This article describes the steps that an investor and/or venture capitalist should take in checking out an investment opportunity and business opportunity. This process takes a lot of time and it begins when an investor is confronted with a business proposal and must decide whether the idea warrants further investigation. There are five critical components to look for in this first stage of evaluation.
1. Accurate figures and financial statements
“Numbers” are the business’ DNA. An investor needs accurate figures on a company’s past performance to avoid the risk that is probably not worth the business opportunity. Current financial statements are essentials and old numbers do not reflect what the company is doing now.
The entrepreneur must have a perfect knowledge of its financials. He must be able to explain the numbers in detail and provide a three to five year detailed projections.
If the start-up has not reached breakeven, it should provide a month by month financial analysis indicating when the company will reach breakeven.
2. The deal must make significant money
Venture capitalists look for a return on investment of at least 25% to 50% return on investment per year. When you look at the projections, you should be asking what the start-up will be worth in three to five years. Based on that projection, investors calculate how much of the start-up they will have to own in order to receive a high return on investment.
3. The management team
The management team should combine honesty, integrity, experience of the industry in which the business is operating, achievement and success in the previous experiences and motivation.
4. The situation should be unique
Competition is hard and small businesses must have something special to survive. It can be a patent, a proprietary process, a two year lead time on competition, a good location (for example a restaurant), etc. The business must have something unique to make people want to buy its product or service. Having a too revolutionary product can be dangerous too since venture capitalists don’t want to wait twenty year before having a return. So the product shouldn’t be revolutionary, it should be a follow-on product.
5. The deal must have an exit
Every venture capitalist is looking at cash flow and how the money will come back. There are only three basic ways to get out the money out of a small business: (1) it can go to public, (2) a large conglomerate or other business may want to buy the entire business, (3) the company can simply buy out the venture capitalist by refinancing the company out cash flow.
This article is a resume made by MyMicroInvest of the chapter one of the book Venture Capital Investing written by D.Gladstone
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