By Tamás Solymosi, Deloitte & Touche Rt.
Hungarians are thought to be innovative people with good ideas, yet entrepreneurs often find obtaining capital difficult. Analysing certain reasons of this paradox, this article concentrates on the investment process from the entrepreneurs point of wiew, and highlights certain key, although often neglected aspects.
When aiming to obtain venture capital, entrepreneurs need to prepare their company, and need to prepare documentation. However bright and experienced the entrepreneur is, all the above tasks cannot be carried out by a single person. Without an appropriate management team and/or long-term advisors (possibly Board), chances for capital are slim. Ideas do not compensate for the lack of these assets.
Of the documents to be prepared the most important is the business plan, which should be reviewed by an independent expert, before sending a copy of its Executive Summary to potential investors. The process, from reviewing the business plan to actually investing in a proposition, can take a venture capital firm anything up to a year.
When the entrepreneur is particularly concerned about confidentiality, it can check whether the potential investor has any major conflicts of interest (such as a significant investment in a competitor), leave out the more confidential data, or use a Confidentiality Agreement.
When a venture capital firm is interested in proceeding further, the key members of the management team should be able to present the business plan convincingly and demonstrate a thorough knowledge and understanding of all aspects of the business, its market, operation and prospects.
When the potential investor is interested after the further enquiries, it will commence discussions regarding the terms of the deal and send an Offer Letter, which sets out the general terms of the proposal, subject to the outcome of the due diligence process and other enquiries and the conclusion of the negotiations. The Offer Letter, without being legally binding on either party, shows that serious consideration is being given to making an investment.
The venture capital firm will want to assess the technical and financial feasibility in detail. Due diligence reports often follow a detailed study, assess and review major points concerning the company and its management. References may also be collected on the company (eg. with suppliers, customers, and bankers) and on the individual members of the management team (eg. previous employers). The due diligence process is used to uncover any fundamental problems or risk areas that may exist.
When the due diligence is complete, the terms of the deal can be negotiated, and the legally binding documents can be prepared.
In most successful business situations entrepreneurs stick to what they know, build a team, and encourage a common philosophy of shared business goals and quality standards.
Nothing is more attractive to a potential investor than a team of high-powered individuals, all experienced in both the disciplines they plan to lead and the market they plan to attack. It is remarkable, how little attention entrepreneurs pay to this issue when thinking about going out to raise money. Often the product concept is the driver while the team and the market are just necessary passengers.
Based on experience, it is believed that successful companies have experienced teams that are capable enough to take what they knew, learn what they didn"t, and adjust accordingly. Therefore the team should be built with as much care and as much attention to quality as products, strong participants should be found before you speak to investors. Founders often step down from management positions to make way for an executive more qualified to run the company. (They recognise the need to direct the company and to not be personally involved in each day-to-day decision, which should be delegated to senior managers.)
Venture capital investors are looking for a solid management team even more at startups, one that has demonstrated success with another start-up or with the division of an existing company. To secure investments, management at start-ups also has to understand how to commercialise a product, take it to market and build a team. A start-ups product or technology must be differentiated, defensible and unique.
Advisors have an important role as well, as they can bring expertise and skills that cannot be obtained or are not worth to be obtained on a full-time basis. The entrepreneurs advisor should be able to assist for instance in the following areas:
ˇ Critically review and appraise the company, and the business plan, do financial modelling (carry out sensitivity analyses on the forecasts, establish the most appropriate capital structure to be used, considering tax issues as well).
ˇ Make informal judgmental opinions on aspects of the plan to the benefit of both management and the venture capital firm.
ˇ Make introductions to appropriate sources of venture capital.
ˇ Review the terms of the deal offered and assist in negotiating.
Venture capitalists invest in people, not just ideas on paper, and they want to make sure that your team can deliver. Excellent management teams and contact networks help produce higher valuations and increase the odds of success.