MABINI COLLEGES, INC.

Daet, Camarines Norte

COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY

2ND Sem., S.Y.2020-2021

FE 8 – VENTURE CAPITAL
MODULE 2
Title: The Venture Capitalist Mindset

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Module Overview:

This module explain what venture capitalist do, how venture capital funds work, why some
Venture Capitalist can work with you and some can’t, and more. Understanding the Venture Capital
business in more detail helps you better understand venture capitalist themselves so that you can work
with them more easily and effectively. Armed with this info, you’ll know what to look for and what to
expect from your VC. After all by finding the right VC, you save yourself time and hassles.

Learning Outcomes

After completing this module, students must have:

1. Understand the Venture Capital Business
2. Joining a venture capital as a partner, not an adversary
3. Sticking to the right type of venture capital for your industry
4. Finding other type of venture capital or investment capital

LECTURE NOTES
Read this…

The Venture Capitalist Mindset

Performing a High- Risk Job: The VC’s Role

 Venture capital is a financial industry in which institutions (the venture capital firms) raise
money sources and invest that money in high- risk companies that possess paradigm-
changing ideas or technology. By its nature, venture capital is a very high- risk endeavor, and
 a career in venture capital is intense and often short. Here are a few general things to know
about venture capitalists:

 VCs are not investing their own money in these selected companies. They invest other
people’s money, which, as you can imagine, is a big responsibility.

 All VCs Can run business just like you do, except that their business are venture
capital ones. Just like all business people, they have to follow through with the
agreements they make with their clients – the people who have given them the
money to invest. If they don’t, they lose their jobs and their careers.

 Venture capital is the most expensive money you can find to fund your business. One
reason it’s so expensive is because of the risks involved (more on that in the next item
in this list). Another reason is that making a venture capital investment takes a lot of
work.
 Remember capital is not a lifeline, a grant, or a charitable contribution. If your
company is having money trouble or is otherwise struggling, a VC wants
nothing to do with you. Venture capital is not an alternative to bankruptcy!
VCs looks for healthy company.

 VCs take huge risks with their careers and reputations when they raise venture capital
funds. First, the risk of losing money when investing in start- up business is so great
that VCs have a difficult time finding the money to invest in the first place. Second,
even if a VC does everything right, bad luck alone can result in lost investments.

Clearing up a few myths about venture capitalists

VCs are not out to steal your company, run your company, or otherwise ruin your life. They simply
want to ensure that their investment fund makes money. Yet these rather uncomplimentary
impressions persist. In this section, we set the record straight.
 Myth 1: A more appropriate name would be “venture capitalists”: Venture capitalists
are sometimes called vulture capitalists; a nickname that has implies that VCs are
opportunistic and pick meat off the bones of sick or dying businesses.
 The VC industry is small, and it doesn’t make sense for a VC to do something
that might tarnish his reputation with entrepreneurs or other VCs.

 Myth 2: They want to steal your company. Another common misconception is that VCs
want to own most of your company then loses motivation to make the company
successful. VCs know that they’re actually investing in the entrepreneur, and without
their knowledge and energy, the company will less likely to be successful. VCs with
long term visions understand that a fair deal is in everyone’s best interest.
 Most VCs don’t want to take too much ownership of the entrepreneurs
company because the entrepreneur
 Myth 3: they’re unscrupulous. Venture capitalists have a reputation of being
unscrupulous because of stories that they fire companies CEO so that they can
gradually take complete ownership and leave the entrepreneur with nothing.
 In fact, VCs need good companies to come to them with possible deals. If a VC
is unscrupulous, and founders start to tell other founders to be wary of her,
 then the she’s not going to be able to make investments in great companies,
and her fund will fail to make money.
 Most VCs want to manage a series of successive funds. To do so, they need to
provide successful returns on their first funds so that they can go back to their
investors the next time around
 When your seeking and working with VCs, be aware of your own mindset. If
you go into the relationship thinking that all VCs are evil and that working
with them is an unpleasant necessity of doing business, you may not notice if
your VC actually is unscrupulous. Keep your mind open so that you can better
judge whether the VC you decide to work with is ethical, trustworthy, and an
all-around good person, if you discover she’s not, find another VC.
 If you get investment, The VC becomes your business partner. As with all
business partners, the relationship bet. Founder and VC is an intimate one.
You must trust your VC and she must trust you. This trust is often built during
the early stages of the relationship, bef. The investment is closed.
When you align your desires with your VC desires, the whole process of
working with VC goes more smoothly

Finding a VC you can trust and work with

When you are seeking investment from a VC, do the following:

 Determine whether you can trust this person. Find out who she has invested in and
contact those companies. Make sure you get in contact with those who are in business
as well as those that are not.
 Interview the VC. The VC isn’t the only one who get to make decisions about whether
or not to pursue the relationship. You do, too. Ask questions of the VC about the size
of her fund, how much is invested, and what funds are remaining for investment.
 A VCs is not king of the financial world. Instead she’s more like a middle
manager who has to answer to the board, partners and public opinions. This
notion may help you get the VC of the pedestal in your mind so you can work
with her as an equal and a business partner. Then you’ll be more comfortable
and more in control going into the pitch and the negotiation.

Knowing what to expect

VCs have their own rules of engagement that are based on managing their own time constraints and
serving the needs of their limited partners.

 Don’t expect easy access: if you think getting an appointment with your dermatologist
is hard, try to get an hour alone with a venture capitalist. VCs are known to be
difficult to corner. They have so many demands on their time that they have to fly
under the radar sometimes.

 Don’t expect advice: VCs rarely give feedback after they reject your deal. First, they
don’t have the time. Second, they may not have any particular reason for rejecting
you; when your job is to screen through hundreds of applications looking for a gem,
you are bound to overlook a few rough diamonds now and again. Third, the VC just
might not get it, in which case she’s unlikely to tell you something specific is wrong
 with your deal; in fact, your deal may be fine. Finally, because VCs don’t have time to
look into your company very closely before they pass it up, they wouldn’t presume to
come back to you with deep feedback after only giving your company a glance.

Understanding How a Venture Capital Fund Works

Venture capital funds are entities that exist to manage large amounts of money, put that
money in growing companies, and then monitor the companies to protect the investment until what
is at its peak value.
 A VC is a business in itself that manages a fund which is also an entity within
itself. A VC firm can manage more than one fund either sequentially or
simultaneously. In conversation, the words are used interchangeably.
Although a limited partner may care which fund his money went into the
entrepreneur cares more about which firms she’s working with.
The lifecycle of a venture capital fund has four parts.

 Fundraising: The VC meets with the potential limited partners to get them to invest
their money in her fund.

 Investing: The VC meets with many companies to find the few that she will invest in.

 Managing: After the fund invests in a company, the VC actively participates on the
board of the company, works with the CEO, and makes business connections to make
sure that the company is making good business decisions.

 Harvesting: When companies undergo liquidity events such as an initial public

offering, merger acquisition, or a sale of shares to another firm, the VC manages the
divvying of funds to all the shareholders.

Fundraising – where the investment money comes from

The capital venture capital comes from wealthy individuals, pension funds, insurance
companies, family offices, foundations and other pools of cash. These entities are looking for higher
returns than they still want to minimize risk. To do so, they look closely at the track record of the
venture capitalist in order to pick the funds that are most likely to provide a great return.
The people and organizations that provide the capital and organizations that provide the
capital are called limited partners, because they have limited liability when they participate in the
fund. They can lose their money, but they are not at fault if something illegal happens within the
venture fund itself or any company that the VC invests in because their participation is limited to
investing and not managing the fund.

Investing- finding companies to fund

After the fund is closed, the VC has to collect applications from companies who want to be
funded. Having a constant stream of interested companies is called deal flow. If a venture capital firm
hopes to fund the best companies, it strives for good deal flow, which means that the firm sees a lot
of companies to pitch, and begins due diligence on the companies it likes.

Step1: Screening initial interest

A VC looks for four things:
 A management team that has track record and experience to execute
  A big idea in what will be a very big market
 A company/ product that has the ability to be the leader in the sector
 Many potential strategic buyers or initial public offering (IPO) potential and a near
term exit which is as potential for 10X-30X (10 times and 30 times) return in three to
seven years.

Step 2: Meeting with companies and seeing their pitch

When the VC finds a company that looks like a good company to fund, she invites the company to
meet with the VC firm.

Step 3: Following up with due diligence

Due diligence is the process of researching a potential investment so well that everything is known
about that company.

Examining how VCs make money off the deal

VCs make money in three ways:
 Management fee: The VC firm earns a management fee that covers its costs for creating
deal flow, screening, due diligence, serving on boards, coaching, accounting and
reporting and engineering the exit. The firms typically make 2 percent of the money
under management for these services.
 Carried interest at the exit: VCs make money at the exit through carried interest, which
is generally called a carry in investor lingo. The carried interest is typically equal to 20
percent of the net profit after an exit.
 Interest from investing their own money: Sometimes VCs get an option to invest their
own money into the fund- a big perk for senior staff members (junior staffs are often
not allowed to invest alongside the firm). Having her own money invested in the fund
shows a personal commitment to the fund and ensures alignment between
the fund managers and the limited partners because they all share the risk of
investment.

Taking a Closer Look VC Investments

You may feel that it is your job as CEO to understand your company, industry, and business like
the back of your hand. That’s true, but when you are raising capital through VCs, you are expected to
understand the VC world, too. If you plan to do business with a VC, then you need to know how venture
capital investments work so that you can be an equal partner in the relationship.

Understanding Key limitations in the selection process

VCs are tied to their limited partnership agreements, and they have certain investing
parameters that they must adhere to. One of the key limitations has to do with what kind of company
the fund can invest in. Another is how long the investment period is.

Going for an industry match

 VCs get hundreds of applications or pitch decks sent to them every year. Any company that
doesn’t fit the types of ventures defined in the contracts between the VC and her limited partners is
going right in the trash.

Limiting the amount of time that money can stay invested

A VC is limited in the amount of time that her money can stay invested in your company. She
signed an agreement with her limited partners that the fund would liquidate in fewer than ten years.
She’s banking on the fact that your company can grow fast and get acquired (or go public) before she
has to give the money back to her limited partners.

Making long-term investments for fast growth

When venture capital firms invest, they intend to keep the company in their portfolios for four
to seven years, effectively tying up their money even longer- in some cases for up to ten years. And ten
years is a long time for an investor to be separated from his capital.

Being VC Backed
When a company has sold equity to a venture capital firm, that company is called VC BACKED.
During the years that company is VC backed, it is supported by the firm through business and industry
expertise and high caliber network connections, as well as capita. This relationship can be very powerful
one for a start-up company.
So what a VC firm looking for a company? VC-backed companies have quick growth potential, large
growth potential and a smart and flexible team- attributes that the VC believes will generate a large
return on investment.

The Goal: Doing well enough to raise money for their next round
As we explain in the earlier section “Examining how VCs make money off the deal”, a significant
part of the VC’s potential income comes to her when the companies she’s invested in have liquidation
events. This payment is called the CARRY, and it’s contingent on returning money to the limited
partners. The better your company performs, the better the fund performs, and the VC’s carry will be a
larger sum of money.

Keeping current with the venture capital industry

The modern venture capital industry has been around only since World War II. When an
industry is young, it tends to still be in a perpetual state of change.

Funds and Venture Companies

Venture capital is great for companies that match the profile, but if your company doesn’t
match, don’t worry. Lots of other opportunities are out there:

 Specialized types of VC Funds are allowed to make their own rules about who they fund
and they don’t fund. They also can make rules about how much they will put in each
 company. Industry- restricted funds often follow the industry expertise of the general
partner. However, funds can be specialized around a certain mission or geographic
region. If you look hard enough, you may be able to find a fund dedicated to support
any given type of company. Here are some common specialized funds types:
 Geography focused: invest in companies that are located in a specific city or region.
 Impact focused: Invest in for- profit companies that help the world by furthering a
social or ecological cause.
 University focused: invest in companies that are coming out of a specific university
or that are started by alumni.
 Industry focused: invest in healthcare IT, clean tech, social media, life sciences, or
energy, for example
 Seed funds: these are venture capital firms that invest small amounts in very early-
stage companies.
 Evergreen and rolling funds: These funds operate differently than the typical model.
The evergreen fund is often found in cause-based investments, and every time the fund
has an exit, it then rolls that money back into new investments.