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A Venture Capital Primer For Small Business GOV4
By LaRue Tone Hosmer
Professor and Chairman Policy and Control Graduate
School of Business Administration
at The University of Michigan
Ann Arbor, Michigan
Summary
Small businesses never seem to have enough money. Bankers and suppliers,
naturally, are important in financing small business growth through loans
and credit, but an equally important source of long term growth capital is
the venture capital firm. Venture capital financing may have an extra
bonus, for if a small firm has an adequate equity base, banks are more
willing to extend credit.
This Aid discusses what venture capital firms look for when they analyze a
company and its proposal for investment, the kinds of conditions venture
firms may require in financing agreements, and the various types of venture
capital investors. It stresses the importance of formal financial planning
as the first step to getting venture capital financing.
What Venture Capital Firms Look For
One way of explaining the different ways in which banks and venture capital
firms evaluate a small business seeking funds, put simply, is: Banks look
at its immediate future, but are most heavily influenced by its past.
Venture capitalists look to its longer run future.
To be sure, venture capital firms and individuals are interested in many of
the same factors that influence bankers in their analysis of loan
applications from smaller companies. All financial people want to know the
results and ratios of past operations, the amount and intended use of the
needed funds, and the earnings and financial condition of future
projections. But venture capitalists look much more closely at the features
of the product and the size of the market than do commercial banks.
Banks are creditors. They're interested in the product/market position of
the company to the extent they look for assurance that this service or
product can provide steady sales and generate sufficient cash flow to repay
the loan. They look at projections to be certain that owner/managers have
done their homework.
Venture capital firms are owners. They hold stock in the company, adding
their invested capital to its equity base. Therefore, they examine existing
or planned products or services and the potential markets for them with
extreme care. They invest only in firms they believe can rapidly increase
sales and generate substantial profits.
Why? Because venture capital firms invest for long-term capital, not for
interest income. A common estimate is that they look for three to five
times their investment in five or seven years.
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