CHAPTER 2

Theory of Venture Capital - implies active investment in ventures where capital is provided through independent, professionally managed, dedicated pools of capital that focus on equity or equity-linked investments in privately held, growth companies.

6 Types of The Venture Investment Process

1.) Generating a Deal Flow - the VC investor creates a pipeline of ‘deals’ or investment opportunities that he would consider investing in. This is achieved primarily through plugging into an appropriate network. The most popular network obviously is the network of VC funds/investors. It is also common for VC funds/investors to develop working relationships with R&D institutions, academia, etc., which could potentially lead to business opportunities.

2.) Due Diligence - is the industry jargon for all the activities that are associated with evaluating an investment proposal. It includes carrying out reference checks on the proposal-related aspects such as management team, products, technology, and market.  The important feature to note is that VC due diligence focuses on the qualitative aspects of an investment opportunity.

3.) Investment Valuation - process is an exercise aimed at arriving at an acceptable price for the deal. It will go through the following sequence: Evaluate future revenue and profitability, Forecast the likely value of the firm based on expected market capitalization or expected acquisition proceeds depending upon anticipated exit from the investment, and forecast the desired appreciation on the proposed investment (on a discounted cash flow basis).

4.) Pricing & Structuring the deal - VC investment requires and permits innovativeness in financial engineering. While VC investments follow no set formula, they attempt to address the needs and concerns of the investor and the investee.

The investor tries to ensure the following:

1. Reasonable reward for the given level of risks;

2. Sufficient influence on the management of the company through board representation.

3. Minimization of taxes; and

4. Ease in achieving future liquidity on the investment

The entrepreneur at the same time seeks to enable:

1. The creation of the business that he has conceptualized (operating and strategic control);

2. Financial rewards for creating the business;

3. Adequate resources needed to achieve their goal and;

4. Voting control.

Common considerations for both sides include:

1. Flexibility of structure that will allow room to enable additional investments later, incentives for future management, and retention of stock if management leaves.

2. Balance sheet attractiveness to suppliers and debt financiers.

3. Retention of key employees through adequate equity participation.

5.) Value Addition & Monitoring - This process of the VC investor’s involvement in the portfolio company is often referred to broadly as ‘value addition’. The ‘value’ that the VC brings to the portfolio company can vary from one VC professional to another depending upon the individual's background and approach to VC. There are VC professionals, especially those who invest in very early-stage situations, whose involvement can go up to providing operating management support.

Monitoring portfolio companies is a straightforward, yet delicate task. The straightforwardness lies in the well-established tools and techniques that are, used for the purpose: periodic reports, Board of Directors meetings, review sessions, and so forth.

6.) Exit - The process of exiting from a VC investment is as important as any other process in the investment cycle. The two exit options are: Sale of the VC’s position either along with or subsequent to a public offering ; and Acquisition of the company.