The investment process, from reviewing the business plan to actually investing in
a proposition, can take a venture capitalist anything from one month to one year
but typically it takes between 3 and 6 months. There are always exceptions
to the rule and deals can be done in extremely short time frames. Much depends
on the quality of information provided and made available.
The key stage of the investment process is the initial evaluation of a business
plan. Most approaches to venture capitalists are rejected at this stage. In
considering the business plan, the venture capitalist will consider several principal
aspects:
- Is the product or service commercially viable?
- Does the company have potential for sustained growth?
- Does management have the ability to exploit this potential and control the company
through the growth phases?
- Does the possible reward justify the risk?
- Does the potential financial return on the investment meet their investment criteria?
In structuring its investment, the venture capitalist may use one or more of the
following types of share capital:
Ordinary shares
These are equity shares that are entitled to all income and capital after the rights
of all other classes of capital and creditors have been satisfied. Ordinary
shares have votes. In a venture capital deal these are the shares typically
held by the management and family shareholders rather than the venture capital firm.
Preferred ordinary shares
These are equity shares with special rights. For example, they may be entitled to
a fixed dividend or share of the profits. Preferred ordinary shares have votes.
Preference shares
These are non-equity shares. They rank ahead of all classes of ordinary shares
for both income and capital. Their income rights are defined and they are
usually entitled to a fixed dividend (eg. 10% fixed). The shares may be redeemable
on fixed dates or they may be irredeemable. Sometimes they may be redeemable
at a fixed premium (eg. at 120% of cost). They may be convertible into a class
of ordinary shares.
Loan capital
Venture capital loans typically are entitled to interest and are usually, though
not necessarily repayable. Loans may be secured on the company's assets or
may be unsecured. A secured loan will rank ahead of unsecured loans and certain
other creditors of the company. A loan may be convertible into equity shares.
Alternatively, it may have a warrant attached which gives the loan holder the option
to subscribe for new equity shares on terms fixed in the warrant. They typically
carry a higher rate of interest than bank term loans and rank behind the bank for
payment of interest and repayment of capital.
Venture capital investments are often accompanied by additional financing at the
point of investment. This is nearly always the case where the business in
which the investment is being made is relatively mature or well-established. In
this case, it is appropriate for a business to have a financing structure that includes
both equity and debt.
Making the Investment - Due Diligence
To support an initial positive assessment of your business proposition, the venture
capitalist will want to assess the technical and financial feasibility in detail.
External consultants are often used to assess market prospects and the technical
feasibility of the proposition, unless the venture capital firm has the appropriately
qualified people in-house. Chartered accountants are often called on to do
much of the due diligence, such as to report on the financial projections and other
financial aspects of the plan. These reports often follow a detailed study,
or a one or two day overview may be all that is required by the venture capital
firm. They will assess and review the following points concerning the company
and its management:
- Management information systems
- Forecasting techniques and accuracy of past forecasting
- Assumptions on which financial assumptions are based
- The latest available management accounts, including the company's cash/debtor
positions
- Bank facilities and leasing agreements
- Pensions funding
- Employee contracts, etc.
The due diligence review aims to support or contradict the venture capital firm's
own initial impressions of the business plan formed during the initial stage.