Although Ronald Reagan expanded the economy through governmental defense spending from the middle to the end of the 1980s, venture capital profits declined through the mid-1990s and a new wealth generator for venture capitalists replaced funding start-up companies…. the Leveraged Buyout.

For definition, a leveraged buyout (LBO) is the purchase of a company with a combination of debt and the target company’s assets, which might include airplanes, real property, and/or cash flow. All of these are used to repay the debt taken out to buy the business. (The debt, much as in real estate when a 90/10 loan is taken out on a rental property, is considered the leverage to buy the business).

Beginning in about 1995, VC money was being sought by and was beginning to “feed” companies creating internet businesses.

Functioning on what was to be known as “the biggest fool theory”— where the last person to own the stock loses all his investment— companies went public with enormous valuations without ever having sold one product. Instead, they were selling blue sky, or opportunity.

By the turn of the century, in the year 2000, the investing world had started to realize that technology and internet companies were yielding either low or non-existent returns and began dumping these stocks in favor of better investment opportunities—leading to what became known as the bursting of the “dot-com bubble.” The sell-off caused VC firms to experience net losses on their internet and technology companies and the private equity business stalled, yet again. Cyclically, VC again must seek out opportunity.

Since 2005, however, VC funding has remained fairly constant even with the market decline of 2008-2010. This window of lending seems to have established itself and seems key to some serious investment and critical infrastructure development.

Let’s ExamineThe VC View on Investing

With very few exceptions, VC firms care where the money is invested as long as it does not violate their moral principles.

Given that moral reality, VC firms are interested in:

1. How much they must invest.

2. When they will get that money back; and

3. How much return they are going to get on their investment.

Venture capital is money invested in a company in exchange for company equity. The venture capitalist earns money from either:

1. Cash flow from the business when it becomes profitable and receives dividends;

2. When the stock is sold privately, and/or

3. After the company goes public through an IPO.

Most VC firms are not out to save the whales, to feed the starving children in Biafra, or stop the war in Uganda. Instead they want returns for their investors and on investment capital expended– and, as mentioned, follow their personal values clearly stated by the company in doing so.

Selecting a Business to Fund

As previously mentioned VC investors carefully look for the following characteristics when considering investing in a company:

1. An experienced, proven management team, with past demonstrable results.

2. Dramatic growth potential for the concept being funded.

3. Capital-efficient/scalable business model which has been fully vetted and approved;

4. Significant barriers to entry

5. Highly differentiated products or services that are compelling and unique;

6. A probable exit from the business in between three and seven years, post-funding.

Interestingly enough, in a survey of over 100 VC firms, it is estimated that the average clock time a VC firm Project Screener invests only about eight minutes on a project before he or she moves to the next project submitted for review. Further, a venture capitalist may screen 400 projects before it ever funds one that it is interested in moving forward to the due diligence phase.

Clearly, the key six points listed previously must be clearly addressed in a business proposal, or the proposal will be thrown into the “round file” faster than can be imagined.

Due Diligence and Business Development

Venture capitalists are careful and do a great deal of detailed research in both the people and the potential business opportunity itself before investing any money. They do this because:

1. They want return of their investment,

2. They want return on their investment, and

3. If they invest in just any project, they may lack insufficient capital to invest later on, in a potentially more profitable opportunity (aka opportunity cost) so they must be certain that each project has a very high probability of success, as well as high profits.

VC firms usually invest in areas in which they have expertise. The expertise may come from VC firm previous experience with other similar investments, or from the VC staff itself, who may have successful business experience in the business being considered for investment.

VC firms universally want at least one seat on the Board of Directors in the businesses they are investing in, depending on how much money has been invested, and are often highly involved in business development because of their successful past similar-field experience.

A business owner should expect this level of involvement and interest from a VC investor.

Dr. Brent Lundell owns http://www.GainStreamGroup.com, a venture capital sourcing and consulting company, and is a partner in The Guinn Consultancy Group, Inc. The Guinn Consultancy Group provides a wide array of business services, including seminars, webinars, and venture capital sourcing services.

Dr. Brent Lundell owns http://www.GainStreamGroup.com, a venture capital sourcing and consulting company, and is a partner in The Guinn Consultancy Group, Inc. The Guinn Consultancy Group provides a wide array of business services, including seminars, webinars, and venture capital sourcing services.

Author Bio: Dr. Brent Lundell owns http://www.GainStreamGroup.com, a venture capital sourcing and consulting company, and is a partner in The Guinn Consultancy Group, Inc. The Guinn Consultancy Group provides a wide array of business services, including seminars, webinars, and venture capital sourcing services.

Category: Finances
Keywords: Venture Capital,Finance,Business Financing,Investing