A Venture Capital Primer For Small Business continued...

Types of Venture Capital Firms

There is quite a variety of types of venture capital firms. They include:

Traditional partnerships--which are often established by wealthy families to aggressively manage a portion of their funds by investing in small companies;

Professionally managed pools--which are made up of institutional money and which operate like the traditional partnerships;

Investment banking firms--which usually trade in more established securities, but occasionally form investor syndicates for venture proposals;

Insurance companies--which often have required a portion of equity as a condition of their loans to smaller companies as protection against inflation;

Manufacturing companies--which have sometimes looked upon investing in smaller companies as a means of supplementing their R&D programs (Some "Fortune 500" corporations have venture capital operations to help keep them abreast of technological innovations); and

Small Business Investment Corporations (SBIC's)--which are licensed by the Small Business Administration (SBA) and which may provide management assistance as well as venture capital. (When dealing with SBIC's, the small business owner-manager should initially determine if the SBIC is primarily interested in an equity position, as venture capital, or merely in long term lending on a fully secured basis.)

In addition to these venture capital firms there are individual private investors and finders. Finders, which can be firms or individuals, often know the capital industry and may be able to help the small company seeking capital to locate it, though they are generally not sources of capital themselves. Care should be exercised so that a small business owner deals with reputable, professional finders whose fees are in line with industry practice. Further, it should be noted that venture capitalists generally prefer working directly with principals in making investments, though finders may provide useful introductions.

The Importance of Formal Financial Planning

In case there is any doubt about the implications of the previous sections, it should be noted: It is extremely difficult for any small firm--especially the starting or struggling company--to get venture capital. There is one thing, however, that owner-managers of small businesses can do to improve the chances of their venture proposals at least escaping the 90% which are almost immediately rejected. In a word--plan. Having financial plans demonstrates to venture capital firms that you are a competent manager, that you may have that special managerial edge over other small business owners looking for equity money. You may gain a decided advantage through well-prepared plans and projections that include: cash budgets, pro forma statements, and capital investment analysis and capital source studies.

Cash budgets should be projected for one year and prepared monthly. They should combine expected sales revenues, cash receipts, material, labor and overhead expenses, and cash disbursements on a monthly basis. This permits anticipation of fluctuations in the level of cash and planning for short term borrowing and investment. Pro forma statements should be prepared for planning up to 3 years ahead.

They should include both income statements and balance sheets. Again, these should be prepared quarterly to combine expected sales revenues; production, marketing, and administrative expenses; profits; product, market, or process investments; and supplier, bank, or investment company borrowings. Pro forma statements permit you to anticipate the financial results of your operations and to plan intermediate term borrowings and investments.

Capital investment analyses and capital source studies should be prepared for planning up to 5 years ahead. The investment analyses should compare rates of return for product, market, or process investment, while the source alternatives should compare the cost and availability of debt and equity and the expected level of retained earnings, which together will support the selected investments. These analyses and source studies should be prepared quarterly so you may anticipate the financial consequences of changes in your company's strategy. They will allow you to plan long term borrowings, equity placements, and major investments.

There's a bonus in making such projections. They force you to consider the results of your actions. Your estimates must be explicit; you have to examine and evaluate your managerial records; disagreements have to be resolved--at least discussed and understood. Financial planning may be burdensome but it's one of the keys to business success.

Now, making these financial plans will not guarantee that you'll be able to get venture capital. Not making them, will virtually assure that you won't receive favorable consideration from venture capitalists.