| Most venture capital firms concentrate primarily on | | | | value of the contribution by the owner of a starting |
| the competence and character of the proposing | | | | or financially troubled company is obviously rated low. |
| firm's management. They feel that even mediocre | | | | Often it is estimated as just the existing value of his |
| products can be successfully manufactured, | | | | or her idea and the competitive costs of the owner's |
| promoted, and distributed by an experienced, | | | | time. The contribution by the owners of a thriving |
| energetic management group. They know that even | | | | business is valued much higher. Generally, it is |
| excellent products can be ruined by poor | | | | capitalized at a multiple of the current earnings and/or |
| management. | | | | net worth. |
| Next in importance to the excellence of the | | | | Financial valuation is not an exact science. The |
| proposing firm's management group, most venture | | | | compromise on owner contribution's worth in the |
| capital firms seek a distinctive element in the | | | | equity financing agreement is likely to be lower than |
| strategy or product/market/process combination of | | | | the owner thinks it should be and higher than the |
| the firm. This distinctive element may be a new | | | | partners of the capital firm think it might be. Ideally, |
| feature of the product or process or a particular skill | | | | the two parties to the agreement are able to do |
| or technical competence of the management. But it | | | | together what neither could do separately: |
| must exist. It must provide a competitive advantage. | | | | 1. grow the company faster with the additional funds |
| After the exhaustive investigation and analysis, if the | | | | to more than overcome the owner's loss of equity, |
| venture capital firm decides to invest in a company, | | | | and |
| they will prepare an equity financing proposal. This | | | | 2. grow the investment at a sufficient rate to |
| details the amount of money to be provided, the | | | | compensate the venture capitalists for assuming the |
| percentage of common stock to be surrendered in | | | | risk. |
| exchange for these funds, the interim financing | | | | An equity financing agreement with an outcome in |
| method to be used, and the protective covenants to | | | | five to seven years which pleases both parties is |
| be included. | | | | ideal. Since the parties can't see this outcome in the |
| The final financing agreement will be negotiated and | | | | present, neither will be perfectly satisfied with the |
| generally represents a compromise between the | | | | compromise reached. The business owner should |
| management of the company and the partners or | | | | carefully consider the impact of the ratio of funds |
| senior executives of the venture capital firm. The | | | | invested to the ownership given up, not only for the |
| important elements of this compromise are | | | | present, but for the years to come. |
| ownership and control. | | | | Control |
| Ownership | | | | The partners of a venture firm generally have little |
| Venture capital financing is not inexpensive for the | | | | interest in assuming control of the business. They |
| owners of a small business. The venture firm | | | | have neither the technical expertise nor the |
| receives a portion of the business's equity in | | | | managerial personnel to run a number of small |
| exchange for their investment. | | | | companies in diverse industries. They much prefer to |
| This percentage of equity varies, of course, and | | | | leave operating control to the existing management. |
| depends upon the amount of money provided, the | | | | The venture capital firm does, however, want to |
| success and worth of the business, and the | | | | participate in any strategic decisions that might |
| anticipated investment return. It can range from | | | | change the basic product/market character of the |
| perhaps 10% in the case of an established, profitable | | | | company and in any major investment decisions that |
| company to as much as 80% or 90% for beginning | | | | might divert or deplete the financial resources of the |
| or financially troubled firms. Most venture firms, at | | | | company. |
| least initially, don't want a position of more than 30% | | | | Venture capital firms also want to be able to assume |
| to 40% because they want the owner to have the | | | | control and attempt to rescue their investments, if |
| incentive to keep building the business. | | | | severe financial, operating, or marketing problems |
| Most venture firms determine the ratio of funds | | | | develop. Thus, they will usually include protective |
| provided to equity requested by a comparison of the | | | | covenants in their equity financing agreements to |
| present financial worth of the contributions made by | | | | permit them to take control and appoint new officers |
| each of the parties to the agreement. The present | | | | if financial performance is very poor. |