Venture capitalists are a group of investors operating in a partnership to make and manage investments in young, early stage companies. VC. Funds made available for start-up firms and small businesses with exceptional growth potential.
Venture capitalists (VCs) represent the most glamorous and appealing form of financing to many entrepreneurs.
They are known for backing high-growth companies in the early stages, and many of the best-known entrepreneurial success stories owe their growth to financing from venture capitalists.VCs can provide large sums of money, advice and prestige by their mere presence.
Just the fact that you have obtained venture capital backing means your business has, in venture capitalists’ eyes, at least, considerable potential for rapid and profitable growth.
VCs make loans to and equity investments in young companies. The loans are often expensive, carrying rates of up to 20%. Many venture capitalists seek very high rates; a 30% to 50% annual rate of return.
Unlike banks and other lenders, venture capitalists frequently take equity positions as well. That means you don’t have to pay out hard-to-get cash in the form of interest and principal instalments.
Instead, you give a portion of your or other owners’ interest in the company in exchange for the VCs’ backing. The catch is that often you have to give up a large portion of your company to get the money.
In fact, VC financiers so frequently wrest majority control from and then oust the founding entrepreneurs that they are sometimes known as “vulture capitalists”. But VCs come in all sizes and varieties, and they’re not all bad.
What are the different types of Venture Capital investors?
There are several types of venture capital:
1. Private venture capital partnerships.
These are perhaps the largest source of risk capital and generally look for businesses that have the capability to generate a 30% return on investment each year. They like to actively participate in the planning and management of the businesses they finance and have very large capital bases – millions of rands’ worth – to invest at all stages.
2. Industrial venture capital pools.
These usually focus on funding firms that have a high likelihood of success, like high-tech firms or companies using state-of-the-art technology in a unique manner.
3. Investment banking firms.
These traditionally provide expansion capital by selling a company’s stock to public and private equity investors. Some also have formed their own venture capital divisions to provide risk capital.
Applying for Venture Capital
What do venture capitalists investors expect of business plans they receive?
A good quality business plan can greatly assist in communicating the relevant points in order to obtain successful funding.
Venture Capital companies typically seek out high growth potential early-phase companies and often place more importance on the management team, entrepreneurial concept and potential for aggressive growth than the quality of the physical business plan itself.
Great emphasis is placed on the entrepreneurs’ ability to clearly communicate a unique business concept and growth strategies in a polished pitch to give the funder confidence that they can easily sell this concept to their market.
That said, obviously a good quality business plan can greatly assist in communicating the relevant points in order to obtain successful funding.
Advice from a venture capital expert
Take note of the following advice offered by venture capital expert Keet van Zyl of HBD Venture Capital:
- Spend significant time on the business plan
- Business plan must be clear, well arranged and not too long. Supporting info can be presented in the appendix
- Write a good one-page executive summary. There is a good chance that the potential funder won’t even read any further if this is not compelling
- Ultimately view the business plan as a motivation for you to continue. You need to convince yourself that this will work and a business plan is one way to do this
- Write your business plan yourself. No-one knows your business better than you. There are various business plan templates available on the internet. However, the areas where you need help – make sure you get it. Use consultants and experts where necessary but don’t outsource the whole process
- Clearly identify your target market
- Clearly identify the need for this product/ service
- Use facts and figures where possible, specifically in the Industry Analysis
- Don’t over-emphasise the technical aspects of the current product or concept. Make it easy to understand and focus on the future growth strategies and implementation.
- Polish your oral pitch to dovetail with your business plan
- Never make false claims or misrepresentations
- Do a ‘due diligence’ on your funder and tailor-make specific elements of your business plan to their needs. Go to their website; study their investment criteria; understand their investment process; look at their investment portfolio; read some press releases and articles; ask around if anyone you know has dealt with them before
- Contact the potential funder before just sending off a business plan to someone’s inbox. A personal referral is even better
- Update your business plan regularly as your thoughts, business activities and market insights evolve
- Have a clear ‘shopping list’ of what you want to do with the funding, and the timelines involved
- Let someone who you trust read through the business plan for feedback and advice
Regardless of the quality of the physical business plan it is only the first step in the process. The entrepreneur will have to pass a number investigative stages before an investment is made.
How do Venture Capital companies typically define their Investment Mandates?
Before approaching a Venture Capital company, entrepreneurs need to do their homework. It is critical to learn as much as possible to about the VC’s Investment Mandate and to ensure that their concept and business plan fits within its scope.
Here is a list of common criteria for VC Investment Mandates:
- Most VC companies shy away from start-ups in favour of companies that are able to demonstrate revenue that has been generated for anything from six months to two years
- Qualities and proven ability of the management team
- Equity based funding is a likely requirement
- VC companies typically favour specific bands of financing requirements – R10 million to R50 million, or R100 million
- Sufficient barriers to entry, cutting down many competitors and ensuring a largely uncontested market space
- Potential for fast-paced, high growth
- Many VC companies will favour certain industries, and exclude others
What attracts VCs?
Venture capitalists typically invest in companies they anticipate being sold either to the public or to larger firms within the next several years. Companies they will consider investing in usually have the following features:
- Rapid, steady sales growth
- A proprietary new technology or dominant position in an emerging market
- A sound management team
- The potential for being acquired by a larger company or taken public in a stock offering
VCs define their investments by the business’s life cycle
VC’s often define their investments by the business’s life cycle: seed financing, start-up financing, second-stage financing, bridge financing, and leveraged buyout. Some venture capitalists prefer to invest in firms only during start-up, where the risk is highest but so is the potential for return. Other venture capital firms deal only with second-stage financing for expansion purposes or bridge financing where they supply capital for growth until the company goes public. Finally, there are venture capital companies that concentrate solely on supplying funds for management-led buyouts.
How does the process for evaluating proposals for Venture Capital investment typically work?
Not unlike other venture capital investors, the HBD Venture Capital process is designed to provide crucial decision points at each step of the investigation in order to ensure that the business owner experiences no unwarranted delays. Keet van Zyl of HBD Venture Capital explains the procedure for evaluating business proposals received by the organisation:
Step 1 – Initial Screening:
The information provided in your business plan is evaluated to determine if it is in line with our funding mandate and whether it is likely to yield venture capital expected returns.
Step 2 – Assessment:
In this initial meeting the business owners will present their business case with the objective of determining possible synergies and the way forward.
Step 3 – Term Sheet:
A short investigation is conducted and a report is presented to the Investment Committee. If the decision is to proceed with due diligence, HBD will negotiate with the business owners a term sheet and exclusivity agreement.
Step 4 – Due Diligence:
Due diligence is carried out by our core team and outside expert consultants. A typical due diligence process can take between one and three months as it requires a very detailed review of the financial, human capital, legal, market and product Components of the business.
Step 5 – Deal Execution:
If our Investment Committee approves the transaction, the legal documents are negotiated, implemented and the funding is disbursed.
What is the percentage of successful Venture Capital funding applications?
According to venture capital expert Keet van Zyl of HBD Venture Capital organisations such as his fund on average less than 1% of proposals received. As van Zyl explains, HBD is a niche venture capital company and due to the large number of proposals received, they are forced to judiciously apply both human and capital resources.
The HBD screening process funnels down proposals until a deal is struck:
- Of the total number of proposal received by HBD Venture Capital, on average, only 25% fit within the HBD funding mandate.
- That number is shrunk to 10% post the initial meeting with the entrepreneurs
- Half of those entrepreneurs, a mere 5%, pass the test and make it to the next round
- Only roughly 1% will make it beyond the due diligence and legal negotiations to be successful in their acquisition of finance
- HBD therefore typically funds less than 1% of business plans received. What will make you that one that stands out from the 99% of other applications at any given time?
What are the key factors Venture Capital organisations typically find in a successful proposal?
VC companies will be on the lookout for the following factors will when analysing an investment opportunity. Venture Capital companies typically favour early stage companies with high growth potential. VC companies will be on the lookout for the following factors will when analysing an investment opportunity:
- Match with the VC company’s Investment Mandate
- Viable current business model
- Aggressive growth strategy
- International expansion opportunities
- Growth in their Industry itself
- Passionate entrepreneurs/ strong management teams
- Can this entrepreneur be an industry leader?
- Can the business model create a ‘Network Effect?
- Unique differentiating products/ concepts
- Barriers to entry
What are some of the red flags that cause a plan to be rejected by a Venture Capitalist?
Nine danger areas to avoid. Most venture capital companies make financing decisions that are based on a company
- Investment Mandate – a mismatch with the mandate will result in rejection
- Slow revenue and profitability growth projections
- Lack of uniqueness
- Lack of scalability
- Lack of understanding of the industry in which the entrepreneur operates
- Inadequate strategic plans to be able to implement and grow a great business concept
- Unreasonable expectations of the valuation of the business concept
- False claims being made or misrepresentations
- Misalignment between the business plan and the entrepreneur’s oral ‘pitch’