|A lot of people become aware of the term venture capital (VC) when they realize that traditional lending institutions and banks are unwilling to finance their business proposal. There is a huge difference between getting a loan from a lending institution (debt) and selling a part of your equity in the venture. Are you really prepared to have a new partner who will put specific controls on management of the business even though they will rarely participate in the day to day operations? Are you prepared to investigate what venture capitalists want (your idea may be good for you but may not provide sufficient potential for attracting VC)? Are you prepared to take the time to find and court venture capitalists (venture capital is much harder to find than looking for a bank loan and getting to know each other as potential new partners is a long process)? Are you prepared to have your business management abilities really scrutinized, and can you accept that they may require a management team or a better management team? Are you prepared to sell more of the company than you would originally have imagined? Those who have the money set the rules and it is not uncommon that almost half or more of the business may be owned by other shareholders. If you can answer “yes” to the above questions, you are ready to proceed.
Remember, in any business venture, equity always precedes availability to debt. Sometimes people are turned down for a loan by lending institutions because of a lack of sufficient equity or collateral in the business venture. Is venture capital your only hope? You may not need as much venture capital as you first might think. By attracting a venture capitalist, you improve the equity level in the proposed business, which may cause a lender to feel less at risk and provide you with that loan you originally could not get. Check everything out first; never assume that a loan will be there if you get venture capital. Other circumstances can come into play.
|Venture capital (VC) is money invested in- rather than loaned to – a business enterprise for the purpose of providing it with needed capital for start-up and/or continuing growth. Venture capitalists do not require a guaranteed monthly repayment with a set rate of interest, nor are they providing capital funding without additional strings attached.Investment from venture capitalists is equity financing, which means that it is in the form of partial ownership – and usually with managerial and operational controls – of the enterprise by the venture capitalist. This type of investment is sometimes known as “patient money” investing and is held over a longer term, usually 3 to 7 years. Most often, they will hold shares in the stock of the company, sit on the board of directors, and take a significant part in ongoing executive decisions.
Venture capital is typically funding enterprises which are nonetheless expected to become highly profitable in a relatively short period of time. Therefore, the money invested by the venture capitalist can grow (and is also at risk) in direct proportion to the success or failure of the business venture. Shareholders in a business are at most risk, because they are the last to obtain the remaining assets of a failed business, if any. Shareholders are also typically last to benefit from the businesses success. In a growing business, profits must be retained for funding the growth, so the real value is in the market value of the shares. It may take considerable time before you see cash available to payout substantial dividends or see a cash return from the sale of your shares.
When venture capital is a suitable source of funding:
Typically, venture capital is most suited for enterprises with one or more of the following characteristics:
Companies that have a well developed business plan for substantial rapid growth.
Companies which are in need of sizeable amounts of capital that are difficult to collateralize.
Companies which are preferably past the start-up phase, and are poised for quick expansion.
Companies with good liquidity prospects, such as going public in the near future, or good prospects of being bought out very profitably.
Companies that can demonstrate that perfect balance between risks and rewards in the investor’s eyes.
Types of venture capitalists:
This is probably the largest source, least complicated, least time consuming and least favored method of obtaining venture capital by most small entrepreneurs. These people are the non-professional venture capitalists: extended family, friends, friends of friends, contacts and associates.
Professional Venture Capital:
Consists of private independent VC investment management companies; capital funds managed by lending institutions such as banks, or by industrial corporation-backed organizations; labor-sponsored VC funds; government-controlled organizations with a mandate for VC investing. Many venture capitalists specialize in specific types of enterprises, such as information technology or biomedical products. Often, they will have experience and knowledge of certain industries and may desire to focus on them exclusively. These firms do a lot of due diligence in investigating the business concept and its owners and expect considerable research and documentation. In Canada, a substantial portion of the venture capital industry consists of approximately 80 professionally managed investment groups who are members of the Canadian Venture Capital Association (CVCA).
“Angel investors” are a specific type of venture capitalist, somewhere in between “love money” investors (such as family, friends) and professional VC investment companies. Angels are usually local persons in business or in the professions with money to invest in small to medium sized local enterprises. Typical investments by angels are under $250K. They are not as stringent as professional venture capitalists but not as informal or reliant on hope as “love money” investors might be. “Angels” are typically the most difficult to locate. Most like to stay anonymous and rely on their business contacts for leads.
Typical stages of venture capital financing:
Usually for very new companies which have not yet produced a product for sale; may still be assembling a management team; financing is provided to foster a concept, develop new product or service, carry out associated marketing. As a percentage of total available VC money, generally this high, high risk stage has the smallest allocation of investment funds.
Company has expended all initial production and marketing budgets and needs additional capital to bring product to market; company may not yet be profitable.
Further financing for expansion of operations; marketing and sales developing, though company may still not be profitable.
“Mezzanine,” or third-stage financing
Capital financing for ongoing operations and expansion; sales increasing, company is breaking even or profitable; financing is for major expansion, marketing, new product development.
Financing for the strategic purchase of other product lines, divisions or companies, or for management/employees to buy out some or all of the company for which they work.
What Professional venture capitalists expect in return for their investment:
First and foremost: a very substantial return on their investment. This can range from 20% – 50% (compounded annually) and is typically in the range of 30% – 40%. The pay-off for the venture capitalist is a liquid market for the shares held in the company: a buy-out of the investment by other shareholders, by going “public” in the stock markets, or sale of the entire company to a well capitalized business.
To protect their investment, they require controls over the actions of management, typically in contract form, to insure key decisions are not made without their knowledge and agreement.
What Professional venture capitalists can provide:
Financing which is accessible when other sources are not prepared to lend the money due to the risk involved such as a lack of collateral or a totally proven management history.
A venture capitalist has the ability to evaluate the growth potential in business enterprises which are in immediate need of sizeable amounts of capital. Being turned down by several targeted VC’s might be an indication that you or the business concept cannot meet their stringent standards or that your vision might be misguided.
Once you obtain a VC investment, additional financing can be obtained relatively quickly and in sufficient quantity to finance the growth needed by an enterprise at a given stage. This is known as having “deep pockets.” In all likelihood, more money will be needed than originally planned for.
The number one benefit provided by a professional venture capitalist is expertise in growth management. Most pro VCs have experience and skill in managing the financial strains of growth. Also, with their many contacts, they can speed growth at less risk and more quickly overcome problems as they arise. Strangely, it has been said by many successful business owners that they found the skills and contacts of the venture capitalist were of more value to them than the money.
Typical qualities which professional venture capitalists look for in a prospective investment opportunity:
A business proposition with good potential for significant profitability, such as a product or technology capable of generating a defensible and sustainable competitive advantage in the market. Being the first one in the market is not enough.
A “big idea”- a market opportunity with enough profit potential to create a company with sales in the multi-millions per year within five years or so.
Tangible evidence of market demand for product(s) of the company.
Momentum already in progress: growing sales, new products being launched, major deals under negotiation, high booking orders.
Strong, solid, and preferably seasoned management in the technical, executive, marketing and financial departments of the company. A competent board of directors in place is desirable.
Financial and personal commitment by the owners of the company to the proposed enterprise. The more the entrepreneur has or will have at stake, the more comfort the VC will have.
A proven record by the company in its industry is a big plus, as are credible third-party endorsements (e.g. from industry experts, market analysts, trade publications, potential alliance partners).
Appropriate exit opportunities. The potential for the enterprise to go public or become an attractive acquisition candidate represents the opportunity for the venture capitalist to exit his investment profitably and conveniently. VCs know that it is easier to invest than it is to get your investment out. They must have a liquid exit strategy.
How venture capitalists are usually approached: Do’s and Don’ts:
Most venture capital companies constantly receive many unsolicited business propositions and only accept a very small number for investment. Patience and persistence is usually required when submitting business plans for approval. “Cold calling,” or sending business plans to VC companies without prior introduction, is generally a very poor strategy compared to making contact through a third-party introduction or recommendation.
Venture capitalists expect to be presented with information which is concise, accurate and detailed enough to enable them to evaluate a prospective enterprise. Organization, clarity and efficiency are essential qualities for business plans, meetings and other communications.
Typical process of arranging a deal for financing with a venture capitalist:
The real starting point is identifying VC prospects or people who can introduce you to VC prospects.
The process of courting venture capital typically can take from three to six months, and in some cases a year or more.
The introduction for a VC deal is a business plan summary that will lead to an examination of the business plan by the venture capitalist. Investment interest will usually result in a meeting with principals from the prospective business and/or a visit by the venture capitalist. This is typically followed by a preliminary round of “due diligence” by the VC company, during which they will make a basic assessment of the prospective enterprise, its finances, management, product, market and competition.
If initial due diligence is satisfied, a proposal of terms will be set forth by the venture capitalist, and a process of negotiations begins.
If an interim agreement for terms is reached, the VC company will next undertake the full process of due diligence, involving a more prolonged and detailed examination of the business plan and operations of the company under consideration.
When due diligence has been completed to the satisfaction of the venture capitalist, the next stage will be writing-up of a contractual agreement for the investment deal, followed by discussion, final negotiations and approvals.
The final stage is the legal writing-up and documentation of the final agreement. A document commonly included in an agreement is a Letter of Intent from the investor, detailing conditions and clauses within the agreement and further defining the role of the venture capitalist within the new enterprise.
The role of the business plan in securing venture capital:
The business plan, an essential element for obtaining business financing under any circumstances, is especially crucial in obtaining venture capital financing. Venture capitalists require information which is as complete, detailed to their needs and accurate as possible regarding a prospective investment in a company. They have to evaluate the soundness of the enterprise, its potential profitability, and the risk involved in providing financing for it.
A business plan submitted for the purposes of securing venture capital has certain unique features. Please refer to the following section “Links to websites with more detailed information or additional resources on the subject of venture capital” for sample VC business plans available online; or contact The Business Link Library for additional resources..
|A venture may be defined as a project prospective of converted into a process with an adequate assumed risk and investment. With few exceptions, private equity in the first half of the 20th century was the domain of wealthy individuals and families. The Vanderbilts, Whitneys, Rockefellers, and Warburgs were notable investors in private companies in the first half of the century. In 1938, Laurance S. Rockefeller helped finance the creation of both Eastern Air Lines and Douglas Aircraft and the Rockefeller family had vast holdings in a variety of companies. Eric M. Warburg founded E.M. Warburg & Co. in 1938, which would ultimately become Warburg Pincus, with investments in both leveraged buyouts and venture capital.|
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