Venture capital

All companies need staff specialized in the various functions of a business – production, marketing, finance, accounting, human resources, R & D, etc. they also need both ideas and the capital necessary to turn them into goods or services, but ideas and capital are particularly important for new companies (start-ups). This unit is about entrepreneurs and the companies that raise finance for them.

Aims

• Consider the essence of venture capital

• Describe the contents of required documents

• Compare different possible investments

• Analyze how and when (stages) venture capitalists or business angels invest

Lead in

• If you were starting a new company, how could you try to raise money?

• What are the main ways that established companies raise money?

Reading

Text 1

Read the text and do the tasks that follow

Venture Capital and Venture Capital Firms

Venture Capital (VC) ("risk capital" or ‘unsecured risk financing’ or ‘development capital’) is the money and resources made available to startup firms and small businesses with exceptional growth potential. Venture capital funds pool investors' cash and loan it to startup firms and small businesses with perceived, long-term growth potential. It typically entails high risk (and potentially high returns) for the investor and the cash infusion often comes at a high price.

Most venture capital comes from groups of wealthy investors, investment banks and other financial institutions that pool such investments or partnerships. Venture firms often take large equity positions in exchange for funding. This form of raising capital is popular among new companies, or ventures, with a limited operating history that cannot raise capital though a debt issue or equity offering. Often, venture firms will also provide start-ups with managerial or technical expertise.

It is typical for venture capital investors to identify and back unquoted companies in high technology industries such as biotechnology and IT. Venture capital assumes four types of risks, these are:

1. management risk (inability of management teams to work together);

2. market risk (product may fail in the market);

3. product risk (product may not be commercially viable);

4. operation risk (operations may not be cost effective resulting in increased cost decreased gross margins).

Venture Capitalist is a wealthy investor who provides capital (more than $ 1 million) to start up ventures or supports small companies that wish to expand expecting higher returns for the additional risks taken.

Venture capital firms typically comprise small teams with technology backgrounds (scientists, researchers) or those with business training or deep industry experience. Just as management teams compete for finance, so do venture capital firms. They raise their funds from several sources. To obtain their funds, venture capital firms have to demonstrate a good track record and the prospect of producing returns greater than can be achieved through fixed interest or quoted equity investments. Most venture capital firms raise their funds for investment from external sources, mainly institutional investors, such as pension funds and insurance companies.

Many funds raised from external sources are structured as Limited Partnerships and usually have a fixed life of 10 years. Within this period the funds invest the money committed to them and by the end of the 10 years they will have had to return the investors' original money, plus any additional returns made. This generally requires the investments to be sold, or to be in the form of quoted shares, before the end of the fund.

Venture Capital Trusts (VCT's) are quoted vehicles that aim to encourage investment in smaller unlisted (unquoted and AIM quoted companies) UK companies by offering private investors tax incentives in return for a five-year investment commitment.

The investment process, from reviewing the business plan to actually investing in a proposition, typically takes a venture capitalist between 3 and 6 months. To support an initial positive assessment of your business proposition, the venture capitalist will want to assess the technical and financial feasibility in detail. They will assess and review management information systems; forecasting techniques and accuracy of past forecasting of the company; the latest available management accounts, including the company's cash/debtor positions; bank facilities and leasing agreements; pensions funding; employee contracts, etc. Venture capital firms will judge you by how prepared you are.

If you are starting a business, you have to get capital from investors. In order to persuade them to invest, you need to prepare several critical documents:

Business Executive Summary. It is a brief statement covering the main points that includes a discussion of management, profits, strategic position, and exit plan.

Business Plan. A detailed document that outlines what you are going to do and how you are going to do it; the management team (including full resumes; business strategy); marketing plan (sales projections, distribution, market, and competition; financials) and a competitive analysis.

Due Diligence. The due diligence review aims to support or contradict the venture capital firm's own initial impressions of the business plan formed during the initial stage.

Marketing Material. Any document that directly or indirectly relates to the sales of your product or service.