Selecting an Investor
Selecting the venture capital investor
AVCAL represents most venture capital organisations in Australia. The AVCAL Directory of Members provides basic information about each member's investment preferences and is available from the association.
Before selecting a venture capitalist, the entrepreneur should study the particular investment preferences set down by the venture capital firm. Often venture capitalists have preferences for particular stages of investment, amount of investment, industry sectors and geographical location.
Once a short list of potential venture capitalists has been drawn up, it is often a good idea to contact the venture capital firm and request a copy of their publications, which will clarify the type of investments they favour.
An investment in an unlisted company has a long-term horizon, typically four to six years. It is important to select venture capitalists with whom it is possible to have a good working relationship.
Often businesses do not meet their cash flow forecasts and require additional funds, so an investor's ability to invest further funds if required is also important.
Finally, when choosing a venture capitalist, the entrepreneur should consider not just the amount and terms of investment, but also the additional value that the venture capitalist can bring to the company. These skills may include industry knowledge, fundraising, financial and strategic planning, recruitment of key personnel, mergers and acquisitions, and access to international markets and technology.
Superior businesses
Venture capitalists look for companies with superior products or services targeted at fast-growing or untapped markets with a defensible strategic position. Alternatively, for leveraged management buyouts, they are seeking companies with high borrowing capacity, stability of earnings and an ability to generate surplus cash to quickly repay debt.Quality and depth of management
Venture capitalists must be confident that the firm has the quality and depth in the management team to achieve its aspirations. Venture capitalists seldom seek managerial control; rather, they want to add value to the investment where they have particular skills including fundraising, mergers and acquisitions, international marketing and networks.Corporate governance and structure
In many ways the introduction of a venture capitalist is preparatory to a public listing. The venture capitalist will want to ensure that the investee company has the willingness to adopt modern corporate governance standards, such as non-executive directors, including a representative of the venture capitalist.Venture capitalists are put off by complex corporate structures without a clear ownership and where personal and business assets are merged.Appropriate investment structure
As well as the requirement of being an attractive business opportunity, the venture capitalist will also be seeking to structure a satisfactory deal to produce the anticipated financial returns to investors.An exit plan
Lastly, venture capitalists look for clear exit routes for their investment such as public listing or a third-party acquisition of the investee company.
Investment process
The investment process begins with the venture capitalist conducting an initial review of the proposal to determine if it fits with the firm's investment criteria. If so, a meeting will be arranged with the entrepreneur/management team to discuss the business plan.
Preliminary screening
The initial meeting provides an opportunity for the venture capitalist to meet the entrepreneur and key members of the management team to review the business plan and conduct initial due diligence on the project. It is an important time for the management team to demonstrate their understanding of their business and ability to achieve the strategies outlined in the plan. The venture capitalist will look carefully at the team's skills and backgrounds.Negotiating investment
This involves an agreement between the venture capitalist and management of the terms of the memorandum of understanding. The venture capitalist will then study the viability of the market to estimate its potential. Often they use market forecasts that have been independently prepared by industry experts who specialise in estimating the size and growth rates of markets and market segments.The venture capitalist also studies the industry carefully to obtain information about competitors, entry barriers, the potential to exploit substantial niches, product life cycles, distribution channels and possible export potential. The due diligence continues with reports from accountants and other consultants.Approvals and investment completed
The process involves exhaustive due diligence and disclosure of all relevant business information. Final terms can then be negotiated and an investment proposal submitted to the board of directors. If approved, legal documents are prepared.A shareholders' agreement is prepared containing the rights and obligations of each party. This could include, for example, veto rights by the investor on remuneration and loans to executives, acquisition or sale of assets, audit, listing of the company, rights of co-sale and warranties relating to the accuracy of information enclosed.The investment process can take up to three months, and sometimes longer. It is important, therefore, not to expect a speedy response. It is advisable to plan the business financial needs early on to allow appropriate time to secure the required funding.
Legal terms
It is likely that a shareholders' agreement would be prepared containing the rights and obligations of each party. This could include:
- Amount and terms of investment.
- Dividend policy.
- Composition of the board of directors.
- Reporting - management reports, monthly accounts, annual budgets.
- Liquidity (exit) plans.
- Rights of co-sale.
- Warranties.
- Matters requiring venture capitalist approval (such as auditors, employment contracts, major asset purchases, major debt obligations and significant variations of plans).