Venture Capital Risk Models

VC expects Equity Participation through the use of Stock Ownership, Warrants, Options and Convertible Securities/ Debt.

Venture Capital Risk Models

Venture capital wants to balance control with the amount of investment risk in a deal. Here are two ways VC firms asses and determine investment risk.

The Risk / Return Evaluation

– At the Product or Service Level:

  • Level 1:  Idea Stage.  Not Operable.  Market Assumptions.
  • Level 2:  Pilot/ Test Stage.  Market refined.
  • Level 3:  Fully Developed.  Few Customers.  Market defined.
  • Level 4:  Satisfied Customers.  Market Established.

– At the Management Level:

  • Level 1:  Entrepreneur.
  • Level 2:  Few Founders.
  • Level 3:  Partial Management Team.
  • Level 4:  Full Management Team.  Highly Experienced.

Note: The higher the Level from both Determinants (Product or Service & Management), the less Risk for a higher Return.  4/4 would be most desirable and cost the Entrepreneur the least.  1/1 would be the least desirable and cost the Entrepreneur the most.  A 2/2 or 3/3 are good Level Combinations to shoot for prior to approaching Venture Capital if financially viable.

The Present Value / Future Value Evaluation

– Scenario: Expected ROI is 35% per year, without inflation, over 5 years.  Present Value of Earnings is $4.5M.  Future Value Earnings in 5 years is $15M.

  • VC Equity Share is calculated:  $4.5M divided by $15M = 30%.
  • Maximum Investment is 10 times first year gross (expected) earnings, which in this example is about $500,000.
  • Conclusions: $5M maximum investment for 30% of the Company at 3/3 Level over a 3 year period.  A 1/1 Level, Seed/Start Up Investment would be a 45-50% Equity Stake, with an expected ROI of 60%.

Venture Capital Objectives

It is important to research your potential Venture Capital Funds to determine exactly what they look for in an investment, what their parameters are and what they specialize in.  A VC Fund will have a detailed website which will layout their Fund’s Objectives.  You can also find this information in their Offering Prospectus/ Memorandum to their Investors.  Below is an outline of a VC firm’s Objectives to give you an idea what to look for.

Investment Objectives

  • Rate of Return expectations.
  • Long- term or short- term capital appreciation.
  • Early, Middle or Late Stage Companies.
  • Sectors interested in.
  • High growth potential.
  • Liquidity Options.
  • Expertise, Experience & Reputation of the Fund.
  • Advisory Board Members.
  • Members of the Fund.

Investment Criteria

  • Evaluate in terms of Management, Product, Markets, Financials, and Business Stage.
  • Highly competent and motivated management team.
  • Proprietary Product or service that:  meets a strong market need:  Favorable price and cost relationship.
  • A market which has a favorable mix of Size, Growth, Competitive Barriers and the potential for high volume sales.
  • Management:
  • People are the most important component in a Company’s success
  • Balanced Team
  • Superior Skills
  • Team leader with a track record
  • Ability to keep on and attract talent
  • Understands Planning & Control
  • Can make difficult decisions
  • Can work with professional advisors
  • Accept assistance from the Fund Members
  • Commitment to the Venture
  • Clearly understands the Funds’ outlook on liquidity, rate of return and investment objectives.
  • Above all, integrity, character, accountability and high business ethics

Product or Service

  • Types of Products and Services in the Fund’s Sectors which are of interest.
  • Competitive Edge:  Cost, Quality & Performance.
  • Premium prices achievable?
  • High Yield Profit Margins.
  • Dominate or Control a significant market share.


  • Young, growing fast and provides opportunity
  • Defined market niche.
  • Dominance in that niche.
  • Niche market should be small enough not to attract big company competitors, yet has a strong potential for expansion.
  • Realistic Marketing Plan.
  • Marketing Team Leaders should have broad industry contacts with sales people, sales reps and distributors.

Financial Outlook

(these are some example numbers that are based on a technology company)

  • $20M in Sales & Earnings, after taxes, within 5 years.  Generate Return on Assets greater than 20%.
  • Venture is not capital intensive.
  • Project prices & profit margins that can cushion early round obstacles.
  • Reaching Break Even in 2 years.
  • If it is a capital intensive deal, should be capable of adding substantial value early on and attract later rounds of financing at higher pricing.
  • Maximum of 10 to 1 return on investment for startups.
  • Liquidity in 5 years for startups.
  • Later stage companies: ROI of 5 to 1 in 5 years or 3 to 1 in 3 years.


  • Mostly early stage but will consider later stage with high growth opportunities.
  • Consider small public companies as well as private.
  • Spin offs as a result of re-structuring and rejuvenation.

Operating Policies

  • Can change at the fund’s discretion
  • Geography:
  • Any geographic area but most companies are in the West and Silicon Valley, China, Taiwan and Singapore.
  • Monitoring Investments:
  • Free access to management
  • Fund receives Business Plan updates regularly
  • Fund will not seek majority ownership or run the venture
  • Help the venture attract Management to fill gaps and develop its business plan in the early stages of investment
  • Board Representation
  • Fund will provide expertise and assistance with securing key employees, filling management gaps, operational planning, key customer and supplier relationships, joint ventures, financing, security offerings, acquisitions and harvest strategies

Source here …


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