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A Very Simple Guide to Venture Capital


What is it?

Venture Capital (VC) is an investment in a business in exchange for a share of the business (equity).

The investment can come from the private sector or the public sector and the fund can be supplied by a number of parties (an independent fund) or a single entity such as a subsidiary of a financial institution or private company (a captive fund).

The funding might be used in a number of ways:

  • Funding to research and develop a new concept (Seed funding often provided by Business Angels)
  • To finance a new start-up company. Venture capital investors may often join a company to help bring a product to market.
  • To finance manufacturing and marketing a product

VC funding is often provided in discrete portions which are referred to as funding rounds. This manages the risk of the investment and also allows different investors to enter or exit (although one fund might provide all the rounds) in response to the investor's appetite for risk.

What is VC looking to invest in?

The characteristics of a VC investment are most often:

  • A concern where there is a competitive advantage, a unique selling point or some other barrier to entry for “me too” followers.
  • A requirement for a minimum of £2M
  • The investment will create value. In other words to fund the implementation of an ambitious (but realistic) business plan. A large earning potential or high return on investment within a specific time period.
  • Good management expertise, either already within the company or the company is willing to recruit necessary expertise to support the business plan.

What you need to do before approaching VC

Firstly, remember that for every 100 business plans submitted to a VC firm for funding only 10 will get a serious look and only one ends up being funded. The market is highly competitive.

You should research what funds are specialising in the stage of development of your company, the sector you operate in and the purpose to which you want to put the investment. Different types of investment are suitable for different stages of business development and different funds will specialise in different sectors or stage of company so you might have a competitive advantage if you fit the criteria.

You need a well thought out up-to-date business case tailored to the investor. See if your business plan fully articulates:

  • your business' funding needs (how much, when…)
  • whether your plans for the business are achievable (have you looked at risks?)
  • whether you need external investment (is there revenue coming in, collateral for loan etc.)

Your business plan may contain commercially sensitive information, so you need to start with an outline proposal to see if a VC investor is interested. Once the conversation becomes more serious you can prepare a letter of confidentiality. This should be signed both by your business and the potential investors before you send them your full business plan.

Although you need to determine what a particular VC fund will require before they invest in your concern, a common set of criteria is:

  • audited accounts usually for a two year period (this can be a problem for recent start-ups)
  • evidence of current performance (again a problem for recent start-ups – what is your track record in the field?)
  • a profit-and-loss forecast for next year. Seed investment will be different and may focus on the “exit strategy” or how the initial investors will recoup their investment and make a profit.
  • business bank statements for the past six months
  • profiles of each partner or director in your business. Particularly with start-ups the investor is looking at your human capital, know-how and expertise. Are staff committed?

The term “investment ready” is often used to describe companies which meet meet the criteria above:

Pros (for the company)

  • The investment is relatively long term
  • The amounts involved can be substantial depending on the value of your business and the prospective return outlined in your business plan
  •  You retain management control over the day to day operation of your business
  • There are no repayments or interest
  • You don’t need collateral

Cons (for the company)

  • You give up a share of your business
  • The process can be challenging, time consuming and therefore costly
  • Not generally suitable for small amounts of investment
  • Finding a VC investor which is a good fit to your needs might take some time.

Pros & Cons for the Investor

  • VC is an illiquid investment in a concern which has no current value. In other words it can be difficult to get your money out until the term is complete.
  • The returns on investment can be significant if successful. However these are only achieved if the company is bought or offers shares on a public stock exchange and only around 1/6th of start-ups ever goes public and around a third acquired. VC funds will therefore hedge their bets by investing in a number of concerns.

Common Mistakes

  • Your business case should be specific to the investment required. For example, in larger companies seeking to launch a new product or expanding an existing product, the business case should refer to the specific opportunity to make it clear what is required and what the return will be. It should also refer to any resources specifically allocated to the opportunity within the context of your larger business activity. It should also put the opportunity in the context of the larger business.
  • You need to clearly articulate when any exit opportunities where the investment and profit can be recovered by the VC investor.
  • Look for a good fit in terms of your companies stage of development, market sector, geographical location and amount of finance required. There are many specialist VC funds out there and you have a better chance of securing investment if you understand what they are looking for.
  • Would you, or have you invested in your concern? It's good if you are confident enought to take a stake in the investment.
  • Are you investment ready?

Sources of Further Information

·        The British Private Equity & VC Association

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