Venture capitalists generally:
- Finance new and
rapidly growing companies;
- Purchase equity securities;
- Assist in the
development of new products or services;
- Add value to the company through
active participation;
- Take higher risks with the expectation of higher
rewards;
- Have a long-term orientation
When considering an investment,
venture capitalists carefully screen the technical and business merits of
the proposed company.
Venture capitalists only invest in a small percentage
of the businesses they review and have a long-term perspective. Going
forward, they actively work with the company's management by contributing
their experience and business savvy gained from helping other companies with
similar growth challenges.
The advantage of venture capital investment is
that you get money that enables you to expand your business and obtain
market share before someone beats you to it. Venture capital is not a loan
that needs to be repaid; rather, venture capitalists (VCs) invest their
money in exchange for equity (an ownership share) in your company. VCs get
their cash out only when your business is acquired by another company or
"goes public," that is, when its shares can be publicly traded on a stock
exchange.
The disadvantage is that you are no longer the sole owner of your
company and may lose control. Moreover, a VC may move your company towards
an Initial Public Offering (IPO) of publicly traded shares faster than might
be best for the long-term health of the business.
In general, the earlier
the stage where you receive funding, the more you have to give up. A few VC
companies or "angel investors" might invest in what is not yet a real
operating business but just a concept. For $500,000, they might take a 60%
ownership in the company, and put in their own management team. If they
decide that this can become a viable business ("proof of concept"), they
might fund the company for another $5 million, taking yet more equity. By
the second round of financing, the original business owner might retain only
a 5% to 10% ownership.
What are the Pros and Cons in having Venture Capital
Funding as a partner?
Pros:
- Financial strength for global competition
- Share buy-back opportunity
- Easier to get listed on a stock exchange
- No
conflict of interest
- VC network can enhance the company's business
- VC’s
provide experience, advice, and mentoring. They are objective, helpful with
networking and hiring the right people. They add credibility and prestige to
your business, share the risks, and help eventually to sell the business.
Cons:
- Lose part of the ownership
- Cannot manage the company as a
family-run business
The risk of working with a VC may be their concern is
more for a profitable and mandatory exit, compared to your concern for your
employees and customers. You loose independence to manage your business and
the VC’s may have the right to fire you and your management team. It can be
a full-time job to manage the venture capitalists that are funding your
business. Venture capitalists usually ask for:
- Anti-dilution protection. If the company's stock price goes down any
time in the future, they get additional stock for free.
- Dividends. In addition to stock, they get a guaranteed rate of return.
- Liquidation preferences. VCs get their principal and dividends back
before anyone else gets a penny.
- Participating preferred. They get to double dip—they first get their
investment plus dividends, then the value of their stock.
- Mandatory redemption. This requires the company to buy their stock back
by a certain date, establishing a deadline for an exit event.
- Demand registration rights. The VCs can force the company to file a
registration statement with the Securities and Exchange Commission to
initiate an initial public offering—another way of forcing an exit event.
- Approval rights. The VCs must approve any new financings and have the
right to participate.
- Reps and warranties. You'll also have to accept personal liability for
representations you've made about key aspects of the company. They will have
the right to sue you for all you own if you forgot to give them any bad
news.
CONCLUSION:
There are no easy choices. If you have orders for your
product with a sufficient gross margin, commercial finance companies may be
your best choice. If you need to develop your product and lack the capital
to fund your business to develop the product, market your brand and receive
orders, venture capitalists can be the best thing that ever happened to your
company. If you commit to a commercial finance company, you can terminate
the contractual relationship. If you commit to a venture capitalist, the
exit strategy is in their domain. “Make a mint” If someone is making a mint,
they are making a lot of money.
“Feel the pinch” If someone is short of money or feeling restricted in
some other way, they are feeling the pinch.
FINANCIAL MYTH: No. 6 All finance companies charge interest on 100% of
the face value of the invoices you sell to them.
FINANCIAL FACT: Some
finance companies base their charges only on actual amount of money you
receive. There is a large range of pricing in the commercial finance
business. Although competition tends to hold prices down, different
industries may be charged more because of historical risk. For instance,
medical and construction accounts receivable financing will be more costly
than commercial financing for a staffing agency.
At one extreme, some commercial finance companies require that 100% of
invoices be sold and interest is charged on 100% of the invoices. This may
be reasonable because the business is high risk and if your company goes
bankrupt, the commercial finance company cannot collect any of the funds
that have been advanced.
The best pricing available is computed with regard to the actual funds
advanced with interest payable on a daily basis for the period the funds are
utilized. This is called per diem interest. Most banks and some commercial
finance companies offer this option which may be described as a “line of
credit” or “asset based financing” for larger transactions.
Assume a commercial finance company charges a 3% monthly fee and you sell
an invoice for $100.00. Assume further that you customer pays in 5 days.
Here is a range of costs you would pay, based on various minimum contract
time and payment terms:
Based on 100% of the invoice:
59 day minimum term = $6.00 cost 30 day minimum term = $3.00 cost 15 day
minimum term = $1.50 cost 10 day minimum term = $1.00 cost Per Diem interest
5 days = $ .41 cost
Based on an 80% advance Per Diem for 5 days = $ .33
“Leave no stone unturned” If you look everywhere to find something, or
try everything to achieve something, you leave no stone unturned. “Game
Plan” A game plan is a good strategy
FINANCIAL MYTH: No. 7 A finance company contract with no term is better
than a contract with a one year term.
FINANCIAL FACT: If you will need
financing for one year and rates and terms are lower, the one year contract
may be a better choice. “Keeping your options open” If someone is keeping
their options open, they are not going to restrict themselves or rule out
any possible course of action.
FINANCIAL MYTH: No. 8 SBA business loans are similar at every bank.
FINANCIAL FACT: Some banks originate SBA business loans with delegated
authority. This allows additional financing for purchase order, accounts
receivable and inventory from third party lenders creating more capital for
growth. “Put all your eggs in one basket” If you put all your eggs in one
basket, you risk everything on a single opportunity, which, like eggs
breaking, could go wrong.
FINANCIAL MYTH: No. 9 All finance company contracts, terms, and
conditions are similar.
FINANCIAL FACT: Terms range from fair to onerous.
When you factor invoices you entrust all your cash flow to a commercial
finance company. “Comfort Zone” It is the temperature range in which the
body does not shiver or sweat, but has an idiomatic sense of a place where
people feel comfortable, where they can avoid the worries of the world. It
can be physical or mental.
FINANCIAL MYTH: No. 10 All finance companies require that your customers
be notified that you are working with them. This is called notification and
verification.
FINANCIAL FACT: Some finance companies allow non-notification
factoring. This makes the financing transparent to your customer. “Take the
plunge” If you take the plunge, you decide to do something or commit
yourself even though you know there is an element of risk involved.
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