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Venture Capitalists and Private Placements

Venture Capitalists

Venture capital can generally be categorized as high risk, usually equity (or convertible debt) capital provided to startups by high net worth individuals and institutions who take an active interest in a startup company. The venture capital industry is highly competitive on the supply side, especially when a promising startup is involved. The venture capital industry is attracting substantial amounts of money, and venture capital firms compete not only among themselves, but with other investors, including "angels" and corporations, such as Adobe, Intel, Cisco, Informix and Netscape. Venture capitalists also compete with other forms of startup financing, including "bootstrapping," commercial lending and public equity markets. Virtually all venture capitalists focus intensely on the experience and maturity of the management team of a startup company. Their investment policies cover a range of preferences in investment size, maturity, location and industry or a business. Individual partners within a venture capital firm frequently specialize in a targeted business market, such as biotech or software. One of the keys to raising venture capital is to seek investors who will truly add value to the startup company well beyond the money. While venture capitalists may require seats on the Board of Directors, they always require significant rights to be informed on a current basis of all material financial and strategic events of a startup. Requests for information begin during the venture lending due diligence, and such information assists in determining conformity of the target investment with the investment criteria, such as the size of the target's potential market and specific projected growth rates. Startup companies that can obtain venture lending are able to minimize overall equity dilution, diversify sources of capital and, and most importantly, better manage cash flow. For most would-be startup founders, venture capital financing is notoriously difficult to obtain. Only those startup that have already raised some money and are affiliated with institutional venture capital firms can obtain venture loans. Typically, this is because most venture lenders will still want the startup company to have at least some outside capital to finance the growth of the business and thus help give value to the venture lender's equity stake.

Private Placement

Private placements, another traditional source of financing, consist of the offer and sale of equity or debt securities which are exempt from many of the more complex federal and provincial securities laws. Private placements are an attractive source of equity capital for a startup company that for some reason has ruled out possibility of going public. If the goal of a startup company is to raise a specific amount of capital in a short time, this equity source may be the answer. In this transaction, the startup offers shares to a few private investors, rather than to the public as in a public offering. In order to qualify for any securities law exemption, most private placements are restricted to institutional investors and wealthy individuals known as accredited investors. The advantage of such an offering is that the startup is able to control its cost of capital and financing timeframe by setting the terms of the sale and selling to those parties willing to buy. In addition, the startup is able to avoid the burdensome disclosure and filing requirements required in public offerings. Obtaining a private placement, however, is generally not a viable option for a startup company to pursue. At the early stages of development, a startup company will likely find it difficult to pay the costs to retain a placement agent or investment bank to help draft a private placement memorandum and to market its securities. In most cases, a startup company will likely have to raise their initial capital from some of the other sources.