Many people dream of having their own business. Often that means consulting, which has low start-up costs. However, what if your dream business requires more money? What if you need more money than you can raise by hocking yourself to your eyeballs and squeezing everything you can from friends and family? If that's your problem, you may want to look into the venture capital game.

Venture capitalists (VCs) invested more than US $1 billion in 153 companies in the "industrial/energy" space in 2001, according to the National Venture Capital Association. Some venture capital funds such as Enertech Capital Partners, Nth Power and Chrysalix Energy Management specialize in the energy and power space. Oil companies including ChevronTexaco, ConocoPhillips and Shell also make venture capital investments. However, it is very difficult to get money from venture capitalists if you don't know how the game is played.

Good technology (known as IP or intellectual property) is crucial. VCs want technology that will become part of a widely used infrastructure and for which there is no competitive substitute.

Don't expect VCs to sign non-disclosure agreements for their initial meetings. Most VCs screen a huge number of deals and refuse to be entangled by non-disclosure agreements early in their due diligence. Before delving into the details of the technology, the VC wants to assess the size of your potential market, the competition and your development plan to see if there is a clear path to profitability.

Good IP is necessary, but not sufficient. Every VC will tell you that good ideas abound, and they bet on people. The standard saying is that good management can win with a bad idea, and bad management can kill a good idea.

Usually, founders will become the technology leadership and "professional management" will be hired to run the company. The investors will approve who is chosen and may tranche the funding, so that funds are made available as milestones are reached in filling management positions.

A key part of the negotiation with VCs is the "pre-money valuation" of the company. The pre-money valuation combined with the "raise" determines what share of the company is sold to the investors. The initial raises are usually not sufficient to take the company to profitability, but rather to achieve important milestones.

Both the founders and investors hope that the company will prosper so that in subsequent fund raising rounds, the new pre-money will be greater than the cumulative amount of all the money previously invested in the company. Then, even though ownership shares are reduced, they are worth more.
VCs are thinking about their exit strategy when they make their first investments. Their goal is to back the company, take it public or sell it, and cash out.

VCs' thoughts about potential exits are reflected in the "term sheet," which details the rights and privileges of the preferred stock they are purchasing. Division of the proceeds from a sale can be specified in liquidity preferences and can be quite different from the ownership percentages. Investors may specify that they get a multiple of their investment back before the common stock holders - including the founder - receive anything.

In tough times, investors do not want to be the sole backers of a company. Investors try to form syndicates. The lead VC firm, which puts together the term sheet, will want other investors, so that if times get rough, they have support from others with "dry powder." Corporate investors want a VC firm to provide company-building support and the pre-money valuation. Some smaller VC firms also prefer not to take on the responsibilities of the lead investor.

Dealing with VCs is a bit like selling your soul to the devil. You lose your freedom, but you get a chance for big riches by having a slice of a much bigger pie.

Eve Sprunt, evesprunt@aol.com, is an oil industry executive.

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