Business Plan for a Venture Capitalist
Writing a business plan specific for a venture capitalist or private equity firm is very difficult. Unlike a business plan that is specific for a bank or lending institution, a venture capital firm is going to want to see that the business is able to generate a substantial return on their investment on a year on year basis. Generally speaking, most venture capital firms and related private investment companies want to see a return of 30% to 40% per year compounded for at least five years to seven years. This is due to the fact that these firms must answer to their investors who have provided them with the funds that they use to invest in third-party businesses.
When you are developing a business plan specific for a venture capital firm – you're going to need to have a number of tables that would not commonly be found in any other type of business plan. A very aggressive focus needs to be placed on the profit and loss statements, cash flow analysis, balance sheet, breakeven analysis, business ratios page, and information regarding the burn rate of the business. Most private investment companies are going to want to see a substantial diagram of how the company will be using their capital over a one year to two year period (burn rate). This is due to the fact that there are a number of clauses within investment contracts between entrepreneurs and venture capitalists that allow the venture capital company to retake control of the business in the event that the entrepreneur does not hit specific milestones. These clauses can include an overview of how the cash is to be used over a 12 month to 24 month timeframe. As
such, proper business planning is needed so that when these investment contracts are developed – the newer has a very clear understanding of what goals need to be had in order to remain in control of the company.
On a side note, it is very important that the entrepreneur work with an attorney during the entire negotiation process. There have been numerous instances when an entrepreneur has actually lost their company given the fact that they have not hit the milestone set forth in the investment contract. A qualified attorney can put – in layman's terms – an explanation of each thing that the entrepreneur must achieve in order to maintain control of their business will also remaining within the letter of their investment contract. One of the downsides to working with venture capital firms, private equity groups, and similar entities is that they are able to routinely submit a substantial amount of control over their investment throughout the life of the business. This is especially true with new work just to establish companies that deal specifically in technology.
As these businesses typically do not generate any revenue at the onset of their operations, these investment groups can easily extract patents and other intellectual property from a corporate entity in the event that the business does not become profitable. As such, an entrepreneur should have a substantial understanding of what they're getting themselves into when they accept investment from a venture capital group. As we have discussed a few times in this website, most entrepreneurs are so hungry for capital that they are willing to take the first deal that comes to them given that they feel that no other company will be able to offer them the money that they need. However, even though only 1 in 250 companies are financed through venture capital – once an initial offer is made it can be assumed that other companies would express a similar interest. Additionally, entrepreneurs will often use the initial offer for a venture capital group so that they
can approach other companies to match or exceed their offer. Again, this is why an attorney is an invaluable resource of assistance when going through this process as they will be able to negotiate on behalf of the business and on behalf of the entrepreneur. We will continue these discussions in further articles that we post to this website.
One of the more challenging things to deal with when developing a business plan for a venture capital group is the valuation tables that are frequently found within this document. There should be analysis regarding internal rate of return, net present value, the profitability index, and other common these metrics are used to determine the valuation of the company. This can be both an art and a science. One of the difficult aspects of doing a valuation on a business that does not yet have any assets or is producing any income is at an appropriate discount rate must be applied to the overall cash flows of the business over a specific period of time.
Generally, for technology-based businesses that have not yet begun revenue generation – discounted rate ranges anywhere from 30% to 60% depending on how risky the investment is. The higher discount rate always represents a much more risky investment for a angel investor or private investment group. This is also one of the key negotiating points when working with a private investment group is what discounted cash flow rate will be applied to the valuation. One of the other things that many people do within a venture capital focused business plan is to take a look at the known valuations of established public companies that operate in a similar capacity.
These valuations are almost always based on a price to earnings multiple. For major technology companies, the P/E ratio can easily exceed 50 to 100 times the previous year's earnings. Of course, there is some level of irrational buying and selling of the stocks given that people are putting a huge premium on the future earnings of the business. During the dot-com bubble of the early 2000's, the valuations of Internet-based businesses were outrageously high which precipitated in a stock market crash. However, industry has become much more in tune with what appropriate valuations are for specific types of technology businesses. One of the other industries has seen a significant amount of increase as it relates to valuation is the biotech industry. This is going to continue to be the case given that there are now numerous advances being made on a yearly basis as it relates to the use of biological focused technology.
If an entrepreneur is having trouble developing the valuation tables that are again common within a venture capital focused business plan and they need to speak with a certified public accountant that can assist with these matters. An accountant can put in a number of different tables that show all the type and types of valuations and provide the underlying reasoning for evaluation. Given the rapid growth of technology on a worldwide basis, a number of people have become experts in the field of valuing general technology businesses, biotechnology businesses, and other companies that are frequently financed by venture capital firms in private equity groups. It should be noted that these valuations can be extremely expensive with experts charging $10,000 to $30,000 to complete the study on behalf of an entrepreneur or new company. In the long run, especially if the business has received a significant amount of interest from private investors – the
investment of having a business value and valuation expert complete the study may be worth it given that it may provide the door with substantially more equity than they initially thought.
As with all business plans, an expansive marketing plan is going to be needed. This is especially true for technology-based business given how competitive it is to have a brand name become highly visible within this market. Most venture capital firms want to see that a qualified marketing and advertising firm will be hired in order to promote the company's service or product line. One of the ways that many technology businesses become popular is to the use of social media marketing especially when they are offering a highly unique piece of technology that is going to change the way that things are done in the world. As such, a marketing firm should have a public relations division that can assist in entrepreneur with expanding their visibility for their brand name as well as any product or service that they are providing to the general public. This, of course, can occur even before the business starts to generate revenue so that there is a significant
amount of press available for when the company commences revenue generation.
In closing, writing a business plan for a venture capital firm is a very different undertaking then receiving a business loan. A much more illuminating presentation needs be made given that many venture capital firms review hundreds if not thousands of business plans on a weekly basis. One of the things that many entrepreneurs will do in order to stand apart is to actually produce two documents. One is known as the traditional business plan and the other is a one page summary showcasing exactly what the business does very succinctly and how much capital they're looking to raise. This elevator pitch can be invaluable especially if you do not feel like distributing the full-scale business plan to the general public.