Tag Archives: venture
Venture Capital 101 (Page 1 of 6)
I. WHAT IS 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 theres a significant risk associated with the companys 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 dont 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.
A venture capitalist is not necessarily just one wealthy financier. Most VCs are limited partnerships that have a fund of pooled investment capital with which to invest in a number of companies. They vary in size from firms that manage just a few million dollars worth of investments to much larger VCs that may have billions of dollars invested in companies all over the world. VCs may be a small group of investors or an affiliate or subsidiary of a large commercial bank, investment bank, or insurance company that makes investments on behalf clients of the parent company or outside investors. In any case, the VC aims to use its business knowledge, experience and expertise to fund and nurture companies that will yield a substantial return on the VCs investment, generally within three to seven years.
Not all VC investments pay off. The failure rate can be quite high, and in fact, anywhere from 20 percent to 90 percent of portfolio companies may fail to return on the VCs investment. On the other hand, if a VC does well, a fund can offer returns of 300 to 1,000 percent.
In additional to a portion of the equity, a VC expects to have a say in how its portfolio company operates. Ideally, the VC fosters growth at the company through its involvement in managerial, strategic, and planning decisions. To do this, the VC relies on the expertise of its general partners who may be former CEOs, bankers, or experts in a particular industry. In most cases, one or more general partners of the VC take Board of Director positions at a portfolio company. They may also help recruit key executives to the portfolio company.
Its important to do your homework before approaching a VC for funding, to make sure youre targeting the right potential partner for your business needs. Not all VCs invest in start-ups. While some may invest small amounts of seed capital for very early ventures, many focus on early or expansion funding (see section III. Types of Funding), while still others may invest at the end of the business cycle, specializing in buyouts, turnarounds, or recapitalizations.
VCs may be generalists that invest in a variety of industries and locations. More typically, they specialize in a particular industry. Make sure your company falls within the VCs target industry before you make your pitch a VC thats focused on biotechnology start-ups will not consider your request for later-stage funding for expansion of your semiconductor firm. You can often gain insight into a VCs investment preferences by reviewing its website.
How to Borrow Money, Part 1
There are two types of financing: equity financing and debt financing.
The most frequent source of funding for a small and mid size businesses is to borrow money. Getting a loan usually is not an easy and short process.
It is always a good idea to learn as much as you can in advance about the factors that important in the decision-making process of banks and other lenders when they consider your loan application. For more detailed information you may refer to my other articles.
When looking for funding, you should consider your company’s debt-to-equity ratio, which is defined by dividing amount of borrowed money by amount of invested in the business. The lower the ratio is: more invested and less money borrowed, the easier for you will be to get financing and at more favorable terms.
The decision what financing to pursue works on case to case basis, but the general rule of tomb is: if you have a high debt to equity ratio you should seek equity financing and vice versa.
In the most cases it is impossible to get 100% financing. Institutions want to see at least 20% of equity in a business. Building equity can be achieved by investing owners cash or build it through retained earnings, but by itself does not guarantee that you get financing for a business.
Equity Financing
Equity financing means financing a business by selling ownership interests to investors or, the money is raised in exchange for a share of ownership in the business or having the right to convert other financial instruments into stock. It is the way raise funds without incurring debt, or without obligation to repay a specific amount of money at a particular time.
Equity sources can be divided into two groups: non-professional such us relatives, friends, and employees, etc. and professional that can be divided into two sub groups: Private such as Angels and Venture Capital and Institutional such as Hedge Funds and Government Assessed Sources. Most of professional groups specialize in particular industries.
Venture Capitalists may review thousands of proposals a year, but invest only in a few that have bigger prospective returns on the capital, great management team, industry growth, competitive advantage and solid exit strategies (e. g. IPO). Venture Capital firms usually passively involved in a companys management, unless business fails to perform as projected.
Many people think that Venture Capital firms finance new businesses, but in the most cases they prefer established companies with stable cash flow. If you need money for a start up look for an Angel (Private) Investors. Angels might work alone or in groups (sometimes as big as few hundred people) and usually actively involved in companys management.
Pros and cons of equity financing
Company shares give you two major rights: participation in the future companys profit-sharing and decision-making processes. The biggest drawback of equity financing is that you relinquish those rights to an outsider.
To be continued.
Yury Iofe, MBA
Universal Business Structured Solution
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