Most venture capital firms concentrate basically on the expertise and character of the proposing firm’s management. They feel that even mediocre products can be successfully made, promoted, and distributed by a seasoned, energized management group. They know that even wonderful products can be trashed by poor management.
Next in importance to the excellence of the proposing firm’s management group, most venture capital firms hunt for a specific element in the technique or product/market/process mixture of the firm. This distinctive component might be a new feature of the product or process or a selected skill or technical competence of the management. However it must exist. It must supply a competitive advantage.
After the exhaustive investigation and analysis, if the venture capital firm decides to take a position in a corporation they'll prepare an equity financing offer. This details the amount of cash to be supplied, the proportion of common stock to be surrendered in exchange for these funds, the interim financing strategy to be used, and the protective covenants to be included.
The final financing agreement will be bartered and usually represents a compromise between the management of the company and the partners or senior executives of the venture capital firm. The vital elements of this compromise are possession and control.
Venture capital financing isn't inexpensive for the owners of a small business. The venture firm receives some of the business’s equity in return for their investment.
This share of equity varies, naturally, and is dependent upon the amount of money provided, the success and worth of the business, and the anticipated investment return. It can range all the way from perhaps 10% in the case of an established, profitable company to as much as 80% or 90% for beginning or financially disturbed firms. Most venture firms, at least initially, don’t want a position of more than 30% to 40% because they want the owner to have the inducement to keep on building the business.
Most venture firms identify the percentage of funds provided to equity requested by a comparing of the present money worth of the contributions made by each of the parties to the accord. The present value of the contribution by the owner of a beginning or financially troubled company is rated low. Often it is estimated as just the current cost of his or her idea and the competitive costs of the owner’s time. The contribution by the owners of a prospering business is valued far higher. Usually, it is capitalized at a multiple of the existing takings and/or net worth.
Financial valuation is not a predictable activity. The compromise on owner contribution’s worth in the equity financing agreement is probably going to be lower than the owner thinks it should be and higher than the partners of the capital firm think it might be. Ideally, the two parties to the contract are able to do together what neither could do separately:
1. Grow the company faster with the additional funds to more than overcome the owner’s loss of equity, and
2. Grow the investment at an adequate rate to compensate the investors for assuming the risk.
An equity financing agreement with a result in 5 to 7 years which pleases both parties is excellent. Since the parties can’t see this result in the present, neither will be superbly satisfied with the compromise reached. The entrepreneur should carefully consider the impact of the percentage of funds invested to the ownership given up, not only for the present , but for the years yet to come.
The partners of a venture firm sometimes have small interest in presuming control of the business. They have neither the technical expertise nor the managerial staff to run a bunch of tiny corporations in various industries. They much wish to leave operating control to the existing management.
The venture capital firm does nevertheless , need to participate in any strategic decisions that might change the basic product/market character of the company and in any heavy investment choices that might divert or deplete the money resources of the company.
Venture capital firms also wish to be able to seize control and make an attempt to rescue their investments, if harsh financial, operating, or selling Problems develop. So, they can often include protective covenants in their equity financing agreements to permit them to grab control and designate new officers if financial performance is very poor.
John has over 40 years of experience in business promoting sales engineering general management online real-estate planning. He has worked for and with worldwide corporations such as IBM Electronic Data Systems and Mahindra British Telecomms. John has a BS from Brown in PC Science an MA through IBM in Industrial Electronics as well as a PhD in International Trade and Management from the London College of Business.