Venture Capital


Overview:

Angel Investors
Venture Capital (VC) is great financing method for small businesses to propel their company through mass commercialization.

However, not all businesses qualify for venture capital funding.

When a venture capital firm decides to raise an investment fund, it solicits investment into the fund from wealthy accredited private investors or institutional investors like state or private pension funds, insurance companies, banks or university endowments.

These investors are termed limited partners in the VC firm - meaning that their liability to the firm is limited only to the amount of money they invest in that fund. They invest in VC firms in hopes of realizing high return for their investment - returns that they could not receive from other investment opportunities like in the stock market, money market accounts, real estate, etc.

The owners of the venture capital firms are termed managing partners - their role is to raise the fund, solicit and invest in high potential companies, manage those companies (usually with board of director seats) then seek an exit from these portfolio companies in five to seven years in order to create a return for their investors. These managing partners typically receive 20% of all profits (return) realized as well as an annual 2.5% fee to manage the operations.

The benefits of this industry are four fold: 1) High growth companies get access to both capital (capital that they might not have raised otherwise) and business management advice. Many venture capitalists can open doors for business owners that the business owner could not open themselves. 2) Investors in these funds can potentially realize a higher return on their investment than they could have achieved elsewhere. 3) Managing partners grow their own businesses (the VC firm) realizing profits from their efforts and further building their wealth. And, 4) consumers get access to needed products and services that might not otherwise be available should these business owner not be able to raise the capital they need to start and grow their operations.

Search For Venture or Angel Capital!

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What VC firms tend to look for in their investments:


Most VC companies have very narrowly defined industries in which they invest. This could be technology and life science companies, green businesses, consumer good manufacturing, etc. Further, some firms even narrow their invest focus further within industries - like VC firms that only invest in online or ecommerce technology companies or only technology hardware companies. Most VCs investment in industries that they are very familiar with.

VCs look for companies that are in industries or markets that have huge return potential. They do not invest in $1 million dollar markets but in $100 million dollar or more markets.

Venture capitalists invest in people rather than products - although products do play a major role. Products must meet consumer needs and, for the most part, be unique in their industry (unique being better, faster or cheaper than other competitors). But, a business owner can create an excellent product that meets all the above criteria however if the business does not have the management team to execute on commercializing the product - the product will probably never realize its true potential. Thus, VC's focus revolves around the management team and their ability to execute. Now, just because you might not have a proper management team in place, if the product and market is compelling enough, the VC can and usually will help the business owner build the proper management team.

VCs like to see track records. Gone are the days when VCs will invest in companies with only ideas. This could mean that the company is already generating revenue, though is still not profitable or that the company has customers or orders lined up but does not have the funds to fulfill those orders. Or, if the company has developed Intellectual Property (IP) that cannot be duplicated and gives the investee company a huge competitive advantage.

Exit - most VCs expect to exit from their investment in their portfolio companies within five to seven years. Most VC firms are organized for a 10 year period. Thus, they will spend the first three to four years seeking new investments, the next three to four years building the companies and the remaining time seeking methods of exit.

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Exit:


There are several methods of exit.

Most VCs want the investee company to make an Initial Public Offering (IPO). Should the company go public; the VCs can then sell their shares on the public market to realize their return. Venture capital is essentially illiquid - meaning that the shares these companies hold are not easily transferable or bought and sold. When their portfolio companies go public, the easy at which they can sell their shares and realize their gains is increase 1,000 fold.

Gaining more popularity in the recent past is Mergers and Acquisitions (M&A). M&A is where another firm (private or public) will buy the VC's portfolio company for a high valuation in terms of what the VC paid for their ownership stake. They will then essentially buy the VC firm out of the company. M&A activity in the VC industry has really picked up in the last few years as down public markets and lower public investment has closed the IPO windows for long periods of time - past the VC firm's investment horizon.

Later round VC investment. This is where a later round investor will invest in VC's portfolio companies - essentially buying out the first or earlier stage investors.

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Types of Investment:


Most investment comes in the form of equity. Where the investors infuse capital into the company for an equity stake of ownership in the company (they buy shares of the company). However, investments can and usually does come in all forms of security; from preferred shares to convertible debt with warrants.

Further, VC firms only invest in businesses in specific stages of growth.

Seed - Pre start up companies. These companies are usually no more than an idea and prototype. They have yet to actually form their business and promote their products/services.

Start-up - These companies are usually under one year old. They have customers but may not be generating huge revenues and no profits.

Later Stage - These companies have been in business for more than one year, are generating revenue and could even be profitable but may be facing growing pains or growth opportunity that they cannot finance through current operations or other means.

Mezzanine - These are usually companies that are about to reach their pinnacle (like going public) yet need a short-term bridge capital infusion to sustain their operations while they seek that next major liquidity event.

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Ownership:


How many shares (and what percentage of ownership) a VC firm gets depends on their valuation pre- and post- money. Example, the VC firm values your company at $5 million as it stands. It decides to put in (invest) an additional $3 million. Thus, after the investment, the firm is worth $8 million. The VC's ownership would essentially be 3/8 of the companies ($3 million investment divided by the $8 million overall value). Just keep in mind that all valuations can and should be negotiated.

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Investment Process:


When a VC has interest in your company, they will begin their due diligence. This process involves checking the background of the company's management, validating their technology or other competitive advantage, contacting existing customers and suppliers, researching the market and valuing the company. After this is complete and they plan to invest, they will usually send out a term sheet outlining their terms and conditions for the deal. Again, these term sheets can and should be negotiated.

When a VC invests in your company, they become your partner as well. This means that they will want to have a say in your operations and direction. Through their board seats, they can and usually exert a lot of influence. Therefore, the business owner who accepts VC equity should remain very flexible; not only in their vision and direction of the firm but is their own role in the company as well.

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Seeking (approaching) Venture Capitalists:


Most VC firms are inundated daily with investment proposals and business plans. Thus, they just cannot review each and every one of these.

Most VCs like to get referrals from people they know and trust. They figure that these (gatekeepers) have already done some diligence on these companies and know them to fit within the VC's investment guidelines - and - vouch for their management team.

How does a company find these gatekeepers? By networking. If a company is seeking venture capital, it must use all available resources at its disposal. This would include:

Online networking sites like LinkedIn, Facebook, Myspace, Twitter, etc, etc.

Seek out business professionals like CPAs, lawyers or other business owners who either have current ties with these VC firms or who have clout and great reputations in the your industry.

Attend networking events where investors or their gatekeepers will be attending. These can be local events as well as events in venture capital hot spots like Silicon Valley, Boston, Austin Texas, etc.

Lastly, don't pass up on business plan competitions where you get a chance to pitch your business plan to potential investors. Even if you do not receive interest from VCs here, they should give you solid advice on how to improve your business.

The key is to do your homework on VC firms. Find out who they are and what stage of business and what industries they work and invest in. Once you have a short targeted list of VC firms, then you essentially have to find your way to market yourself and your business to them.

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What Companies Should Prepare for VCs:


Business Plan - outlining what your company offers, its management, its target market and how it will penetrate that market and its financial history as well as projections. - Don't forget a strong Executive Summary.

Private Placement Memorandum (Prospectus) - A PPM is a legal document that businesses use to describe the securities they are offering to buyers to include the type of share or stock as well as potential returns.

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Venture Capital Resources:


Directory of Venture Capital Firms and other Resources - vFinance, Inc.

National Venture Capital Association

Venture Capital Database - Venture Deal

Entrepreneurial Foundation - Kauffman Foundation

Just remember, if you want to grow your business with venture capital and realize your every dream - you have to play their game. When you try to play your own game in their industry - they take their ball (money) and go home. Play by their rules and find a way to win. It is all up to you and the effort and dedication you are willing to put in!

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Venture Capital - Business Money Today