How to get VC funding for your start-up

How does venture capitalists (VCs) decide whether to invest or not and how do they evaluate each deal?

In a study by Tyebjee and Bruno, this five step process decribing how VCs invest was presented. Bellow is a figure followed by and explanatory text.

Step 1-Deal Origination
It’s a difficult environment to scan for investment opportunities; small, yet-to-be companies (objects) are hard to find, the authors expects intermediaries

Step 2-ScreeningThis is done by staff of VC for numerous proposals, objects in areas where the VC is comfortable goes through, particularly in terms of the technology, product and market scope of the venture.

Step 3-Evaluation
The objects have no history and VC has to rely on the subjective business plan, the VC weight risk and return, the process is similar to new product evaluation methods.

Step 4-Deal Structuring
This include agreeing on price (capital in, shares out) and covenants (VCs control on management and ability to liquidate investment, managements power to get more funding and dilute VC) and the earn-out arrangement where the entrepreneurs equity share is determined upon meeting agreed-upon milestones.

Step 5-Post-Investment Activities
VCs doesn't want control of the day-to-day operations, but can install new management in a crisis, the VC will guide the company to a merger, acquisition or IPO as he wants returns within 5 to 10 years.

So that's the decision process of a VC, in this process, step number three is particularly interesting to an entrepreneur. The evaluation process is presented as a figure and a list bellow.

Market Attractiveness depends upon the size, growth and accessibility of the market and on the existence of a market need.

Product Differentiation is determined by the ability of the entrepreneur to apply his technical skills in creating a product which is unique can deter competition through patents and enjoy a high profit margin.

Managerial Capabilities of the venture's founders. This capability is associated with favorable references given to the entrepreneurs

Environmental Threat Resistance represents the extent to which the venture is resistant to uncontrollable pressures from the environment (changing technology, sensitivity to economic conditions or low barriers to entry by competition)

Cash-Out Potential represents the extent to which the venture capitalist feels that the investment can be liquidated or "cashed out" at the appropriate time

The two issues that increase the perceived risk of the deal the most were managerial capabilities and resistance to environmental threats. Cashout potential was less important, which is surprising.

Tyebjee and  Bruno has the following tip to the entrepreneur: focus on the four aspects of the business plan are used to evaluate the riskiness and potential profit associated with a particular deal. These are (1) the marketing factors and the venture's ability to manage them effectively, (2) product's competitive advantages and uniqueness, (3) quality of the management team, particularly in its balance of skills, (4) exposure to risk factors beyond the venture's control, e.g., technological obsolescence, competitive entry, cyclical sales fluctuations. In presenting a deal to a venture capitalist, these four aspects should be used to favorably position the venture.

This is an interesting article in spite of being a bit fundamental. There are several more good perspectives on the screening process and other aspects to the VCs evaluation an decision processes. The results were gathered from 90 VCs and presented in this article in 1984. So my question is; what has changed since then? How are VCs using social media to evaluate and decide on investment prospects? The answer to this question is something I hope will help entrepreneurs in getting funded in these early days of social media.