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An Essential Entreprenuerial Skill To Get The Venture Capital Interest You Deserve

by Nathan Roberson | June 22, 2012

So you have that next great idea -- you might even have a flourishing business -- but you need more financing. So you prepare your pitch for a venture capitalist, but are you going to say the right things? Will you understand all of the terms?

Being an entrepreneur requires more than just good ideas. You need to know how to talk the talk. That's why it's important to learn essential accounting and financing skills. Sure you could always just pay a lawyer to review every term sheet you receive, but knowing what each term on those term sheets mean can save you from receiving the raw-end of a deal.

Like anything complicated, such as pitching for funding from a skilled venture capitalist, you need to understand basic concepts of accounting. That starts with understanding debits and credits -- the backbone of any accounting system. Understanding these two concepts will help you understand the entire concept.

For every accounting entry in the general ledger contains bot ha debit and a credit. All debits must equal all credits and if they don't, the entry is out of balance. An out of balance ledger throws your entire balance sheet out of balance.

That seems pretty straightforward, but what happens when a venture capitalist enquires about your liquidation preference or increasing their participation? If you feel a bit lost, you're not alone.

Mark Suster, author at the popular blog "Both Sides of the Table," published a post on this topic. As a successful entrepreneur and startup business blogger, Suster knows the ins and outs of dealing with venture capitalists.

"I don't feel that as a VC sneaking in nefarious terms into a term sheet that the entrepreneur doesn't understand is a good way to build a long-term relationship nor to build a long-term reputation but this does happen and more frequently that we all would like," Suster writes.

After you receive your term sheet from the potential investor, you need to understand how a venture capitalist calculates the valuation of your company. Whatever the investor decides to put up against your pre-money valuation is the percentage of the company they would own. That seems simple enough -- but it's not that easy.

That's because the venture capitalist assumes you have an option pool -- the senior members of your team, i.e. the CEO, CTO, VP of marketing, etc. Assuming the Venture Capitalist wants the options before he or she funds -- which is very common -- their ownership remains the same, but your ownership becomes more diluted. If the Venture Capitalist calculates for the average 15 percent option pool, that brings your overall ownership down.

The next major step you need to worry about is how the sale or dissolution of your company will be distributed. Investors will tend to put a 2x liquidation preference in the event that you sell off your company. That means you would have to pay them two times the amount of money they were promised. Aim for a 1x liquidation when making a deal.

This is just a short summary of some basic accounting concepts you need to understand as an entrepreneur. If you're scratching your head, you're not alone. That's why it's important to study the basics of accounting and financing -- preferably at a higher education institution where you can grasp and understand those more complicated ideas and concepts.

About Author Nathan Roberson

Article courtesy of Southern New Hampshire University's Online Accounting Degree Deparment. Great ideas can create a business, but knowledge of business can allow it to flourish.

 

About Chia-Li Chien

Chia-Li Chien Chia-Li Chien, CFP®, CRPC, PMP; Chia-Li “like JOLLY!” Succession Strategies for Women Entrepreneurs. She is Chief Strategist of Value Growth Institute dedicated to helping private business owners increase the value of their firms. She is the award-winning author of Show Me The Money and faculty member of American Management Association. Her blog and newsletter was named a top small business resource by the New York Times “You’re the Boss” blog.
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