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Venture capitalists are the entrepreneurs to invest in other entrepreneurs, investors and other risks, they through the investment profit. But the difference is venture capitalists all cast out of the capital owned by all of its own, and not entrusted the management of capital.
Funding Guide The MSC Technopreneur Development Flagship prepared this funding section for entrepreneurs involved in the ICT/multimedia industry in Malaysia. Its aim is to serve as a guide to the various sources of funding available to entrepreneurs in the local ICT/multimedia industry. This area covers an overview of venture Capital and seeks to give entrepreneurs a brief introduction to the industry. Please visit our Venture Capital directory, Business Angel directory, Grant directory and Debt Financing directory for information on sources of funding and grants. What Is Venture Capital? What Is The Difference Between Venture Capital, Angel Funding, Debt Financing and Grants? What Are The Various Stages of Company Growth? Why Is Venture Capital Needed? Why Is Venture Capital Needed? What Is The Current State Of The Venture Capital Industry In Malaysia? What Do Venture Capitalists Look For? How Do I Approach A Venture Capitalist? What Is Venture Capital? Venture capital (VC) is in a nutshell “risk money”. This is because VC investments in companies are often not supported by any collateral and venture capitalists are dependent on the founders/management to make a success of the company. Thus, whilst venture capitalists put in sizeable investments into companies, they have little control over the management of the company and face the risk of losing their entire investment in the event the company fails. However, the high risk is offset by high returns when an investee company succeeds – in fact, because of the spectacular successes of some investee companies within the entire portfolio, venture capitalists expect to produce an ROI (return on investment) of at least 20% to 25% per annum on the VC funds they manage. This level of ROI is exceptional compared to many investment benchmarks such as the S&P Index and US Treasury Bills. VC investments are typically equity based, meaning that the venture capitalist takes a percentage of the equity in the company that receives VC funding. Unlike debt financing through bank loans for instance, VC funding requires no collateral and no repayment period. The venture capitalist receives its repayment in the form of – hopefully huge – capital gains when the investee company undergoes a liquidity event, for example, an IPO or trade sale. Due to the high risk nature of the investments, venture capitalists will carry out extensive screening, or due diligence in VC parlance, on potential investee companies from various aspects such as management, technology, and business model. A venture capitalist typically looks at a mid-to-long term partnership (3-5 years) with any company that receives its funding. The keyword “partnership” is important here – venture capitalists are not mere providers of capital, but business partners providing guidance, management assistance and networking to companies in their portfolio. What Is The Difference Between Venture Capital, Angel Funding, Debt Financing and Grants? It should be noted that different enterprises present different risk profiles to financiers, hence the need for different funding regimes such as venture capital, angel funding, grants and debt financing. Enterprises that do not fit the criteria for one funding regime may well fit another. For example, a solid yet low-growth company may not be suited for venture capital funding but would be better served by a working capital loan to finance its operations. Similarly, a company heavily involved in R&D should target the many R&D grants available rather than apply for debt financing. Venture CapitalAngel Debt Financing Grants Funding Objective Capital gains Capital gains Interest and Development principal Holding Mid-to-long term Short-to-mid Short-to-mid - Period term term Collateral No No Yes - Criteria Potential returns Potential Interest spread - on investment returns on and security investment Impact on Reduce leverage Reduce Increase - Balance leverage leverage Sheet Impact on Dividend payout Dividend Interest/principal - Cash Flow payout repayment Monitoring Seat on Board of Management Loan servicing - Directors, control in monthly/quarterly day-to-day operational operations & reports decision- making Value Add Management Management None - assistance, assistance, strategic strategic alliances through alliances contacts etc. through contacts etc. Exit IPO, trade sales, Trade sale, Principal - Mechanism buy-back buy-back repayment What Are The Various Stages Of Company Growth? The terms seed stage, startup, mezzanine and others are often used by venture capitalists in categorising a company’s stage of growth. Although their classification may differ slightly from one venture capitalist to another, the stages of company growth can be broadly classified into the categories below. Stage of Growth Description Pre Seed Individuals or companies that just have ideas or concepts and require funds for prototypes or proof of concept Seed/Start up Companies that may be in the process of setting up or have been in business for a short period of time and require capital for commercialisation in the areas of production, marketing or sales. These companies may not be generating profits yet Growth/Expansion Companies that may be breaking-even or trading profitably but require additional capital to increase production, expand market presence and/or further develop their products Mezzanine/Pre- Companies that are seeking capital, advisors and IPO partners to assist in a public floatation or corporate exercise IPO/Public Companies that are publicly quoted on a stock exchange It is important to note that different venture capitalists may choose to focus their funding on different stages of company growth based on their risk appetite. In general, the earlier the stage of growth of a company, the higher the risk or probability of failure. It is therefore imperative for the entrepreneur seeking funding to ensure that his company’s stage of growth (or its risk profile) is compatible with the risk appetite of the venture capitalist he is approaching; the company will not be funded if there is a mismatch. Why Is Venture Capital Needed? Despite having excellent business ideas, many companies have failed to succeed due to the difficulty in financing their operations in the early stage of company growth. At this point, the company is still developing its products/services and may have limited sales, and is therefore unable to cover its expenses. A graphical representation of the various stages of company growth is shown below. Due to the lack of tangible, bankable assets, and a reliable, profitable track record, a company is unlikely to obtain loans from banks and other “traditional” sources of financing. This is where VC money serves a purpose. VC funds are often geared towards funding high-risk early stage companies that offer potential for high growth and returns because of their innovativeness. It is at this stage that the venture capitalist steps in with the funding required; in addition, the venture capitalist will more often than not help enhance the company’s business model and facilitate the growth of the company towards becoming a profitable self- sustaining entity. However, it should be noted that venture capital is relevant not just for companies in the early stage of development but at all stages of growth. What Is The Current State Of The Venture Capital Industry In Malaysia?* Malaysia Venture Capital Management Bhd (MAVCAP) and MSC Malaysia – through its caretaker Multimedia Development Corporation (MDeC), had signed a Memorandum of Agreement (MoA) in June 2008, aimed at spurring the growth of the indigenous industries and nurturing them into global players. An initiative, known as Innovation Eco-System for Industry Development, is aimed at enhancing competitiveness of the information and communications technology (ICT) industry by addressing the challenges faced by technopreneurs namely technology risks, funding risks and market risks. This initiative plans to facilitate the formation of necessary connectivity from technology perspectives, funding assistances and market access. Under the MoA, MIMOS will help facilitate with technology acquisition and adaptation, CIP to fund promising ideas and provide mentoring and commercialization support, MDeC to assist with Technoprenuer Development and Market Access while MAVCAP consider injecting necessary Commercial venture funding. The VC industry in Malaysia continues to play an important role in providing an alternative source of financing to the economy. On this note, new funds raised in Malaysia’s venture capital industry in 2006 had increased significantly to RM715 million from RM323 million in 2005. Government agencies and local corporations continue to contribute to the majority of these funds at 40.73 percent and 37.59 percent respectively. The Malaysian government, having long recognised the strategic importance of the venture capital industry as a source of funding for growth, has been promoting the industry through the provision of funds and incentives. These measures include the RM1.6 billion allocated for venture capital under the Ninth Malaysia Plan to bridge the crucial financing gap in the early stages of enterprise development, and tax exemption for 10 years granted to venture capital companies investing at least 50 per cent of funds in seed capital, as announced under the 2007 Budget. Excerpt from: http://www.mvca.org.my http://www.mimos.my What Do Venture Capitalists Look For? Venture capitalists typically look at several fundamental investing principles when evaluating a company’s attractiveness as an investment. When assessing the company and its business plan, the key factors examined and some typical areas of focus are: Management o Is management committed? How much of a stake do they have in the company? o Is management focused and of high caliber? What is their expertise and background? o What is the track record of the senior management team? o Have they been successful businessmen or entrepreneurs before? o Is the management team complete? • Product/Service or Technology o What is the value proposition to customers? o Is the product/service or technology unique? What are its breakthrough qualities? o Does the company have a sustainable competitive advantage? o What are the barriers to entry for other companies? o Does the company own the intellectual property/patents? Business Model o What are the revenue drivers? o How workable is the business model? o Is the business sustainable? Is there a clear path to profitability? o How will the company market its product/service? • Market o Is the market insular, regional or global? o Is it expanding, shrinking or plateauing? o Are there signifcant competitors in the market? o How does the company stack up? o Do potential customers exist or does the market have to be created? • Financial and Legal o Are the company’s financial projections reasonable? o How well does the company manage its cash? o Is the valuation offered reasonable given the company’s track record (if any), potential for growth and current market conditions? o What is the likelihood of an exit event (IPO, trade sale etc) within the next 3-5 years? o What is the expected return on investment (ROI)? o What are the terms and conditions of investment that the entrepreneur is willing to accept? Is there a seat on the board of directors for the venture capitalist? Although all the factors above are important, having a solid management team ranks as one of the more salient attributes that a venture capitalist would look for. Be sure to cover these key areas before meeting a venture capitalist and while crafting your business proposal. How Do I Approach A Venture Capitalist? When approaching these exotic creatures known as venture capitalists for funding, we the following advice for the entrepreneur: • Understand the risk profile you present to the venture capitalist i.e. whether your company is in the seed, startup, growth or mezzanine stage. The earlier the stage of growth, the riskier the investment for the venture capitalist. Hence, this impacts whom you approach and also the valuation of your company. • Know your investor and their investment focus areas – be it communications, content, biotechnology and so on. • Look for value in addition to money, that is, make sure the venture capitalist can provide guidance, contacts and other value added assistance in addition to monetary investment. • Have a complete business plan ready • Be realistic about your valuation, rollout and IPO plans • Know your market segment or niche • Separate hype from reality. Investors do try to verify your claims • Be upfront and honest • Keep an open mind. Many venture capitalits are free with their advice, so use the advice to improve your proposal further
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