The veil shrouding venture capital funding was “peeled back” by Catharine Merigold, founding general partner of Vista Ventures, during a Peak Venture Group breakfast last week at the Garden of the Gods Club.
As a venture capitalist who vets companies and entrepreneurs’ business plans as part of an ordinary work day, she brought a realistic perspective to the audience.
“My hat’s off to you — being an entrepreneur is not easy,” Merigold said. “What you do is riskier than what we do. When we make an investment, we choose from a basket of 200 — when you make an investment, you choose from a basket of one.”
That said, she advises entrepreneurs to pursue or contemplate other forms of funding first, because venture capital is the “most expensive capital there is.”
Currently, it is rare for “really early-stage or seed-level — still in proof-of-product” — companies to receive venture capital.
For courageous souls who are undeterred by such news, the next bit of wisdom regards choosing an industry.
“Don’t even think about what’s ‘hot’ these days,” Merigold said. “You need to start a business with what you’re good at and passionate about. Unless you’re really good at it, you have a higher probability of being roadkill if you’re in a ‘hot’ sector,” such as clean technology or solar technology.
To give the audience an idea of how intense the competition for venture capital is, she told them, “I say ‘no’ to 99 out of a 100 good ideas.”
There is a smidgen of hope.
“The majority of successful businesses are created without venture capital.”
But for those entrepreneurs who have sagely and judiciously determined that they don’t need/want funding from traditional banks, strategic investors, private equity/mezzanine sources, etc., then it’s time to ask oneself a few questions.
“How much money do you need? How big do you intend to become and how quickly? How long will you need financing? Can you support debt?” And, “What help do you need besides capital?”
And while “no two VCs are alike,” when looking for companies to invest in, there are three elements they have in common, which Merigold calls the 3Ms: “market, management and mumbers” — no, that’s not a typo, keep reading.
First, the “market” for a product/service should be more than $1 billion or small and rapidly growing — as in, a sales level of $25 million or more in five years.
Typically, venture capitalists will not invest if a company needs less than $5 million in capital.
If that seems puzzling, well, it all has to do with fund size and rate of return.
If a fund has $100 million to invest, she said, it would take 10 “home runs” of 10-times return on a $1 million investment just to “return” the fund, much less to make a profit.
Now back to the 3Ms.
“Management” is a VC’s mantra, much like real estate’s “location.”
Chant “management” three times and you’ll eventually understand how important this is.
“At the end of the day — unless an irrational market lifts all boats — it is management that’s responsible for success,” Merigold said.
When looking for prospects, she prefers what she terms “sticky entrepreneurs”: The type of business owner who can get people, employees and advisers “to stick with” them.
And the final 3M is “mumbers — made up numbers,” she said, to much audience laughter.
Venture capitalists — gasp! — expect to make more than the market.
And about 60 percent of the deals in a portfolio either lose money or only return the original investment, “so on my winners, I have to make 10 to 12-times,” Merigold said. “It’s not because we’re greedy — it’s because a lot of businesses fail.”
So, back to why an entrepreneur’s “mumbers” are Über important.
“I always say, numbers don’t make a business successful — but they can make you fail if you don’t have the right numbers. They may all be made up,” Merigold said, “but they’re important — they tell me a lot about who you are.”
Turns out, “nobody ever hits their numbers,” but they show whether an entrepreneur knows what he or she is doing and if they have an unrealistic idea about valuation.
If, for instance, a business plan indicates that a business will be “wildly profitable” by year five, or that only 3 percent will go toward research and development, then “you don’t know much about running a business,” she said.
So, credibility is key for the financials — projected revenue growth, profit and loss, balance sheet, statement of cash flow and amount of capital needed.
And when attempting to woo venture capitalists, remember that “valuation” is what they think (yeah, verily obsess) about. In order “to increase your valuation — decrease your risk,” she said. “You’re a risk taker — I’m a risk manager.”
If you need their capital, you have to play their game.
And, remember that “financing is a process, not an event,” Merigold said.
Be tenacious, and “go for the incremental ‘yes.’”
Rebecca Tonn covers banking and finance for the Colorado Springs Business Journal.