10 Ocak 2013 Perşembe

Venture Capital Process

The process of making a venture capital investment has four main steps:[1]
·         Understanding the process
·         Writing the business plan
·         Negotiations
·         Preparing the financials

All of these processes have different types of tasks that must be completed before having the venture capital investment. We will go through each process with its sub processes.

We can start with the “understanding process” phase as it is the first step of receiving a venture capital. For an entrepreneur who is seeking venture capital financing for the first time, an understanding of the venture capital process is essential. The venture capital industry includes many firms with substantial funds to invest; however, it is often a challenge for an entrepreneur to tap into this vital source of financing.

Choosing the right venture capital firms is an important part of the fund raising process. An entrepreneur who has not researched and targeted venture firms runs the risk of lengthening the search and overshopping the plan. Venture capitalists readily exchange information, so rejection from one firm may influence others.

The criteria for selecting the right venture capitalists to approach include their geographic, industry specialization, stage of development and size of investment preferences. Also important are whether the fund will act as a lead investor and whether there are complementary or competing investee ventures within the fund’s portfolio.[2]

The entrepreneur should be aware that the venture capitalists are looking for some fundamental attributes in the entrepreneurs. These are; honesty and integrity, experience, achievement, high energy level and motivation.[3] Without these, non of the venture capitalists will invest money into the company. Therefore, it is needless to say that the entrepreneur should act according to the above factors.

However on the other side, the entrepreneurs are known for their high need for autonomy, high degree of self confidence and require for control, high tolerance for ambiguity,  sense of urgency, knowing what is real, high level of energy, mental stamina and strong communication skills.[4] These characteristics make them risky for the professional investors. The professional investors (i.e. venture capitalists) require more analysis of the entrepreneurs.

On the other hand, it was estimated by a study that more than 40 percent of the owners of small businesses in the United States are older than age 50. It is also said that 22 percent of men and 14 percent of women over 65 are self-employed. That's compared to just 7 percent for other age groups. A study by Vanderbilt University reports that the number of entrepreneurs ages 45 to 64 will grow by 15 million by 2006. The study sees a decline of four million for entrepreneurs age 25 to 44. This is also an important factor for the venture capitalists.[5]

After the understanding process, the venture capitalist and the entrepreneur know each other. The main problem is to convince the venture capitalist and manage the fund raising process. Therefore a business plan should be written.

Business plan is one of the most important phases of the venture capital process. C.Gordon Bell, from Digital Equipment Corp. states that the ability of a CEO and his or her top level group to write a business plan is the first test of their ability to function as a team and run their proposed company successfully.[6] This shows how important a business plan is.

Because venture capitalists have to deal with so many business plans, the plan must immediately grab the reader’s attention. They prefer business plans that are clear, concise, thorough and professional in presentation.[7] The executive summary will either entice venture capitalists to read the entire proposal or convince them not to invest further time.

A good plan is crucial for two reasons:
·         As a management tool and
·         As a mean to obtain financing.

While the plan is an essential element in securing financing, it should also be an operating guide to the business—with the goals, objectives, milestones and strategies clearly defined and well-written.

This is the best way to demonstrate the viability and growth potential of the business and to showcase the entrepreneur’s knowledge and understanding of what is needed to meet the company’s objectives. The first reading of a plan is the venture capitalist’s initial opportunity to evaluate the individuals who will manage the business and to measure the potential for return on this investment.

The plan should also address the following business issues from the perspective of the venture capitalist:[8]
·         Is the management team capable of growing the business rapidly and successfully?
·         Have they done it before?
·         Is the technology fully developed?
·         Is the product unique, and what value does it create so that buyers will want to purchase the product or service?
·         Is the market potential large enough?
·         Does the team understand how to penetrate the market?
·         Do significant barriers to entry exist?
·         How much money is required and how will it be utilized?
·         What exit strategies are possible?

If the above questions are fully answered by the business plan then the negotiation process where the structure and terms of financing will be determined begins. The entrepreneur must carefully prepare for this next step by becoming familiar with the various structures of venture capital financing and preparing a bargaining position after consulting with an attorney who has extensive venture capital experience. Attorneys will give guidance on the issues worth fighting for. Issues to consider are: vesting, salary, stock restrictions, commitment to the venture, debt conversion, dilution protection, downstream liquidity and directors. The negotiation will involve most or all of these issues in addition to price per share. However, price-per-share concerns should not be the overriding interest; the end result of this process must be a win/win situation in order for the relationship to progress successfully. The last step is to document and close the transaction—resulting in a term sheet, investment agreement(s) and finally, the closing.

As the last step, realistic financial forecasts within the business plan are important to attract investors and retain their interest to participate in future rounds of financing. The financials must accurately reflect the various product development, marketing and manufacturing strategies described in each section of the plan.

In order to be successful in the process of venture capital funding, the entrepreneurs should:[9]
·         understand how the process works
·         know where they must seek capital and should have the contacts necessary to be introduced to the investors,
·         be aware that different different capital sources fit different stages of investment and type of companies
·         know that raising money is correlated with the flair of the intermediates
·         not underestimate the duration of finding an investor for the company

Both the investor and the entrepreneur should know that the success of the venture capital investment will probably result like the following table due to several reasons that affect both parties.[10]

 

The Possible Results of Venture Capital Investment


# of companies out of 10 investments
Annual rate of return for VC
Failure
4
0%
Viable
3
15%
Solid
2
50%
Superstars
1
100%
Blended Average

24.5%




[1] Price Waterhouse Coopers, Three Keys to Obtaining Venture Capital, US: 2008, p.1-3
[2] Price Waterhouse Coopers, p.1.
[3] Gladstone, Gladstone, 2003, p.6-10.
[4] Gladstone, Gladstone, 2003, p.35-42
[5] Maty Furlong, “Entrepreneurship and Venture Capital: By and for People in Mid- and Later Life”, Generations, 28, 4, (Winter 2004-2005), p.46.
[6] Justin J. Camp, Venture capital due diligence: a guide to making smart investment choices and increasing your portfolio returns, US: John Wiley and Sons, 2002, p.6.
[7] Camp, 2002, p.6.
[8] Price Waterhouse Coopers, p.2.
[9] Hill, Power, p.8.
[10] Hill, Power, p.10.

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