Wednesday, 20 June 2012

WHAT VENTURE CAPITAL FIRMS LOOK FOR


One way of explaining the different ways in which banks and venture capital firms evaluate a small business seeking funds, put simply, is: Banks look at its immediate future, but are most heavily influenced by its past. Venture capitalists look to its longer run future.

To be sure, venture capital firms and individuals are in­terested in many of the same factors that influence bankers in their analysis of loan applications from smaller companies. All financial people want to know the results and ratios of past operations, the amount and intended use of the needed funds, and the earnings and financial condition of future projections. But venture capitalists look much more closely at the features of the product and the size of the market than do commercial banks.

Banks are creditors. They're interested in the pro­duct/market position of the company to the extent they look for assurance that this service or product can pro­vide steady sales and generate sufficient cash flow to repay the loan. They look at projections to be certain that owner/managers have done their homework.

Venture capital firms are owners. They hold stock in the company, adding their invested capital to its equity base. Therefore, they examine existing or planned pro­ducts or services and the potential markets for them with extreme care. They invest only in firms they believe can rapidly increase sales and generate substan­tial profits.

Why? Because venture capital firms invest for long‑term capital, not for interest income. A common estimate is that they look for three to five times their investment in five or seven years.

Of course venture capitalists don't realize capital gains on all their investments. Certainly they don't make capital gains of 300 percent to 500 percent except on a very limited portion of their total investments. But their intent is to find venture projects with this appreciation potential to make up for investments that aren't successful.

Venture capital is a risky business, because it's difficult to judge the worth of early stage companies. So most venture capital firms set rigorous policies for venture proposal size, maturity of the seeking company, re­quirements and evaluation procedures to reduce risks, since their investments are unprotected in the event of failure.

Size of the Venture Proposal.

Most venture capital firms are interested in investment projects requiring an investment of 250,000 Pounds  to 2,500,000 Pounds. Projects requiring under 250,000 are of limited interest because of the high cost of investigation and administration; however, some venture firms will consider smaller proposals, if the investment is intriguing enough.

The typical venture capital firm receives over 1,000 pro­posals a year. Probably 90 percent of these will be rejected quickly because they don't fit the established geographical, technical, or market area policies of the firm -‑ or because they have been poorly prepared.

The remaining 10 percent are investigated with care. These investigations are expensive. Firms may hire consultants to evaluate the product, particularly when it's the result of innovation or is technologically complex. The market size and competitive position of the company are analyzed by contacts with present and potential customers, suppliers, and others. Production costs are reviewed. The financial condition of the company is confirmed by an auditor. The legal form and registra­tion of the business are checked. Most importantly, the character and competence of the management are evaluated by the venture capital firm, normally via a thorough background check.

These preliminary investigations may cost a venture firm between 2,000 and 5,000 pounds per company in­vestigated. They result in perhaps 10 to 15 proposals of interest. Then, second investigations, more thorough and more expensive than the first, reduce the number of proposals under consideration to only three or four. Eventually the firm invests in one or two of these.

Maturity of the Firm Making the Proposal.

Most ven­ture capital firms' investment interest is limited to pro­jects proposed by companies with some operating history, even though they may not yet have shown a profit. Companies that can expand into a new product line or a new market with additional funds are particularly interesting. The venture capital firm can pro­vide funds to enable such companies to grow in a spurt rather than gradually as they would on retained earn­ings.

Companies that are just starting or that have serious financial difficulties may interest some venture capitalists, if the potential for significant gain over the long run can be identified and assessed. If the venture firm has already extended its portfolio to a large risk concentration, they may be reluctant to invest in these areas because of increased risk of loss.


Management of the Proposing Firm.

Most venture capital firms concentrate primarily on the competence and character of the proposing firm's management. They feel that even mediocre products can be suc­cessfully manufactured, promoted, and distributed by an experienced, energetic management group.

They look for a group that is able to work together easi­ly and productively, especially under conditions of stress from temporary reversals and competitive pro­blems. They know that even excellent products can be ruined by poor management. Many venture capital firms really invest in management capability, not in pro­duct or market potential.

Obviously, analysis of managerial skill is difficult. A partner or senior executive of a venture capital firm normally spends at least a week at the offices of a com­pany being considered, talking with and observing the management, to estimate their competence and character.

Venture capital firms usually require that the company under consideration have a complete management group. Each of the important functional area - pro­duct design, marketing, production, finance, and control - must be under the direction of a trained, experienced member of the group. Responsibilities must be clearly assigned. And, in addition to a thorough understanding of the industry, each member of the management team must be firmly committed to the company and its future.

The "Something Special" in the Plan.

Next in impor­tance to the excellence of the proposing firm's manage­ment group, most venture capital firms seek a distinc­tive element in the strategy or product/market/process combination of the firm. This distinctive element may be a new feature of the product or process or a par­ticular skill or technical competence of the manage­ment. But it must exist. It must provide a competitive advantage.

...to be continued

Monday, 11 June 2012

Is your management growing with your business?


Effective management is the key to the establishment and growth of the business. The key to successful management is to examine the marketplace environment and create employment and profit opportunities that provide the potential growth and financial viability of the business. Despite the importance of management, this area is often misunderstood and poorly implemented, primarily because people focus on the output rather than the process of management.
Toward the end of the 1990s, business managers became absorbed in improving product quality, sometimes ignoring their role vis-a-vis personnel. The focus was on reducing costs and increasing output, while ignoring the long-term benefits of motivating personnel. This shortsighted view tended to increase profits in the short term, but created a dysfunctional long-term business environment.
 Simultaneously with the increase in concern about quality, entrepreneurship attracted the attention of business. A sudden wave of successful entrepreneurs seemed to render earlier management concepts obsolete. The popular press focused on the new cult heroes Steve Jobs and Steve Wozniack (creators and developers of the Apple Computer) while ignoring the marketing and organizing talents of Mike Markula, the executive responsible for Apple's business plan. The story of two guys selling their Volkswagen van to build the first Apple computer was more romantic than that of the organizational genius that enabled Apple to develop, market and ship its products while rapidly becoming a major corporation.
In large businesses, planning is essential for developing a firm's potential. However, many small businesses do not recognize the need for long-range plans, because the small number of people involved in operating the business implies equal responsibility in the planning and decision-making processes. Nevertheless, the need for planning is as important in a small business as it is in a large one.

Few decades ago, Alvin Toffler suggested that the vision of the citizen in the tight grip of an omnipotent bureaucracy would be replaced by an organizational structure of "ad-hocracy." The traditional business organization implied a social contract between employees and employers. By adhering to a fixed set of obligations and sharply defined roles and responsibilities, employees received a predefined set of rewards.
 The organizational structure that Toffler predicted in 1970 became the norm 20 years later, and with it came changed concepts of authority. As organizations became more transitory, the authority of the organization and firm was replaced by the authority of the individual manager. This entrepreneurial management model is now being replicated throughout society. As a result, the individual business owner must internalize ever increasing organizational functions.
 Another change in today's business environment is dealing with government agencies. Their effect on the conduct of business most recently appears to have increased. As industries fail to achieve high levels of ethical behavior or individual businesses exhibit specific lapses, the government rushes in to fill the breach with its regulations.



Thursday, 7 June 2012

The Underground Economy

There is a bustling and shadowy world where jobs, services, and business transactions are conducted by word of mouth and paid for in cash to avoid scrutiny by government officials. It is called the “underground economy,” which is as old as government itself.
It springs from human nature that makes man choose between given alternatives. Facing the agents of government and their exactions, man will weigh the alternatives  and may choose to go “underground.”
In our era, man has again become a subject under the watchful eye of government.
When government intervention fails to satisfy him, or even works evil, he is slow to relinquish his notions and prejudices. He may cling to them with tenacity and perseverance, but may seek to avoid the ill effects through circumvention, evasion, and escape.He may find his way to the “black market,” where economic transactions
take place in violation of price control and ration laws. Or he may descend to the “underground” where political edicts are ignored and exactions avoided through word-of- mouth dealings and cash transactions.
The underground economy must be distinguished clearly and unmistakably from the criminal activities of the underworld.
Government officials and agents are ever eager to lump both together, the criminals and their organization with the producers in the underground. Both groups are knowingly violating laws and regulations and defying political authority.
But they differ radically in the role they play in society. The underworld comprises criminals who are committing acts of bribery, fraud, and racketeering, and willfully inflicting wrongs on society. The underground economy involves otherwise law-abiding citizens who are seeking refuge from the wrongs inflicted on them by government. They are employers and employees who are rendering valuable services without a license or inspection sticker, or failing to report their productive activities to the political authorities.
Underground activities can be grouped into four main categories:
  1. Economic activity yielding income that is not reported to the tax authorities.
  2. Economic production that violates one or several other mandates, such as compulsory government licensing and rate making, inspection and label laws, labor laws, government regula tions of agriculture, export and import controls, government control over money and banking, governmental control of energy production and distribution, andcountless others. Violators may or may not evade taxes, but they all work illegally, hiding from swarms of government inspectors.
  3. Productive activity by transfer beneficiaries who draw Social Security benefits or receive public assistance. Their freedom to work is severely restricted.
  4. Productive activity by illegal aliens without residence status. They may pay income taxes and other taxes, but must remain underground for fear of deportation
Many people enter the labor market via the underground. As young children they may earn their pocket money through odd chores that make  them think, and teach them to be attentive, industrious, and confident.
Many parents are convinced that children should labor to be healthy and happy. But if they should work they probably violate some child- labor law. And if they should neglect to file an income tax return and fail to pay
the levies, the children are actually working in the underground. Surely, there is a minimum amount that is exempt from income taxation.
In a climate of economic stagnation and decline the underground economy serves a useful economic and social function. It provides jobs to millions of willing workers, affords opportunities for learning and
training, and teaches the importance of individua l initiative. It constitutes an important safety valve that relieves discontent and tension in a world wracked by political disruptions.