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Venture Capital Investing: The Complete Handbook for Investing in Private Businesses for Outstanding Profits

Book Description

In his classic bestseller Venture Capital Handbook, leading venture capitalist David Gladstone showed thousands of companies how to get funding and work with early stage investors. Now, in his revision of the classic, Venture Capital Investing, he looks at venture capital through the eyes of the investor. Gladstone shows all of you VC investors and angels exactly how to weed through scores of business proposals and find the gem that will deliver outstanding returns, especially in these soft economic times. You will learn what to look for in a business proposition; how to assess entrepreneurs and their management teams; how to evaluate financial statements, market niches, competitive environments, and product innovations; how to investigate a business that's already operating; and how to build effective partnerships with existing portfolio companies.

Table of Contents

  1. Copyright
  2. Prentice Hall Financial Times
  3. Financial Times Prentice Hall Books
  4. Introduction
    1. Background on the Authors
    2. Acknowledgments
  5. 1. Keys to Successful Investing
    1. What are the Basic Items to Look for in a Business Proposition?
      1. 1. The Numbers Should Be Properly Presented
      2. 2. The Deal Must Make Lots of Money
      3. 3. The Acid Test of a Deal Is Management
        1. Honesty and Integrity
        2. Experience
        3. Achievement
        4. High Energy Level
        5. Motivation
      4. 4. The Situation Should Be Unique
      5. 5. The Proposed Venture Should Be Oriented Toward the Market
      6. 6. The Deal Must Have an Exit
    2. It’s Not an Investment, It’s a Partnership
    3. Prepare a Written Summary Before You Begin to Invest
      1. What Are You Investing In?
      2. Who Is Your Contact at the Business?
      3. Summarize the Business Situation
      4. Who Is the Management Team?
      5. What Are They Selling?
      6. How Much Money Are They Raising and How Much Are You Considering Investing?
      7. Is There Any Security for Your Investment?
      8. How Will the Money Be Used?
      9. What Is the Past Financial Performance?
      10. What Are the Projections?
      11. How Will You Cash Out?
      12. How Much Can You Make?
      13. What Do You Like About This Situation?
      14. What Do You Dislike About This Situation?
    4. What Does A Summary Look Like?
      1. Company
      2. Type of Business
      3. Company Summary
        1. Management
        2. Funds Requested
        3. Collateral
        4. Use of Proceeds
        5. Financial History
        6. Financial Projections
        7. Exit
      4. A Second Summary
      5. Company
      6. Type of Business
      7. Company Summary
        1. Management
        2. Product/Service and Competition
        3. Funds Requested
        4. Collateral
        5. Use of Proceeds
        6. Financial History
        7. Financial Projections
        8. Exit
      8. What Makes It Exciting?
    5. Some Words about Franchising
      1. Sound Concept
      2. Well-Financed Franchisor
      3. How Does the Franchisor Make Money?
      4. Good Relations
    6. Summary—Quick Standards of Venture Capital Investing
  6. 2. Analysis of Management
    1. The Study of Entrepreneurs
    2. Characteristics of Entrepreneurs
      1. Need for Achievement
      2. High Need for Autonomy and Power
      3. High Degree of Self-Confidence and Need for Control
      4. High Tolerance for Ambiguity
      5. Need to Assume Only Moderate Risk
      6. High Degree of Determination
      7. High Degree of Resourcefulness
      8. Sense of Urgency
      9. Knowing What Is Real
      10. High Level of Energy
      11. Mental Stamina
      12. Strong Communications Skills
      13. High Degree of Integrity
      14. Seeking Partnership Status
      15. Seeking Fair Play
    3. How We See Entrepreneurs
      1. How We Make Judgments
      2. Analytical Approach to Evaluations
    4. Interviewing Entrepreneurs
      1. Be Prepared
      2. Clear Mind
      3. Conducive Environment
      4. Be an Effective Listener
      5. Keep on Your Toes During the Interview
      6. Types of Interviews
      7. Document Your Work
    5. Assessment of Entrepreneurs
      1. Intellectual Effectiveness
      2. Work Approach and Style
      3. Personal Relationships
    6. What Venture Capitalists Look for in Entrepreneurs
      1. The Entrepreneur’s Individual Characteristics
      2. Experience of the Entrepreneur
    7. Characteristics of Small Business Managers versus Entrepreneurs
    8. Conclusions on Entrepreneurs
    9. Developing Background Information
      1. Personal References
      2. Business References
      3. Credit Reports
      4. Private Investigations
      5. Psychological Assessment Tests
      6. Written Information
      7. Information from the Entrepreneur
      8. Local People
      9. Public Information
      10. Customers
      11. Investors
      12. Employees
      13. Management Team
      14. Organization Structure and Decision Making
      15. Documentation
      16. Strengths and Weaknesses
    10. Final Judgment
  7. 3. Reviewing Personnel and Compensation
    1. How Is the Company Organized?
      1. Corporate Organizational Chart
      2. Officers and Directors
      3. Stockholders
      4. Characteristics of Management
    2. How Are People Compensated?
      1. Employee Compensation
      2. Compensation System
      3. Pension Plan
      4. Profit-Sharing Plan
      5. Bonus Plan
      6. Stock Option Plan
      7. Other Benefits
    3. What Employment Contracts Exist?
      1. Employment Contracts and Special Compensation Arrangements
      2. Noncompete Agreements
      3. Nondisclosure Contracts
    4. What Is the Workforce Structure?
      1. Unions
      2. Work Stoppage
      3. Training Program
      4. Morale of the Workforce
    5. What Personnel Records Are Maintained?
      1. Maintaining Internal Records
      2. Payroll Records
      3. Employee Books and Manuals
      4. Reports from the Personnel Department
      5. Hiring Procedures
      6. Motivating Employees
      7. Personnel Files of Management
      8. Employee Litigation
      9. Regulatory Agencies
      10. Personnel Consultants
      11. Other Employee Benefits
      12. Health Insurance
      13. Summary
    6. Major Strengths and Weaknesses
      1. Ratio Analysis
      2. Checklist
  8. 4. Analysis of Marketing and Sales
    1. Who Are the People Who Market and Sell?
      1. Personnel
      2. Salesperson Analysis
      3. Outside Representatives
      4. Motivation
      5. Termination of Employees
    2. What Are They Selling?
      1. Products
      2. Product Descriptions
      3. Seasonality of Products
      4. Product Literature
      5. Product Development
    3. Who Buys the Product or Service?
      1. Customers
      2. Contracts with Special Customers
      3. Loss of Customers
      4. Customer Complaints
      5. Order Backlog
      6. Customer Credit Approval
      7. Customer’s Credit Terms
      8. Disputed Invoices
    4. What Is Said to the Customer?
      1. Public Relations
      2. Advertising
      3. Formal Advertising Program
      4. Advertising Budget
      5. Questions for the Advertising People
    5. What Is the Marketplace for the Product or Service?
      1. Market Size
      2. Competitors
      3. Market Growth
      4. Market Information
      5. Substitutes in This Marketplace
      6. Marketing Objectives
      7. Marketing Strategies
    6. How Is Price Determined?
      1. Pricing Policies
      2. Pricing Process
      3. Price Changes
      4. Product Warranty
    7. What Internal Reports Are Made?
      1. Marketing Reports
      2. Sales Projections
      3. Procedures Manuals
    8. What External Information Is Available?
      1. Industry Associations
      2. Trade Shows
      3. Trade Publications
    9. Basic Information
      1. Ratio Analysis
    10. What Are the Strengths and Weaknesses?
      1. Conclusions on Marketing
      2. Checklist
  9. 5. Investigating Production
    1. The Facility
      1. Plant Moves
    2. Equipment
      1. The Need for New Equipment
      2. Surplus Equipment
      3. Capital Expenditures
    3. Production Capacity
    4. Production Employees
      1. Motivating Employees
      2. Unions
      3. Retirement Plans
      4. Staff Meetings of Production People
    5. Regulatory Agencies
    6. Subcontracting Work
    7. Inventory
    8. Quality Control
    9. Production Costs
    10. Production Levels
    11. Back to Capacity
    12. Strengths and Weaknesses of the Production Process
    13. Purchasing Process
      1. Suppliers
    14. Receiving
    15. Shipping
    16. Customer Service
    17. Research and Development
      1. Research and Development Strengths and Weaknesses
    18. Basic Information
      1. Production Reports
      2. Ratio Analysis
    19. Conclusions About Production
      1. Checklist
  10. 6. Analysis of the Financial Statements and Projections
    1. Personnel
    2. Analysis of the Numbers
      1. Financial Analysis
        1. Analyzing the Income Statement
        2. Percentage of Completion
        3. Loss Leaders
        4. Research and Development
        5. Standard Cost
      2. Cash Flow Analysis
      3. Analysis of the Balance Sheet
        1. Inventory
        2. Fixed Assets
        3. Liabilities
    3. Budgeting and Control
    4. Past Financings
      1. Past Bank Financings
      2. Entrepreneur’s Investment
      3. Entrepreneur’s Ownership
      4. Participation with Other Investors
    5. Use of Proceeds
    6. Projections
    7. Basic Information
      1. Ratio Analysis of the Financial Statement
      2. Profitability Ratios
      3. Liquidity Ratios
      4. Leverage Ratios
      5. Cash Ratios
      6. Financial Reports
    8. Conclusions on the Financial Area
      1. Checklist
  11. 7. Reference Information
    1. Corporate Identification
    2. Corporate Structure
    3. Management Questions
      1. Stock Questions
    4. Professional References
      1. Questions for Bankers
      2. Other Institutional Lenders
      3. Questions for Accounting Firms
      4. Questions for Lawyers
      5. Suit Settlement
      6. Questions for Insurance Agents
      7. Questions for Landlords
      8. Questions for Manufacturers’ Representatives
      9. Questions for the Advertising People
      10. Questions for Suppliers
      11. Questions for Customers
      12. Questions for Competitors
      13. Questions for Subcontractors
    5. Credit Information
    6. Conclusions on Reference Information
  12. 8. Negotiating the Deal and Commitment Letter
    1. Pricing the Deal
      1. Risk/Reward
      2. Removing Risk by Structure
      3. Return on Investment
      4. Types of Deals
      5. Using Probability
      6. Probabilities and Deviation
      7. Return
      8. Return to Investor
      9. Present Value
      10. Internal Rate of Return
      11. Net Present Value
      12. Investor’s Standard
    2. Commitment Letters
      1. 1.. Terms of the Investment
      2. 2.. Collateral and Security
      3. 3.. Conditions of the Loan
      4. 4.. Representations
      5. 5.. Conditions of the Commitment Letter
    3. An Investment Memorandum
      1. 1.. Terms of the Investment
      2. 2.. Collateral and Security
      3. 3.. Conditions of the Investment
      4. 4.. Representations
      5. 5.. Conditions of the Commitment
      6. Other Items
    4. Conclusions About the Commitment Letter
  13. 9. The Legal Closing
    1. First Type of Closing: Loan with Options
      1. Document One: The Loan Agreement
        1. 1. Purchase and Sale
        2. 2. Collateral Security and Subordination
        3. 3. Affirmative Covenants
        4. 4. Negative Covenants
        5. 5. Events of Default
        6. 6. Equity Rights
        7. 7. Representations and Warrants
        8. 8. Fees and Expenses
        9. 9. Definitions
        10. 10. Conditions of Closing and Miscellaneous
      2. Document Two: The Note
      3. Document Three: The Stock Purchase Option
      4. Other Documents: Exhibits
      5. Simple Is Good
    2. Second Type of Closing: Legal Documents for the Purchase of Stock
      1. Stock Purchase Agreement
        1. 1. Purchase and Sale
        2. 2. Affirmative Covenants
        3. 3. Negative Covenants
        4. 4. Equity Rights
        5. 5. Representations and Warranties
        6. 6. Fees and Expenses
        7. 7. Definitions
        8. 8. Restrictions
        9. 9. Voting Trust
        10. 10. Employment Agreement
        11. 11. Consulting Contract
        12. 12. Conditions to Closing
    3. Lawyers as Investors or Business Owners
    4. Experienced Lawyers are Best
    5. Procedures for Reviewing Documents
    6. Legal Fees Keep Going Up
    7. How Lawyers Run up Your Legal Bill
      1. Disagree on Legal Points
      2. Rewrite Sections
      3. Research Points of Law
      4. Legal Style
      5. Arguments
      6. Syndications and Lawyers
    8. The Closing: A Moment of Truth
      1. Last-Minute Changes
      2. Closing Fees
    9. What to Remember About Lawyers
    10. Documentation
  14. 10. Monitoring the Investment
    1. Involvement
    2. Major Policy Decisions
    3. Monthly Reports
      1. Monthly Written Report
    4. Board Meetings/Investor Meetings
    5. Other Discussion Items
    6. Maintaining Good Records
      1. Legal Records
      2. Correspondence File
      3. Financial Recording File
      4. Board Meeting Files
      5. Tracking File
    7. Warning Signs
      1. Late Payments
      2. Loss of Profits
      3. Late Financial Reports
      4. Poorly Prepared Financial Reports
      5. Large Changes in Balance Sheet Items
      6. Unavailable Entrepreneur
      7. Large Thefts
      8. Major Adjustments in Figures
      9. Significant Changes in Management
      10. Major Changes in Sales and Order Backlogs
      11. Inventory Changes
      12. Lack of Planning
      13. Changes in Accounting Methods
      14. Loss of a Major Customer, Supplier, or Lender
      15. Labor Problems
      16. Changes in Prices and Market Share
      17. External Warning Signs
      18. Technical Change
      19. General Industry Decline
      20. Government Changes
      21. Ratio Analysis as a Warning Indicator
      22. Our Personal Favorites of Early Warning Signals
    8. Why Entrepreneurs Have Financial Problems
      1. The Financial Control Problem
      2. The Undercapitalization Problem
    9. Why Entrepreneurs Have People Problems
      1. Poor Job Definition
      2. Poor Selection Process
      3. Poor Incentives to Management
      4. Poor Review Program
      5. Poor Development Program
    10. What to Do with Problems
      1. What Is Your Next Step?
        1. 1. Fix the Problem
        2. 2. Sell the Business
        3. 3. Foreclose on Assets
        4. 4. Bankruptcy
        5. 5. Liquidation
    11. Secret of a Successful Relationship
    12. Degree of Involvement by the Venture Capitalist
      1. Amount Invested
      2. Need for Assistance
      3. Management’s Willingness to Accept Advice
      4. Experience in Certain Areas
      5. Lead Investor
      6. Distress of Company
      7. Relationship with the Entrepreneur
      8. Time Availability
      9. Tips on Monitoring
        1. 1. Set the Tone on the Way In
        2. 2. Understand the Business and the Products
        3. 3. Keep Up with the Industry and the Competition
        4. 4. Subscribe to Industry Magazines
        5. 5. Know the People in the Business
        6. 6. Spend Time with the CEO
        7. 7. Track Performers
      10. Pitfalls of Monitoring
        1. 1. Appear Only When There Is Trouble
        2. 2. React to Problems
        3. 3. Second-Guess Management
        4. 4. Pain Factor
    13. Venture Capitalist Objectives
  15. 11. The Exit
    1. Exit One: Going Public
      1. When to Go Public
      2. Underwriter’s Fees in the Public Offering
      3. Selection of a Brokerage House for a Public Offering
    2. Exit Two: Sale to a Strategic or Financial Buyer
      1. Selling the Stock in the Company for Cash
      2. Selling Stocks for Notes
      3. Selling Stock for Stock
      4. Selling Assets for Cash
      5. Selling Assets for Notes
      6. Selling Assets for Stock
      7. Other Forms of Payment
    3. Exit Three: Sale Back to the Company
      1. Purchase by Employee Stock Ownership Trust
      2. Exit by Puts and Calls
    4. Exit Four: Sale to Another Investor
      1. Corporate Partner
      2. New Venture Capital Partner
    5. Exit Five: Reorganizing the Company
    6. Exit Six: Liquidation
    7. When You Are in a Workout
      1. Quick Study
      2. The Business Plan
      3. Turnaround Experts
      4. Liquidation Analysis
    8. Save Your Investment
  16. 12. Finding Good Investments
    1. Developing an Investment objective
      1. Purpose of Investing
      2. The Type of Money You Have to Invest
      3. Stage of Development
      4. Specialty Investing
      5. Timing of Your Investment Exit
      6. Size of Your Investment
      7. Geographic Preference
      8. Liquidity Preference
      9. Risk Profile
      10. Activity Level
      11. Timing of Return
    2. Originating Investment Opportunities
      1. Banks
      2. Accountants
      3. Attorneys
      4. Investment Bankers/Stockbrokers
      5. Business Brokers/Financial Brokers
      6. Consultants
      7. Conventions
      8. Economic Development Organizations
      9. Industrial and Professional Trade Organizations
      10. Local Chambers of Commerce
      11. Friends and Associates
      12. Venture Capital Companies and LBO Funds
      13. Cold Calls
      14. Advertising and Direct Mail
      15. Suppliers
      16. Other Groups
    3. Proactivity
    4. Handling Investment Opportunities
    5. Using Brokers
      1. Qualities to Look for in a Broker
        1. Experience
        2. Professional
        3. Credentials
        4. Special Knowledge
      2. Agreement with Brokers
        1. Definition of the Service
        2. Time Frame
        3. Termination Clause
        4. Amount of the Fee
        5. Reports on Progress
        6. Ownership of Work Completed
        7. Nondisclosure Clause
        8. Indemnification
        9. Complete Agreement
      3. Some Tips on Dealing with Brokers
    6. Final Word
  17. A. Questions Used in Venture Capital Investigations
    1. I.. Management Area
      1. Basic Information You Need to Collect
    2. II.. Personnel Area
      1. Basic Information
    3. III.. Marketing Area
      1. Marketing People
      2. Products
      3. Customer Description
      4. Customer Service (C/S)
      5. Competitive Analysis
      6. Industry Analysis
      7. Marketing Strategy
      8. Distribution of the Product
      9. Basic Information
    4. IV.. Production Area
      1. Production Process
      2. Purchasing, Suppliers, Shipping, and Receiving
      3. Basic Information
    5. V.. Research and Development
      1. Basic Information
    6. VI.. Financial Area
      1. Basic Information
      2. Analysis of Financial Operations
      3. Financial Statement Analysis
      4. Other Assets and Liabilities
      5. Taxes
      6. Other Sections
      7. Analysis of Projections
      8. Basic Information
    7. VII.. Reference Area
  18. B. Actual Documents
    1. What Do Actual Commitment Letters and Legal Documents Look Like?
    2. Commitment Letter
    3. Legal Document 1
      1. Loan Agreement
      2. I.. Parties
      3. II.. Loan
      4. III.. Use of Proceeds
      5. IV.. Collateral
      6. V.. Representations and Warranties
      7. VI.. Affirmative Covenants
      8. VII.. Negative Covenants
      9. VIII.. Investment Covenant
      10. IX.. Fees, Expenses, and Indemnification
      11. X.. Unlocking
      12. XI.. “Put” Rights
      13. XII.. Default
      14. XIII.. Notice
      15. XIV.. Entire Agreement
      16. XV.. Controlling Law
      17. XVI.. Headings
    4. Legal Document 2
      1. Promissory Note
      2. Interest
      3. Payments
      4. Maturity
      5. Prepayment
      6. Default and Acceleration
      7. Definitions
      8. Seal
    5. Legal Document 3
      1. Stock Purchase Warrants
    6. Legal Document 4
      1. Stock Purchase Agreement
    7. Legal Document 5
      1. Schedule A: Exhibits to Stock Purchase Agreement
  19. C. List of Traits for Analysis of People
  20. D. Evaluation of an Entrepreneur by an Industrial Psychologist
    1. Summary and Recommendation
      1. Ego-drive
      2. Empathy
      3. Growth
      4. Leadership
      5. Decision Making
      6. Delegation
      7. Detail Ability