My friend Gerry Lemborg is a premier venture capitalist based in London.  I picked this primer up from one his posts on another forum.

The various posts on this forum demonstrate a diverse series of views on what it takes to successfully fund a venture. There are no absolute answers to the question of how to successfully fund any venture with investment capital, as opposed to debt capital. However, in order to achieve a successful outcome in securing investment, it is imperative that entrepreneurs understand how the investment community operates. The first rule you must accept is that in order to be successful, entrepreneurs and investors must be partners not adversaries. If you start off will an adversarial attitude, the deal will go nowhere.

Here is a short primer. Please forgive the length. If I had more time, I might have been able to shorten it.

There are essentially six types of players in the investment community:

The Four “F’s” – Founders, Families , Friends and Fools
These type of investors participate in the very early seed stage of a start-up. In most cases, their investment is driven by their hearts rather than their heads. Every single start-up needs investment from this group to reach a proof of concept stage so they can have a story to tell to attract more serious capital. In some cases, the capital raised from these people will be enough to create a lifestyle business, defined as a business that generates enough revenue to keep the founder comfortable and able to repay the capital

Investment Bankers

The term Investment Banker is well recognised at the high end of investment pyramid. They are the intermediaries in M&A who broker the deals between investors and the buyers and sellers. They are paid fees by either the buyer or seller to find a deal and receive a substantial additional fee for closing the deal. At the middle and lower end of the investment pyramid, Investment Bankers are called Finders,Middlemen or Consultants. They do the same job as the Investment Bankers at the high end of the pyramid, but the sellers (Entrepreneurs) expect them to take all the risk to create and structure the deal and get the funding.

Match making is only one part of their function. It can only take place after they have structured a fundable deal. If after investing a lot of their time they find that the deal isn’t fundable, no match making can take place and it is unreasonable that any entrepreneur expects them to work for nothing. If you want to work with a competent Investment Banker at this level you will have to share the risk and pay them regardless of whether the funding is secured. If you don’t want to pay them and they accept your success only terms, you will end up with a half hearted attempt to securing any funding. There are a lot of unemployed “consultants” out there that would take you on a success basis, but that is why they are unemployed. In order to get the best out of the Investment Bankers at this level, you must perform a careful due diligence to determine their competency. You can start this process just by “Googling ” them. The vast majority of competent investment bankers secure their retainers by referral. In many cases, Investment Bankers operating at all levels of the investment pyramid co-invest their own capital alongside the capital they raise from outside sources

Business Angels

Business angels are usually successful and wealthy individuals who invest their own capital in start-ups and early stage businesses. In additional to capital, many business angels insist on being active in the business. They are usual successful entrepreneurs in their own right and can add a lot of experienced business skills to any early stage company. They are willing to accept more risks than other professional investors like VC’s and Private Equity. Both the entrepreneur and the Business Angel should go through an elaborate tango to ensure themselves that they are compatible in their objectives and can work together. The Business Angel will spend much more time with an early stage entrepreneur than a VC. Since the capital they are investing is their own, the decision making process is much quicker than a VC or Private Equity firm. A lot of care should be undertaken on both sides in the selection process, since many early stage companies fail because of personal conflicts between the Business Angel and the entrepreneur. Their source of deal flow is through personal contacts from investment bankers and through the many business angel networks. Early stage entrepreneurs have many opportunities to pitch their companies business angel network events; however they usually have to pay from $500 to $2000 for the privilege.

Venture Capitalists

VC’s manage funds consisting of other people’s money, rather than their own. They are paid 2% – 3% of the size of the fund they manage each year the fund runs and an additional 20% carry on any profits. If they are managing a large fund, they tend to make larger investments which is why very few of them will invest less then a few $ million. Thus they have a stronger fiduciary responsibility to their investors than to the entrepreneurs in which they invest. That means that they must take as much care as possible to mitigate risks. As a result, they take much longer to come to an investment decision. Most VC’s invest at the A or B stage of a business, which means that the business has traction and is generating significant six to seven figure revenues. However, there are a number of VC’s that do invest in pre-revenue start-ups, but they have to demonstrate the following to even be considered:

A specific definition of your potential customer’s pain that you are relieving
A sustainable advantage in the relief you are offering
An accessible market big enough to achieve high growth
A credible team that can execute the business plan
Deal flow to VC’s almost always comes from warm referrals from:
Management of successful companies in which they have invested
Investment bankers as defined above
Close personal contacts and their networks
A warm referral to an established VC does not guarantee that they will fund it; it only guarantees that they will read your summary and , if the introduction is warm enough, agree to meet you. Their final decision as to whether they fund you has more to do with how they perceive you rather than your idea, technology or business plan. since they invest in people, if the people don’t perform, they are ruthless in repacing them. They can do that because the term sheet they will offer you if they fund you will give them that right regardless of the number of shares they control.

Corporate VC’s

Corporate VC’s manage their own capital. While they are also interested in capital growth, their principal objective for investing in outside companies is to further their own corporate objectives. They are interested in investing in companies that have technologies that they can leverage and access to markets that may not be currently serving. All the major technology companies have investment arms and their deal flow comes from reading the literature about new and compelling product and service offerings. Another source of their deal flow is warm referrals from their own staff and investment bankers.

Private Equity

Private Equity firms either manage funds of other people’s money or act as Investment Bankers by structuring a deal and then securing the capital from outside sources. Private Equity firms focus on established companies that are usually publicly traded. In many cases these companies are in trouble and the Private Equity company moves in new people as well as capital to turn it around. In some cases they just strip out assets and bury the rest; however many Private Equity firms build a portfolio of synergistic highly successful companies. These firms are not a good source of investment capital for early stage companies; however, they can be approached for capital once the company has traction and as an exit for these companies.

Finally

Since you only have one chance to make a first impression, there are a some rules that you should follow when dealing with professional investors.

Never ask a VC or any professional investor to sign an NDA to read your Executive Summary or Business Plan. If you do that, you are putting the mark of Cain on your forehead as a complete amateur who has very little concept of the world you are entering. A VC sees hundreds of submissions and many of them are similar in concept, technology and products, so they will not put themselves in any jeopardy of an NDA. Also, they invest in people who can execute rather than ideas or business plans. If you present them an opportunity that that they execute without you, they won’t invest in you anyway. An NDA may be in order later in the process, but never at the initial stage.
Never approach a professional investor without knowing their name and their investment criteria. Most all professional investors have a website that describes their investment criteria, and if they don’t, at least “Google” them to find out with whom you will be dealing. If you can’t do that much, they will never believe that you could ever successfully run a company.
Professional Investors have a very short attention span; therefore the summary you submit should not be longer than three (3) pages. Even at three pages, they will not read the last two, unless you capture their attention in the first paragraph of the first page. Whatever your idea is, assume that they have seen it before, because they probably have. You have to make an impact in that first paragraph.
The minimum return that any professional investor will entertain on a start-up is a 30% IRR over five years. If you can’t demonstrate the possibility of that type of return, the chances are nil that they will proceed much further with you. Their real target is a minimum of a 60% IRR to serve their investors needs and assure themselves of raising another fund.
Never submit forecasts created from the top down such as “our addressable market is $50 billion and if we get 1% of it we will all be prosperous”. Forecasts should be created from the bottom up based on the number of sales people you will deploy and the average sale sale value times the number of sales they expect to close. Anything else is an admission that you don’t understand how to run a business.