Venture Capital

 

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Venture capital ("VC") firms supply funding from private sources for investing in select companies that have a high, rapid growth potential and a need for large amounts of capital. VC firms speculate on certain high-risk businesses producing a very high rate of return in a very short time. The firms typically invest for periods of three to seven years and expect at least a 20 percent to 40 percent annual return on their investment.

Warning When dealing with venture capital firms, keep in mind that they are under great pressure to identify and exploit fast growth opportunities before more conventional financing alternatives become available to the target companies. Venture capital firms have a reputation for negotiating tough financing terms and setting high demands on target companies. Three bottom-line suggestions: Make sure to read the fine print. Watch for delay maneuvers (they may be waiting for your financial position to weaken further). Guard your trade secrets and other proprietary information zealously.

Venture capital financing may not be available, nor a good choice of financing, for many small businesses. Usually, venture capital firms favor existing businesses that have a minimal operating history of several years; financing of startups is limited to situations where the high risk is tempered by special circumstances, such as a company with extremely experienced management and a very marketable product or service. In 1995, venture capital firms invested in less than 2000 companies. The target companies often have revenues in excess of two million dollars and a preexisting capital investment of at least one million.

VCs research target companies and markets more vigorously than conventional lenders, although the ultimate investment decision is often influenced by the market speculations of the particular venture capitalists. Due to the amount of money that venture capital firms spend in examining and researching businesses before they invest, they will usually want to invest at least a quarter of a million dollars to justify their costs.

Warning Be wary of "shopping" innovative ideas to multiple venture capitalists or private investors. Use caution in revealing any information you consider proprietary. Even if you already have intellectual property protection (e.g., a patent, trademark, or copyright), you don't want to be forced to police your rights. Do your best to limit the details of your particular innovation and seek confidentiality arrangements for additional protection of any preexisting legal rights you may have.

The price of financing through venture capital firms is high. Ownership demands for an equity interest in 30 percent to 50 percent of the company are not uncommon even for established businesses, and a startup or higher risk venture could easily require transfer of a greater interest. Although the investing company will not typically get involved in the ongoing management of the company, it will usually want at least one seat on the target company's board of directors and involvement, for better or worse, in the major decisions affecting the direction of the company. The ownership interest of the VC firm is usually a straight equity interest or an ownership option in the target company through either a convertible debt (where the debt holder has the option to convert the loan instrument into stock of the borrower) or a debt with warrants to a straight equity investment (where the warrant holder has the right to buy shares of common stock at a fixed price within a specified time period). An arrangement that eventually calls for an initial public offering is also possible.

Despite the high costs of financing through venture capital companies, they do offer tremendous potential for obtaining a very large amount of equity financing and they usually provide qualified business advice in addition to capital.

Venture capital firms are located nationwide, and a directory is available for $125 through the National Association of Venture Capital http://www.nvca.org , 1655 N. Fort Meyer Dr., Arlington, VA 22209, (703 524-2549). In addition, other sources for venture capital can be found through bankers, insurance companies, and business associations.