Is Venture Capital Good for Your Business?

Venture capital is a possible source of funding for new, relatively unproven enterprises that appear to have promising futures. However, such money is often hard to come by. Be realistic in your quest for venture capital. Venture capital firms expect a business to be able to return their investment not only with interest, but with a large profit. 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 and a few are publicly held. Once you accept venture capital, you have relinquished some of your autonomy and accepted the understanding that the venture capital firm will take a large share of the profits you earn.

As the entrepreneur, you should understand the nature of a vendor firm, before pursuing this as a financing source. This type of investor expects a projected return on investment that is directly related to risk. The greater the risk, the greater the return expected. Typically, however, an investment firm will not be interested in getting involved with a new firm until the business has established itself in some way, so the risk factor can be determined.

The venture capital firm and its interest usually depends upon the stage of the new firm’s development. Once the new firm has established itself and has a working organizational structure, a viable business plan and start-up arrangement—a venture capital firm may be interested. However, some firms prefer a later stage of new business development, perhaps when the new company is in its second or third round growth state and needs more capital either to carry out expansion plans or to tide it over until a merger or public offering carries it to the next stage of corporate growth.

A company’s business plan serves as the primary analytical tool for the venture capitalist. In analyzing the plan, a venture capital firm would most likely focus on three features.

• 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 tempting to such investors.
  
  
• Management capability. No matter how good the product or how innovative the service, the quality and experience of the management is a key factor in the success of the business. The astute investor is well aware of this and looks for solid evidence of such skill.
  
  
• The industry’s growth. Investors also want to be sure that the product or service is in a growth field. A significant or revolutionary product improvement, by itself, may not have appeal in a declining product or service category.

Most venture capitalists purchase common or convertible stock rather than burden the fledgling enterprise with interest payments on debt or debentures. They may possibly want more than 50 percent ownership. Additionally, while the venture capitalists may insist on sitting on the Board of Directors or offering management and technical advice, they are rarely interested in the day-to-day management of the enterprise, unless its survival and their investment is at stake.

Keep in mind that the minimum investment is generally from $50,000-$500,000, but investment ceilings are almost unlimited.

Before taking the next step, get outside advice. Talk with your accountant and tax advisor. You may also call upon the expertise of the SCORE Association (Service Corps of Retired Executives). SCORE is a nonprofit, volunteer service organization, which provides small business counseling and mentoring. More than 3.5 million entrepreneurs have participated in SCORE’s business counseling sessions. All SCORE counselors have experience as business owners, executives or managers and can bring real-world experience to the table. For a referral to one of the 389 SCORE chapters around the country, call 1 (800) 634-0245 for free and confidential business mentoring.

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