Start-ups seeking funding often turn to venture capital (VC) firms. They can include capital; strategic assistance; introductions to potential clients, partners and employees; and much more.

Venture capital funding is not easy to receive. Venture capitalists usually tend to invest in companies that are targeting broad markets with strong growth potential and that have already shown some traction; for example, they have a working product prototype, early consumer acceptance, etc.

It is important to note that venture capitalists typically concentrate their investment activities on one or more of the following criteria:

  • Specific industry sectors(software, digital media, semiconductor, mobile, SaaS, biotech, mobile devices, consumer, etc.)
  • Stage of the business (early seed or Series A rounds or subsequent rounds with companies that have generated considerable sales and traction)
  • Geography(such as San Francisco/Silicon Valley, New York, etc.)

Before approaching a venture capitalist, try to find out if his or her focus is compatible with your business and its stage of growth.

The second main point to consider is that VCs are overwhelmed with investment opportunities, many of them via unsolicited emails. Almost all of these unsolicited emails are overlooked. The best way to get the attention of a VC is to have a warm introduction through one of their trusted colleagues or another competent VC friend, such as a lawyer or a fellow entrepreneur.

The startup must have a decent elevator pitch and a solid investor pitch deck to draw the attention of the VC.

Startups should also recognize that the venture process can be very time-consuming – just holding a meeting with the head of a VC company can take weeks; followed by further meetings and conversations; followed by a presentation to all the investors of the venture capital fund; followed by releasing and negotiating a term sheet with continued due diligence, and finally the document/legal drafting and negotiation by lawyers on both sides of numerous legal documents to evidence the investment.

The primary terms agreed under the Venture Financing Agreement include:

  • Valuation of the company
  • Amount of investment
  • Type of investment (usually by convertible preferred stock)
  • Liquidation privilege of the equity investment (the right to be repaid first on the sale or liquidation of the business)
  • Board of Directors composition and having any Board observer rights
  • Approval or “veto” rights of investors, including items such as future equity funding, business sale, or amendments to charter documents;
  • Rights to participate in future financings (“pre-emptive rights”)
  • Rights to receive periodic financial reports and other information
  • Vesting requirements for any founder stock
  • Anti-dilution defense, shielding investment from dilution if subsequent funding rounds take place at a reduced valuation (there are various types of formulas for this)
  • Redemption rights (if any)
  • Right of first refusal or co-sale / tag-along rights to the sale of any founder’s shares
  • Drag-along rights (giving the company the right to force all shareholders to vote for a sale of the company if the sale has been approved by a specified percentage of shareholders)
  • Registration rights (giving the investor the right to require the company to register their shares with the SEC in a public offering)