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Venture Capital
Canada Business Service Centres - CBSCs
A lot of people become aware of the term venture capital (VC) when they
realize that lending institutions are unwilling to finance their business
proposal. There is a huge difference between getting a loan from a lending
institution (debt) and selling a part of your equity in the venture. Are
you really prepared to have a new partner who will put specific controls on
management of the business even though they will rarely participate in the
day to day operations? Are you prepared to investigate what venture
capitalists want (your idea may be good for you but may not provide
sufficient potential for attracting VC)? Are you prepared to take the time
to find and court venture capitalists (venture capital is much harder to
find than looking for a bank loan and getting to know each other as
potential new partners is a long process)? Are you prepared to have your
business management abilities really scrutinized, and can you accept that
they may require a management team or a better management team? Are you
prepared to sell more of the company than you would originally have
imagined? Those who have the money set the rules and it is not uncommon
that almost half or more of the business may be owned by other
shareholders. If you can answer "yes" to the above questions, you are ready
to proceed.
Remember, in any business venture, equity always precedes availability to
debt. Sometimes people are turned down for a loan by lending institutions
because of a lack of sufficient equity or collateral in the business
venture. Is venture capital your only hope? You may not need as much
venture capital as you first might think. By attracting a venture
capitalist, you improve the equity level in the proposed business, which
may cause a lender to feel less at risk and provide you with that loan you
originally could not get. Check everything out first; never assume that a
loan will be there if you get venture capital. Other circumstances can come
into play.

What venture capital is... and is not:

. Venture capital (VC) is money invested in- rather than loaned to - a
business enterprise for the purpose of providing it with needed
capital for start-up and/or continuing growth. Venture capitalists do
not require a guaranteed monthly repayment with a set rate of
interest, nor are they providing capital funding without additional
strings attached.
. Investment from venture capitalists is equity financing, which means
that it is in the form of partial ownership - and usually with
managerial and operational controls - of the enterprise by the venture
capitalist. This type of investment is sometimes known as "patient
money" investing and is held over a longer term, usually 3 to 7 years.
Most often, they will hold shares in the stock of the company, sit on
the board of directors, and take a significant part in ongoing
executive decisions.
. Venture capital is typically funding enterprises which are nonetheless
expected to become highly profitable in a relatively short period of
time. Therefore, the money invested by the venture capitalist can grow
(and is also at risk) in direct proportion to the success or failure
of the business venture. Shareholders in a business are at most risk,
because they are the last to obtain the remaining assets of a failed
business, if any. Shareholders are also typically last to benefit from
the businesses success. In a growing business, profits must be
retained for funding the growth, so the real value is in the market
value of the shares. It may take considerable time before you see cash
available to payout substantial dividends or see a cash return from
the sale of your shares.
When venture capital is a suitable source of funding:
. Typically, venture capital is most suited for enterprises with one or
more of the following characteristics:
o Companies that have a well developed business plan for
substantial rapid growth.
o Companies which are in need of sizeable amounts of capital that
are difficult to collateralize.
o Companies which are preferably past the start-up phase, and are
poised for quick expansion.
o Companies with good liquidity prospects, such as going public in
the near future, or good prospects of being bought out very
profitably.
o Companies that can demonstrate that perfect balance between
risks and rewards in the investor's eyes.

Types of venture capitalists:

. "Love Money":

This is probably the largest source, least complicated, least time
consuming and least favoured method of obtaining venture capital by
most small entrepreneurs. These people are the non-professional
venture capitalists: extended family, friends, friends of friends,
contacts and associates.
. Professional Venture Capital:

Consists of private independent VC investment management companies;
capital funds managed by lending institutions such as banks, or by
industrial corporation-backed organizations; labour-sponsored VC
funds; government-controlled organizations with a mandate for VC
investing. Many venture capitalists specialize in specific types of
enterprises, such as information technology or biomedical products.
Often, they will have experience and knowledge of certain industries
and may desire to focus on them exclusively. These firms do a lot of
due diligence in investigating the business concept and its owners and
expect considerable research and documentation. In Canada, a
substantial portion of the venture capital industry consists of
approximately 80 professionally managed investment groups who are
members of the Canadian Venture Capital Association (CVCA).
. "Angel Investors"

"Angel investors" are a specific type of venture capitalist, somewhere
in between "love money" investors (such as family, friends) and
professional VC investment companies. Angels are usually local persons
in business or in the professions with money to invest in small to
medium sized local enterprises. Typical investments by angels are
under $250K. They are not as stringent as professional venture
capitalists but not as informal or reliant on hope as "love
money"investors might be. "Angels" are typically the most difficult to
locate. Most like to stay anonymous and rely on their business
contacts for leads.

Typical stages of venture capital financing:

. "Seed financing"

Usually for very new companies which have not yet produced a product
for sale; may still be assembling a management team; financing is
provided to foster a concept, develop new product or service, carry
out associated marketing. As a percentage of total available VC money,
generally this high, high risk stage has the smallest allocation of
investment funds.
. First-stage financing

Company has expended all initial production and marketing budgets and
needs additional capital to bring product to market; company may not
yet be profitable.
. Second-stage financing

Further financing for expansion of operations; marketing and sales
developing, though company may still not be profitable.
. "Mezzanine," or third-stage financing

Capital financing for ongoing operations and expansion; sales
increasing, company is breaking even or profitable; financing is for
major expansion, marketing, new product development.


Leveraged buy-outs

Financing for the strategic purchase of other product lines, divisions
or companies, or for management/employees to buy out some or all of
the company for which they work.

What Professional venture capitalists expect in return for their
investment:

. First and foremost: a very substantial return on their investment.
This can range from 20% - 50% (compounded annually) and is typically
in the range of 30% - 40%. The pay-off for the venture capitalist is a
liquid market for the shares held in the company: a buy-out of the
investment by other shareholders, by going "public" in the stock
markets, or sale of the entire company to a well capitalized business.

. To protect their investment, they require controls over the actions of
management, typically in contract form, to insure key decisions are
not made without their knowledge and agreement.
What Professional venture capitalists can provide:
. Financing which is accessible when other sources are not prepared to
lend the money due to the risk involved such as a lack of collateral
or a totally proven management history.
. A venture capitalist has the ability to evaluate the growth potential
in business enterprises which are in immediate need of sizeable
amounts of capital. Being turned down by several targeted VC's might
be an indication that you or the business concept cannot meet their
stringent standards or that your vision might be misguided.
. Once you obtain a VC investment, additional financing can be obtained
relatively quickly and in sufficient quantity to finance the growth
needed by an enterprise at a given stage. This is known as having
"deep pockets." In all likelihood, more money will be needed than
originally planned for.
. The number one benefit provided by a professional venture capitalist
is expertise in growth management. Most pro VCs have experience and
skill in managing the financial strains of growth. Also, with their
many contacts, they can speed growth at less risk and more quickly
overcome problems as they arise. Strangely, it has been said by many
successful business owners that they found the skills and contacts of
the venture capitalist were of more value to them than the money.
Typical qualities which professional venture capitalists look for in a
prospective investment opportunity:
. A business proposition with good potential for significant
profitability, such as a product or technology capable of generating a
defensible and sustainable competitive advantage in the market. Being
the first one in the market is not enough.
. A "big idea"- a market opportunity with enough profit potential to
create a company with sales in the multi-millions per year within five
years or so.
. Tangible evidence of market demand for product(s) of the company.
. Momentum already in progress: growing sales, new products being
launched, major deals under negotiation, high booking orders.
. Strong, solid, and preferably seasoned management in the technical,
executive, marketing and financial departments of the company. A
competent board of directors in place is desirable.
. Financial and personal commitment by the owners of the company to the
proposed enterprise. The more the entrepreneur has or will have at
stake, the more comfort the VC will have.
. A proven record by the company in its industry is a big plus, as are
credible third-party endorsements (e.g. from industry experts, market
analysts, trade publications, potential alliance partners).
. Appropriate exit opportunities. The potential for the enterprise to go
public or become an attractive acquisition candidate represents the
opportunity for the venture capitalist to exit his investment
profitably and conveniently. VCs know that it is easier to invest than
it is to get your investment out. They must have a liquid exit
strategy.

How venture capitalists are usually approached: Do's and Don'ts:

. Most venture capital companies constantly receive many unsolicited
business propositions and only accept a very small number for
investment. Patience and persistence is usually required when
submitting business plans for approval. "Cold calling," or sending
business plans to VC companies without prior introduction, is
generally a very poor strategy compared to making contact through a
third-party introduction or recommendation.
. Venture capitalists expect to be presented with information which is
concise, accurate and detailed enough to enable them to evaluate a
prospective enterprise. Organization, clarity and efficiency are
essential qualities for business plans, meetings and other
communications.
Typical process of arranging a deal for financing with a venture
capitalist:
. The real starting point is identifying VC prospects or people who can
introduce you to VC prospects.
. The process of courting venture capital typically can take from three
to six months, and in some cases a year or more.
. The introduction for a VC deal is a business plan summary that will
lead to an examination of the business plan by the venture capitalist.
Investment interest will usually result in a meeting with principals
from the prospective business and/or a visit by the venture
capitalist. This is typically followed by a preliminary round of "due
diligence" by the VC company, during which they will make a basic
assessment of the prospective enterprise, its finances, management,
product, market and competition.
. If initial due diligence is satisfied, a proposal of terms will be set
forth by the venture capitalist, and a process of negotiations begins.

. If an interim agreement for terms is reached, the VC company will next
undertake the full process of due diligence, involving a more
prolonged and detailed examination of the business plan and operations
of the company under consideration.
. When due diligence has been completed to the satisfaction of the
venture capitalist, the next stage will be writing-up of a contractual
agreement for the investment deal, followed by discussion, final
negotiations and approvals.
. The final stage is the legal writing-up and documentation of the final
agreement. A document commonly included in an agreement is a Letter of
Intent from the investor, detailing conditions and clauses within the
agreement and further defining the role of the venture capitalist
within the new enterprise.
The role of the business plan in securing venture capital:
. The business plan, an essential element for obtaining business
financing under any circumstances, is especially crucial in obtaining
venture capital financing. Venture capitalists require information
which is as complete, detailed to their needs and accurate as possible
regarding a prospective investment in a company. They have to evaluate
the soundness of the enterprise, its potential profitability, and the
risk involved in providing financing for it.
. A business plan submitted for the purposes of securing venture capital
has certain unique features. Please refer to the following section
"Links to websites with more detailed information or additional
resources on the subject of venture capital" for sample VC business
plans available online; or contact The Business Link Library for
additional resources..

Finding sources of venture capital:

. It is advisable to do enough research to determine which providers of
venture capital are appropriate candidates for possibly financing an
enterprise.
. A traditional - and often reliable - means of locating sources of VC
is by word-of-mouth. Check out the Who's Who of key players, suppliers
and distributors in your industry, past and current business contacts,
monied contacts in the professional world (doctors, dentists, lawyers,
etc.) An additional source is qualified referrals based on experience
of third parties.
. Directories of venture capital investors:

The Canadian Venture Capital Association publishes an annual directory
of its members; this information is also accessible on the CVCA
website (see lists of links at end of this document).

There are a number of other directories of VC published in-print or
online, such as The Money Book, published by Venture Alberta Magazine
(see lists of links at end of this document),or Pratt's Guide to
Venture Capital Sources.


The Business Link Library has several directories of venture capital
sources.
. There are a variety of online "matchmaking" services currently on the
Internet which attempt to connect VC investors with suitable
investment opportunities, usually for a fee. Critical judgement should
be exercised in using such services, whose quality may vary. Online
"matchmaking" generally has a much lower success rate than most people
looking for VC would wish.

Compiled by The Business Link Business Service Centre, Edmonton,
Alberta, Canada.