Have you met Jim? Jim is 28 years old, graduated from a top MBA school at the top of his class, and has a stellar entrepreneurial idea to create a mobile application that can help couples who are getting hitched request for and manage their incoming gifts for their big day. The idea garners gallons of interest from his fellow graduates, three of who join him in bootstrapping ‘Nuptials Inc.’, a small self-funded company.
Jim leads the pack, David controls the finances, Jane is the face of marketing and Samuel codes his way through life. After months of deliberation, they ready the beta version of their app when Jim realizes that the company is short by about $120,000 to fully develop and market the product. He approaches Platitude LP, a venture capital (VC) firm known for supporting young entrepreneurs.
The Venture Capital Fund
Wealthy private investors, pension funds, insurance companies, etc. place heaps of faith in Platitude LP due to its venture capital fund success. The firm pools money from these entities, spots high-growth potential startup businesses with bull’s eye precision and invests this money, hoping for high returns in about 5 years. Platitude generally demands about 25% of the startup’s earnings as compensation and a small percentage as management fees. It’s like buying the shares of a company and becoming a financial partner.
The Venture Capitalist
Emily is a picky venture capitalist and investment committee member at Platitude who injects funds into startups created by MBA graduates. She takes these investment risks because she believes some of them can produce high-profit yields. Emily is also wary of potential failures due to the inexperience of startup companies. She only backs companies that:
- Have a shrewd management team and a strong business model.
- Are looking to commercialize their idea, and not to start from scratch
- Have a unique product with a competitive advantage
- Want to launch the product in an industry where investor has some experience
- Are open-minded about some of the investors’ ideas
Jim braces for his big meeting with Emily. He pitches his idea to her, hoping for a gleaming outcome. His goal was to hit $120k, for which he was prepared to offer 20% of his company. Highlights of his presentation included:
- Company description
- Terms of the funding
- Market analysis
- Competition analysis
- Go-to market plan
- Sales and promotion strategy
- Financial projections
- Exit strategy
Originally from the match-making industry, Emily catches hold of Jim’s idea. She decides to deploy $100,000 as equity financing to Nuptials Inc. in exchange for a 30% stake in the startup. Jim is thrilled about the amount from Emily, but still frowns at the 30% slice of his company that she wants. They shake hands. Emily hands over the term sheet, a non-binding document that explains the basic terms and conditions of the investment agreement. Jim signs the dotted line and gets the startup capital or first-round funding.
The Public Offering
Nuptials shows a lot of promise in its performance in the first two years. Emily further grants the company some expansion stage capital for penetrating other geographical markets or starting another product line. After years of successfully operating his business, Jim contemplates about an initial public offering (IPO), backed by Platitude LP. He would need Platitude’s approval for going public. This exit strategy could prove lucrative for both Nuptials Inc. and Platitude, as a well-oiled company will churn a lot of returns. Platitude helps Jim with the bridge capital or fourth-round funding to facilitate this exit process. At this juncture, he could think about merging or acquiring related/competition companies.
There are others like Jim who get VCs to invest in their companies, but don't necessarily perform as well as he does. Emily identifies players like this from miles away and pulls out of any deal she may have struck with them. In fact, she understands that about 80% of startups worldwide are unable to survive being the first year.