Venture capitalists invest money in businesses, often at an early stage, that have the potential to grow rapidly. In return for their investment, they take an equity stake which they ultimately plan to convert back into a significantly larger amount of cash through an ‘exit’ event such as a flotation or trade sale.
What venture capital offers you A typical venture capital investment in an individual company will be between £1m and £5m. Although the focus of venture capital tends to be early stage businesses, these days’ VCs will often look for companies that have already established a track record of sales rather than start-ups. This reflects the slightly more cagey approach adopted after the dot com boom of the late 1990s and subsequent collapse.
This contrasts with angel investors who often do fund start-ups but provide much smaller amounts of money and private equity investors who concentrate on investing larger sums on well established businesses for events such as management buy-outs and re-financings, where one institution buys out another’s stake in order for certain parties to achieve a desired exit.
A vast amount venture capital money is channelled through venture capital trusts (VCTs). A VCT is a capital fund. Venture capitalists set up these funds to attract money from individual investors and institutions. The cash is then invested in a portfolio of companies, perhaps as many as a dozen in a year. The trust managers will be looking for a 25% return on investment. Given that a high percentage of early stage companies fail, that means they make most of their profits from a few stellar successes.
Pros and cons
Venture capital can provide the money you need to grow. For instance, if you are making sales but need to spend on ramping up production or expanding your sales force into new territories, venture capitalists can provide the cash. Unlike a bank loan, there won’t be a drain on cash due to repayments.
However, there is a price to be paid in equity. To compensate for their risk, VCs often drive a very hard bargain. Entrepreneurs often find that to secure a VC deal, they have to give up a greater share of the company than they originally expected. In cash terms, that is not necessarily a bad thing. You may end up owning, say, 60% of your company rather than 100% but if the investment fuels significant growth then your new stake will soon be worth considerably more than the old. It’s also worth remembering that while VC investors won’t micro-manage your company, they will provide help, advice and contacts. Expect to have them appoint to board member.
A venture capital investment will to a very great extent define your future. VCs want an exit, and that usually means that the original owner will exit at the same time. You need to be comfortable with this before going down the VC route.
What you need to do
You will need to prepare a business plan that will appeal to VCs and very possibly revamp the management team. Put simply you must demonstrate that your company has both the products and the management acumen to deliver the kind of growth that will justify a venture capital investment. They tend to like companies working in markets that have high barriers to competitor entry. If necessary seek help from a business adviser to prepare your company and hone your pitch before seeking VC cash.
Research the market.
Some venture capital trusts are generalists while others specialise. If you’re growing a restaurant chain, don’t bother with VCs that specialise in technology.
Next steps
For further information, contact the British Venture Capital Association (BVCA) or visit its website at www.bvca.co.uk. It will provide information on venture capital trusts. Other possible contacts include British Smaller Companies VCT, Baronsmead VCT, Close Venture Management, Elderstreet Investments, Electra Quoted Management, F&C Management, Foresight Venture Partners, Beringea, and Library House.
