28 FAQs people ask about obtaining venture capital.
- Why would we want to raise venture capital?
- What are the drawbacks of venture capital?
- How do I find people who would be prepared to put venture capital into my business?
- What is the minimum they would be prepared to invest?
- What is the maximum they are likely to invest?
- What is the difference between a venture capitalist and a business angel?
- Would a venture capitalist (or a business angel) be looking for an all-share deal, or would they be willing to put up debt capital as well?
- What sort of a stake would they want to take?
- What rights would they get with the shares?
- How much say would they want in the management of the business?
- Would I have to give them a seat on the board?
- How long would they want to hold the investment?
- How can I best plan to control the impact a future sale is likely to have on the business?
- What happens if things go wrong - for example, if they invest, but I subsequently find I cannot comply with the agreed terms?
- Will I be able to go back to the same people for more money in the future?
- Will I be able to go back to different people for more money in the future?
- What is mezzanine finance?
- What sort of information do I have to provide when I go looking for venture capital?
- What experience does the management team need?
- I was involved in the past with a company which went into receivership. Will this count against me?
- Will a venture capital firm be looking for all its gain on exit, or will it want income in the meantime?
- Can I restrict who they sell the shares to?
- Can I restrict when they sell the shares - for example, not for at least two years?
- How much growth in value will venture capitalists be looking for, over how long a period?
- How do we negotiate the investment?
- What legal agreements will we need?
- Why do negotiations fail?
- How much will professional advice cost?
If you need additional funding but do not want to (or cannot) take on more debt, you are likely to be looking for equity investment. Venture capital – or for smaller businesses, an investment from a business angel – may be the solution.
Venture capital may be an option if you are:
- running a successful business that needs money to grow - for example, to increase capacity to meet existing demand, or to develop new products or markets
- members of an existing management team looking to buy out the existing owners (a management buy-out, or 'MBO') or an external management team looking to do the same (a management buy-in or 'MBI')
- an exceptionally promising start up looking for funds for development and marketing
You should always take advice before approaching a VC or business angel, especially if you have been turned down by other sources of finance.
Only you can decide whether it is worth giving up part of the ownership of your business in return for finance to take it to the next level. Disadvantages are:
- You must generate the cash needed to make the agreed payments of capital, interest and dividends. This can create great financial pressure.
- You will have to agree to certain restrictions as part of the deal, such as how much you are paid and your involvement with other businesses. You will usually need your investor's consent for major business decisions.
- Your investor may insist on putting a representative on your board (or having power to do so if financial targets are not met). For VCs, this is usually a non-executive director who will only take an active part if things go wrong. A business angel will usually want to be on the board and play a more active part.
- You are under greater scrutiny generally, particularly in relation to your compliance with your duties and responsibilities as a director: for example, to act in the company's best interests, and to disclose personal interests in your company's affairs.
- Your investor will expect regular information and consultation to check how things are progressing. For example, monthly management accounts and minutes of board meetings.
You could spend a very long time going nowhere if you try to tackle this one on your own. Your best bet is to tap into an existing network of venture capital providers, by way of a lawyer or accountant who specialises in providing services to SMEs (small to medium-sized enterprises).
There are also brokers who claim to offer introductions to venture capital sources. Their services are variable in quality and can prove expensive.
The intermediary, should be able to give you a good idea of what individual venture capital providers are looking for, and what they are likely to offer in return. They may be able to steer you towards the providers most likely to be interested in your project, and they may be willing to advise on your presentation, to maximise your chances of success.
Of course, none of this will come cheap, so you need to set a budget for the costs of raising capital. Lawyers and accountants will normally work on a fee per hour worked. Brokers will look to receiving a percentage of the sum raised. Some may also expect a bonus payment for success in raising capital for you.
Bear in mind that payment may be due whether or not you actually succeed in raising money. At a very rough estimate, a successful small company in a conventional business would probably have to pay between £10,000 and £25,000 in fees, to raise £250,000.
It can take almost as much time and effort to size up a business looking for £50,000 as it does for one looking for £1 million. Most venture capitalists are unwilling even to look at any business wanting less than £500,000. A business angel will often be prepared to invest lower amounts in the business.
In practice, assume a maximum of £50 million, unless the circumstances are really exceptional - for example, where part of a large, established business is being sold off to its management.
Both provide equity capital for investment in new or expanding companies. But generally speaking, a venture capitalist is an investing institution - for example, an insurance company, a pension fund or another fund management organisation. Because they are investing money on behalf of other people, they are likely to have strict criteria - for example, on the type of business in which they are prepared to invest, the rate of return they expect, and so on.
Business angels are private individuals who are looking to invest a lump sum on their own behalf, very often in a business to which they can make a non-monetary contribution too - for example, in helping with marketing or other management skills. Their financial resources will be more limited than those of the venture capitalists, but their approach probably more flexible.
7. Would a venture capitalist (or a business angel) be looking for an all-share deal, or would they be willing to put up debt capital as well?
Some venture capitalists are certainly willing to think in terms of putting up both equity and debt capital, though they would be unlikely to consider a deal for debt alone. That is what banks are for. If you do want a debt and equity package, however, you would do better to get your own intermediary to put it together: after all, you are 'buying' this money, and you do not want to tie yourself in too tightly to any one supplier.
This is up for negotiation. In broad terms, few venture capitalists would want more than a 30% stake. Many will be restricted by the terms on which they are allowed to invest, to holding no more than 10-20% of the shares in any one business. The question then becomes, whether a 10-20% stake in your business is worth the money you would like them to provide.
A business angel might be willing to take a higher stake, if the growth prospects are sufficiently enticing. But you would have to be very certain you could work with them, before you gave them a stake of more than 30%.
This is up for negotiation, too. As a minimum, if they are buying ordinary shares - and most venture capitalists and business angels will be unwilling to accept anything less - they will get the voting rights attributable to those shares. These usually include the right to vote on acceptance (or rejection) of the company's annual accounts, the right to vote on the directors' remuneration, and the right to vote on the appointment and dismissal of directors.
- Holders of at least 5% of the voting have the right to force the directors to call a general meeting (a meeting of the shareholders), or to call it themselves at the company's expense if the directors refuse to do it within a reasonable time.
- Holders of at least 25% of the ordinary shares can block special resolutions. A special resolution is required to change the company's articles of association.
- Minority shareholders cannot block the majority in accepting the accounts, agreeing the directors' remuneration or appointing new directors. But restrictions might be included in a shareholders' agreement.
Taking on outside shareholders is not a matter to be undertaken lightly. You, and the other directors of the company, have a fiduciary duty to act in good faith to promote the success of the company. If you take on outside shareholders, they will be checking to make sure you do it.
Outside shareholders will also be entitled to their share of whatever dividends are being paid, and to their share of the assets left (if any), if the company has to be wound up.
As a general rule you can assume that venture capitalists will want to know what is going on.They will not usually want to be involved day-to-day, provided they are getting plenty of information. But business angels will want to get involved in day-to-day management in any event. However, there are going to be as many variations on that rule as there are funders involved. This is another reason why it will pay you to consult an intermediary, who knows what the funders want, rather than trying to go to them directly.
Perhaps. Some venture capital firms will take the view that managing the business is your affair, and will simply judge you by the end results. Others would prefer to know which way you are thinking, so that if they see you doing something they know has proved disastrous elsewhere, they can at least suggest a rethink. Most will want the right to appoint 'their' director to the board if things are not going well for the business.
Most business angels will want a seat on the board, and should prove to be level-headed and sensible members of it.
Venture capitalists will often expect to sell their shares after as little as three years.
Business angels by contrast will probably be thinking longer-term - say five years, in the first instance. If things are going badly they may try and bail out sooner; if things are going well, they will probably be content to hold their investment for somewhat longer.
The most common exit routes are:
- a trade sale to another company
- refinancing of their investment by another institution
- a listing of the shares on an exchange that enables them to be offered to the public, such as AIM (the Alternative Investment Market) or the Stock Exchange Main Market
- repurchase of the investor's shares by management, or by the company itself
Discussions with your investors, as their time for exiting approaches, will include agreeing steps to prepare for their preferred exit route. In a perfect world you, or your advisers, would arrange to have other investors willing and anxious to buy up the shares your venture capitalists want to sell.
That way your venture capitalists would be happy (because they had obtained a good price for their shares) and your other shareholders would be happy (because they had received a good valuation on their shares). The business could proceed unencumbered by disgruntled shareholders (unable to get out at a reasonable price) or by disgruntled ex-shareholders (sitting on lower profits than they were expecting to obtain).
The world is rarely perfect, but there are things you can do to push it in the right direction:
- Do what you can to make sure that your figures - sales, profits, profit margin and dividends - are moving in the right direction.
- Build up a relationship with your outside shareholders, and try to develop a 'feel' for their intentions. Do not hold it against them if they are planning to sell your shares - they will not be as committed as you are, but their help will have been worth having while you had it. When they decide to sell, you want to be the first to hear about it.
- Maintain your relationship with intermediaries and, if possible, develop a relationship with other potential investors.
14. What happens if things go wrong - for example, if they invest, but I subsequently find I cannot comply with the agreed terms?
Start talking. Venture capitalists and business angels know that some of their investments will give them problems. What they really do not like is being kept in the dark. So tell them what is happening, and what you propose to do about it.
If they are not happy with your explanations and proposals, there will be very little that minority shareholders can actually do - apart from dumping the shares for the best price they can get, and passing the word around. (That could blight your attempts to raise new capital for years to come, so do not take it lightly.) If your outside investors hold debt, however, they may (depending on the terms), be able to force you to repay it. Whether they do it will depend, at least to some extent, on whether they think you are reliable and trustworthy, and are prepared to back your efforts to turn the situation around.
That depends on why and when. If you need more money in the short run (ie within two years), because you miscalculated how much you would need, or the returns are coming in more slowly than you anticipated, or something else has gone wrong, the answer is probably no. Both investing institutions and business angels are fairly hard-headed, and you are most unlikely to be able to tempt them into throwing good money after bad. But if you need more money in the medium-term, to expand production, or move into new markets, the answer might well be yes.
Certainly - provided that you have not tied yourself up into some sort of exclusive deal, which would be most unwise.
Mezzanine finance is a type of funding that lies somewhere between ordinary shares and traditional bank loans. For example, many venture capitalists will ask for preference shares in addition to ordinary shares.
- The preference shares give them a guaranteed percentage of the amount they have invested, or of the company's profits, as dividend each year (provided the business is making sufficient profits to make the payments)
- This right is usually cumulative - that is, if the preferential dividend is not paid in one year it is carried forward and added to the dividend payable in subsequent years.
- If the company becomes insolvent, the preference shares are repaid after secured bank loans (but before ordinary shares).
- Preference shares may be 'redeemable', ie the investor can cash shares in and be repaid on a fixed date or series of dates.
- Preference shares often have an option to convert into ordinary shares.
You will need to put together a business plan, and you must take advice on doing it. At the very least you will have to provide:
- an explanation of who you are (including your age, qualifications, background, etc)
- an explanation of what your business does and where you plan to take it
- sales and profits figures as far back as you can go
- a balance sheet showing assets and liabilities
- a detailed three year sales and profits projection
- a detailed cash flow projection over the same three year period
- an idea of what you expect to do in the following two years
- details of your management team (if any)
Business plans, particularly those designed for investment institutions, are becoming sophisticated documents. Be prepared to spend time and trouble on yours. This is your selling document, and you will only get one chance at presenting it. Venture capitalists are swamped with applications for money, most of them pretty iffy, and it is very unlikely that they will be willing to look at yours a second time.
You should have a successful track record, particularly if you are raising money from a venture capital firm. Some business angels may be more open to backing unproven talent.
If it is not already profitable, the business should have a strong chance of generating sustainable and predictable cash flow and profits in the near future.
Ideally you need a balanced, experienced and professional management team, who:
- are putting their own money into the business
- are prepared to link a significant portion of their earnings to performance
- are contractually tied in - for example, an advertising agency will find it difficult to secure venture capital if key creative people could leave
20. I was involved in the past with a company which went into receivership. Will this count against me?
Possibly. It will depend on why the company went into receivership, when, to what extent you were responsible, and what you have been doing since. If the receivership was more than 10 years ago, and either you were only peripherally involved, or you have since rebuilt your fortunes, you probably do not need to worry about it. Be prepared to talk about it in terms of a learning experience. If it was more recent you will have to work harder to convince investors that you are worth backing.
21. Will a venture capital firm be looking for all its gain on exit, or will it want income in the meantime?
It will depend on the firm. All will expect most of their gain on exit, but many will want dividends in the meantime too. Make sure you know what they are looking for before you sign up to anything.
As a rule, no. You could try offering shares with restrictive conditions (for example, a requirement that they have to be sold back to internal shareholders), but venture capital companies would almost certainly walk away from the deal. Why should they tie their hands in advance? And anyway, what guarantee is there that the internal shareholders will have the money to buy when they want to sell?
Possibly. This is not an unreasonable request. Take advice from whoever is putting you in touch with the money people.
Assume that they will want to see their shares double in value if they hold them for three years, and treble if they hold them for five. Of course they will not get anything like that if they invest through the stock market - but they are not so likely to see their investment wiped out, either.
Don't underestimate the management time required to find and negotiate a deal. An investment can take three to six months to complete (though it can be much faster). During this time, business performance can decline.
First, choose advisers who are corporate finance specialists. Request - subject to confidentiality - a list of the venture capital deals they have personally completed in the last 12 months.
Use your advisers to identify potential investors (the British Private Equity & Venture Capital Association publishes a directory, listing each member's preferred investment amounts and industries). Your advisers can contact candidate investors to get an indication of how much each usually invests, and what they will expect in return.
At this stage, everything they say will be subject to further negotiation and 'due diligence'. For example:
- what percentage of the company they will expect to own in return for their investment
- what additional requirements they will want to impose
- whether they will supply finance in a lump sum or in stages, increasing investment as the company reaches specific targets
Create a list of preferred investors and contact them through your advisers, circulating your executive summary. You will be in a much stronger negotiating position if you can interest more than one potential investor, so approach several. Send the full business plan to those who express an interest and arrange an initial meeting and/or presentation.
Prepare in advance for the lengthy due diligence process (typically one to three months) during which the potential investor's advisers will examine your company's books, records and managers. You should be able to provide key information quickly, such as:
- Financial details: for example, the real value of your assets and liabilities; how realistic your profit and loss forecasts are; how good your financial controls are.
- Legal details: for example, whether the business is involved in any litigation; what the key supplier and employee contracts are; whether the business has good title to its premises and any intellectual property.
- Key business factors: for example, what the business trends are; how well the business is managed.
Use your advisers to help negotiate valuations, the financial structuring of the deal, and tax implications. Your solicitor will draw up and negotiate the main terms of the investment agreement, which is likely to include:
- The amount and form of the finance to be provided and the rights the investor(s) will have.
- Warranties confirming that the information you have provided is true. If the business later fails and it is proved that you gave misleading information, the investor will usually have the right to claim compensation from whoever provided the warranties (typically you).
- Indemnities, where you agree to accept liability in certain circumstances. For example, if the company is sued in regard to pre-existing contracts.
- Service contracts that tie in key members of management and staff.
- Provision for payment of the investor's costs - ensure you only pay in the event the investment is completed.
Your solicitor will also advise on other legal issues such as service contracts for key employees and conflicts of interest in the case of management buy-outs.
Nothing will be finalised until the agreement is signed. In particular, the final terms may not be negotiated until the last minute when you are desperate to complete the deal.
The most common reasons are:
- failure to agree a price or other key terms (this is especially common when several investment firms 'syndicate', ie join together to provide the necessary finance)
- legal problems cannot be resolved
- trading performance declines substantially during the process of raising investment
Total costs of 10% or more of the amount raised are not uncommon for smaller investments, and 5% for larger amounts. You will usually be required to pay the VC's costs too. At a very rough estimate, a successful small company in a conventional business might have to pay between £10,000 and £25,000 in fees to raise £250,000.
You will need an accountant and a lawyer. There are also brokers who claim to offer introductions to venture capital sources, although their services are variable in quality and can prove expensive.
Lawyers and accountants typically charge on the basis of hours worked, while brokers usually charge a percentage of the sum raised. Some may also expect a bonus payment for success in raising capital for you. You will have to pay professional fees even if you do not succeed in raising the money.