Using venture capitalists to fund your growth
On this page
- Who or what are venture capitalists?
- What investments will venture capitalists consider?
- What will they expect in return?
- What is the process if a venture capitalist is interested in investing in my business?
- The importance of an exit strategy
- Other advantages of venture capitalists
Who or what are venture capitalists?
Venture capitalists can be defined as investment companies or fund managers that give cash in return for part-ownership of your business. In return for risking their funds, they tend to favour only high-growth companies that are likely to provide them with high returns. They plan to realise their gains on exit from the investment.
What investments will venture capitalists consider?
Venture capitalists are a different class of investors to angel investors. Their core business is investing in other businesses (unlike angel investors, who may still be in business) so they are typically far tougher in their requirements. Because of the time and cost of due diligence (checking out your business), venture capitalists are not usually interested in looking at small investments. Venture capitalists value their time as much as the returns they want for their investors.
Venture capitalists will provide more money than an angel and will also provide expertise, support, contacts and management help. Funding is usually only offered when you’re more established.
What will they expect in return?
Venture capitalists will be looking for a high return for investing in your business. Many will expect an average of 30–40 percent annual return on their money – this equates to a return of more than 500–1000 percent (5–10 times) on exit.
They will typically want to play an active role in your business. This may range from actually placing a manager inside your company (if they feel the business lack certain skills), to helping you with strategic alliances and contacts with other companies. At the very least, they will require representation on your board of directors to oversee the running of the company.
Venture capitalists also add value through their experience of taking products or services to commercialisation, and through their international networks.
Take heart that if a venture capitalist invests in you, then you’re well on your way. It’s a vote of confidence in your project. They will also usually agree to continue to invest in you as the years go by, or will introduce other investors (as required). They will work with you to ensure that their investment is as lucrative as possible, which, of course, is good for you. They will also drive a hard bargain.
What is the process if a venture capitalist is interested in investing in my business?
Here’s a typical list of actions you will face in a successful venture capital deal.
- The venture capitalist looks at your short proposal. They will initially spend anywhere from 30 seconds (if the proposal is just part of the daily flow across their desk) to ten minutes if you’ve been referred to them by a credible source.
- They mention that your proposal is among hundreds of others they are looking at (Key message: don’t get your hopes too high).
- They call saying they would like to talk to you, which means you are one of maybe four or five proposals being considered. You will likely send them your Information Memorandum (ask for a Confidentiality Agreement first, either yours, or they may have a standard one they use).
- You visit, and they discuss your proposal, attacking any weak spots and evaluating both you and your proposal. Do you have a passionate commitment to your business? Can you do it?
- They start the due diligence process, which means they investigate you and your business proposal more closely. This is where you need to provide your full business plan and access to many, if not all, of your documents, suppliers, distributors, and staff.
- A deal is struck (an Investment Agreement or Term Sheet is agreed) where they value your business, and then buy a percentage of it. Usually this is done by injecting cash directly into your business. This cash contribution is often done on a staged basis (bit by bit) as the company grows and you reach agreed objectives. At the same time, you will also agree on a likely exit strategy for the venture capitalist. The venture capitalist may appoint a person to assist with the running of your business, to help with opening up new markets and ensuring all targets are met.
- Years may go by (probably no more than five). The venture capitalist will now want to exit and take their profits. They sell, take their money, and then invest in another venture, or divest the venture capital fund and distribute the earnings to investors.
At the end of the day, venture capitalists want to buy low and sell high, making sure they get out of the investment at the right time.
The importance of an exit strategy
Venture capitalists are not normally long-term investors. Venture capitalists have a set timeframe (the average length of time is three to five years) for their involvement in your business. They will want an eventual exit as the funds they run are generally limited to ten years.
Most will have a range of investments (they operate a ‘portfolio’ of deals, usually sector specific such as the IT sector or biotech) so that in investing with you, they are spreading their risk across one sector that they know a lot about.
They get out by:
- Selling their shares back to you (a buy-back deal).
- Selling their shares to another investor.
- Selling when the whole company is bought out by a larger company (a trade sale).
- Helping list your company on the local stock exchange. The shares are then sold to the public in an Initial Public Offering, or IPO.
Other advantages of venture capitalists
The other advantage of venture capitalists is that they should bring more than the money to the table. In fact, if all a venture capitalist can offer is money, you may want to look for a better one, but be aware the local pool is quite small. There are reported to be less than 20 active venture capital or private equity firms in New Zealand.
Good venture capitalists should be able to offer considerable experience in growing businesses, including:
- Strategy management.
- Board participation.
- International contacts.
- Industry knowledge.
- Expansion advice.
- Strategic alliances.
- Marketing assistance.
- Financial structuring.
The Venture Capital Association has news about what’s happening in the venture capital field and a list of venture capitalists in New Zealand.
- This information is provided by New Zealand Trade and Enterprise
