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Wednesday, March 19, 2008

Raising Venture Capital - The Alternative Golden Rule

The economic translation of the Golden Rule is "he who has the gold makes the rules." If you are raising venture capital, then you need funding. The more you need it, the less control you will have at the end of the day.

A typical entrepreneur scenario I see is: 1) I have a great idea or product and I'm going to start a company although I have no monetary resources myself to put into it.
2) I can scrounge up a hundred or two hundred thousand dollars through loans, grants, credit cards, a few early sales, etc. 3) I've worked on this for a year now and can really see the potential if I only had the money to hire salespeople, build a factory, hire production employees, buy servers...and 4) I've worked for a year and a half and I am tired of being poor, but I don't want to give up on my idea. Hey, I'll raise venture capital.

At this point, the entrepreneur is pretty close to desperate and is willing to give up just about all control to get a decent, steady salary. The other scenario is the company has already raised some amount of money, either friends and family or angel and the money is running out. This entrepreneur is really desperate and is willing to give up just about all control to keep his or her business alive.

Venture capitalists are not really big risk takers. They carefully evaluate every investment and the management team before deciding to invest. Once they have decided that the business has a decent chance of succeeding, they insist on a variety of controls to ensure that they can keep a tight rein on the business, including replacing management if necessary.

Even if the VC owns only a minority of the shares, they will include in their investor rights agreement certain voting rights and protective provisions (see my post on Elements of a Term Sheet for definitions) that will ensure them the ability to protect their investment.

If you are planning to start a business and believe that you might want to raise venture capital someday, you can do several things to avoid losing your company. First, have a plan for growing your company without venture capital. You may not be able to raise it, but if you are and you don't like the provisions in the term sheet, you can walk away.

Second, if you do raise venture capital, be careful with your selection of investor. Make sure that the investor is honest and treats his or her management teams with respect and fairness. Once you have a term sheet, you can ask for a list of their CEOs' contact info. If the VC is reluctant to give references or will only give a couple, you might want to look for another investor. The CEOs will give you the honest opinion of the VC, so make sure you follow up.

If you are going to put your blood, sweat and tears into a company, you don't want it taken away by an unscrupulous investor just for a few investment dollars.

Please visit my website for more small business finance advice: http://cfoyourself.com

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Cathy Harris is an Empowerment and Motivational Speaker, Non-GMO Health and Wellness Expert, Self-Publishing and Business Coach.