Raising Venture Capital

Financing an invention or new business venture can be one of the most difficult obstacles to hurdle for an entrepreneur. The late Malcolm S. Forbes on more than one occasion was quoted as saying “you have to spend money to make money”. But many good ideas don’t get past the planning stage because the fledgling entrepreneur doesn’t have the resources to see his idea to fruition. A new invention for example may often require thousands of dollars in research and development costs for producing a satisfactory prototype, patenting, and eventual marketing. Most new business ventures are usually also cost prohibitive with overhead in property leasing and equipment, and marketing and advertising. Also, existing businesses looking to expand into a new line are also often faced with significant monetary constraints.

Traditional sources of capital such as banks have become less willing to lend money to speculative ventures because of the bad debt exposure that many suffered during the last decade. Certainly banks are willing to lend money to speculative ventures in situations where the borrower is also capable of posting substantial collateral. But most entrepreneurs and newer businesses operate on “shoe string” budgets and are usually not capable of meeting a bank’s asset requirements. These people might be better served by seeking out a venture capital consortium.

A venture capital firm, as the name implies, is in the business of providing capital to new and existing business ventures in return for interest payments or partial ownership. Like traditional banks, venture capital firms will lend money to conservative well backed ventures for a competitive rate of return. But unlike banks, venture capitalists will also invest in highly speculative ventures if the potential for significant capital gains exists and the lender is able to share in that potential. A new invention will often provide such an opportunity for return.

A typical venture capital deal with a new or existing company usually involves the use of some kind of convertible bond or other convertible debt instrument. The venture capital firm will lend the company money in return for some kind of convertible bond backed by the companies’ assets, if any. These assets might just be a patent or trademark if nothing else exists. The venture capitalist will usually help the borrower prepare the bond issue and since it will be a private placement it will not require SEC registration or the costs associated with a public offering. The term convertible in this sense means that the bonds can be converted into the borrowing company’s stock at the discretion of the lending venture capital firm. The venture capitalist not only wants to maximize his potential return, but also to insure that he can get his investment back if the venture fails. Bondholders as creditors are paid before shareholders in the event of bankruptcy. Subsequently, if the venture fails the venture capitalist as a creditor has first rights to whatever monies are left in the company. If the venture succeeds, the venture capitalist exercises his option and converts the bonds into the companies stock and becomes a partial owner in the business.

Most people think that such a transaction might be a bit complicated and unrealistic for their company. But even the smallest of companies can work out this kind of deal if they can convince a venture capital firm that their idea is good enough to warrant research and has the potential to provide an extraordinary rate of return on investment.

For those who don’t have a company but merely an idea or a new invention they can still turn to a venture capital firm. Most venture capitalists are willing to invest in what they call “seed” capital. Seed capital as its name implies is investing in the initial stages of a new idea. Since it is new and innovative ideas that can lead to the most significant returns, venture capitalists are always on the look out for ground floor opportunities that can return ten or twenty times their investment. If the idea or invention is promising enough. a savvy venture capital outfit will finance and develop the project. The type of fees involved might vary from deal to deal but will inevitably involve some form of partial ownership.

Finding venture capital firms can be a time consuming process. Venture capital firms are always flooded with more ideas then cash on hand to finance them and therefore don’t often actively seek business. A good source of information would be your local finance professionals, stockbrokers, lawyers and accountants probably have some knowledge of firms and individuals who lend money for new ventures. The local college library, particularly if it has an undergraduate or graduate business school, will probably have some listing of finance or venture capital firms. Check with a business school’s librarian. Finally, the major newspapers (New York Times Sunday Business Section, Wall Street Journal, etc.) usually have listings of “Capital to Invest”. These are usually venture capital affiliates who have extra cash on hand. But do remember that anyone with large sums of money to invest probably has talented professionals behind him. Therefore, it would be wise to retain a good lawyer to advise you before you begin negotiations, and certainly before you sign anything.