Tag Archives | venture capital

What is a Term Sheet?

See Also:
Other Peoples Money
Angel Investor
Venture Capital
5 Cs of Credit
Working Capital

What is a Term Sheet?

What is a term sheet? It contains the terms of an investment made by a venture capital firm. It is a summary of the legal and financial terms of a proposed deal. Basically it is a letter of intent (LOI) for venture capital investments.

Term Sheet & Valuations

It is important to understand the pre and post money valuations of your firm if you are taking on a VC partner. Contain the details of these valuations within the term sheet. It is important to understand how much of the equity you will hold after the transaction. Each round of equity financing typically has its own terms.

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term sheet, What is a Term Sheet

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Venture Capitalists Definition

See Also:
Why Venture Capital
The Dilemma of Financing a Start-up Company
Angel Investor
What is a Term Sheet
Working Capital

Venture Capitalists Definition

A venture capitalist is an investor who invests in risky startup businesses. The venture capital investor provides funding to an entrepreneur who may not have access to substantial bank loans or other sources of capital. Venture capitalists also invest in small companies that are expanding. They also invest in private companies planning to go public. They will often want to participate in the decision-making of the business in which they invest.

Venture Capital Investor

The venture capital investor may be one of the following:

Consider venture capital investing to be high risk and high yield. Additionally, the recipients of venture capital loans are typically small startup companies with great growth potential.

Venture Capital Funding

Venture capital funding is a source of private equity for startups, small expanding companies, and private companies that are planning to go public.

The startup business is usually at the earliest stages of development. In addition, it may be little more than an idea and a business plan. Because the startup enterprise has no record of success, the venture capital investment is considered risky. In return for the venture capital funding, the venture capitalist typically wants high returns on the loan as well as a stake in the equity of the startup company.

If the recipient is a small expanding company or a private company planning to go public, then they may not have access to substantial funding from commercial bank loans or capital markets. In any case, the venture capitalist can be a good source of funding when the business has few or no other alternatives.

Venture Capitalist Funds

Venture capital funds are pools of capital from various investors, such as wealthy individuals or investment banks. They are managed and invested in various startups or other risky enterprises. The funds seek investment opportunities with great growth potential. Consider the venture capital fund a high risk investment. As a result, investors expect to be compensated for the high risk with high yields. If you want to remove any potential destroyers risking your investment, then download the Top 10 Destroyers of Value whitepaper.

Venture Capitalist Funds, Venture Capital Investor, venture capitalists definition

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Why Venture Capital?

See Also:
The Dilemma of Financing a Start-up Company
Angel Investor
Mezzanine Debt Financing
What is a Term Sheet
Working Capital

Why Venture Capital?

Why venture capital versus other forms of equity? For one, VC partners tend to be experienced entrepreneurs themselves who have taken a startup from inception to an exit through an IPO or private sale once or more. They can help an entrepreneur avoid common mistakes and also help position the company as it nears an exit opportunity.

They also tend to have a large number of industry contacts, which can make it easier to strike deals with suppliers and customers, as well as weather the ups and downs within a given market.

It should be noted that most VC backed startups fail, but the ones that do succeed can do so spectacularly, as a host of VC backed firms, especially in tech, have done so since 1995, such as eBay, Yahoo!, and Google.

But one must know why they believe they need to bring in a VC investor. It can be costly and business history is replete with examples of entrepreneurs who took their startup from an idea on the back of an envelope into some of the largest firms in the world without any outside equity partners.

What is Venture Capital?

Venture capital is an expensive form of financing for an entrepreneur. With most VC funds expecting compounded annual returns in excess of 25% from their investments, an entrepreneur can find themselves giving up a substantial part of their equity in the company, not to mention the loss of control and a new demanding partner to contend with. So why do it?

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why venture capital
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Venture Capital

See Also:
Every Business Has A Funding Source, Few Have A Lender
Don’t Tell Your Lender Everything
Due Diligence on Lenders
The Relationship With Your Lender
What Does A Lender Want To Know?

Venture Capital Definition

The Venture Capital definition is a funding source for start-up businesses or turnaround businesses. There is typically more risk associated with these types of investments, but high returns as well.

Venture Capital Meaning

The Venture Capital meaning is when a lender, usually a private equity group or high net worth individuals, provides financing for a new business, a business that needs cash for growth, or a company attempting to make a turnaround. Associated with these different business needs are the different stages of venture capital.

Seeding Stage

The first stage for the companies that are just starting up is known as the seeding stage.

Growth Stage

The next stage is the growth stage for those businesses that are not quite ready for an Initial Public Offering (IPO), but are in need of some financing to get them to that point. Often times venture capital firms provide the funding for these companies knowing that they are high risk. However, these lenders usually earn a high return as these companies go public. This is because the lenders receive large compensation in the form of equity in the company or a large cash settlement. If a company is in a turnaround stage this is the highest risk of venture capital.

Exit Stage

The exit strategy in this stage often go for a much higher cash option or equity stake than even the first and second stages of company development. This type of capital is often necessary because the companies in need of this financing are not large enough to obtain the capital from the markets in the quantity needed.

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Internal Rate Of Return Example

See Also:
Internal Rate of Return Method
Discounted Cash Flow vs. IRR
NPV vs IRR
Required Rate of Return

Internal Rate of Return Example

An internal rate of return example is quite common in capital markets. The internal rate of return example below will be seen by anyone seeking angel, venture capital, equity mezzanine, or other forms of Owner’s Equity.

For example, Techco has developed a revolutionary online shopping cart for e-commerce. It believes that, with an investment for marketing expenses, the company concept can be quickly grown to profitability.

Capco is a venture capital firm that invests in early-stage companies that serve the business to business market. Furthermore, Capco invests only in companies with an existing product and an expectation of quick return on equity. They use the internal rate of return method and only invest in companies which currently have a rate of return of 30% or more. So, their IRR hurdle is 30%.

Initial Investment -$5000 Cash flow in Year 1 $1,000 Cash flow in Year 2 $3,000 Cash flow in Year 3 $6,000

Techco and Capco had a great first meeting. Techco would love to gain marketing expertise and funding from the Capco team. Capco appreciates the experience of the Techco management team, feels the company concept fits well into their field of interest, and knows that this investment has the growth potential necessary. The only concern is whether Techco can yield the required IRR calculation of 30%.

IRR Calculation

To make the final decision, Techco and Capco run the following IRR formula calculation as an internal rate of return financial calculator:

0 = -$5000 + ($1000 / (1 + IRR) ^1) + ($3,000 / (1 + IRR) ^ 2) + ($6,000 / (1 + IRR) ^ 3)

IRR = 32.979%

Techco and Capco mutually come to the conclusion that Techco’s IRR is 32.979%. As a result, Capco is confident that since Techco’s internal rate of return model is currently above 30%, it will probably grow with additional marketing. Capco and Techco, because of this, decide to become partners.

Private equity markets regularly deal with the above internal rate of return formula example and IRR formula calculation. As a matter of survival, they must have a strong grasp of the IRR definition, IRR formula, and IRR limitations.

Limitations of Internal Rate of Return

The internal rate of return calculation assumes that you will reinvest cash flows each year at a constant rate. For those internal rate of returns that are high (greater than 25%), it is impractical to think that you will find alternative investments at that same higher rate. This limitation is the biggest drawback to using the internal rate of return method. In order to compensate for the high return of the internal rate of return calculation, the Modified Internal Rate of Return (MIRR) was created so that the annual cash flows are reinvested at a lower, more probable reinvestment rate.

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Internal Rate of Return example

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Business Driver Example

See Also:
Business Drivers
Planning Your Exit Strategy
Selling Your Business to a Private Equity Group
Leadership Action Plan

Business Driver Example

Look at the following business driver example. Dan is the owner of a startup web development firm. He has done his initial research, written a business plan, and is prepared for the operations of his business. Now, Dan needs to understand the business drivers of software development. Understanding the business drivers can give an owner a better overall understanding of their company. In other words, the more knowledgeable an owner is about the inner workings of his/her company, the more successful his company has the capability to be.

To do this, Dan begins by finding all the reading materials he can. He studies technologies, operations, human resources, and most importantly marketing and sales. Dan is attempting to discover the business drivers for enterprise architecture. He is on the path to achieving this goal.

Meet With Experts

Next, Dan attempts to meet experts in the industry. He starts with those who are close to him: family, friends, and college acquaintances. Then, he begins to find and attend networking events related to his industry. In these places Dan will flush out those who truly know about the business drivers in software development.

Dan has found information as well as experts in both operations and marketing. Now, Dan must find experts in financing his firm. He attends banker’s organizations, venture capital networking events, and his local angel investors conference. Dan, due to the assets he holds, has settled on a bank loan as his method of financing.

Conclusion

In conclusion of this business driver example, Dan’s future seems bright as he paves the way for his success. By constantly studying the business drivers, software development success is only a matter of time. He prepares for the future, resolves to save cash as best he can, and aligns his thoughts for his future.

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business driver example

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