm such that your confidence in it will accelerate your problem solving and decision making to enable you to emerge as a world class competitor in your industry?

Top Tier, Second Tier, Third Tier?

Everyone wants a top tier firm. The fact that they only fund 1/1000 plans should be reason enough to keep your options open. If you are lucky enough to be negotiating with a top tier firm, you will most likely be giving up more equity than a lower tier firm. The trade off for their help and connections is that a top tier firm will nearly guarantee you the entre's and support you need, where a lower tier firm may not have either the connections or the capacity to assure you second and third round funding.

Here is one example we ask our client companies to consider. If you had a choice to get the same money for different equity, which firm would you choose?

• Top Tier, 35% of equity
• Second Tier, 30% of equity
• Third Tier, 20% of equity

Be sure to investigate the venture firms portfolio companies, their current status, co-investors, and how these funded firms interact with the VC. Remember "There is always more money looking for a good deal than there are good deals looking for money." Be cautious and don't dive for the first check.

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