Key Players in the Venture Capital Game

Key Players in the Venture Capital Game

THE ANGEL INVESTORS

The first set of equity investors a rising entrepreneurial venture typically encounters are the Angel Investors – the informal network of the high net-worth individuals who invest their own money into ventures where they usually have domain knowledge, first-hand commercial experience and where they can add value over and above the capital they supply.

Angels typically invest between $50,000 and $500,000 individually although deals of up to $3 million can occur. Angels seek a high Internal Rate of Return – usually between 30% – 40% IRR. As they invest at an earlier, more risky stage than Venture Capitalists, Angels tend to be the most patient of investors and their investment horizon is typically between 3 and 7 years.


The Good, the Bad & the Ugly

The ‘good’ angel can be worth their weight in gold as they will have a wide and relevant network of contacts and will strategically and constructively work with the entrepreneur and management team as a mentor, advisor and director.

Importantly, this type of angel has enough personal wealth to lose the money invested without feeling the pain too heavily. As a consequence, she typically has enough funds available to invest in further rounds to avoid dilution of her shareholding. There is no point in attracting investors who can’t afford to “pay to play” in the inevitable follow-on funding rounds – they will just get diluted down to nothing and blame the entrepreneur as a result.

The ‘bad’ angel is one who can’t really afford to invest – and lose – the money. It’s not unusual for these types to have little or no commercial experience or value-add. They generally take up a great deal of the entrepreneur’s time answering a constant stream of unnecessary questions. While it’s tempting to take any money that’s offered, sometimes it’s best to say “No, thank you” and keep looking.

The ‘ugly’ angel is the chap – almost always male – who has more money than he will ever spend and who thinks that money makes him smarter than everyone else – especially the entrepreneur. This angel has an ego bigger than his wallet and tends to make decisions emotionally, not strategically. Doing a deal with this type of angel is akin to getting in to bed with a gorilla – the outcome is predictable and highly unpleasant.

THE VENTURE CAPITALISTS

Venture Capitalist funds and their investment managers are the professional players on the investment team. Highly formalized, they will be members of AVCAL, the Australian Venture Capital & Private Equity Association Limited. (www.avcal.com.au)

Venture Capitalist funds – or VC’s as they are commonly known – provide financial capital to early-stage, high potential, high risk entrepreneurial companies in exchange for a high degree of ownership and control. VC’s also provide added value to the deal by way of strategic, operational and financial advice, access to follow-on funding and arranging debt facilities, access to a sophisticated network of contacts and alliance partners and facilitating exit strategies.

Venture Capital Investment Managers are completely focused on the financial return as they have a mandate from their investors – typically superannuation funds – to deliver as high a return as possible. Their investment horizon is usually between 3 – 6 years and they might seek an IRR of between 35% – 45% with at least one seat on the Board and usually a high degree of control over financial and strategic matters, as well as preferential shareholder rights and Put/Call Options embedded in the Shareholders’ Agreement.

Like Angels, VC’s seek to realise their investment through a Significant Liquidity Event – typically by way of a Trade Sale to a large corporate or less commonly by way of an Initial Public Offering (IPO) of the company’s shares on the Australian Stock Exchange (ASX) or overseas exchanges, such as NASDAQ.

In today’s environment, it is a myth to think that VC’s will fund a start up with little more than a concept or an unproven technology. With many funds badly burnt by the tech wreck in 2000, VC’s tend to enter the investment cycle at a later stage than Angel Investors, investing between $2 million – $5 million over a number of stages (known as “tranches”).

VC’s tend to specialize in one or more market segments where their core skills can be of most value to their investee companies.

While each fund is different, in general VC seeks to invest in high growth ventures with the underlying potential to develop into well-rounded companies that:

  1. Have an owner-base who are seeking growth and who understand the need to leverage equity to maximise the wealth position of all shareholders.
  2. Have a provable business model with products and services that address a Tier 1 market-need in a potentially global market that is currently under-satisfied, with the model demonstrating substantial sales potential within 7 years.
  3. Can attract high-quality management, staff and board members.
  4. Can be leaders in their field.
  5. Are in emerging growth markets.
  6. Have proprietary technology/IP with compelling and sustainable competitive advantages that is or near market ready.
  7. High gross margins and a requirement for modest expansion capital.
  8. Have the type of risks that can be mitigated and/or removed during the venture development project.
  9. Satisfactory valuation and investment terms
  10. Have the potential to attract follow-on venture funding and/or have potential for substantial gains via a trade sale or IPO within 3-5 years.

THE STRATEGIC CORPORATE INVESTORS

Unlike a VC, a Strategic Corporate Investor (SCI) is not solely motivated by financial return. SCIs typically look for technologies, products and/or business models that either complement existing business units within their group or that can be “bolted in” to their existing operation as a new strategic business unit.

This means that they may not necessarily be looking to sell them off to the highest bidder but rather to take a strategic stake to make outright acquisition of the company later on an easier process to control.

While a SCI will generally be interested in the success of the venture, there may be commercial opportunities that the entrepreneur will be unable to pursue by virtue of a conflict of interest. On the flip side, competitors of the Strategic Corporate Investor – usually key customers in the market – may not want to deal with an entity controlled (or strongly influenced) by their competitor.

While rare, there is also the real possibility that the SCI is simply making a defensive move to withhold the new technology from the market in order to protect their dominant position and prevent the venture from winning VC investment which would result in a greater threat and potentially would cost considerably more to acquire.

With a Strategic Corporate Investor in place early in the deal, the business may be less attractive to downstream VC investment as the potential for a strategic sale to another large corporate or an IPO on the public market is significantly limited.

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