In assessing options for financing a new small business, many entrepreneurs look to venture capital. This approach can benefit a relatively unproven enterprise that appears to have a promising future. Securing this type of funding is not easy, however. Venture capital firms expect a business to return their investment with interest plus a large profit. And after the disappointments with many tech-sector companies in recent years, venture capital providers are particularly wary about where they invest.
Many venture capital firms are affiliated with banks, insurance companies, other financial institutions and large corporations. Some are owned by individuals or private groups of investors; others are publicly held. The minimum investment is generally from $50,000 to $500,000, but investment ceilings are almost unlimited.
The interest of a venture capital firm in a small business usually depends on the stage of the new firm’s development. An investor may be interested only after the new firm has established itself and has a working organizational structure, a viable business plan and start-up arrangement. However, some firms prefer to come in at a later stage—perhaps when the new company is in its second or third round growth stage and needs more capital either to carry out expansion plans or to tide it over until a merger or public offering takes place.
A company’s business plan serves as the primary analytical tool for the interested venture capital investor. In analyzing the plan, investors have three specific concerns:
1) The product or service. Investors seek product or service innovations that give the company a strong competitive advantage. A new idea, backed by market surveys (measuring the appeal of the product or service and its potential market), may be appealing to investors.
2) Management capability. No matter how good the product or how innovative the service, the quality and experience of the management are key factors in the success of the business. The astute investor looks for solid evidence of such management skill.
3) The industry’s growth potential. Investors also want to be sure that the product or service is in a growth field. A significant or revolutionary product improvement may nevertheless lack luster in a declining product or service category.
Most venture capital investors purchase common or convertible stock rather than burden the fledgling enterprise with interest payments on debt or debentures. They may want more than 50 percent ownership. Additionally, while investors may insist on a position on the board of directors or expect to give management and technical advice, they are rarely interested in day-to-day management issues unless the survival of the business and their investment are at stake.
Before taking the next step for obtaining venture capital, get outside advice. Talk with your accountant and tax advisor.
Richard Strug
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