Is Your Company Right For Venture Money? 4 Questions VCs Ask Themselves

People often ask me:

"Paul, what type of projects are suited to venture capital funding? For example, is venture capital a viable source of funding for film and other entertainment projects?"

To answer this, let's put business issues aside for the moment. When I say business issues, I mean things like management, business model, customers, etc... Attracting venture capital depends partly on the business issues, but also on how well your business fits with the type of investment a VC wants to make.

When considering a project, VCs always ask themselves 4 questions (among others, but these are always considered):

Question #1 - How much money will this business need and over what period of time?

• VCs are limited by the size, structure and focus of their funds. Those factors determine a VCs sweet spot. For example, many VCs can't make investments representing more than 10% of the total size of their fund. Also, many VCs identify themselves as "stage" investors: seed stage investors, early stage investors, or late stage investors. Others, on the other hand, like to participate in various rounds of funding throughout the life of the company. Each has a sweet spot. 
  

Question #2 - What is the expected risk?

• This is difficult to quantify without getting into discussions about business issues. However, it is important to know that different VCs have different appetite for risk, which is (once again) often dependent on the nature/size/structure of their fund. There is no absolute right answer to this question. Stay tuned for more about risk in a future post. 
  

Question #3 - What is the expected return?

• For most VCs, the expected return is a homerun, sometimes referred to as a "10-bagger". In other words, a VC has to believe that there is a chance this investment will return 10x his money. If a VC knows ahead of time that an investment could "only" return 3x his money, then that's usually not an attractive investment.
  

Question #4 - Can I add value?

• For most VCs, the answer to this question has to be yes. If a VC doesn't believe he can add value through his own network or domain expertise, then he is relegated to being just a passive investor. VCs get paid to actively manage money, not be passive investors.
  

Now let's look at film and entertainment projects using the same 4 questions as an initial screen:

1. Money/Time Required: Major motion pictures require tens of millions of dollars, invested over a very short period of time. Thus, that type of project is outside the mandate/capabilities of most venture capital funds. Independent films require less cash, and therefore are more amenable to venture capital investment. --> A film project might pass.
   
2. Risk: Film projects are very high risk. Having said that, the level of risk is similar to the risk assumed in an early stage technology investment. --> A film project might pass.
   
3. Return: Successful movies can be tremendously profitable, and those big wins occur with roughly the same frequency as traditional venture capital investments. However, for most VCs, the biggest exits are generated by IPOs. A movie isn't a business, and therefore the potential for an IPO is ruled out from day 1. That's not an attractive prospect for a VC. Additionally, a VC would likely have to take a huge ownership stake in a movie to make it worthwhile - an arrangement that might be difficult to swallow for most filmmakers. --> A film project would likely not pass here. 
   
4. Ability to Add Value: Very few VCs could add value to a film project. Filmmakers aren't building businesses. A VC's network and experience could very rarely affect the outcome of a movie. This is where a film project wouldn't make the cut. VCs don't want to be passive investors. --> A film project would not pass here. 

The 4 question screen explains why few VCs (if any) invest in film projects.

It is important to be aware of the fact that VCs always ask themselves these 4 questions. You don't have to answer them explicitly in a pitch deck, but you should know ahead of time if you're a good fit for venture money. Not every idea or business can attract venture capital. Fit matters.

Think of these 4 questions as the first screen that a VC will use. But don't be discouraged. All venture money is not created equal, and different VCs will have different criteria. Just make sure you understand the baseline, and the expectations. Venture money can be your ticket to explosive growth and the creation of a great business.