Wednesday, August 18, 2010

Stay tuned!

Today was an extremely busy day for me (due to the job search), but I will continue the posts starting again tomorrow!

Tuesday, August 17, 2010

Venture Capital Firms (Part II)

In Part I, we went over some of the fund mechanics as well as the employee structure of a venture capital firm. In this section we are going to go over the different types of financing stages that a firm may use. When visiting venture capital websites, you will find that the strategic direction of a firm will be based on one or more financing objectives.

Types of Financing

There are three main groups that venture capital investment can be divided into: early stage, expansion, and buyout. Each of these groups is further divided into subgroups, as illustrated in the chart below:

I will go through each of the subgroups so that you will gain a better understanding about them.

Early Stage

Early stage investing is divided into three subgroups: seed financing, startup financing, and 1st stage financing.

Seed Financing
This type of financing will be very early in the life of the business, usually pre-revenue and sometimes even before the product or service is created. It will also make it easier for the entrepreneur to get loans after being financed this way. The entrepreneur will use seed money for market research and early product or service development.

Startup Financing
Startup financing is used by businesses to finish the development of their products and services. In some cases, it will also be used for marketing the products and services. This helps the company launch their operations.

1st Stage Financing
This is the last subgroup of financing in the early stage category, and would be used to continue operations of the company at a higher scale. Products (or services) would start to be mass produced, and the initial funding would have been used by this time.


Expansion investing is also broken up into three subgroups: 2nd stage financing, bridge financing, and 3rd stage financing.

2nd Stage Financing
This stage of financing is used by a business for initial expansion plans, whether that involves products or services. The company usually will not be profitable even after receiving this type of financing.

Bridge Financing
Bridge financing is used as a short term investment that will maintain liquidity, especially if an inflow of cash is going to be received. One example could be if the company plans to have an IPO; since investors will be expecting money from the sale, bridge financing can be used to sustain the company for a short period of time.

3rd Stage Financing (Mezzanine)
This type of financing is also called mezzanine financing, and is invested into a company that has achieved its breakeven point, and in some cases is achieving profitability. This type of financing will be used by a company for marketing, plant expansion, and new products or services.


The buyout stage of investing can be broken down into two subgroups: acquisition financing and leveraged buyouts (LBO).

Acquisition Financing
This type of financing is use to acquire either part of a company or the entire company. The original business making the acquisition would have expanded to the point where this strategy is feasible.

Leveraged Buyout (LBO)
This type of financing is also called a management buyout; the management group of the company will acquire an equity stake in a company and potentially buyout certain assets of the company. The company acquisition will be primarily financed through debt. Management teams or companies themselves use this strategy when they do not want to commit capital to the deal.


I wanted to include all of the financing stages in one easy-to-use graph, shown below:

I could not find the original source for it, but you can find it using a Google image search. It ties in everything you have learned about financing in this article.

Sunday, August 15, 2010

Venture Capital Firms (Part I)

A venture capital firm is organized with the intent to invest capital into a portfolio of companies to eventually profit from the investment. Venture firms are all different sizes, and so are the funds that they raise. Part I will address what the fund is, and the employee structure of a venture capital firm.

The Fund

Venture capital will raise a fund to invest in select companies. The fund will be raised from institutional investors and sometimes private individuals. For example, let’s take a fictional firm called Venture Captain Partners. For our purposes, the firm will be involved in a multitude of industries. The firm will set a goal of $100 million in capital to raise for their fund. Usually, the fund will be given a title; in our case, we’ll call it Venture Fund I. Once the capital requirements are met, the fund will close and will be ready to invest in companies.

The fund is invested anywhere from 3-8 years into the companies before a return is actualized and profits are distributed back to the investors. Since the investors are limited partners in the fund, they do not have as many rights as the general partners of the firm. They usually will not be able to withdraw their money earlier than the time frame of the fund, and will not be able to make management decisions.

Employee Structure of the Firm

Firm structure can vary based on the scope and size of the firm. Large firms like Kleiner Perkins Caufield & Byers may have a tiered structure with multiple positions. Small firms may only have one or two analysts and be heavier on the partner side. The basic structure of the firm employees is shown below:

General Partner
General Partners are the owners of the firm, and many times the name of the firm will include their names. There are responsible for the direction of the firm, including what companies the firm will invest in. They will invest some of their own personal income into the fund. GPs also will sit on the boards of their portfolio companies and provide expertise to entrepreneurs running the companies. The GPs make the decision when to actualize their investment, either by selling the company privately or through an IPO. They charge a management fee that is around 20% which is carried over from the fund.

Salary: up to $600,000 plus bonuses and management fees which could be in the millions

Junior Partner
Junior Partners are very similar to general partners, except for the fact that they are paid less and do not have nearly as much decision making power regarding the portfolio companies.

Salary: $210,000-$270,000 plus a part of the carry or percentage of profits

Associates do more of the grunt work for the venture capital firm. Many of them will have an MBA degree, and some will have experience on the investment banking side of business. Associates will look over business plans before they go to the general partners of the firm. They will also contact businesses over the phone searching for investment opportunities, and may visit companies in the firm’s portfolio.

Salary: $180,000-$260,000 plus bonus

This position is usually part of a larger or more established firm, and may not exist at the smaller firms. They are the entry level position in venture capital firms, and general consist of undergraduates. The positions are heavily research oriented, and will revolve around performing due diligence of companies and industries. Analysts in venture capital differ from their counterparts in traditional finance because they need good interpersonal skills to match their analytical skills. Analysts will stay 2-3 years at the firm before going on to business school or joining a portfolio company.

Salary: $100,000-$120,000 plus bonus

Salary information:

Venture Capital Terminology

I decided to construct a list of common terms that are used throughout the venture capital industry. As I write future articles, I realize that this will make it easier for readers to utilize instead of trying to search for the terms online. Over the course of time, I will update it and add more terms if necessary. I’ve attached it as a pdf file that has the definitions hyperlinked, which is available here here.

Two of the sources I used that helped me out were and I would recommend going to these two sites if you want to look up additional terminology that is not in this list.


Alphabet rounds
The early rounds of funding for a startup company, which get their name because the first is known as Series A financing, followed by Series B financing, and so on. Alphabet rounds of financing are provided by early investors and venture capital (VC) firms, which are willing to invest in companies with limited operational histories on the hope of larger future gains. These investors will typically wait until the startup has shown some basic signs of maturity and has exhausted its initial seed capital.

Angel investor
An investor who provides financial backing for small startups or entrepreneurs. Angel investors are usually found among an entrepreneur’s family and friends. The capital they provide can be a one-time injection of seed money or ongoing support to carry the company through difficult times.

A situation in which an entrepreneur starts a company with little capital. An individual is said to be bootstrapping when he or she attempts to found and build a company from personal finances or from the operating revenues of the new company.

Business plan
A written document that describes in detail how a new business is going to achieve its goals. A business plan will lay out a written plan from a marketing, financial and operational viewpoint. Sometimes a business plan is prepared for an established business that is moving in a new direction.

Deal flow
The measure of the number of potential investments that a fund reviews in any given period.

A lessening of real value (as of equity) by a decrease in relative worth; specifically, a decrease of per share value of common stock by an increase in the total number of shares.

Due diligence
Research and analysis of a company or organization done in preparation for a business transaction.

Earnings Before Interest, Taxes, Depreciation and Amortization. An indicator of a company’s financial performance; it can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.

Elevator Pitch
A term used to describe a brief speech that outlines an idea for a product, service or project which can be delivered in a short time (60 seconds or less).

Exit Strategy
The method by which a venture capitalist or business owner intends to get out of an investment that he or she has made in the past. Most often it will be an IPO or a sale to a larger company.

Free cash flow
A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value.

General Partner
The partner in a limited partnership responsible for all management decisions of the partnership. The GP has a fiduciary responsibility to act for the benefit of the limited partners (LPs), and is fully liable for its actions.

Hurdle rate
The minimum amount of return that a person requires before they will make an investment in something.

Incubator firm
A firm engaged in the business of fostering early-stage companies through the developmental phases until such time as the company has sufficient financial, human and physical resources to function on its own.

Initial public offering (IPO)
The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded.

Internal Rate of Return (IRR)
The discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. Generally speaking, the higher a project's internal rate of return, the more desirable it is to undertake the project. As such, IRR can be used to rank several prospective projects a firm is considering. Assuming all other factors are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first.

Investment bank
A financial intermediary that performs a variety of services. This includes underwriting, acting as an intermediary between an issuer of securities and the investing public, facilitating mergers and other corporate reorganizations, and also acting as a broker for institutional clients.

Limited Partner
An investor in a limited partnership who has no voice in the management of the partnership. LP's have limited liability and usually have priority over GP's upon liquidation of the partnership.

Liquidity event
An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an exit strategy for an illiquid investment. Liquidity events are typically used in conjunction with venture capital/angel investors or private equity firms, which will aim to reach one within a reasonable amount of time after initially making an investment.

Management fee
Compensation for the management of a venture fund's activities, paid from the fund to the general partner or investment advisor. This compensation generally includes an annual management fee.

Non-Disclosure Agreement (NDA)
A legal contract between two or more parties that signifies a confidential relationship exists between the parties involved. The confidential relationship often will refer to information that is to be shared between the parties but should not be made available to the general public.

Post money valuation
The value of a company after external financing alternatives are added to its balance sheet.

Pre-money valuation
A phrase that refers to the value of a company's stock before it goes public.

A formal written offer to sell securities that provides an investor with the necessary information to make an informed decision. A prospectus explains a proposed or existing business enterprise and must disclose any material risks and information according to the securities laws. A prospectus must be filed with the SEC and be given to all potential investors. Companies offering securities, mutual funds, and offerings of other investment companies including Business Development Companies are required to issue prospectuses describing their history, investment philosophy or objectives, risk factors and financial statements. Investors should carefully read them prior to investing.

Restructuring a company's debt and equity mixture, most often with the aim of making a company's capital structure more stable. Essentially, the process involves the exchange of one form of financing for another, such as removing preferred shares from the company's capital structure and replacing them with bonds.

To bring in (as profit).

The chance that an investment will lose value.

Stock options
A privilege, sold by one party to another, that gives the buyer the right, but not the obligation, to buy (call) or sell (put) a stock at an agreed-upon price within a certain period or on a specific date.

Sweat equity
The equity that is created in a company or some other asset as a direct result of hard work by the owner(s).

Term sheet
A non-binding agreement setting forth the basic terms and conditions under which an investment will be made.

Venture capital
Seed capital or growth capital that is invested in early stage companies that have high growth potential, and have the potential to generate high returns for investors.

Venture capitalist
An investor who either provides capital to startup ventures or supports small companies that wish to expand but do not have access to public funding.

Saturday, August 14, 2010

An Angel Gave Me Money!

For many entrepreneurs, here is what comes to mind when they think of an angel investor:

Flying Money!
I had given a very brief sentence about what an angel investor in a previous article: basically, a person with high net worth who invests (usually up to $200,000) in early stage companies. Angel investors are usually the first individuals to make the investment in a company, even before the traditional venture capital firms. This means that they have the highest risk out of any investor barring the actual entrepreneurs of the company.

In return for this investment, angels usually will want to take an equity stake, and will be looking for a very high return from their investment (in the neighborhood of 20-30x). Sometimes entrepreneurs think that achieving angel investment is easier than from a venture capital firm, but this view is incorrect. What is truer is that the investment criteria will be different, not easier or harder.

Profile of an Angel
It is difficult to construct a profile of the average angel investor. Someone with a salary of $150,000 per year could be an angel investor; so could an individual with a salary of $5 million per year. Many angel investors have had previous careers starting their own businesses, or have worked for a venture-backed startup company. So in addition to providing small businesses with capital, they can also serve as mentors to the small businesses. Entrepreneurs can leverage this existing knowledge from angels and avoid making mistakes in their own business.

Angel Groups

Even though the average investment by an angel investor is small (<$200K), angel funding rounds are higher. Very few venture capital firms, if any, would consider an investment opportunity of less than $2 million. You’ll find that an angel round of investing will be anywhere from $500,000-$1 million. How can that be, you might ask? Individual angel investors will band together to form an angel group. Many times, these groups will take the name of the city where they are based. For example, up here in Minneapolis, there is group called the Twin Cities Angels. Some groups will have minimum salary requirements, while other groups are more informal.

Upside of Angel Investment
  1. Your company may not have to solicit capital from venture firms later in their growth cycle
  2. Many angels have individual expertise in one or more industries
  3. Your business can tap into an angel investor’s current network and find more opportunities
Downside of Angel Investment
  1. An angel investor may demand a consulting role or a board seat as part of their investment
  2. They may want a higher equity stake than a venture capital firm would want based on risk
  3. Multiple angel investors’ expectations may not be aligned as well as partners in a venture capital firm would be

Angel investors are a very diverse group of people, and there really cannot be an “average profile” for them. They provide a specialized form of investment, and without them many startup companies would have failed. To learn more about angel investors, I’ve attached a link at the bottom that will take you to the Twin Cities Angels page. It will show you what criteria they use, as well as previous companies they have invested in. You can also Google angel groups and see if there are any close to where you live.

Twin Cities Angels:

Friday, August 13, 2010

Andy Grove article and rebuttal

There is an article by Andy Grove, the co-founder of Intel, that has been circulating on the web about American jobs.  It is entitled How to Make an American Job, and can be found here  There is also a rebuttal of the article by another author from Business Week, located here  Let me know your thoughts on it.

What in the World is Venture Capital?!

So what exactly is venture capital? We hear about it in newspapers, online, and depending on where you live, even from random strangers (i.e., in Silicon Valley). Let’s start by thinking of the term from a very basic and literal perspective; it is capital (money) that is invested into a new or existing business (a venture). Now, you may say “doesn’t that mean any individual can invest money into a company and be called a venture capitalist?” or “if I buy stock in a company am I not a venture capitalist?” Clearly, our working definition needs to be distilled further.

The types of businesses that receive venture capital are early stage companies that have high growth potential. So venture capital may be seed capital (money that is used to get the venture off the ground) or growth capital (money that is used to sustain and possibly scale the venture). So now we have a better definition of venture capital: seed capital or growth capital that is invested in early stage companies that have high growth potential.

One last item to add to the definition would involve something about returns; no individual or group is going to invest in a venture without the possibility of profiting from it. In fact, many ventures are inherently more risky than other established businesses, so investors are looking for a much higher return. The expected return will be a multiple of the initial investment; for an early stage startup, venture capitalists will look for a 10x return or higher. The investors will realize a return on their investment though the sale of the venture either privately or if the company has an IPO (Initial Public Offering). So know we have our final definition of venture capital:

Seed capital or growth capital that is invested in early stage companies that have high growth potential, and have the potential to generate high returns for investors

Venture Hero!
The Venture Capitalist

A venture capitalist (VC) is an individual or a firm that invests into these types of early stage companies to generate high returns. An individual investor is called an Angel Investor; this person usually has a high net worth and will invest up to $200,000 in a company. Firms that invest in early stage business are called venture capital firms. Venture capital firms will raise a fund of capital from individuals and institutions, and then use that entire fund to invest in multiple early stage companies. The rationale behind investing in multiple businesses is that some of the early stage companies will fail, and usually one or maybe two of them will be successful enough to generate a high return.

Starting next week, I am going to be writing a few articles on the stages of funding. Stay tuned!