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By M. Isi Eromosele
There are only three basic ways to get your invested money
out of a business:
- It can
go public (this is one of the most common ways VCs reach liquidity).
- A
business in the same industry (a strategic buyer) or another investor
group (a financial buyer) may want to buy the entire business, pay off its
debts, and give the existing stockholders a good return on investment.
- The company can simply buy out the VC by refinancing the company out of cash flow.
The point being made here is this: Make sure there are ways
for you, the venture capitalist, to get out of the deal (a liquidity event)
before you get into a venture capital investment.
Creating A Partnership
When you put substantial money into a private company, you
are not really making an investment as much as you are creating a partnership. The
relationship between the investor and the entrepreneur is a strong partnership.
It must be a trusting relationship in which neither party is tries to get the
upper hand.
Both parties must work together to make money. Therefore, every
investor should get
to know the management of a company before investing any money
in it. Try to spend extra time with members of the management team so that both
parties would feel comfortable with one another.
Written Summary
Prepare a thumbnail sketch of the company’s present
situation. As the investor, emphasize the strong points that draw you toward
this investment. You should be able to do this in one paragraph, perhaps two. It
should be brief and it should crystallize in your mind the business situation
that you are getting involved with.
If you cannot do this in a few words, ask yourself whether
you really know what you are investing in.
Management Team
Accentuate some of the highlights that make you want to
invest in the business, such as the entrepreneurs’ experience and past
achievements. Make sure you put down the names and the credentials of the top
two or three people in the enterprise.
Highlight in only two or three sentences what aspect of
their backgrounds sets them apart from other management teams that you have seen
and why their backgrounds are pertinent to this particular investment situation.
Remember, you are investing in a team.
What Is The Company Offering In Its Market?
Briefly describe the product or service the company is
selling. State why the product or service is unique, and if it is not unique, explain
why this product or service will succeed over other products and services that
are offered by the competitors.
You need not discuss the competition in detail, but it is
important to differentiate the company in summary form from others in the
industry. More than a paragraph here would be too much.
How Much Money Are They Raising?
Every business proposal tells you how much money its principals
are looking for, but the amount should not be expressed in ranges. For example,
the business proposal should not say $5 million to $10 million. The company
should know how much money it needs to do the job and should state that figure.
In addition, you will want to know the type of money that
the business is raising. Is it selling common stock, preferred stock, convertible
debentures, subordinated debentures, or junior loans with warrants? What
structure and format will be used in raising this money? You should know
exactly what the deal involves on all levels of the balance sheet.
How Is Your Investment Secured?
Even though you are an investor, your investment can be in
the form of debt with collateral security (sometimes referred to as second
liens). You may take a second mortgage on the assets of the business or you
might have outside collateral, such as a mortgage on the person’s house.
Venture capital takes many forms, but whatever the form, the
investor’s prime consideration should be how to lower his risk. Collateral is
one way to lower that risk. However, most VCs who invest using stock, options or
warrants are the farthest down on the balance sheet and usually never see any
type of collateral, which is why they demand such high returns.
Past Financial Performance
Here, you want to summarize the sales, earnings, assets, liabilities
and net worth of the company. In three or four columns, you should be able to
sketch out where the company has been and what kinds of trends it is setting. You
may be surprised by what you can learn by analyzing the business plan and
placing these items in your summary.
Future Projections
As a VC, take a long-range view of the situation. You should look at the five-year projections
for the company. Even though the fifth year is highly speculative, it gives you
a clear idea of how the company will grow and, in essence, how much money you
stand to make if it meets the projected goals.
Without a summary projection in the same format as the financial
history, you will not be able to develop a basic understanding of the company.
Always make your own projections and do it with your own
model. Building your own model will give you much deeper insights into the
business than you can ever get from reviewing someone else’s model. You need to
look at the business from your own perspective.
When Will You Cash Out?
No venture capital company wants to remain a stockholder in
a company forever. Every VC must realize the capital gains on the fund’s
investment in the business. Even though your horizon may be three to seven
years, you must have a clear perception of how you are going to get out of the investment
before you go into it. You should be able to state in
three or four sentences how you plan to get out of this
situation.
How Much Will You Make?
The expected profit is the final test of a promising
business proposal. If you own a certain percentage of the company, what will it
be worth when you cash it in? Set out in a tabular
format the cash that we will be expected to be put into the
company over the next seven years and the cash that we can expect to receive
back.
This format enables you to summarize clearly the cash in and
cash out. There are probably a thousand ways to determine this, but use a
calculator that gives you an internal rate of return.
If a company can’t show a strong internal rate of return and
the situation entails all of the typical risks of a venture capital investment,
it doesn’t deserve any more of your time.
M. Isi Eromosele is
the President | Chief Executive Officer | Executive Creative Director of Oseme
Group - Oseme Creative | Oseme Consulting | Oseme Finance
Copyright Control ©
2012 Oseme Group
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