Venture Capital Investment: Worth the Risk? Long Term Benefits Can Tip the Scales in Favor of This Type of Financing
Hofman, Clement L., American Banker
Venture capital investments represent the financial grist for the development of new technologies in American industries. Through venture capital subsidiaries, banking organizations are capable of providing the financial catalyst for those fast-growing "new generation" companies.
Venture capital activity can achieve two significant objectives that are critical to preparing banking organizations for operating in a deregulated environment.
A venture capital subsidiary can be a substantial source of other operating income for its banking parent, alleviating some of the impact deregulation of interest rates has had on a bank's net interest income. Income from the sale of securities resulting from venture capital investments is typically taxed at the long-term capital gains rate.
A venture capital arm also can serve as a marketing tool for growing banks. As such, it is capable of projecting a progressive image for a bank holding company to small- and medium-sized companies that are experiencing an expansion or high-growth phase. Venture capitalists traditionally take a position on the ground floor of new companies, and as those firms mature, venture capital investors may refer the firm to a bank for traditional financing.
Venture capital is one of the fastest growing sources for investment funds in the nation. In 1976, an estimated $65 million of new capital was invested in venture capital funds. By the end of 1983, that amount had increased to over $3 billion. Once an elite and little-known group of investment funds managers, venture capitalists today are competing for opportunities to provide ground-floor equity financing for small businesses that plan to become substantial concerns in a relatively short period of time. Bridging the Gap
But banking organizations considering plunging into the venture capital field should not treat this relatively new business activity lightly. Venture capital is a risk-taking business and runs contrary to the traditional role of banking organizations, which are credit-oriented. Therefore, a successful venture capital subsidiary must be able to bridge the historical gap between credit and equity investment philosophies. The bank that decides that it will become a player in the venture capital industry must find a fund manager who has experience and an orientation toward equity investments.
While venture capital generally involves a higher degree of risk than the credit buinsess, that risk can be offset by the opportunity to provide business assistance to the companies that are recipients of venture capital funds. In many respects, the managers of a venture capital fund serve as management consultants who have a vested interest in a company's health and its prognosis for growth.
Venture capital investments are equity investments, and in some respects criteria for investment may be compared to stock market investments in mature, publicly traded firms. The most important component when considering a venture capital investment is the quality and depth of the management of a company. In many cases, there are seemingly, contradictory qualities which, ideally, should exist.
On one hand, the chief executive officer, if not the entire management team of a firm being considered for investment, should have total confidence that the company's products will succeed. That confidence should almost border on being an ego problem. On the other hand, management should have an analytical, non-emotional approach toward problem-solving. …