What is venture capital?
Venture capital is capital invested or available for investment in the ownership element of a new enterprise. While there may also exist a preferred return or debt component, the defining characteristic is that the capital investor retains some equity in the venture. There are several types or stages of venture financing typically referred to as: 1. Seed 2. Start-Up 3. Second Stage 4. Third Stage 5. Mezzanine 6. Initial Public Offering (IPO)
What is seed money?Seed money, seed capital or seed financing is venture capital used to finance the early development of a new product or service concept. Generally, it is the most expensive in terms of equity concessions since there is no guarantee that the product or service under development will ever make it to the stage of a workable prototype much less a viable commercial enterprise. While there are many firms that specialize in seed-stage financing, this is generally not the niche most attractive to Venture-Net. What is start-up capital?Start-up capital usually refers to venture funding sufficient to generate initial sales and profits. Our view is that if an initial private placement, distributed on the basis of a viable three-to-five-year plan to reach fundamentals sufficient to undertake a successful public offering, is fully subscribed, there should be no need for second and third-stage equity offerings. This is advantageous to both the founders, management team and first-stage investors in that neither suffer any subsequent dilution prior to the firm's initial public offering (IPO). Why would these later stages be necessary?In the event that the firm's initial private offering does not prove sufficient, the company may need to resort to additional debt or equity placements to raise more capital. This may become necessary due to management's failure to utilize properly its initial financial resources or it may result from unforeseen changes in the company's operating environment or from many other factors. If a follow-on-stage offering is used to fund an expansion that enables a company to later conduct a public offering, it is sometimes referred to as a mezzanine financing. In all later-stage financings you can be sure of one thing, management's equity will almost certainly be reduced, drastically so in many cases. We've seen common share "cram downs" as bad as 60-to-one. Is there a way to avoid later-stage financings?The probabilities that later-stage private offerings will be necessary can be reduced by stating your total funding requirements up front and raising adequate reserve capital. Properly presented, investors should prefer this approach because it charts the most direct course towards the twin goals of profitability and liquidity. Does that mean it's best to ask for as much money as you think you can get?We don't believe so. We feel it is important to have a well-thought-out three-to-five-year financial plan and to balance the need for contingent reserves against the need to provide adequate return on investment. We believe that most investors want to see that management has both (i) requested sufficient capital to create a viable enterprise capable of effecting a successful IPO within a reasonable time frame and (ii) has a plan to utilize such capital in an efficient, cost-effective manner. Therefore, we believe it is wise to base a new venture's financial projections and private offering plan on adequate and substantial, but not excessive, capital reserves. What is an "IPO"?IPO is the frequently-used abbreviation for initial public offering. Many venture investors think of it as "payday". That's because, if successful, an initial public offering will create a viable market for the company's stock and provide its founders and early-stage investors with a cash return on their investment and, eventually, liquidity for their remaining shares. Further, since liquidity is an intrinsically-valuable investment component, the market will usually assign it a premium. At least part of a publicly-traded security's price/earnings ratio can be thought of as a liquidity premium. Investors are usually willing to pay more for a security which can quickly and easily be converted into cash than for a security which does not offer this option. What if I am seeking venture funding during a downturn in the stock or IPO market?In the past few years, the IPO market has fluctuated between irrationally euphoric and virtually non-existent. Fortunately, since it is impossible to predict market conditions for more than a few months out, venture capitalists generally do not factor in the current state of the IPO market when considering new investments in start-ups. "It is very hard to invest in anticipation of a market cycle. The companies we fund now are going to be going public two, three, four, five years from now. We have no idea what the [IPO] markets are going to be like at that point, so we might as well not worry about it,"
says Robert Nelson, Co-Founder and Managing Director of ARCH Venture Partners. What is a "price/earnings ratio"?A price/earnings ratio, or P:E, is a mathematical articulation of the relationship of a company's earnings to its market capitalization as expressed as a fraction with the current share price as the numerator and the current after-tax earnings per share as the denominator. For example, a company with a total of 10 million shares issued and outstanding, after-tax earnings of $5 million and currently trading for $6.00 a share would be said to have a price/earnings ratio (or multiple) of twelve-to-one (or simply 12). Notice if you multiply your earnings per share ($0.50) by 12 you get $6.00. It's important to realize that a stock's P:E is not arbitrary; the board can't declare it. The price/earnings ratio is determined by the market and is influenced by many factors including investors' expectations of future earnings, the company's book value and other fundamentals and all those factors which affect the public securities markets as a whole such as interest rates, inflation, unemployment, Federal Reserve policy, etc. It is the potential for a private company to attain sufficient fundamentals to allow for a successful public offering, and, hence, a much higher price/earnings ratio (than for a privately-held firm), which provides a return attractive enough to warrant the risk usually associated with venture capital investing. And to a certain extent, industries which historically command higher price/earnings ratios should, on margin, be more attractive to astute venture investors. Aren't founders' shares and private placement stock subject to restrictions on transfer? If so, how then do the founders and early-stage investors cash out?Shares issued under private offering exemptions are subject to restrictions on transfer imposed by the Securities and Exchange Commission (SEC) Rule 144. Such stock is often referred to as legend stock, restricted securities or 144 stock and may not be sold immediately following the firm's IPO. This protects IPO investors from a drastic drop in share price due to a sudden increase in supply and allows for the development of a healthy aftermarket. There is a simple and fair way for founders and early investors to cash in at least some of their holdings and this involves the registration of a portion of their shares (and the sale thereof) in the firm's initial public offering. As long as management continues to retain most of their holdings, the company's underwriters (brokerage firms contracted to market the company's stock to the public) and IPO investors will generally not view this as a bail out. Many entrepreneurial companies allow early-stage investors, and even founders, to register (and sell off) up to about 20 percent of their holdings in the IPO. Further, after one year, the SEC will generally allow limited sales of restricted securities and unlimited sales after two years. Note: This is not intended as a complete discussion of Rule 144 but is given to demonstrate one method investors and founders may use to cash out. What if the underwriters do think management is bailing out?If management seeks to sell too many of its shares in the IPO, the company's underwriters may balk. Naturally, they will be concerned that investors will shy away from the offering, interpreting this sell off as an indication that management is not thrilled by the company's future prospects. The underwriters may demand other concessions (such as higher discounts) or they may conclude that the offering is not viable. Provided that the IPO is not premature, that is, it is based on sound economic fundamentals, a balance can usually be struck - and a do-able deal negotiated - which satisfies underwriters and IPO investors, results in a favorable market capitalization, a solid aftermarket and also puts significant cash into the pockets of the founders, managers and early-stage investors. Who invests in start-ups?Venture investors include: 1. Institutional venture capital funds typically organized as limited partnerships.
2. Corporations seeking to gain access to new technologies and/or markets. 3. Corporations seeking venture opportunities strictly to enhance return on equity. 4. Wealthy individuals who either specialize or have a percentage of their portfolio in venture capital investments. 5. Entrepreneurial business owners and corporate managers.
Says John H. Martinson, president of the National Venture Capital Association, "The success of the venture industry is now attracting record amounts of growth capital from other sources such as corporate venturing programs. This expands the sources of growth funding available for entrepreneurs."
While all venture investors can be assumed to fancy a profitable opportunity, secondary motivational factors, as well as corporate cultures, vary amongst the groups cited above. To quote Prime Computer founder and prominent venture investor John Poduska, "I do angel deals for some of the same reasons I support the ballet. Take one look at me and you'll know I'm not a ballet dancer, but I like being part of something that's worthwhile."
On the other hand Corporate Venturing News reports that, "Over 80 percent of corporate venture capital groups are investing primarily for strategic return."
Hence, the strategies taken with respect to soliciting financial assistance from various investors may differ significantly. Part of what contributes to a successful private offering is the credibility gained by approaching prospective investors in a fashion with which they are comfortable and most likely to interpret as professional. Through industry analysis, research, personal contact and experience, Venture-Net has developed a proprietary database of active, pre-qualified, accredited venture capital investors. These include both private and institutional investors who are interested in financing start-up ventures. Some may specialize in a particular area such as medical or high-tech ventures. Others may be open to virtually any promising opportunity. The common denominators are: 1. They have or control substantial financial resources liquid and available for venture capital investments. 2. They actively investigate, review and invest in start-up ventures; they are not merely LBO funds masquerading as venture capitalists. 3. They have an established business relationship with Venture-Net Partners, its general partner, or other affiliate, sufficient to determine that they are sophisticated and qualified investors interested in exploring various types of venture opportunities.
Aren't there securities laws concerning investor solicitations?Yes, there are both state and federal securities laws regulating many aspects of private offerings which specify both civil and criminal sanctions for violators. Further, these laws vary from state to state and many statutes are subject to fairly complex legal interpretations. Potential problem areas include: prohibitions on general solicitation and public advertising; investor suitability and sophistication standards; sufficiency of previously-established business relationships; and form, accuracy and completeness of investment-inducing disclosures. Don't you have to register your offering with the SEC?Federal law requires that an offering of securities be registered unless a specific exemption from registration is available. If no such exemption is available, a company seeking to offer its securities for sale must first register them with the Securities and Exchange Commission pursuant to the Securities Act of 1933. Such an issuer must complete a specified registration statement (such as a Form S-1) and obtain SEC clearance on its adequacy before offering its securities. The company must also satisfy the securities regulations ("blue sky laws") of each and every state in which it intends to offer its securities. Fortunately, both federal and most state's securities laws provide exemptions from registration in specified circumstances. It is important to note, however, that a securities offering is never exempt from the anti-fraud provisions of the 1933 Act. Further, exemption from federal registration does not necessarily result in a corresponding state exemption nor is an exemption obtained in one state necessarily available in every state in which an issuer may wish to offer and sell its securities. Though often thought of as a "mini-public offering", private offerings differ from registered public offerings in the following ways: 1. Private offerings are generally less time-consuming and expensive in terms of legal, accounting, development and offering costs. 2. Disclosure requirements vary but are generally less extensive for a private offering. 3. Reporting requirements under the 1933 Act and certain other obligations of public companies are not triggered under a private offering. 4. Limits are imposed on the number and qualifications of investors allowed to purchase privately-placed shares and, in certain instances, on the amount which may be raised.
5. Market capitalizations will generally be less for a private offering due to constraints on the number of purchasers and restrictions on resales. 6. The publicity that results from a public offering, and the public image that accrues to a reporting company, will not be obtained in a private offering.
Today, the most commonly-used exemptions from federal registration requirements are the private placement and limited offering exemptions provided by the 1933 Act as modified by the Small Business Investment Incentive Act of 1980 and SEC Regulation D adopted on March 3, 1982. According to SEC Release No. 6389, at 84,907, Regulation D is designed "to simplify and clarify existing exemptions, to expand their availability, and to achieve uniformity between federal and state exemptions in order to facilitate capital formation consistent with the protection of investors." Regulation D consists of six Rules, i.e., 501 through 506, which became effective on April 15, 1982 and two, 507 and 508, which became effective April 19, 1989. These rules set forth the conditions attached to Regulation D exemptions. Rules 501 through 503 define the uniform terms and conditions; Rules 504 through 506 describe the three specific transactional exemptions; and Rules 507 and 508 modify the previous Rules and address the consequences of an issuer's failure to comply with the terms, conditions and requirements of Regulation D. The most commonly-used exemptions from registration in the state of California are provided under Corporations Code Sections 25102(f) and 25102(h). In general, such offerings are restricted to an unlimited number of "excluded", and a maximum of 35 "non-excluded", investors who must be, nonetheless, sophisticated enough to evaluate the merits of the offering as well as financially-able to risk the loss of their entire investment. Such prospective investors may not be contacted via public advertisement or general solicitations and must receive disclosure documents sufficient to satisfy the anti-fraud provisions of the 1933 Act. An application for permit under 25102(n) requires further restrictions on investor qualifications but allows for certain types of advertisements (such as an Internet-published listing on the Direct Stock Market) which would otherwise be illegal. Employment of experienced securities counsel is an essential prerequisite to the successful placement of a private offering of equity securities; however, prior registration with the SEC is not always necessary in order to raise capital. Note: This is not intended as a thorough or sufficient discussion of all aspects of securities law as related to limited offerings and private placements. How much money is available for investment in venture capital situations?During a six year run beginning with 1995, the venture capital industry witnessed an unprecedented expansion of resources and activity with a record $106 billion invested in 2000. From the second quarter of 2000 to the first quarter of 2003, the trend was downward - but the total amount invested still exceeded $100 billion over the "down years" of 2001 through 2004. Total Annual U.S. Venture Fund Investments 1995 $7,627,000,000
1996 $11,523,000,000
1997 $14,807,000,000
1998 $21,258,000,000
1999 $54,524,000,000
2000 $105,860,000,000
2001 $40,582,000,000
2002 $21,700,000,000
2003 $18,187,000,000
2004 $20,400,000,000
2005 $21,700,000,000
2006 $25,500,000,000
2007 $29,400,000,000 Source: National Venture Capital Association Despite of all the difficulties associated with an economy in recession, a stock market in decline, continued fallout from the dot-com fiasco and the attacks on the World Trade Center, U.S.-based venture fund investments exceed $40 billion during 2001 and $21.7 billion in 2002, at the time ranking these years the third and fourth largest in history in terms of total dollars invested. The year 2003 marked turnarounds in the economy, the stock market and venture capital funding. The decline in VC activity hit its lowest level in five years at $4.2 billion in the first quarter of 2003. The trend then reversed and the year ended with $4.9 million invested in the fourth quarter. After three consecutive years of decline, venture capital investment increased 12 percent in 2004 with $20.4 billion invested in 2,067 deals and continued on course in 2005 with $21.7 billion invested in 2,939 deals and in 2006 with $25.5 billion in 3,410 deals. During calendar year 2007, VC funds invested a total of $29.4 billion in 3,813 deals, an increase of 10.8 percent over 2006 levels and the highest total dollar amount since 2001 according to The MoneyTree Report by PricewaterhouseCoopers and the National Venture Capital Association based on data from Thompson Financial. Tracy Letteroff of PricewaterhouseCoopers comments, "2007 was a good year to be an entrepreneur. With an encouraging M&A market and the most venture-backed IPOs that we've seen in several years, it's no surprise that VCs have stepped up their investments."
Says Mark Heeson, president of the National Venture Capital Association, "The stability of the overall venture capital investment levels, coupled with an increased focus on the most innovative new industry sectors suggests that the venture capital industry is continuing to support our country's most promising start-up companies in a rational and deliberate manner."
A flood of money poured into venture funds during (and even after) the Internet boom. Current estimates of the "overhang" or "dry power" (money raised by VCs but yet to be deployed) range from $50 to $75 billion. "If you look at long-term returns over the past 10 or 20 years, you see that venture capital provides the best returns,"
says Anthony Romanello of Thomson Venture Economics, a research firm.
Accordingly, many wealthy individuals and pension fund managers - and particularly those who were late to recognize the value of this asset class - want to invest in American-based venture capital firms. In fact, the general consensus in the industry today is that there is actually far more money available from the limited partner community than venture funds are willing to take. Thomas Burton, a partner at Mintz Levin Cohn Ferris Glovsky and Popeo, comments, "Venture firms have recognized that they can only deploy so much capital in the standard life-span of a fund. It's not so much the manpower but the notion that there just aren't enough quality deals to support the capital that wants to go into the industry."
Robert Whyte, co-chair of the Capital Zone, says, "It is clear that growth is back, and that the capital markets are buzzing with activity. From angel investing and venture capital to IPOs, acquisitions, private equity, PIPEs and follow on offerings, there are vast pools of capital available for quality companies at every stage."
Moreover, studies by PriceWaterhouseCoopers and others conclude that venture capital funds now supply over 90 percent of all dollars invested in start-up companies. Our conclusions: 1. Availability of capital is not the problem. The challenge lies in developing a credible and attractive offering and then selling the deal. 2. If you seek to launch a start-up venture and you are not prepared to solicit capital from VCs, you are ignoring at least 90 percent of the venture capital market.
What type of return do venture investors require?Venture investing is a high-risk, high-return proposition. "Venture capitalists want to hit home runs with their investments",
says David J. Blumberg, managing director of Blumberg Capital. Entrepreneurs always seem to underestimate the high level of risk associated with even the most promising and well-planned endeavor. Frequently, investors find themselves in an adversarial position with management, even when the venture succeeds, because the entrepreneurs forget the risks taken, focus only on the current results and begrudge the investors (and investment bankers) their just profits. Entrepreneurs also forget that not all of a venture investor's projects are going to be successful; therefore, the successful enterprise must not only provide a sufficient return to warrant the risk of that investment, it must also provide a return sufficient to cover the investor's inevitable losses in other deals. For most start-up situations, investors are going to want at least a six-to-one return in three years or approximately 90 percent compounded annually. This can rarely be achieved based on cash flow alone, especially assuming the investor has taken a minority equity position. However, if management has a well-thought-out business plan including a strategy to take the company public, it's possible to project, and deliver, such a return based on the liquidity premium obtained from the establishment of a viable public market for the company's stock. What types of returns are possible?Kleiner Perkins Caufield & Byers, a San Francisco-based venture fund which backed Genentech in 1976, got an 800-to-one return on its money when the company went public in 1981. Janet Axelrod was a secretary employed by a tiny computer software company. Offered stock in the company, she invested $4,000 because some other employees were doing so. The name of the firm? Lotus Development Corporation. The eventual value of her shares? $9 Million. One reason why start-up ventures have become a sort of new American dream is that capital appreciation deals give management and investors, alike, the opportunity to amass multi-million dollar fortunes without paying enormous income taxes. Since you only pay tax on your stock when you convert it to cash (by selling it), the majority of your increase in net worth comes tax free. Even when you sell your stock, your income from such sale (capital gains) is generally taxed at a much lower rate than other so-called ordinary income. The tax laws are somewhat volatile in this area - so you never know for sure what the tax rate is going to be three to five years out - but the current federal rate for assets held over 18 months is only 15 percent. Thus, at the top of the Forbes 400 you'll find mostly entrepreneurs and astute investors who have accumulated their fortunes through the capital appreciation of equity assets. Relational Investors' Ralph Whitworth sums up the potential for outstanding returns in venture capital with the following comment, "It only takes one."
What else do investors expect?Venture investors are likely to concentrate their attention on three areas: 1. The proposed product or service. 2. The potential market. 3. The management team.
While all three need to be satisfactory, you'll hear different investors say they emphasize one area or the other. Many are product or technology-oriented. Others are more fascinated by vast, emerging or protectable niche markets. Probably most would say that management is the most important factor. Stan Fung of Zero Stage Capital claims, "Ninety-five percent of a company's success is determined by its team anyway, not a unique product idea."
Some even comment that what they really invest in is the entrepreneur - not the deal. Our view is that all three aspects are vitally important and that emphasizing one over the other is a nonproductive exercise. However, we believe it's not unproductive to recognize that many investors are biased such that they may be more heavily influenced by one of these three elements. Discerning a particular investor's hot button may enable one to present the deal in a more persuasive manner. How important is the offering circular?The offering circular, also referred to as the private placement memorandum, consists essentially of the issuer's business plan, financial projections, a thorough discussion of the risks inherent and all other disclosures necessary and sufficient for an investor to make a fully-informed and intelligent investment decision. Not only is it critical in terms of compliance with securities laws and limiting future liability and possible lawsuits from disgruntled investors, much of an offering's initial credibility will be created (or destroyed) by the content of the private placement memorandum. To quote Edwin Goodman, general partner of Hambro International Investment Fund, "A business plan and business proposal will never make you successful but [poorly done] it can screw you badly."
In his now-classic, best-selling work, In Search of Excellence, author/lecturer Tom Peters offers, "The most valuable and successful companies will be those that add value to information."
We believe that to be an accurate description of Venture-Net's involvement in the private offering development, solicitation and negotiation process. What are the most important elements of the offering circular?David Pierce, CEO of Pierce Investments, offers the following as essential questions to be answered in any offering circular:
1. What is unique about this company or project? Investors do not necessarily need to find a unique product but one with growth potential that sets it apart from other industry members or from other proposals received. 2. What does the company do? The prospective investor wants to be able to understand the company’s product and services and the operations of the company. 3. How does the company plan to attain profitability? This area should discuss the market and competition as well an analysis of areas such as revenue and profit margins. 4. What benefit will be derived from a capital infusion? In other words, how will the proceeds of the proposed financing be utilized and what results benefiting the investor will be achieved. This should translate into increased revenues and profits and an excellent return on investment. 5. Is management capable of implementing the business plan? Many investors consider this the most important element of a business plan. An investor must be comfortable with the experience and abilities of the management team. Many investors believe that an outstanding management team can, many times overcome other plan deficiencies. 6. Do the financial projections make sense? Over optimistic projections reflects on management’s judgment. Projections can be aggressive but must be within the realm of the real business world. 7. Is there an exit strategy for the investor? If the business has the potential to: (i) merge, be acquired or go public; (ii) obtain an attractive price/earnings ratio and, hence, (iii) provide investors with both liquidity and an outstanding return on investment, investors have a compelling economic incentive to further their due diligence. If not, there really isn't much point in studying the deal. Given that you have a good business concept, a potentially lucrative market and a competent management team, we believe the two most important elements of the offering circular are: 1. Competitive advantage(s); and 2. Pro forma financial projections.
The first element, your competitive advantage, is what sets you apart from your competitors and (hopefully) makes you unique in the marketplace. It may be, or incorporate, a proprietary technology, software, marketing device or other intellectual property. It may include a specific benefit, or menu of benefits, which your product or service provides which cannot be elsewhere easily obtained. It may be a process or technology which enables you to produce a product or provide a service which others cannot easily match. In any event, your competitive advantage is the fundamental strength of your venture which you will seek to exploit, develop and maximize. The second element, your pro forma financial projection, not only describes in detail how you will seek to exploit, develop and maximize your competitive advantage, it also gives a prospective investor some direct indication of your management strategy and skills. If you can't manage cash flow on paper, you're not likely to do too well with the real thing either. Since the pro forma financial projections contain the financial details of your business concept, many investors will peruse your projections before reading your business plan. Hence, that famous first impression is frequently garnered from your pro forma financial projections. Finally, a motivated investor is almost certain to, at some point, begin to ask very specific questions regarding your plan and your projections. Entrepreneurs, especially CEOs, need to know these numbers "backwards and forwards" and be able to field questions in a relaxed and confident manner. Deferring such inquiries to your CPA - or even your CFO - is one way to lose investor confidence... and blow a deal. How do you determine the offering price per share and the equity percentage offered?The offering price per share and the equity percentage offered are based on the anticipated achievement of certain income and profitability projections and the need to provide sufficient compensation to investors to thus induce them to assume the financial risks of the enterprise. As mentioned, most venture investors will want to have a reasonable expectation of a minimum 90 percent compounded annual return which works out to about six times their money back in three years. For example, if a new enterprise (i) requires $20 million in venture capital, (ii) has a realistic goal of $100 million in sales in its third year, (iii) projects third-year after-tax of profits of $12 million, (iv) can reasonably expect to receive a price/earnings multiple of 22 and (v) can convince investors that their pro forma financial forecasts are attainable and reasonably conservative and that the company has a good chance of either being taken public, cashed out or acquired by another company within three years, investors may be induced to purchase 50 percent of the company for $20 million, satisfied that, if the company reaches its objectives, their stock would be worth about $143 million and, hence, they will have achieved a 92 percent compounded annual return. One very important consideration is: Can sufficient funds be raised using this valuation method and still leave management in control of the company? Generally, we agree with multi-billionaire venture investor H. Ross Perot, "The builders must have control."
Are we guaranteed to get our offering price?No. Venture investors are usually savvy and frequently ruthless. They know you are anxious to get started. They know you have probably experienced some degree of prior frustration. Even though your offering may be fairly and attractively-priced, they will still want to get the best deal they can. If you appear to have only one prospect, they may be tempted to play hardball. Ever wonder why so many venture firms advise entrepreneurs not to "shop" their deal? Limiting your prospects to a few well-chosen firms seems, to us, to be a strategy which works in favor of those few firms... and against the entrepreneur. Conversely, we believe issuers need to cast a wide net, and get the best possible supply and demand fundamentals, before sitting down to negotiate a close. Frankly, it can be more than a little intimidating to sit across a desk from an internationally-renown, self-made billionaire (who's listed near the top of the Forbes 400) and hear him say, "Well, we would like to participate... provided we can agree on the valuation." If you start to jump out of your shoes, you're very likely to invite a low-ball offer. There is really no way to sugar coat it. The bottom line is - it's basically a poker game and the stakes are high. Luis Villalobos, of the Tech Coast Angels, says the object of entrepreneurial management should be "to end up with four to five percent of a successful enterprise". We agree with the successful enterprise part but believe that management's equity goal should be more like 50 to 60 percent. Ultimately, there are no guarantees in venture capital but we maintain that management retention of majority ownership is a worthwhile and attainable objective. Realistically, however, in order to maximize your eventual equity position, you will probably need to attract more than one genuinely-interested prospective investor, and/or investor group, and you will definitely need to avoid multiple rounds of financing. You will also need to handle all discussions and negotiations in a most-professional manner. Venture-Net strongly recommends that management keep us informed of all telephone conversations and invite us to attend all meetings with prospective investors even if such investors ask to meet with you outside of our presence. That comment generally means they have concluded they can extract greater concessions from you without us in your corner. Venture-Net Partners and associates have had the opportunity to size up a variety of investors in more than a few situations; we believe we're a bit more objective than management and a bit more able to find a prospect's bottom line; we also feel strongly that if there's a deal to be made, we will find a way to close it. How do investors feel about working with financial intermediaries?Walter Lipper, author, venture investor, former Chairman of Venture Magazine and a member of the New York Stock Exchange and New York Futures Exchange, writes in Financing and Investing in Private Companies, "It must be pointed out that the presence of a reputable financial intermediary or investment banker can add enormously to the credibility of a proposal. Such an investment banker's reputation is on the line, and he is probably assuming some legal liability in making the offer, notwithstanding claims to the contrary... The use of intermediaries is an accepted part of business. Successful entrepreneurs have almost always used intermediaries successfully."
Hambro International Investment Fund's Edwin Goodman adds, "Usually [good deals] come in through other venture capitalists or through intermediaries that we respect, so we have some confidence that it is a quality deal before we begin the process. Very few deals are done that come in absolutely cold from the entrepreneur with no introduction."
It should be noted, however, that, once introduced to a deal, many investors believe they can get entrepreneurs to agree to better terms if they can get them and away from their financial partners, advisors and attorneys. All the more reason, we believe, why you should be well represented at all meetings. What constitutes a credible intermediary?Venture capital investors are far more likely to spend their time and resources investigating a deal that has already been prescreened by someone who has demonstrated previous success in picking winners. Most entrepreneurs will, at some point, be approached by someone who will offer to help them secure financing for their project. This can be a treacherous area for entrepreneurs for there are many individuals who claim to have experience, expertise and/or existing relationships in this space but who, in fact, bring no value to the situation whatsoever. Some of these may be individuals whose intentions are good but who have yet to establish any level of credibility within the VC community. Some are just outright frauds. Fortunately, the Internet has made it much easier to qualify and sort through these intermediary candidates. Venture-Net Partners recommends the following five step test. 1. All credible intermediaries should have a website that is visible and accessible to the public (including securities regulators) at all times, i.e., not password protected.
2. Such visible and accessible website should also identify a physical address (not a Post Office box) for their place of business.
3. Their website should also list the names of the owners, partners or principals of the organization.
4. The professional resumes of all such principals should identify specific posts previously held at specific companies, e.g., "he has previously served as CFO for The Gospel.com" rather than nebulous statements such "he has 25 years experience in the finance".
5. Their website should also list specific portfolio companies, e.g., "Accuray, Inc.", rather than "a software developer", at least some of which should have made it all the way from a successful raise through a successful launch and onto a successful IPO or other liquidity event.
If a potential intermediary is lacking any of these five elements, our experience has always been negative and, accordingly, we would advise that you are well served to move on before wasting your time or, worse yet, getting entangled in a bad deal. Additionally, if you run the names of the principals of your intermediary candidate on search engines such as Google or Yahoo, their resumes should show up on at least some of their portfolio company web sites as it is common for such individuals to hold board seats (either past or current) at these companies. Finally, whenever anyone guarantees a successful outcome or otherwise downplays the difficulties of raising venture capital, they're almost certainly not for real. Does Venture-Net seek to be involved in day-to-day management?No. We are desirous of maintaining a presence on the board of directors for the purposes of representing minority interests, keeping ourselves informed and to avail the company of our latest research and networking capabilities. We may be able to introduce entrepreneurs to inventory financing sources, manufacturers, distributors, attorneys, accountants and/or other subcontractors, vendors or professionals who may positively impact the venture. But, we absolutely do not seek to micro manage any enterprise and feel most strongly that managerial meddling is rarely successful. All Venture-Net Partners have started and managed several small business ventures. We understand and appreciate the challenges, effort and level of commitment required. We do not seek to undermine or undervalue the contributions of management nor do we want to take your place or play your role. Instead, we choose to focus on the development and distribution of a private equity offering of sufficient size to launch the venture. Managing the business, making it work, is up to you. What does Venture-Net look for in management?Venture-Net recognizes that an academic analysis of a business plan is one thing while its implementation is another. That is why we generally like to see some practical business experience somewhere on the management team. We put a lot of faith in managers with intimate knowledge of bottom-line accountability, i.e., entrepreneurs who have operated a successful business without the infrastructure of a large organization. On the other hand, a lot of institutional investors come from academic and/or corporate backgrounds and, likewise, are impressed with similar credentials. Thus, ideally, we would like to see a diverse mix of entrepreneurial talent with a variety of ages and experience represented including intelligent managers from academic, small business, military and/or corporate backgrounds. What types of ventures does Venture-Net view as most attractive?Change, whether technological, demographic or regulatory, seems to create opportunity. Inexpensive personal computers, and the emergence of the Internet, have spawned innumerable venture opportunities in hardware, software and services. The aging of the populations of the developed countries of the world has produced opportunities in healthcare, housing, leisure and recreation. Regulatory changes have generated opportunities in banking, telecommunications, import/export and utilities. Several funds have been chartered with mandates to invest specifically and exclusively in one or more of these areas. Venture-Net recognizes these niches as potentially very profitable and would be delighted to participate in any venture which services any one of them effectively. However, we also believe it to be a mistake to become too narrow-minded when evaluating potential investment opportunities. There is already far too much "me-too-ism" in the venture capital community. We, at least, like to believe that we would be receptive to an original or unusual business model - or even a common and rather ordinary concept with a new twist or unique competitive advantage. We also place a high value on the passion and enthusiasm which certain entrepreneurs bring to a project. Any venture is sure to have its breakthroughs and its setbacks. Keeping the entire team focused, involved and upbeat throughout the inevitable ups and downs of the start-up process goes a long way toward achieving a successful result. | .gif)
