The operating process of venture investment invested in the venture enterprises is generally divided into 6 stages:
Look for the opportunity of investment. Venture investment undertakes the risk of technology development and market expansion of investing project. In order to reduce this kind of risk to the maximum extent, the screening and the evaluation of venture investment to the projects are very strict so as to help the enterprise obtain the vitality through getting involved in the management of project deeply.
Raise the venture capital. Venture capital has many kinds of sources, including pension fund of company, public pension fund, donating fund, bank holding company, rich family and individual, insurance company, investing bank and some non-banking financial institutions.
Carry out the trading procedure and discern the potential venture enterprises. Take the careful and detailed investigation on the Quality of founder, the expectation of product market, the feasibility of technology, the management of Company and etc, select the really potential enterprises from great many of venture enterprises which are looking for the support of venture investments.
Assess, negotiate, and reach the transaction. The venture enterprise puts forward the prospectus of project and the prediction of prospect, so both sides have the foundation of negotiation if the venture investor makes an affirmative evaluation on the technology and economy of applying project. The main problems that should be solved in the negotiation are: the number and investing capital, the distribution of shares, the structure of enterprise, the arrangement of position, the right of both sides and the definition of responsibility, the performance of investor’s obligation.
Cooperate and create the value together. After signing the contract, the venture investor and the venture enterprise step on the same ship and need to cooperate in solving numerous problems together, including make the developing strategy, set up the profitable board of directors, employ the outside experts, absorb other investors, supervise and control.
Plan and implement the withdrawing strategy. Withdrawal is the ultimate goal of venture investment and the key whether the venture investment succeeds or not. Only through the withdrawal can the venture investment be fluid and realize the profit really. There are three main methods of withdrawal: public floatation, M&A, and clearing. Public floatation is the best channel for the withdrawal of venture investment. Clearing is the best method to reduce the loss when the business condition of enterprise is worsening and the situation is difficult to turn back.
Four steps of venture investment
The industrialization of a high-new technology has four stages generally: the ferment and invention, the innovation, the spread, and the industrialized manufacture. Both the completion of each stage and the transition to the latter stage need the cooperation of funds, and the character and the scale of necessary funds in each stage are different.
First, the input of venture investment: (seed stage)
Seed stage refers to the fermenting and inventing stage of technology with few requirements on the capital. The technological founder solves it by himself generally from the ferment of intention to the sample of laboratory, then to the rough work. Some inventions are the brainwaves of engineer and inventor in the other experiments, which are unable to turn into the samples under the originally existing channel of investment, and further to form the products. So the inventor will look for the new investing channel. The venture investment in this period is called seed capital. Main sources are: personal savings, family property, borrowed money from friends, and natural science fund. If still not enough, the inventor will look for the specialized venture investors and venture investment organizations. It is far from enough to get the investment of venture investors by an idea. It is better to have a sample. And it is also not enough only explaining how advanced, reliable and creative the technology is, the detailed investigation to the sales and profit situation of this product in the market and the scientific forecast need to have the written documents and to be provided to the venture investors. The success of a newly emerging enterprise can't depend on the clever of engineer and the wise of inventor only, but should be familiar with the administration, the marketing, and the financing. If the venture investor agrees to provide the funds through the investigation, a small-scaled joint-stock company will be organized. The venture investor and the inventor take certain shares separately, and cooperate in the production until forming the formal products. This kind of enterprises face three big risks, first, the technological risk of high-new tech, second, the market risk of high-new tech products, third, the managing risk of high-new tech enterprise. The proportion of Investments in the seed stage is quite few seldom exceeding 10% but undertaking very great risk. It is first because of many uncertain factors difficult to test and assess, then the higher repayment needed for the long period to reap the harvest.
Second, the input of venture investment: (start-up stage)
Start-up stage refers to the innovation of technologies and the trial sale of products, the capital input at this stage increases notably. On one side, the enterprise need to produce a few products in this stage for solving the problem of technology further, especially get rid of the risk of technology through the experiment, on the other side, it will enter into the market for trial sale and listen to the opinion of market. The capital at this stage mainly stems from the increase of capital input of former venture investment organizations. The capital input at this stage is called start-up capital. If this kind of channel is unable to satisfy the demand, other venture investment channels may be used to get the capital. The main risks at this stage are still the technology, the market and the management. The risks of technology and market begin to rise especially. Great many of capitals are required at this stage. It is the main stage of venture investment. A venture investment organization is difficult to meet the requirement of a larger project, sometimes many venture investment organizations make up a group to invest a project, which can disperse the risk. The investing repayment required at this stage is also very high. Once the venture investment finds that the risk of technology can't be overcome, or the risk of market exceeds the acceptability, the investors may withdraw the investment. No matter the increase or the withdrawal at this stage should be decisive avoiding of waiting and seeing attitude. Overcautious at the investing time may miss a very good change, and can’t give full play to the original investment. Hesitating at the withdrawing time may fall into an abyss. Besides the scientific analysis and judgment, entering or withdrawing also depends on the intuition, which is a kind of art and also why a lot of venture investors like to do the familiar business only. The familiar industry is easy to train the intuition which can’t be replaced with the mathematical model and the statistics generally. Certainly, this will also limit the personal development of investors especially when this industry has had no huge developing potentiality any more.
Third, the input of venture investment: (expansion stage)
Expansion stage refers to the stage with the technical development and the production expansion. The capital demand at this stage increases more than the above two stages in order to expand the production on one hand, develop the market and increase the input of marketing on the other hand, finally, the enterprise reach the basic scale. The capital at this stage is called expansion capital stemming mainly from the added capital of former venture investors and the input of new venture investments. In addition, the sale of products can take back great many of capitals and some steady capitals such as bank will also select the opportunity to enter into. This is also the main stage of venture investment, the technology is not the main risk at this stage, which has already been solved basically at the first two stages, but the risks of market and management are larger. Because the technology has been already mature, the competitor begins to imitate and will seize some markets. Most of leaders of enterprise have the technological background but are not very familiar with the marketing, they would have an improper accept or reject between the advance of technology and the market. The expansion of enterprise will challenge the original framework. How to keep the advance of technology as well as enjoy the achievements of market leads to the risks of market and management. So the venture investment organization should assess the risk positively, send personnel to take part in the board, participate in the decision of major events, offer the consultation of management, employ and change the administrative staff, disperse and get rid of the risks by these means. The risks at this stage have been reduced greatly comparing with the first two stages, but the rate of profits is also reduced, the venture investor should prepare to withdraw while help to increase the value of enterprise
Fourth, the input of venture investment: (mature stage)
Mature stage refers to the stage that the technology becomes mature and the products enter into the industrialized manufacture. The capital at this stage is called mature capital. The capital demand at this stage is very large, but the venture investment seldom increases again. On one hand the sale of products has already brought some cash flow, on the other hand because of the mature technology and the steady market at this stage, the enterprise has already been credit enough to attract the loan of bank, issue the bonds or stocks. More important is that the rate of profits is no longer attractively high along with the greatly drop of risks, which has no attraction to the venture investment any more. Mature stage is the harvest season of venture investment and also the withdraw stage. The venture investors can take out generous profits as the repayment to investors. The withdrawal of venture investment at this stage is not only because this stage is no longer attractive to the venture investment, but also because this stage is attractive to other investors such as banks and general shareholders. The venture investment can withdraw at a quite good price, and hand over the relay baton to other investors. There are many choices on the withdraw methods of venture investment but the withdrawal is necessary and unhesitating.
In view of this, the input of venture investment has four stages: small input in seed stage, great input in start-up stage and expansion stage and parts of input in mature stage. They correspond to four growth courses of products separately. And in fact, there is no obvious limit among these four stages. Four growth courses of enterprise reflect the view of life periodicity theory of products, the method used often to differentiate these four courses is according to the change of sales increasing rate.
The operating process of venture investment company
Every company has its own operating process, but generally speaking, there are four steps:
1.Initial verification
When get the summary of business plan, have a glance at a very short time and decide whether it is worth doing or not
2.Communication among venture investors
The relevant venture investors get together regularly, research the proposal of vetted project, and decide whether to discuss face to face, or refuse.
3.Discuss face to face
If the venture investors are interested in the project of founder, they will invite the founder to discuss face to face. It is the most important meeting in the whole process.
4.Verification of responsibilities
If the initial discussion gets success, the venture investors will have a careful assessment to the technology, the market potentiality, the scale and the management departments of enterprise through a strict procedure, including contacting with the potential customers, having the consultation of technology, meeting with the management departments for many times.
5.List of clause
If the venture investors think that the applying project has a good prospect, they will begin to negotiate the investing form and the assessment. Usually the founder will receive a list of clause summarizing the contents involved. This process will last several months.
6.Sign the contract
Generally speaking, the early risk of investment is large, so the potential profit is high, and the later risk of investment is small, so the profit is low. In order to make the repayment of investment conform to the risk, the venture investors will have a analysis on the value of investment in the future 3-5 years according to the specific conditions. First, calculate the cash flow and the income forecast, then determine the risk according to the assessment of technology, management departments, skill, experience, business plan, intellectual property right, and progress of work, choose the appropriate rate of cash, calculate the net present value of venture enterprise.
After the negotiation, enter into the stage of agreement. Once signed the agreement finally, the founder would get the capital. The plan of withdrawal is included in most of agreements.
7.Supervision after the investment comes into force
When the investment comes into force, the venture investors have the shares of enterprise and occupy the seats of board. Most venture investors play a role of consultation in the board. As the consultant, they put forward the suggestion on improving the operating mechanism so as to obtain more profits, contact with the founder regularly so as to follow the progress of operation, vet the financial analysis report submitted by the accounting firm regularly. Because the venture investors are quite familiar with the investing field, their suggestions are valuable.
In order to reduce the risk, the venture investors often cooperate to invest in a certain project. Every venture investor has 20-30% shares of the same enterprise, which can reduce the risk on one hand, and bring many more resources of management and consultation to the venture enterprise on the other hand, moreover, providing several results of assessment to the venture investment enterprises reduces the error of assessment.
Six withdrawing channels of venture capital
Summary: This text analyzes and introduces six withdrawing channels of venture capital: public floatation acquisition of shells or backdoor listing, M&A, buy-back of venture enterprise, looking for the second acquisition, clearing. Combining the cases, it analyzes the advantages and disadvantages of these measures.
The characteristics of venture capital and the unique operating methods of venture investment make the combination of venture capital and innovative project only a kind of transient combination. Venture capital has been making great efforts to look for a convenient, security and maximum value-added withdrawing channel from the input moment. Whether can withdraw successfully is one of the important test stones whether the venture investment can get the success or not.
China is late in the venture investment and lags behind in the development, so it should make full use of the existing experiences of foreign countries when looks for the withdrawing channel of venture capital. Looking from the current developing situation of foreign countries, there are six withdrawing channels mainly: public floatation, acquisition of shells or backdoor listing, M&A, buy-back of venture enterprise, looking for the second acquisition, and clearing. Different channel has different status and different rate of repayment in the actual operation. According to the survey of 442 venture investments of U.S., 30% venture investments withdraw by the public floatation of enterprise. 23% by the M&A, 6% by the buy-back of shares, 9% by the second acquisition, 6% by the deficit clearing, 26% by canceling the shares for the deficit. The repay rate of venture investment is quite different by different methods of withdrawal. Pubic floatation up to 1.95 times, M&A up to 0.4 times, buy-back of shares up to 0.37 times, second acquisition up to 0.41, deficit clearing up to - 0.34 times, canceling shares for the deficit up to - 0.37times.
1.Public floatation
Public floatation refers to the initial public offering (IPO) of venture enterprise, which is the major and the most ideal withdrawing method. About 30% venture capitals withdraw by this method. According to the statistics, over 1,400 venture enterprises had their IPO from 1982 to June 1996 and raised over US$3.5 billion. Public floatation has created many myth of venture investment. IPO of Apple obtains 235 times of income, Lotus is 63 times, and Compaq is 38 times. Taking three Chinese companies listed on NSDQ as an example, IPO of Sina raises US$ 68 million, Netease is US$69.75million and Sohu is US$59.8million. All companies invested in them have had a good appreciation on the capital.
Advantages: Public offering of shares is an affirmation of financial market to the achievements of company; Keeping the independent of company is easy to be welcomed by the administrative level; The venture investors can obtain great many of profits through the public floatation of shares; the listed companies can have a channel to raise the capital continuously on the stock market; the option of companies is quite easy to fulfill; the founder can get great many of repayment.
Disadvantages: In order to protect the public investors, the laws of most countries stipulate that listing enterprises must reach some conditions. Although these conditions are much lower than the main market, quite many of enterprises can’t reach and are unable to list on the market. The listed public companies need to disclose great many of internal situations regularly, which helps the competitors grasp more information about their operating conditions. The listed companies should abide by the reporting requirements stipulated by the laws strictly, especially the requirements of Securities and Exchange Commission, and should provide the required information to the shareholders. So the companies should take more time and money in the report and audit; Once the achievement declines, the investors will hurry to sell off the shares, which makes the price of stock drop; According to the stipulations of relevant laws, the enterprise can’t sell out all its shares immediately after IPO, it should take a certain period (two years generally) to sell step by step. So the withdrawal of venture capital can’t be realized immediately and this method is difficult to get a high repayment when the stock market is in low spirits.
2.Acquisition of shells or backdoor listing
Acquisition of shells or backdoor listing is a higher pattern of capital operation phenomenon. It is a good withdrawal for the venture capital that can’t meet the conditions to list and withdraw from the investing field through the public floatation.
Backdoor listing means that the holding company (group company) of listed company depends on the existed listed company to realize the whole listing of group company gradually through the reconstruction of assets and the input of good assets of group company to the listed company and then the venture capital withdraws gradually through the market.
Acquisition of shells means non-listing company controls the listed company through acquiring the shares of listed company on the stock market, input its assets and businesses to the listed company through many ways, and reach the goal of indirect floatation. Then the venture capital withdraws gradually through the market.
Specific operating methods are as following:
(1) Pubic acquisition in the level 2 market, namely offer
(2) Paid transfer of non-liquid shares
(3) Combine its own assets or shareholdings with the listed company and change the registered capital and the shareholding structure of listed company.
(4) Realize the indirect floatation through controlling the holding company of listed company
Advantages:
(1) Make a detour on the public floatation avoiding of all kinds of requirements of market to the listing enterprise and realize the floatation indirectly
(2) Obtain the new channel to raise capital with low cost through the rights issue, mitigate the pressure of capital.
(3) The speculation on the level 2 market when carry out the acquisition of shells or backdoor listing will take a huge profit.
Disadvantages:
(1) No matter the public acquisition on the level 2 market or the paid transfer of non-liquid shares needs the cooperation of big shareholders of listed company, otherwise the cost and the difficulty of acquisition would be increased.
(2) Most objectives on the shells are the listed companies with difficult operation, they can’t have the rights issue immediately, moreover, they have to undertake the responsibilities to improve the assets of original listed company, so they have a heavy burden.
3.M&A
The venture capital can withdraw from the enterprise invested by the M&A venture capital of another enterprise. Along with the increase of demands to the high-new tech and the deep understanding to the importance of developing the high-new tech industry, this withdrawing method will be adopted more and more. Because all kinds of risks are reducing constantly when the venture enterprise develops to a certain stage, the advantages of technology and market have been developed, and the prospect of enterprise are becoming clearer, other companies with the aspiration to enter into this field would be glad to get involved with this method right now. As for the venture investors, they would also consider to use this faster method for thinking that it need some time to withdraw completely form the venture enterprise through the public floatation. It is quite common at present in China especially at the present depressing period of NSDQ. Many companies that can’t list temporarily use this method successively.
Methods of M&A
(1) One party acquires all or part of shareholdings of another party. Once the corresponding shareholdings of venture capital are acquired, the venture capital could withdraw successfully (cash-shareholding). For example, Feihua transferred the famous domestic 163.net to TOM Online Inc, and obtained nearly 10 times the investment as the repayment. Advantages: easy in the procedure and quick in the withdrawal. Disadvantages: the profit is lower than the public floatation, and if the venture enterprise can’t keep its independence after acquired by a big company, the administrative level of company will be influenced.
(2) Exchange the shareholdings of acquiring enterprise with the shareholdings of venture investors in the venture enterprise. Advantages: It is easy to find the purchaser for no cash needed. Disadvantages: Cash the profits only after selling out the exchanged shares. It takes a long time, and the actual income is influenced by the change of market price.
(3) Trade of notes. Pay the acquired shareholdings with the notes. Advantages: get the advantage of reducing the taxes through postponing the payment. Disadvantages: Have the risk that the note can't be cashed.
(4) Combinative acquisition: M&A party gets the shareholdings of venture enterprise held by the venture investors through the combinative methods with cash, notes and shares. Advantages: flexible in the trade. Disadvantages: complex in the trading structure.
4.Buy-back of venture enterprise
M&A by the other companies means that the original venture enterprise will lose the independence and the operation of company will also be influenced, which the administrative level of company is unwilling to see. So selling the venture enterprise to the other enterprises sometime will meet the obstruction of administrative level and its staff. The buy-back of shareholdings by the administrative level and the staff of venture enterprise not only can let the venture capital withdraw successfully, but also avoid of too big influence to the operation of venture enterprise taken by the withdraw of venture capital. Because the buy-back is attractive to both sides, it develops very fast.
There are three main methods:
(1) MBO: The administrative level of venture enterprise acquires and holds parts of shares of venture investment through raising the capital. The company is held by the administrative level and the shareholders after completing the acquisition. The payment can be the loaned cash, other shareholdings of administrative level, long-term notes and so on. Advantages: keep the independence of company, avoid of the big shock to the operation of enterprise taken by the withdrawal of venture capital. The entrepreneur can get the rights of holding and controlling of expanded enterprise. Disadvantages: the administrative level should find a good lever to raise the capital, provide the capital support to the buy-back.
(2) EBO: The staff of venture enterprise acquires and holds parts of shares of venture investment. Generally Staff shareholding funds is needed as the capital sources of acquisition. Advantages: The funds are transferred before paying the taxes, so it can reduce the taxes.
(3) Sell and buy the equity option. Sell the equity option: The venture investor can require the entrepreneur or the company to buy back the shares of company he holds at the pattern and price discussed in advance. Buy the equity option: The founder or the company has the rights to buy the shares held by the venture investor with the same or similar pattern. Advantages: apply the tool of financial innovation to the buy-back of venture enterprise, which strengthens the flexibility and the attraction of buy-back and guarantees the benefits of enterprise or investor.
5. Look for the second acquisition
Looking for the second acquisition is a kind of withdrawal by selling the shares, which means that transfer the shareholding to another venture investment company onetime and let it to take over the second acquisition. If the former venture investment sells parts of shareholdings only, parts of original investments realize the fluidity, and form the investing portfolio with the new investments. If transferred completely, the former venture investment company withdraws completely, but the venture capital is not withdrawn from the venture enterprise, the enterprise will not be shocked by the withdrawal of capital. Advantages: The venture investment company can withdraw flexibly, what is transferred is only the different venture investors. Disadvantages: may encounter the conflict of administrative level of company.
6. Clearing
Venture investment is a profitable activity with high risk. Generally only 10-30% of projects can get success. According to an analysis and research to 13 venture investment funds of US, 50% of total income of venture investment come from 6.8% investments. 75% of total income come from 15.7% investments. So the venture investment on the confirmed failed project should adopt the method of clearing to withdraw so as to take back the capital as many as possible. There are two methods: deficit clearing and deficit cancellation.
Not all failed enterprises have the bankrupt clearing. It should spend some cost, a long time and a quite complex legal procedure to apply the bankrupt and have the clearing. If a failed investing project has no other debts or only a little, but the creditor lets the matter pass, then, some venture capitalists and venture entrepreneurs will not apply the bankrupt but operate with other methods, and determine the distribution of remains of enterprise by way of negotiation. Advantages: prevent the losses from the further expanding or the operation of capital from the low benefit. Disadvantages: The ratio of income is generally 0%. According to the statistics, this method can only withdraw 64% of original investments.
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