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 Only Seven Out Of One Thousand Companies Are Chosen Back to the Index

The Venture Capital firms surveyed eventually invest in roughly 7 out of 1,000 companies that contact them. They receive an average of more than 20 business plans per week--almost 1,100 per year--and state that they invest in, on the average, 7.2 companies each year. This translates into making one investment approximately every 50 days during the year.

The highest stated number of investments in a year by any one firm was 35 companies; the lowest was 2. The dispersion of responses was as follows:

 Annual Investment

The average amount of capital invested annually by each firm was $18.4 million. More than 40% of the firms that responded invest less than $10 million annually. 18% invest between $10 million and $20 million. An additional 18% invest between $20 million and $30 million. A smaller number invest between $30 and $40 million--2%. 4% of the firms invest between $40 and $50 million. And a significantly larger number, 13%, invest more than $50 million.

 Transaction Size

When asked the average size of their investment in any one deal, the results were as follows:

The average investment that was checked off most frequently--$1 to $3 million reflects the cost of building an enterprise of significant enough size to create the eventual shareholder value the VC is seeking. The small percentage of investments under $500,000 reflects the fact that the time and cost of making a small investment is the same as a large one, and most firms would prefer making a lesser number of sizable investments rather than many small ones.

How Do Venture Capital Companies Find The Deals? Back to the index

Venture capital companies are introduced to deals from a number of different sources. Most mentioned at least two sources as important; some said all sources were important. When asked the question, "What is the most common way you found the companies that you actually have invested in?" the entrepreneurs themselves, intermediaries, accounting firms and other venture capital companies were all cited as sources by roughly 40% of the respondents. Law firms were listed by 28%; 24% said they found the companies themselves; and attendance at events was listed as important by more than 17%.

 When asked, "How are most companies brought to your attention?" the results were somewhat different. A higher percentage listed the entrepreneurs themselves as a source--almost 60%, and more than 50% listed intermediaries. The percentage that listed referrals from accountants and lawyers dropped. The number of respondents that listed referrals from other venture capitalists held steady in percentage terms. The referrals from accountants and lawyers may have been higher quality deals than those brought from other sources, or perhaps these professionals contacted venture capital companies that fit well with their client's companies. It may also be true that the VCs gave the referred deals more attention because of the relationship they had with the accountants and lawyers. One respondent even stated that it was a mistake not to have your company referred to them by someone they know instead of contacting them directly. Venture capital conferences and other events appear to be important in generating sheer numbers of investment prospects, in a short period of time, but don't necessarily translate into deals that get done, for many of the respondents, at least.

 The results clearly show, however, that the entrepreneur did not have to be referred to the venture capitalists from professionals in order to secure funding. In the sources of actual deals that got done, deals brought in by the entrepreneurs themselves were tied for the top spot in percentage terms.

 Several respondents emphasized that they are proactive seeking out high-quality deals rather than simply waiting for business plans to come in over the transom. This means attendance at venture capital conferences and other events where they get a chance to mix with entrepreneurs looking for capital.

 Many venture capital firms now have web sites venture capital company links that entrepreneurs can use to contact them and leave e-mail information about their companies. Although this speeds up the contact process, the VC firms that noted the Internet as a source of deals said so with the caveat that it was not yet a source of deals they actually invested in.

 The results suggest that entrepreneurs should explore more than one way of contacting potential investors: do some of it themselves and also take advantage of relationships that other professionals may have with the venture capitalists, and network at venture capital conferences. By using as many different avenues as possible, they increase the chance that they may be using the method that works best with a given venture capital firm.

People, Not Projections Are What Matters Most Back to the index

Respondents were asked to rank five important factors that influence their decision to invest, with 5 being the highest rank you could award a factor, 1 being the lowest. These factors were:

The results indicate that all of these factors are of importance to venture capitalists, with quality of the management team by far the most important. All of the factors received an average score of greater than 3 (out of five). The other four factors besides management were all ranked fairly closely together, indicating that entrepreneurs must address all of these factors in the business plans they write and the in-person presentations they make to venture capitalists. Several respondents ranked each category as a "5" and said they viewed them all as critical and could not rate one higher than the other.

The percentage of respondents that awarded "5" to a factor were as follows:

In overall average score (listed in parenthesis), the factors were ranked as follows:

This shows that there is some variation in how the venture capitalists view or weight these factors; for example some VCs were more "growth" oriented than others. Management strength must be emphasized in presentations to investors, and all of these factors must be addressed in order for an entrepreneur to attract capital.

 Why Do Venture Capitalists Say No? Back to the index

The next most frequently mentioned reason for declining (17%) was that the company did not fit their investment criteria, the industry(ies) on which they focus or the geographic area. Many entrepreneurs contact venture capitalists without doing their homework regarding what industry they focus on, so in effect they are contacting the wrong audience. Related to this reason was another one that appeared on a number of the responses, that the company was too early stage: the entrepreneur did not know that the venture capital firm does not invest in start-ups, for example, but contacted the VC anyway. 

Following this reason was that the size of the market the company was in, or the need in the market that the product serves, was too small (13%). The chance therefore of building a significant, valuable enterprise is smaller.  

The venture capital firms also said they frequently decline because the company has no competitive advantage or has a non-compelling technology (13%).  

Strategic weaknesses were next most important as reasons for declining. The company said what it planned to do, but not how it was going to do it. The steps to execute the business strategy were poorly thought out or incomplete--there was no clear execution strategy (10%). 

Other reasons include: 

The Business Plan Back to the index

The business plan document is often the first exposure a venture capital firm has to a company seeking financing, often even before talking to the entrepreneur on the phone or having a meeting. Because it makes the critical "first impression" for the company, a poorly prepared plan can be a reason for the venture capitalist declining on the investment, and not taking the time to ask for more information. 

The survey participants were asked: What is the worst mistake an entrepreneur can make when completing their company's business plan? 

According to the respondents to the survey, there are eight major mistakes.

The response that occurred most frequently (17%) was that entrepreneurs were not clear in explaining the opportunity--why the business made sense, why it would make a good investment. Some VCs said this was because the plan was incomplete, but others said it was because the plan had too much detail, was not concise or focused. This lack of clarity kept the venture capital firm from being excited enough about the company to proceed to the next stage. The plan was the first chance to sell the investor on the deal, by telling the company's story in a clear fashion. 

Another critical error was one that is very difficult for entrepreneurs to avoid: unrealistic projections (13% of respondents). A significant number of respondents (8%) said they see "simplistic assumptions" in the business plans they read, and the plans were filled with mistakes and errors. One respondent complained about the tendency for entrepreneurs to claim their projections are conservative, when this is simply not true. In the many years this venture capital firm has been in business, they have had many "winners" in their investment portfolio, but never once had a company achieved the projections of their original business plan--never once. One respondent expressed this mistake as "entrepreneurs believing whatever they write is factual." 

The analysis of competition in business plans is an area that the venture capitalists believe entrepreneurs are weak on (10%). Many do not make the effort, or find it too difficult, to gather data in a systematic way about competitors. Two critical mistakes result, according to the respondents: entrepreneurs say there is no competition, or underestimate the strength of competitors; and the plan does not describe a competitive advantage the company may have, or how to achieve a competitive advantage.  

Mistakes and errors appear frequently in the plans they see, according to more than 10% of the respondents, who also said that entrepreneurs sometimes try to mislead them with the information in the plan, or do not trust the venture capitalists sufficiently to give them key pieces of sensitive information in the plan. 

Another response that occurred regularly was that management strengths were overstated in the plan (8%) with one respondent even saying that entrepreneurs "lie" about their credentials, and this is a critical mistake because the venture capitalist always thoroughly checks out the background of people involved in a company they are contemplating investing in.  

Incompleteness, including leaving sections out of the plan or not including sufficient financial data, were cited by 8%.  

Failure to describe a sustainable competitive advantage was also noted by 8%. 

Even though quality of management was viewed as the most important factor in an investment decision, only a small fraction of respondents believed a major mistake they have seen in plans to be that they were not focused enough on management experience (2%). The error of not clearly explaining the opportunity was more glaring to the venture capitalists, and they tend to draw conclusions about the management team after meeting them.

Other responses that came back were: 

One interesting response was that the entrepreneur failed to provide the name of anyone in the company to contact after finishing reading the plan. He or she must have been in quite a hurry to get the plan in the mail!

Common Mistakes Back to the index

This question was then asked a slightly different way: What is the most common mistake entrepreneurs make when completing their business plan?

By far the most frequently mentioned mistake was saying that the company had no competition, or underestimating the strength of competitors (32%). The failure to describe a sustainable competitive advantage was also mentioned by 9%. Not clearly explaining the opportunity was the next most frequently mentioned mistake, by 27%. Following that was the related mistake of having a disorganized, unfocused, or even poor presentation (12%).

 Miscalculation of market share and market size (9%) were also regarded as frequently seen mistakes, with several respondents saying that they still receive business plans that say, "The total market is $1 billion, if we only get 10% of it, we will be a $100 million company"--without ever explaining how they are going to sell $100 million worth of their product.

 Respondents also said they commonly see business plans that do not address the risks of a venture, and contain no contingency plans for coping with the risks (also 9%).

 Other less frequently mentioned responses were: 

Conclusion: What Does All This Mean To The Entrepreneur? Back to the index

If You Want To Make A Good First Impression On The Investors: Back to the index

From the above responses, entrepreneurs should consider the following when constructing their business plan documents:

The business opportunity is presented in a clear, exciting manner.

The entrepreneur understands that projections are, at best, hopeful guesses and tries to base the projections on realistic assumptions.

The entrepreneur makes as full disclosure as possible of the pitfalls of the business as well as its strengths.

The plan is carefully proofread and edited until it does not contain any errors in grammar or math.

The plan shows why the company and its products are different and significantly better than what is out there in the marketplace. 

The company has taken the time to study and understand its competitors and can address their strengths and possible weaknesses. 

The plan contains enough information to tell a complete story about the company, but is presented in a concise, tight writing style. 

The plan does not make exaggerated claims about the product or the management.

The entrepreneur knows the plan by heart before making a presentation to the venture capitalist.

If You Want To Improve Your Chances of Obtaining Capital Back to the index

Put together a strong, experienced management team, with people who have been successful in the past.

Research the investment criteria of the venture capitalists to ensure that what you offer is what they are looking for. 

Use every method you can think of to reach potential investors. Don't rely simply on referrals, or on contacting them yourself, or on an intermediary to find the capital for you. 

Hone your market research and analysis skills. Systematically gather information on your competitors, so that you can make a credible case for why your product/service offering will be better. 

Put together a clear, concise, realistic business plan that gets the reader excited about the opportunity your company presents. The plan must not only cover what you are going to do but how you are going to do it. 

Let other experienced business people read and critique your plan, testing it for clarity and reasonableness. Never send a first draft to the venture capitalists. Proofread it a number of times. 

Keep trying, don't give up. Continually widen your network of contacts to give you more avenues of approach to investors.

 (And don't forget to put your name and phone number in the business plan, so the investor can call you!)

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Profit Dynamics Inc. is a management consulting firm founded by Brian Hill and Dee Power in 1987. The company, based in Scottsdale, specializes in assisting small and mid-sized companies with business planning and finding capital.

 Mr. Hill and Ms Power, along with Gerald "Rab" Paquette are owners of National Acquisition Network LLC, which publishes the Growth Network Dige$t (a matching service for investors and entrepreneurs), and the Acquisition Opportunity Journal (which links buyers and sellers of businesses).

 They sponsored the First Virtual Venture Capital Conference, a four-day event which took place entirely on-line, June 8-11. The Fall Virtual Venture Capital Conference is scheduled for November 2 through November 5, 1998. There will be guest speakers, seminars, an "exhibit hall" and presentations by entrepreneurs. For more information, visit our web site at: