Venture Capital Debt Financing
The Requirements To Even Be Considered
When attempting to access venture capital, there are certain things that need to be in place to be considered. Below, I’ve outlined what 99.9% of venture capitalists are going to look at when it comes to determining wheher or not a loan will be issued. Here are the 6 requirements to move forward with venture capitalists.
Requirement #1: Credit
Credit is always important in today’s lending market and many times lenders see it as a reflection of the business owner. There are always exceptions to this rule as most business owners will go through adversities at some point but it’s important to know your personal and business credit before you approach anyone for a loan. When it comes to Venture Capitalists they tend to look for long term partnerships so if you do have credit hurdles make sure you point them out up front and have a good explanation. Understanding how credit affects a business loan can help you through the process of getting venture capital debt financing.
Requirement #2: Executive Summary
Your executive summary is your pitch. You’ve heard of and probably even given an “elevator pitch.” Write your business plan’s executive summary like it’s an elevator pitch that you’ve had the time to edit to perfection. It should introduce you, your business and your product, but the purpose of writing an executive summary is also to deliver a hard sell. Convince your reader here that you have a great idea they should invest their time and/or money in.
Write it last. Even though the executive summary is at the beginning of a finished business plan, many experienced entrepreneurs (including me) choose to write the executive summary after they’ve written everything else. Ideally the executive summary is short—just a page or two—and highlights the points you’ve made elsewhere in your business plan, so if you save it for the end, it will be quick and easy.
What Should An Executive Summary Include?
If you’re looking for investment or a loan, say so in your executive summary. Specify the amount required, and in the case of an investment, specify the percent of equity ownership offered in return. (Leave loan details out of the executive summary.)
And if you’re shopping around for capital, your executive summary should be persuasive. Make your prospective investor want to keep reading; convince them to invest in your new business idea.
The best way to do this is to include these 7 key components of a pitch:
The most important thing is to identify a problem that is worth solving. If your product or service doesn’t solve a problem that potential customers have, you don’t have a viable business. Simple as that. The problem you solve doesn’t need to be earth-shattering—”there are no good ice cream shops in Portland” is a perfectly valid problem to solve with a business—but you need to identify it.
Once you’ve clearly defined the problem you’re solving, you need to explain your solution. A clear problem statement will help you focus your solution on solving that one problem, and not stretch the solution to solve multiple potential problems. Try to describe your product or service and how it functions as a solution in just a few sentences or bullet points.
- Target Market
It’s always tempting to define a target market that’s as large as possible, but that does not make for a credible pitch. For example, if you want to open an ice cream shop in Portland, you might think your target market is “everyone in Portland who eats ice cream”. But what’s the personality of your business? Is your ice cream shop a kid-friendly place with lots of candy toppings and funny flavor names and maybe even a playground? Is it an artisan place with locally-produced ingredients and intriguing flavors like Raspberry-Habanero Sorbet? For the first ice cream shop, your target market is Portland-area families with young kids; for the second, your target market is Portland-area foodies.
Next you’ll need to do a little research to estimate how many people are in each target market segment you’re after. If you live in the US, the U.S Census site is an invaluable resource for this. The SBA site also has a great collection of links for market research. After you have some population data, try and estimate what an average person in each group currently spends each year on their current solution to the problem you are solving. Now, just multiply the number of people in your target market segment by how much they currently spend and you will have a realistic “market size” number or your target market. These numbers are critical and are part of any good pitch.
Every business has competition. Even if no one has come up with a solution similar to what you have come up with, your potential customers are solving the problem they have with some alternative. For example, the competitors to the first cars weren’t other cars but horses and walking. As you think about your competition and existing alternatives, think about what advantages your solution offers over the competition. Are you faster, cheaper, better? Why would a potential customer choose your solution over someone else’s?
No matter how great or unique your solution is, if you don’t have the right people on board, you won’t be able to see it to fruition. Why is your team the right team? Explain how you and your business partner(s) are each uniquely qualified to execute your vision for this business, and why you are the right team to bring this business to success.
If you don’t have your entire team in place, that’s not a mark against you. The more important thing is to understand that you have gaps in your management team and that you need to find and hire the right people. Address any gaps you think you have, and explain your plan for filling them.
- Financial Summary
Where does your revenue come from, and what are your expenses? If your business plan is developed enough that you have a detailed sales forecast and expense budget included, reference the numbers you have (and direct the reader to the correct page of your business plan’s financial summary in case they want to see more). If you don’t know your industry very well yet and are still assembling a detailed financial summary for your business plan, that’s okay—for a pitch, a detailed forecast and budget aren’t necessarily required. Explain your business model and detail how your business will earn revenue and what your expenses will be in operation.
Talking about upcoming milestones in your pitch makes your business a reality. Tell your reader about your upcoming goals and when you plan to achieve them. If you have already accomplished notable milestones, you should mention those. For example, if you are opening an ice cream shop, investors will want to know about your plans to sign a lease, design the interior and open for business. Or if you’ve invented a new medical device, prospective investors will want to know where you are in the clinical trial process. What steps have been accomplished and what’s the projected schedule for final approvals from the FDA?
Never waste words in an executive summary. Experts differ on how long an executive summary should be—some insist that it takes just a page or two, others recommend a more detailed summary, taking as much as ten pages, covering enough information to substitute for the plan itself—but although 50+ page business plans used to be common, investors and lenders these days expect a concise, focused plan.
Requirement #3: Business Plan
A business plan is a formal statement of business goals, reasons they are attainable, and plans for reaching them. It may also contain background information about the organization or team attempting to reach those goals.
Business plans may target changes in perception and branding by the customer, client, taxpayer, or larger community. When the existing business is to assume a major change or when planning a new venture, a 3 to 5 year business plan is required (See Pro Forma), since investors will look for their annual return in that time frame.
Requirement #4: 5 year Pro Forma/Cash Flow Projections
Pro forma is a Latin term meaning ‘for the sake of form’. In the investing world, it describes a method of calculating financial results in order to emphasize either current or projected figures.” The purpose of a pro forma statement for a small business is to summarize how much money the business will make over a three- to five-year period, less any expenses incurred. It is structured so as to show revenue projections, estimated expenses and positive cash flow within a business plan.
Requirement #5: Detailed “Use of Funds” Statement
When pursuing business capital, the desired use of the proceeds received from a business loan or venture capital transaction is detailed in the Business Plan. After the executive summary, which provides a broad overview of the project, the next page should be a statement for the Detailed Use of Funds. Investors and lenders want to know the funding request is based on a well thought out plan. The Detailed Use of Funds provides the funding source insight into where the capital will be going.
If the detail is not provided, it will appear the funding request does not have a solid foundation. The word “Detailed” in the term means that the statement should provide a clear and concise break down of the use of proceeds. A statement that is general and vague won’t be acceptable. If the funds will be used to purchase equipment, then the manufacturer, equipment type, model number, etc., should be listed and each piece of equipment priced. If there is going to be shipping, installation fees, and sales taxes then funds for those expenses also need to be specified.
When there is an acquisition of a business, the business plan and funding request will include amounts for real estate, equipment, inventory, and goodwill. Each category should be broken out and supporting documentation in the business plan will provide the sound reasoning of why the items have that value. Real estate appraisals and business valuations will be part of the supporting documentation. When the total amount needed to fund the project, adds up to $1,234,567.89, this is a specific amount the Lender will use to base their calculations on. If the funding request is for $3 million…..where is the rest of the money going? The rest of the business plan should support the Detailed Use of Funds statement. To be successful at obtaining the required funding be clear, concise, and specific.
Requirement #6: Co-Capital
Most businesses are familiar with the lending practices of banks, one of the more familiar practices of a bank is to ask for collateral and this can be the end of the line for those seeking a business loan. In the Venture Capital world you will hear the term “co-capital”, which is term used to describe the prospective borrower contributing liquid funds to their project.
Co-capital is a percentage of the loan amount and can range from 5%-20% in most instances. An example would be if you are pursuing a loan in the amount of $5,000,000 the investment bank would ask for a “co-capital” contribution of 10% of the loan amount which would equal $500,000.00. The co-capital is held in escrow and is used for 2 purposes. One purpose would be to protect the investor in case of default and the 2nd purpose is what the lending world calls “skin in the game”, what this means is the investor is not comfortable being the only one holding the risk so they pass on a small percentage of that risk to the business that seeks funds. Co-capital is usually held in escrow and returned to the business once they pay off their loan.
The requirements outlined above will help any business owner be in a position to be successful at accessing venture capital debt financing. Without each requirement, you’re likely to fail at accessing the money. So don’t cut yourself short or take short cuts. Be sure each requirement is up to the standard you need it to be before presenting your business idea. You only get one shot with VC’s typically so you want to have all your ducks in a row.