JOHANES LIM CONSULTING

Is Venture Capital Good for Your Business?

• Venture capital is a possible source of funding for new, relatively unproven enterprises that appear to have promising futures. However, such money is often hard to come by. Be realistic in your quest for venture capital. Venture capital firms expect a business to be able to return their investment not only with interest, but with a large profit. Many venture capital firms are affiliated with banks, insurance companies, other financial institutions and large corporations. Some are owned by individuals or private groups of investors and a few are publicly held. Once you accept venture capital, you have relinquished some of your autonomy and accepted the understanding that the venture capital firm will take a large share of the profits you earn.

• As the entrepreneur, you should understand the nature of a vendor firm, before pursuing this as a financing source. This type of investor expects a projected return on investment that is directly related to risk. The greater the risk, the greater the return expected. Typically, however, an investment firm will not be interested in getting involved with a new firm until the business has established itself in some way, so the risk factor can be determined.
• The venture capital firm and its interest usually depends upon the stage of the new firm’s development. Once the new firm has established itself and has a working organizational structure, a viable business plan and start-up arrangement—a venture capital firm may be interested. However, some firms prefer a later stage of new business development, perhaps when the new company is in its second or third round growth state and needs more capital either to carry out expansion plans or to tide it over until a merger or public offering carries it to the next stage of corporate growth.

A company’s business plan serves as the primary analytical tool for the venture capitalist. In analyzing the plan, a venture capital firm would most likely focus on three features:

• The product or service: Investors seek product or service innovations that give the company a strong competitive advantage. A new idea, backed by market surveys (measuring the appeal of the product or service and its potential market) may be tempting to such investors.
• Management capability: No matter how good the product or how innovative the service, the quality and experience of the management is a key factor in the success of the business. The astute investor is well aware of this and looks for solid evidence of such skill.
• The industry’s growth: Investors also want to be sure that the product or service is in a growth field. A significant or revolutionary product improvement, by itself, may not have appeal in a declining product or service category.

How to be an Angel Investor

• If a would-be entrepreneur has been turned down by the bank because it thinks the idea won't work or is too risky, the best bet may be a personal investor -an angel.
• Banks and rich relatives want to make sure they get their money back; angels do too, but they're much more willing to take a risk on what they believe is a good idea.
• Angels use their own money. They're mostly people who have been successful and now want to see someone else become successful, and make some money off it. Angels tend to invest in their area of expertise. "My money brings my personality with me. You, as an entrepreneur, can leverage that person's knowledge along with their money."
• Yet some investors know very little about the business they're helping. Instead, they rely on a network of experts to determine the risk-reward level.
• How much money they're willing to lend ultimately depends on their resources. Individual investors tend to set a cap of $1 million and may be willing to lend as little as $100,000. Investors who team up with other investors may lend as much as $2 million to $5 million and set a bottom limit of $100,000 or $250,000.
• Finding angel investors isn't easy. Most value their privacy and don't want to be approached by every person who's looking for financial backing. A search of the Internet will come up with plenty of listings but may be a waste of more than just time.
• About 75 percent of business plans that get funded get it because of a personal introduction. That's so important. It doesn't guarantee funding but it guarantees some attention.
• Entrepreneurs will be on the road to making the right contacts by getting immersed in their local business community. Join the Rotary, Lions, a local trade association that has a speaker every month -networking is important- network with the people you play golf with and the people you buy products from. Stay in touch with people, keep them updated.
• Or you can buy an introduction. Another avenue to try is investor-matching services. The easiest way to find these companies is by searching the Internet. Some companies are dirt-based; others exist only in cyberspace. Information about the entrepreneur and the venture is entered into a database and matched with potential investors. Many matching services charge both parties a fee and there's no guarantee that either the entrepreneur or the investor have been checked out by the matching service.

We know you're excited. What else?

• Whether an entrepreneur is looking for an angel investor or a venture capital firm that finances larger amounts, it's important to have a plan.
• The business plan should include information about the management team. What's their experience? What do they bring to the table that improves the likelihood of success? They also need sound financial projections, a detailed discussion about operational control, how they'd organize the business, a marketing plan, sales plan, manufacturing capacity and a realistic time frame for starting this up.

Private Funding Sources. What You Need to Know

• Many projects are funded by these sources, and often one investor will assist in the funding of multiple projects. Here’s what you need to know:
• Who typically invests in private deals?
• What amounts of money are possible from private investors?
• How will these investors normally participate?
• What do they bring to your project besides money?
• What type of returns will they require and over what period of time?
• Where can you meet or be introduced to the right people?
• How do you avoid the scams and shams that waste your time?
• How do you check out the money sources? Are they clean and are they legitimate?
• What criteria will a private investor use to evaluate your deal and what is the most important item?
• How and when do you approach seed or venture capital funds, and how will they evaluate your project?
• Why you should not contact a fund directly without an introduction. How to get that introduction.
• What are the deal criteria for Venture Capital funds?
• How do Venture Capital Funds operate, and what do they expect from their portfolio companies?

How are deals done, and why?

• How do you structure your deal after all the business planning, market studies, business valuations and research are done? There are six basic elements that will entice an investor to take a serious look at your project. They are:
• Do I like the feel of this project? Its market area? Its management team?
• Will I get my capital back off the top or the bottom?
• Is there a big upside potential? Stock conversions, possible IPO, early payouts, etc.?
• What assurances will I have that the business plan will be followed and can be executed?
• How will I be involved?
• What other opportunities are there available that are better than this one?

Investor Returns Funding Criteria

• Each stage of funding has its own set of criteria, and its own group of individuals who work in that field. The earlier the financing stage, the greater the risk, the greater expected return, and the greater percentage private investors and venture capitalists will request.
• Don't be surprised if an investor asks to control of up to 90% of your company. Entrepreneurs, however, are usually given the opportunity to earn back controlling interest if certain milestones and performance standards are met.
• Also, the earlier the stage, the more difficulty will be encountered in raising the initial capital. It may take six months to a year to locate the proper partner for your business.

Private Placement Returns:

• Start ups, 10-12 times return in 5-7 years.
• Existing companies, 5-7 times investment in 4-5 years.

Why are expected returns so high?

• Quite simply, because of all the non-performing investments, or losses, and the lack of liquidity and the availability of other opportunities. Once invested with you he may not see a return for several years, if ever. And, he has the loss of a more liquid investment that could have been realized.
• In order to have excess cash available for your business, the private investor may have had to earn three times the amount he is investing in your business. He must earn enough to cover his overhead, enough for taxes and finally his investment money for you.

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