VENTURE CAPITAL BUSINESS March 19th, 2010

VENTURE CAPITAL BUSINESS

Mid-Term Assignment

Farah Anisa Setyawati (13406109)

Industrial Engineering, Institut Teknologi Bandung
Email: farah.anisa@yahoo.com

Abstract: This paper contains the definition of venture capital business (VCB) and its history.
Characteristics based on literature are respectively explained to describe ways to invest. VCB also has
mechanism to fund the entrepreneur’s business. To make wise investment, this paper also provides the
characteristics of ideal entrepreneurs and field industry, also how to manage deal with entrepreneurs.
Index term: venture capital business, venture capitalist investment, entrepreneur.

I. INTRODUCTION technology, decides how much they would

I.1 Definition
“Venture capitalists invest in equity in the
form of common stock, or preferred stock,
convertible debentures, or other financial
instruments convertible into common stock when
the small firm is sold either through a merger or
a public equity offering. A most strict definition
of venture capital excludes buyouts, loans, and
other financial transactions” (Kenny, 2000).
Venture capital is equity financing to high
risk young companies” (SBM, 2010).
From the definition above, we can perceive
the venture capital as an institute to manage
people’s private equity into (mostly) some
investments. People who commit the venture
capital business (VCB) are called venture
capitalist (VC). VC may consist of people or a
firm. Differences between VCB and other fund
sourcing will be explained in the next chapter.
The VC investments are commonly used for
build the start-up or the grown business. This
situation is a bit intriguing, regarding the profit
for start-up and grown business are not
predictable. Any kinds of prediction or
probability in investment are risky investment.
According the type of industry, if the invested
capital was big enough for the successful
industry, then the VC would have higher
valuation in the future. If the business declined,
VC would lose all investment. For those reasons,
the VC should counting the risks of market,
people (customer and resources), money,
invest and manage the investment dealing.
I.2 History and Growth
Great Depression era starts in 1930 bringing
on the lack of investment. Many kinds of small
business couldn’t return the investment because
the industrial trend wasn’t good back then.
Investors were unable to take their investment
because they don’t have leverage on the
entrepreneurs.
World War II had been a shift era for young
investors, such Mellon, Phipps, Rockefeller and
Whitneys to invest in small business as a family
VC fund. When industrial revolution starts in
1946, the continuing growth of industry makes
more space for VC investment. Remarkable
private VC in the era was establishment of
American Research and Development (ARD).
ARD encourage the students of Harvard
Business School (HBS) to practice of
investment, and proof how VCB could give the
significant return.
In 1958, US Government had established
the Small Business Investment Corporation
(SBICs) to attract investment into small
businesses. Two contributions from SBIC are:
(1) regulation of loan guarantees, which makes
investors able to expand in low-cost capital; (2)
permitted bank to have more than 5% equity if
the bank’s investment was the venture
investment alike (smaller amount).

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 VENTURE CAPITAL BUSINESS
Bank was a source of venture capital in
1960-1970 and replaced by independent VC in
1980.
Nowadays, common people can be VC. It’s
all about the right timing and the right field of
industry. Based on the historical data of firm,
VC should predict the growth of industry, and
decide how much to invest. Basically, one to
other capitalists is trade-off connected. USA
businesses are usually attracting and funded by
foreign investors. So that USA has a stable and
grow industry, could invest in foreign business.
II. VCB CHARATERISTICS
As written previously, VCB is about timing.
Actually, VC couldn’t predict whether they
would invest in almost-mature industry. It’s has
unknown revelation for the worth of investing in
early stages. VC have to count the limitation of
funding, how much risk willing to take, how to
manage the risks, and regarding the firm’s
profile to evaluate and reduce the risk. The
picture below is trying to depict that after period
of VC investing period, there could be winning
or losing graphic.
Picture: Timing is Everything (HBS, 1998)
VC invest the early stage but not at the very
beginning. Most of entrepreneurs are in small to
medium business. This is favorable high return,
compare to another established business.
Therefore, private VC only invest in small
amount, but very careful to pick out the area of
business.
If the VCB were organized as a firm, VCB
could act as a lender for smaller business.
The risky investment not only offers the
great return in the matter of entrance timing, but
also the timing for VC to leave the business. Exit
strategies that VC could use are: sale of the
Farah Anisa  13406109
March 19th, 2010
stock through initial public offering (IPO),
merger, and bankruptcy (Kenny, 2000). VC
should know when a firm could recover he
investment and gives VC their share as higher as
possible before another investors making
entrance; or the firm (also the investment) into
bankruptcy.
III. COMPARISON TO OTHER
FINANCIAL SOURCES
III.1 Angel Investor (AI)
Different with AI, VC isn’t obliged to invest
the firm regularly. VC could decrease or increase
the amount of investment based on prospect
business, annually. While VC interests of rate of
return of investment, AI more interests on
having investment in such specific business area.
Regarding the less investment, unlike VC, AI
doesn’t have option to control or secure the
investment.
III.2 Investor
In providing the same firm, Investor may
cooperate with VC. VC is called General Partner
and Investor is called Limited Partner. Investors
are taking care of firm’s pension, wealthy and
endowment expenses while the VC managing
the money of investors.
Different with VC, investors are usually
provide the business continuously from the
beginning and stay longer until the business
decline. Due to investor’s amount of investment,
which invest more than VC, investors are having
60-70% while VC only 20-30% of equity shares.
III.3 Bank
Bank invests as much as the historical
financial data of firm promising the bright future
in immediate years. But VC looks firm’s
prospect in a long run and considering aspects:
product selling, market prospect and distribution
of product, instead only financial data.
Bank has nothing to do about running the
firm, only as a creditor. But VC earned annual
paid, giving advices and running the operational
decision (naturally the owner of the firm itself).
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In general positive side, VC could be
organized as a private or a company. VC could
invest in small to medium size of investment and
have a lot of firms provided by their equity.
Consider the period of investing, VC may
provide and control the firms for set period of
time (7-12 years). VC may control their own
investment and commonly having exceed return
the business’ MARR (minimum rate of return).
In general minus side, VC is perceived as
more individualist and opportunistic because
they don’t have to stick with the business and
having exit strategies.
IV. VENTURE BUSINESS MECHANISM
IV.1 Fund Sources
Basically, VC could be personal or based on
corporation. As a private VC, you may want to
risk your private equity, manage your investment
and working the business on your own. But
dealing with other capitalist and act as a
corporate VC actually have some advantages,
like having investor group, sharing equity, and
expand more investment. As VC, we need
another fund resource to map our possibility to
co-invest. These are other fund resources for
entrepreneurs:
1. Individual relatives: VC may want to try
nearest people who wealth enough to be
investor. The advantages of taking this
personal type are professionally managed,
focus in returning the investment, also easy
to sharing with.
2. Angel Investor/Professionally Managed
Pools: Naturally, angel investors are venture
capitalists, money institutional with
different condition of investing. They like
traditional partnerships, VC could be close
enough to live vicariously like the investors
themselves, and taking advantage (network,
business advice, and credibility).
3. Corporate: VC may have to learn
something inside the corporation, such as:
implement and innovating the products and
technologies in the Research and
Development Department, learning
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March 19th, 2010
operational skills managing risk and doing
distribution networks.
4. Government: VC may want to play big and
approaching government to use the private
equity into creating new jobs and grow
economy. VC also could ask for favor from
Government, because they offer cash also
tax incentives.
5. Investment Banking Firms: VC may want
to avoid this type because they put the
highest return above other fund resource.
But this type is the most fits funding for
established securities, occasionally for
investor syndicates for venture proposals.
IV. 2 Investment Stages
VC interests on firm’s future. The more
firm growth, the more VC has the higher return
investment. To manage those matters, VC should
do these following stages orderly:
1. Entrepreneurs were better introduced by
recommended capitalist, so that VC could
presume what business will be presented.
Should the VC not interest, VC would feel
free to re-recommend to another contact list.
2. Comes to entrepreneurs or make them
having opportunities to describe their
business plan, organization structure
(explaining the people involved in the
business), and how they manage the
competitors.
3. VC should interview the prospective
customers. Since most of industries are pull
system, market identification is very
important. What kind of product they would
like to buy and why.
4. Join the Board of Director (BOD) of the
firm; so that VC could manage the firm’s
operational. The operational terms such as:
employee recruitment, provide the key
network (lawyer, accountant)
5. VC should have knowledge about the
business and project feasibility and project
management (from technical people are
preferable),
6. Making contract deal about the investment
(how much, growth potential, when to exit),
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also by compromising terms for investment
and to committing firm’s success.
7. In order to succeed the firm, VC should
manage the investment, assisting, giving
advice also help to decide.
V. VCB PROFILE & DEAL
V.1 Venture Investment Profile
In order to investing, VC should assure the
investment worthy, so that VC should identify
the ideal entrepreneur or firm to invest.
Qualifications for ideal entrepreneur are
excerpted below (HBS, 1998):
1. Delivers sales or technical advances with
reasonable probability,
2. Understand the cost of capital and typical
deal structures,
3. Get along with the investor group and not
offended by them; et cetera.
Besides the profile of ideal entrepreneur,
VC should pay attention if the entrepreneur
themselves were in good industries, not only the
people and idea (based on their Business Plan).
The shift of advance technology has change the
paradigm of production cost and period.
Example: If you sell the products, you should
produce as many as the quantity you want to sell.
But if you sold software, you just have to
produce one product and duplicate for another
selling. The period of producing the software is
short, yet VC has many possibility entrances to
starting the investment or to exit the business as
well.
This kind of technology always has market
(drawn in the middle of industrial S-curve).
Should there any market want the different type
of software, the software firm may ask another
investment to keep the demand coming. Any
developments of software content are easily
added in the program (remaining the same
software).
V. 2 Logic of the Venture Deal
After finding the right entrepreneurs VC
wants to invest with, dealing is the edge chapter
of start-up the relationship between VC and
entrepreneur. Naturally, the deal is
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compromising the patronage of investment and
privileges retrieved from investment. Some legal
advisor needed to arrange the clausal protecting
rights of investors, such as: position in the firm
to make additional investment, percentage shares
from equity, to have the firm’s assets and
technology as assurance for failing the business.
Regarding the position in the firm, VC may want
to secure their position to not cross another
investment and make them as “followers” who
assessing the risk and managing deal.
VI. CONCLUSION
Should you interest investing VCB, start to
pick a field of industry and expand your
networking (other capitalists and stakeholders of
industry). Many investors stuck in myth which
believe that people reflect a good managerial
organization of firm and that good idea means
the business afford the technology also the
potential R&D.
Being VC, you should learn more about risk
investment, technical, valuating the business
field and exit strategies. In optimistic case, you
will gain the higher return in some range of time
and right field.
VII. REFERENCES
1. Kenney, Martin. 2000. Journal: A Note on
Venture Capital. BRIE Working Paper.
2. Rustiadi, Sonny 2010. Lecture Slide:
Introduction on Venture Capital Business.
Bandung: School of Business Management
ITB.
3. Zider, Bob. 1998. Journal: How Venture
Capital works. Harvard Business Review.
4. Henderson, Wade. Article: Some of the
Characteristics That Define Venture Capital.
Source: http://ezinearticles.com/?Some-of-
the-Characteristics-That-Define-Venture-
Capital&id=2479940 (last accessed: March
18th 2010).
5. Risky but High Potential Return Nature of
Venture Capital Investments. Sources:
http://www.askventure.com/risks-return-
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venture-capital-investments.html (last
accessed: March 18th 2010.

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