In an earlier blog, I discussed the financial motivations for a Venture Capital firms ROI. But recently, a company, which underwent a phone interview with VCs, asked a simple question: when to follow up to inquire about the VC firm’s deliberations with regard to financing? Again, before going through this process, one should do some homework and see how VC firms function.
VC firms are structured as limited partnerships, with the general partner being the management team or founders of the firm, and the limited partners as passive investors, many of which could be insititutional. VC firms tend to be small enterprises, not having more than 10 general partners. These general partners tend to have senior executive experience in fast growing companies either as founders or senior managers. And have had considerable financial return for their service. However, note that we have less than 10 individuals with their own experience guiding them while effecting due diligence. Their interest and knowledge are limited by their experience. Unlike a Wall Street investment bank, which has considerable size and innumerable teams that cover every industry, VC firms will only entertain those companies to which the individual managers have had experience. So a startup needs to look at the firm’s managers and see their background and experience to determine whether there would be any interest in seeing the pitch book for the company.
Then there are the limited partners. A week ago, I noted the limited partners for a VC firm in Maryland. Some partners were retirement funds such as CalPers. Others consisted of university endowment funds as well as secondary private schools. Even a couple of commercial banks were mentioned. Limited partners by legal definition don’t partake in the management of the investments. Yet they would not participate in investing millions in the VC firm unless they checked out the type of investments made in the past, the performance and industry categories. So, if the institutional investor has misgivings on the performance after several years, they will not participate again with fund. Therefore, that process will have an impact on investment classifications.
Now, we need to address the day-today activity. In the case of the company that had the phone interview, it had passed the first hurdle of scores of business plans that crossed the desk of the interviewer/VC guy. This manager received the business plan and should know that industry well from his investment experience or direct management. In other words, the company should be well prepared with reams of information about the company during the interview process. The interviewer will need to determine whether to invite that company to the VC firm’s offices.
We stated earlier that this is a partnership moreover. That individual does not have the sole authority to invite that company over. He needs to discuss this company with the rest of the partnership. Generally, these are firm meetings held weekly or monthly to discuss those companies that passed the first hurdle. From my experience, that involves marking a scoring system for each major element comprising a business plan – with 10 the highest points to zero, identical to any academic grading exercise. More often than not, these elements would be the sections of a business plan – the management team, macro-economic environment, competition, etc. – recited in a former blog. Each general partner must participate and provide his or her scores. That company with the highest score will be invited to the firm. And they will request from that company additional information for review then – detailed business plan and financials – in preparation for the office visit and due diligence. The office visit becomes the best opportunity to meet the senior management team and ask in greater detail any questionable issue with the business plan.
Once that process is covered with another scoring system, then the firm is prepared to offer a term sheet – an outline of the offer for investment in the company. The term sheet is an outline, not the final legal paperwork. And, finally, there is the closing – the final legal work is executed and the check is in the mail.
So, let’s go back to that company inquiring about getting back to the firm. Well, if it occurs within a few days of the phone interview, it has to be too early. The interviewer has had no time to raise this company’s assessment to the other partners. That company should wait at least one week before doing so. I realize that every company urgently needs to know the results; however, that will not change the classical management infrastructure of the VC firm. Indeed, I always recommend keep going to others, leveraging this opportunity and increase the momentum for finding other VC firms that would also entertain a phone interview. There is no guarantee that the company will get to the next round. Mathematically, the odds are against such success – less than 8%. With one VC firm under the belt, the company can pursue others and if it receives another term sheet, it now has the opportunity of negotiating better terms.