Introduction
For all the right reasons, Inventors are “true believers” in their business concepts and technologies, and yet, they are often frustrated by how difficult it is to raise sufficient capital to turn their concepts into actual products and services.
It is said that if you understand your customers’ needs as well as they do, you are in the best position to provide them what they really want to buy. This truly applies to companies interested in raising money. Understanding the constraints that the financing companies are operating under makes it much easier to develop opportunities that they are willing to “buy”.
VCs, Angels, Private equity and Project finance firms all survive by developing an expertise in a certain market specialty and risk level – an investment premise. They often have to review hundreds, if not thousands of opportunities before finding ones that seem realistic and viable and meet these investment criterion. They tend to focus on specific market segments and business maturity levels due mostly to time and knowledge constraints, since doing high quality assessments of opportunities is difficult and time-consuming.
Finding Investors that either have prior experience or are interested in developing experience in your market space makes life much less frustrating all around.
Venture Funds
It is important to understand that venture funds get their capital from much larger fund managers, such as insurance companies and retirement funds that are investing only a small portion of their available equity in these high risk/high return vehicles. Remarkably, returns to these “limited partners” from the VC fund are typically expected to be only 15% to 20% annualized, which is perhaps 3 to 4 points above long-term market rates. Venture firms attempt to create this premium by investing in companies through their super-high growth periods, liqudating, and then reinvesting.
The 15% to 20% annualized return needed to satisfy their investors is much less than 50% to 100% annualized returns that are considered the hurdle for VC investment in a startup. This is simply because it is so difficult to pick which ones will be successful – perhaps only 1 out of 10 of the companies they fund are successful enough to provide returns sufficent to a) cover the losses from the other investments, b) pay themselves, and c) provide the desired returns to the limited partners. By investing in a pool of companies, and managing the risk carefully, VCs have been able to be relatively successful with this strategy. However, in recognition of the difficulty in picking winners, VCs will seek to invest only in companies with very low “perceived risk to the knowledgeable investor”, as a continuing attempt to improve their odds.
Companies seeking VC financing must do everything possible to mitigate their potential risks – before even approaching the VCs.
Project Financing
Project financing groups have a completely different investment premise than venture groups. Rather than focusing on companies with high risk in new or emerging technologies and markets, they focus entirely on opportunities with “nearly guaranteed” long-term returns. As the risk is lower, the returns from these projects is also lower, but this is typically offset by the size of the investments which are often $50 to $500 Million. Typical projects might be the building of a new housing development, industrial production plant, or renewable energy generation plant. Here, the risk of success is not dependent upon the product per se, it is instead fully a function of execution and the impacts of unforeseen events, such as geologic or environmental issues. project financing groups have learned to scope these potential uncertainties and are very successful in delivering long-term returns to their limited partners. Although the expected returns are not represented at being as good as venture returns, the lower risk provides a good tradeoff. In fact, as VC returns over the last 5 years have been very poor, investing in project financing funds has proven to be a very attractive alternative, which may be why we have been seeing a large number of VC firms closing their doors in the last few years.
Project Financing is very attractive for businesses with very low risk and known long-term returns