Venture Capitalist

Report

- Sunil Mody -

Final Analysis Summary

What is a Venture Capitalist Firm?

A venture capitalist firm is a group of experienced professionals who help company CEO’s raise money for operating capital. Their expertise in management and financing, combined with a commitment to help a venture grow, improve the chances of a significant return to investors.

What we did?

In order to understand the venture capitalist sector and to see how AIESEC can relate to it, we decided to meet with a firm in the Ann Arbor area. This resulted favorably in a one hour discussion with the firm, Arbor Partners, LLC. Since they are the 2nd largest venture capitalist firm in the Ann Arbor area with a high level of assets, they are a good representation of the sector because any smaller firm would have been more difficult to approach. During the meeting, we asked a series of questions (transcribed down below) in addition to us being very open to what they felt was important about their firm.

Analysis:

Since venture capital firms invest money into startup companies, there is very little opportunity for international growth in both the VC firm and the invested firm. The offices are small, and their new hires are generally only the contacts they have. Even as of right now, international operations do not exist. . We were told other VC firms do not have an international department. The only opening for AIESEC is to check in the future if venture capital firms are doing any research internationally. Then we have some potential of helping them towards their goals.

Final Statement:

Currently, there is no reason for AIESEC to approach venture capitalist firms.

How are Venture Capitalist Firm Works

Cited Information Source: Jonathan Roosevelt

Venture capital is high-risk, high-return investing in support of business creation and growth. In pursuit of high returns, a venture capital ("VC") firm raises a fund of anywhere from $10 million to $350 million in size.

The legal structure of a VC fund is a limited partnership. Those who invest money into the fund are known as limited partners (LPs). Those who invest the fund's money in developing companies, the venture capitalists, are known as general partners (GPs). Generally, the LPs contribute 99% of the committed capital of the fund while the GPs contribute 1% of it. As returns are made on the fund's investments, committed capital is distributed back to the partners in the same percentage.

VC firms receive compensation for their investment and management activities in two ways. First, they receive an annual management fee paid by the fund to a management corporation, which employs the venture capitalists and their support staff. The annual management fee approximates 2.5% of committed capital; however; it is usually lower at the very beginning and end of the fund when investment activity is low. Secondly, the VC firm receives compensation through the allocation of the net income of the fund. The fund's primary source of net income is capital gains from the sale or distribution of stock of the companies in which it invests. The GPs typically receives 20% of net capital gains while the LPs receive 80%.

A venture capital fund passes through four stages of development which last for a total of ten years. The first stage is fundraising. It typically takes the GPs of a venture fund six months to a year to obtain capital commitments from its LPs. LPs include state and corporate pensions funds, public and private endowments, and personal investors.

The second stage lasts between three and six years and is comprised of sourcing, due diligence, and investment. When a VC firm sources a company, it simply means that the company has been brought to the attention of the firm. Sourcing occurs through reading trade press, attending trade conferences, and speaking to those with industry familiarity. A junior member, a.k.a. an Associate or Analyst, spends the majority of his/her time sourcing companies. After a GP or junior member sources a prospective deal, extensive research is done on the company and its market. Occasionally this process, called due diligence, leads to an investment. Companies in which VC firms invest become "portfolio companies."

The third stage, which lasts until the closing of the fund, is helping portfolio companies grow. The portfolio company and the VC firm unite to form a team whose goal is to increase the value of the portfolio company. The VC firm becomes an equity participant in the portfolio company through a deal structure typically comprised of a combination of stock, warrants, options, and convertible securities. In return, the VC firm provides financing and a representative who sits on the portfolio company's board. As a board member, the VC representative offers strategic advice to the management team and assures that his/her firm's interests are considered.

The fourth and final stage in the life of a venture fund is its closing. By the expiration date of the fund, the VC firm should have liquidated its position in all of its portfolio companies. Liquidation usually occurs in one of three ways: an Initial Public Offering (IPO), the sale of the company to a third party, or Chapter 11. Typically an IPO realizes the greatest return on investment.

Depending on the investment focus and strategy of the venture firm, it will seek to exit the investment in the portfolio company within three to five years of the initial investment.

The initial public offering is the most glamorous and visible type of exit for a venture investment. In recent years technology IPO's have been in the limelight during the IPO boom of the last six

years. At public offering, the venture firm is considered an insider and will receive stock in the company, but the firm is regulated and restricted in how that stock can be sold or liquidated forseveral years. Once this stock is freely tradable, usually after about two years, the venture fund will distribute this stock or cash to its limited partner investor who may then manage the publicstock as a regular stock holding or may liquidate it upon receipt. Over the last twenty-five years, almost 3000 companies financed by venture funds have gone public.

INVESTMENT EVALUATION CRITERIA

VC firms judge potential investments on the basis of four fundamental criteria: management, market, products, and financial opportunity. They evaluate each criterion from the perspective of minimizing their risk and maximizing their return.

Management

A strong management team is comprised of individuals who have successful track records in relevant industries and have gained a superior understanding of their market. The team must work well together and have an extraordinary drive to make their company grow.

Market

The ideal market is growing rapidly and has the potential to become enormous. If strong direct competition exists, the market opportunity needs to be large enough to sustain two or more successful companies. The management team needs to understand and establish relationships with the key distribution channels in their market. An effective way to establish a profitable channel often includes both a direct sales force and relationships with Value Added Resellers (VARs) and Original Equipment Manufacturers (OEMs). Government regulations, if they affect the dynamics of the market, should enhance a company's position.

Products

The ideal product has few technical risks and has many proprietary features that differentiate it from the products of competing companies. In addition, the product should achieve above-average gross margins, have a short sales cycle, offer repeat sales opportunities, and demand a limited amount of additional capital. Because the fate of the company should not be riding on a single product, plans for a full product line are important.

Financial Opportunity

Once the VC firm decides that a company has superior management, an attractive market opportunity, and excellent product, it strives to invest its capital at as low a price as possible. An entrepreneur, of course, wants to raise capital at as high a price as possible. The price of a deal is the value of the company as determined by both parties. Liquidity is the final goal; thus, an assessment of likely exit (liquidation) opportunities is made before money is invested.

VC firms rarely find an investment that suits all of their criteria. Even when they find a good deal opportunity, they are not guaranteed success. If a VC firm is both skilled and lucky, it will probably make a profit on 50% of its companies and lose money on the other 50%.

INVESTMENT STRATEGY

Most VC firms evaluate companies based on the above criteria. However, because of competition among their VC peers to be chosen by the limited group of entrepreneurs who are both experienced and successful, VC firms have developed unique investment strategies which center around specific industries and particular stages of corporate development.

Industry

VC firms focus on particular industries based upon the skill sets and experience of their GPs. A GP's market experience and contacts make him/her a valuable board member. Popular industries of expertise in the venture industry include biotechnology, computer software, communication, retail, and other specialty niche areas.

Stage

While most companies do not seek outside financing at every stage in their development, early-stage financing, expansion financing, and acquisition/buyout financing exist for all stages of development. VC firms often focus on one of these categories. In general, the later the stage of the company, the smaller the risk for the VC firm. Therefore, VC firms that invest in later-stage companies must "ante-up" and pay a higher valuation for their equity positions. Typically, VC firms strive to achieve a return on their investment in start-ups within four to seven years, and, in established companies, within two to four years.

Early-stage financing:

Seed financing is an initial infusion of capital provided to entrepreneurs with little more than a concept. These funds are used to conduct both market research and product development. Once research and development are underway and the core management team is in place, start-up financing can be obtained to recruit a quality management team, to buy additional equipment, and to begin a marketing campaign. First-stage financing enables a company to initiate a full-scale manufacturing and sales process to launch the product in the market.

Expansion financing:

Second-stage financing facilitates the expansion of companies that are already selling product. At this stage a company may raise between $1 to $10 million to recruit more members to the sales, marketing, and engineering teams. Because many of these companies are not yet profitable, they often use the capital infusion to cover their negative cash flow. Third-stage or mezzanine financing, if necessary, enables major expansion of the company, including plant expansion, additional marketing, and the development of additional product(s). At the time of this round, the company is usually break-even or profitable.

The final step for a successful company is going public. Once a company goes public, the VC firm realizes a great deal of value from its initial investment. For example, if over the course of several rounds of financing, the VC firm has bought 40% of a company for $6 million, and if the company achieves a public market capitalization of $150 million, then the value of the VC firm's investment has grown to $60 million. This provides the VC firm with a ten-fold return on its investment.

Acquisition and buyout financing:

Acquisition financing, which can occur at any point in a company's growth, provides the necessary funds to acquire another company. Management/leveraged buyout financing assists management's purchase of a product line or business from another public or private company. In buyout situations, a key area of consideration for the VC firm is its confidence in the management team's ability to assimilate the assets of the two merging entities.

A VC firm's "VALUE ADDED"

Venture capital firms are not the only ones looking for value. Usually the entrepreneurs expect more than money in return for a share in their company. While it is said that an active venture capital investor is one who phones yearly to see if the company is still in business, this scenario is not typical. In fact, what differentiates venture capitalists from the world of passive investors is their long-term involvement with their investments. As an active board participant, a VC investor offers his/her unique set of experiences and skills. A good VC firm arranges for the long-term financing of a company and aids in developing the

management team, advisory board, new product ideas, strategic relationships, and key customers and accounts.

JOB PROSPECTS AND DESCRIPTION

The primary role of junior members is to assist the GPs in locating, analyzing, and evaluating investment proposals. In essence, the junior member's job is to source deals and perform due diligence. While an understanding of finance and some knowledge of a relevant industry can be helpful, it is often not necessary. What venture capital firms are looking for in their junior members are excellent analytical, interpersonal, and communication skills, and the ability to work in both an unstructured and a team environment. For the most part, junior-level opportunities in VC are two-to four-year positions. A promotion offer into the partnership is unusual, especially if a junior member does not have an MBA.

Before interviewing, you should understand both the investment philosophy of the firm to which you are applying and the specific nature of the job being offered. While at first, junior members are expected to spend the majority of their time sourcing companies, as their level of experience and industry expertise increases, they will spend more time performing due diligence.

Tip: Often venture capital firms that have recently raised, or are in the process of raising, a fund provide the best prospect for a job. A newly funded firm often needs junior members to help them in the time-intensive, three-to six-year investment phase of the fund. To determine which firms are in fundraising mode, refer to journals such as The Red Herring, The Venture Capital Timesaver, or Venture Capital Journal.

Name of Firm: Arbor Partners

Name of Contact: Donald Walker & Jason Berr

Position of Contact:

Date: 02/23/99

Your Name: Sunil Mody

Information Questions

1. What services do you provide?

What do they do:

Various investors (wealthy individuals, universities, insurance companies, government, etc) put in money into a venture capitalist firm, and the firm invests money into startup companies.

The Arbor Partners have two funds: a software and telecommunication fund developed several years ago (has $5.4 million in it), and a new fund, e-commerce, which they are developing now. The firm is looking for investors for this fund.

- How do they find deals:

- Receive 30 – 40 business plans every week- About 4 are passed on to partners after the reviewer approves them- May develop a syndication with other VC firms (another VC firm already has a deal and they

wants to team up with them)

- Once they choose a plan, they go through a Due Diligence Process (deciding whether to invest)

- The selected company does a presentation at the VC firm, or the VC goes there- Talk to contacts- Look for a strong management team - Look at the market where the potential company is in, and see if there is growth, a market for

the products, how close are they in demanding it, and if the product is viable- Background check on the company and the people in the company

- Contract:

- If Arbor Partners decides to invest money into the startup company, they have to determine the protection they have if they want to get out. If a company is doing badly, the VC firm has to determine if they can get out.

- Determine what % of the company Arbor Partners (and their investors) will own, so when a sale occurs, they know how much money they get.

- Add value:

- The VC firm gets on the Board of the company and makes sure the investment is running smoothly by a strategic partnership

- Get out – liquidating event, sale of company, or IPO (Initial Public Offering)

- When the VC firm sells their part of the company, (either by IPO or straight selling), they have to determine how much the company is worth. This is determined in the selling of stock to the company, or when a third party makes an offer.

- Example: If the contract says the Arbor Partners owns 10% of the company, and the company is sold for $100 million, then Arbor Partners will get $10 million in which they will distribute most of it to their investors, and they keep the rest.

- Arbor Partners wants to make sure they can get their money out, but there is a 180 day lockout period where they cannot do an IPO.

- Arbor Partners want s to get out at the first liquidating event.

How do they get paid:

- Investors pay 2.5% of their investment per year in order to keep their investment there- Arbor Partners receives 20% of all profit made. i.e.: If they invested $1 million, and the

company sells for $2 million, Arbor Partners gets $200,000

2. What are your departments? (List format)

Arbor Partners has no specific departments. The four partners have specialties in strategy, marketing, technical, and operational. The support group helps in research and administration.

No partners have been in venture capitalism before (unusual).

- To what extent do the departments interact with each other

The people within the firm work closely together.

- How many employees total

4 Partners, 2 Associates, 2 Administrative

- Relative size of each department

N/A

3. Do you have any busy seasons? (When and why) How do you handle the increased workload during those busy seasons?

No.

4. How are your operations involved internationally?

None.

- Do you have international clients?

No, because they need to keep relatively close to clients.

- Do you have offices in other countries? If Yes: do people go on international assignments?

No.

- Are you looking to expand internationally? Why or why not?

No.

If Yes, What are you planning to do?

If No, Do you see it in your near future?

- Do people work with or research in international markets

Not as of right now, but could research internationally.

Human Resources Information

1. How does your recruiting process work?

They don’t have a recruiting process. If they need somebody, they find a personal through contacts. However, hiring is rare.

- How much are the departments involved in recruiting?

Everybody is involved in making the decision to hire a new person.

- Do you have an on-going recruiting or is the recruitment in batches? Is there a certain time of the year where you need people the most?

N/A

- What department requires the most recruits?

N/A

- What role do the departments play in recruitment? To what extent is it a combined effort with actual recruitment, interviews, and selection?

N/A

- How many new hires do you have in a year?

N/A

- How long do they stay? (Turnover rate)

It is long-term. Jason Berr is interested in becoming a partner.

- Range of salaries of new hires:-

2. What are their credentials?- Type of academic background and degree level:

MBA required. Need to have contacts, and have knowledge in the venture capitalist community.

- Level of computer skillsN/A

- Level of experience

Prefers some experience

- Commission or salary based

3. What do the new hires do? Do they have a training program? Describe?

N/A

4. Do you have contract employees (Temp Services)? If Yes:- How many employees do you have working for a Temp Service

No- What type of work do they do?

No- What type of skills do they have?

No- Range of salaries?

No- How long do they stay?

No- What are your reasons for working with a Temp Service? Are you doing to save money on salary,

to avoid hassle of finding people, to save on health benefits, or because of a labor/talent shortage?No

Other Info:

- Windpoint Partnerships is the largest VC firm in the area.

- In the VC firm, Avalon, the CEO, Rick Sneider, was the former president of Gateway Computers. He wants to run for governor.

Points to consider before approaching:

- They are small offices- They have a few entry level positions- AIESEC can only help them do international research – narrow field