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Navigating the Hurdles: Challenges in Securing Venture Capital for a Start-up Company

Venture capital (VC) is a critical lifeline for many start-up companies, providing the necessary funding to fuel growth, innovation, and market penetration. However, securing venture capital is no easy task and in many ways having a Capital Partner or a Lead Investor to help syndicate and secure co-investors is an important step to success. VC Fundraising requires meticulous planning, a compelling business proposition, and the ability to overcome various challenges along the way. In this blog post, we’ll explore the key hurdles start-up companies often face when seeking venture capital and discuss strategies to increase their chances of success.

  1. Competitive Landscape:
    The start-up ecosystem is highly competitive, with numerous entrepreneurs vying for limited venture capital funding. Investors receive countless pitches, making it crucial for start-ups to stand out from the crowd. A unique value proposition, a well-defined target market, and a compelling story are essential to capture investors’ attention and differentiate themselves from competitors.
  2. Early-stage Risks:
    Start-ups at the early stages face inherent risks that can deter venture capitalists. These risks include unproven business models, lack of market traction, and uncertain revenue streams. Investors seek a balance between risk and reward, so start-ups need to demonstrate a clear vision, a thorough understanding of their market, and a robust strategy to mitigate risks effectively.
  3. Market Size and Scalability:
    Investors are often interested in start-ups that have the potential for significant growth and scalability. They want to invest in companies that can disrupt industries, capture a sizable market share, and deliver substantial returns on their investment. Start-ups must articulate a compelling growth plan backed by credible market research, demonstrating a large and expanding target market.
  4. Team and Execution:
    The strength and experience of the founding team play a vital role in securing venture capital. VC Investors assess the capabilities of the team to execute the business plan, navigate challenges, and adapt to market dynamics. Start-ups should highlight the expertise, track record, and complementary skills of their team members to instill confidence in potential investors.
  5. Financial Projections and Metrics:
    Accurate financial projections and metrics are crucial for attracting venture capital. Start-ups must demonstrate a deep understanding of their business’s financials, including revenue projections, cost structures, and profitability forecasts. Realistic financial models, supported by market data and conservative assumptions, can enhance credibility and showcase the start-up’s growth potential.
  6. Due Diligence and Validation:
    Venture capitalists conduct thorough due diligence before committing capital. Start-ups need to anticipate this process and be prepared to provide detailed documentation, such as legal contracts, intellectual property rights, market analysis, and competitive landscape assessments. Solidifying partnerships, securing initial customers, and obtaining validation from reputable industry experts can significantly bolster a start-up’s credibility during this stage.
  7. Timing and Persistence:
    Timing plays a critical role in securing venture capital. Start-ups need to align their funding needs with the market conditions and investor interests. It is important to note that fundraising can be a time-consuming process, often requiring multiple rounds of pitching, negotiations, and revisions. Persistence is key; even if a start-up faces initial rejections, learning from feedback and adapting the pitch can improve the chances of success.

Conclusion:
Securing venture capital is a significant challenge for start-up companies. By understanding the hurdles they face and proactively addressing them, entrepreneurs can increase their likelihood of securing funding. A compelling value proposition, a strong founding team, a scalable business model, meticulous financial planning, and persistence are key elements that can help start-ups navigate the path to successful fundraising. While the road to securing venture capital may be challenging, the rewards can be transformative, enabling start-ups to accelerate growth and bring their innovative ideas to fruition.

The Challenges Faced by Emerging Managers in the Private Equity Industry

VCengine

VCengine

April 6, 2023

Private Equity Investors Focused on Established Managers, Leaving Emerging Managers Struggling for Financing

The Challenges of Emerging Managers in the Private Equity Industry

Emerging managers in the private equity industry, defined as companies that manage less than $200 million in assets under management (AUM), are facing challenges in obtaining financing. Investors are now more cautious and prefer to invest in established managers under difficult fundraising circumstances. This trend is disadvantageous for new managers who usually lack an established reputation, track record, and industry connections.

As per a recent survey by Silicon Valley Bank, 83% of limited partners expressed interest in developing new relationships with managers, while only 16% were focused on investing exclusively with well-established managers. Despite this trend, emerging managers are facing significant challenges in raising funds due to their lack of industry connections and brand recognition.

Limited partners have shifted their capital allocation towards the top 35 funds in the US private equity market. These funds achieved excellent results and outperformed their peers, attracting 75% of all investments made by limited partners. This shift in capital allocation has made it increasingly challenging for new managers to raise funds because they lack a proven history of success.

However, investors are still dedicated to including private equity as a foundational asset class in their investment portfolios. Private equity produced a 54% return on investment in 2021, which was superior by 12% compared to returns generated in the public stock markets. The latest annual performance report for private equity from investment adviser and manager Cliffwater has been released, and preliminary data indicates that there may be a decline in this asset class by 2023. Nonetheless, unless private equity firms cease operating, this trend is likely to continue.

Emerging managers are still essential for limited partners as they provide diversification and specialize in various industries, which lead to higher returns. Investors recognize the importance of investing in new groups and accept the risks associated with it. Limited partners need to balance the desire for returns with the reality of a challenging fundraising and investment environment.

Despite the difficulties that emerging managers face, limited partners are still dedicated to linking these emerging managers with appropriate funders. In 2023, Calpers announced plans to commit $1 billion to diverse emerging private equity managers as a part of a comprehensive program aimed at aiding early-stage investors.

Investing in smaller managers may pose some difficulties in the near future, but investors are still devoted to private equity and seek out opportunities to invest with up-and-coming managers. Overall, private equity remains essential to the investment strategy of these investors aiming to build a portfolio that performs well over an extended period. Emerging managers still have a chance to thrive, and they remain an important strategy for creating a successful portfolio over a long period of time.

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Corey Singleton, Lead Director North America Email: corey@vcengine.com

Why you should stop avoiding conflict in the workplace

When organizations avoid conflict, they’re missing out on productivity and innovation.

I was recently hired to help a group of doctors work through their issues and get their business back on a growth trajectory. They aren’t talking much. They’re barely making eye contact. After only a few hours, it’s clear to me what’s wrong. I share my diagnosis: “You need more conflict.”

Mad frustrated multiethnic employees sit at office meeting dispute quarrel have stressful job situation, angry diverse colleagues debate fight over paperwork financial statistics, work stress concept

It’s the last thing they expect me to say. They’re already in agony dealing with the smallest decisions. Each meeting is an excruciating cocktail of trepidation, anger, guilt, and frustration. How could they possibly need more conflict?

What they don’t realize is that they’re mired in all those negative emotions because they’re unwilling to work through them. As long as they avoid the topics that are creating anger, guilt, and frustration, they’re stuck with them. There are many topics that they haven’t discussed for years. They’ve tried every way to go around the contentious issues, but now they need to go through them.

THE IMPORTANCE OF CONFLICT

The doctors are not the only ones who avoid conflict. Most of us have been raised to think of conflict as a bad thing. Conventional wisdom holds that conflict is bad for productivity and corrosive to trust and engagement. But that view is totally at odds with how an organization works.

Conflict isn’t bad for organizations: it’s fundamental to them. After all, you need to be able to work through opposing sides of an issue and come to a resolution in the best interest of managers, shareholders, and customers–whether you’re on the shop floor or the boardroom. Conflict is part of strategic planning, resource allocation, product design, talent management, and just about everything else that should happen in an organization.

Unfortunately, most humans don’t embrace conflicts. Rather, we avoid, postpone, evade, duck, dodge, and defer them. The result is conflict debt.

CONFLICT DEBT

Conflict debt is the sum of all the contentious issues that we need to address to move forward, but remain undiscussed and unresolved. It can be as simple as withholding the feedback that would allow your colleague to do a better job, and as profound as continually deferring a strategic decision while getting further and further behind the competition.

The doctors I worked with are in conflict debt. Each time they avoid the discussions, debates, and disagreements that they need to have to get their business growing again, they sink further in. Think of it like financial debt–when you use credit to buy things you otherwise can’t afford. You want something, maybe even need it, but you don’t have the cash at the time, so you use credit. You rationalize to yourself that you will pay it off as soon as you get your next paycheck, but if you’re like 65% of American credit card holders, you carry that balance over from month to month. The debt mounts, and over time, it gets harder and harder to get out from under it.

THREE UNPRODUCTIVE WAYS PEOPLE DEAL WITH CONFLICT DEBT

As with financial debt, conflict debt starts innocently. An issue comes up that’s a little too hot to handle, so you defer it. You promise yourself that you’ll revisit it when things are less busy, or when cooler heads prevail. You buy yourself time and space. But days pass, and no spontaneous resolution materializes. Instead, the issue becomes more contentious. Suddenly, you’re in conflict debt. You’re feeling anxious, and you find yourself steering clear of your colleagues to avoid having to confront the issue. (Have you ever taken the long way around the office so you don’t run into a disgruntled coworker?) You’re feeling frustrated at the lack of progress, not to mention a little guilty for your role in the stalemate. Conflict debt weighs you down.

Avoiding the issue is only one path to conflict debt. Another is to avoid the opposition. In this case, you broach the topic but exclude people who might disagree or cause tension, surrounding yourself with those who agree with you. You focus on how friendly and productive the discussion is, deluding yourself that your solutions are going to fly with the people who you strategically disinvited. But pretending the opposition isn’t there won’t make it disappear. It will resurface when your opponents kill your plan or, worse, leave it to fail.

There’s a third way to get into conflict debt–avoid the friction. Even if you discuss the difficult subject, there’s still room to get yourself into trouble if you veer safely away from the distressing parts of the discussion. When you make it clear (either intentionally or inadvertently) that nothing antagonistic should taint your conversation, you start to rack up conflict debt. I see this all the time when, just as the discussion gets perilously close to the crux of the matter, someone suggests they “take it offline” to avoid having to deal with the conflict. Everyone smiles and pretends that they’ll actually come back to it at some point–when in reality, they’ve just stifled dissent.

Are you avoiding the conflicts that your organization requires you to work through? If so, you are setting your organization, your team, and yourself up for trouble. When you’re unwilling to work through uncomfortable situations, you stretching your resources thin, stifling innovation, and allowing risks to go unnoticed. On your team, the aversion to prickly conversations forces strong performers to compensate for weak ones and mature people to put up with immature ones. At an individual level, you’re probably burning out from the stress.

When your conflict debt gets too high, it becomes overwhelming. You’re exhausted by the thought of trying to pay it off. You’ve destroyed your credit rating with your boss and your coworkers by letting these issues go unresolved for so long. But don’t give up–there are many things you can do to get out from under your conflict debt. That starts with embracing, and not avoiding, conflict in the first place.

This article is adapted from The Good Fight: Use Productive Conflict to Get Your Team and Organization Based on Track.

8 Rituals of the World’s Best Boards

Reid Hoffman
Entrepreneur, Investor & Strategist

Reid Garrett Hoffman is an American internet entrepreneur, venture capitalist, podcaster, and author. Hoffman was the co-founder and executive chairman of LinkedIn, the business-oriented social network used primarily for professional networking.


Reid recently posted on twitter:

1. Be inclusive.
Many board meetings are dominated by one or two board members.
The best boards seek out the opinions of everyone in the room, not just the loudest.


2. Fundraise proactively. 
Most boards reactively raise money when the company runs out of cash.
The best boards proactively plan for fundraising opportunities like market shifts and inbound offers.

3. Advise, don’t pilot.
The worst boards can break a company by dictating priorities.
The best boards take a hippocratic oath of “do no harm”. They aren’t pilots. They’re front-seat advisors.

4. Hire for cofounder mindsets.
The best boards understand this secret to hiring great executives.
People with a cofounder mindset are willing to take risks when success isn’t guaranteed.

5. Invest in relationships.
Hollywood idolizes board meetings as the place where crucial decisions are made.
The truth is the best ideas, collaboration, and feedback happen outside the boardroom in informal 1:1 meetings.

6. Tap into individual superpowers.
Everyone has a superpower — a unique combination of skills, experiences, strengths, and networks.
The best boards leverage the superpowers of individual board members, to help the company navigate threats and unlock opportunities.

7. Send personal emails.
How would you feel if you got a personal email from someone on the board of your favorite company?
The best boards send personal emails to help the company sell, hire, and raise money.

8. Think big. 
The best boards are the CEO’s biggest cheerleader. They inspire the company to stretch the limits of what’s possible.
Airbnb famously did this by designing an 11-star experience for guests.

PRIVATE EQUITY: A DEEP DIVE INTO SUBSCRIPTION LINES

By Erick Podwill 

Distorting Private Equity Performance: The Rise of Fund Debt – Institute  for Private Capital

Private equity managers have increasingly been utilizing subscription lines of credit to manage capital calls from limited partners. This results in a delay of capital called from investors, which increases the fund’s internal rate of return (IRR) while lowering the multiple of invested capital (MOIC) due to interest paid on the credit line. This post seeks to explain the mechanics and impact of subscription lines as well as some of the merits and considerations of their utilization.

What is a Subscription Line?

Subscription lines are loans taken out by private equity funds that must be repaid over a defined period of time. These lines are backed by limited partners’ committed capital to the fund and generally have an interest rate of between 3% and 6% depending on the size of the line, time of repayment, and the limited partners invested in the fund.

Subscription lines are not a new phenomenon in private equity; in fact, their utilization dates back decades. At the start and for many years after, they allowed managers to make life easier for both themselves and limited partners by borrowing to fund bridge financings and then immediately calling the capital from limited partners, thus repaying the line in 30 days or less.

As time has gone by and in part driven by a low interest rate environment, the prevalence of subscription lines, their size, and the time to repay them has been increasing rapidly. Private equity funds now regularly utilize a facility that represents a significant percentage of limited partner commitments and are only required to repay them every 90, 180, or even 360 days — and the terms are only getting more aggressive over time.

Impact of a Subscription Line

The following example shows a performance comparison between two funds that invested $1 million over an investment period of just over three years. Both funds make the exact same investments at the same time, but Fund A calls capital whenever investments are made or fees/expenses are incurred, while Fund B has a subscription line that is paid off every six months.

IRR is the main measurement of performance for private equity funds, which is based on inflows to and outflows from the investor, as well as the time period in which these inflows and outflows occurred. As shown by the comparison in exhibit A, the impact on the IRR is substantial after three years with a spread of 470 bps, or 4.7%. Please note that negative numbers indicate contributions while positive numbers indicate distributions and valuations.

Credit Line Exhibit A

Exhibit A. 

Exhibit B shows the performance of both funds after seven years of distributions. For simplicity’s sake, in this hypothetical example, capital is distributed once per year

Credit Line Exhibit B

Exhibit B.

The utilization of a credit line for capital calls early in the fund’s life still had a small impact 10 years later when the fund was fully liquidated. This example does not account for the interest paid on the line of credit, which would bring the terminal performance even closer together. In conclusion, while subscription lines have a meaningful impact on net IRR in the early stages of a fund, the disparity is dampened substantially in the long run.

What are Some of the Positives of Subscription Lines?

1. Less frequent and more predictable cash flows

Some private equity strategies, such as fund-of-funds or secondaries funds, involve making commitments to a large number of underlying funds. As a result, the funds will have frequent capital call obligations, as often as multiple times per week. A subscription line enables these funds to instantly pay their capital calls using the line, then call capital from their limited partners on a predictable basis, generally quarterly or semi-annually.

2. Ability for managers to act quickly on opportunities

At times, funds will come across an opportunity that must be executed quickly. In general, capital calls issued to limited partners require payment within 14 days, so it would therefore be possible that an opportunity is missed due to this constraint. By utilizing a line of credit, the fund can make the investment immediately and call the capital at a later date.

3. J-curve mitigation

The j-curve refers to the performance timeline of private equity funds. Early in a fund’s life, capital is called for investments as well as fees and expenses while the portfolio companies have not yet had the time required to appreciate. As a result, the general trend of performance is as illustrated below:

Hypothetical J-Curve

Exhibit C.

The deferment of early capital calls and stronger early performance mitigates the impact of the j-curve and decreases the amount of time required for a fund to generate positive returns.

Considerations of Subscription Lines

1. Impact on carried interest

The higher early IRR from utilizing a credit line can enable a fund to eclipse its preferred return, most commonly 8%, at an earlier stage of its life. This is most impactful for funds that have a deal-by-deal carry structure, meaning that carry is paid on the performance of each deal rather than the overall fund. Canterbury notes that the overall amount of carried interest paid is not impacted substantially by the use of a credit line as full-term performance remains similar and the multiple actually decreases slightly.

2. Higher overall expenses

While the borrowing rate has been lower than historical averages in recent years, interest still must be paid on the borrowed capital from the credit line. This results in a lower multiple of invested capital for funds with subscription lines, as there are no additional profits in dollar terms to offset this interest.

3. Potential UBTI Generation

Unrelated Business Taxable Income (UBTI) can be incurred through the use of a credit line. This is particularly meaningful to tax-exempt investors who are required to pay taxes on UBTI, which is inclusive of income derived from assets subject to “acquisition indebtedness.” While firms have the ability to mitigate this through the use of blocker structures or other means, the likelihood of UBTI generation remains higher with the utilization of a subscription line.

Takeaways

  • Private equity firms are almost required to use long-term subscription lines to stay competitive with peers from a benchmarking perspective. It is important to take into consideration the terms of a manager’s credit line when benchmarking past fund performance, specifically the most recent fund which is generally between two and four years old at the time of fundraising.
  • Subscription lines currently appear to be relatively neutral to limited partners, as the interest expense on the lines is comparable to cash management benefits and j-curve mitigation. However, as discussed above, an increase in interest rates would result in higher expenses for limited partners and at some point, the tradeoff will become undesirable.
  • Subscription lines would be a negative to investors that are holding their undrawn commitment in cash as there would be no benefit to the delayed capital calls. For investors that have the undrawn commitment allocated to highly liquid investments, the return made could potentially outweigh the interest expense.
  • The utilization of a subscription line with consistent paydowns enables limited partners to better plan for capital calls as they are more predictable. The predictability allows investors to invest this capital intelligently in the interim to make a return.

This article was written by Erick Podwill, Senior Associate, Investment Research. As a member of Canterbury’s Research Group, Mr. Podwill is responsible for sourcing, evaluating, and monitoring private capital managers. He serves as vice chair of Canterbury’s Private Equity Manager Research Committee, and sits on the Capital Markets and Fixed Income Committees. Prior to joining Canterbury, Mr. Podwill was an associate at TorreyCove Capital Partners, LLC, where he performed due diligence on private capital managers, with an emphasis on the areas of growth equity and venture capital. Mr. Podwill double majored in finance and business administration at the University of San Diego, where he received a Bachelor of Business Administration.

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