This is the second in a series of articles.  This was published in Venture Capital Focus magazine in June 2001.

Money for Nothing, Advice for Free 

The title of this article loosely summarises the key benefits of obtaining venture capital. Of course, if a deal sounds too good to be true, it probably is. There are strings attached and even the best of intentions may not keep you out of dire straits. Let's discuss the benefits and the pitfalls of venture capital financing.

Money for Nothing

A key benefit is that venture capital is usually provided in the form of equity financing. In fact, at Dynamic Equity that is the only form of financing we provide. This means it is not a loan or a debt. Instead, the capital is provided permanently to the company that requires it. It does not need to be repaid. There is no interest on it. There are no requirements for collateral, security, or personal guarantees. If the company does not make a profit there are no dividends. There is no burden on cash flow. In effect, it may be regarded as free money. In particular for young or expanding companies - that usually do not yet generate cash - venture capital can provide the financing to realize and accelerate growth.

The Catch

Of course, venture capitalists do not work for free. Considering all the risks they are taking they even require an above-average return on investment. Because they become shareholders in a company they can achieve this in two ways. First, by maximising the growth and value of the company. This is good for everyone involved. Second, by maximising the price they get when they eventually exit the investment by selling their shareholding. This is good if other shareholders exit at the same time, e.g. in a flotation on a stock exchange, and all get gloriously rich together. It is bad if the other shareholders, or the company itself, expect to buy back the shares from the venture capitalist.

If a company or its existing shareholders only require money temporarily, and have the ability to pay it back, they will be better off by borrowing. For those reasons venture capitalists usually do not get involved in project financing, property development, bridge loans, or other short-term arrangements. Venture capital is most suitable and beneficial for companies that expect to keep growing, and need permanent capital for that.

Advice for Free

Venture capitalists only make a profit if the value of companies they invest in increases. Some VC firms try to invest in the best companies they can find and subsequently hope and pray. Most professional VC firms, including Dynamic Equity, take a more hands-on approach. We too are very selective about the companies we invest in. Thereafter, however, we will also appoint one of our directors to the Board, closely monitor the performance, and assist where we can to help our investee companies achieve their plans and goals. Surveys done among entrepreneurs in other countries indicate that they often value the advice and support from venture capitalists even more than the money itself.

With Strings Attached

VC firms do not like to have their free advice freely disregarded. Any venture capital financing will be accompanied by investment contracts and shareholder agreements. Those serve to protect the minority shareholder interest of the VC investor. They typically will contain shareholder restrictions and specify company actions that require prior consent. Companies that are not willing to accept any limits on their actions at all, or are not prepared to deal with external shareholders, are not going to be happy with a VC investor on board.

Conclusion

Venture capital is very beneficial for growing companies that need permanent capital and can appreciate contributions from external shareholders. It is certainly not a panacea for everyone in all circumstances. Venture capitalists are very selective in the investments they make and are very aware of the pitfalls. If you have a suitable investment opportunity please do contact us. If we like it, we may even buy you a free lunch.