The work that goes into venture capital (VC) transactions is much more intricate than simply finding unicorns and writing checks. That’s why we’ve created this VC guide that outlines every step of a successful transaction.
By following these 4 steps, investors and early-stage deal sponsors can quickly and confidently close their complex venture deals. The fewer hang-ups and hold-ups you have throughout every deal, the better your deal flow — and your reputation in the VC industry — will be.
Step 1. Sharpen your specialty and raise funds
The first step to a successful transaction is getting other investors to commit to your idea or fund before going out to find startups to invest in. However, it won’t be easy to convince others to back you unless you’ve already established yourself as an expert who’s specialized in a particular space. Here are some ways you can build your reputation and gain the trust of investors.
Self-segmentation
Take a trick out of the investment banker playbook and choose a product, sector, or region to become an expert in. By cementing yourself as a specialist in a specific area, you’ll be able to achieve the following:
- Help your service providers assign their best talent to your deals.
- Solidify your position among rival VCs when financing the deal.
- Prove to entrepreneurs that their investments are in good hands.
If you specialize in a product, then your expertise will likely cross many industries and regions. For example, you may differentiate yourself from other VCs by championing business process automation products, or by backing commercial kitchen gaskets.
You can also specialize in a certain industry, and search for asset acquisitions that cross product segments and regions within that industry.
You might also consider localizing to help differentiate your group. Citizens love to see local investors keeping their investments close to home. Consider joining your nearest National Venture capital Association (NVCA) and signing up to judge or promote a local Venture capital Investment Competition (VCIC).
Fundraising
Once you’ve found your niche, plan how you’d ideally structure a deal. Unlike your specialty, this decision is flexible. For the right deal, you can stretch the strategy slightly.
Before taking on a deal, decide how you’d prefer to approach it:
- Undertake the project alone as an angel investor yourself.
- Launch a general partnership (GP) and supplement your VC fund with limited partner (LP) capital commitments.
- Create a VC syndicate that will become a co-GP with what would otherwise be rival VCs.
Keep in mind that these fundraising options may involve debt financing. Debt leverages favorable interest rates in the hopes of creating more profit in the future. The downside is that involving bankers complicates venture deals considerably, so some leave debt to deals involving distressed legacy properties bought by private equity (PE) investors.
Once you’re ready to begin the VC deal process, you’ll need access to robust, real-time market information, as well as software to help you present your case to both fellow investors and the operators of businesses you’ll be targeting.
Step 2. Conduct preliminary valuations and introductions
Typically, VC groups employ investment professionals to scour sources for interesting and promising deals, as well as opportunities that may prove fruitful down the line. To build a strong pipeline, set up screening criteria to quickly and confidently identify which venture deals you should pursue, shelve, or outright dismiss.
Initiate early due diligence
Start by conducting valuation and potential assessments on targets. This includes analyzing the following:
- The deal’s source — You’ll naturally prioritize a deal if it’s from a trusted contact.
- Executive summary — This one- or two-page overview of the deal argues why it deserves a capital infusion.
- Team bios and management meetings — Good VCs scope out operators’ social media activity and community involvement to better understand their passions and personalities.
- Management presentation — Pay attention to the operators’ presentation ability, not just their presentation of the target’s details.
- Business plan — Look at the target’s financial model and their planned expenses, and ask for a series of resulting scenarios. Assure them you won’t hold them to what they propound; these are just hypotheticals.
After you’ve learned a bit about the business, send a non-binding letter of intent (with conditions to close), and begin preliminary valuation work. Engage your analysts to create financial models and projections, and request the business’s customer pipeline data. Inquire about future tuck-in M&A plans, and ask whether the business has completed any competitive analyses you can review.
Organize relationship-building activities
By now, all the promising deals in your pipeline — and the relationships that accompany them — have generated a lot of activity data. Every phone call, text, meeting, and email has produced some sort of outcome, whether it’s sharing a new document, exchanging information, or making a decision.
Keep these outcomes organized and up to date by establishing processes and workflows and by adopting a task-, relationship-, and deal-management information system that’s purpose built for venture deals. Intapp DealCloud helps teams establish processes and workflows by centralizing all the data that every investment professional generates each day.
Step 3. Negotiate the deal’s details and create your term sheet while building rapport
It’s time to conduct formal due diligence and negotiate and create the deal’s term sheet. During this step, dealmakers invest more than money: They devote valuable time and energy to nailing down the transaction’s terms.
Although you should approach a deal’s facts objectively and impartially, remember that your investigation and negotiations involve humans. Soften your communications with empathy to build rapport and maintain strong relationships.
Conduct formal due diligence
Formal due diligence process is the legal, financial, and technical investigation into the business.
Begin by engaging a lawyer and industry expert who has done due diligence work on startups before. Next, shop due diligence checklists online, like the ones provided by the U.S. Chamber of Commerce. Compare the ones used by your service providers with those you find online. Consider combining them to create a more comprehensive list.
Make diligence a two-way exam. Offer to introduce targets’ boards to portfolio company (portco) leaders to interview and ask questions about you as an equity owner.
Agree on economic and control terms
Based on all the information your diligence uncovers, you must negotiate your returns on liquidity and control during the hold period.
Decide and document how much equity and preferred stock your firm will receive. Determine whether you plan to transact future staged financing and what events will need to occur for you to fulfill that plan.
Consider using both letters and numbers when naming series in your term sheet (e.g.; Series B-2 or C-1) to show how many rounds of financing you expect to conduct. Don’t be surprised if you have more rounds that anticipated: Startups are now raising so many rounds of capital that seeing a Series K infusion isn’t abnormal.
Economic terms that make up the term sheet include:
- Price and valuation — This is the original purchase price per share that represents a fully diluted pre-money value. It also includes the fully diluted post-money valuation. You may choose to simply list the full amount of the investment at this time, in aggregate.
- Preferred liquidation and participation method — Detail how the proceeds will be distributed in a liquidity event. For example, the original price per share is divided up into a set multiple and returned to you before the common stock is even considered. (We’ve seen anywhere between 2 and 10 times multiples in a VC term sheet’s liquidation preference.) Clarify whether your shares are full participation, capped participation, or no participation.
Other provisions to include in the economic terms are pay-to-play mandates (if appropriate), vesting requirements, exercise period specifics, option pool details, dividends (if applicable), redemption rights, and a clear anti-dilution clause.
Control terms to negotiate and include in the term sheet include:
- Who you plan to put on the board of directors — The earlier the stage, the fewer members who should be on the board. The founder and CEO and the VC are almost always at the table. Second VCs and outsiders such as other founders are brought in in later stages.
- Protective provisions — These are veto rights, which can be as powerful as voting rights.
Other control terms you may wish to add to the term sheet include drag-along agreements, non-negotiable conversion, and information rights. Your private capital markets lawyer will help you determine the necessity of each of these clauses and can craft the best phrasing to communicate these provisions.
Step 4. Wrap up final details, close the deal, and begin operational improvements
The last step of a VC deal is simply administering the decisions that your firm and your founder or operator have made together. Take your legal documents to the investment committee (IC) for formal approval and have them execute and sign the term sheet.
Finally, sign definitive documents, including:
- Stock Purchase Agreement (SPA) and disclosure schedule for SPA
- New certificate of incorporation
- Investor rights agreement (IRA)
- Voting agreement
Some of these documents will already have been executed earlier in the process; you’ll just need to sign and double-check that these documents are ready to be activated to complete the deal.
Once you’ve dotted the i’s and crossed the t’s, administer the funds transfer. This moment is the beginning — not the end — of a successful venture capital deal.
Harvest relational equity to fuel your pipeline
You’ve just been through a lot with your new colleagues, so don’t waste the momentum you’ve built together. Keep all these relationships warm in the coming months and use the experience as a learning opportunity.
Set reminders on your calendar to check in with your contacts to stay top of mind moving forward. It’s also a good idea to send memorable thank-you gifts to key service providers, introduce contacts, and ask for referrals at this point.
Depending on the size and complexity of each VC deal, you’ll also want to document learnings for future dealmaking efficiency and to help streamline upcoming transactions. Every nugget of information has value, from which new VCs appeared in the bidding process to which lawyers have switched firms. Without these documented learnings, institutional knowledge is lost, and your traction slips.
Implementing DealCloud lets you capture every detail of a transaction. The system automatically grabs information along the way and allows you to input key deal details at this final stage of the transaction.