Capital Opportunities for Small Businesses - sbtdc

C A P I T A L O P P O R T U N I T I E S F O R SMA L L B U S I N E S S E S
Venture Capital
Professional venture capital is defined by the National Venture Capital Association as “money provided by
professionals who invest alongside management in young, rapidly growing companies that have the potential
to develop into significant economic contributors.” Venture capital is, however, a viable alternative for only a
limited number of small, growing companies.
Venture capitalists are professional managers of investment funds whose primary aim is to purchase equity in
growing companies and then sell that investment at a profit within a designated period. The primary
institutional source of venture capital is a venture capital firm. Venture capitalists take higher risks by investing
in an early-stage company with little or no history, and they expect a higher return for their high-risk equity
investment.
Most venture capitalists prefer to purchase equity in ongoing businesses as opposed to start-ups and generally
specialize in high-tech companies. Venture capitalists search for high-growth firms possessing a new technology
or product innovation. Because of the risk associated with the typical investment, the investor will require a 30
to 40 percent (or higher) realized annual rate of return. The most heavily negotiated issue in any venture capital
investment is valuation. This will determine what percentage of the company the investor will receive in return
for his cash outlay. Valuations are determined not only by the quality of the company but also by the supply of
available funds. 5
The traditional venture capital investment is typically equity-based and may take the form of common stock,
preferred stock, or convertible debt. The investment will not be structured to require a current payout in the
form of interest or dividends; instead, the venture capitalist expects to achieve the return upon liquidation of
the investment. At the time of the initial investment an exit strategy is usually devised to sell or bring the
company public within three to five years. Therefore venture capital is not the answer for a company desiring to
remain private.
The advantages of acquiring venture capital financing are the minimal current costs and its availability to
companies with promising future but limited current profits. It may also reduce interest costs for debt financing
since a lower debt-to-equity ratio may result in more favorable borrowing rates. Finally, since many venture
capitalists were once budding entrepreneurs, they can be invaluable sources for advice. The basic disadvantage
of this type of financing is the dilution of ownership interest and the difficulty in making a match between
business and investor.
It is important to note that not all monies a venture capital fund has under management are available for
current investments. In fact, some firms may have substantial assets under management but not be active in
terms of seeking new investments. The firm may have already invested in venture deals or may have the funds
designated for the expansion of companies already in their portfolio. Venture capital firms, however, will often
5 Capital.com provides a free online valuation tool whereby the user can value their company, background on valuation methodologies,
as well as an online submission form whereby the applicant can request between $1 million and $100 million from competing capital
sources. Capital.com’s Financial Provider network includes Wachovia, GMAC Commercial Finance, Oxford Capital, and other smaller and
larger banks and institutions nationwide. Capital.com also contains a lengthy section on how to raise financing and the various types &
forms of financing available. Visit: www.capital.com. [This website is included here for informative purposes only; this is not an express
endorsement of this site. The user must investigate fully any funding opportunities arising from use of the site.]
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