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Tuesday, 31 March 2009
Venture capital funds as an option
If obtaining bank credit has become exceedingly difficult, perhaps SMEs should consider alternative sources of financial support, such as venture capital funding, which typically focuses exclusively on start-ups.
If obtaining bank credit has become exceedingly difficult, perhaps SMEs should consider alternative sources of financial support, such as venture capital funding, which typically focuses exclusively on start-ups.
The primary difference between venture capital funds and bank credit, explained Eugene Wong, chairman of the Singapore Venture Capital and Private Equity Association, is that venture capital funds see themselves as being ‘fundamentally shareholders’ and not creditors.
As a consequence, while the approaches of banks and venture capital funds may share broad similarities, Mr. Wong said that banks are primarily concerned with a company’s ability to repay the loan over a given time frame.
Venture capital funds, on the other hand, obtain capital from investors, called ‘limited partners’, who are cognizant of the risks involved in relatively higher-yielding investments. As such, their sights are primarily trained on maximising profit, rather than limiting potential losses.
In other words, Mr. Wong said, venture capital funds basically want to know if their ‘$1 can make $20’.
Mr. Wong offered this illustration to clarify the difference: While banks may prefer that entrepreneurs acquire fixed assets, such as property and equipment, due to considerations of fund recovery in the event of a failure, venture capital funds generally prefer that entrepreneurs not tie up funds in fixed assets unnecessarily, and instead focus on developing the product or service, because their priority is not to minimise losses - it is to maximise profit.
Profit is realised once the company achieves significant growth, through an initial public offering (IPO) or trade sale.
More often than not, the investment is made via redeemable convertible preference shares - redeemable because they may be exchanged for cash at a date and return rate mutually agreed upon; convertible because they may be converted into ordinary shares if the company gets listed; and preference implying that the venture capital fund gets priority in recovering its capital in the event of liquidation.
Mr. Wong acknowledged that this choice of funds often ‘turned off’ SMEs, owing to a lack of familiarity. However, venture capital funding had much to offer SMEs, he said.
Given their relatively long-term investment horizon, many venture capital funds often forego the equivalent of a dividend payout, preferring instead to let the company use its profits to grow.
Besides this, having invested heavily in the company, venture capital funds ‘really want you to succeed’, said Mr. Wong.
They are ‘focused on keeping the company focused’, and often serve as a sounding board to discuss strategies with entrepreneurs, he said. They also extend access to their global networks to entrepreneurs, thus saving them time and effort in sourcing for partners and professional service providers, such as law firms in foreign jurisdictions.
While venture capital funds have become increasingly ‘conservative’ because of the financial crisis, they have not ‘dried up’, said Mr. Wong. There are still funds which are willing to invest in SMEs with a compelling value proposition.
So how exactly do SMEs obtain venture capital funding?
Given that the nature of the investment presupposes a great degree of trust, venture capital funds usually rely on referrals, said Mr. Wong. However, these referrals are not limited to those from trusted friends and business associates - government agencies such as Spring Singapore play the role of matchmaker as well.
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Venture capital funds as an option
By VICTOR KATHEYAS
31 March 2009
If obtaining bank credit has become exceedingly difficult, perhaps SMEs should consider alternative sources of financial support, such as venture capital funding, which typically focuses exclusively on start-ups.
The primary difference between venture capital funds and bank credit, explained Eugene Wong, chairman of the Singapore Venture Capital and Private Equity Association, is that venture capital funds see themselves as being ‘fundamentally shareholders’ and not creditors.
As a consequence, while the approaches of banks and venture capital funds may share broad similarities, Mr. Wong said that banks are primarily concerned with a company’s ability to repay the loan over a given time frame.
Venture capital funds, on the other hand, obtain capital from investors, called ‘limited partners’, who are cognizant of the risks involved in relatively higher-yielding investments. As such, their sights are primarily trained on maximising profit, rather than limiting potential losses.
In other words, Mr. Wong said, venture capital funds basically want to know if their ‘$1 can make $20’.
Mr. Wong offered this illustration to clarify the difference: While banks may prefer that entrepreneurs acquire fixed assets, such as property and equipment, due to considerations of fund recovery in the event of a failure, venture capital funds generally prefer that entrepreneurs not tie up funds in fixed assets unnecessarily, and instead focus on developing the product or service, because their priority is not to minimise losses - it is to maximise profit.
Profit is realised once the company achieves significant growth, through an initial public offering (IPO) or trade sale.
More often than not, the investment is made via redeemable convertible preference shares - redeemable because they may be exchanged for cash at a date and return rate mutually agreed upon; convertible because they may be converted into ordinary shares if the company gets listed; and preference implying that the venture capital fund gets priority in recovering its capital in the event of liquidation.
Mr. Wong acknowledged that this choice of funds often ‘turned off’ SMEs, owing to a lack of familiarity. However, venture capital funding had much to offer SMEs, he said.
Given their relatively long-term investment horizon, many venture capital funds often forego the equivalent of a dividend payout, preferring instead to let the company use its profits to grow.
Besides this, having invested heavily in the company, venture capital funds ‘really want you to succeed’, said Mr. Wong.
They are ‘focused on keeping the company focused’, and often serve as a sounding board to discuss strategies with entrepreneurs, he said. They also extend access to their global networks to entrepreneurs, thus saving them time and effort in sourcing for partners and professional service providers, such as law firms in foreign jurisdictions.
While venture capital funds have become increasingly ‘conservative’ because of the financial crisis, they have not ‘dried up’, said Mr. Wong. There are still funds which are willing to invest in SMEs with a compelling value proposition.
So how exactly do SMEs obtain venture capital funding?
Given that the nature of the investment presupposes a great degree of trust, venture capital funds usually rely on referrals, said Mr. Wong. However, these referrals are not limited to those from trusted friends and business associates - government agencies such as Spring Singapore play the role of matchmaker as well.
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