Venture Capital and Venture Capital Firms

Venture Capital (VC) ("risk capital" or ‘unsecured risk financing’ or ‘development capital’) is a source of financing for new businesses. Venture capital funds pool investors' cash and loan it to startup firms and small businesses with perceived, long-term growth potential. This is a very important source of funding startups that do not have access to other capital and it typically entails high risk (and potentially high returns) for the investor. Most venture capital comes from groups of wealthy investors, investment banks and other financial institutions that pool such investments or partnerships. This form of raising capital is popular among new companies, or ventures, with a limited operating history that cannot raise capital though a debt issue or equity offering. Often, venture firms will also provide start-ups with managerial or technical expertise. For entrepreneurs, venture capitalists are a vital source of financing, but the cash infusion often comes at a high price. Venture firms often take large equity positions in exchange for funding and may also require representation on the start-up's board.

It is typical for venture capital investors to identify and back unquoted companies in high technology industries such as biotechnology and IT. As a rule of thumb, unless a business can offer the prospect of significant turnover growth within five years, it is unlikely to be of interest to a venture capital firm. Venture capital assumes four types of risks, these are:

1. m anagement risk (i nability of management teams to work together);

2. m arket risk (p roduct may fail in the market.);

3. p roduct risk (p roduct may not be commercially viable);

4. o peration risk (o perations may not be cost effective resulting in increased cost decreased gross margins).

Obtaining venture capital is substantially different from raising debt or a loan from a lender. 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 investments are generally made in cash in exchange for shares in the invested company. As a shareholder, the venture capitalist's return is dependent on the growth and profitability of the business. This return is generally earned when the venture capitalist "exits" by selling its shareholding when the business is sold to another owner.

Venture Capitalist isa wealthy investor who provides capital (more than $ 1 million) to start up ventures or supports small companies that wish to expand expecting higher returns for the additional risks taken.

Venture capital firms typically comprise small teams with technology backgrounds (scientists, researchers) or those with business training or deep industry experience. Just as management teams compete for finance, so do venture capital firms. They raise their funds from several sources. To obtain their funds, venture capital firms have to demonstrate a good track record and the prospect of producing returns greater than can be achieved through fixed interest or quoted equity investments. Most venture capital firms raise their funds for investment from external sources, mainly institutional investors, such as pension funds and insurance companies.

Many funds raised from external sources are structured as Limited Partnerships and usually have a fixed life of 10 years. Within this period the funds invest the money committed to them and by the end of the 10 years they will have had to return the investors' original money, plus any additional returns made. This generally requires the investments to be sold, or to be in the form of quoted shares, before the end of the fund.

Venture Capital Trusts (VCT's) are quoted vehicles that aim to encourage investment in smaller unlisted (unquoted and AIM quoted companies) UK companies by offering private investors tax incentives in return for a five-year investment commitment. The first were launched in Autumn 1995 and are mainly managed by UK venture capital firms. If funds are obtained from a VCT, there may be some restrictions regarding the company's future development within the first few years.

The investment process, from reviewing the business plan to actually investing in a proposition, typically takes a venture capitalist between 3 and 6 months. To support an initial positive assessment of your business proposition, the venture capitalist will want to assess the technical and financial feasibility in detail. They will assess and review management information systems; forecasting techniques and accuracy of past forecasting of the company; the latest available management accounts, including the company's cash/debtor positions; bank facilities and leasing agreements; pensions funding; employee contracts, etc. Venture capital firms will judge you by how prepared you are.

Critical documents are:

Business Summary. It is a brief statement covering the main points that includes a discussion of management, profits, strategic position, and exit plan.

Business Plan. A detailed document that outlines what you are going to do and how you are going to do it; the management team (including full resumes; business strategy); marketing plan (sales projections, distribution, market, and competition; financials) and a competitive analysis.

Due Diligence. The due diligence review aims to support or contradict the venture capital firm's own initial impressions of the business plan formed during the initial stage.

Marketing Material. Any document that directly or indirectly relates to the sales of your product or service.

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