Business investments are at an all-time low: could Venture capitalists be the answer?

Tom Biggs, Associate at Wellers, discusses why business investments are at a record low and how owner-managers can raise finance through Venture Capitalist. 

Investing is a game of risk. It doesn’t matter the state of the market, there is always an element of uncertainty. Nothing is ever a sure thing. So, the question becomes, how big of a risk is the investment and is the bank willing to commit?

The UK economy is currently in a state of flux. Kwasi Kwarteng’s mini budget sent the markets spiralling, and they are yet to fully recover despite various measures by the Chancellor, Jeremy Hunt. There are talks of an impending recession, although the figures look quietly optimistic following unexpected economic at the end of 2022. Ongoing strike action across sectors is also predicted to influence the economy. 

When an economy is deemed unstable, the risk of investing in a business is potentially greater. There is more at stake as things are considered more likely to go wrong. This all culminates in less investment being made. Whilst there is an argument for continued investment during times of economic uncertainty as a means to leapfrog the competition, itcan be difficult to get a bank manager on side. 

Businesses, however, need investment to grow, expand, and thrive. Owner managers cannot afford to sit back and wait for the market to recover. Who knows how long that will take? One answer to this conundrum could lie with venture capitalist finance. 

What is a Venture Capitalist? 

Venture Capitalists set themselves apart from traditional banks because not only can they provide finance in exchange for an equity stake in the business, but they also provide knowledge and experience to help businesses through their next phase of growth, andexpansion. 

Venture Capitalists are also more comfortable with the additional risk of investing during economic fluctuation because they are well-versed in working with high-risk enterprises. Their aim is to achieve a significant return on investment. 

How does a Venture Capitalist firm work? 

Venture Capitalist firms typically consist of General partners and Limited partners. 

General partners are essentially the people on the ground. They are members and managers that take active roles in the investment business, therefore bearing the liabilities. These are the people that identify businesses they think would make good investments and negotiate the terms with business owners. 

Limited partners refer to the people and organisations that contribute money to the capital for the general partners to commit to investments. 

Venture Capitalist funds make money by the ‘carry’ (carried interest) and management fees. Shares of profits from investments will be distributed to partners (the ‘carry’) with 80 percent going to Limited partners and 20 percent to General partners, in a typical scenario.

Management fees are also charged, typically at 2-3 percent per year. Plus, arrangement fees of 2 percent usually apply. 

What’s in it for businesses? 

Funding from Venture Capitalists can:

• Boost working capital

• Fund investment in fixed assets such as equipment and machinery 

• Fund the development of sales and marketing functions

• Improve back office infrastructure 

However, Venture Capitalist funding is not usually long-term. Typically, arrangements will last no longer than 10 years as it is hoped that by that point the business would’ve grown to a certain size. Typically, after this duration, the Venture Capitalist firm will look to exit. This could take the form of: 

• The SMEs management team buys out the Venture Capitalist firm 

• A stock market flotation 

• A sale to other investors

• Liquidation (as a worst-case scenario)

How to get a Venture Capitalist 

Unlike banks that get bogged down in the numbers and rarely get to know the face behind the organisation, Venture Capitalists are all about people. Obviously, they are looking for a financial investment that has the potential to make them a lot of money too. They get excited by entrepreneurs. They have a vested interest in the business’s success and are looking for teams they can work closely with to nurture and see them flourish. 

To prepare a business for Venture Capitalist investment, ensure your accountant is part of the process. They will help you prepare and understand the numbers when it comes to negotiating. 

Visit the Wellers website to find out more.