Capital According to the National Venture Capital

¶ … Capital

According to the National Venture Capital Association (NVCA, 2012), the venture capital industry is attracted to companies that are developing significant innovations. Some examples cited are a new piece of software, a new drug or a new model for consumer sales. Venture capitalists enter the industry when the product is ready to take to market, and is in a position to enjoy significant growth. Venture capitalists therefore seek out businesses with a high potential for success, and they provide the capital that allows those businesses to succeed.

The businesses that venture capitalists prefer are at a stage where they are more than just an idea, that there is something the company can take to market. Venture capitalists want to see that there are revenue streams coming down the pipeline, because the venture capitalist needs to be able to envision an exit strategy.

Often, venture capitalists seek out companies where they can add their own value. This usually means in terms of management. VCs will seek out companies that have inventors, engineers and scientists, but perhaps have a deficit in professional management or in marketing expertise. This is where the venture capitalist can enter, add this expertise and financing, and allow the business to thrive to a level it would otherwise have been unable to.

2. The investment that Pacific Ridge is proposing for Neverfail is $1million. In order to return 40% over five years, the future EBIT would need to grow at that rate over the course of this period. Indeed, there will be dilution if there is another round of financing in twelve months, so the growth must take that into account as well.

Currently, Neverfail is losing money. The company had sales of $2.2 million, but has a high burn rate. The company's revenues will need to double for the next five years in order to put the company into a position where it can be profitable and the equity value can increase. There are many ways for Pacific Ridge to earn its return, however, and much of the return might come at the point where Neverfail is taken public. The total value that Neverfail is hoping to extract from the company is around $5.4 million on the initial $1 million investment.

3. There are two major issues in the terms and conditions from the perspective of Neverfail. The first is that the preferred stock has a 20% accrued dividend. This creates no incentive for Pacific Ridge to contribute to the company, and it represents significant risk for Neverfail and its partners. If the company does not succeed to expectations, this obligation could overshadow the equity holdings of others. Thus, the risk protection for Pacific Ridge gives it too much preference in the event of liquidation.

Another major issue from the perspective of Neverfail is the on-demand registration rights. Neverfail will prefer to control this, not have it in the control of Pacific Ridge. Demand registration rights are burdensome for the company, because of the process involved (Koester, 2009). Registration rights are the right of the investor to demand that the company register their shares with the SEC, and this process is both expensive and time-consuming. Therefore, these rights should be subject to negotiation, and they are not something that Neverfail will want to give away.

From the perspective of Pacific Ridge, there are some remaining areas of concern as well. The time frame is a concern for the company. Neverfail needs the money by the end of the year, but that leaves only six weeks for Pacific Ridge to perform its due diligence. It has built in some protections into the agreement specifically because of the tight time squeeze, but ideally would have more time to perform the due diligence.