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First Capital Solutions Project Development & Financial Solutions
Venture Capital Basics
Venture capital is an option available to businesses that do not meet lending standards required by banks or other traditional lenders. Unlike conventional sources, venture capital provides funding in exchange for a portion of ownership in the business.
Businesses need capital in order to start, grow and expand. These funds can come from various traditional sources: the entrepreneurs themselves, the business operations, lending sources such as banks, wealthy private investors (called "angels"), or the public stock markets. Sometimes these traditional sources of funds are inaccessible to businesses that need capital. When this happens, Venture Capital (VC) can play a pivotal role in the life of businesses. Generally, entrepreneurs and venture capitalists team up to fulfill a business plan. This partnership provides the enterprise with capital that would otherwise be unavailable. Venture capital is sometimes called risk capital in a manner that indicates it takes on higher risks than traditional funding sources. To compensate for this added risk, providers of venture capital receive a portion of the equity of the business. VC firms raise funds from varied sources and then invest these funds with entrepreneurs in return for a share of ownership. This type of funding has nourished many of the great business success stories in their earliest stages. Financial Service Companies like Advantage, EMS, Entrust, and PsBill have all benefited from venture capital financing. Generally, VC firms provide more than financing. They also assist their clients through strategic advising, networking relationships, and through membership on the client's of Board of Directors. VC companies expect a successful exit from their investments within five to seven years from their initial investment. This exit can come in several forms such as an IPO, a strategic acquisition, or the entrepreneur buying back the ownership.
What does a Venture Capitalist look for?
Venture capitalists are higher risk investors and, in accepting these higher risks, they desire a higher return on their investment. The venture capitalist manages the risk/reward ratio by only investing in businesses that fit their investment criteria and after having completed exhaustive due diligence.
Venture capitalists have differing operating approaches. These differences may relate to the location of the business, the size of the investment, the stage of the company, industry specialization, structure of the investment and involvement of the venture capitalists in the company's activities. The entrepreneur should not be discouraged if one venture capitalist does not wish to proceed with an investment in the company. The rejection may not be a reflection of the quality of the business, but rather a matter of the business not fitting with the venture capitalist's particular investment criteria.
Venture capital is not suitable for all businesses, as a venture capitalist typically seeks:
Superior Businesses
Venture capitalists look for companies with superior products or services targeted at fast-growing or untapped markets with a defensible strategic position. Alternatively, for leveraged management buyouts, they are seeking companies with high borrowing capacity, stability of earnings and an ability to generate surplus cash to quickly repay debt.
Quality and Depth of Management
Venture capitalists must be confident that the firm has the quality and depth in the management team to achieve its aspirations. Venture capitalists seldom seek managerial control; rather, they want to add value to the investment where they have particular skills including fundraising, mergers and acquisitions, international marketing and networks.
Corporate Governance and Structure
In many ways the introduction of a venture capitalist is preparatory to a public listing. The venture capitalist will want to ensure that the investee company has the willingness to adopt modern corporate governance standards, such as non-executive directors, including a representative of the venture capitalist.
Venture capitalists are put off by complex corporate structures without a clear ownership and where personal and business assets are merged.
Appropriate Investment Structure
As well as the requirement of being an attractive business opportunity, the venture capitalist will also be seeking to structure a satisfactory deal to produce the anticipated financial returns to investors.
Investment Process
The investment process begins with the venture capitalist conducting an initial review of the proposal to determine if it fits with the firm's investment criteria. If so, a meeting will be held with the Review Board Team to discuss the business plan.
The initial meeting provides an opportunity for the venture capitalist to review the business plan and conduct initial due diligence on the project. It is an important time to determine the management teams understanding of their business and ability to achieve the strategies outlined in the plan. The venture capitalist will look carefully at the management team's skills and backgrounds. This involves an agreement between the venture capitalist and management of the terms of the memorandum of understanding. The venture capitalist will then study the viability of the market to estimate its potential. Often they use market forecasts that have been independently prepared by industry experts who specialise in estimating the size and growth rates of markets and market segments. The venture capitalist also studies the industry carefully to obtain information about competitors, entry barriers, the potential to exploit substantial niches, product life cycles, distribution channels and possible export potential. The due diligence continues with reports from accountants and other consultants.
Approvals and Investment Completed
The process involves exhaustive due diligence and disclosure of all relevant business information. Final terms can then be negotiated and an investment proposal submitted to the board of directors. If approved, legal documents are prepared.
A shareholders' agreement is prepared containing the rights and obligations of each party. This could include, for example, veto rights by the investor on remuneration and loans to executives, acquisition or sale of assets, audit, listing of the company, rights of co-sale and warranties relating to the accuracy of information enclosed. The investment process can take up to three months, and sometimes longer. It is important, therefore, not to expect a speedy response. It is advisable to plan the business financial needs early on to allow appropriate time to secure the required funding.
An Exit Plan
Lastly, venture capitalists look for clear exit routes for their investment such as public listing or a third-party acquisition of the investee company.
Our Best Advice to Entrepreneurs
Learn to sell, face-to-face, one-on-one. Not just your product or service, but your entire business vision.
Buy an HP 19B or equivalent financial calculator, and become proficient in all aspects of finance for startup companies. Surround yourself with a quality team, build your network in sales, finance, management. Take a public speaking course and learn to give tight presentations to tough audiences. Try Toastmasters, Rotary, or Junior Achievement, etc.
Apply for Venture Capital, Joint Venture, Debt or Combination
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