AN OVERVIEW OF VENTURE CAPITAL FUNDING AND PROJECT DEVELOPMENT

By Mark Paulsmeier, Group Chairman, the Paulsmeier Inc. Group
4 June 2004

This document seeks to define venture capital; to distinguish between traditional financing (loan financing), venture capital financing (equity financing), and investment angel financing (loan/equity financing; to define the various stages of the venture capital process as well as the initial costs involved. The minimum amount of venture capital and angel investment financing within the Paulsmeier Inc. Group’s two corporate network associations are also provided.

According to the British Venture Capital Association’s Guide to Venture Capital, venture capital “makes managers into owners, giving them the freedom, focus and finance to enable them to revitalize their companies and take them onto their next phase of growth… Venture capital is committed, long term and risk sharing. It provides companies with personal experience and a stable financial base on which to make strategic decisions”.

Venture capital business generally takes the form of:

• Venture capital funding (equity financing) or investment angel financing (loan/equity financing), or a combination of both.
• A viable project opportunity or business opportunity.
• A period of between two and more than ten years.
• An exit point that can take the form of a trade sale, a re-purchase, a refinancing, a flotation on a stock market, or an involuntary exit (i.e. liquidation) – aimed at realizing a return on investment (capital gain).

Within the Paulsmeier Inc. Group, ‘project’ is defined as any business activity or opportunity, corporate arrangement or undertaking, development proposal, business venture, concept or plan.

Venture capital is appropriate for companies of various sizes and in a range of industries that have aspirations, high growth potential and the desire to undergo rapid growth.

Businesses or project opportunities seeking venture capital funding may be in any number of stages, including start-up operations, other early stages, expansion, refinancing bank debt, secondary purchase, and management buy-out or buy-in.

As a rule of thumb, the closer to break-even point or profitability the less equity will need to be relinquished. On the other hand, investment angels tend to invest in earlier stage companies than venture capitalists.

Apart from the stage of development, other factors are relevant to financiers looking at opportunities:

The type of mixture of investment the project requires.

• The industry and sector in which the project operates.
• The type(s) of financing the project requires.
• The amount of financing the project requires.
• The geographical location of the project.

Financing in venture capital vs. traditional funding

The major difference between venture capital funding and traditional financing centers around the level of commitment from the financier. Within traditional financing, guarantees are sought in return for risk, rather than any interest in the growth or success of a project or business opportunity

Traditional financing can vary from short- to long-term, while venture capital funding is generally medium- to long-term – depending on the exit point.

Venture capital funding involves vested interests in a project. Venture capitalists become business partners who share risks and rewards. They will work hard to ensure a turn-around in a situation of danger.

Traditional financing institutions tend to end their commitment in the case of danger that often results in personal liquidation.

Financing for venture capital opportunities may come from a number of sources. These include clearing banks, merchant banks, finance houses, facilitating companies, governments and related sources (grant funding), and mezzanine firms.

The Paulsmeier Inc. Group has multiple potential sources of funding, including venture capitalists, investment angels, banks and syndicate funders.

Venture capital funding

Venture capitalists offer equity-structured finance for projects requiring medium- to long-term financing. This type of financier is typically directly involved in the business, providing strategic direction to management as well as financial support for the company. The venture capitalist may have a seat on the board but does not usually participate in the day-to-day management.

The reward is rapid growth of the enterprise in the medium- to long-term, with the funder exiting through the sale of the company, a management buy-out or a flotation on the stock market.

Within the Paulsmeier Inc. Group’s international corporate network association, Professional Investors Group, equity finance is available for projects of US$5-million or more. Within the Group’s South African corporate network association, Business Ventures Unlimited, the corresponding amount is ZAR10-million or more.

In the venture capital industry, on average between four percent and five percent of projects seeking venture capital funding are funded and developed.

Investment angel funding

Investment angels provide loan-structured finance, utilizing various loan and equity structures, with interest determined by the level of risk inherent in the venture. On average, one percent of projects seeking investment angel funding are funded and developed.

Within both Professional Investors Group and Business Ventures Unlimited, investment angel funding is available for projects of US$1-million or more.

Process stages

The venture capital investment process may be divided into the following stages:

• Preparing the business plan.
• Presenting the business plan
• Early enquiries and negotiation.
• Offer letter.
• Due diligence process.
• Final negotiation and drawing up of completion documentation.
• Monitoring of the project.
• Exit point.

This process can last from a month to one year, depending on the venture capital organization, the project leader(s), and the nature of the project. Projects can be unnecessarily delayed because of:

• Incomplete documentation being submitted.
• Geographical considerations.
• Comprehensive due diligence process.
• Lack of dedicated expertise and management support on the part of the project leader.
• Nature and scale of projects.

Initial costs

The costs involved in the preparation of the documents, due diligence research, commissions, and the legal and financial specialists involved in negotiations, are referred to as the initial costs. They are for the project leader’s account.

Within the Paulsmeier Inc. Group, these costs range from six percent to ten percent of the total project value up to the time of signing the financing and/or development agreement. Within the Group, these costs can – under certain circumstances – be financed, but this is not always the case. However, the costs of the initial evaluation, preparation of documents and the due diligence research must always be paid up-front.

References:

Keith Arundale (Price Waterhouse) British Venture Capital Association (BVCA): A Guide to Venture Capital. London, 1998. Pp. 55. ISSN 1351-1726.

The Paulsmeier Inc. Group, Corporate Management International, Oakwell Associates.

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