Before you, or your client jump in bed with a venture capitalist, it’s best to know the ground rules.
The growing significance of the venture capital industry means that accountants need to have a strong appreciation of the issues arising from the involvement of a venture capitalist. This knowledge provides a foundation on which to pro-actively seek out the opportunities that exist.
Venture capital represents a significant, albeit low profile funding source for private organisations and is a flexible alternative to the traditional borrowing avenues. As many organisations have experienced, bank finance is often exasperatingly limited by the property asset backing of the borrower (or the net wealth of any unfortunate guarantors!). Moreover, unlike banks, venture capitalists are encouraged to grow the equity value of an organisation because their incentives are aligned with the interests of the other shareholders. Similarly, the capacity of wealthy individual investors is often also limited and does not offer the value-added benefits of an institutional shareholder. Venture capital is very flexible in that it can be structured as either equity debt or hybrid instruments, and can be applied in a variety of means, including:
Management buyouts – where funds are used by the management team to acquire the business from its previous owner(s);
Sell-down by an existing shareholder – where a shareholder either wishes to partially or wholly realise the value of their equity (for example, in retirement);
Expansion – via acquisitions and/or geographic expansion.
It’s important for accountants to recognise that the venture capital community, while still small in Australia compared to the US or the UK, is nonetheless very diverse. Given such variety, accountants add value by undertaking research in advance of approaching venture capitalists. This not only saves significant time and energy, but more importantly ensures a match with the client’s needs.
Investment parameters
Venture capitalists can be segmented on the basis of their preferred investment size, industries and stage of business. For example, RMB Ventures invests from $10 million to $20m in most industries excluding agriculture and resources, and in well- established businesses that have an EBIT exceeding $4m. By contrast, other firms may provide funding of up to only $1m. In terms of semantics, the smaller, early stage funding is often referred to as venture capital, while the funding provided to larger, mature organisations is referred to as private equity. In this article, the term venture capital is used to encompass both funding classes.
Investment parameters are tangible features by which accountants can target specific venture capital firms. As importantly, however, there are a number of intangible features that should be weighed up and researched when evaluating funding partners. The following are a number of questions to ask in the review process.
Skill base/industry familiarity
What is the experience and industry knowledge of the principals of the venture capital firm? The greater their experience with the industry in which the client operates, the more likely they will be able to add strategic value to any growth and improvement opportunities.
Contact network
What is the contact network of the venture capital firm? The greater the contact network, and its relevance, the more likely that the venture capital firm can provide subsequent introductions to assist in the growth of the business.
Investment philosophy
Is the venture capitalist comfortable with a long-term investment, or will they seek an early exit. Is the management team treated as a partner, or as subordinates? The extent of the involvement by the venture capital firm is a key consideration. Firms have philosophies that range from very passive (for example, not participating in either the management or board), through to actively assisting in the management of the business. It is important to understand the needs of the business, and what style of investment philosophy is the best match. For example, a successful management team is unlikely to want an investor interfering in the day-to-day operations. Equally, it is necessary to recognise that involvement, particularly at a board level, may be valuable and complementary to the management resources.
Investment horizon
Is the investor a short-term or long-term investor? While all venture capitalists will seek an exit from their investment at a point in time, it is preferable that this matches with the businesses requirements and management team preference as much as possible in order to avoid debates about exit opportunities down the track.
Chemistry
How compatible are the principals of the venture capital firm with the other shareholders/senior management? As most venture capitalists seek a board role and adopt a medium to long-term investment philosophy, (three to five years) it is critical that the key people share similar values and philosophies and are able to work together.
Investment track record
How financially successful has the venture capitalist been? The performance of the venture capitalist may provide an insight into their ability to deliver value beyond supply of funding. It is true of course that external events and inappropriate initial valuations can mask value-added performance, and it is therefore important to dig below the surface to ask the nature of the services and involvement of the venture capitalists.
WHAT ARE THE BENEFITS?
i) Accountants, either acting on behalf of a client or as part of an organisation, are well positioned to act as the linchpin in securing funding supplied by venture capitalists.
ii) Venture capitalists, as financial shareholders, have a strong appetite for accounting and tax advice throughout the investment lifecycle, and CPAs are well placed to meet this growing need.
PHILIP LATHAM IS THE FOUNDER AND MANAGING DIRECTOR OF RMB VENTURES, WHICH MANAGES A PORTFOLIO OF 10 PRIVATE EQUITY INVESTMENTS, RANGING FROM A SMALL BROADBAND SERVICES BUSINESS TO A LARGE GROUP OF AIR-CONDITIONING COMPANIES. HE CAN BE REACHED AT [email protected] OR ON (02) 9256 6279
Copyright CPA Australia Jul 2003
