Venture Capital: January 2010

Saturday, January 23, 2010

Derisking to Make Your Business More Attractive to Venture Capital Investors

Derisking is the process of removing risk factors from your business in order to make it more attractive to an outside investor or to an outside buyer. It is one of the most important factors in the grooming process in order to be an attractive company to invest in i.e. "Investor Ready".

There are dozens of areas and hundreds of ways in which a business may be exposed without knowing it. In the normal course of business an owner may not worry about these factors, as they are within the "comfort zone" of operation. For an external party to get involved however, they need a much more transparent organisation so they are not confronted at a later date with skeletons in the closet.

It is important because businesses already face uncertainty. And while a venture capital investor may have a reasonable tolerance for risk, they will not welcome unnecessary risk. The goal is to control as many areas of risk as possible, so at least the risks are known. Most companies who have had an internal focus (i.e. have focused on sales, marketing and operations in order to grow) have not thought about all the areas in which they are vulnerable.

The process of derisking limits the areas of exposure, and therefore decreases exposure to uncertainty. It also increases the chance of success through improvements in clarity in almost all areas of the business.

Derisking falls into two areas - one is simply clarification (i.e. creating a contract where an informal arrangement was in place) and the other a change of substance i.e. changing a supplier because it lowers risks.

Some examples include:

Formalising employee agreements. This may mean creating contracts for employees that have previously operated without one, or strengthening existing contracts. Particular issues would be with protection of IP, ownership of IP, confidentiality and restraint of trade after employees leave.
Creating / clarifying written agreements with suppliers
Creating/ clarifying agreements with customers
Moving "ad hoc" sales to contracted revenue where possible
Formalising and documenting internal processes
Protection of IP - patents, designs, copyright and so on.
Protection of data by limiting and monitoring access to key systems (CRM, accounts etc)
Key employee insurance (including of the owners) in the event of death.
Creating or clarifying credit terms and policies. Getting credit offered back within trading terms, and ensuring that all credit offered is documented with the correct application forms and personal guarantees.
Removing reliance on key personnel, in particular vulnerability to information or relationships which may be lost on their departure. This may mean adding additional points of contact to key client accounts so individual relationships are less critical.
Documenting key processes - getting the knowledge out of people's heads
Ensuring insurances of assets are up to date, and sufficient.
Lowering legal exposure (liability). Ensuring insurances are held that cover product liabilities and so on.
Ensuring compliance with all ATO and ASIC regulations. Creating systems for their ongoing compliance.

As you can see, this is a lengthy, but not even remotely exhaustive list. Often an audit is carried out which will highlight those areas which need further work. This might cost several thousand dollars, and lead on to significantly more expense than that. In some cases the process may take a year, and cost hundreds of thousands of dollars.

One of the important things to remember in raising capital is to build in the cost of raising the capital.

This falls into two main areas:

Actual costs - such as hiring consultants - legal, accounting, corporate advisors, strategists etc
Opportunity cost and change in focus. The process of raising capital for business can take anywhere from three months to a year (or more) of attention from key owners and managers of the business. During this time, it can be difficult to maintain a normal focus on things which are essential for survival - sales, marketing and operations for example. This cost can be significant, while at the same time be difficult to measure. In fact, this defocusing is a major impact for any growing company that is pursuing two goals - new business, and business funding (or preparing for a sale of the business).

The need to derisk is apparent if you place yourself in the shoes of a buyer contemplating a purchase of (or investment in) your company. Without going through the derisking process, your company could contain any one of a dozen hidden time bombs (key staff who could leave and set up in competition, unsettled legal issues, poor data security etc). By transparently documenting how you have examined, reduced or been able to totally eliminate risks in your business then you are showing a buyer that you understand their concerns.

The flip side of the coin is that your company is now a far more attractive proposition to purchase or invest in. You will have invested a significant amount of money in the derisking process, but the result will be a company that is now sellable (all other things being equal) compared to a mystery. This means first of all that you may achieve a sale when previously none would have taken place, and secondly that you are likely to achieve a far higher sale price than before.

The Venture Capital Centre works with businesses at all stages of their evolution through corporate and business advisory and can assist companies with raising venture capital.

Businesses that are seeking capital for growth in their organisation can be confident with access to our sophisticated investors, venture capitalists and private equity.

Article Source: http://EzineArticles.com/?expert=Dennis_Robertson

Alternative Options to Venture Capital For Raising Growth Capital

Venture Capital is a specific term that refers to funding obtained from a venture capitalist. These are professional serial investors and may be individuals or part of a firm. Often venture capitalists have a niche based on business type and or size and or stage of growth. They are likely to see a lot of proposals in front of them (sometimes hundreds a month), be interested in a few, and invest in even fewer. Around 1-3% of all deals put to a venture capitalist get funded. So, with the numbers that low, you need to be clearly impressive.

Growth is usually associated with access to, and conservation of cash while maximising profitable business. People often see venture capital as the magic bullet to fix everything, but it isn't. Owners need to have a huge desire to grow and a willingness to give up some ownership or control. For many, not wanting to lose control will make them a poor fit for venture capital. (If you work this out early on you might save a lot of headaches).

Remember, it's not just about the money. From the perspective of a business owner, there is money and smart money. Smart money means it comes with expertise, advice and often contacts and new sales opportunities. This helps the owner, and the investors grow the business.

Venture Capital is just one way to fund a business and in fact it is one of the least common, yet most often discussed. It may or may not be the right option for you (a discussion with a corporate advisor might help you decide what is the right path for you).

Here's a few other options to consider.

Your Own Money - many business are funded from the owner's own savings, or from money drawn from equity in property. This is often the simplest money to access. Often an investor would like to see some of the owner's fund in the company ("skin in the game") before they'd consider investing.

Private Equity - Private Equity and Venture Capital are almost the same, but with a slightly different flavour. Venture Capital tends to be the term used for an early stage company and Private Equity for a later stage funding for further growth. There are specialists in each area and you'll find different companies with their own criteria.

FF & F - Family, Friends and Fools. Those closer to the business and often not sophisticated investors. This type of money can come with more emotional baggage and interference (as opposed to help) from its providers, but may be the fastest way to access smaller amounts of capital. Often multiple investors will make up the overall amount needed.

Angel Investors - The main business angels vary from venture capitalists in their motives and level of involvement. Often angels are more involved in the business, providing ongoing mentorship and advice based on experience in a particular industry. For that reason, matching angels and owners is critical. There are substantial easily locatable networks of angels. Pitching to them is no less demanding than to a venture capitalist as they still review hundreds of proposals and accept only a handful. Often the demands around exit strategies are different for an angel and they are satisfied with a slightly longer term investment (say 5-7 years compared to 3-4 for a venture capitalist).

Bootstrapping - growing organically through reinvesting profits. No external capital injected.

Banks - banks will lend money, but are more concerned about your assets than your business. Expect to personally guarantee everything.

Leases - this may be a way to fund particular purchases that allow for expansion. They will normally be leases over assets, and secured by those assets. Often it is possible to lease specialist equipment that a bank would not lend on.

Merger / Acquisition Strategy - you may seek to acquire or be acquired. Generally even a merger has a stronger and a weaker partner. Combining the resources of two or more companies can be a path to growth - and when it is done with a company in the same business, can make a lot of sense - on paper at least. Many mergers suffer from differences in culture and unforeseen resentments that can kill the benefits.

Inventory Financing - specialist lenders will lend money against inventory you own. This may be more expensive than a bank, but might allow you to access funds you could not have otherwise.

Accounts Receivable Financing / Factoring - again a specialist area of lending that may allow you to tap into a source of funds you didn't know you had.

IPO - this is normally a strategy after some initial capital raising and having proven a business is viable through the development of a track record. In Australia there are various ways to "list". They are useful for raising larger amounts of money ($50m and up) as the costs can be quite high ($1m plus).

MBO (Management Buy Out) - This tends to be a later stage strategy, rather than a startup funding strategy. In essence debt is raised to buy out the owners and investors. It is often a strategy to gain back control from outside investors, or when investors seek to divest themselves from the business.

One of the most important things to remember across all these strategies is that they all require a significant amount of work in order to make them work - from the way the business is structured, to dealings with staff, suppliers and customers - need to be examined and groomed so that they make the company attractive as an investment proposition. This process of grooming and derisking can take anywhere from three months to a year. It is often costly both in actual expenses (consultants, legal advice, accounting advice) as well as changing the focus of the owners from "sticking to the knitting" and making money within the business to a focus on how the business presents itself.