Home Articles Preparing for US venture capital: Due diligence is a two-way street

Preparing for US venture capital: Due diligence is a two-way street


In part five of our series on the capital raising cultures in Australia and the US, San Francisco-based Steve Anderson explores how Australian entrepreneurs can best prepare for securing US venture capital.

Also in this series:

Part 1 – Funding in the US – Holy Grail or Holy Hell
Part 2 – The benefits of Australian VCs and US VCs
Part 3 – Five must-sees before Australian VCs will invest

Part 4 – When seeking investment, preparation is everything

The US venture community – worth approximately US$2 billion – is very small compared to private equity and miniscule when compared to the trillion dollar hedge fund industry. But it is a very important capital source for new businesses, which create new taxable revenue and new jobs.

Annual venture investment is one-tenth of one percent of the US GDP, but it creates 11 percent of private sector employment and $3 trillion in annual revenue, according to the National Venture Capital Association.

And while Silicon Valley is the best known and probably the largest centre of venture capital firms and activity, it is not the only place where venture capitalists are aggregated. Austin, Texas; Boston, Massachusetts and New York City are active centres for venture investors – and there are other, smaller communities of venture capitalists throughout the US.

Basics to begin capital raising plan

When determining whether a company is ready to seek capital from US venture firms, Australian and New Zealand businesses need to consider these basics:

  • The business has been self-funded and received follow-on investments from local angel investors and/or venture capitalists.
  • Revenue growth is significant and the company is near break-even or into profitability.
  • The product or service makes such a significant difference to customers that they cannot do without it.
  • The current management team has built every aspect of the company for its next growth stage.

Preparation to proceed begins with having the following:

  • A due diligence “package” of everything the potential investor wants to know about the company. Preferably, all the documents will be held on a secure website.
  • A revised business plan – including a financial plan – that includes the execution of business in the US and other anticipated markets for the next three years.
  • A list of all the venture firms in the US that have invested in your business sector in the past two years, the partner that led those investments and a list of the companies in which they invested.
  • A PowerPoint presentation that takes 10-12 minutes to present.
  • A fund-raising plan that is based on achievement in six to nine months.

Entrepreneurs seeking to build investor confidence during the pitching process should incorporate several facts based on reality and the economic history of business development centres such as Silicon Valley.

The dot-com era is the bogey-man in the closet. It shattered the confidence of investors, particularly venture capitalists, and scared them away from cavalier investing. But take a look at this:

According to the US Bureau of Labor Statistics, Silicon Valley’s high-tech industry employment fell 17 percent from 2001 to 2008. But out of this whipping, three industries stood out as successes despite everything. Employment numbers in pharmaceuticals, aerospace and scientific research all increased. And across the board, wages rose an average of 36 percent over that same period.

The point here is that entrepreneurial businesses can bring new employment, new revenue and can improve society.

Setting the stage with US venture capitalists

In order to keep a level playing field with an entrepreneur’s potential partner – the venture capitalist – both parties need to start the relationship with equal amounts of information on each other and respect for one other.

Compare the contents of the due diligence package the entrepreneur prepares for the potential investor with the information the entrepreneur has on the potential investors. On a balance scale, generally the due diligence of the company significantly outweighs the due diligence the company has on the venture capitalist.

The question is: How do you get the information from the venture capital firm?

The answer: You ask for it.

Information gathering before first venture capital meeting

Questions to ask portfolio companies:

Talk to the founder/CEO, COO or CFO of portfolio companies that are closely aligned with the entrepreneur’s business. Ask them the following questions:

  • What specifically, for a strategic or management contribution, has the VC firm provided that made a positive difference to the business?
  • What did the founder/CEO or other find out about the VC firm after the investment that they wished they had known prior to the investment?
  • What are they like in Board meetings in terms of working with other Board members, sticking to the agenda, following up on prior agenda items, frequency of new ideas not previously discussed?
  • Who in the firm has provided the best advice?
  • How much of the investment fund does the VC firm have left to invest?
  • Have they been true to their pre-investment philosophy with the company?
  • What were the contract negotiations like?
  • What was the company’s size and revenue at the time of the investment?

These are questions that should be asked of at least three of the portfolio companies, so that there are comparisons to triangulate and determine where reality sits.

Questions to ask the venture capital partners at the first meeting:

  • What is the current size of available funds to invest?
  • What percentage of the original fund does that represent?
  • How much does the firm typically hold back for further support investment and/or a second round for each portfolio company?
  • Who would be the company’s primary partner in this relationship and what is their experience in management as it relates to our business?
  • Who else on the staff would be available and what is their management experience as it relates to our business?
  • How many boards does each partner usually sit on at one time?
  • What are the partner’s other responsibilities in the firm?
  • How close are current portfolio companies to exit?
  • What does the firm see as the best exit for companies like ours yours entering the relationship?
  • What do their customers – portfolio companies – think is the major contribution the firm makes to their success?
  • What are the firm’s weaknesses?

It is important to begin the first meeting with these questions, before the company’s presentation. This first meeting is the beginning of a potentially long negotiation that will continue from now until the exit. It is very important to establish this relationship as one of equals.

Steve Anderson started as a journalist, working first at The New York Times and the next 30 years interpreting business to investors. He is now Managing Partner, Marquis Advisory Group (San Francisco and Sydney).

Photo: PDR