How Venture Capitalists Structure Their Investments
How Venture Capitalists Structure Their Investments
It is first important to understand how venture capitalists achieve their targeted rates of return of 30% per year. Not every company will make this return on equity but there are ways around it.
Much depends on the exit value of your company. A 30% rate of return reflects a price-earnings ration of 3. If the investor can exit at a higher price-earnings ratio they will earn more than their 30% desired return.
Another way to reach this target is by offering options. An option is the right to purchase shares of your company in the future at a pre-determined price today. If you grow at 20% annually and your earnings were 100 in the first year, your earnings would be 120 in the second year and 145 in the third. By using options the investor can then immediately purchase additional shares at 100 and sell them for 145 which can be added to their 20% annual return to reach the desired 30%.
A 30% return is an average figure and relates to the degree of perceived risk. If you have an early stage company you will need to provide a high rate of return. If you have a more mature business that has traction and you need financing for expansion or working capital, 30% may not be the required target due to the lower risk level.
Younger companies may also be forced to give up a disproportionately high percentage of shares to compensate for the high degree of risk. However, venture capitalists will frequently sell a certain amount back to you based on you meeting clearly defined performance objectives.
Another investment structure is subordinated debt. This usually caries a high yield and is usually not accompanied by equity. Subordinated debt is ideal for companies with solid cash flow and who need addition capital to grow thereby raising the value of their shares before raising any equity capital.
It is first important to understand how venture capitalists achieve their targeted rates of return of 30% per year. Not every company will make this return on equity but there are ways around it.
Much depends on the exit value of your company. A 30% rate of return reflects a price-earnings ration of 3. If the investor can exit at a higher price-earnings ratio they will earn more than their 30% desired return.
Another way to reach this target is by offering options. An option is the right to purchase shares of your company in the future at a pre-determined price today. If you grow at 20% annually and your earnings were 100 in the first year, your earnings would be 120 in the second year and 145 in the third. By using options the investor can then immediately purchase additional shares at 100 and sell them for 145 which can be added to their 20% annual return to reach the desired 30%.
A 30% return is an average figure and relates to the degree of perceived risk. If you have an early stage company you will need to provide a high rate of return. If you have a more mature business that has traction and you need financing for expansion or working capital, 30% may not be the required target due to the lower risk level.
Younger companies may also be forced to give up a disproportionately high percentage of shares to compensate for the high degree of risk. However, venture capitalists will frequently sell a certain amount back to you based on you meeting clearly defined performance objectives.
Another investment structure is subordinated debt. This usually caries a high yield and is usually not accompanied by equity. Subordinated debt is ideal for companies with solid cash flow and who need addition capital to grow thereby raising the value of their shares before raising any equity capital.
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