December 15, 2010

How to set up your company to attract investors and outside sources of funding: VCs, angel investors, private equity funds

About seven or eight years ago, I had a client with such interesting patented technologies that I was willing to invest in the company, do away with my practice, and run the company through what I thought would be massive growth. Before I did that though, I decided to consult a private equity attorney to help me through the process, and what I learned during those discussions was invaluable for myself and for many of my future clients.

I’ve been talking to many companies lately who are looking for investments to grow their companies, and after attending (yet another) VC event yesterday, and talking to companies looking for money there, I thought an article about this topic was in order. 

As a backgrounder, it's important to know that angel investors typically spend around $1-3M on new ventures. VC investments typically range from low single digit millions to low double digit millions. Anything above that is typically private equity territory, where they look for much more established outfits, rolling up geographically diverse companies, etc., and they will invest up to billions. Most early stage investors look for 5-10X return over 3-5 years, equivalent to an internal annual rate of return of about 35%. And here’s what they look for in the companies they invest in:

A strong, experienced, energetic management team. I’ve never talked to a VC that didn’t have this as their top 3 criteria. They’re investing in the team as much as the technology. They need to know the team can execute otherwise they’ll just hold on to their money until they find the right company.

Game changing technologies, preferably with patents. Although some investors will invest in incremental improvements in existing technologies, they typically look for game changing technologies, locked up with patents, and with very high long-term returns. This is why green tech has been attracting so much money over the past few years. Not too many investors I know are actively looking for service oriented companies unless they show very strong financials, or rolling up geographically diverse companies.

Existing sales or contracts. If you can show your technology or product is already selling, you have a much higher chance of attracting investors. No brainer, but so many small companies just don’t get it when it comes to this. 

Strong market indicators or market research validating demand. At yesterday’s event, this guy from a startup was looking for investors for some patents they had developed without prototyping them. He was so adamant that somebody would invest in their company because he knew in his “gut” that this was going to change the way the world operated. Last time I checked investors didn’t invest in “gut” feelings of startup salesmen. This is why you need solid strategic understanding of your market before approaching investors (or show that the product sells).

Low capital, SAG, and structural expenses. If you need national advertising or expensive manufacturing plants, you’re less likely to attract investors. This is why I love licensing business models where the company focuses on R&D and leaves the product manufacturing and marketing to corporate licensees, an ideal setup for middle market companies.

Realistic financial models, projections, and contingency plans. This will show you know the size of your market, how it operates, and that you have the knowhow to sell the product, and have built in intelligence in case things don’t work out as expected. You will also need to show a detailed plan for the money you’ll ask for. It’s an inside joke that everyone is looking for $5-10M in investments. But why? What’s the plan for that money?

Lack of litigation threats or regulatory barriers. The last thing an investor wants to deal with.

Follow up financing plans. Particularly for early stage investments, you need to show a strategic view of where you’re taking the company and the plans for future financing to support that strategy.

It’s important to note that most investors no longer invest in patents alone. That part of the market has now moved over to patent portfolio managers where they actively purchase and group patents from various inventors for sale as a portfolio.

By the way, the company I wanted to invest in missed several of the above criteria (the best thing it had going for it was the technology), and I walked away without losing any money in the deal – and gaining a ton of understanding about private money.

If you have any stories or additional pointers about raising equity, I’d love to hear about it.


  1. Excellent article, Kat.

    I attended one VC event about five years ago... and mostly remember one comment that the featured speaker made at the start of his remarks. The comment was, "Looking for an 'Angel' should be the last place you look for capital because they will quickly run your life - and besides, 99% of all deals are with people the investors know already or are introduced to by a known "player." The idea of sending your business plan to Angel investors or VC firms where you do not know someone has less than a 1% chance of going anywhere."

    Do you agree or disagree?

  2. Thanks Alan. I've been known to steer my clients away from investors. Taking outside funding isn't for everyone, and you'll see expectation issues both on the company side and the investor side. As with any other venture, you'll hear horror stories about this, but I don't think every situation ends up in a horror story. I wrote this article for those who have already tried other venues to raise funds. Outside funding can help companies go to the next level through the injection of funds, but also with the guidance of the investors and their connections. With tight liquidity in the equity markets, and difficulty in getting business loans, some companies have no choice but to turn to outside investors. The key point is to be smart about dealing with them, and think about long term returns for both the company and the investors. Hope this helps.