Analyzing Venture capital proposals – Criteria

A venture capitalist considers the following factors before committing the funds:

Fundamental Analysis:
Fundamental analysis refers to an examination of the fundamental aspects of the business, without which the investor cannot even begin an informed decision. As part of fundamental analysis, the following factors are considered:

1. History: A brief of the company, including date of incorporation and a summary of progress.
2. Management: The quality experience strategy and motivations of management directors and existing shareholders.
3. Products: A complete description of the company’s or services.
4. Markets: The markets which the company serves, including size and nature of the industry, location and characteristics of customer base, potential competition and unique selling points
5. Manufacturing: Manufacturing and operational aspects of the business, including a description of the technology used, access to sources of supply, manufacturing capacity and the premises owned or occupied.
6. Risks: An objective analysis of the fundamental risks and the management’s plans to cope with the same.

Financial Analysis:

The purpose of financial analysis is to set out the financial implications of a company’s strategy and to measure its performance. Following aspects are considered by a venture capitalist to determine the financial viability of the project:

a. Earnings growth potential
b. Sensitivity of earnings to sales and margins
c. Likely time lag between investment and return
d. Likely impact on cash flow
e. Expected value of the company at the notional of divestment
f. Analysis of the financial risks and management’s plans to cope with these

Portfolio Analysis:

Portfolio analysis consists in examining the venture capitalists portfolio balance at the time the investment proposal is being considered. Accordingly, the proposed investment must be an acceptable addition to the venture capitalist’s portfolio, in terms of its size, its stage of development, its geographic location and its industry sector.

Following aspects are considered in this connection:

Size of investment: The amount of money per investment has a significant impact on the size of the portfolio. Moreover, if the venture capitalist builds up a very large portfolio, hands on management will be difficult.

Stage of development: A venture capital portfolio will typically consist of some companies, which are in the startup phase, some companies in a development stage and others in the mature phase of its life cycle, such as MBO investments.

Geographic Location: In order to reach an acceptable level of portfolio diversity and volume, many funds will go in search of foreign investments. The basic principle of a successful international investment policy is to join a syndicate with a local fund, which will have a superior understanding of the market, and also the social investment and tax environment.

Industry sectors: This is fourth on portfolio diversification. Venture capitalists attempts to diversify the portfolio in order to offset problematic or slow growth investments.

Divestment Analysis:

Divestment calls for venture capitalists to have a clear idea about the method, the timing and the valuation of the company upon divestment. There are four principal means by which ventures capitalists realize investments.
They are:

1. Trade sale: The process of selling the investment to a company in the trade, i.e. a competitor wishing to buy the investee’s market share or production capacity, a supplier intending to integrate forward, or a customer trying to integrate backward or tie up sources of supply, is referred to as “trade sale”. A trade sale is in the form of an unexpected and unsolicited bid.

2. Take off: The process of selling the investment to another professional investor, another venture capitalist, by way of private placement with a major institutional investor such as an insurance company or pension fund managers, or to a management holding company, is known as ‘take out’. Under this arrangement, typically only the ventures capital company will sell its shares while the entrepreneur retains his stake.
3. Earn out: In this method, the venture capital investment is realized through the entrepreneur buying back the ventures capitalist shares with the proceeds of the project. For this purpose the entrepreneur is given an option at the time of investment.
4. Floatation: This is the final exit route or the venture capital investment. Under this method, issue of securities is made in the stock market. In order to float, the company must have a good and complete management team. The methods of floatation may vary as shown below:

(a) Placings, where a company’s shares are placed with pre-arranged buyers
(b) Offer for sale, where a company invites the public to subscribe to its fixed price, which is underwritten
(c) Tender, where the public is invited to name the number of shares and the price it will pay, with a minimum price underwritten.