The Venture Capital Process for Medium Businesses | Friday January 30th, 2004 | |
Are you allowing enough time to get the deal done?
The venture capitalist reviews hundreds, even thousands, of requests for funding each year. Most of the
proposals are business plans. It is at this stage of the process that most companies are eliminated -
some because the fund may not invest in this particular type of company; because of the stage of investment;
or because of the size of the company. The importance of the business plan can't be stressed enough, and it
must be thoroughly researched and prepared. This vital portion of your request for venture capital is
outlined earlier in this publication.
Obtaining Venture Capital is a lengthy process. Even with the hundreds of requests before the investor,
by reviewing the business plan, a good venture capitalist should be able to tell relatively quickly
whether or not there is any interest in further investigation of the firm.
Assuming the company "has made the cut" and the venture capitalist has decided that the company is
worthy of further research, the next step is generally an interview and/or a meeting with the company.
At this point, the venture capitalist and the company usually exchange letters of intent or some simple
legal document expressing an interest in further investigating the firm.
The Due Diligence Process
The process that follows the preliminary business plan review is called "due diligence," when the
investor attempts to get to know the firm by talking to the employees (present and past at all levels)
and by interviewing the company's customers. The investor also uses this time to become comfortable
with the industry and all of its nuances. A seasoned venture capitalist also uses this time to make
sure that bad investments of the past do not repeat themselves.
David Gladstone's Venture Capital Investing presents a lengthy discussion of what a potential portfolio
company can expect from this process. According to Gladstone, this process can take anywhere from several
weeks to several months, depending upon the complexity of the company or industry.
VENTURE CAPITALCONSIDERATIONS
There are several criteria, which all venture capitalists consider when making a decision to invest
in a company. They include: management, return, and the exit.
Management (The Team)
Venture capitalists look for competitive advantage. The most important characteristic of any venture
capital investment is the entrepreneur or the company's management. David Gladstone identifies two
categories of characteristics in which venture capitalist would be interested: (1) personal or individual
characteristics and (2) experience of the individual. Management is critical to the venture capitalist
because, in some cases, there is no actual history to the company. Therefore, the venture capitalist is
buying a plan and an implementation team, and the plan is secondary to the implementation team.
The portfolio company can have the best plan in the world and still not be able to implement it
without the best people in place to accomplish the goals. Any venture capitalist is going to take
a close look at those involved in the operation of the business and seriously review their
credentials and capabilities.
The venture capitalist's objective is to make a good return to his limited partners. Return on
the investment, then, is very important to the venture manager. While the amounts may vary,
a manager or general partner usually can reap 20% or more of the "upside." Return is also critical
since most venture capitalists raise several funds in their investing lifetimes, and return is
now a potential investor will measure the venture capitalists' business prowess.
The Exit (Achieving the Goal)
Of secondary importance to a venture capitalist is "The Exit," i.e., how will the venture capitalist
be able to sell of the investment in the portfolio company? Exits take many forms including:
(1) participating in an Initial Public Offering (IPO) when shares of a once private company
are sold to the public: (2) selling the portfolio company to another company or an investor,
or; (3) liquidation. Of all the options, most venture capitalist prefer "going public."
An IPO provides maximum opportunity for return and liquidity for the venture investor.
Although selling the interest in the portfolio company is an option, it usually is only
possible for companies with the very best portfolios. Many portfolio companies do not
have the cash or available lines of credit to enable them to buy-out the venture capitalists' interest.
Quite many of which are in the same industry or in a closely related one. Although this
option is acceptable, it does not allow the venture capitalist to maximize the value of the company.
Since the venture capitalist and the portfolio company have to weather most of the very risky stages
of the investment process, another company or investor may find the company attractive for investment.
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