When starting a business, it is sometimes easy to get caught up in the moment after you've grown into a respectable company and are ready to raise venture capital to get to the next level.
You have guided your small company from infancy to maturity, and now there are venture capitalists chomping at the bit to take a bite.
At this critical stage, it is easy for an entrepreneur to be a little too excited about the prospect of his or her company really taking off.
However, it is important to understand the terms used by venture capital firms and the ways in which each respective venture capitalist operates. After all, at the end of the day, many of them are only interested in a dollar or percentage return.
A business, in contrast, is the entrepreneur's labor of love, so it will be your job to protect it with due diligence on the VC terms and the VC firm itself.
Things to Watch Out for When Dealing With VC Firms
Some people in business often stretch the truth to the breaking point. It may be nice to believe that everyone has morals, but it is simply not the case. When dealing with expert investors, there are several things that you should look for.
The VC phrases outlined below should be regarded carefully. They may not be "lies," but they are certainly not whole truths. For the sake of avoiding hurting any venture capitalists' feelings, I will call them "untruths" instead of "lies." After all, it isn't nice to call someone a liar.
Untruth #1: "We're sending the terms right now. Once you sign it we will be ready to kick it into high gear!"
In actuality, they have probably just begun looking at every facet of the business to make sure that you are worthy of an offer. Venture capitalists look through so many businesses that when they finally find a suitable candidate, they often have to string them along in order to give them enough time to perform their due diligence. During this time, the entrepreneur or small business owner really can't do much other than sit and wait. You don't really have a VC firm term sheet until you have it in your hands.
Untruth #2: "We can help you negotiate with investment banks. Our firm is very close to some of the best investment bankers."
Maybe the venture capitalist met an investment banker at a banquet or played a round of golf with one ten years ago. Generally, most venture capitalists will exaggerate the level of relationship between them and the "best" investment banks. They might not even know the name of the front office secretary, but they will tell anyone who will listen that they baptized the CEO's first born. Just be sure that whatever they say to you makes sense; a small firm from North Carolina probably isn't that tight with Goldman Sachs' investment banking division. Probe further to find out who they really have good relationships with.
Untruth #3: "We offer different service for our dollar. You will have a personalized experience!"
Again, you need to investigate this claim to make sure it's true. Most venture capitalists are already on ten boards and constantly search for the next big winner. If this is the case with your VC firm, your company may not have a personalized experience for any extended period of time. Once they are inside, if they feel the investment is doing OK, they may spend more of their time searching for the next big thing.
If they have a lot of capital to invest, they need to find a home for it and this can often be a priority relative to managing existing portfolio companies. In that case, when it comes time to woo Company B, you may end up saying goodbye to any personalized services or value add you may have been enjoying.