Catching The Punter'S Eye

"There is no question that irrespective of the horse (the product), horse race (the market), or odds (financial criteria), it is the jockey (the entrepreneur) who fundamentally determines whether the venture capitalist will place a bet at all."

Professor Ian MacMillan, Wharton

Any experienced "punter" will tell you there are two fundamental facts of life in trying to predict the outcome of any race. First, the future cannot be predicted with accuracy and second, there is inevitably an element of luck in "picking winners".

Having said this, before placing a bet, experienced punters gather as much information as possible on the condition of the horse, the track and the jockey in the hope that this will increase their chances of winning.

The horse racing analogy applies equally to the world of the venture capitalist. Any experienced "investor" will tell you there are also two fundamental facts of life when trying to determine which ventures to back.

First, the only thing that is known for certain is that the projections upon which an investment decision is based are "wrong". Investors and entrepreneurs alike hope the venture's performance will exceed projections. However, in reality, Murphy's Law often holds true - whatever the problems encountered along the way, the venture inevitably takes longer to develop than planned.

Second, timing and luck can, and do, influence the level of returns achieved by investors.

Venture capitalists make "informed bets" on the basis of information presented to them in a business plan that outlines the nature of the opportunity, the strategy developed to exploit it profitably and on a sustainable basis, and the credentials of the management team involved.

During due diligence, investors will seek additional information to satisfy themselves that:

* all elements of the plan "hang together";

* relevant risks have been identified and accounted for whenever possible;

* prospective returns offered adequately compensate for the risk being borne by the investor and entrepreneur alike; and, most importantly,

* the management team has the skills, drive and ambition to succeed, particularly in the face of the inevitable pitfalls associated with building and managing a business.

Investors work under the presumption that through gathering additional information and insights, their ability to identify "winners" is enhanced.

An entrepreneur seeking external equity from either venture capitalists or private individuals (so called "business angels") needs to understand the criteria investors use to evaluate potential investment opportunities.

In many ways, investors are like the Yukon panhandlers of the gold rush days. Panhandlers spent a great deal of time and energy sifting through silt and gravel for gold nuggets. Likewise, investors sift through a great number of potential opportunities to identify those that are worthy of further detailed consideration.

A vast majority of proposals, typically 80 per cent or more, are rejected after a cursory review of the business plan. When an investor chooses to review a proposal in greater detail, relatively few are actually funded.

How do investors decide which proposals to back? Venture capitalists and private investors tend to rely on similar decision-making processes in determining which proposals to support. The two markets are in many ways distinct, however, and thus it is useful to discuss the approach of each separately. (The private investment market - so-called "business angels" - is discussed in detail in Part 3).

The venture capital perspective

Generally speaking, venture capital funds screen proposals on the basis of a number of generic criteria including:

* the minimum size of the investment they are willing to consider (usually more than