Venture capital financing
is a type of financing by venture capital: the type of private equity capital
is provided as seed funding to early-stage, high-potential, growth companies
and more often after the seed funding round as growth funding round (also referred
as series A round) in the interest of generating a return through an eventual
realization event such as an IPO or trade sale of the company.
To start a new start up
company or to bring a new product to the market, the venture needs to attract
funding. There are several categories of financing possibilities. Smaller
ventures sometimes rely on family funding, loans from friends, personal bank
loans or crowd funding.
More ambitious projects
that need more substantial funding may turn to angel investors - private
investors who use their own capital to finance a ventures’ need, or Venture
Capital (VC) companies that specialize in financing new ventures. VC firms may
also provide expertise the venture is lacking, such as legal or marketing
knowledge.
* Venture Capital Financing Process :-
There are five common stages of venture capital financing.
- The Seed stage
- The Start-up stage
- The Second stage
- The Third stage
- The Bridge/Pre-public stage
The number and type of stages may be extended by the VC firm
if it deems necessary; this is common. This may happen if the venture does not
perform as expected due to bad management or market conditions.
The following
schematics shown here are called the process data models. All activities that
find place in the venture capital financing process are displayed at the left
side of the model. Each box stands for a stage of the process and each stage
has a number of activities. At the right side, there are concepts. Concepts are
visible products/data gathered at each activity. This diagram is according to
the modeling technique founded by Professor Sjaak Brinkkemper of the University of Utrecht in
the Netherlands.
- The Seed stage :-
This is where the seed funding takes place.
It is considered as the setup stage where a person or a venture approaches an
angel investor or an investor in a VC firm for funding for their idea/product.
During this stage, the person or venture has to convince the investor why the
idea/product is worthwhile. The investor will investigate into the technical
and the economical feasibility (Feasibility Study) of the idea. In some cases,
there is some sort of prototype of the idea/product that is not fully developed
or tested.
If the idea is not feasible at this
stage, and the investor does not see any potential in the idea/product, the
investor will not consider financing the idea. However if the idea/product is
not directly feasible, but part of the idea is worth for more investigation,
the investor may invest some time and money in it for further investigation.
After a few meetings,
the executives are successful in convincing the bank to take a look in the
feasibility of the idea. ABN AMRO decides to put a few experts for
investigation. After two weeks time, the bank decides to invest. They come to
an agreement of invest a small amount of money into the venture. The bank also
decides to provide a small team of marketeers and market researchers and a
supervisor. This is done to help the venture with the realization of their idea
and to monitor the activities in the venture.
- The Start-up stage :-
If the idea/product/process is qualified
for further investigation and/or investment, the process will go to the second
stage; this is also called the start-up stage. A business plan is presented by
the attendant of the venture to the VC firm. A management team is being formed
to run the venture. If the company has a board of directors, a person from the
VC firms will take seats at the board of directors.
While the organization is
being set up, the idea/product gets its form. The prototype is being developed
and fully tested. In some cases, clients are being attracted for initial sales.
The management-team establishes a feasible production line to produce the
product. The VC firm monitors the feasibility of the product and the capability
of the management-team from the board of directors.
To prove that the
assumptions of the investors are correct about the investment, the VC firm
wants to see result of market research to see whether the market size is big
enough, if there are enough consumers to buy their product. They also want to
create a realistic forecast of the investment needed to push the venture into
the next stage. If at this stage, the VC firm is not satisfied about the
progress or result from market research, the VC firm may stop their funding and
the venture will have to search for another investor(s). When the cause relies
on handling of the management in charge, they will recommend replacing (parts
of) the management team.
Now the venture has
attracted an investor, the venture needs to satisfy the investor for further
investment. To do that, the venture needs to provide the investor a clear
business plan how to realize their idea and how the venture is planning to earn
back the investment that is put into the venture, of course with a lucrative
return.
Together with the market
researchers, provided by the investor, the venture has to determine how big the
market is in their region. They have to find out who are the potential clients
and if the market is big enough to realize the idea.
From market research, the
venture comes to know that there are enough potential clients for their portal
site. But there are no providers of lunches yet. To convince these providers,
the venture decided to do interviews with providers and try to convince them to
join.
With this knowledge, the
venture can finish their business plan and determine a pretty good forecast of
the revenue, the cost of developing and maintaining the site and the profit the
venture will earn in the following five years.
After reading the business
plan and consulting the person who monitors the venture activities, the
investor decides that the idea is worth for further development.
- The Second stage :-
At this stage, we presume that the
idea has been transformed into a product and is being produced and sold. This
is the first encounter with the rest of the market, the competitors. The
venture is trying to squeeze between the rest and it tries to get some market
share from the competitors. This is one of the main goals at this stage.
Another important point is the cost. The venture is trying to minimize their
losses in order to reach the break-even.
The management team has to
handle very decisively. The VC firm monitors the management capability of the
team. This consists of how the management team manages the development process
of the product and how they react to competition.
If at this stage the
management team is proven their capability of standing hold against the
competition, the VC firm will probably give a go for the next stage. However,
if the management team lacks in managing the company or does not succeed in
competing with the competitors, the VC firm may suggest for restructuring of
the management team and extend the stage by redoing the stage again. In case
the venture is doing tremendously bad whether it is caused by the management
team or from competition, the venture will cut the funding.
The portal site needs to
be developed. (If possible, the development should be taken place in house. If
not, the venture needs to find a reliable designer to develop the site.)
Developing the site in house is not possible; the venture does not have this
knowledge in house. The venture decides to consult this with the investor.
After a few meetings, the investor decides to provide the venture a small team
of web-designers. The investor also has given the venture a deadline when the
portal should be operational. The deadline is in three months.
In the meantime, the
venture needs to produce a client portfolio, who will provide their menu at the
launch of the portal site. The venture also needs to come to an agreement on
how these providers are being promoted at the portal site and against what
price.
After three months, the
investor requests the status of development. Unfortunately for the venture, the
development did not go as planned. The venture did not make the deadline.
According to the one who is monitoring the activities, this is caused by the
lack of decisiveness by the venture and the lack of skills of the designers.
The investor decides to cut
back their financial investment after a long meeting. The venture is given
another three months to come up with an operational portal site. Three
designers are being replaced by a new designer and a consultant is attracted to
support the executives’ decisions. If the venture does not make this deadline
in time, they have to find another investor.
- The Third stage :-
This stage is seen as the
expansion/maturity phase of the previous stage. The venture tries to expand the
market share they gained in the previous stage. This can be done by selling
more amount of the product and having a good marketing campaign. Also, the
venture will have to see whether it is possible to cut down their production
cost or restructure the internal process. This can become more visible by doing
a SWOT analysis. It is used to figure out the strength, weakness, opportunity
and the threat the venture is facing and how to deal with it.
Except that the venture is
expanding, the venture also starts to investigate follow-up products and
services. In some cases, the venture also investigates how to expand the
life-cycle of the existing product/service.
At this stage the VC
firm monitors the objectives already mentioned in the second stage and also the
new objective mentioned at this stage. The VC firm will evaluate if the management
team has made the expected reduction cost. They also want to know how the
venture competes against the competitors. The new developed follow-up product
will be evaluated to see if there is any potential.
Finally the portal site is
operational. The portal is getting more orders from the working class every
day. To keep this going, the venture needs to promote their portal site. The
venture decides to advertise by distributing flyers at each office in their
region to attract new clients.
In the meanwhile, a small
team is being assembled for sales, which will be responsible for getting new
lunchrooms/bakeries, any eating-places in other cities/region to join the
portal site. This way the venture also works on expanding their market.
Because of the delay at the previous stage,
the venture did not fulfill the expected target. From a new forecast, requested
by the investor, the venture expects to fulfill the target in the next quarter
or the next half year. This is caused by external issues the venture does not
have control of it. The venture has already suggested to stabilize the existing
market the venture already owns and to decrease the promotion by 20% of what
the venture is spending at the moment. This is approved by the investor.
- The Bridge/Pre-public stage :-
In general, this is
the last stage of the venture capital financing process. The main goal of this
stage is for the venture to go public so that investors can exit the venture
with a profit commensurate with the risk they have taken.
At this stage, the
venture achieves a certain amount of market share. This gives the venture some
opportunities, for example:
- Merger with other companies
- Keeping new competitors away from the market
- Eliminate competitors
Internally, the venture has
to examine where the product's market position and, if possible, re-position it
to attract new Market segmentation. This is also the phase to introduce the
follow-up product/services to attract new clients and markets.
Ventures have occasionally
made a very successful initial market impact and been able to move from the
third stage directly to the exit stage. In these cases, however, it is unlikely
that they will achieve the benchmarks set by the VC firm.
Faced with the dilemma
of whether to continuously invest or not. The causation of major risk by this
stage of development is 33%. This is caused by the follow-up product that is
introduced.
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