New Book, Venture Capital Investments by Raj Kumar and Manu Sharma, published under the SAGE Essentials series by SAGE Publications India, provides an overview of the industry in India, its history and delves into how venture capitalists evaluate potential investment deals.
Laced with extensive examples, the book broadly discusses the fund-raising process of venture capital general partners and explains how fund structures and fund economics of venture capital firms are evaluated.
Amount of Funds
The amount of funds that would be raised through this source of financing is something that should be clearly discussed. The entrepreneur and the VC list should be straightforward about what to expect from one another. The number of funds that the entrepreneur requires should be clearly discussed so that the investors understand whether they can provide that sort of amount of investment or not. This is not something that can be ignored when discussing the terms and conditions of the deal. Instead, it is something around which the whole deal would be based so it should be clearly discussed. The amount that the entrepreneurs have and the amount that it would be borrowed or expected from the venture capitalist to be invested should be at the forefront. If anything is unclear or not specified, then respective parties should reach out and discuss it for clarification. The investors in case of VC would only be paid back in case of an IPO, a merger or an acquisition. Thus, the entrepreneurs would not have to take out cash that could have been used for other aspects of the business.
Purpose of Funds
An entrepreneur should be particular about the purpose of the funds, why the business is reaching out to venture capitalists for a source of funding and how it will be used. This information would develop a sense of transparency between the entrepreneur and venture capitalists, ensuring the latter that their funds are not being misused or misappropriated. If the investors are not provided with the relevant information about the purpose and uses of the investment, it will make it difficult for the general partners to justify the investment to the LPs. Whether the business would use the funds for buying assets, raw materials, setting up a plant or any other purpose, a clear financial justification should be provided to the investors.
The amount of working capital and runaway capital that the business has and would need should be discussed and explained as well. This information would provide the investors with the necessary numbers, that would show that the management has done its work and understand where and how their capital will be used. Having a substantial amount of working capital would ensure that the business has the opportunity for more investment and growth. Using its own capital for further investment in the business would make it easy for the business to operate over a long time, as it would not have to rely on investment and to borrow more than it should. Having a low level of working and runaway capital would make even basic operations for the business very difficult.
The entrepreneur should be able to provide the investors with a basic and to the point overview of the record of ownership. This information should include the percentage of ownership that the founders and investors have in the business, dilution of the equity, and value that equity would have in each of the investment rounds.
The formation should provide all the details about the investors, the sources of investment and the owners of the business. Managing this information would be beneficial for the investors as well as the owners as they share the equity with ease.
Along with this, such information is beneficial when the business plans on expanding and growing. The general partners would benefit from this information a lot, as they would be able to provide the facts and figures to the LPs if they ever ask for it. Along with this, it would help in calculating the return and profit on the investment quickly at any time.
The impact that the funding would have on the monthly cash burn is something that should be looked into and shared with the investors as well. The burn rate of any company is the speed at which it would be using up the investment from the VC, to pay for the overhead and operational expenses, before any cash flow can be generated. The rate is mostly estimated as the amount of cash that is spent every month. For instance, if the company has estimated to have a burn rate of $5 million, it means that every month it would be spending an amount of $5 million. This rate is used by both the VC and the start-up firm to keep track of the monthly cash flow before it can generate any income.
 Pearce and Barnes, Raising Venture Capital.
Note: An excerpt from Venture Capital Investments by Raj Kumar and Manu Sharma, published under the SAGE Essentials series by SAGE Publications India.