Venture Capital, Part I

A client came to me last week with the opportunity to be a venture capital investor in a small start-up company. He knew how much he wanted to invest, had some clear ideas about what he wanted back out of the company, and then left it to me to prepare a venture capital agreement.

Venture Capital is simply a term for money obtained by a company that needs to change its position. Perhaps that position is that it needs to actually get started ("start-up capital"). Perhaps the company is on the verge of collapse. Often, as in this case, an already-existing company needs additional money in order for it to successfully grow in order to keep up with its new business.

Often, the business can raise money by debt--that is, by borrowing money (either from a bank or from private lenders). But borrowing, however, is tied in with risk--and most lenders do not want an exceedingly risky loan. If a business is brand new, or is getting ready to expand or change direction, there may be certain risks involved such that a traditional lender is unwilling to take the loan risk, considering that its return would likely be somewhere between six and ten percent per year.

On the other hand, there are investors who may be willing to invest their money or capital in riskier propositions--if they believe the risk will be appropriately rewarded. These are venture capitalists. These investors quite often will infuse money into a company that may have more risk, in return for the possibility of greater reward. In the next few blog posts, I'm going to discuss items to consider if you're asked to invest capital into a small or start-up company. But for today, the major considerations are as follows:

1. Debt versus Equity: Is your investment going to be treated like a loan, like ownership in the company, or like a mixture of the two?

2. Period of the investment: Is this open-ended, or do you want a specific time-frame in which your investment return should be realized?

3. Control: What rights of control will you have in the company?

4. Operation of the Company: What can the company do with your money? How much can the owners pay themselves?

Hopefully, this discussion will help both potential investors, as well as company owners looking to find investors.