We work with Government to develop a world-best regulatory and tax framework for the venture capital and private equity industry.
How To Get Venture Capital
Venture capital has a number of advantages over other forms of finance, such as:
The venture capitalist typically injects long-term equity finance, which provides a solid capital base for future growth. The venture capitalist may also be capable of providing additional rounds of funding should it be required to finance growth.
The venture capitalist is a business partner, sharing the risks and rewards. Venture capitalists are rewarded by business success and the capital gain.
The venture capitalist is able to provide strategic, operational and financial advice to the company based on past experience with other companies in similar situations.
The venture capitalist also has a network of contacts in many areas that can add value to the company, such as in recruiting key personnel, providing contacts in international markets, introductions to strategic partners and, if needed, co-investments with other venture capital firms when additional rounds of financing are required.
Facilitation of Exit
The venture capitalist is experienced in the process of preparing a company for an initial public offering (IPO) and facilitating in trade sales.
New Zealand’s professional venture capital and private equity managers had funds under management or committed of approximately $NZ 1.2 billion at June 2003.
New Zealand’s VC and PE firms typically source most of their funding from high net worth individuals, corporates and large investment institutions such as superannuation funds and banks. These institutions invest in a VC or PE fund for a period of up to ten years.
To compensate for the long-term commitment and lack of security and liquidity, investors expect to receive very high returns on their investment. Therefore, venture capitalists invest in companies with high growth potential or in companies which have the ability to quickly repay a high level of debt – as in the case of a leveraged management buyout.
Venture capitalists typically exit the investment through the company listing on the stock exchange, selling to a trade buyer or through a management buyout. Although the venture capitalist may receive some return through dividends, their primary return on investment comes from capital gain when they eventually sell their shares in the company, typically three to seven years after the investment.
Venture capitalists are therefore in the business of promoting growth in the companies they invest in and managing the associated risk to protect and enhance their investors’ capital.
The NZVCA represents most professional VC and PE organisations in New Zealand. Basic information about each member’s investment preferences is set out in the Members section of this website.
Before selecting a venture capitalist, the entrepreneur should study the particular investment preferences set down by the VC or PE firm. Often venture capitalists have preferences for particular stages of investment, amount of investment, industry sectors and geographical location.
Once a short list of potential venture capitalists has been drawn up, it is often a good idea to contact the venture capital firm and request information that will clarify the type of investments they favour.
An investment in an unlisted company has a long-term horizon, typically three to seven years. It is important to select venture capitalists with whom it is possible to have a good working relationship.
Often businesses do not meet their cash flow forecasts and require additional funds, so an investor’s ability to invest further funds if required is also important.
Finally, when choosing a venture capitalist, the entrepreneur should consider not just the amount and terms of investment, but also the additional value that the venture capitalist can bring to the company. These skills may include industry knowledge, fundraising, financial and strategic planning, recruitment of key personnel, mergers and acquisitions, and access to international markets and technology.
Venture capitalists are higher risk investors and, in accepting these higher risks, they desire a higher return on their investment.
The venture capitalist manages the risk/reward ratio by only investing in businesses that fit their investment criteria and after having completed extensive due diligence.
Venture capitalists have differing operating approaches. These differences may relate to the location of the business, the size of the investment, the stage of the company, industry specialisation, structure of the investment and involvement of the venture capitalists in the company’s activities. The entrepreneur should not be discouraged if one venture capitalist does not wish to proceed with an investment in the company. The rejection may not be a reflection of the quality of the business, but rather a matter of the business not fitting with the venture capitalist’s particular investment criteria.
Venture capital is not suitable for all businesses, as a venture capitalist typically seeks:
The venture capital firm will ask prospective investee companies for information concerning the product or service, the market analysis, how the company operates, the investment required and how it is to be used, financial projections and, importantly questions about the management team.
In reality, all of the above questions should be answered in the business plan. Assuming the venture capitalist expresses interest in the investment opportunity, a good business plan is a prerequisite of the investee company.
The initial meeting provides an opportunity for the venture capitalist to meet the entrepreneur and key members of the management team to review the business plan and conduct initial due diligence on the project. It is an important time for the management team to demonstrate their understanding of their business and ability to achieve the strategies outlined in the plan. The venture capitalist will look carefully at the team’s skills and backgrounds.
This involves an agreement between the venture capitalist and management of the terms of the memorandum of understanding. The venture capitalist will then study the viability of the market to estimate its potential. Often they use market forecasts that have been independently prepared by industry experts who specialise in estimating the size and growth rates of markets and market segments.
The venture capitalist also studies the industry carefully to obtain information about competitors, entry barriers, the potential to exploit substantial niches, product life cycles, distribution channels and possible export potential. The due diligence continues with reports from accountants and other consultants.
Approvals and Investment Completed
The process involves exhaustive due diligence and disclosure of all relevant business information. Final terms can then be negotiated and an investment proposal submitted to the board of directors. If approved, legal documents are prepared.
A shareholders’ agreement is prepared containing the rights and obligations of each party. This could include, for example, veto rights by the investor on remuneration and loans to executives, acquisition or sale of assets, audit, listing of the company, rights of co-sale and warranties relating to the accuracy of information enclosed.
The investment process can take up to three months, and sometimes longer. It is important, therefore, not to expect a speedy response. It is advisable to plan the business financial needs early on to allow appropriate time to secure the required funding.
- Amount and terms of investment.
- Dividend policy.
- Composition of the board of directors.
- Reporting – management reports, monthly accounts, annual budgets.
- Liquidity (exit) plans.
- Rights of co-sale.
- Matters requiring venture capitalist approval (such as auditors, employment contracts, major asset purchases, major debt obligations and significant variations of plans).
Building a Business
The Business Plan
The business plan should explain the nature of the company’s business, what it wants to achieve and how it is going to do it. The company’s management should prepare the plan and should set challenging but achievable goals.
The length of the business plan depends on the particular circumstances but, as a general rule, it should be no longer than 10 pages. It is important to use plain English – especially if you are explaining technical details.
Avoid jargon and general position statements.
Essential areas to cover in your business plan
1. Executive Summary
This is the most important section and is often best written last. It summarises your business plan and is placed at the front of the document. It is vital to give this summary significant thought and time, as it may well determine the amount of consideration the venture capital investor will give to your detailed proposal.
It should be clearly written and powerfully persuasive, yet balance “sales talk” with realism in order to be convincing. It should be limited to no more than two pages and include the key elements of the business plan.
2. Background on the company
Provide a summary of the fundamental nature of the company and its activities, a brief history of the company and an outline of the company’s objectives.
3. The product or service
Explain the company’s product or service in plain English. This is especially important if the product or service is technically orientated. A non-specialist must be able to understand the plan.
Emphasise the product, or service’s competitive edge or unique selling point.
Describe the stage of development of the product’s or service (seed, early stage, expansion or MBO – if necessary, refer to AVCAL’s glossary of terms in the Resource Centre). Is there an opportunity to develop a second-generation product in due course? Is the product or service vulnerable to technological redundancy?
If relevant, explain what legal protection you have on the product, such as patents obtained, pending or required. Assess the impact of legal protection on the marketability of the product.
4. Market analysis
You need to convince the venture capital firm that there is a real commercial opportunity for the business and its products and services. Offer the reader a combination of clear description and analysis, including a realistic “SWOT” (strengths, weaknesses, opportunities and threats) analysis.
Define your market and explain in what industry sector your company operates. What is the size of the whole market? What are the prospects for this market? How developed is the market as a whole, ie. developing, growing, mature, declining?
How does your company fit within this market? Who are your competitors? For what proportion of the market do they account? What is their strategic positioning? What are their strengths and weaknesses? What are the barriers to new entrants?
Describe the distribution channels. Who are your customers? Comment on the price sensitivity of the market.
Explain the historic problems faced by the business and its products or services in the market. Have these problems been overcome, and if so, how? Address the current issues, concerns and risks affecting your business and the industry in which it operates. What are your projections for the company and the market? Assess future potential problems and how they will be tackled, minimised or avoided.
Having defined the relevant market and its opportunities, it is necessary to address how the prospective business will exploit these opportunities.
Outline your sales and distribution strategy. What is your planned sales force? What are your strategies for different markets? What distribution channels are you planning to use and how do these compare with your competitors’? Identify overseas market access issues and how these will be resolved.
What is your pricing strategy? How does this compare with your competitors’?
What are your advertising, public relations and promotion plans?
6. Business operations
Explain how your business operates:
Explain how you make the products or provide the service, first in brief and then in more detail. What are the sources of raw materials? Who are your suppliers?
What are the labour requirements? What is the company’s approach to industrial relations?
Outline your company’s approach to research and development.
7. The management team
Demonstrate that the company has the quality of management to be able to turn the business plan into reality.
The senior management team ideally should be experienced in complementary areas, such as management strategy, finance and marketing, and their roles should be specified. The special abilities each member brings to the venture should be explained. A concise curriculum vitae should be included for each team member, highlighting the individual’s previous track record in running, or being involved with, successful businesses.
Identify the current and potential skills gaps and explain how you aim to fill them. Venture capital firms will sometimes assist in locating experienced managers where an important post is unfilled, provided they are convinced about the other aspects of your plan.
Explain your controls, performance measures and remuneration for management, employees and others.
List your auditors and other advisers.
Include organisation chart.
8. Financial projections
Consider using an external accountant to verify and act as “devil’s advocate” for this part of the plan. The NZVCA has a range of associate members who could help you with this.
- Realistically assess sales, costs (fixed and variable), cash flow and working capital. Produce a pro-forma profit and loss statement and balance sheet. Ensure these are easy to update and adjust. Assess your present and prospective future margins in detail, bearing in mind the potential impact of competition.
- Explain the research undertaken to support these assumptions.
- Demonstrate the company’s growth prospects over, for example, a three to five year period.
- What is the value attributed to the company’s net tangible assets?
- What is the level of gearing (i.e. debt to shareholders’ funds ratio)? How much debt is secured on what assets and what is the current value of those assets?
- What are the costs associated with the business? Remember to split sales costs (e.g. communications to potential and current customers) and marketing costs (e.g. research into potential sales areas). What are the sale prices or fee charging structures?
- What are your budgets for each area of your company’s activities? What are you doing to ensure that you and your management keep within these or improve on these budgets?
- Present different scenarios for the financial projections of sales, costs and cash flow for the short and long term.
- Ask “what if?” questions to ensure that key factors and their impact on the financings required are carefully and realistically assessed. For example, what if sales decline by 20 per cent, or supplier costs increase by 30 per cent, or both? How does this affect the profit and cash flow projections?
- Keep the plan feasible. Avoid being overly optimistic. Highlight challenges and show how they will be met.
- Relevant historical financial performance should also be presented. The company’s historical achievements can help give meaning, context and credibility to future projections.
9. Amount and use of finance required and exit opportunities
State how much finance is required by your business and from what sources (i.e. management, venture capital, banks and others) and explain the purpose for which it will be applied. Outline the capital structure and ownership before and after financing.
Consider how the venture capital investors will exit the investment and make a return. Possible exit strategies for the investors may include floating the company on a stock exchange or selling the company to a trade buyer.
It takes courage to build a new venture when you start with nothing except an idea. You are taking on hard work and unknown risks. But this is how the world’s largest businesses all began, and it is the way you could turn your idea into a real business.
There is no blueprint to guarantee success for your venture. Every entrepreneur builds their company in a different way. But you can manage your risks and plan for growth by doing your homework.
That’s why it helps to know the key ingredients for success: keen people, solid products, effective marketing and – of course – some ‘smart’ money.
This is our guide to starting a business. Use this guide to find out more about:
- Finding the right people. The qualities you need to look for.
- Delivering the best products. Plan to win the acceptance of the market.
- Refining your marketing. It’s not just about selling.
- Smart money. How venture capital gives you the edge.
- What do you need to grow? Build your resources to match your opportunities.
- What we will be looking for. How venture funds assess new companies.
- Who do you need to help you? The value of independent directors.
- Knowing whether to sell. What’s your exit strategy
Buying a Business
Management Buy out (MBO) – Buying out your business
A management buy-out, or MBO, gives you the freedom to manage your business and a financial stake in the results. You would take control. The existing owners of the business might be attracted to this as a way to realise the value of their holding and step away from the business. In the process, they could protect the company’s independence (an alternative, for instance, might be a trade sale) and reward the existing management team. This kind of opportunity is rare. Most managers only get a chance to participate in an MBO once in their career – which means that it is hard to find any management team that has substantial experience with the MBO process.
What is an MBO? It is a transaction where a business is purchased by its existing management team, with the help of outside investors like venture capital firms. The trend towards MBOs grew strongly in the 1980s and 1990s. Companies involved range from small family businesses to subsidiaries of big companies.
When an investor looks at an MBO opportunity, they will consider issues like the size of the company, its profitability, the calibre of its management, its market share and its cash flow.
If you are a business manager and see an opportunity, your first step may be to approach the existing shareholders to see if they are willing, in principle, to sell their company to you and perhaps others in the management team. The shareholders might also agree to pursue negotiations with you exclusively, giving you time to put together your offer. Many investors need this kind of agreement in advance before they can commit their support. Your business plan will sum up the opportunity. It should include:
- a description of the business
- an analysis of its competitors
- the company accounts from the past five years
- the accounts for the current year to date
- financial forecasts for the near future
- detailed biographies of the current management (the MBO team), and
- an organisational chart.
This clarifies the financial objectives of the MBO. Outside investors will want to know how the MBO team will buy and operate the company in a way to substantially increase the original investment. Once you have reached an in-principle agreement with the shareholders and have the support of investors, you can move on. You should document the offer and gain a written commitment from the existing shareholders to the terms of the deal – a ‘heads of agreement’, for instance. The transaction could be long and complicated. But it could end with you being in control of your own business as a manager and important shareholder.
Management Buy-in (MBI) – Buying into a business
If you see a business that might reward a new investment and a new management team, you should consider a management buy-in, or MBI. In these circumstances, a manager or team of managers from outside a company finds the financial support – often a venture capital firm – to buy the company. The manager who leads the MBI typically becomes the chairperson or chief executive.
Not all the finance goes towards the purchase of the company. There is also a substantial amount set aside for working capital, to fund new growth. In many MBIs, new managers take over the company to launch major new projects.
There are also hybrid versions of the MBI. One alternative is the buy-in buy out, or BIMBO, in which outside managers join forces with existing managers to buy the company. Another example is the BINGO, in which more than 25 per cent of the total funding is directed towards new growth rather than solely the purchase of the company.
The biggest factor in a successful MBI is management talent, which means your skill at putting the MBI deal together and achieving your aims once you gain control of the company. Potential investors will consider your direct managerial experience when they weigh up the investment opportunity. Some factors count against the success of an MBI. If existing managers are not included in the transaction, company morale can suffer and the business can stall during the MBI process. One way to avoid this dilemma is to consider the BIMBO – combining your role as an external manager with the talents of the existing internal managers. In general, MBIs prove difficult when the companies involved are too small to grow. Make sure your opportunity is large enough to provide scope for your skills and rewards for you and your investors.
Consider looking for some experienced individuals to help you manage the MBO or MBI. Some New Zealand venture funds have a history of working on these kinds of transactions and may be able to offer you the advice you need to get started. Look for experienced individual managers as well. Some executives have been through the MBO/MBI process before and may be available to act as advisors or independent directors. This helps reduce the risk of a difficult endeavour, where you never really know what lies in store for you once you have assumed control of the business. In addition, the support of an experienced individual could help sway venture capital managers or other investors – and help you win financial backing for your plan.
How to proceed
Every management buy-in or buy-out proceeds differently, but all work best when there is a level of trust between the MBO or MBI leader – probably you – and the existing shareholders of the company. It is vital to communicate the benefits of the MOB or MBI to all concerned – not only to your new investors, but to existing employees, shareholders and management.
If you consider the current management to be talented and effective, you should aim to include them in the process. Many outside investors prefer existing management to share in the transaction, in order to have the motivation to make the effort succeed. For some investors, BIMBOs now account for two-thirds of all their MBI deals.
In most cases, MBOs and MBIs involve the assumption of debt to finance the purchase. The debt can typically cover half the purchase price. One of your primary aims, then, is to keep that debt low by offering a conservative valuation for the company in question. Once the deal is complete, it becomes vital to generate strong cash flow to reduce the debt quickly.
Those who lead MBO or MBI deals usually put capital into the deal, which means you should be ready to commit your own cash towards your plan. If you succeed, you reap the rewards.
Hit the ground running
As soon as you complete the transaction, you need to start generating cash flow. Your challenge is not only to reduce debt but also to plan new investments that will achieve growth. Over time, you increase the value of the company.
The most likely executives to succeed are those who can demonstrate a record of solid management and entrepreneurial drive. They need a clear vision to take an existing company and transform it, creating a new company with a much greater value.
If that is you, then you should start planning your MBI now.
‘These opportunities are like the thickness of a hair. They are barely definable. Throughout life there are moments like this when crucial decisions are made or missed.’ Frank Lowy Chairman, Westfield Holdings.
As soon as you start, you need to have some idea of where you would like to finish. That is what venture capitalists mean when they talk about ‘exit strategies’ – the plans you put in place to turn your company into an asset.
You might decide to sell your company in a trade sale to a competitor or a complementary partner. Or you might set your sights on an initial public offering on the sharemarket. In either case, you put a financial value on your company and can finally receive a monetary reward for your hard work.
Some venture capitalists say it’s unhealthy for entrepreneurs to focus too early on their exit strategy. After all, the most important thing is to create real value. Sooner or later, though, you and your investors will come to a point where it makes sense to consider going to the sharemarket or selling part or all of your company to another player.
The chances are that your company will not be a candidate for the sharemarket. Only a small proportion of start-up companies ever go public. The overwhelming majority of successful companies realise their value through some form of trade sale, merger or strategic alliance.
If you reach the stage where you consider selling your business, you need to be prepared. This will be the most important financial transaction of your life. It needs careful work to build the relationship that can lead to a successful sale.
Deciding the terms
One of the most common problems at this stage of the business could be your fear of losing control. Remember, though, that you decide the terms of any deal.
You can decide, for instance, to sell on terms that leave you to run the company. Most merger and acquisition agreements involve ‘earn-out’ agreements under which some of a company’s owners have to stay with their company after they sell.
If you choose, you may remain in control of your company’s day-to-day operations. If you are worried about the acquirer moving your office or reducing your staff, you should consider ways to maintain your say in the business.
You never know who may be a likely buyer for your company. Chances are that the first company to approach you probably won’t be the eventual buyer. One merger specialist, the Corum Group of the US, puts it this way:
‘In roughly 75 per cent of cases, in a professionally managed merger process, there is almost always someone willing to pay more and give you a better structure.’
When it comes time to consider an exit, remember that a successful deal is the result of a careful process to find the best possible partner on the best possible terms. This is a process that you must control.
If you take the right approach, you will create significant wealth.
New Business Guide
Throughout the relationship, our member funds are most likely to hold a minority shareholding in your company – although you should also be aware that some venture arrangements lead to the fund taking majority control. Any decision to invest will be based on a firm belief in your ability to run the business.
Most important of all, our member funds have the capital to support you over the long term. That means you have the partners to help you gain further financial support if you need more capital in the future.
Bill Ferris – Executive Chairman, Castle Harlan Australian Mezzanine Partners
Talking your project through with our member funds is a good way to identify the strengths and weaknesses of your plan.
If a New Zealand venture capital fund agrees to back your idea, you will not only gain money but also the credibility of a major financial supporter. That could make a big difference to the way you work with your customers and suppliers.
Here’s what member funds are likely to look for when they talk to entrepreneurs with fresh idea:
- strong, motivated management teams
- clear strategies
- large but carefully defined target markets
- proven abilities to outperform the competition
- barriers to entry
– Benjamin Franklin
You might already have a strong company with a history of steady growth. Or you might be a start-up with ideas but no track record.
Whatever your background, you may find yourself with the prospect of rapid growth – but also the risk that your opportunities may outweigh your current resources. Now you must choose how to manage your growth without endangering your company. Because either you grow, or someone else takes your business from you.
You need a solid financial strategy. Before now, you have probably been using the support of a bank or other financial partner to achieve your initial goals. But this might only give you short-term support, which comes with the added restriction of interest payments that drag on your cash flow.
Serious growth will require additional capital that you can rely upon over the long term. This equity finance or venture capital could give your company a stable capital structure to be able to act upon your business plans.
By finding a new source of finance, you can limit your dependence on a bank and gain more flexibility. Choosing the right venture capital partner could give you the freedom to achieve your goals.
– Steve Jobs, Founder, Apple Computer
The right people, products and sales skills can only take you so far. You will need money to build your company, and you will probably need to raise the money at several different stages as your company grows.
Few businesses can grow successfully through self-funding and most rely on capital from outsiders. Chances are you don’t have all the funds required to finance your business, so you need to find the right partners to help you achieve your goals.
If you only need a small amount of money and you have some assets, you could try a bank. But if your idea is bold and innovative, you will need capital from an experienced investor that knows how to support young companies over the long term.
You will need ‘smart money’ – the sort that comes with experience and skill.
This is what venture capital is all about. The members of the NZVCA, for instance, have helped small companies grow quickly and know what it takes to achieve similar results in the future.
When venture capital executives decide to invest in a new company, only one of their roles is to provide cash. They also bring their knowledge of the market, networks and experience of working with ambitious companies.
– Akio Morita – Founder, Sony Corporation
Marketing is one of the most misunderstood requirements for business success. It is not about selling, but communicating.
To make your ideas work, you’ll need to know what to sell, who to sell to and how to sell it. That means identifying your customers and understanding their needs. It also means finding the right way to tell them about your product’s most important benefits – and why you can offer something better than your competitors.
Before you know whether you have a real business opportunity, you have to know whether your customers are willing to pay for what you intend to offer.
– Henry Ford Founder, Ford Motor Company
Your challenge is to win the acceptance of customers in a market that is probably intensely competitive and already crowded.
Success depends on how well you can identify gaps in the market and anticipate what your likely customers really want. It takes hard work to create the right product and convince the market of its merits. No product or service, no matter how good, will sell itself.
– Estee Lauder, Founder, Estee Lauder
Your venture cannot succeed without the right people to put your plans into practice. You will need senior employees who are:
Because these people will eventually manage your teams for you, they must be able to motivate their colleagues and demonstrate their commitment by working hard.
One way to improve your chances of success is to find a team that has worked together before and includes people who have taken responsibility for key financial objectives – revenue growth, cash flow, net income – in the past.