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7 Things You Need to Know about Venture Capital

By | Regina Thomas

So you are thinking of going the venture capital way? Have you found a committed investor who can back your company? If yes, you must be lucky. But wait. Before you break the champagne, confirm that you have what it takes to make the deal succeeds in a manner that protects and benefits you.

Here are seven things you need to know about venture capital.

1. Venture capital deals involve a lot of paperwork

There are many legal issues connected with venture capital, and the legal documentation can take a big chunk of your negotiation process. What this means is that you’ll need a good lawyer who can take care of your interests in the deal.

To reduce paperwork and make things move faster and efficiently, you can consider using a virtual data room that can bring all interested parties together.

2. Money raised

Before you approach an investor, you must already have some money with you. An investor can not finance your project 100%. All investors require that you have a certain minimum amount before they can listen to your case and release their funds. So you have to consider the minimum amount the investors require before you approach them. Remember, it’s upon you to raise that money, so set a realistic goal that you can manage.

If you are working on a budget, you can shop around for venture capitalists that require the lowest minimum amounts.

3. Consider the chunk of your company that you’ll give up

As you work on the amount you are supposed to raise, don’t forget the level of ownership you’ll be willing to give up. The extent of ownership will depend on the amount the investor will pump into the business and the minimum amount you’ll be required to raise. You have to balance all these, so you don’t lose a big chunk of your company.

4. You’ll have to pay all the legal bills

More surprises? It is the standard practice that the companies that seek funding through venture capital must foot all the legal bills. So as you have to budget for the legal fees as you also work on the minimum amount required by the venture capitalists.

The best thing is to shop around to find out what other business owners are paying to help you in your budgeting.

5. Your company value

The value of your company is very important for an investor. It is from this value that the venture capital will calculate the percentage they will own in your company after adding their funds, of course.

So, negotiate with your potential investor about the “pre-money” valuation of your company (that’s the value of your company before they inject their funds).

Pre-money valuation is computed based on the “fully diluted” value of your company. “Fully diluted” value of your company refers to the total of the common shares, both outstanding and issued, plus those shares that can be claimed by converting the preferred stock (convertible) or by exercising the outstanding warrants and options.

6. Liquidation preference

The liquidation preference should come out cleaning at the time of negotiations. There are many options when it comes to liquidation preferences, but all point to the fact that the investor must get back their money first before the ordinary shareholders.

One option is the 1X liquidation preference. This is a non-participating liquidation in which the investors have to get back all their investment before any other parties. 2X liquidation preference means the investors will get twice their investment back.

Non-participating liquidation may also allow the investor to take part in pro-rata with other shareholders at the time of exit. This means the investors can choose the liquidation option or go for the pro-rata model of sharing.

7. Board representation

The investors would want to ensure they are involved in your company affairs as it grows. This is meant to protect their investment and interest in your company. For this reason, the investor will request representation on your board of directors.

Conclusion

Getting the first investor is a gruesome experience. You’ll still be green on almost anything required of you. That’s why you’ll need experts to hold your hands. If you get a good investor, he can also act as your mentor, and in the initial stages, it may appear as if the investor is in charge of your company. Whatever the case, ensure you have a good lawyer on your side to ensure you are advantaged in the forthcoming deal.

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