Is Venture Capital Right for Your Business?
NTERA was developing several patents for its display technology for appliances that changes colors. The owners believed it had real promise but they were spending more money than they were earning and needed funding to turn the technology into marketable products. Most banks won’t offer loans to small businesses with negative cash flow. So how was NTERA going to survive?
NTERA turned to Cross Atlantic Capital Partners, a Radnor, PA-based venture capital firm. Convinced that NTERA’s patents would pay off in the long run, Cross Atlantic invested about $2 million. NTERA used the money to hire engineers to develop its products. “Cross Atlantic also offered us advice on business planning and provided access to their network including vendors and other potential customers in our industry,” says Dave Corr, one of the founders of NEFTRA, which has headquartered in both West Conshohocken, PA and Dublin, Ireland. “In fact, they introduced us to other investors, which led to additional capitalization,” says Corr.
Venture capital (VC) organizations are much like angel investors. They both infuse cash into businesses that appear to have strong growth potential in return for equity. (To learn more, see SBR’s Angel Investors Finance Small Businesses.) Venture capital firms generally are formal partnerships funded by private and public pension funds, endowment funds, foundations, corporations, and wealthy individuals who infuse $2 million+ into businesses. These professional investors devote all of their time to investing and building later-stage companies, and are often willing to take on riskier investments that banks shy away from.
Small businesses use venture capital money to expand into new markets, launch or expanding advertising/marketing campaigns, and hire staff and experienced managers, says Harrison Miller, a partner at Summit Partners, a Boston, MA-based venture capital company. The funding also provides a cushion to help the business through any downturn.
Accepting funds often means giving up some equity and a minority ownership of the business, and usually a spot or two on the company board. To protect their investment and bolster the business, venture capitalists become active participants in day-to-day operations. “We view ourselves as a service provider,” says Miller. We help in areas such as recruiting, management, partnerships, distribution and sales planning, says Miller.
Venture capitalists realize a return on their investment when the company reaches critical mass and is then taken public, sold or merged with another business. Exit plans usually fall in the three to seven-year range.
“Both investor and venture capitalists must have liquidity as their goal,” says Miller. “If you want to pass your business onto your family, then it won’t be a good fit.”
If you aren’t married to your business, and are willing to take on partners, then VC funding might be a worthwhile consideration.
Working with VCs can be quite lucrative for both the investor and business owner. For example, Summit invested $10 million in Keystone RV, a recreational vehicle manufacturer and distributor, in 1998 and helped arrange a $25 million bank credit line. Keystone’s revenue grew from $70 million in 1998 to $400 million in 2001 before management sold its stake to Thor Industries for $150 million in 2001.
Potential for Growth is Key to Attracting Capital
Acquiring venture capital funding is challenging though. VCs infused more than $26.1 billion in businesses last year. However, that money was dolled out for only 3,522 deals, according to a Money Tree Report conducted by the National Venture Capital Association (NVCA) and PriceWaterhouseCoopers.
“A company’s size is somewhere irrelevant,” explains Gerry McCrory, a partner in Cross Atlantic Capital Partners. “If a venture capital company invests dollars at the right time in a company with a differential strategy that has intellectual property, it can lead to a substantial return. It’s the market opportunity that counts.”
But to convince VC’s that they are worthy of investment, small businesses need to perfect their “elevator pitch,” a five-minute synopsis of what makes their company special. Investors are looking for a potential market leader, unique patents or proprietary products, and a strong leader and management team, says Emily Mendell, vice president for strategic affairs at the National Venture Capital Association. In some cases, however, venture capital researchers identify companies and solicit them.
A high percentage of VC funding goes to the technology industry. Why? Technology companies offer the best opportunity for growth, says McCrory. “Most people didn’t know they needed a cell phone until they had one, the same with Google and iPods. Technology creates a need rather than meets a need,” he adds.
However, there are numerous firms that are willing to take a risk on other industries. Summit Partners, for example, has invested in an array of companies, including financial services, business services, healthcare, technology and life sciences.
Before signing on the dotted line, it’s important to conduct some due diligence and learn about your new partner. Contact another company they’ve invested in and ask a few key questions:
- What kind of business expertise does the venture capital company offer?
- How much pressure do they exert to ramp up revenue?
- What do they do if problems arise and revenue plummets?
Ultimately, you and your venture capitalist form a team. You both want to grow a successful business— and make money.
Resources:
If your business has significant growth potential and you don’t mind giving up equity, then venture capital might by a financing option worth considering. Here are some resources to learn more:
The trade association for the venture capital industry, The National Venture Capital Association, holds educational events and offers useful directories of regional and international VC groups.
Read Alex Wilmerding’s Deal Terms—The Finer Points of Venture Capital Deal Structures, Valuations, Term Sheets, Stock Options and Getting VC Deals Done. (Aspetore Books 2006).
