Funding woes

When many entrepreneurs and business owners think about raising money, they think about venture capital. Unfortunately, most of these entrepreneurs don’t qualify for venture capital. As a result, they fail to raise it and are never able to launch or grow their ventures.

In fact, the number of firms who receive venture capital is incredibly low. According to PricewaterhouseCoopers and The National Venture Capital Association, in the last 12 months, only 3,199 U.S. companies raised money from venture capital firms.

So, why do entrepreneurs continue to seek venture capital, even when their chances of success are so low? I’ve found two key reasons. First, they are unaware of the vast number of other sources of funding they can access, such as crowdfunding, social lending, bank loans, vendor financing and others. And because they don’t know about these sources, venture capital becomes “the usual suspect.”

Secondly, venture capitalists dish out the big bucks. Those 3,199 companies I mentioned raised $21.8 billion (according to PricewaterhouseCoopers and The National Venture Capital Association). That’s an average of $6.8 million each. Seeing such big dollars, and the vision of what their businesses could achieve with them, can seduce even the most seasoned entrepreneur.

So why is the success rate for raising venture capital so low? Well, the No. 1 reason is that businesses that seek venture capital aren’t qualified. That’s not to say they will never qualify, because some companies just aren’t ready now. And it’s also not to say that they are bad companies, because the vast majority of successful and public companies did not raise nor would they have qualified to raise venture capital.

So what are the qualifications of a “venture-capital-worthy” company? The first key criterion is scalability — or the potential for the company to achieve significant annual revenue, typically in excess of $50 million to $100 million within a five- to seven-year period.

The second criterion is barriers to entry. Barriers to entry are those things that make it difficult for another firm to compete against you, such as patents or proprietary technology, a unique location, and long-term customer contracts.

The third criterion is having a strong management team. This is because most venture capitalists realize that the people running the companies and not the product or service itself will ultimately cause the company’s success or failure.

The fourth criterion is that venture capitalists need to feel confident of the company’s exit strategy, mainly that the chances are good of eventually having another firm purchase it or the company going public. This is because venture capitalists take equity in companies and only “cash out” when there is an exit or liquidity event.

The final criterion is that a company meets the sector, stage and geographic criteria of the specific venture capital firm that it is targeting. For example, some venture capital firms will only invest in health care companies, some will only invest in companies that have first achieved customer traction, and many will only invest in companies located within 100 to 200 miles of them.

While the overall success rate of raising venture capital is terribly low as stated above, when you weed out the entrepreneurs who don’t meet these criteria, the rate goes up substantially.

That’s not to say that it’s ever easy to raise venture capital, since the process is extremely arduous and often takes six to nine months of continual work. But by targeting only the venture capital firms for which you are qualified, and methodically working through the process, you can raise venture capital.

Dave Lavinsky is the president and co-founder of Growthink (www.growthink.com). Since 1999, Growthink has helped thousands of entrepreneurs and business owners develop business plans and raise numerous forms of financing, from bank loans to venture capital and private equity transactions. Lavinsky can be reached at [email protected].