Due to the high volume of business plans a VC reviews, only approximately 10% will actually move into the due diligence process and be considered for an investment.
The due diligence process entails a thorough look at all aspects of the business including primary and secondary research and monitoring over a period of time, usually taking 3 – 6 months to complete. Everything from market size to customer calls to a number of meetings with management will take place. It is important for all business pieces to be thoroughly investigated, but three of which stand out at the time of investment:
- Management
- Market
- Deal Structure
1) Management – It is a belief in the VC world that it is better to invest in a mediocre technology with a phenomenal management team, rather than a phenomenal technology with a mediocre team. The reasoning being that it is the team that lines up the deals, structures the business model, rolls the product out to market with accurate timing and keeps the passion alive in the business.
It is also common for venture capitalist to back the same entrepreneur in a number of different ventures if the entrepreneur has previously proven his/her talent.
2) Market – The market size and growth is obviously a needed variable due to the point that without a market there isn’t a need for the product/service, nor the possibility of creating a profitable business that can create a return to the investors.
3) Deal structure – Deal structure contains many different variables many of which will be addressed in later posts. Mainly, the structure needs to make sense through its pre-money valuation by being in line with the market comparables and structured to allow the venture capitalist the opportunity for a return at the time of an exit. Complementary to the valuation is ownership. The venture capitalist expects a certain amount of ownership with an investment but wants to keep the majority for the founder and team to keep success as a motivating factor. If previous investors have taken too much equity it is real hard for a venture capitalist to come in without diluting the owner.
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