Venture Capital Business Plan

Venture capital finance is instrumental in inducing technological development, stimulating creativity and innovation and nurturing entrepreneurship. Concerted efforts are required by financial institutions, private sectors and other agencies to create a conducive environment for the growth of venture capital. In particular, initiatives are required to widen the perspective of venture capital finance and create a favorable fiscal and regulatory environment.

The venture capital schemes of the term-lending financial institutions presently focus mainly on supporting development of technology and implementing indigenously developed yet untested technologies. While this concern is understandable because of a genuine need for expanding the base of viable indigenous technology, it leads to a somewhat limited view of venture capital. What is required is a broader perspective on venture capital so that it is viewed as an instrument for financing a wide range of projects that essentially have a “high risk- high-return” profile.

In this context, it is important that entrepreneurs, financing bodies, fiscal authorities, regulatory bodies and others understand the concept and relevance of venture capital. It should be appreciated that venture capital is an instrument for strengthening entrepreneurial forces in the economy; a device for inducing risk taking and a mechanism for promoting a closer investor/investee relationship. Those who participate in venture capital arrangements must overcome certain traditional psychological barriers and be willing to build a relationship of genuine partnership and not a perfunctory association of limited involvement.

To nurture the growth of venture capital, a favorable fiscal and regulatory environment should be created. Some of the specific things that may be are investors subscribing to the capital of venture capital funds may be given greater tax reliefs, and the long-term capital gains of the venture capital funds may be taxed at a concessional rate or even exempted totally from taxation. Orderly and efficient mechanisms must be evolved to facilitate liquidation of investments of venture capital funds.

50% of Venture Capital Investment is Lost – Deployment of the Right Patent Analytics Can Improve Odd

The Skinny on the Quality of Venture Capital-Related Investment Decisions

If you are a counselor of venture capital firms or entrepreneurs who owning start-up companies that are targets of venture capitalists, you might already be familiar with the high rate of failure associated with such investments. Nonetheless, you may be surprised to find out that 50% of all money invested in venture capital is a loss.(1) This figure, which is based upon separate research projects by a Chicago Graduate School of Business (“GSB”) professor and a former Chief Economist at the Securities and Exchange Commission, indicates that the actual return on venture capital investment is not much different from the average annualized returns on the smallest NASDAQ stocks. In particular, the return on venture capital investment from 1987 to 2001 in these smallest stocks was 62% as compared to the 59% mean return of venture capital funds.

This 59% figure certainly does not reflect the investing public’s general perception that venture capital return on investment markedly outweighs what one can obtain on the stock market. And, it is this apparently erroneous assumption of perceived higher return that presumably justifies the higher risks your venture capital and entrepreneurial clients associate with venture capital. Investor perception certainly does not match investment reality for your clients who play in the venture capital space.

Why this disconnect between perception and reality on venture capital returns? Professor Cochrane, the Chicago GSB professor, posits that, in effect, traditional methods of measuring venture capital return do not take into account the fact that ventures that are a total loss disappear and are not measured. Because these losing ventures are not around to be measured for calculation of rate of returns, Professor Cochrane states that this survivor bias significantly skews the rates of return on venture capital. His simple explanation of the effect of these missing numbers is telling (quoting from the Jacobius article): “They collect the returns for everybody that is around,” he said. “It is like collecting data from everyone still in the casino: They’re not asking the people on the bus … who are on their way home.”

How Your Clients Can Improve The Quality Of Their Business Decisions

From the Jacobius article, it appears that there is much room for improvement in your venture capital clients’ investment decision-making, as well as the quality of entrepreneur’s decisions regarding their start-up companies. As an IP Business Strategist and Consultant, I am a strong advocate of using knowledge and information to reduce risk and improve the rate of return on investment. I firmly believe that venture capitalists, and entrepreneurs who are seeking venture capital investment, can improve the quality of their business and investment decisions by collecting and analyzing business information available in published patent data.

When one knows how to extract and analyze the right data in patents, significant business insights are effectively “hiding in plain sight.” In short, valuable business information is available for the taking by smart entrepreneur and investors. And, why wouldn’t your client seek to gain knowledge that could reduce the strategic uncertainty of her investment decisions to better manage decision-making risk?

In particular, before your venture capital firm client invests in a new business idea for a new venture, why wouldn’t she want to know whether the business idea is ownable in the long term or whether she will possess the opportunity to innovate freely in relation to that business idea? Or, why wouldn’t she want to know whether another firm has invested $100K or more in patent rights alone in the new business idea that she is investigating for investment? This, and other, valuable business insights and information are embedded in published patent filings.

For your start-up entrepreneur client, patent filing information can also provide valuable insights to provide enhanced long term business value and raise the value of her start-up company to venture capital investors. For example, patent filing information can reveal where the entrepreneur should focus her patenting efforts beyond the parameters of her specific inventive concept. By undertaking a competitive review of what others have sought to protect in her relevant product or technology area, your client can better understand the full breadth of patent rights obtainable. This can allow your client to gain enhanced patent claim scope that can serve to prevent competitive knock-offs of her product or technology concept. As a result, her start-up company’s value to venture capital investors can be significantly increased.

Your Clients Don’t Just Need Patent Analytics, They Need Patent Analytics That Provide The Right Business Insights

However, it is not enough for your clients to collect and graph published patent data to obtain insights that will improve the odds of making the right investment decisions. Rather, specific business-focused data collection and analysis methodology is necessary for successful use of patent data for use by your clients. This is easier said than done.

In my experience as an actual purchaser of patent analytics costing upwards of $20K per single business question, I found that the vendors that collecting and analyzed the patent data generally had no basic understanding of the business questions that my company required answering. As such, these patent analytics vendors’ products were effectively useless to answer our business team’s investment and innovation questions. Put simply, these vendors’ products did not provide my team with actionable business insights. I thus learned an expensive lesson about patent analytics: the data collection must be based upon the right foundation for the results to have any value. In other words, with patent analytics it is “garbage in, garbage out.”

As one example of patent analytics “garbage,” one vendor, who offered a patent analytics product for $25-30K for a single business question, presented example data to us in his sales pitch regarding complex patent portfolio where the business conclusions were based upon published patent assignment information. The analytics vendor affirmatively stated that because the primary inventor named on this portfolio’s moved from Tennessee to Arizona, we should be concerned because he likely had gone to work for a major competitor of ours. He further stated that our company should be concerned that our major competitor was entering a new technology area in which the inventor was a renowned expert.

These conclusions seemed reasonable because they were supported by Patent Office assignment data, as well as other signals informally observed by our marketing team. We therefore considered investigating this competitive threat more thoroughly and addressed making preliminary steps toward evaluating a new product introduction in our competitor’s apparent new technology area. Before doing so, however, one of our team members contacted a former colleague of his who had worked in the same department as the inventor who now worked for our competitor.

Our team member found out that the inventor moved to Arizona not to work for our competitor, but to tend to his ailing mother. This intelligence revealed that the inventor was working in a wholly different product area at our competitor than he had worked at while being a prolific inventor at the Tennessee company. The technology area did not pose a competitive threat to our company. Fortunately, we found out this was the case before investing significant time and effort into the patent analytic vendors’ conclusions from patent assignment data.

Interestingly, the patent analytics vendor did not consider any alternative reasons for the inventor’s change of residence, other than that he presented. In his view, if the data revealed by his analysis said it, it must be true. But, it wasn’t the data that was the problem, it was the conclusions he presented to us. If we would have been more credulous about his conclusions, we would have wasted considerable corporate resources chasing his erroneous assumption about our major competitor’s activities.

How Your Client Can Select the Right Patent Analytics

In the world of start-up company management and attendant venture capital investment, information is undoubtedly power that can fuel your clients’ decision-making processes. But before your client spends good money on patent analytics to improve the payback from her business decisions, she must ensure that the data and insights she obtains are based upon methodology that extracts actionable business insights from patent filings. As shown above, selection of the wrong analysis methodology could be worse than her not conducting patent analytics at all because her investment decisions could be influenced by information that provides the wrong business conclusions. Only those methodologies that are founded on methodology that extracts the business purpose from patent filings can provide your client with investment-grade insights from patent filings.

Methodologies I recommend to my venture capital and entrepreneurial clients use a combination of data and legal analysis to extract the business information from patent filing data. Importantly, the business question must be well defined prior to starting the analysis. A broad business question will lead to comparably, and likely non-insightful, answers. Anyone seeking business answers from patent information should therefore spend considerable time up-front clearly defining the business or investment question they seek to obtain an answer to, and also in communicating this to the patent analyst.

I also believe that the best patent analytics vendor is not the one who demonstrates that its data analysis techniques are the most efficient in analyzing 1000′s of patent documents to provide attractive and succinct pictures of the data in landscape form. Indeed, rarely would a well-defined business question lead to more than several hundred relevant patent documents at most. This number of patents typically can be reviewed at a high level by a trained patent analyst. As such, when selecting a patent analytics vendor, your client should move past the charting and picturing aspects of the sales pitch, to better understand how the vendor will work with your client to define and answer the specific business question.

Furthermore, I strongly recommend that your client seeks a patent analytics vendor whose methodology centers on reviewing the patent filing documents not for what they say, but for what they claim. The claims provide the relevant business information because that is what your client’s competitors seek to prevent them from doing. In other words, this exclusionary aspect is what matters because it defines what your client can and cannot do (or patent). In my experience few patent analytic vendors truly understand that this aspects of patents, a fact which significantly lowers the value of most product offerings.

Only after the patent analytics vendor analyzes the claims for relevance to the specific business question does your client care about who might own the patent filing or what they might wish to accomplish with it. This means that the vendor should present your client not with graphs, pictures and analysis of 1000′s of patents, but rather, with substantive analysis of a fraction of this number of patent documents that are directly or substantially directly related to your client’s business question. In my experience, better analysis of a more precisely generated library of patent filing documents provides clients with more readily actionable business insights from patent information.

Conclusion

Given that more than 50% of venture capital investment is lost, there is certainly room for improving the quality of the decision-making processes involved. I believe that patent analytics can serve a critical need in this regard. At a minimum, those entrepreneurs and venture capital investors who use such information are obtaining an additional piece of information that is not commonly used to make investment decisions today. The critical factor for those seeking to use patent analytics to improve their investment decisions is to make sure the vendor they choose for such information is providing them with the right information in accordance with the methodologies set out in this article.

[1] Arlene Jacobius, Pensions and Investments Online, September 19, 2005, available at, http://www.pionline.com/apps/pbcs.dll/article?AID=/20050919/PRINTSUB/509190734/1031/TOC, retrieved April 20, 2009.

“It’s not about IP, it’s about IP that makes you money.” Jackie Hutter is Principal of The Hutter Group ([http://www.JackieHutter.com]), a leading provider of strategic IP (“Intellectual Property”) business counseling to organizations and entrepreneurs that wish create and maximize asset value by capitalizing on the power of IP in today’s market. Jackie has also founded Patent MatchMaker (http://www.PatentMatchMaker.com) to assist companies and entrepreneurs to identify opportunities to sell their patents. She has over 13 y

An Alternative to Venture Capital Funding – Give Control to the Company

Using Reverse Mergers Instead of Venture Capital for Venture Funding

The more you look at reverse mergers the more you start to understand that reverse mergers compare favorably with the classic venture capital model for venture funding.

Venture funding is obviously key to the success of any new or growing venture. The classic venture capital model seems to work like this: The entrepreneur and his team formulate a business plan and try to get it in front of a venture capital firm. If they are well connected, they may succeed, but most venture capital firms are overloaded with funding requests.

If the entrepreneur is not in a business that is the latest fad among venture capitalists, he may not be able to find funding.

If the entrepreneur is very lucky, he will be invited to pitch the VC. If the venture survives this trial, it will receive a venture capital terms sheets. After prolonged and adversarial negotiations, a deal is struck and the venture company signs hundreds of pages of documents. In these documents, the entrepreneur and his team give up most of the control of the company and usually most of the equity in the deal. Their stock is locked up and if they want to sell to get some cash, they probably have to offer the buyer to the VC first. Time from start to finish – 90 days or more.

If the company needs more money, it must negotiate with the VC and the entrepreneurial team may lose ground in the deal. The company may have to reach certain set milestones to get funds. If the company falls behind of schedule, it may lose equity share.

As the venture develops, the venture capitalists may or may not add value, and most likely will second-guess the entrepreneur and his team. If the venture succeeds, the venture capital firm will reap most of the rewards. If the venture does not succeed, most of the capital will be lost forever. Some ventures wind up in the land of the living dead – not bad enough to end, not good enough to succeed.

Worst case scenario, the venture capitalists take control at the outset, become dissatisfied with management, and oust the original management which loses most of not all of their position and their jobs.

The Reverse Merger Model

The entrepreneur finds a public shell. He has to come up with some cash to do this and pay the legal and accounting bills.

He buys control and merges into the shell on terms he determines. He keeps control but he has the burdens of a public company.

He determines how to run his company, including salaries. He can offer stock options to attract talent. He can acquire others companies for stock. He determines when he cashes out.

Instead of having to report to the venture fund, he has to report to the shareholders.

Subject to the limitations of the securities laws, he can sell part of his stock for cash.

He can seek money whenever he wants; he is in control.

Problems: He may be attacked by short sellers. He may buy a shell with a hidden defect. He has to pay for the shell.

From the Investors’ Point of View

Venture capital funds are typically funding by institutional investors seeking professional management. They do not have the time to manage a number of small companies and delegate this task to the venture capital partners. Small investors are rarely permitted. Venture capital funds allow the institutional investors to diversify.

Venture capital fund investors are locked in over a period of years. If they make 30% per year returns, they have done very well.

The venture capital model encourages the venture capital firm to negotiate hard for a low price and harsh terms. A venture team seeking funding that knows it has a big future may not submit to such terms. However, for a weak company that is just looking to collect salaries for a few years before folding, in other words a company that is a bad investment, can accept any terms, no matter how harsh. Thus, the venture capital model is skewed toward selecting out the worst investments and repelling the best.

Small investors can buy stock in reverse merger companies. They must take the time to investigate these companies but may lack the resources to do so intensively. Most small investors lose money. If they win, they can win big. They can, if they choose do so, diversify their investments. They have no influence on management, except to sell when they are displeased.

Summary

The reverse merger model compares very favorably with venture capital. Whereas venture capital is perpetually in scarce supply, reverse mergers are always out there for any company that can interest investors. The company can usually raise money on better terms from the public than from venture capitalists.

Overall, the big advantage of the reverse merger is that the company has total control over its destiny. The team can be assured of being rewarded well for success. The company sets the terms, can sell stock whenever it sees fit on whatever terms it merits, the insiders can sell too, and the venture team is not second-guessed by amateurs in their field, and the venture team does not have to fear losing equity or jobs.

Another advantage is less risk to the investor. The investor is in a publicly trading stock. If the investor does not like what is happening, he can sell. He may sell at a loss, but he can get out. The investor can also pick and choose companies himself, instead of making only one investment decision – the decision to back the VC company which then takes control of the rest o

Do You Know What the Difference is Between Venture Capital, Private Equity, and Debt Capital?

Have you ever heard the terms “venture capital” or “private equity?” Well, if you are starting a business, you will need to know what kinds of investors you need to contact and the difference between venture capital, private equity, debt capital, and how investors are categorized. You will also need to know about what conditions different forms of capital is distributed to aspiring entrepreneurs.

Debt Capital

What is debt capital? Well, you can think of debt financing as a loan from a bank that you have to pay back with interest. In reality, that’s exactly what debt capital is. Many entrepreneurs often resort to getting some debt financing to start their business. Debt capital, depending on its size, can be obtained from your regular bank or if it is a large sum of money, you might have to go to a special bank known as an investment bank. As far as the investor who is giving you the debt capital is concerned, debt financing is a much lower risk investment compared to equity capital. This is because debt capital is funding that is lent to you, just like as if you are taking a loan out for a car or a mortgage on your home.

What is the interest rate on debt capital? In most cases, when in investor who invests debt capital to a budding company, he expects to make at least ten percent off of the sum that was invested into a given company. Furthermore, debt financing is usually given to those entrepreneurs, who the investor believes is most likely believes will pay the debt off in due time.

Equity Capital

Equity capital, on the other hand, is different because unlike debt capital; you do not need to pay anything back to the investor. Equity capital is funding that practically every company gains as its business grows. Equity is usually invested out of a particular fund and is classified as either private equity and venture capital.

Private Equity and Venture Capital

Basically, private equity is an equity fund that belongs to either privately owned institutions or private individuals. Usually private equity is invested by institutional investors, who are people that specialize in investing private equity from such institutions. Institutional investors usually work for a private equity or PE firm that manages private equity. Venture capital is also private equity but is managed slightly differently than private equity. Venture capital is actually private equity that is usually reserved for investments to companies that have the potential for high growth.

For those of you who need financing and do not want to have to worry about debts, you would like to have some kind of equity capital, be it private equity or venture capital. This funding is much better than debt capital, because unlike debt capital, you do not have to pay the investors back. Instead, with equity funding, an investor makes money when a company cashes out. This usually means that when a company is bought by another company or is prepared for public offering, that is when equity firms make their money. The other side of the coin, however, equity capital is a much more risky investment for the investor than debt financing, because with equity capital, an investor makes money only with a buyout, initiate public offering or IPO, or an exit strategy.

Investors

As mentioned before, there are different investors and investing institutions. Some investors are wealthy individuals who invest their own money to entrepreneurs whom they like, whereas others work for institutions, such as private equity or venture capital firms and invest money from their institutional funds.

Angel Investors

Angel investors are wealthy private individuals who invest their money into a given entrepreneur for whatever reason. Some angel investors invest in a particular company because they might like that particular entrepreneur or feels charitable and wants to share their own entrepreneurial experience with other budding entrepreneurs to get on their feet. Other angels might invest in a company because a particular company might fit into that angel investor’s values, ethics, or other personal interests. If you have a wealthy relative and he invests in your company simply because he wants to help out a member in his family, he is also an angel investor.

Venture Capitalists and Institutional Investors

Unlike angel investors, venture capitalists and institutional investors do not invest their own money. Institutional investors usually work for a private equity firm and invest equity from funds that are usually parts of a pension fund or other types of funds. Venture capitalists are investors who solely invest in venture capital and work for venture capital firms.

Where Does the Money Come From?

Well, that is a good question. In the case with most successful private equity and venture capital firms, the money for investments comes from venture funds that these firms have raised. When a venture capital or private equity firm is successful with their investments, they are able to raise new funds for future investments. Again, as mentioned before, equity investors cash in on their investments when a company is liquidated by either being bought out from another company, etc.

How Do You Contact Investors?

Older posts »