Guest Post: Roberto Castro, fth Capital, LLC, Salt Lake City, Utah (www.fthcapitalllc.com)
Both innovation and intangible assets are critical factors that drive economic growth and enable companies and countries to set themselves apart. More often than not, the development of these factors requires capital.
In our experience, entrepreneurs of small and medium-sized companies are confounded by the funding choices that are available. An entrepreneur’s attempt to raise capital is a distraction from their business focus (a product or service) and/or core strengths. Since many endeavors fail, an entrepreneur’s plan will often be meet with skepticism. In the quest for capital the entrepreneur will likely encounter a fair number of “no’s” from potential funding sources.
However, there are a great number of funding sources and not all funding sources are alike. The purpose of this series is to highlight the funding sources, their market niche and factors that the different sources consider before giving the firm their approval or refusing the funding request.
The first part of this series covers venture capital. Dermot Berkery, General Partner with Delta Partners, a leading Dublin-based venture capital company that focuses on UK and Ireland, traces modern venture capital to the mid-1940’s when General Georges F. Doriot, a Harvard Business School professor, help launch American Research & Development, a publicly traded venture capital firm. One of ARD’s most renowned investments was an investment of $70,000, made in 1956 to a team of MIT scientists who had a plan to build powerful minicomputers. In return for this investment ARD ended up with 70% of that company; the company was Digital Equipment Corporation.
The VC model has evolved since then—full initial funding is a rarity … and also something that may not favor the entrepreneur—yet, venture capital remains relevant. It is an important funding source.
Assessing the Appropriateness of VC Financing
VCs seek growth and strong returns, that means that they are largely focused on firms that produce products and services that are unique, have strong management and intangible assets (people and/or intellectual property, such as patents), and enable them to exit at a substantial profit; the exit can be during one of the financing rounds or a reaching a milestone. So, where do VCs invest? It changes, but VCs are presently focused on software, biotechnology, nanotechnology, and alternative energy.
Who funds VCs? Pension plans and endowments provide the “dry powder” or cash for investments. Usually, the VCs will establish a fund for a term of 10-years, where the GPs can seek an extension of one to two years to unwind the investments made.
What is an ideal VC investment? VCs are less interested in financing start-up firms than in financing established, ongoing firms in which they can invest at least $5M in the first round of financing. Very few companies are funded that are just at the idea phase. VCs invest a very small percentage of their funds into seed capital for start-up firms. In such cases, the VC investment is usually at least $2M; VCs will usually provide the firm with several rounds of financing based on the firm achieving certain milestones.
How long will VCs keep an investment? Assuming the best case scenario, VCs will hold investments for 5 to 7 years. The exit strategy is typically through an IPO, sale to strategic buyer, or sale to another financial buyer, usually another VC or a Private Equity firm that invests either in that particular segment of the Middle Market.
