Angel investor groups and venture capital funds tend to follow the same 6-step process in evaluating each potential investment. The process is important because most well-known angel or venture funds receive as many as a thousand business plans monthly from entrepreneurs hopeful of receiving capital funding to launch or build their companies. Without a specific process, the evaluation and management of such a volume of applications would be overwhelming.
Some angel or venture capital groups have a formatted questionnaire that asks for specific information on the proposed venture; other groups rely on the review of submitted business plans. Either way, the first screening looks for industry potential, market opportunity for the specific venture, well-planned and -articulated strategy, proprietary processes or patents, realistic exit strategy, management experience and attitude of cooperation. The business plans or applications that seem to fit the first-screening criteria are advanced to the second stage of the capital investment process.
The first meeting can be either a phone interview or face-to-face meeting. Its purpose is to eliminate as many of the applicants as possible by again applying the same criteria used in the initial screening. At this stage, the presentation of the entrepreneurs is most important. It shows their attitude as well as their potential as business managers. Arrogance, business naivete and lack of ability to clearly articulate the value proposition of the business venture are elements that will disqualify most applicants.
The remaining applicants are then put through a detailed due diligence process that includes scrutiny of their financial records, contracts, patents, trademarks, business reputation, credit, professional and educational backgrounds and investigation to discover any criminal records. This period of due diligence will also involve character evaluation of the entrepreneurs.
Those companies that pass the due diligence process move on to the negotiation process. This is a group of meetings or a final meeting in which the investor group presents suggestions and discusses its valuation of the company. The valuation governs how much the investor will receive in ownership for the amount of money invested. It is generally at this point where deals are made or broken, as entrepreneurs tend to value their companies more highly than do the investors. A smooth meeting, however, is a good sign.
When an angel group or venture capital fund decides to invest in a company, it presents a "term sheet," which is a legal document outlining the amount of money to be invested, how it will be distributed to the entrepreneur, the ownership percentage to be transferred to the investor, board seats and any management positions to be occupied by agents of the investor and other details such as launch schedule, benchmarks and events that would result in termination of the investment deal.
The entrepreneur receives the term sheet and reviews it with his cofounders and other stakeholders as well as his attorney. There may be a need for more negotiations if the term sheet is unacceptable for some reason, but if the entrepreneur and stakeholders are agreeable, they sign the term sheet and move on to the closing, which may include additional contracts, exchange of stock certificates for investment funds and other closing tasks.
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