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Friday, May 1, 2009
Inside Venture Capital
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How is the economic crisis affecting tech companies?
Obtaining financing for your venture can be difficult in any economic environment. Unfortunately, this has become more challenging in this economic downturn. Here are some ways to you can increase your chances of attracting funding.
1. Build a strong team. Investors highly value the experience and skills of those running the business. To investors, people can be as important as technology or market opportunity. In difficult economic times, investors are more likely to invest in teams that they know or have backed before. Therefore, you should seek to assemble a team with a proven track record. A weak economy — where even people with successful management experience may be out of work — may actually make it easier to assemble a team with a proven track record. Take advantage of this opportunity to build your team before approaching potential investors.
2. Build a compelling solution. Build a business whose solution customers will need — and pay for — even in a difficult economy, because the solution generates increased revenues, reduces costs or improves efficiencies. In a strong economy, companies whose products deliver incremental improvements or that offer “nice-to-have” solutions can still derive revenues from customers and can still attract funding. In tough economic times, however, companies that address a significant and current “pain point” in their market and whose customers are therefore likely to buy their solutions even in a poor economy are more likely to secure financing.
3. Take advantage of reduced competition. Delivering a solution that is superior to your competitors’ products is important now more than ever. Ironically, the poor economy might benefit entrepreneurs in this regard. As more-established businesses reduce their R&D budgets to focus on their core businesses, early-stage companies can develop applications that target areas where more established companies are not devoting their time or resources.
4. Build a sustainable business plan with an attractive cash flow story. Investors prefer companies that already have revenues or will generate revenue quickly. Businesses that have a “first-mover advantage” are also attractive. However, in this economy, revenue or being the “first-to-market” may not be enough. Investors are increasingly focused on business models that include lower projected cash needs and lower burn rates. So, develop your business plan to show potential investors that their capital will last longer and help the company achieve more important milestones.
5. Consider funding alternatives. Identify alternative sources of financing, particularly non-dilutive sources like government funding. These sources may help fill any “funding gap” between your financing needs and what investors are willing to invest. Having more than one funding option provides you with flexibility and provides you with leverage in negotiations with investors. Moreover, financial investors will be pleased to learn that plans include non-dilutive alternatives.
6. Know potential investors. Entrepreneurs should focus as much on screening potential investors as they focus on identifying and pitching to them. Some venture capital firms have had, or are likely to have, difficulty raising the funds they had hoped from limited partners whose own portfolios have been hard hit by the downturn. As a result, some venture capitalists may not be capable of providing sufficient funding for your business over the long-term. Do your own due diligence to determine whether firms are actively investing and to determine whether firms have raised funds large enough to participate in future equity rounds.
Raising outside capital is always a challenge, but is even more so in difficult economic times. Entrepreneurs can increase their chances of attracting financing by using difficult economic conditions to their advantage by, for example, tapping a larger talent pool to help them build a more experienced team and taking advantage of potentially reduced competition. Combining these elements with a smart business plan and attention to all of your fundraising options will increase your chances of success.
Increase your chances
Ways that entrepreneurs can increase their chances of attracting funding — especially in difficult economic times
• Build a strong team
• Build a sustainable business plan with an attractive cash flow story
• Know potential investors
• Take advantage of reduced competition
• Build a compelling solution
• Consider funding alternatives
Mick Bain is a partner and Joshua Fox is a counsel in the WilmerHale Venture Group in Waltham. They can be reached at michael.bain@wilmerhale.com and joshua.fox@wilmerhale.com.
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