How to get Venture Capital
Advantages of venture capital
Venture capital has a number of advantages over other forms of finance.
|Finance||The venture capitalist injects long-term equity finance, which provides a solid capital base for future growth. The venture capitalist may also be capable of providing additional rounds of funding should it be required to finance growth.|
|Business Partner||The venture capitalist is a business partner, sharing the risks and rewards. Venture capitalists are rewarded by business success and the capital gain.|
|Mentoring||The venture capitalist is able to provide strategic, operational and financial advice to the company based on past experience with other companies in similar situations.|
|Alliances||The venture capitalist also has a network of contacts in many areas that can add value to the company, such as in recruiting key personnel, providing contacts in international markets, introductions to strategic partners and, if needed, co-investments with other venture capital firms when additional rounds of financing are required.|
|Facilitation of Exit||The venture capitalist is experienced in the process of preparing a company for an initial public offering (IPO) and facilitating in trade sales.|
How does the professional venture capital industry work?
Venture capital firms typically source most of their funding from large investment institutions such as superannuation funds and banks. These institutions invest in a venture capital fund for a period of up to ten years.
To compensate for the long-term commitment and lack of security and liquidity, investment institutions expect to receive very high returns on their investment. Therefore, venture capitalists invest in companies with high growth potential or in companies which have the ability to quickly generate cashflow.
Venture capitalists typically exit the investment through the company listing on the stock exchange, selling to a trade buyer or through a management buyout. Although the venture capitalist may receive some return through dividends, their primary return on investment comes from capital gain when they eventually sell their shares in the company, typically three to seven years after the investment.
Venture capitalists are therefore in the business of promoting growth in the companies they invest in and managing the associated risk to protect and enhance their investors' capital.
The investment process begins with the venture capitalist conducting an initial review of the proposal to determine if it fits with the firm's investment criteria. If so, a meeting will be arranged with the entrepreneur/management team to discuss the business plan.
The initial meeting provides an opportunity for the venture capitalist to meet the entrepreneur and key members of the management team to review the business plan and conduct initial due diligence on the project. It is an important time for the management team to demonstrate their understanding of their business and ability to achieve the strategies outlined in the plan. The venture capitalist will look carefully at the team's skills and backgrounds.
This involves an agreement between the venture capitalist and management of the terms of the memorandum of understanding. The venture capitalist will then study the viability of the market to estimate its potential. Often they use market forecasts that have been independently prepared by industry experts who specialise in estimating the size and growth rates of markets and market segments.The venture capitalist also studies the industry carefully to obtain information about competitors, entry barriers, the potential to exploit substantial niches, product life cycles, distribution channels and possible export potential. The due diligence continues with reports from accountants and other consultants.
Approvals and investment completed
The process involves exhaustive due diligence and disclosure of all relevant business information. Final terms can then be negotiated and an investment proposal submitted to the board of directors. If approved, legal documents are prepared.A shareholders' agreement is prepared containing the rights and obligations of each party. This could include, for example, veto rights by the investor on remuneration and loans to executives, acquisition or sale of assets, audit, listing of the company, rights of co-sale and warranties relating to the accuracy of information enclosed.The investment process can take up to three months, and sometimes longer. It is important, therefore, not to expect a speedy response. It is advisable to plan the business financial needs early on to allow appropriate time to secure the required funding.
Selecting the Venture Capitalist Investor
AVCAL represents most venture capital organisations in Australia. The AVCAL Directory of Members provides basic information about each member's investment preferences.
Before selecting a venture capitalist, the entrepreneur should study the particular investment preferences set down by the venture capital firm. Often venture capitalists have preferences for particular stages of investment, amount of investment, industry sectors and geographical location.
Once a short list of potential venture capitalists has been drawn up, it is often a good idea to contact the venture capital firm and request a copy of their publications, which will clarify the type of investments they favour.
An investment in an unlisted company has a long-term horizon, typically four to six years. It is important to select venture capitalists with whom it is possible to have a good working relationship.
Often businesses do not meet their cash flow forecasts and require additional funds, so an investor's ability to invest further funds if required is also important.
When choosing a venture capitalist, the entrepreneur should consider not just the amount and terms of investment, but also the additional value that the venture capitalist can bring to the company. These skills may include industry knowledge, fundraising, financial and strategic planning, recruitment of key personnel, mergers and acquisitions, and access to international markets and technology.
It is likely that a shareholders' agreement would be prepared containing the rights and obligations of each party. This could include:
- Amount and terms of investment
- Dividend policy
- Composition of the board of directors
- Reporting - management reports, monthly accounts, annual budgets
- Liquidity (exit) plans
- Rights of co-sale
- Matters requiring venture capitalist approval (such as auditors, employment contracts, major asset purchases, major debt obligations and significant variations of plans).
Searching for venture capital
You should ensure that you are well prepared before you make your phone call. Note that the search will allow you to look for the following:
- All paid up AVCAL member venture firms
- Some product specific information that may allow you to filter according to general industry products
- Some general capital amount guidance.
The blackcitrus Pitch Kit is also a valuable resource that can help you understand the underlying principles and due diligence required in structuring, developing and optimising your business to attract and facilitate investment.
Author: Adrian O’Shannessy, Director, Greenwoods & Herbert Smith Freehills
Author: Dr Kar Mei Tang, Head of Policy and Research, AVCAL