Q U A E S T U S Strategy & Marketing Consultants
Don't bother to look for venture capital unless you forecast
a 1,000% return over five years
One common myth is that venture capitalists invest in good people and good ideas. While that is true the reality is that they invest in good industries with profit potential. If a venture capitalist decides to invest in technology, he/she will avoid the early stages of development where there is uncertainty about the technology and market demand. In addition, the venture capitalist will avoid the later stages where competition and consolidation rule and growth rates dip significantly. The venture capitalists see their niche in the segment of high growth where an investee company can fill a market need. They will identify management who can deliver to this demand or who can advance the technology to a stage of approval in market acceptance. This achievement may also provide them with an exit opportunity from the investment thus reducing the risk considerably and earning a good return. Alternatively the VC may install a new management team to take the company forward to the next stage of development.
The venture capital industry has four main players: entrepreneurs who need funding; investors who want high returns; investment bankers who need companies to float or sell; and the venture capitalists who make money for themselves by making a market for the other three. In a typical deal, the venture capital fund may buy in at a favourable rate, often ignoring market valuation. They have a blocking right over key decisions by management should the company falter and have to raise additional capital; the venture capitalist will likely be given shares to maintain its equity position. Alternatively if a company is thriving, investors may enjoy the right of further investment at a predetermined price. This means that they can increase their investment at below market price.
A venture capitalist who finances the initial two years of a company's start up will expect a return on the order of tenfold over five years.
When combined with the preferred position of the venture capitalist this is expensive capital - something of the order of circa 58% compound interest. This high rate is needed to return fund averages in excess of 20% as the fund will contain a lot of losers and laggards. Only one in ten companies will be a "winner". Darach McEvoy is managing director of
Quaestus, Strategy and Marketing