Here’s How VCs Decide to Invest in Your Company

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If you’re an entrepreneur, you’ve probably been out beating the bushes for funding. But to increase the odds of landing some dollars for your fledging venture — or at least come away with a deeper understanding of the process — here’s a bit of insight into how venture firms work.

Where It Begins

Before you consider hitting up a VC, did you know they have their own hitting up to do? It’s true. Venture firms need to solicit investors to seed their own funds through what are known as “limited partners,” who contribute enough money to make the VCs viable.

Once a VC raises the money it needs for a venture fund, it starts placing bets on companies that fall within the parameters of the fund’s intent. Some focus on early stage mobile companies, for example, while others focus on software developers trying to address a certain market. Should any of those companies launch an IPO or get sold, a portion of the proceeds go back to the venture firm’s fund. That money is then distributed to the limited partners, ideally at a level much higher than what they invested in the first place.

Where to Find VCs

Especially when they’ve launched a new fund, VCs are on the prowl for deals. You’ll find them at meetups, demos, on panels and at conferences. It’s better to meet them and begin developing a relationship at such venues than it is to approach them through cold calls or emails, says Jo Tango, a partner with venture capital firm Kepha Partners in Waltham, Mass. Indeed, the best chance of landing a meeting is to get a warm introduction through a mutual friend, business acquaintance, another VC or angel investor, or one of the VC’s limited partners.

Making the Pitch

When it’s time to make your pitch, bear in mind that the investors’ decision relies heavily on three legs of a stool: the validity of the idea and size of the market, the traction your venture has been able to achieve to date, and the industry experience of the management team. That includes whether the founder or co-founders have previously launched a startup that resulted in an IPO or profitable sale. A worthwhile read is this Forbes article, which lays out 65 questions entrepreneurs should be prepared to answer when pitching to VCs.

Remember, the name of the game for VCs and their limited partners is to get not only their money back, but to do so by a factor of 10. And they’re aiming to get their payday — or “liquidity event” — within five to seven years after making their investment, if not sooner.

They Want Me

Say you’re lucky enough to find a venture firm that wants to invest in your startup. A term sheet, or contract, will be drawn up for you to sign. Business Insider has a copy of a straightforward term sheet that UK-based Passion Capital presents to startups it wants to fund. And, yes, you can negotiate on these term sheets.

While some venture capitalists may set pre-negotiated milestones for the startup to hit before receiving a second round of funding, that’s the less preferable route to go. More commonly, VCs will determine the amount they want to invest and not set up milestones that need to be reached, says Ajit Deshpande, an associate for Opus Capital in Menlo Park, Calif.

Once a VC has handed over the funding, you’ve got to focus on executing on your business plan. If you fail, or lack the ability to pivot to a new approach should that become necessary, it’ll be far more difficult to entice VCs to reinvest.