venture capital presentation

By: Mohamed Ismail Megahed

DBA, FinanceDBA

VC Concepts and Definition

Venture capital is the capital invested in a business where the chances of success are uncertain.

It is term to describe the financing of startup and early stage business as well as businesses in “ turn around” situations

VC Concepts and Definition

Venture capitalist is a person who make such investments.

Venture capital fund is a partnership or trust or a company that primarily invests the financial capital of promoters and other investors in enterprises that are too risky for the standard capital markets or bank loans

VC History

VC concept is a US origin concept. Organized VC fund was started in 1946 when

American research and development corporation (ARD), a publicly traded, closed-end investment company was formed.

In 1958 for computer maker digital equipment corp was provided with start-up financing by ARD.

ARD was eventually profitable, providing its original investors with a 15.8% annual rate of return over its 25 year as an independent firm

VC Advantages

1 ) The most distinguishing feature of Venture Capital is that it is provided largely in the form of equity, when the investee company is unable to float its equity shares independently in the market, or from other sources in the initial stage. Thus risk capital is provided, which is not available otherwise due to the high degree of risk involved in the venture.

2) The venture capitalist, though participates in the equity, does not intend to act as the owner of the enterprise. The venture capitalist does not participate in the day-to-day management, but aids and guides the management by providing the benefit of his skill, experience and expertise.

VC Advantages

3) The Venture Capitalist does not intend to retain his investment in the investee company for ever. He intends to divest his shares, as soon as the company becomes a profitable business and the returns from the business are high as per expectations. At this stage he withdraws himself from the venture and in turn provides finance for another venture.

4) A Venture Capitalist intends to earn largely by way of capital gains arising out of sale of his equity holdings, rather than through regular returns in the form of interest on loans.

5) A Venture Capitalist also provides conditional loans which entitles him to earn royalties on sales depending upon the expected profitability of the business.

VC Firm features

Investment in high-risk, high-returns ventures

Participation in management

Raises fund from several sources

Diversification of the portfolio

Exit after specified time

Methods Of Venture Financing Equity

Conditional Loan

Income Note

Other Financing Methods

VC’s contribution to entrepreneur In addition to money, professional VC as a

shareholder bring strong industry, operational, financial and investment banking skills to the partnership with the target company

VC adds the most value by assisting in the creation of the best possible team to manage and supervise the target company

Management assessment is one of the major tasks to be carried out by the venture capital before deciding to invest

VC’s contribution to entrepreneur• Through the VC’s expertise and network the

portfolio companies could gain access to:1. Follow-on capital through venture capital ties2. Knowledge of partnership opportunities in

multiple markets3. In-depth operational and management

experience’4. Access to high-quality management teams5. Ties to the investment banking community

STAGES OF VENTURE CAPITAL FINANCING

Finance Stage

Early Stage

Seed Capital

Start Capital

Later stage

Expansion

Follow On Financing

Replacement

Turn Around

Management Buy Out


A venture capital fund provides finance to the venture capital undertaking at different stages of its life cycle according to requirements. These stages are broadly classified into: (1) Early stage financing.(2) Later stage financing. Each of them is

further sub-divided into a number of stages.


Early Stage Financing includes: Seed capital stage, Start-up stage, and Second round financing.

Seed Capital Stage: This is the primary stage associated with research and development. The concept, idea, process pertaining to high technology or innovation are tested on a laboratory scale. Generally, the ideas developed by Research and Development wings of companies or scientific research institutions are tried. Based on laboratory trial, a prototype product development is carried out. Subsequently, possibilities of commercial production of the product is explored. The risk perception of investment at this stage if quite high and only a few venture capital funds invest in the seed capital stage of product development. Such financing is provided to the innovator in the form of low interest bearing personal loans.


Start-up Stage: Venture capital finance is made available at the start-up stage of the projects which have been selected for commercial production. A start-up refers to launching or beginning a new activity which may be the one taken out from the Research and Development stage of a company or a laboratory or may be based on transfer of technology from abroad. Such product may be an import substitute or a new product/service which is yet to be tried. But the product must have effective demand and command potential market in the country. The entrepreneurs who lack financial resources for undertaking production, approach the venture capital funds for extending funds through equity. Before making such investments, venture capital fund companies assess the managerial ability, capacity and the commitment of entrepreneur to make the project idea as success. If necessary, the venture capital funds lend managerial skills, experience, competence and supervise the implementation to achieve successful operation. High degree of risk is involved in start-up financing.


Second Round Financing: After the product has been launched in the market, further funds are needed because the business has not yet become profitable and hence new investors are difficult to attract. Venture capital funds provide finance at such stage, which is comparatively less risky than the first two stages. At this stage, finance is provided in the form of debt also, on which they earn a regular income.


Later Stage Financing: Even when the business of the entrepreneur is established it requires additional finance, which cannot be secured by offering shares by way of the public issue. Venture capital funds prefer later stage financing as they anticipate income at a shorter duration and capital gains subsequently.


Expansion Finance: Expansion finance may be needed by an enterprise for adding production capacity once it has successfully gained market share and expects growth in demand for its product. Expansion of an enterprise may take the form of an organic growth or by way of acquisition or takeover. In the case of organic growth the entrepreneur retains maximum equity holdings of the entrepreneur and the venture capitalist could be in much higher proportion depending upon factors such as the net worth of the acquired business, its purchase price and the amount already raised by the company from the venture capitalists.


Replacement Finance: In this form of financing, the venture capitalist purchases the shares from the existing shareholders of the company who are willing to exit from the company. Such a course is often adopted with the investors who want to exit from the investee company, and the promoters do not intend to list its shares in the secondary market, the venture capitalist perceives growth of the company over 3 to 5 years and expects to earn capital gain at a much shorter duration.


Turn Around: When a company is operating at a loss after crossing the early stage and entering into commercial production, it may plan to bring about a change in its operations by modernizing or expanding its operations, by addition to its existing products or deletion of the loss-making products, by reorganizing its staff or undertaking aggressive marketing of its products, etc. For undertaking the above steps for reviving the company, infusion of additional capital is needed. The funds provided by the venture capitalist for this purpose are called turn


around financing. In most of the cases, the venture capitalist which supported the project at an early stage may provide turnaround finance, as a new venture capitalist may not be interested to invest his funds at this stage. Turn around financing is more risky proposition. Hence the venture capitalist has to judge in greater depths the prospects of the enterprise to become viable and profitable. Generally substantial investment is required for this form of financing. Besides providing finance, the venture capitalist also provides management support to the entrepreneur by nominating its own directors on the Board of the company to effectively monitor the progress of recovery of the company and to ensure timely’ implementation of the necessary measures.


Buyout Deals: A venture capitalist may also provide finance for buyout deals. A management buyout means that the shares (and management) of one set of shareholders, who are passive shareholders, are purchased by another set of shareholders who are actively involved in the operations of the organisation. The latter group of shareholders buyout the shares from the inactive shareholders so that they derive the full benefit from the efforts made by them towards managing the enterprise. Such shareholders may need funds for buying the shares, venture capitalist provide

Types of VCs

Angel investors Financial VCs Strategic VCs

Types of VCs

Angel investors• Typically a wealthy individual• • Often with a tech industry background, in position to

judge high-risk investments• • Usually a small investment (< $1M) in a very early

stage company.• • Motivation:• – Dramatic return on investment via exit or liquidity

event:• • Initial Public Offering (IPO) of company• • Subsequent financing rounds• – Interest in technology and industry

Types of VCs

Angel investorsTypically a wealthy individual• Often with a tech industry background, in

position to judge high-risk investments Usually a small investment (< $1M) in a very early stage company.

• Motivation: Dramatic return on investment via exit or liquidity event:• Initial Public Offering (IPO) of company• Subsequent financing rounds• Interest in technology and industry

Types of VCs

Financial VCsMost common type of VC• An investment firm, capital raised from institutions

and individuals Often organized as formal VC funds,

• Sometimes organized as a holding company• Fund compensation: carried interest• Holding company compensation: IPO• Fund sizes: ~$25M to 10’s of billions• Motivation:

• Purely financial: maximize return on investment• IPOs, Mergers and Acquisitions (M&A)

Types of VCs

Strategic VCsTypically a (small) division of a large technology

company• Examples: Intel, Cisco, Siemens, AT&T• Corporate funding for strategic investment• Help companies whose success may spur revenue

growth of VC corporation• Not exclusively or primarily concerned with return on

investment• May provide investees with valuable connections and

partnerships• Typically take a “back seat” role in funding

Where Does Venture Capital Money Come From?

• Professional Venture Capital Firms raise money from Insurance Companies, Educational Endowments, Pension Funds and Wealthy Individuals.

• These organizations have an investment portfolio which they allocate to various asset classes such as stocks (equities), bonds, real estate etc.

• One of the assets classes is called “Alternative Investments”- venture capital is such an investment. Perhaps 5% to 10% of the portfolio might be allocated to Alternative Investments.

• The portfolio owners seek to obtain high returns from these more risky Alternative Investments.

How are Venture Capital Funds Organized?

• Most Venture Capital Funds are Limited Partnerships:

Venture Capital Fund

Limited Partners

Pension Funds, Educational Endowments, Foundations, Insurance Companies, Wealthy

Individuals

General Partners The General Partners use an Offering Memorandum to raise a fund of a given size

from the Limited Partners by convincing them that the GPs have a unique strategy or

expertise in a particular sector or sectors of the market. Fund raising can take a year or more.

If the GPs are successful they will convince enough Limited Partners to invest enough money to achieve the size fund offered.

When this happens there is a first “close” of the fund.

What Do Venture Capitalists Do?

• Source Deals• The GPs have to “source” deals- I.e. find

investment opportunities. This is done in a variety of ways- referrals from trusted sources (other funds, entrepreneurs they have invested in before, lawyers, accountants etc.)

• Make Investment Decisions• From the opportunities identified the GPs pick

the ones they think will be the “winners”. They might look at 50 or 100 opportunities for each one they invest in

What Do Venture Capitalists Do?

• Manage The Investment• The GP/VCs have a fiduciary duty to the LPs to

“manage” the investment. This means they usually sit on the Board of Directors. Given this time commitment a VC might only be able to handle 6 to 10 portfolio investment companies at a time.

• Harvest The Investment• The GP/VCs win only if they can get their money out of

the investment (“harvest the investment”). This usually takes the form of an acquisition of the portfolio company or taking the portfolio company public in an Initial Public Offering (IPO). Note: even the most successful funds rarely have even 1/3 of their portfolio investments become successful – i.e even with careful vetting 2 out of 3 investments are not “wins”.

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