New Markets Venture Capital

In order to create job opportunities and wealth while promoting economic development, the Small Business Administration developed the New Market Venture Capital or NMVC program.  The program is geared towards individuals who currently reside in low-income geographical areas and was modeled after the SBA’s Small Business Investment Company (SBIC) program.

About New Markets Venture Capital

When entrepreneurial companies need funding and cannot obtain it from banks, public markets, and other traditional sources, they will oftentimes seek out a specific type of equity financing known as venture capital.  Investments of venture capital are made in exchange for an active role (e.g. a position on the board of directors) and shares in the invested company.

There are significant differences between the more traditional financing sources and venture capital sources that you need to be aware of when applying for the SBA’s New Market Venture Capital program.  Venture capital typically:

  • employs board participation, capital structuring, governance, and strategic marketing to actively monitor and target specific portfolio companies
  • focuses on high-growth, younger companies
  • invests equity capital, not debt
  • offers a much longer investment horizon compared to traditional financing
  • pursues higher risks in exchange for potentially higher returns on investments

With many businesses, successful long-term growth is attributed to the amount of equity capital that is available.  However, before they will lend funds to a smaller business, lenders may require collateral or some type of security.

The amount of debt financing that will be available can be limited by a lack of equity.  Furthermore, one of the requirements of debt financing is the ability to use the current interest payments in order to service the debt.  So the funds are not available for expansion and growth.  The equity providers do have the last call where the company’s assets are concerned even though venture capital gives the business a financial cushion.  As a result equity providers look for a greater ROI than what traditional lenders do.

Understanding Venture Capital

“Angel investors” or individuals with a high net worth and venture capital firms are typically the entities that provide emerging and new businesses with venture capital.  Since this type of funding carries a high degree of risk and is typically unsecured, these lenders tend to loan funds to private, younger companies that have a potential for fast growth.  However, venture capital allows more time for companies to mature and become profitable.

Additionally, this is an active form of financing, not passive.  In addition to the capital, investors look to add value to the companies they are investing in.  This helps the company grow and provide a greater ROI.  Most investors will take an active role in the company, such as a seat on the board of directors.  However, it doesn’t mean that they will be involved indefinitely.  Their main objective is to obtain the highest rate of return possible.

Angel Investors

As was mentioned in the prior section angel investors are individuals with a high net worth who provide private investments to start-up companies in the hopes of seeing a high return on their money.  These investors are a very diverse group and used a variety of sources to become wealthy.  Interestingly enough, many of them were entrepreneurs or executives who were lucky enough to retire early from prior ventures that became very profitable.

Although they are diverse individuals, they typically share a number of common characteristics such as:

  • Sometimes they will invest more than money because of their past experiences.  This includes consulting with young entrepreneurs or mentoring them as well as other active forms of involvement.  In so doing, they accept lower returns and take bigger risks.
  • They invest in certain industry niches or technologies that they have experience in are very familiar with.
  • They oftentimes partner with business associates and trusted friends in order to co-invest in specific companies.  Typically, there is a lead investor in these circumstances that the rest of their group trusts explicitly.
  • They seek out younger companies with a high potential for rapid growth, solid business plans, and strong management teams.

Understanding Equity Capital

When a company raises money for the business and they provide a share of ownership to the lender, this is commonly known as equity capital, equity financing, or share capital.  Ownership is typically represented in one of two ways.  The investor can convert other financial vehicles into that private company’s stock or they can own stock shares outright.

Angel investors and venture capitalists are the primary sources of this financing.  This capital is usually appropriate for businesses in every stage of their development, covers most industry niches, and is unsecured by assets.  Equity capital, in contrast to debt capital, is invested money that is typically not repaid under normal business operations.

Furthermore, its value is calculated by estimating by taking the company’s assets current market value and subtracting its liabilities from them.  It is typically listed as either owner’s equity or stockholder’s equity on the company balance sheet.

The Venture Capital Process

High growth technology or start-up companies that are searching for venture capital can typically expect the following to transpire:

Submission of a business plan – the entrepreneur must submit their business plan to the venture fund members and must meet the investment criteria that they require.  Most funds will concentrate on a specific geographic area, industry niche, or stage of development.

Due diligence – the venture fund members will perform due diligence on the business needing the capital provided they are interested in the propose prospectus.  They will perform research on the company’s corporate governance documents, financial statements, management personnel, market, operating history, and products or services.  The terms and conditions of the investment will usually be described by the fund members at this time.

Investment – if the venture fund members are still interested after the due diligence is performed, they may choose to invest in the company in exchange for some of its debt and/or equity.

Execution with VC support – once the funds have been invested, its members take an active role in the company.  For the most part, the investment is not made all at once but in phases, “rounds”, or stages based on accomplishing specific milestones.  As each milestone is reached, more funds are invested in the company.

Exit – since the investment horizons of venture capital is typically longer than traditional funding sources, venture fund members usually expect to exit the invested company an average of 4 to 6 years after the initial investment.  This is typically the way in which these investors make their money.  When the time to exit arrives, it will usually be performed as an acquisition, merger, or initial public offering (IPO) of company stock.  In many instances, the venture fund members will use their business networks and experience to help the company exit.

Additional Notes

One of the most common obstacles that start-up companies face is not being able to attract a sufficient amount of funding and technical assistance.  This is especially true where the more rural companies are concerned as they face a number of different barriers to sustainable expansion and growth.  As a result, the SBA became the administrator of the New Markets Venture Capital program.

The companies involved in this program are privately managed for-profit investment funds that serve to promote economic growth as well as the creation of jobs and wealth.  In order to accomplish these objectives, New Market Venture Capital companies make equity investments in smaller (sometimes rural) companies that are located in defined and designated geographical areas.

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