Modal Ventura

Modal ventura

Modal ventura adalah merupakan suatu investasi dalam bentuk pembiayaan berupa penyertaan

modal ke dalam suatu perusahaan swasta sebagai pasangan usaha (investee company) untuk

jangka waktu tertentu. Pada umumnya investasi ini dilakukan dalam bentuk penyerahan modal

secara tunai yang ditukan dengan sejumlah saham pada perusahaan pasangan usaha. Investasi

modal ventura ini biasanya memiliki suatu risiko yang tinggi namun memberikan imbal hasil

yang tinggi pula. Kapitalis ventura atau dalam bahasa asing disebut venture capitalist (VC),

adalah seorang investor yang berinvestasi pada perusahaan modal ventura. Dana ventura ini

mengelola dana investasi dari pihak ketiga (investor) yang tujuan utamanya untuk melakukan

investasi pada perusahaan yang memiliki risiko tinggi sehingga tidak memenuhi persyaratan

standar sebagai perusahaan terbuka ataupun guna memperoleh modal pinjaman dari perbankan.

Investasi modal ventura ini dapat juga mencakup pemberian bantuan manajerial dan teknikal.

Kebanyakan dana ventura ini adalah berasal dari sekelompok investor yang mapan keuangannya,

bank investasi, dan institusi keuangan lainnya yang melakukan pengumpulan dana ataupun

kemitraan untuk tujuan investasi tersebut. Penyertaan modal yang dilakukan oleh modal ventura

ini kebanyakan dilakukan terhadap perusahaan-perusahaan baru berdiri sehingga belum memilkii

suatu riwayat operasionil yang dapat menjadi catatan guna memperoleh suatu pinjaman. Sebagai

bentuk kewirausahaan, pemilik modal ventura biasanya memiliki hak suara sebagai penentu arah

kebijakan perusahaan sesuai dengan jumlah saham yang dimilikinya.

Sejarah awal mula modal ventura modern

Walaupun penyertaan modal sudah dikenal serta dilakukan oleh investor sejak zaman dahulu,

Georges Doriot dikenal sebagai penemu dari industri modal ventura.

pada tahun 1946, Doriot mendirikan American Research and Development Corporation

(AR&D), dimana investasinya pada perusahaan Digital Equipment Corporation adalah

merupakan sukses terbesar. Pada Tahun 1968 sewaktu Digital Equipment melakukan

penawaran sahamnya kepada publik, dan ini memberikan imbal hasil investasi (return on

investment-ROI) sebesar 101% kepada AR&D .

Investasi ARD's yang senilai $70.000 USD pada Digital Equipment Corporation pada tahun

1957 tersebut telah bertumbuh nilainya menjadi $355 juta USD.

Biasanya juga dianggap bahwa modal ventura yang pertama kali adalah investasi yang

dilakukan pada tahun 1959 oleh Venrock Associates pada perusahaan Fairchild

Semiconductor,

Awal mula tumbuhnya industri modal ventura ini adalah denganj diterbitkannya Undang-

undang investasi usaha kecil (Small Business Investment Act) di Amerika pada tahun

1958 dimana secara resmi diperbolehkannya Kantor Pendaftaran Usaha Kecil (Small

Business Administration (SBA)) untuk mendaftarkan perusahaan modal kecil untuk

membantu pembiayaan dan permodalan dari usaha wiraswasta di Amerika.

Di Indonesia

Mengacu kepada Keputusan Menteri Keuangan Republik Indonesia No. 1251/1988, perusahaan

modal ventura dapat membantu permodalan maupun bantuan teknis yang diperlukan calon

pengusaha maupun usaha yang sudah berjalan guna:

Pengembangan suatu penemuan baru.

Pengembangan perusahaan yang pada tahap awal usahanya mengalami kesulitan dana.

Membantu perusahaan yang berada pada tahap pengembangan.

Membantu perusahaan yang berada dalam tahap kemunduran usaha.

Pengembangan projek penelitian dan rekayasa.

Pengembangan berbagai penggunaan teknologi baru dan alih teknologi baik dari dalam

maupun luar negeri.

Membantu pengalihan pemilikan perusahaan

Sejarah modal ventura di Indonesia

Perusahaan modal ventura di Indonesia diawali dengan pembentukan PT Bahana Pembinaan

Usaha Indonesia (BPUI), sebuah badan usaha milik negara (BUMN) yang sahamnya dimilki

oleh Departemen Keuangan (82,2%) dan Bank Indonesia (17,8%).[1]

Gema nama Bahana memang sempat menggetarkan "dunia keuangan" nusantara. Ketika pada

tahun 1993 salah satu anak usahanya, PT Bahana Artha Ventura (BAV), agresif melebarkan

usaha ke seluruh provinsi, membentuk Perusahaan Modal Ventura Daerah (PMVD). Sasarannya,

usaha kecil menengah (UKM) untuk dibiayai.[2]

Cara pembiayaan modal ventura di Indonesia

Beberapa cara pembiayaan yang dilakukan oleh modal ventura di Indonesia, yaitu dengan cara :

Penyertaan saham secara langsung kepada perusahaan yang menjadi pasangan usaha.

Dengan membeli obligasi konversi yang setelah waktu yang disepakati bersama dapat

dikonversi menjadi saham / penyertaan modal pada perseroan.

Dengan pola bagi hasil dimana persentase tertentu dari keuntungan setiap bulan akan

diberikan kepada perusahaan modal ventura oleh perusahaan pasangan usaha.

Pola bagi hasil yang mungkin dilakukan adalah sbb:

Bagi hasil berdasarkan pendapatan yang diperoleh (revenue sharing).

Bagi hasil berdasarkan keuntungan bersih (net profit sharing).

Bagi hasil berdasarkan perjanjian.

Venture capital

Venture capital (VC) is financial capital provided to early-stage, high-potential, high risk,

growth startup companies. The venture capital fund makes money by owning equity in the

companies it invests in, which usually have a novel technology or business model in high

technology industries, such as biotechnology, IT, software, etc. The typical venture capital

investment occurs after the seed funding round as growth funding round (also referred as Series

A round) in the interest of generating a return through an eventual realization event, such as an

IPO or trade sale of the company. It is important to note that venture capital is a subset of private

equity. Therefore all venture capital is private equity, but not all private equity is venture capital .[1]

In addition to angel investing and other seed funding options, venture capital is attractive for new

companies with limited operating history that are too small to raise capital in the public markets

and have not reached the point where they are able to secure a bank loan or complete a debt

offering. In exchange for the high risk that venture capitalists assume by investing in smaller and

less mature companies, venture capitalists usually get significant control over company

decisions, in addition to a significant portion of the company's ownership (and consequently

value).

Venture capital is also associated with job creation (accounting for 21% of US GDP), [2] the

knowledge economy, and used as a proxy measure of innovation within an economic sector or

geography. Every year there are nearly 2 million businesses created in the USA, and only 600-

800 get venture capital funding. According to the National Venture Capital Association 11% of

private sector jobs come from venture backed companies and venture backed revenue accounts

for 21% of US GDP.[3]

History

A venture may be defined as a project prospective of converted into a process with an adequate

assumed risk and investment With few exceptions, private equity in the first half of the 20th

century was the domain of wealthy individuals and families. The Vanderbilts, Whitneys,

Rockefellers, and Warburgs were notable investors in private companies in the first half of the

century. In 1938, Laurance S. Rockefeller helped finance the creation of both Eastern Air Lines

and Douglas Aircraft and the Rockefeller family had vast holdings in a variety of companies.

Eric M. Warburg founded E.M. Warburg & Co. in 1938, which would ultimately become

Warburg Pincus, with investments in both leveraged buyouts and venture capital.

Origins of modern private equity

Before World War II, money orders (originally known as "development capital") were primarily

the domain of wealthy individuals and families. It was not until after World War II that what is

considered today to be true private equity investments began to emerge marked by the founding

of the first two venture capital firms in 1946: American Research and Development Corporation.

(ARDC) and J.H. Whitney & Company.[4]

ARDC was founded by Georges Doriot, the "father of venture capitalism"[5] (former dean of

Harvard Business School and founder of INSEAD), with Ralph Flanders and Karl Compton

(former president of MIT), to encourage private sector investments in businesses run by soldiers

who were returning from World War II. ARDC's significance was primarily that it was the first

institutional private equity investment firm that raised capital from sources other than wealthy

families although it had several notable investment successes as well. [6] ARDC is credited with

the first trick when its 1957 investment of $70,000 in Digital Equipment Corporation (DEC)

would be valued at over $355 million after the company's initial public offering in 1968

(representing a return of over 1200 times on its investment and an annualized rate of return of

101%).[7]

Former employees of ARDC went on and established several prominent venture capital firms

including Greylock Partners (founded in 1965 by Charlie Waite and Bill Elfers) and Morgan,

Holland Ventures, the predecessor of Flagship Ventures (founded in 1982 by James Morgan). [8]

ARDC continued investing until 1971 with the retirement of Doriot. In 1972, Doriot merged

ARDC with Textron after having invested in over 150 companies.

J.H. Whitney & Company was founded by John Hay Whitney and his partner Benno Schmidt.

Whitney had been investing since the 1930s, founding Pioneer Pictures in 1933 and acquiring a

15% interest in Technicolor Corporation with his cousin Cornelius Vanderbilt Whitney. By far

Whitney's most famous investment was in Florida Foods Corporation. The company developed

an innovative method for delivering nutrition to American soldiers, which later came to be

known as Minute Maid orange juice and was sold to The Coca-Cola Company in 1960. J.H.

Whitney & Company continues to make investments in leveraged buyout transactions and raised

$750 million for its sixth institutional private equity fund in 2005.

Early venture capital and the growth of Silicon Valley

One of the first steps toward a professionally-managed venture capital industry was the passage

of the Small Business Investment Act of 1958. The 1958 Act officially allowed the U.S. Small

Business Administration (SBA) to license private "Small Business Investment Companies"

(SBICs) to help the financing and management of the small entrepreneurial businesses in the

United States.[9]

During the 1960s and 1970s, venture capital firms focused their investment activity primarily on

starting and expanding companies. More often than not, these companies were exploiting

breakthroughs in electronic, medical, or data-processing technology. As a result, venture capital

came to be almost synonymous with technology finance. An early West Coast venture capital

company was Draper and Johnson Investment Company, formed in 1962 [10] by William Henry

Draper III and Franklin P. Johnson, Jr. In 1962 Bill Draper and Paul Wythes founded Sutter Hill

Ventures, and Pitch Johnson formed Asset Management Company.

It is commonly noted that the first venture-backed startup is Fairchild Semiconductor (which

produced the first commercially practical integrated circuit), funded in 1959 by what would later

become Venrock Associates.[11] Venrock was founded in 1969 by Laurance S. Rockefeller, the

fourth of John D. Rockefeller's six children as a way to allow other Rockefeller children to

develop exposure to venture capital investments.

It was also in the 1960s that the common form of private equity fund, still in use today, emerged.

Private equity firms organized limited partnerships to hold investments in which the investment

professionals served as general partner and the investors, who were passive limited partners, put

up the capital. The compensation structure, still in use today, also emerged with limited partners

paying an annual management fee of 1-2.5% and a carried interest typically representing up to

20% of the profits of the partnership.

The growth of the venture capital industry was fueled by the emergence of the independent

investment firms on Sand Hill Road, beginning with Kleiner, Perkins, Caufield & Byers and

Sequoia Capital in 1972. Located, in Menlo Park, CA, Kleiner Perkins, Sequoia and later venture

capital firms would have access to the many semiconductor companies based in the Santa Clara

Valley as well as early computer firms using their devices and programming and service

companies.[12]

Throughout the 1970s, a group of private equity firms, focused primarily on venture capital

investments, would be founded that would become the model for later leveraged buyout and

venture capital investment firms. In 1973, with the number of new venture capital firms

increasing, leading venture capitalists formed the National Venture Capital Association (NVCA).

The NVCA was to serve as the industry trade group for the venture capital industry.[13] Venture

capital firms suffered a temporary downturn in 1974, when the stock market crashed and

investors were naturally wary of this new kind of investment fund.

It was not until 1978 that venture capital experienced its first major fundraising year, as the

industry raised approximately $750 million. With the passage of the Employee Retirement

Income Security Act (ERISA) in 1974, corporate pension funds were prohibited from holding

certain risky investments including many investments in privately held companies. In 1978, the

US Labor Department relaxed certain of the ERISA restrictions, under the "prudent man rule," [14]

thus allowing corporate pension funds to invest in the asset class and providing a major source of

capital available to venture capitalists.

1980s

The public successes of the venture capital industry in the 1970s and early 1980s (e.g., Digital

Equipment Corporation, Apple Inc., Genentech) gave rise to a major proliferation of venture

capital investment firms. From just a few dozen firms at the start of the decade, there were over

650 firms by the end of the 1980s, each searching for the next major "home run". While the

number of firms multiplied, the capital managed by these firms increased by only 11% from $28

billion to $31 billion over the course of the decade.[15]

The growth of the industry was hampered by sharply declining returns and certain venture firms

began posting losses for the first time. In addition to the increased competition among firms,

several other factors impacted returns. The market for initial public offerings cooled in the mid-

1980s before collapsing after the stock market crash in 1987 and foreign corporations,

particularly from Japan and Korea, flooded early stage companies with capital.[15]

In response to the changing conditions, corporations that had sponsored in-house venture

investment arms, including General Electric and Paine Webber either sold off or closed these

venture capital units. Additionally, venture capital units within Chemical Bank and Continental

Illinois National Bank, among others, began shifting their focus from funding early stage

companies toward investments in more mature companies. Even industry founders J.H. Whitney

& Company and Warburg Pincus began to transition toward leveraged buyouts and growth

capital investments.[15][16][17]

The venture capital boom and the Internet Bubble (1995 to 2000)

By the end of the 1980s, venture capital returns were relatively low, particularly in comparison

with their emerging leveraged buyout cousins, due in part to the competition for hot startups,

excess supply of IPOs and the inexperience of many venture capital fund managers. Growth in

the venture capital industry remained limited throughout the 1980s and the first half of the 1990s

increasing from $3 billion in 1983 to just over $4 billion more than a decade later in 1994.

After a shakeout of venture capital managers, the more successful firms retrenched, focusing

increasingly on improving operations at their portfolio companies rather than continuously

making new investments. Results would begin to turn very attractive, successful and would

ultimately generate the venture capital boom of the 1990s. Former Wharton Professor Andrew

Metrick refers to these first 15 years of the modern venture capital industry beginning in 1980 as

the "pre-boom period" in anticipation of the boom that would begin in 1995 and last through the

bursting of the Internet bubble in 2000.[18]

The late 1990s were a boom time for venture capital, as firms on Sand Hill Road in Menlo Park

and Silicon Valley benefited from a huge surge of interest in the nascent Internet and other

computer technologies. Initial public offerings of stock for technology and other growth

companies were in abundance and venture firms were reaping large returns.

The private equity crash (2000 to 2003)

The technology-heavy NASDAQ Composite index peaked at 5,048 in March 2000, reflecting the

high point of the dot-com bubble.

The Nasdaq crash and technology slump that started in March 2000 shook virtually the entire

venture capital industry as valuations for startup technology companies collapsed. Over the next

two years, many venture firms had been forced to write-off large proportions of their investments

and many funds were significantly "under water" (the values of the fund's investments were

below the amount of capital invested). Venture capital investors sought to reduce size of

commitments they had made to venture capital funds and in numerous instances, investors

sought to unload existing commitments for cents on the dollar in the secondary market. By mid-

2003, the venture capital industry had shriveled to about half its 2001 capacity. Nevertheless,

PricewaterhouseCoopers' MoneyTree Survey shows that total venture capital investments held

steady at 2003 levels through the second quarter of 2005.

Although the post-boom years represent just a small fraction of the peak levels of venture

investment reached in 2000, they still represent an increase over the levels of investment from

1980 through 1995. As a percentage of GDP, venture investment was 0.058% in 1994, peaked at

1.087% (nearly 19 times the 1994 level) in 2000 and ranged from 0.164% to 0.182 % in 2003

and 2004. The revival of an Internet-driven environment in 2004 through 2007 helped to revive

the venture capital environment. However, as a percentage of the overall private equity market,

venture capital has still not reached its mid-1990s level, let alone its peak in 2000.

Venture capital funds, which were responsible for much of the fundraising volume in 2000 (the

height of the dot-com bubble), raised only $25.1 billion in 2006, a 2% decline from 2005 and a

significant decline from its peak.[19]

Funding

Venture capitalists are typically very selective in deciding what to invest in; as a rule of thumb, a

fund may invest in one in four hundred opportunities presented to it. Funds are most interested in

ventures with exceptionally high growth potential, as only such opportunities are likely capable

of providing the financial returns and successful exit event within the required timeframe

(typically 3–7 years) that venture capitalists expect.

Young companies wishing to raise venture capital require a combination of extremely rare, yet

sought after, qualities, such as innovative technology, potential for rapid growth, a well-

developed business model, and an impressive management team. VCs typically reject 98% of

opportunities presented to them[citation needed], reflecting the rarity of this combination.

Because investments are illiquid and require 3–7 years 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. Venture capitalists typically assist at four

stages in the company's development:[20]

Idea generation ;

Start-up ;

Ramp up ; and

Exit

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 s/he wants a follow-up meeting. In addition there

are some new private online networks that are emerging to provide additional opportunities to

meet investors.[21]

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.

Financing stages

There are typically six stages of venture round financing offered in Venture Capital, that roughly

correspond to these stages of a company's development.[22]

Seed Money: Low level financing needed to prove a new idea (Often provided by "angel

investors")

Start-up: Early stage firms that need funding for expenses associated with marketing and

product development

First-Round (Series A round): Early sales and manufacturing funds

Second-Round: Working capital for early stage companies that are selling product, but

not yet turning a profit

Third-Round: Also called Mezzanine financing, this is expansion money for a newly

profitable company

Fourth-Round: Also called bridge financing, 4th round is intended to finance the "going

public" process

Between the first round and the fourth round, venture backed companies may also seek to take

"venture debt".[23]

Venture capital firms and funds

Venture capitalists

A venture capitalist (also known as a VC) is a person or investment firm that makes venture

investments, and these venture capitalists are expected to bring managerial and technical

expertise as well as capital to their investments. A venture capital fund refers to a pooled

investment vehicle (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. Venture

capital firms typically comprise small teams with technology backgrounds (scientists,

researchers) or those with business training or deep industry experience.

A core skill within VC is the ability to identify novel 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 versus taking the chance of putting all of their money in one

start up firm.

Diagram of the structure of a generic venture capital fund

Structure

Venture capital firms are typically structured as partnerships, the general partners of which serve

as the managers of the firm and will serve as investment advisors to the venture capital funds

raised. Venture capital firms in the United States may also be structured as limited liability

companies, in which case the firm's managers are known as managing members. Investors in

venture capital funds are known as limited partners. This constituency comprises both high net

worth individuals and institutions with large amounts of available capital, such as state and

private pension funds, university financial endowments, foundations, insurance companies, and

pooled investment vehicles, called fund of fund.

Types

Venture Capitalist firms differ in their approaches. There are multiple factors and each firm is

different.[24]

Some of the factors that influence VC decisions include:

Business situation: Some VCs tend to invest in new ideas, or fledgling companies. Others

prefer investing in established companïes that need support to go public or grow.

Others invest solely in certain industries. Others prefer operating locally while others will

operate nationwide.

Company expectations 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.

Roles

Within the venture capital industry, the general partners and other investment professionals of

the venture capital firm are often referred to as "venture capitalists" or "VCs". Typical career

backgrounds vary, but broadly speaking venture capitalists come from either an operational or a

finance background. Venture capitalists with an operational background tend to be former

founders or executives of companies similar to those which the partnership finances or will have

served as management consultants. Venture capitalists with finance backgrounds tend to have

investment banking or other corporate finance experience.

Although the titles are not entirely uniform from firm to firm, other positions at venture capital

firms include:

Venture partners – Venture partners are expected to source potential investment

opportunities ("bring in deals") and typically are compensated only for those deals with

which they are involved.

Principal – This is a mid-level investment professional position, and often considered a

"partner-track" position. Principals will have been promoted from a senior associate

position or who have commensurate experience in another field such as investment

banking or management consulting.

Associate – This is typically the most junior apprentice position within a venture capital

firm. After a few successful years, an associate may move up to the "senior associate"

position and potentially principal and beyond. Associates will often have worked for 1–2

years in another field such as investment banking or management consulting.

Entrepreneur-in-residence (EIR) – EIRs are experts in a particular domain and perform

due diligence on potential deals. EIRs are engaged by venture capital firms temporarily

(six to 18 months) and are expected to develop and pitch startup ideas to their host firm

(although neither party is bound to work with each other). Some EIR's move on to

executive positions within a portfolio company.

Structure of the funds

Most venture capital funds have a fixed life of 10 years, with the possibility of a few years of

extensions to allow for private companies still seeking liquidity. The investing cycle for most

funds is generally three to five years, after which the focus is managing and making follow-on

investments in an existing portfolio. This model was pioneered by successful funds in Silicon

Valley through the 1980s to invest in technological trends broadly but only during their period of

ascendance, and to cut exposure to management and marketing risks of any individual firm or its

product.

In such a fund, the investors have a fixed commitment to the fund that is initially unfunded and

subsequently "called down" by the venture capital fund over time as the fund makes its

investments. There are substantial penalties for a Limited Partner (or investor) that fails to

participate in a capital call.

It can take anywhere from a month or so to several years for venture capitalists to raise money

from limited partners for their fund. At the time when all of the money has been raised, the fund

is said to be closed and the 10 year lifetime begins. Some funds have partial closes when one half

(or some other amount) of the fund has been raised. "Vintage year" generally refers to the year in

which the fund was closed and may serve as a means to stratify VC funds for comparison. This

free database of venture capital funds shows the difference between a venture capital fund

management company and the venture capital funds managed by them.

Compensation

Main article: Carried interest

Venture capitalists are compensated through a combination of management fees and carried

interest (often referred to as a "two and 20" arrangement):

Management fees – an annual payment made by the investors in the fund to the fund's

manager to pay for the private equity firm's investment operations. [25] In a typical venture

capital fund, the general partners receive an annual management fee equal to up to 2% of

the committed capital.

Carried interest – a share of the profits of the fund (typically 20%), paid to the private

equity fund’s management company as a performance incentive. The remaining 80% of

the profits are paid to the fund's investors[25] Strong Limited Partner interest in top-tier

venture firms has led to a general trend toward terms more favorable to the venture

partnership, and certain groups are able to command carried interest of 25-30% on their

funds.

Because a fund may run out of capital prior to the end of its life, larger venture capital firms

usually have several overlapping funds at the same time; this lets the larger firm keep specialists

in all stages of the development of firms almost constantly engaged. Smaller firms tend to thrive

or fail with their initial industry contacts; by the time the fund cashes out, an entirely-new

generation of technologies and people is ascending, whom the general partners may not know

well, and so it is prudent to reassess and shift industries or personnel rather than attempt to

simply invest more in the industry or people the partners already know.

Main alternatives to venture capital

Because of the strict requirements venture capitalists have for potential investments, many

entrepreneurs seek seed funding from angel investors, who may be more willing to invest in

highly speculative opportunities, or may have a prior relationship with the entrepreneur.

Furthermore, many venture capital firms will only seriously evaluate an investment in a start-up

company otherwise unknown to them if the company can prove at least some of its claims about

the technology and/or market potential for its product or services. To achieve this, or even just to

avoid the dilutive effects of receiving funding before such claims are proven, many start-ups

seek to self-finance sweat equity until they reach a point where they can credibly approach

outside capital providers such as venture capitalists or angel investors. This practice is called

"bootstrapping".

There has been some debate since the dot com boom that a "funding gap" has developed between

the friends and family investments typically in the $0 to $250,000 range and the amounts that

most Venture Capital Funds prefer to invest between $1 to $2M. This funding gap may be

accentuated by the fact that some successful Venture Capital funds have been drawn to raise

ever-larger funds, requiring them to search for correspondingly larger investment opportunities.

This 'gap' is often filled by sweat equity and seed funding via angel investors as well as equity

investment companies who specialize in investments in startup companies from the range of

$250,000 to $1M. The National Venture Capital Association estimates that the latter now invest

more than $30 billion a year in the USA in contrast to the $20 billion a year invested by

organized Venture Capital funds.[citation needed]

Crowd funding is emerging as an alternative to traditional venture capital. Crowd funding is an

approach to raising the capital required for a new project or enterprise by appealing to large

numbers of ordinary people for small donations. While such an approach has long precedents in

the sphere of charity, it is receiving renewed attention from entrepreneurs such as independent

film makers, now that social media and online communities make it possible to reach out to a

group of potentially interested supporters at very low cost. Some crowd funding models are also

being applied for startup funding.[21][26]

In industries where assets can be securitized effectively because they reliably generate future

revenue streams or have a good potential for resale in case of foreclosure, businesses may more

cheaply be able to raise debt to finance their growth. Good examples would include asset-

intensive extractive industries such as mining, or manufacturing industries. Offshore funding is

provided via specialist venture capital trusts which seek to utilise securitization in structuring

hybrid multi market transactions via an SPV (special purpose vehicle): a corporate entity that is

designed solely for the purpose of the financing.

In addition to traditional venture capital and angel networks, groups have emerged which allow

groups of small investors or entrepreneurs themselves to compete in a privatized business plan

competition where the group itself serves as the investor through a democratic process.[27]

Law firms are also increasingly acting as an intermediary between clients that seek venture

capital and the firms that provide it.[28]

Geographical differences

Venture capital, as an industry, originated in the United States and American firms have

traditionally been the largest participants in venture deals and the bulk of venture capital has

been deployed in American companies. However, increasingly, non-US venture investment is

growing and the number and size of non-US venture capitalists have been expanding.

Venture capital has been used as a tool for economic development in a variety of developing

regions. In many of these regions, with less developed financial sectors, venture capital plays a

role in facilitating access to finance for small and medium enterprises (SMEs), which in most

cases would not qualify for receiving bank loans.

In the year of 2008, while the Venture Capital fundings are still majorly dominated by U.S.

(USD 28.8 B invested in over 2550 deals in 2008), compared to International fund investments

(USD 13.4 B invested in everywhere else), there have been an average 5% growth in the Venture

capital deals outside of the U.S- mainly in China, Europe and Israel [11] . Geographical

differences can be significant. For instance, in the U.K., 4% of British investment goes to venture

capital, compared to about 33% in the U.S.[29]

United States

Venture capitalists invested some $6.6 billion in 797 deals in U.S. during the third quarter of

2006, according to the MoneyTree Report by PricewaterhouseCoopers and the National Venture

Capital Association based on data by Thomson Financial. A National Venture Capital

Association survey found that a majority (69%) of venture capitalists predicted that venture

investments in the U.S. would have leveled between $20–29 billion in 2007.[citation needed]

Canada

Canadian technology companies have attracted interest from the global venture capital

community as a result, in part, of generous tax incentive through the Scientific Research and

Experimental Development (SR&ED) investment tax credit program[citation needed]. The basic

incentive available to any Canadian corporation performing R&D is a refundable tax credit that

is equal to 20% of "qualifying" R&D expenditures (labour, material, R&D contracts, and R&D

equipment). An enhanced 35% refundable tax credit of available to certain (i.e. small) Canadian-

controlled private corporations (CCPCs). Because the CCPC rules require a minimum of 50%

Canadian ownership in the company performing R&D, foreign investors who would like to

benefit from the larger 35% tax credit must accept minority position in the company - which

might not be desirable. The SR&ED program does not restrict the export of any technology or

intellectual property that may have been developed with the benefit of SR&ED tax incentives.

Canada also has a fairly unique form of venture capital generation in its Labour Sponsored

Venture Capital Corporations (LSVCC). These funds, also known as Retail Venture Capital or

Labour Sponsored Investment Funds (LSIF), are generally sponsored by labor unions and offer

tax breaks from government to encourage retail investors to purchase the funds. Generally, these

Retail Venture Capital funds only invest in companies where the majority of employees are in

Canada. However, innovative structures have been developed to permit LSVCCs to direct in

Canadian subsidiaries of corporations incorporated in jurisdictions outside of Canada.

Europe

Europe has a large and growing number of active venture firms. Capital raised in the region in

2005, including buy-out funds, exceeded €60bn, of which €12.6bn was specifically for venture

investment. The European Venture Capital Association includes a list of active firms and other

statistics. In 2006 the top three countries receiving the most venture capital investments were the

United Kingdom (515 minority stakes sold for €1.78bn), France (195 deals worth €875m), and

Germany (207 deals worth €428m) according to data gathered by Library House.[30]

European venture capital investment in the second quarter of 2007 rose 5% to 1.14 billion Euros

from the first quarter. However, due to bigger sized deals in early stage investments, the number

of deals was down 20% to 213. The second quarter venture capital investment results were

significant in terms of early-round investment, where as much as 600 million Euros (about

42.8% of the total capital) were invested in 126 early round deals (which comprised more than

half of the total number of deals).[31] Private equity in Italy was 4.2 billion Euros in 2007.

Israel

Main article: Venture capital in Israel

Israel’s venture capital industry has rapidly developed from the early 1990s, and has about 70

active venture capital funds, of which 14 are international VCs with Israeli offices. Israel's

thriving venture capital and Business incubator industry played an important role in the booming

high-tech sector.[32] In 2008, venture capital investment in Israel rose 19 percent to $1.9 billion.[33]

Asia

Further information: Indian Venture Capital Association and China Venture Capital Association

India is fast catching up with the West in the field of venture capital and a number of

venture capital funds have a presence in the country (IVCA). In 2006, the total amount of

private equity and venture capital in India reached US$7.5 billion across 299 deals.[34]

China is also starting to develop a venture capital industry (CVCA).

Vietnam is experiencing its first foreign venture capitals, including IDG Venture Vietnam

($100 million) and DFJ Vinacapital ($35 million) [35]

Middle East and North Africa

The Middle East and North Africa (MENA) venture capital industry is an early stage of

development, but growing. The MENA Private Equity Association Guide to Venture Capital for

entrepreneurs lists VC firms in the region, and other resources available in the MENA VC

ecosystem.

Confidential information

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.

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.

Popular culture

Robert von Goeben and Kathryn Siegler produced a comic strip called The VC between the years

1997-2000 that parodied the industry, often by showing humorous exchanges between venture

capitalists and entrepreneurs.[36] Von Goeben was a partner in Redleaf Venture Management

when he began writing the strip.[37]

Mark Coggins' 2002 novel Vulture Capital features a venture capitalist protagonist who

investigates the disappearance of the chief scientist in a biotech firm in which he has invested.

Coggins also worked in the industry and was co-founder of a dot-com startup.[38] In the Dilbert

comic strip, a character named 'Vijay, the World's Most Desperate Venture Capitalist' frequently

makes appearances, offering bags of cash to anyone with even a hint of potential. In one strip, he

offers two small children with good math grades money based on the fact that if they marry and

produce an engineer baby he can invest in the infant's first idea. The children respond that they

are already looking for mezzanine funding.

Drawing on his experience as reporter covering technology for the New York Times, Matt Richtel

produced the 2007 novel Hooked, in which the actions of the main character's deceased

girlfriend, a Silicon Valley venture capitalist, play a key role in the plot.[39]

In the TV series Dragons' Den, various startup companies pitch their business plans to a panel of

venture capitalists. In the 2005 movie, Wedding Crashers, Jeremy Grey (Vince Vaughn) and

John Beckwith (Owen Wilson) are two bachelors who create appearances to play at different

weddings of complete strangers, and a large part of the movie follows them posing as venture

capitalists from New Hampshire.

Introduction to Venture Capital

Venture Capital is a form of "risk capital". In other words, capital that is invested in a project

(in this case - a business) where there is a substantial element of risk relating to the future

creation of profits and cash flows. Risk capital is invested as shares (equity) rather than as a

loan and the investor requires a higher"rate of return" to compensate him for his risk.

The main sources of venture capital in the UK are venture capital firms and "business

angels" - private investors. Separate Tutor2u revision notes cover the operation of business

angels. In these notes, we principally focus on venture capital firms. However, it should be

pointed out the attributes that both venture capital firms and business angels look for in

potential investments are often very similar.

What is venture capital?

Venture capital provides long-term, committed share capital, to help unquoted companies

grow and succeed. If an entrepreneur is looking to start-up, expand, buy-into a business,

buy-out a business in which he works, turnaround or revitalise a company, venture capital

could help do this. 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 is invested in

exchange for an equity stake in the business. 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 capital in the UK originated in the late 18th century, when entrepreneurs found

wealthy individuals to back their projects on an ad hoc basis. This informal method of

financing became an industry in the late 1970s and early 1980s when a number of venture

capital firms were founded. There are now over 100 active venture capital firms in the UK,

which provide several billion pounds each year to unquoted companies mostly located in the

UK.

What kind of businesses are attractive to venture capitalists?

Venture capitalist prefer to invest in "entrepreneurial businesses". This does not necessarily

mean small or new businesses. Rather, it is more about the investment's aspirations and

potential for growth, rather than by current size. Such businesses are aiming to grow rapidly

to a significant size. 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 investors are only interested in companies with high growth

prospects, which are managed by experienced and ambitious teams who are capable of

turning their business plan into reality.

For how long do venture capitalists invest in a business?

Venture capital firms usually look to retain their investment for between three and seven

years or more. The term of the investment is often linked to the growth profile of the

business. Investments in more mature businesses, where the business performance can be

improved quicker and easier, are often sold sooner than investments in early-stage or

technology companies where it takes time to develop the business model.

Where do venture capital firms obtain their money?

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 UK venture capital firms raise

their funds for investment from external sources, mainly institutional investors, such as

pension funds and insurance companies.

Venture capital firms' investment preferences may be affected by the source of their funds.

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.

What is involved in the investment process?

The investment process, from reviewing the business plan to actually investing in a

proposition, can take a venture capitalist anything from one month to one year but typically

it takes between 3 and 6 months. There are always exceptions to the rule and deals can be

done in extremely short time frames. Much depends on the quality of information provided

and made available.

The key stage of the investment process is the initial evaluation of a business plan. Most

approaches to venture capitalists are rejected at this stage. In considering the business

plan, the venture capitalist will consider several principal aspects:

- Is the product or service commercially viable?

- Does the company have potential for sustained growth?

- Does management have the ability to exploit this potential and control the company

through the growth phases?

- Does the possible reward justify the risk?

- Does the potential financial return on the investment meet their investment criteria?

In structuring its investment, the venture capitalist may use one or more of the following

types of share capital:

Ordinary shares

These are equity shares that are entitled to all income and capital after the rights of all other

classes of capital and creditors have been satisfied. Ordinary shares have votes. In a venture

capital deal these are the shares typically held by the management and family shareholders

rather than the venture capital firm.

Preferred ordinary shares

These are equity shares with special rights.For example, they may be entitled to a fixed

dividend or share of the profits. Preferred ordinary shares have votes.

Preference shares

These are non-equity shares. They rank ahead of all classes of ordinary shares for both

income and capital. Their income rights are defined and they are usually entitled to a fixed

dividend (eg. 10% fixed). The shares may be redeemable on fixed dates or they may be

irredeemable. Sometimes they may be redeemable at a fixed premium (eg. at 120% of

cost). They may be convertible into a class of ordinary shares.

Loan capital

Venture capital loans typically are entitled to interest and are usually, though not

necessarily repayable. Loans may be secured on the company's assets or may be

unsecured. A secured loan will rank ahead of unsecured loans and certain other creditors of

the company. A loan may be convertible into equity shares. Alternatively, it may have a

warrant attached which gives the loan holder the option to subscribe for new equity shares

on terms fixed in the warrant. They typically carry a higher rate of interest than bank term

loans and rank behind the bank for payment of interest and repayment of capital.

Venture capital investments are often accompanied by additional financing at the point of

investment. This is nearly always the case where the business in which the investment is

being made is relatively mature or well-established. In this case, it is appropriate for a

business to have a financing structure that includes both equity and debt.

Other forms of finance provided in addition to venture capitalist equity include:

- Clearing banks - principally provide overdrafts and short to medium-term loans at fixed or,

more usually, variable rates of interest.

- Merchant banks - organise the provision of medium to longer-term loans, usually for larger

amounts than clearing banks. Later they can play an important role in the process of "going

public" by advising on the terms and price of public issues and by arranging underwriting

when necessary.

- Finance houses - provide various forms of installment credit, ranging from hire purchase to

leasing, often asset based and usually for a fixed term and at fixed interest rates.

Factoring companies - provide finance by buying trade debts at a discount, either on a

recourse basis (you retain the credit risk on the debts) or on a non-recourse basis (the

factoring company takes over the credit risk).

Government and European Commission sources - provide financial aid to UK companies,

ranging from project grants (related to jobs created and safeguarded) to enterprise loans in

selective areas.

Mezzanine firms - provide loan finance that is halfway between equity and secured debt.

These facilities require either a second charge on the company's assets or are unsecured.

Because the risk is consequently higher than senior debt, the interest charged by the

mezzanine debt provider will be higher than that from the principal lenders and sometimes a

modest equity "up-side" will be required through options or warrants. It is generally most

appropriate for larger transactions.

Making the Investment - Due Diligence

To support an initial positive assessment of your business proposition, the venture capitalist

will want to assess the technical and financial feasibility in detail.

External consultants are often used to assess market prospects and the technical feasibility

of the proposition, unless the venture capital firm has the appropriately qualified people in-

house. Chartered accountants are often called on to do much of the due diligence, such as

to report on the financial projections and other financial aspects of the plan. These reports

often follow a detailed study, or a one or two day overview may be all that is required by the

venture capital firm. They will assess and review the following points concerning the

company and its management:

- Management information systems

- Forecasting techniques and accuracy of past forecasting

- Assumptions on which financial assumptions are based

- The latest available management accounts, including the company's cash/debtor positions

- Bank facilities and leasing agreements

- Pensions funding

- Employee contracts, etc.

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. References may also be

taken up on the company (eg. with suppliers, customers, and bankers).

venture capital (VC)

Venture capital (VC) is funding invested, or available for investment, in an enterprise that offers the

probability of profit along with the possibility of loss. Indeed, venture capital was once known also as

risk capital, but that term has fallen out of usage, probably because investors don't like to see the words

"risk" and "capital" in close conjunction. Venture capitalists often don't tend to think that their

investments involve an element of risk, but are assured a successful return by virtue of the investor's

knowledge and business sense. DataMerge, a financial information provider, says that VC investments in

an enterprise are usually between $500,000 and $5 million, and that the investor is likely to expect an

annual return of 20% to 50%.

Venture capitalists were instrumental in the enormous increase in the number of dot-com startups

of recent years. Because the Internet was a new and untried business venue with enormous

potential, many analysts feel that standard business rules were too frequently suspended in what

was a very optimistic market. Internet-based enterprises were expected to enjoy unprecedented

success; many venture capitalists were said to have encouraged dot-coms to focus on scaling

upward rather than on realizing early profits. According to VentureWire, U.S. venture capital

funding for 2000 was $105 billion, more than the total funding available in all the 15 years

before that. However, in April of that same year, severe market corrections brought about a

radical change in the financial climate, and since then online businesses have been failing at rates

similar to the rates of startups in the early days of the dot-com boom. Vulture capitalist, a term

coined in the volatile financial environment of the 1980s, has been revived to refer to the venture

capitalists that have recently begun to buy up failing dot-com enterprises at rock-bottom prices.

Venture capital is the second or third stage of a traditional startup financing sequence, which

starts with the entrepreneurs putting their own available funding into a shoestring operation.

Next, an angel investor may be convinced to contribute funding. Generally an angel investor is

someone with spare funds and some personal or industry-related interest - angels are sometimes

said to invest "emotional money," while venture capitalists are said to invest "logical money" -

that is willing to help give the new enterprise a more solid footing. First-round venture capital

funding involves a significant cash outlay and managerial assistance. Second-round venture

capital involves a larger cash outlay and instructions to a stock or initial public offering (IPO)

underwriter, who will sell stock in exchange for a percentage of what is sold. Finally, in the IPO

stage, an investment bank is commissioned to sell shares to the public.

In the currently sober economic climate, a return to traditional business wisdom has meant that

enterprises are generally expected to show a clear path to profitability if they want to attract

investment funds.

Venture capital is the term used when investors buy part of a company. A venture

capitalist places money in a company that is high risk and has a high growth. The

investment is usually for a period of five to seven years. The investor will expect a

return on his money either by the sale of the company or by offering to sell shares in

the company to the public.

When investing venture capital, the investor may want receive a percentage of the

company’s equity, and may also wish to have a position on the director’s board. Always

remember that an investor who agrees to place venture capital in a company is looking

to make a healthy return. She can demand repayment by the sale of the company,

asking for her funds back or renegotiating the original deal.

There are three different types of venture capital investment. Early stage financing

includes seed financing, start-up financing and first stage financing. Seed financing

refers to a small amount of venture capital given to an entrepreneur or inventor who

wishes to start a business. It may be used to build a management team, for market

research or to develop a business plan.

Start up financing refers to venture capital that is given when a business has been

operating for less than a year. Their product will not have been sold commercially yet,

and they will just be ready to start doing so. First stage financing is used when

companies wish to expand their capital and to proceed full scale and enter the public

business arena.

Another type of venture capital investment is expansion financing. This covers second

and third stage financing and bridge financing. Second stage financing is an investment

used to expand a company that is already on its feet. The company is trading and has

growing accounts and inventories, although it may not yet be showing a profit.

Third stage financing is an investment to companies that are breaking even or

becoming profitable. The venture capital is used to expand the business. It may be used

in the acquisition of real estate or for further in-depth product development.

Bridge financing covers a variety of different meanings. It is a short term, interest only

investment. It is used when company restructuring is taking place. The money can also

be used if an initial investor wants to liquidate his position and sell his stock.

Another common form of venture capital is acquisition financing, in which the

investment is used to acquire a percentage or the whole of another company. Venture

capital can also be used by a management group to buy out another a line of products

or business, regardless of their stage of development. The company they buy out can

either be a private or a public company.

What Is Venture Capital Financing?Start-up companies that may have yet to generate cash flow are often in need of some

type of financial backing to grow. Venture capital financing is one channel that helps

new businesses to accomplish this type of expansion. Financing might be provided in

the form of equity to privately held companies with solid prospects for growth and

profitability. Venture capitalists could provide the financing in rounds and in return seek

to share in profits at some point in the future.

New businesses seeking start-up capital from a venture capital firm typically have to

request it. Often, the decision to provide venture capital financing to an entrepreneur

must be something that all of the senior members of the investing organization must

agree on. Even if a business owner has developed a relationship with one member of a

venture capital firm, there needs to be additional support from the financing firm in

order for the financing to work. Upon agreeing to invest in a start-up business, venture

capitalists gain a vested interest in the success of that company. Subsequently, in

addition to financial capital, venture capital involvement might extend to other types of

support, including management, operational, or marketing expertise.

The debut round of venture capital financing involves seed capital. Seed financing is

designed to propel an entrepreneur and a new business to the development stage of a

product or service. Any financing provided at this stage may be a relatively small

amount because the company remains in the early stages of growth, and the risks

associated with investing are often high. Subsequent rounds of financing are likely to be

greater as the stakes become higher and venture capitalists seek a greater presence in

the management of a company and future profits.

Venture capital firms are often dedicated to a certain niche or industry. It is helpful for

entrepreneurs seeking venture capital financing to learn about the types of projects that

firm tends to support before making contact. Marketing materials surrounding a venture

capital firm are likely to be provided on the company's website or in some type of

venture capital database. Upon extending venture capital financing, the firm will likely

obtain a position on the start-up business's board of directors to influence the direction

of the company. An exit strategy for a venture capital firm, or a way to cash in on

profits, may be to introduce the company to the public stock market in an initial public

offering.

What Is Venture Capital Equity?Venture capital equity is the measure of what a party puts into a beginning business or

other investment. Venture capital is a term largely used by finance professionals to

describe outside parties funding specific startup operations. When the venture capital

providers add their money into the mix, they are said to have “venture capital equity,”

which refers to value that they should get back out of the startup when it expands or

“matures” as a business or operation.

In general, a startup company will seek venture capital from investors in order to help

get its beginning operations off of the ground. Business leaders who need cash for initial

equipment purchases, labor costs, advertising, or anything else will seek out “angel

investors” who will hand over money to the business in exchange for future

concessions. Some businesses offer bond yield to venture capitalists, while others offer

other opportunities like stock or partial control of the startup.

When investors establish venture capital equity in a startup, it represents their “stake”

in the business. These investors hope to be rewarded with big gains when the business

becomes profitable. They may also seek to be “partners” in the business who will

receive compensation as a kind of high-level paid executive, or be on the board of a

leadership team. Venture capital equity is what the business basically “owes” the

investing party.

Finance pros who are evaluating equity in a startup will often reference “human plus

capital” investment, where personal involvement may go hand in hand with invested

money. Some of the biggest issues with foreign venture capital equity involve the rules

on outside ownership of companies, where those with some kinds of equity may have to

funnel their involvement through third party management firms with domestic status.

With domestic venture capital equity, the typical considerations include establishing

appropriate business structures and solid agreements for profit sharing.

Business leaders who want to benefit from a venture capital equity arrangement should

understand that this kind of monetary influx is hardly ever done without establishing

standards for investment. Investors will want to know that a business has solid potential

before putting money down on its success. Entrepreneurs should also understand the

usual amounts of money that go into these kinds of deals, and seek out finance

agreements accordingly. It’s incumbent on the startup leadership to look for venture

capital equity in a responsible way and to treat incoming money realistically,

maintaining a good relationship with those who hold this kind of equity.

What Is Seed Venture Capital?Seed venture capital is money invested in a company by private investors at the earliest

stages of the company's inception. Such capital is used by start-up companies as a way

to fund market research, develop products, or perform some other function crucial to

get the business up and running. The investors who provide the seed venture capital

can benefit in the future if the company in which they invested grows and becomes

successful. These investments are particularly risky but generally require far less capital

than investments in companies that are more established.

Private business investment is something that is usually reserved for investors with a

great deal of capital who can purchase equity in mid-market companies looking to move

up in the business world. There are companies that may be in the opening stages of

existence that need the kind of capital that even investors with moderate capital can

provide. These companies just need money to get off the ground, and seed venture

capital can allow them to do just that.

Whereas other venture capital investments usually take place through investment firms

that require a significant minimum contribution from investors, seed venture capital is

often done on an individual level. For example, those starting up a company might

reach out to family, friends, or other acquaintances in an effort to raise funds. Investors

in such cases will have a personal stake in the success of the company as well as their

obvious financial concerns.

Since some companies requiring seed venture capital may not have even opened their

business to the public, any investment in these companies generally requires a leap of

faith from investors. The money they provide might help fund a necessary business

expense that the company might not be able to otherwise afford. Still, there is no track

record or earnings report for investors to study in such cases, so there is no guarantee

that any of their investment capital will ever be returned to them.

The upside to seed venture capital investment for investors is that it generally requires

a smaller amount than other types of venture capital or private equity arrangements.

For their help with funding, the investors generally get some share of ownership in the

nascent business, which is usually determined by the amount of capital they provide.

This ownership share can be extremely valuable down the road if the start-up company

manages to survive its early stages and becomes established in the industry in which it

competes.

What Is Early Stage Venture Capital?Sometimes known as seed capital, early stage venture capital is money invested in a

start-up company during the earliest phase of the company’s operation. This typically

includes the launch period in which the company is structured and actually begins to

produce goods or services. This type of first round financing is often critical to the new

business, since it provides the money needed to allow the business to function as it

attracts the attention of consumers and begins to build a client base.

Investors sometimes find that early stage venture capital is a good way to earn a return

in a relatively short period of time. The funds invested are often dedicated to specific

aspects of the operation, such as the establishment of a manufacturing facility or the

creation of a public relations campaign. As the business begins to generate income,

investors who directly contributed funds to those functions are repaid with interest, or

receive a repayment of the principal and shares of stock issued by the new company.

Since the method of earning returns on early stage venture capital vary, it is important

to understand the terms and conditions associated with each venture. This includes

identifying how interest payments are to be made, whether the principal will be repaid

in installment payments or a lump sum by a specific date, or even if the investor may

be offered shares of stock in lieu of repaying the venture capital. Making this type of

assessment on the front end is important, since the idea is to match the goals of the

investor with the needs of a new business venture, resulting in both parties being

satisfied with the arrangement.

There are some risks associated with providing early stage venture capital. The most

common has to do with the failure of the business venture to begin generating income

within the anticipated time frame. When this takes place, the investor may have to wait

a little longer to begin receiving some sort of payments on the initial investment.

Depending on the length of time that it takes for the business to become profitable, the

investor may find that the funds are tied up for much longer than anticipated.

Another potential risk is that the business will fail to attract consumers and ultimately

not generate any profit at all. In this scenario, the investor may or may not recoup the

early stage venture capital, and is highly unlikely to receive any type of additional

compensation such as interest payments. For this reason, investors should evaluate

every aspect of the business model and ascertain the potential for its products to

attract enough consumers to support the venture. If there is any reason to believe the

venture does not have a good chance of succeeding within a reasonable period of time,

the investor should seek other early stage venture capital opportunities that show more

promise of a successful launch.

What Is the Difference Between Private Equity

and Venture Capital?Investing in either private equity or venture capital has similarities, and some industry

experts even consider both private equity and venture capital to be part of the same

asset class, or category of investing. Others separate each into its own category but

consider them both to fall under the alternative investment umbrella, which represents

a class of investing that is less traditional then stocks and bonds but carries with it the

possibility of greater returns or profits. For all their similarities, such as the fact that at

the core both generate profits by acquiring a stake in another business, there are still

decisive differences that make the nomenclatures of private equity and venture capital

unique. The biggest difference between private equity and venture capital is that

private equity generally is invested in a proven company, and venture capital typically

is invested in a much newer company that is still early in its development.

Private equity and venture capital both represent sectors that invest in businesses in

transactions that are not open to the general public. Private equity firms will either

acquire a stake in a business or buy the company outright, and venture capital provides

investment capital in the young stages of a company's development in an attempt to

capitalize on the anticipated growth of that business. Eventually, private equity and

venture capital earn profits through either the eventual sale of that company or when

that business is launched into the stock market through an initial public offering, which

allows other investors can obtain a stake in the company as well.

Historically, venture capital will be invested in early stage or start-up companies that

present a significant amount of risk because there is no real proven history of

performance, profits or revenues, but these bets also carry with them the potential

promise for generous rewards. Receiving venture capital funding can be the difference

between success and failure for a start-up, because companies in the early stages of

development and in the private market do not yet have access to the public capital

markets where they can raise large amounts of equity or debt in an offering. After the

venture capital team has obtained a stake in a business, it will have a say in some of

the managerial decisions and direction of that business.

Private equity, on the other hand, traditionally will purchase a stake in a company that

has a proven track record. This business might be in jeopardy for one reason or another,

and the private equity investment team might become involved with the day-to-day

operations of that entity. As a result, the talent pool in private equity tends to be

specialized to a particular industry, such as energy, retail or restaurants. Private equity

firms create what is known as a portfolio of investments and typically hold onto that

stake for a period of five to seven years.

Inside this Article

1. How does venture capital work?

2. Venture Capital Firms and Funds

3. Venture Capital in a New Company

When you start a new business, you need money to get it off the ground. You need the money to

rent or purchase space for the business, furniture and equipment, supplies, etc. You also need

money to pay employees. There are several places where you can get the money that a new

business needs:

Personal savings -- you can fund the business yourself from savings or by getting a

second mortgage on your home.

Bootstrapping -- In some simple businesses, you can bootstrap the business. That means

that, with a very small investment, you get the business going and then use the profits

from each sale to grow the business. This approach works well in the service industry

where start-up expenses are sometimes low and you don't need employees initially.

Bank loan -- You can borrow money from a bank.

All three of these techniques have limitations unless you are already a wealthy individual. A

fourth way to get money to start a business is called Venture Capital -- with venture capital you

can sometimes obtain large quantities of money, and this money can help businesses with big

start-up expenses or businesses that want to grow very quickly.

Venture Capital Firms and Funds

You often hear about Venture Capitalists (VCs) funding Dot Com companies, and they fund all

sorts of other businesses as well. The classic approach is for a venture capital firm to open a

fund. A fund is a pool of money that the VC firm will invest. The firm gathers money from

wealthy individuals and from companies, pension funds, etc. that have money they wish to

invest. The firm will raise a fixed amount of money in the fund -- for example, $100 million.

The VC firm will then invest the $100 million fund in some number of companies -- for

example, 10 to 20 companies. Each firm and fund has an investment profile. For example, a fund

might invest in biotech startups. Or the fund might invest in Dot Coms seeking their second

round of financing. Or the fund might try a mix of companies that are all preparing to do an IPO

(Initial Public Offering) in the next 6 months. The profile that the fund chooses has certain risks

and rewards that the investors know about when they invest the money.

Typically the Venture Capital firm will invest the entire fund and then anticipate that all of the

investments it made will liquidate in 3 to 7 years. That is, the VC firm expects each of the

companies it invested in to either "go public" (meaning that the company sells shares on a stock

exchange) or to be bought (acquired) by another company. In either case, the cash that flows in

from the sale of stock to the public or to an acquirer lets the VC firm cash out and place the

proceeds back into the fund. When the whole process is done, the goal is to have made more

money than the $100 million originally invested. The fund is then distributed back to the

investors based on the amount each one originally contributed.

Let's say that a VC fund invests $100 million in 10 companies ($10 million each). Some of those

companies will fail. Some will not really go anywhere. But some will actually go public. When a

company goes public, it is often worth hundreds of millions of dollars. So the VC fund makes a

very good return. For one $10 million investment, the fund might receive back $50 million over

a 5 year period. So the VC fund is playing the law of averages, hoping that the big wins (the

companies that make it and go public) overshadow the failures and provide a great return on the

$100 million originally collected by the fund. The skill of the firm in picking its investments and

timing those investments is a big factor in the fund's return. Investors are typically looking for

something like a 20% per year return on investment for the fund.

Venture Capital in a New Company

From a company's standpoint, here is how the whole transaction looks. The company starts up

and needs money to grow. The company seeks venture capital firms to invest in the company.

The founders of the company create a business plan that shows what they plan to do and what

they think will happen to the company over time (how fast it will grow, how much money it will

make, etc.). The VCs look at the plan, and if they like what they see they invest money in the

company. The first round of money is called a seed round. Over time a company will typically

receive 3 or 4 rounds of funding before going public or getting acquired.

In return for the money it receives, the company gives the VCs stock in the company as well as

some control over the decisions the company makes. The company, for example, might give the

VC firm a seat on its board of directors. The company might agree not to spend more than $X

without the VC's approval. The VCs might also need to approve certain people who are hired,

loans, etc.

In many cases, a VC firm offers more than just money. For example, it might have good contacts

in the industry or it might have a lot of experience it can provide to the company.

One big negotiating point that is discussed when a VC invests money in a company is, "How

much stock should the VC firm get in return for the money it invests?" This question is answered

by choosing a valuation for the company. The VC firm and the people in the company have to

agree how much the company is worth. This is the pre-money valuation of the company. Then

the VC firm invests the money and this creates a post-money valuation. The percentage

increase in the value determines how much stock the VC firm receives. A VC firm might

typically receive anywhere from 10% to 50% of the company in return for its investment. More

or less is possible, but that's a typical range. The original shareholders are diluted in the process.

The shareholders own 100% of the company prior to the VC's investment. If the VC firm gets

50% of the company, then the original shareholders own the remaining 50%.

Dot Coms typically use Venture Capital to start up because they need lots of cash for advertising,

equipment, and employees. They need to advertise in order to attract visitors, and they need

equipment and employees to create the site. The amount of advertising money needed and the

speed of change in the Internet can make bootstrapping impossible. For example, many of the

eCommerce Dot Coms typically consume $50 million to $100 million to get to the point where

they can go public. Up to half of that money can be spent on advertising!

When seeking financing for your venture, it's easier to gain the confidence of potential investors if you speak, or at least understand, their language. For instance, entrepreneurs are sometimes surprised to learn that 'Venture Capital' is not a catchall phrase meaning 'funding'. In fact, it's a specific type of funding with definite terms and guidelines. The following is a sampler of terms you may come across as you go through the funding process.

VENTURE CAPITAL

Venture capital is a process by which investors fund early stage, more risk-oriented ventures. It differs substantially from 'traditional' financing in the following ways:

Funding provided to new or existing firms with potential for above-average growth.

Often provided to startup and other emerging enterprises because they lack the collateral, track record, or earnings required to get a loan.

The investment, typically requiring a high potential of return, is structured so that it can be liquidated within a three to seven year period.

Then an initial public offering may take place, or the business merges or is sold, or other sources of capital are found.

The entrepreneur typically relinquishes some level of ownership and control of the business.

Venture capitalists typically expect a 20-50% annual return on their investment at the time they are bought out.

Typical investments range from $500,000 to $5 million.

Management experience is a major consideration in evaluating financing prospects.

STAGES of DEVELOPMENT of a BUSINESS

Seed Capital. Source of funding for the early stages of a startup venture where the product, process, or service is in its conceptual or developmental phase.

Startup. From founding the business to the beginning of operations and the generation of revenue.

First Stage. Initial growth phase, funded by the initial capitalization. Management and operations are in place, and markets initially identified are being penetrated using available resources.

Second Stage. The business seeks to expand its product line, expand its facilities, identify and penetrate new markets, and continue the growth phase.

Third Stage. The business is established in its target markets.

Mezzanine Financing. Financing provided, usually by private investors or venture capital firms, prior to a company going public, or initiating its next stage of financing.

Private Placement. An offering of debt, equity or limited partnership interests to a small number of investors (generally 35 or fewer) on a 'private' basis. Exempt from the registration requirements of the securities laws.

Dilution. Either the percentage reduction of ownership in a company resulting from the sale of additional shares of stock, or in the difference between the price paid by investors in either a private-placement or public financing.

Due Diligence. The process of investigation by venture capital firms and other investors of a company, its business, and financial plans, prior to proceeding with an investment.

Feasibility Study. A study that evaluates a proposed venture's potential for success.

Equity Stake. An equity ownership position that is provided to a funding source as compensation, or additional compensation, for providing management consulting, financing or miscellaneous services.

Sweat Equity. The value assigned to the entrepreneur's contribution or investment of time and effort in the venture.

FIND a CHAMPION

If you have not raised money for a venture before, you will find this a very interesting experience. Even people who love your idea, will run to the exits when you ask them for money. The most important thing you can do is find an experienced money raiser or gatekeeper for your business. Have your management team interview at least 5 candidates, and do your due diligence. You want someone with direct connections in your industry sector who has successfully raised money in the past for your type of company.

While the money sources will want to hear directly from your team, the use of a properly selected gatekeeper will help you with introductions and champion your cause. Choosing the wrong gatekeeper can delay receiving funds or even totally wipe out your deal.

TIME FRAME

Vital to your success is the awareness that fund raising is a never ending-process as your company grows. The end of one round of funding is just the beginning of the next round. You can expect to invest at least six months in finding your first round of funding, and three to six months for your next round.