Venture capital can give you an infusion of cash that can expand your business dramatically. However, this kind of money has costs associated with it that you should know about before looking for a venture capital investor. Such investors expect a return on their money. You must be prepared to offer a competitive return before they consider investing in your company. Also, you may have to give up part of the ownership of your company.
A new venture can earn returns as high as 700 percent or have a negative return. According to the National Bureau of Economic Research, the average return is 25 percent. A venture capital firm will expect to at least make the average return but may have higher expectations, depending on the potential for your business. Keep in mind that venture firms could simply invest in the stock market or buy bonds, so you will have to offer returns that beat the average returns of the stock and bond markets. A 25 percent return is higher than those other markets, so look at that percentage as a starting place for negotiations with venture capitalists.
Doubling Venture Money or Better
Venture capitalists expect to double their money -- or even triple and quadruple it -- over a period of several years. Venture capitalist Fred Wilson considers making 2.5 times his money in 10 years to be a successful investment, but he points out that some venture firms would consider such an investment a failure. Don't focus on the annual percentage you will pay to the exclusion of a multi-year return you can offer. You will have to factor in some growth to double or quadruple a venture capitalist's money over time.
Negotiating Expected Returns
Most venture capital firms have a portfolio of investments. Your company will be just one business they have invested in among many, so that gives you some leeway when negotiating returns. For example, if your company is fairly steady, you may offer a lower return than some riskier businesses. This can be attractive to venture firms because they need to diversify among safe and risky investments. On the other hand, if you are unable to meet your payroll and invest in growth, the venture firm may worry that you are in trouble and present a higher risk. A higher risk means a higher return, so be prepared to offer more if your company has high risk.
Valuing the Company
One way venture firms calculate the returns they want is by placing a value on your company. You do not have to accept the venture firm's valuation of your business. Forbes Magazine suggests that you ask for a valuation that is 25 percent higher than whatever the venture firm says your company is worth. Such firms expect you to negotiate, and a counteroffer that is 25 percent higher is routine in negotiations. A higher value means that the investor will receive a higher return, so you make your company more attractive by negotiating a higher valuation.
Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.