The Optimisation of Venture Capital Processes

Project Report, 2014

37 Pages, Grade: B-


3. Table of Contents

1. Title Page

2. Abstract

3. Table of Contents

4. Contents of Tables & Figures

5. Introduction

6. Literature Review
6.1. What is Venture Capital?
6.2. Venture Capital and the Financial Landscape
6.3. Venture Capital Companies’ Structure
6.4. Actors & Relationships within Venture Capital
6.5. Venture Capital Process
6.5.1. Investment Decision Conventional Common Method Real Options
6.5.2. Contracting Venture Capital’s Market Size Exit Strategy Risk & Uncertainty Capital Market Timing
6.5.3. Control and Value Adding
6.5.4. Exit Initial Public Offering (IPO) Trade Sale Secondary Sale
6.5.4,4, Buyback or Management Buyout (MBO) Reconstruction, Write-off, Bankruptcy or Liquidation

7. Reseach Aim, Questions & Objectives
7.1. Research Aim
7.2. Research Questions
7.3. Research Objectives

8. Methodology, Data Collection, Analysis & Results
8.1. Methodology
8.2. Data Collection
8.3. Analysis
8.3.1. Investment Decision NPV Method Internal Rate of Return (IRR) Real Options
8.3.2. Research Paper on Contracting
8.3.3. Case Study on Control & Value Adding
8.3.4. Journal Article on Exit Strategy
8.4. Results
9. Discussion, Conclusion & Recommendations
8.1. Discussion
8.2. Conclusion
8.3. Recommendations

10. References

4. Contends of Figures & Tables

Figure 1 Flows of Venture Capital, adopted from Bygrave & Timmons (1992)

Figure 2 FUELCO's Decision Tree

Table 1 Newco's Financial Statement

2. Abstract

This dissertation is written on the topic of “Optimisation of Venture Capital Processes: The scope of this dissertation is broad as it will closely signify and analyse all the important factors incorporated within the process of venture capital and would direct the underlying venture backed company towards the way of optimisation It has been observed that venture capital is frequently perceived as a synonym of private equity. According to Bygrave & Timmons (1992), the venture capital process is composed of four different phases (Investment Decision, Contracting, Control & Value Adding and Exit). The investment decision phase is much significant and is also time consuming. In relation to Contracting aspect, it has been assumed the each negiotated contract would be distinctive from each other and it would happen as a result of variation in term of assigning of control right adequate to that specific investment. With respect to Control & Value Adding aspect, It has been ascertained that through their active participation in the governance, aspect would have an opportunity in transfering their resources & competencies to the company in which they have invested. Therefore, major reason behind the significance of exit strategy in the venture capital is that in the earlier phases of development it seems very rare for the company to pay dividends to its shareholders. From the results of Investment Decision cases of all companies that there are three kinds of approaches (NPV, IRR and Real Options) that could be adopted for the purpose of estimating the value of companies’ projects backed by venture capital From the research paper on contracting factor, It has been discovered that important terms (regarding the composition and form of financial claims held by the entrepreneurs and venture capitalists) seemed to depend more on the size of underlying venture capital market size. From the case study on Control & Value Adding, it has been indicated that there is a direct relationship exists among the venture capitalists’ active participation and the performance of entrepreneurial companies. From the Journal on Exit Strategies, it has been observed that IPO is determined as exensively pursued exit strategy. However, trade sale is regarded as second preferred exit strategy It has been recommended that all companies venture backed companies) should take account of all of these aspects (Investment Decision, Contracting, Control & Value Adding and Exit

5. Introduction

This dissertation is written on the topic of “Optimisation of Venture Capital Processes: The scope of this dissertation is broad as it will closely signify and analyse all the important factors incorporated within the process of venture capital and would direct the underlying venture backed company towards the way of optimisation Major aim for undertaking research on this topic would be to enhance the understanding regarding the process of venture capital where the primary focus would be on analysing the relationships existing between venture capitalists & entrepreneurs. It has been observed that venture capital is frequently perceived as a synonym of private equity. According to Bygrave & Timmons (1992), the venture capital process is composed of four different phases (Investment Decision, Contracting, Control & Value Adding and Exit). And this research report would closely extract the major aspects of all of these phases. So that it would help the readers in observing that how a venture backed company could direct its venture capital process towards the way of optimisation.

6. Literature Review

According to Storey (1998), Small & Medium Sized Enterperises’ (SMEs) formation and growth is acknowledged as the major aspect for current econmic growth. Addtionally for funds acquisition purposes, SMEs are frequently emphasised on the fact of accessing equity (risk) capital and it is now emerged as critical source through which SMEs and relatively new venture companies could pursue and accomplish growth opportunities (Davidsson et al., 1996). Relatedly because of two factors (limited corporate experience and absence of steady cash flows), the new companies in the begininning phases would have to face more problems in term of accessing capital from the traditional debt sources. And the sourcing of capital from enterpreneur is also not seems to be an appropriate alternative because it has already been utilised or the proportion of this source is not much large (Bygrave & Timmons, 1992). Therefore, it has been observed that there are many rarely cases where the companies with potential of experiencing grow at fast pace have acquired capital for the given purpose (Brophy, 1997). Lastly, acquiring capital through equity sourcing is inclined to be more appropriate way of financing than debt specifically for the firms that are aiming for growth and expansion in a shorter time span. And according to Cornell & Shapiro (1988), the major reason behind this point is that on the later stages it would be proved as major demerit for such companies as it increases their financial risks (due to interest rates and amortisations). Wetzel (1983) termed such problems for enterpreneurial firms for aquiring and growing capital as equity gap.

Alongside the equity gap, it has been discovered that small companies with relatively greater potential for growth are also directed towards the competence gap (Barth, 1999). Generally, the development concept tends to increase complications for the companies’ management and also has been resulted in raising new demands for the companies’ management on a constant basis (Greiner, 1972). And in the most cases, these companies’ management seemed to meet that capital and competence needs by acquiring funds through the venture capital. It has been believed that the existence of venture capital market has the ability to bridge this competence gaps and is also considered as prerequisite (Klofsten, 1992).

Venture capital companies are companies that are intended in co-investing equity with the entrepreneur with the core motive of surviving in the early stages or to successfully undergo expansion process. And all the things reflect that through the funding made through venture capital has entitled venture capital companies not only to contribute entirely for capital growth but also have to assist entrepreneurial companies with necessary competence so that it would intend these companies to grow.

Specifically, there are many significant and interesting aspects that could be analysed for purpose of pursuing research on venture capital as its challenges and gaps could be discovered anywhere. For instance, it could be studied from the perspective of industry-market where the major intension would be to analyse and understand the industry of venture capital at macro level (by observing the current trends in market behaviour). Bygrave & Timmons (1992) had conducted research on given perspetive and briefly explained how US venture capital industry had managed to shift from the state of classic venture capital (early stages of investment) towards merchant venture capital (so called as later stages of investment). Moreover, another aspect that could be studied is the influence of venture capital on the society. Kortum & Lerner (1998) had studied venture capital from this perspective and have found out the increased intensity of venture capital have major contribution in term of increasing the patenting rate of innovation in the specified industry.

Additionally, one more aspect that could be focused is the investing process of venture captal. It has been highlighted that traditionally this process incorporates everything from the sourcing of capital for capital investment to the management of that investment and then to the harvesting of its outcome (Gompers & Lerner, 2002). However, one more aspect that could be analysed is the relational aspect which is more focused on the fact of intending the venture capitalists to determine the relational advantages of venture capital process. Fried & Hisrich (1995) had closely analysed the process of venture capital from the view of relational aspect and had drawn the point that the venture capitalist is a relational investor (Fried & Hisrich, 1995).

6.1. What is Venture Capital?

Venture Capital is considered to be an important category of risk capital in which the investor seems to offset the risk of losing his/her capital by compelling the fund raising company to give him/her ownership stakes in case of company’s success. As a concept, it has been believed that venture capital has been around from ages as in the part there had been found many incidents where the rich persons had intended

themselves to put their wealth at risk for a potential success or gain. One could called Isabella’s financing of Columbus as a part of venture capital contract where the capital gain had been in the form of exploring of new trade route towards India.

In European, venture capital is frequently perceived as a synonym of private equity. And within this context, venture capital is represented as an investment which is to be made by individuals, firms or financial institutions so that the new or established companies would able to successfully undergo initial or expansion stages.

6.2. Venture Capital and the Financial Landscape

It has been found out that the venture capital is not the only financing source for the companies in the start-up phases as many incumbents companies have also utilised this financing source in order to successful pursue certain projects that promise the grow of massive intensity. On the other hand, there are many companies that seems to avoid this financing source because of certain reasons (reluctant in term of giving ownership stakes to the investors or the force growth would be resulted in overstretching the company). The major reason behind the attraction of venture capital as a source of capital is the high growth potential of relatively new firms which has been evident and experienced mostly by technology based companies.

For many companies, venture capital is believed to be as the only source of capital. Isaksson (1999) conducted research work on Swedish venture capital backed companies and discovered that around 31% companies alleged that venture capital was the only possible source of financing so that they would meet their working capital requirements. Moreover the significance of venture capital is seems to be more realistic especially considering the fact the the surveyed companies had been growing at much fater pace than the other companies in the respective sectors. Correspondingly other associated findings generated from the studies conducted at international level have been stressing positive influence of venture capital on the macro and micro economics aspects (Hellman & Puri, 2000).

6.3. Venture Capital Companies’ Structure

One could divide venture capital into several categories based on the companies’ ownership structure or source of capital contributed by these companies. In this regard the first set of companies are known as Private Independent venture capital companies, that used to invest their capital in the form of organised funds (limited partnerships) where these companies are obliges as general partner. These forms of companies are in dominant numbers in US as well as in Europe (Sahlman, 1990).

If there is a case that the venture capital company sourced funds primarily from the interal sources of patent organisation then it is categorised as captive venture capital company (Jeng & Wells, 2000). These companies have been determined to be a part of an established corporations that are more focused upon investing their own resources. In the majority cases, the parent organisations are banks or insurance companies that are treated as separate category and sometime also known as corporate venture capital organisations (McNally, 1997).

The final category of venture capital organisations are determined as public sector venture capital organisations that are controlled and financed by government institutions. Specifically, the degree of government instutions’ influence could vary from entirely owned to partialy supported or financed.

6.4. Actors & Relationships within Venture Capital

In general, the research studies on the process of venture capital are intended more on analysis the fact that how the venture capitalist and entrepreneur manages to form businesses on collective basis. So, which meant that it is significant to briefly focus upon the relationships and actors incorporated for the brief understand of venture capital process. There are three major actors: Fund Providers (Investors), Venture Capitalists and Entrepreneurs. On the supply side of venture capital there are two actors (investors and venture capitalists) whereas the entrepreneurs are on the demand side. Venture Capitalists act as an intermediaries between the providers of funds (investors) and the enterpreneurial companies. Most precisely, for enterpreneurial companies the venture capitalists perform the role of supplier of funds and for investors the venture capitalists perform the role of seeker of funds (Amit et al., 1998). And the relationships between these involved actors are considered as contractual & reciprocal and are build upon the considerationable trust. If there would be a case where these actors loses that trust then it would make severe impact on their relationships (Shepherd & Zacharakis, 2001). It has been analysed that for the purpose of avoiding any potential conflicts, enterpreneurial companies allocate equal values to its relationships with the investors and the portfolio companies.

Abbildung in dieser Leseprobe nicht enthalten

Figure 1 Flows of Venture Capital, adopted from Bygrave & Timmons (1992)

Above illustrates the principal actors involved in the process of venture capital. Generally, there various forms of interaction within these relationships. First one is the relationship existed between investors and venture capitalists. It has been seen that investors are seeking relationships with venture capitalists because of the fact that the venture capitalists are informed and effective in term of developing and evaluating entrepreneurial ideas (Amit et al., 1998).

6.5. Venture Capital Process

For the brief understanding of issues incorporated with the process of venture capital, it is more vital to clearly depict how the overall process works. According to Bygrave & Timmons (1992), this process is composed of four different phases that are listed below:

a) Investment Decision
b) Contracting
c) Control and Value Adding
d) Exit

Additionally, Bygrave & Timmons (1992) had signified five major principal activities (Deal Origination, Deal Screening, Deal Evaluation, Deal Structuring and Post Investment Activities) that are pursued by venture capitalists.

6.5.1. Investment Decision

It has been understood from the past studies that most of the projects got rejected especially during the screening process (Mason & Harrison, 1999). The investment decision phase is much significant and is also time consuming. It composed of complete examination of given due diligence which then gets finance on the basis of specified conditions. According to Tyebjee & Bruno (1984), venture capitalists used to spend nearly half of their time in screening and evaluating projects. Major concern in selecting new enterpreneurial companies are directly linked with the hurdles in term of estimating their risks and potential. Hence, majority of these projects incorporate information on specified products or services. Additionally there might be an inadequate knowledge about the current and potential consumers & markets. Therefore, there is a high level of uncertainty about the success of these projects. Sometime, there is also a problem of information asymetry existed between the venture capitalists and the entrepreneurs (Amit et al., 1998).

In order to resolve this issue of inadequate distribution of knowledge, the investors should need to utilise various methods. Some of these methods are listed below:

-Entrepreneur’s self-selection
-Social Networks for the transfer of knowledge Environmental selection
-Syndication of investment decisions
-Use of selection criteria and checklists.

It has been analysed that all the studies that have undergone the research on the use of venture capitalists’ criteria in relation to making investment decision have discovered that management related criteria is the significant factor in influencing the investment decisions (Gibson et al., 2007). Conventional Common Method

Traditionally, there are two approaches (Net Present Value & Internal Rate of Return) that could be adopted by the companies for the valuation purposes.

a) NPV (Net Present Value)

NPV can be calculated by obtaining the annual figure of projected in-flow of funds and then deducted it from the projected outflow of specified venture capital project. The resulted sum of NPV can be obtained by multiplying it with the discount rate. In this way, total present value of specified venture capital project will be estimated. If the NPV figure of specified is greater than zero then it means that it would be feasible for the company to carry on that project.

b) Internal Rate of Return

It has been observed that the venture capitalists used this method of IRR on frequent basis for the valuation of venture capital projects. In actual this method is based on the approach of bringing all series of cash flows (either positive or negative) to a NPV of 0.


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The Optimisation of Venture Capital Processes
University of West London
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optimisation, venture, capital, processes
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Junaid Javaid (Author), 2014, The Optimisation of Venture Capital Processes, Munich, GRIN Verlag,


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