The Entrepreneurial Bible to Venture Capital - Book Summary

A peek into the venture capital world: Bolster your startup with the right funds.

Every successful startup has a backstory involving a daring investor who braved the early-stage pitfalls — the phase where the risk of failure is alarmingly high. This investment maverick is typically a venture capitalist, a daring individual who's not afraid to place all their chips on the line in the hopes of hitching a ride with the next big thing — perhaps the upcoming Facebook or Twitter.

Dive deep into this narrative and unearth the day-to-day realities of venture capitalists. By doing so, you'll gain a nuanced understanding of how your startup can secure the crucial funding it needs to taste success. There's no two ways about it — you have to play your hand skillfully in the venture capital game if you aspire to emerge victorious.

In this narrative, you'll explore

how you can assemble an impressive management team that can draw investors like bees to honey;

why possessing a foolproof exit strategy is tantamount to success; and

why finding an "angel" should be your priority before you even contemplate knocking on a venture capitalist's door.

Surge in technology startups fuels venture capital investment spree.

Anyone who's rolled up their sleeves and delved into the startup ecosystem, perhaps even birthing a startup, would attest to the invaluable role venture capital plays in birthing business dreams.

But let's put a pin in that for a moment — What's venture capital and how does the machinery work?

Venture capital is akin to a lifeline thrown to fledgling companies by the private sector to help them find their footing and expand their horizons. Venture capital, or "VC" firms, are always on the lookout for promising investment avenues in fast-growing sectors like information technology (IT) or biotech. In return for their financial injection, the startup hands over a sizeable chunk of its company equity to the VC firm.

The venture capital landscape has been witnessing an unprecedented boom in recent times, with an influx of startups seeking investment to power their growth. There's never been a more opportune time to kickstart a new company.

Rewind to the 1990s, and the scene was markedly different. Startups faced an uphill task in putting together the finances to cover costs associated with servers and software licenses.

Fast forward to the present day, as technological advancements gain momentum, the financial burden of birthing a new company has significantly eased up. Cloud computing has dramatically reduced storage costs — to cite just one example. Presently, launching a beta version of a website or mobile application could set you back less than $5,000!

VC firms are well aware of the high stakes, but they also recognize the vast potential that a startup's idea holds. Traditional banks usually shy away from extending loans to startups without a market-ready product, but VC firms are more than ready to shell out the necessary funds at an early stage, in anticipation of a hefty future payoff.

The word "venture" alludes to the risks VC firms willingly take when they invest in a new company. But here's a sobering statistic: Around 60 percent of startups backed by venture capitalists file for bankruptcy before they can recoup the investment.

Shockingly, only one in ten venture capital investments hit the jackpot — but that lone success might well be the next Facebook or Twitter in the making!

Venture capital firms: A symbiotic partnership aimed at a profitable exit.

With the eruption of the startup ecosystem, venture capital transactions are happening at breakneck speed globally. But do you really know how a venture capital firm operates?

A typical venture capital firm is structured as a limited partnership. The bulk of the investment capital comes from limited partners (LPs), while general partners (GPs) of the fund channel that capital into various projects representing the LPs.

General partners, however, don't stand idle; they, too, invest their money in ventures. To put that into perspective, if a general partner rallies $100 million from limited partners for a specific project, it's not uncommon for the general partner to toss in an additional $1 million to $5 million, reflecting the venture capital firm's confidence in the project.

A venture capital firm has a single-minded aim — to make a profitable exit when the backed startup goes public or changes hands. The venture capital group's objective is to reward its investors with a handsome return on their initial investments. Naturally, the venture capital firm wants its slice of the pie too — typically around 20 percent of the final public valuation or sale price.

So, how does a venture capital firm cover its operational expenses? It retains a management fee, roughly two percent annually, on the total original investment.

If you're wondering who to reach out to at a venture capital firm, here's the breakdown:

The pecking order starts with general partners, then managing directors, followed by partners. These decision-makers determine investment strategies. When you're ready to pitch your groundbreaking idea, these are the folks you need to impress.

Initial boost from an angel investor paves the way for venture capital influx.

Every fledgling start-up requires a healthy dose of funds to spread its wings. An excellent way to secure this initial capital infusion, particularly when you're still finding your footing, is through an angel investor.

So, who exactly are these angel investors?

Angel investors are individuals who personally channel their funds into companies, nurturing their growth. The concept of "angels" first saw the light of day in the 1920s in Los Angeles. Back then, affluent individuals backed the production of the earliest Hollywood films. The term "angel" eventually found its way into other business domains, with generous benefactors willing to part with their money to aid young companies becoming known as business angels.

Since then, the influence and significance of business angels have only grown. To illustrate this, in 2011, the overall investments made by angel investors outstripped those made by venture capital firms.

Start-ups stand to gain immensely from angel investors. They provide crucial financial backing without demanding too much in return. This is a striking contrast to venture capitalists who typically insist on a large enough share in a start-up to have a say in its decision-making.

More importantly, an investment from an angel opens the doors to profitable networking opportunities, improving a start-up's odds of securing additional funding from a venture capital group.

Let's envision a scenario — your biotech start-up is engaged in pioneering a cure for cancer. Given the enormity of the task, you're on the lookout for a billion-dollar investment. That sum is likely too steep for any single investor. However, an angel investor could bankroll your preliminary lab trials. If those trials yield promising results, you'd have a stronger case when pitching to a venture capital firm.

But here's a word to the wise when hunting for funding from angel investors — don't aim for the stars. Banking on an angel investor to come up with $10 million might be a stretch. Typically, angel investors invest anywhere from $500,000 to $1 million in a single project, providing just the right amount of capital to navigate a start-up through its maiden year.

For venture capitalists, a robust, versatile management team is key.

In the real estate world, location is the mantra. For venture capitalists, it all pivots around the management team.

The future of a start-up rests heavily on having an adaptable yet proficient management team. The quality of a start-up's business plan is a secondary consideration. In reality, the management team will have to continually refine that plan, altering the course to react to market dynamics and pressures. Being prepared to tackle unexpected hurdles is a must.

That's why venture capital firms seldom invest in ideas in isolation. It's always more prudent to back a capable team.

The foundation of most triumphant companies is a strong, balanced team. An unmistakable pattern emerges when you analyze Silicon Valley's success narratives: successful companies often stem from the blend of a visionary leader with a global outlook, a technical expert capable of actualizing the vision, and a salesperson adept at moulding a product to meet market demands.

A prime example of this winning formula is the computer graphic card pioneer 3Dfx. Back in the 1990s, the founding trio of this company included a visionary specializing in polygonal mathematics, a Massachusetts Institute of Technology professor with expertise in 3D mathematics, and a seasoned senior sales vice president.

This is the kind of team that captures the attention of a venture capitalist. A company with a missing link in key positions signals a potential imbalance in the management team. Additionally, venture capitalists raise eyebrows at a start-up unable to lure at least one founder with a strong technical background.

All things considered, if the management team fails to impress, venture capitalists may conclude that the start-up is not quite ready for an investment.

A creative approach to growth and innovation draws venture capital investments to start-ups.

Entrepreneurs, in their excitement of securing needed capital, can sometimes lose sight of their goals and embark on a spending extravaganza. Let's delve into some of the usual pitfalls to equip you to sidestep these traps.

Avoid the temptation of splurging on marketing at the onset. The growth trajectory of start-ups should be charted by crafting a captivating product that taps into a market gap. If you've hit the bullseye, you wouldn't have to dedicate too much energy or resources explaining your product — it should stand out on its own merits.

Take, for instance, Facebook, Uber, and Paypal — none of these brands pumped an excessive amount into advertising. Instead, they channelled their resources into infusing value into their products.

Real innovation emerges when your start-up can spot a need that the market hasn't even discerned yet. Apple's Steve Jobs perfectly embodies this out-of-the-box thinking: his belief was that most people didn't recognize what they desired until it was presented to them. Market research is just one side of the coin; your idea needs to not only cater to present demands but also anticipate future needs.

However, a cutting-edge concept isn't a sure-shot formula for success. You also need a game plan to introduce your concept to the right audience. Venture capitalists are keen to learn how a start-up plans to cultivate a community around its product or service.

Skype serves as an apt illustration of this. When Skype was first launched, it was one among 200 start-ups offering similar telephony services. But Skype carved out a unique identity by displaying a banner on Kazaa, a well-liked file-sharing service at that time.

The banner cheekily read, "Don't pay for your music, why pay for telecom?" This tongue-in-cheek remark resonated with the Kazaa community and swiftly bolstered Skype's user base.

Remember, your product should inherently carry viral potential; you can't artificially instill it post-launch. For instance, YouTube allows users to upload a video and then embed it elsewhere. Consequently, YouTube-branded videos are ubiquitous online, making it an enviable viral concept.

A start-up must master the dual art of creating a thriving business and orchestrating a sound exit strategy.

At the crux of a venture capitalist's strategy lies the aspiration to invest in a start-up and reap profits when the company gets sold or goes public. As an entrepreneur, it's your responsibility to demonstrate to potential investors your cognizance of their goals through a credible exit strategy.

The true test for a start-up is to shape a viable business, generate consistent revenue, and cultivate a dedicated customer base that eventually positions the company as a sellable asset. Achieving this is no walk in the park, and even tech giants like Google have grappled with it.

Take, for instance, the early 1990s when Excite, one of the pioneering internet portals, had an opportunity to acquire Google for a mere one million dollars. The offer was dismissed because Google had zero revenue, and at that time, monetizing search engines was an enigma.

It's crucial for you to comprehend how potential buyers perceive your start-up. The most substantial deals are often struck when a buyer identifies a target company as a strategic acquisition. A classic example is Google's purchase of YouTube, which was a strategic maneuver aimed at extending its presence in internet services.

As you sketch your exit strategy, bear in mind that the best deals are likely not from those meticulously analyzing the numbers. The buyers you're after are the emotional buyers — those who feel a pressing need to assimilate your company into their operations.

An emotional buyer could be a well-established company witnessing a decline in market share. If your start-up offers a lifeline that could arrest their fall, they wouldn't hesitate to purchase irrespective of the price tag.

And if you're considering exiting the market, a fresh round of venture capital funding could arm you with a stronger bargaining position for a sale. Consider Instagram's scenario: Twitter was keen on acquiring Instagram but the negotiations hit a roadblock. Instagram's response was to raise additional funds, which elevated their overall market valuation. This spurred Twitter to finally table an offer.

Despite Instagram declining their proposal, it ended up being a stroke of luck for them — they were eventually bought by Facebook for double the price!

At times, investors might be hesitant to buy a company until they observe rival interest. Your competition could inadvertently help you secure better exit deals, so employ this strategy to your benefit.

Streamline your pitch — venture capitalists appreciate brevity and clarity.

Venture capitalists are always pressed for time. To secure that crucial funding, it's imperative to respect their limited availability. Be well-prepared with all your materials before your meeting to ensure you make a positive impact.

Gone are the days of multi-page, detailed business plans. What investors today seek are crisp, succinct plans with clearly defined objectives. As an entrepreneur, you need to demonstrate your ability to launch your ideas in the market, analyze the outcomes swiftly, and be ready to pivot if required.

In today's fast-paced world, venture capitalists juggle multiple modes of communication. As such, they prefer bullet points addressing significant issues in as few words as possible.

Your start-up's financial needs, your management team's expertise, your present development stage, and future objectives — these are key topics that should be addressed in your business plan's executive summary. And all this within a one or two-page limit.

Once you've got a foot in the door, you can present supporting documents, such as the investor slide deck. This comprises ten slides encapsulating your start-up's most vital areas, including aspects like your competition and your company's value proposition.

Having a comprehensive financial model is equally crucial to showcase your project's feasibility. This model should incorporate three to five years of financial data, covering forecasted revenue, key costs, and net results — all neatly organized in a spreadsheet.

A well-constructed model accurately depicts the variables that will influence your company's profitability. Don't cut corners on the specifics! If you're inaugurating a restaurant, for example, you need to account for the number of patrons you'll serve, price fluctuations of raw materials, potential rent hikes, and so on.

Equip yourself with different versions of your pitch to cater to diverse audiences.

A key aspect that significantly influences your quest for funding is your pitch — the brief outline of your project. You'll need to arm yourself with a variety of versions of your pitch, each tailored for a different audience.

At networking events, use a rapid-fire, 30-second version of your pitch. However, always have a detailed, two-minute version on standby for individuals who express further interest. For potential investors who want an exhaustive understanding, a 20-minute version is optimal.

Never underestimate the power of your 30-second pitch; it's your secret weapon for snagging people's attention. Take a cue from the founder of Half.com, an online marketplace for preowned books, who had a dynamic micro-pitch.

In a networking conference, Half.com's founder posed a question to the audience about the latest bestseller. When a majority confirmed they'd read it, he asked who intended to read it again — receiving no affirmative responses. He then pointed out that every person in the room was a potential Half.com seller.

Avoid bewilderment or ambiguity when interacting with potential investors. They are eager to understand what distinguishes you from others. So, avoid generic descriptions of your idea, such as “We're a fusion between Facebook and Pinterest.” Such comparisons don't provide clarity about your unique concept.

Steer clear of cliched buzzwords like "disruptive lean start-up." Aren't most start-ups aiming to disrupt something? Such terms offer little comprehension of your actual idea.

Lastly, perfect the art of storytelling. Your investors are eager to be swayed by your narrative. Thus, sharpen your oratory skills and breathe life into your idea.

Remember, it's only natural for investors to probe for more specifics about an idea or a plan. Responding defensively to questions might come across as agitated or unprofessional.

Concluding thoughts

The central takeaway from this book:

Venture capitalists play a pivotal role in the startup landscape. Almost all notable tech companies that have emerged in recent years have benefited from VC funding. Budding entrepreneurs need to understand what VC firms desire and how to put their best foot forward. Assemble a competent management team, master your pitch, and demonstrate a thorough understanding of a VC's exit strategy expectations. Procuring financial backing is a vital step towards realizing your start-up vision.