By Karen E. Klein Q: A business consultant told me that venture-capital companies expect fees for reviewing and optimizing your business plan and shopping it around for funding. Is this true? Also, can you explain the difference between venture capitalists, investment houses, and investment brokers?
---- D.B., San Diego
A: Your consultant has his terminology mixed up. Venture-capital firms
do not normally charge fees, they provide capital to independent companies in exchange for partial ownership. If you are fortunate enough to get a chance to pitch your business idea to a VC firm -- something typically accomplished only with the help of a personal referral -- the board may evaluate your plan to determine whether they are interested in funding it, but they will not usually give you detailed feedback on it unless they opt for a long-term relationship.
However, there are third-party sources, such as investment brokers/dealers, investment bankers, consultants, and venture catalyst firms that will indeed work with you to polish your business plan, work up an investor presentation and financial model, and then help introduce you to appropriate capital sources for your company.
Investment houses and banks may help entrepreneurs raise money, do private funding, make venture-capital investments, and also
broker mergers and acquisitions. Experts say that if you are serious about getting funding and can devote some money toward professional help, an outside expert can better your materials and improve your plan significantly, increasing your chances of raising the money you need and getting you a better valuation for your company.
OPTIONS AND COSTS. These third parties have different methods of charging for their services, says Janis Machala, of venture catalyst firm Paladin Partners in Kirkland, Wash. "Some charge on an hourly basis, with $150 to $250 per hour the going rate for this type of help. Sometimes they will defer part of the cash compensation and take it in options or stock or warrants," adds Machala. "The mix of equity and cash for fund-raising will be based on how hard it will be to raise money for your venture."
Some investment bankers and brokers will take a cash retainer (which can be as much as $50,000 in very large deals) along with a "success fee" for locating funding for your company. The fee is typically a percentage of the total money raised, ranging from 3% to 10%.
Elton B. Sherwin Jr., managing director of Ridgewood Capital, a VC based in Palo Alto, Calif., says that the venture-capital funding route works only for companies that have very high growth potential. "The company's appreciation potential has to be high enough to justify their risk, since they're not taking collateral like a banker would do," Sherwin says. "For many -- if not most -- small businesses, an SBA loan or a bank loan are better sources of capital." Have a question about running your business? Ask our small-business experts. Send us an e-mail at firstname.lastname@example.org, or write to Smart Answers, BW Online, 6th Floor, 2 Penn Plaza, New York, NY 10121. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally.