The venture capital playbook is getting a major rewrite. After decades of the traditional model (write checks, offer advice, make introductions), a growing number of funds are morphing into something that looks more like merchant banks than passive investors. They’re building internal engineering teams, offering shared services, and getting their hands dirty in the operational trenches of their portfolio companies……..Continue reading….
Source: Forbes
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Critics:
Obtaining venture capital is substantially different from raising debt or a loan. Lenders have a legal right to interest on a loan and repayment of the capital irrespective of the success or failure of a business. Venture capital is invested in exchange for an equity stake in the business. The return of the venture capitalist as a shareholder depends on the growth and profitability of the business.
This return is generally earned when the venture capitalist “exits” by selling its shareholdings when the business is sold to another owner. Venture capitalists are typically very selective in deciding what to invest in, with a Stanford survey of venture capitalists revealing that 100 companies were considered for every company receiving financing.
Ventures receiving financing must demonstrate an excellent management team, a large potential market, and most importantly high growth potential, as only such opportunities are likely capable of providing financial returns and a successful exit within the required time frame (typically 8–12 years) that venture capitalists expect.
Because investments are illiquid and require the extended time frame to harvest, venture capitalists are expected to carry out detailed due diligence prior to investment. Venture capitalists also are expected to nurture the companies in which they invest, in order to increase the likelihood of reaching an IPO stage when valuations are favourable.
Because there are no public exchanges listing their securities, private companies meet venture capital firms and other private-equity investors in several ways, including warm referrals from the investors’ trusted sources and other business contacts; investor conferences and symposia; and summits where companies pitch directly to investor groups in face-to-face meetings, including a variant known as “Speed Venturing”, which is akin to speed-dating for capital, where the investor decides within 10 minutes whether he wants a follow-up meeting.
In addition, some new private online networks are emerging to provide additional opportunities for meeting investors. This need for high returns makes venture funding an expensive capital source for companies, and most suitable for businesses having large up-front capital requirements, which cannot be financed by cheaper alternatives such as debt. That is most commonly the case for intangible assets such as software, and other intellectual property, whose value is unproven.
In turn, this explains why venture capital is most prevalent in the fast-growing technology and life sciences or biotechnology fields. If a company does have the qualities venture capitalists seek including a solid business plan, a good management team, investment and passion from the founders, a good potential to exit the investment before the end of their funding cycle, and target minimum returns in excess of 40% per year, it will find it easier to raise venture capital.
There are multiple stages of venture financing offered in venture capital, that roughly correspond to these stages of a company’s development.
- Pre-seed funding: The earliest round of financing needed to prove a new idea, often provided by friends and family, angel investors, startup accelerators, and sometimes by venture capital funds. Equity crowdfunding is also emerging as an option for seed funding.
- Early Stage: Early stage funding includes Seed and Series A financing rounds. Companies use this capital to find product-market fit.
- Growth Capital: Once companies have found product-market fit, companies will use growth capital to scale the business. These are typically larger financing rounds with have higher valuations because the companies have started to prove traction and de-risk the investment. Growth capital typically includes Series B, Series C, and later rounds.
- Exit of venture capitalist: VCs can exit through secondary sale or an initial public offering (IPO) or an acquisition. Early stage VCs may exit in later rounds when new investors (VCs or private-equity investors) buy the shares of existing investors. Sometimes a company very close to an IPO may allow some VCs to exit and instead new investors may come in hoping to profit from the IPO.
- Bridge financing is when a startup seeks funding in between full VC rounds. The objective is to raise a smaller amount of money to “bridge” the gap when current funds are expected to run out prior to planned future funding, intended to meet short-term working capital needs.
In early stage and growth stage financings, venture-backed companies may also seek to take venture debt. A venture capitalist, or sometimes simply called a capitalist, is a person who makes capital investments in companies in exchange for an equity stake. The venture capitalist is often expected to bring managerial and technical expertise, as well as capital, to their investments.
A venture capital fund refers to a pooled investment vehicle (in the United States, often an LP or LLC) that primarily invests the financial capital of third-party investors in enterprises that are too risky for the standard capital markets or bank loans. These funds are typically managed by a venture capital firm, which often employs individuals with technology backgrounds (scientists, researchers), business training and/or deep industry experience.
A core skill within VCs is the ability to identify novel or disruptive technologies that have the potential to generate high commercial returns at an early stage. By definition, VCs also take a role in managing entrepreneurial companies at an early stage, thus adding skills as well as capital, thereby differentiating VC from buy-out private equity, which typically invest in companies with proven revenue, and thereby potentially realizing much higher rates of returns.
Inherent in realizing abnormally high rates of returns is the risk of losing all of one’s investment in a given startup company. As a consequence, most venture capital investments are done in a pool format, where several investors combine their investments into one large fund that invests in many different startup companies. By investing in the pool format, the investors are spreading out their risk to many different investments instead of taking the chance of putting all of their money in one start up firm.
Venture capitalist firms differ in their motivations and approaches. There are multiple factors, and each firm is different.Venture capital funds are generally three in types:
- 1. Angel investors
- 2. Financial VCs
- 3. Strategic VCs
Some of the factors that influence VC decisions include:
- Business situation: Some VCs tend to invest in new, disruptive ideas, or fledgling companies. Others prefer investing in established companies that need support to go public or grow.
- Some invest solely in certain industries.
- Some prefer operating locally while others will operate nationwide or even globally.
- VC expectations can often vary. Some may want a quicker public sale of the company or expect fast growth. The amount of help a VC provides can vary from one firm to the next. There are also estimates on how big of an exit a VC will expect for the company (i.e. if the size of the VC fund is $20M, estimate that they will at least want the company to exit for the size of the fund)
Unlike public companies, information regarding an entrepreneur’s business is typically confidential and proprietary. As part of the due diligence process, most venture capitalists will require significant detail with respect to a company’s business plan. Entrepreneurs must remain vigilant about sharing information with venture capitalists that are investors in their competitors.
Most venture capitalists treat information confidentially, but as a matter of business practice, they do not typically enter into Non Disclosure Agreements because of the potential liability issues those agreements entail. Entrepreneurs are typically well advised to protect truly proprietary intellectual property. Startups commonly use a data room to securely share this information with potential investors during the due diligence process.
Limited partners of venture capital firms typically have access only to limited amounts of information with respect to the individual portfolio companies in which they are invested and are typically bound by confidentiality provisions in the fund’s limited partnership agreement.
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