The Rules of Venture Capital 2010

The mating dance that entrepreneurs do with prospective investors--venture-capital firms, angels or even just friends and family members--has obvious parallels to the dating scene.

On the one hand, you don't want to seem so eager for a term sheet that the investor thinks you're desperate and tries to low-ball you. On the other, you don't want to appear so aloof and arrogant that the investor passes on your deal because he doesn't think you need his money.

With the stock market rallying and banks beginning to lend again, the market for early-stage capital is once again showing signs of life. While last year I was urging my clients to keep knocking on doors until they got a meeting, this year I'm busy advising them on the finer points of equity vs. convertible debt. Though it's too soon to know if our clients will get funded or at what valuation, they're starting to line up meetings with investors--and, in the case of one client, three meetings this week. So, while the experts expect the market for angel financing to remain flat this year, at least the fish seem to be biting.

Here are some things to keep in mind when you walk into the shark tank:

1. Do your homework. It's not enough to go in with a well-researched business plan, slide deck or financial model. You need to study up on each investor you pitch and find out what kind of deals he's looking for. For example, does the investor prefer B2C or B2Bbusiness models? What types of deals has his firm funded in the past? Is the investor looking for immediate cash flow or is he patient enough to watch your company grow over time?

2. Know your bottom line. It's hard to negotiate a good deal if you don't know what you want to get out of it. While it may be tempting to jump at the first term sheet an investor sends over, you need to make sure that the terms are reasonable (no unattainable milestones, no overlydilutive liquidation preferences, etc.) before you sign on the dotted line. Because pre-revenue companies are difficult to value, you may be better off doing a debt deal (that is, borrowing money from the investor at an interest rate of, say, 8 percent to 10 percent) if you think your company can ramp up quickly rather than sell a big chunk of equity at a low price and regret it later.

3. Play the field. In order to get the best deal--debt or equity--you need to talk to more than one investor. While you may find someone who loves your deal so much that he's willing to write the whole check, it's more likely that you'll have to piece together your funding from multiple sources. And, unlike the dating scene, you can dance with several VCs at the same timewithout risking your company's reputation--and possibly get a highervaluation to boot.