The purpose of investing by a Venture Investor is to invest money in an enterprise and then organize its effective work to raise the value of the enterprise, and, consequently, its shares, so that in the indicated 5-7 years he could sell his shares and receive an amount for them, 3-5 times higher than the capital invested by him, which will be the specified return on invested funds. Another difference between the approaches is that the bank evaluates the enterprise in terms of the solidity of its current position, and the Venture Investor evaluates it in terms of the future of this enterprise and the ability of the enterprise's management to realize this future. To be sure, venture capital firms are interested in many of the same factors that influence bankers in their analysis of loan applications. All financiers want to know the results of past performance, the validity of the quantitative funding request and the planned income, the detailed planned calculation of the use of investments, as well as the planned financial position of the enterprise. But the Venture Investor pays much more attention to the professionalism of the management, the characteristics of goods or services, the state and prospects of the market than banks.
What Venture Capital Firms (Investors) Are Looking For...
Banks are only lenders. They are interested in the quality of the products or services and their prospects in the market in order to obtain some assurance that these products or services can generate stable sales and generate sufficient income to repay the loan and pay interest. And they, like investors, demand a business plan to make sure that the leaders of the enterprise evaluate and plan everything correctly. If the loan is not returned or interest is not paid, then the creditor bank will implement the guarantees provided by the enterprise. The Venture Capital firms are the same owners. They invest their capital in the enterprise without receiving any guarantees. Therefore, it is natural that they research the goods or services that are being produced or planned and their potential markets for their sale with extreme care. They invest only when they believe and are convinced that the business can quickly increase sales and generate substantial profits. This is what the business plan should prove. Investing in venture capital is a risky undertaking for the investor also because it is very difficult to assess the future value of the enterprise at a very early stage. Therefore, most Venture Investors set strict requirements for the form and content of the investment request and business plan, the competence of management personnel, and also want to find something special in the project that would make this project attractive to them. The project must be beneficial not only to the applicant, but above all to the investor, and the application, project summary and business plan must prove this to the investor in the most attractive form for the investor. They also use strict evaluation and verification procedures to mitigate risk, as their investment is not protected in the event of a failed venture.
The first hurdle for the applicant is a properly written business plan and summary, the next is to pass the scrutiny of the business plan provisions. To overcome the first barrier, it is necessary to prepare a business plan and a summary in the form that is accepted in the West and is understandable to the investor, otherwise he simply will not read it, and he simply does not consider any intermediate requests and does not respond to them. To overcome the second barrier, one must not only accompany the business plan with evidence of the statements made in it, but in every possible way facilitate any verification, from the submission of additional materials to the provision of names, addresses, telephone numbers, etc. to contact other persons and enterprises who can confirm the information you provide.
The amount of the requested investment
Most Venture Capital firms work on projects requiring an investment of between $250,000 and $1,500,000. The typical VC firm receives over 1,000 inquiries a year. Probably 90% of them will be rejected quite quickly because they do not correspond to the geographic, technical or market policies of the Venture Firm - or because the requests, business plans and attached documents were poorly prepared. The remaining 10% are being carefully researched. These studies are expensive. Firms hire consultants to evaluate the final product or service, especially when it is the result of innovation or high-tech production. The market potential and competitiveness of the enterprise are tested by establishing contacts with existing and potential buyers, suppliers and others. Production costs are analyzed. The financial condition of the applicant's company is confirmed by audits. The legal form and legality of the registration of the enterprise is checked.
The Venture Firm especially carefully assesses the competence of the enterprise's management personnel, since their competence and experience are the only guarantee for the Venture Capital.
Investor that the venture will be successful.
These preliminary studies can cost the Venture Firm $2,000, $3,000, or $10,000, so the firm will not conduct research and bear these costs if the investor is not interested in the project, the meaning of the project is not clear, it is not clear what it will have from what will invest, and even just if the business plan is made with grammatical errors, etc. Of those remaining 10% of requests, after checks, interest will remain only to 10-15. These are already subject to more complete and more expensive checks, after which only 3-4 projects remain! Ultimately, the firm invests in one or two of them. At the same time, it should be noted that in this business there is no workaround, godfather, matchmaker or "brother" that could influence the positive decision of the investor. Nothing will force the Venture Investor to invest in a project that he is not sure about, since he is risking his own money or the money of his investment fund.
Maturity of the firm submitting the request
Unfortunately, most inquiries come from firms with low profits or debt, which are unattractive to investors. Of interest are only enterprises capable of expanding production, introducing new products that promise high demand and profit. It makes sense to give investments to such enterprises in order to ensure their rapid growth. Establishing ventures may only be of interest to some Venture Investors if the potential of the venture and the significant benefit to them can be reliably identified and valued. While most Venture Capital firms won't consider very many new venture proposals at all, there are still some that do. Even a small enterprise that has a well-thought-out and carefully prepared business plan, and that proves the high efficiency of the project and that its management personnel have exceptional qualifications and practical experience (even if in other enterprises), has a chance to receive the necessary investment.
Management personnel of the enterprise
Most Venture Capital firms focus primarily on the competence and experience of the applicant's management. They know that even mediocre products can be successfully manufactured and sold by an experienced, energetic, and efficient management team. They want to see a leadership team that is able to work together a lot, easily and productively, especially under stressful situations and fierce competition. Obviously, it is difficult to assess organizational skills. Therefore, a partner or senior employee of a venture capital firm usually spends at least a week in the offices of the venture in question, observing and talking with everyone to assess their competence and characteristics. Venture capital firms usually require the venture in question to have a fully staffed management team. Each of the important functional areas—product development, marketing, manufacturing, finance, and quality control—should be under the direction of a trained, experienced person. The duties of each must be clearly stated. And, in addition to fully understanding the Venture Investor's approach, each member of the management team must be firmly connected to the enterprise and its future, for example, to be a shareholder in the enterprise.
"Something special" in the business plan
Next in importance, after a great management team, most VC firms are looking for a differentiating element in the strategy or product/market/production process of the venture. Such distinctive elements may be new qualities of a product or production process, or specific advantages, or special technical competence of management, which should distinguish this enterprise from others. But this special must be present in the business plan. This should provide a competitive advantage for the enterprise.
Elements of a Venture Capital Request
The request itself and a summary of the business plan, as well as the business plan itself, are submitted. These materials should clearly outline: the goals and objectives of the joint venture and the Funding Required.
You must state the amount of money the business will need from inception to full launch, how the proceeds will be used, how you plan to structure the funding (funding stages), and why the amount is required, i.e. for what exactly each amount will be used.
Describe the market share you have or plan to have, the competition, the characteristics of the market, and your plans (with the costs involved) to win the planned market share.
History of the enterprise requesting investment
Summarize significant financial and organizational milestones, descriptions of employees and relationships between them, indicate relationships with your banks, list the main goods or services that
rye your enterprise offered during its existence, etc.
Description of products or services
Include a full description of the products or services offered by the business, both costs and prices, in detail.
Include the state of both the last two years and the planned indicators (balance sheet, income and cash flows) for the next three to five years, show the expected effect of receiving investments. (This should include an analysis of the key financial metrics that impact financial performance, showing what might happen if the projected income level is not met.)
Also give a list of shareholders, how much and by whom has invested so far, in what form and in what amount (share capital/loan).
Describe the career path and qualifications of each of the key owners and employees.
Major suppliers and buyers, issues Other information
Give an honest and objective description of any debts, pending litigation, tax or licensing difficulties, and any other issues that might affect the project you are proposing. Include a list of names, addresses and telephone and fax numbers of suppliers and buyers; they will be contacted to verify your claims regarding payments, suppliers, products and customers.
Conditions of the Investment Offer
What happens when, after exhaustive research and analysis, Venture Capital firms decide to invest in a venture? Most investment firms prepare a financing proposal specifying the size of the investment, the share of the company's shares required for such an investment, the methods of financing, as well as certain mechanisms for protecting their interests (for example, appointing a representative on the board in charge of the use of investment funds). This proposal will be discussed with the management of the enterprise. An investment agreement will be concluded, which will be a compromise between the management of the enterprise and partners or responsible representatives of the Venture Capital firm. Important elements of this compromise: ownership, control and management, annual payments, ultimate goals.
Venture Capital funding does not come cheap for business owners. The JV partners actually buy part of the company's shares in exchange for an investment. This percentage of shares in different cases is different and depends on the amount invested, the value of the enterprise, the expected return on investment. It can range from perhaps 10% in the case of an established, profitable enterprise, to 80 or 90% if the enterprise is being started from scratch, or if the enterprise is experiencing financial or other problems. Most Venture Capital firms, at least initially, don't require more than 30-40% because they want the owner to have an incentive to keep building the business. If additional funding is then required to support business growth, the investor's share may exceed 50%, but investors understand that the owner/managers of the business may lose their entrepreneurial zeal under such circumstances.
In the final analysis, however, the investment firm, regardless of its percentage of ownership, does want to leave management in the hands of the enterprise's managers because it actually and above all invests in the management team.
Most investment firms measure their ownership of an enterprise by the ratio of their investment compared to the present value of the enterprise and the contributions of all participants in the joint venture. It is obvious that the existing value of the contribution by the owners of a financially disadvantaged enterprise will be rated low. Often this is estimated only as the cost of the idea and the cost of the owner's time. The contribution of the owners of a prosperous business is valued much higher. Financial valuation is not an exact science. The final compromise on the value of the original owner's equity contribution is likely to be lower than the owner thought and higher than the investor thought. Ideally, of course, these two parties are able to do together what neither can do separately: 1) the enterprise is able to grow fast enough after receiving investment, which compensates for the loss of a certain part of the property; and 2) the investor earns high returns as compensation for the risk taken.
Management is a much simpler problem to solve. Unlike the division of ownership, in which the investor and the enterprise are likely to have serious discussions, control and management is a task in which they will have a common interest. While it is understandable that the management of a small enterprise will have some concern in this regard, the joint venture partners have no interest in subordinating the management of the enterprise to themselves. They do not have the technical or management staff to manage the many small
companies in a variety of industries in which they invest their money. They prefer to leave the operational management of the enterprise to the existing management.
The Venture Capital firm, however, wants to participate in any strategic decisions that might change the core product/market feature of the company and in any major investment decisions that might affect the company's financial resources. They will, therefore, insist that at least one of their representatives be made one of the directors of the undertaking and endowed with agreed rights. They also want to participate in the decision making of complex financial, operational or marketing issues that affect the financial position of the enterprise, i.e., the fate of investments. Thus, they usually include safeguards in contracts providing for their right to take over the management of the enterprise and appoint new managers if the financial performance of the enterprise proves unsatisfactory.
An investment in a joint venture can be made outright, for a certain share of the shares, which does not involve fixed annual payments. It is more likely, however, that this will be done in a mixed form - the provision by the investor of a loan with some interest against a debt obligation and the receipt by him of preferred shares. In this case, annual payments will be made by analogy with a bank loan, but with a higher percentage (the same question about the failure to provide guarantees!). Debt obligations can be converted into shares of the enterprise that do not belong to the investor, thus providing a certain security to the investor. The annual payments on such a loan are set by agreement.
Venture capital firms generally intend to make their return on investment by providing for a share buyback by the enterprise itself, a sale of shares on the stock exchange, a sale of the enterprise itself, or a merger with another enterprise. They usually plan to do so five to seven years after the initial investment. Most investment contracts include terms to ensure that the VC firm can participate and have the final say in any sale of its shares or negotiate, for example, any merger of companies, regardless of their percentage of ownership of the shares. Sometimes the contract explicitly establishes that management works for the subsequent sale of shares or a merger of companies. It is clear, therefore, that a business owner seeking investment must consider the future impact on his ownership rights or ambitions to run the business, as attracting an investor may actually mean a commitment to eventually sell part of the business.
The Importance of Planning
There is no doubt that it will be extremely difficult for any small enterprise, or for an enterprise with a bad financial situation, or for the founders of a new enterprise, to receive investments. There is, however, something that the business owner or managers can do to improve their chances of not falling into the 90% of applications that are rejected almost immediately. It is expressed in one word: a business plan. Having a well-written business plan demonstrates to the investor that you are a competent manager, that you can have a special advantage over other investment seekers. You can gain a decisive advantage over others with a solid business plan that includes: budgets, targets, investment analysis, etc. Writing a business plan can be cumbersome, it takes a lot of effort, time and money, but it is one of the keys to business success.
Drawing up a business plan will not mean that you will immediately and automatically receive funding. But not drafting it certainly guarantees that your ideas and your project, which may be good, will never even come close to an investor.