About Venture Capital
Starting and growing a business always require capital. There
are a number of alternative methods to fund growth. These include the owner or proprietor’s own capital, arranging debt finance, or seeking an equity partner, as is the case with private equity and venture capital Venture capital is money provided by an outside investor to finance a new, growing, or troubled business. The venture capitalist provides the funding knowing that there’s a significant risk associated with the company’s future profits and cash flow.
Capital is invested in exchange for an equity stake in the business rather
than given as a loan, and the investor hopes the investment will yield a better-than-average return. Venture capital is an important source of funding for start-up and other companies that have a limited operating history and don’t have access to capital markets. A venture capital firm (VC) typically looks for new and small businesses with a perceived long- term growth potential that will result in a large payout for investors. When venture capitalists invest in a business they typically require a seat on the company's board of directors. They tend to take a minority share in the company and usually do not take day-to-day control. Rather, professional venture capitalists act as mentors and aim to provide support and advice on a range of management, sales and technical issues to assist the company to develop its full potential.
"Money provided by professionals who invest alongside
management in young, rapidly growing companies that have the potential to develop into significant economic contributors.“
Venture capital is a means of equity financing for rapidly-
growing private companies. Finance may be required for the start-up, development/expansion or purchase of a company. Venture Capital firms invest funds on a professional basis, often focusing on a limited sector of specialization (eg. IT, infrastructure, health/life sciences, clean technology, etc.).
It injects long term equity finance which provides a solid
capital base for future growth.
The venture capitalist is a business partner, sharing both
the risks and rewards. Venture capitalists are rewarded by business success and the capital gain.
The venture capitalist is able to provide practical advice
and assistance to the company based on past experience with other companies which were in similar situations.
The venture capitalist also has a network of contacts in
many areas that can add value to the company, such as in recruiting key personnel, providing contacts in international markets, introductions to strategic partners, and if needed co-investments with other venture capital firms when additional rounds of financing are required.
The venture capitalist may be capable of providing
additional rounds of funding should it be required to finance
Unique Features of Venture Investment in high-risk, high-returns ventures: As VCs invest in untested, Capital risks. In return, they expect a innovative ideas the investments entail high
much higher return than usual. Participation in management: Besides providing finance, venture capitalists may also provide technical, marketing and strategic support. To safeguard their investment, they may also at times expect participation in management. Expertise in managing funds: VCs generally invest in particular type of industries or some of them invest in particular type of businesses and hence have a prior experience and contacts in the specific industry which gives them an expertise in better management of the funds deployed. Raises funds from several sources: A misconception among people is that venture capitalists are rich individuals who come together in a partnership. In fact, VCs are not necessarily rich and almost always deal with funds raised mainly from others. The various sources of funds are rich individuals, other investment funds, pension funds, endowment funds, et cetera, in addition to their own funds, if any. Diversification of the portfolio: VCs reduce the risk of venture investing by developing a portfolio of companies and the norm followed by them is same as the portfolio managers, that is, not to put all the eggs in the same basket. Exit after specified time: VCs are generally interested in exiting from a business after a pre-specified period. This period may usually range from 3 to 7 years.
Step 1: Business Plan Submission The first step in approaching a VC is to submit a business plan. At minimum, your plan should include: 1. a description of the opportunity and market size;
2. 3. 4. 5. resumes of your management team; a review of the competitive landscape and solutions; detailed financial projections; and a capitalization table.
Once the VC has received your plan, it will discuss your opportunity internally and decide whether or not to proceed. Step 2: Introductory Conversation/Meeting
If your firm has the potential to fit with the VC’s investment preferences, you will be contacted in order to discuss your business in more depth. If, after this phone conversation, a mutual fit is still seen, you’ll be asked to visit with the VC for a one- to- two hour meeting to discuss the opportunity in more detail. After this meeting, the VC will determine whether or not to move forward to the due diligence stage of the process
Step 3: Due Diligence The due diligence phase will vary depending upon the nature of your business proposal. The process may last from three weeks to three months, and you should expect multiple phone calls, emails, management interviews, customer references, product and business strategy evaluations and other such exchanges of information during this time period. Step 4: Term Sheets and Funding If the due diligence phase is satisfactory, the VC will offer you a term sheet. This is a non-binding document that spells out the basic terms and conditions of the investment agreement. The term sheet is generally negotiable and must be agreed upon by all parties, after which you should expect a wait of roughly three to four weeks for completion of legal documents and legal due diligence before funds are made available.
Types of Funding
It’s important to know the preferences of the VC you’re approaching, and to clearly articulate what type of funding you’re seeking: 1. Seed Capital. If you’re just starting out and have no product or organized company yet, you would be seeking seed capital. Few VCs fund at this stage and the amount invested would probably be small. 2. Start-up Capital. At this stage, your company would have a sample product available with at least one principal working full-time. Funding at this stage is also rare. It tends to cover recruitment of other key management, additional market research, and finalizing of the product or service for introduction to the marketplace. 3. Early Stage Capital. Two to three years into your venture, you’ve gotten your company off the ground, a management team is in place, and sales are increasing. At this stage, VC funding could help you increase sales to the break-even point, improve your productivity, or increase your company’s efficiency.
4. Expansion Capital. Your company is well established, and now you are looking to a VC to help take your business to the next level of growth. Funding at this stage may help you enter new markets or increase your marketing efforts. You should seek out VCs that specialize in later stage investing. 5. Late Stage Capital. At this stage, your company has achieved impressive Sales and revenue and you have a second level of management in place. You may be looking for funds to increase capacity, ramp up marketing, or increase Working capital.
What do VCs look for?
VC tends to focus on the following factors: Commercially viable. Does the company have a product or service that can be reproduced efficiently to generate revenue? Identifiable market. Is there a clearly defined market for the company’s Product or service? Does the company’s product or service meet an identifiable need in that industry? Does the company have a reasonable plan to meet the identified need in an efficient, revenue-generating manner? Strong management. Does the company’s leadership inspire confidence? Do they have the vision, expertise, and the ability to propel a business to a significant level of growth? Does the team consider best practices of those that have gone before them?
Sustainable competitive advantage. Has the company hit upon an idea that’s truly unique to the industry, one that has significant barriers to entry that will inhibit others from encroaching upon its market? Has the company considered economic and technological change that may affect the business model? Who are the company’s potential competitors, and what are those companies’ strengths and weaknesses?
VC Exit Strategy
The exit strategy is the VC’s way of cashing out on its investment in a portfolio company. A VC often hopes to sell its equity (stock, warrants, options, convertibles, etc.) in a portfolio company in three to seven years, ideally through an initial public offering (IPO) of the company. The company becomes liquid through the sale of its stock to the public and the VC sells its stock to reap its return. While an IPO may be the most visible and glamorous form of exit, it’s not the most common. Most companies are sold through a merger or acquisition event before an IPO can occur. If the portfolio company is bought out or merges with another company, the VC receives stock or cash from the event. Another alternative may be the reorganization of a portfolio company’s debt and equity mixture, called a recapitalization. The VC exchanges its equity for cash, the management team gains equity incentives, and the company is positioned for future growth.
Before you approach a VC for funding, examine your goals. How much capital do you need? Do you want passive or active investors? Are you looking to ramp up your marketing efforts? Grow your management team? Does your Board of Directors need more seasoned expertise? Answering these questions for yourself will help you decide whom to approach for investment capital, whether that be a VC, angel investor, strategic investor, or other. If you choose the VC path, make your best effort to get an entrée into your target VCs through a trusted referral. And always do your homework, both on the VCs you’re targeting and on your own business needs.
Private equity consists of investors and funds
that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity. Capital from private equity is raised from retail and institutional investors and can be used to fund new technologies, expand working capital within an owned company, make acquisitions or to strengthen a balance sheet.
Investments in private equity
Private equity firms generally receive a return on
their investments through one of the following avenues: an Initial Public Offering (IPO) - shares of the company are offered to the public, typically providing a partial immediate realization to the financial sponsor as well as a public market into which it can later sell additional shares; a merger or acquisition - the company is sold for either cash or shares in another company; a Recapitalization - cash is distributed to the shareholders (in this case the financial sponsor) and its private equity funds either from cash flow generated by the company or through raising debt or other securities to fund the distribution.
Investment features and considerations
Substantial entry requirements. With most private equity funds
requiring significant initial commitment(usually upwards of $1,000,000) which can be drawn at the manager's discretion over the first few years of the fund.
Limited liquidity. Investments in limited partnership interests (which is the
dominant legal form of private equity investments) are referred to as "illiquid" investments which should earn a premium over traditional securities, such as stocks and bonds. Once invested, it is very difficult to achieve liquidity before the manager realizes the investments in the portfolio as an investor's capital is locked-up in long-term investments which can last for as long as twelve years. Distributions are made only as investments are converted to cash; limited partners typically have no right to demand that sales be made. Investment Control. Nearly all investors in private equity are passive and rely on the manager to make investments and generate liquidity from those investments. Typically, governance rights for limited partners in private equity funds are minimal.
Unfunded Commitments. An investor's commitment to a
private equity fund is drawn over time. If a private equity firm can't find suitable investment opportunities, it will not draw on an investor's commitment and an investor may potentially invest less than expected or committed. equity investments, an investor can lose all of its investment. The risk of loss of capital is typically higher in venture capital funds, which invest in companies during the earliest phases of their development or in companies with high amounts of financial leverage. By their nature, investments in privately held companies tend to be riskier than investments in publicly traded companies. private equity can provide high returns, with the best private equity managers significantly outperforming the public markets.
Investment Risks. Given the risks associated with private
High returns. Consistent with the risks outlined above,