UNDERSTANDING VENTURE CAPITAL 2
© Tien Nguyen
Throughout the history of the financial industry, the currency has always been under pressure to depreciate due to inflation and must create a surplus from its own value through financial activities. In order to make a profit on the capital you manage, you have many options such as lending at interest, investing in other funds, buying stocks, buying government bonds, buying oil or rare metals, etc., if you are managing a venture fund, you will primarily invest in the equity of a startup.
Part 2: Investing in business equity
When a VC invests in a business, which is mostly high-growth startups or owns technology that promises future outperformance, the VC buys the equity in that business. That is also why startups that are oriented to raise capital from VCs should set up joint-stock enterprises to be able to transfer equity more easily.
A VC’s purchase of equity in a business is similar to the purchase of shares in a listed business, except that there are a few differences:
The openness of information: VCs mostly invest in private companies (Private). Therefore, share prices and investment volumes for these investments are not required to be disclosed to the public as is the case when buying shares of companies on the stock exchange. However, some VC investments are now being announced like: “Company A gets an investment of $700,000 from Fund X at a 7-figure valuation”. This activity has the purpose of communication rather than the transparency of investment information.
Liquidity: Unlike shares on a stock exchange, equity in a private enterprise is not highly liquid. This means that VCs cannot easily sell this capital for cash or more liquid assets. In contrast, when buying a stock on the HOSE, for example, you will be able to liquidate faster by selling that stock almost anytime right on the floor at a published price.
To liquidate this investment, VCs will have to take an additional period of time, usually 3 to 7 years, and the price must be negotiated. Most startups are even more liquid than real estate. VCs, based on expertise, problem-solving skills and market sensitivity as well as a little luck, will get liquidity from this investment through the sale of their shares to mutual funds. other private investors, other companies or, in rare cases, go public through an initial public offering (IPO).
Active role: Unlike stock investment, investors who choose startups as an investment object will have to take a more active role. Often, they will have to use their knowledge, experience, and connections to help startups succeed. A VC will typically invest a 20-40% stake in a startup to ensure they have a seat on the board and have a say in strategic decisions.
Creation of new preferred shares: In the case of stock trading on the exchange, no new shares are created. Conversely, when a VC invests in a startup, a new amount of preferred stock is created in exchange for the cash the VC transfers to the startup’s bank account through shareholder equity. The increase in the number of shares causes the ownership of the business of the founders and previous investors to be diluted.
In addition, these newly created shares are often preferred shares. This means that VC shares will be preferred over common shares in a number of ways, such as divestment priority, voting preference, undiluted priority in the next funding round, priority. be eligible to participate in the following round of funding or dividend incentives. These rights will be discussed by the parties and we will analyze in detail in the next series of Term Sheet articles.
In Asia and especially Southeast Asia, VCs often ask startups to set up new companies to receive investment capital. Newly established company locations will be countries with open and professional financial services systems, strict investment legislation or easy cash flow. The locations that are usually chosen are the area where the fund is located, Singapore, Hong Kong or the tax havens of Virgin Islands, Cayman Islands, etc. This sometimes leads to some legal risks when raising money to come. The real market of startups. Therefore, startups and VCs need to discuss carefully, as well as balance the benefits when choosing the option of establishing a new company in another country to receive investment capital.
Equity and Debt: As discussed in the previous post, venture capital is a process that requires more than money with high risk, so the cost of equity investments is very high. expensive. When faced with the choice of borrowing or raising VND 2 billion for a startup, you will have to consider a few things:
If you borrow, you will have a personal debt (because a startup has no assets to mortgage). And if that startup fails, you’re sad twice, once for your startup and again for the upcoming time you have to plow to pay off debt.
If you raise capital, you will (1) not have to pay debt to VC because this is an investment, jointly owning the business, and the same board. It’s not easy for you (2) to get out of a VC just by paying off their debt. If the startup thrives, the VC will benefit more than the bank gets from you. This is obvious because the risk of VC is much higher. VC will create (3) pressure to divest because they will only be able to get the most profit from divestment. VCs won’t stay in startups to enjoy annual dividends because that amount is too small compared to the risk they are taking and the return investors give them hope for.
Building rapport and understanding the VC is extremely important because it is clear that when a dispute arises, you cannot get out of the VC easily. A popular example is Benchmark Capital’s 2017 lawsuit in Delaware court accusing UBER CEO Travis Kalanick of fraud for personal gain, breach of contract, and breach of fiduciary duty. The case was dropped a year later under an internal agreement involving a deal to buy back a large portion of capital at a valuation of $48 billion (30% lower than the most recent valuation) by UBER and a group of investors. another investment, led by SoftBank.
However, with that said, VCs don’t just invest money. They are the launching pad for many successful startups thanks to their experience, knowledge, relationships and strategic vision.
A Startup needs to understand and analyze carefully before making a decision to borrow or call for VC capital. There is never the best source of capital, only which capital is suitable for which business at a particular stage.
In part 3, we will focus our discussion on the audience most interested in investment funds: Fast-growing startups.
Documentation of the case: https://www.courthousenews.com/wp-content/uploads/2017/08/Benchmark-Kalanick-COMPLAINT.pdf