Understanding How Venture Capital Really Works
To have a successful venture capital raise campaign, be sure you have solid Business Plan in place. As experienced an Business Consultant with a background in private equity and business finance, I see many business plans, marketing plans and strategic plans that simply don’t meet muster. Give yourself the best chance possible by spending some time and effort in this area. Also, having a good Executive Summary and Investment Overview for an initial introduction to your business opportunity will serve you well.
Understanding how Venture Capital works is crucial when you are trying to raise venture capital funds. This article gives you inside insights into venture capital so you can develop an effective venture capital strategy. This will go a long way toward the success or failure of your venture capital campaign. You can seek Venture Capital for any growth Phase. VC expects Equity Participation through the use of Stock Ownership, Warrants, Options and Convertible Securities/ Debt.
Researching venture capital firms is utterly essential to figure out precisely what they look for and expect in an investment, exactly what their investment parameters entail, and what the VC firm specializes in. Typically the fund will have a detailed website which will clearly explain their Fund Objectives. You will also find this vital information on their Offering Prospectus / Memorandum to their investors. Below I have outlined the different objectives of a VC fund to give you an idea what you need to find in your research.
Investment Objectives
? Rate of Return expectations.
? Long- term or short- term capital appreciation.
? Early, Middle or Late Stage Companies.
? Sectors interested in.
? High growth potential.
? Liquidity Options.
? Expertise, Experience & Reputation of the Fund.
? Advisory Board Members.
? Members of the Fund.
Investment Criteria
? Evaluate in terms of Management, Product, Markets, Financials, and Business Stage.
? Highly competent and motivated management team.
? Proprietary Product or service that: meets a strong market need: Favorable price and cost relationship.
? A market which has a favorable mix of Size, Growth, Competitive Barriers and the potential for high volume sales.
? Management:
o People are the most important factor in a Company’s success
o Balanced Team
o Superior Skills
o Team leader with a track record
o Ability to keep and attract talent
o Understands Planning & Control
o Can make difficult decisions
o Can work with professional advisors
o Accept assistance from the Fund Members
o Commitment to the Venture
o Clearly understands the Funds’ mind-set on liquidity, rate of return and investment objectives.
o Above all, integrity, character, accountability and high business ethical motive
Market
? Young, growing fast and provides opportunity
? Defined market niche.
? Dominance in that niche.
? Niche market should be small enough not to attract big company competitors, yet has a strong potential for expansion.
? Realistic Marketing Plan.
? Marketing Team Leaders should have encompassing industry contacts with sales people, sales reps and distributors.
Stage
? Mostly early stage but will consider later stage with high growth opportunities.
? Consider small public companies as well as private.
? Spin offs as a result of re-structuring and rejuvenation.
A Venture Capitalist wants just enough Control to justify the investment risk. Here are two of the important Risk Models VC Firms use to determine the Risk of an Opportunity.
The Risk / Return Evaluation
— At the Product or Service Level:
? Level 1: Idea Stage. Not Operable. Market Assumptions.
? Level 2: Pilot/ Test Stage. Market refined.
? Level 3: Fully Developed. Few Customers. Market defined.
? Level 4: Satisfied Customers. Market Established.
— At the Management Level:
? Level 1: Entrepreneur.
? Level 2: Few Founders.
? Level 3: Partial Management Team.
? Level 4: Full Management Team. Highly Experienced.
Note: The higher the Level from both Determinants (Product or Service & Management), the less Risk for a higher Return. 4/4 would be most desirable and cost the Entrepreneur the least. 1/1 would be the least desirable and cost the Entrepreneur the most. A 2/2 or 3/3 are good Level Combinations to shoot for prior to approaching Venture Capital if financially practicable.
The Present Value / Future Value Evaluation
— Scenario: Expected ROI is 35% per year, without inflation, over 5 years. Present Value of Earnings is $4.5M. Future Value Earnings in 5 years is $15M.
? VC Equity Share is calculated: $4.5M divided by $15M = 30%.
? Maximum Investment is 10 times first year gross (expected) earnings, which in this example is about $500,000.
? Conclusions: $5M maximum investment for 30% of the Company at 3/3 Level over a 3 year period. A 1/1 Level, Seed/Start Up Investment would be a 45-50% Equity Stake, with an expected ROI of 60%.
Having good Commercial Loan Package makes a world of difference in trying to raise venture capital. Furthermore you need to have in place seriously well developed Business Turnaround Process to really attract venture capital. Frank Goley is a highly experienced business consultant for ABC Business Consulting, and he is author of a business plan workbook. Frank also writes the business success blog, and he has written over 170 articles on business success.
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