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Venture Capital
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Despite being a widely used phrase, we don't have an exact definition for Venture capital. But typically it refers to investment funds or partnerships and even venture capital divisions within large corporations that focus on investing in promising start-up and emerging companies. A venture capitalist (VC) is a person who makes such investments. Most venture capital comes from a group of wealthy investors, investment banks and other financial institutions that pool such investments or partnerships.
Other than providing the company with money, the Venture Capitalist also provides assistance and expertise with business planning, bringing industry knowledge, experience in growing businesses and expertise in taking the company public some day in the future. However, the primary motive of venture capitalists is to make a lot of money on their intended investment. Further, it should be the measure of any VC's past performance record.
You should also know that most venture capitalists are interested only in businesses that have a growth potential. So, if you're a small grocery store, a neighborhood sushi bar, or a corner lemonade stand, don't waste your time seeking venture capital – until and unless you plan to create a lemonade or raw-fish empire. Starbucks is an example of how this was applied. The venture capitalists believed that the founders could expand beyond their local market.
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Venture Capital Associations |
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The Structure of a Venture Capital Investment |
A typical venture capital investment is structured, so as to give the venture capitalist an adjustable preferred stock in the company. A convertible stock would then give the venture capitalist a preference over the common shareholders, in the event of a liquidation or merger.
A preferred stock can even be converted into common stock at the option of the holder. But at times it may get automatically converted into a common stock in the event of an initial public offering (IPO) of the company to simplify the capital structure of the company and to facilitate the IPO. The Venture capital investments are also sometimes "staged." Initially, a certain amount of money is invested right away and later as your company meets the targets, additional money is invested. From the company's perspective, it's important that these milestones are clearly defined and reasonably obtainable.
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Venture Capitalists' Rights |
As a Venture Capitalist you have certain rights that you receive with an investment:
- You have the right to elect one or more directors to the company's board of directors.
- You have the right to receive various reports, financial statements and related information.
- You have the right to have its stock registered for sale in a public offering at the company's cost.
- You have the right to maintain its percentage share ownership in the company by participating in future stock offerings.
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The Stock Purchase Agreement |
A summary of the proposed terms and conditions of the investment is prepared after the company and the venture capitalist agree on the terms sheet. The attorney of the venture capitalist usually prepares the agreement.
In the agreement, the most important one would be the stock purchase agreement, which typically would contain the following information:
- The selling price of the stock and the number of shares to be purchased.
- Representations and warranties of the company.
- Company commitments.
- Closing conditions of the deal.
- A requirement to reimburse the venture capitalist's legal fees.
- Exhibits and related agreements, containing other rights for the venture capitalist.
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Representations and Warranties |
Representations and warranties from the company are ever present as the part of a venture capital investment. It is expected of the company to represent its financial and operational condition and outlook. Any violation of the company's representations and warranties policies can lead to a real problem for the company, giving the investor various remedies laid out in the agreement.
Representations and warranties could take many pages, as venture capitalists want to close any "loophole" in advance. Most importantly, for early-stage companies, the venture capitalists may insist that the founders should make the representations and warranties personally.
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