Venture capital law deals with the rules and restrictions regarding venture capital. This is money provided to a new startup company that has a high potential for growth after the round of early growth funding, which is also called seed funding. Venture capital can also refer to funds given to new or existing firms that already demonstrate above-average growth rates, have a need for additional financing for business expansion or maintenance and exhibit a strong potential for market expansion.

Venture capital law is made up of different M&A and financing transactions, including public and private mergers. It also includes strategic partner transactions like OEM and VAR arrangements, acquisitions, and a number of non-venture capital financing transactions that involve public and private sale of equity and debt securities.

Dodd-Frank Wall Street Reform and Consumer Protection Act

12 U.S.C. Section 5301 et seq. discusses the Dodd-Frank Wall Street Reform and Consumer Protection Act that was passed in 2010. The Act introduced several new legal requirements for fund managers, investment banks, and other people in the financial industry. The Volcker Rule is a provision of the Dodd-Frank Act, and it prohibits financial institutions from using their own money — including funds on deposit from their customers — for certain investments. One of these prohibitions is private equity. This means a bank can't generally serve as a venture capital firm.

Venture Capital Proposal Basics

To improve the chances that a proposal will be taken seriously by venture capital organizations, the entrepreneur needs to provide several basic elements:

  • Statement of objectives and purpose
  • Outline of the requested financing arrangements — how much money the small business is asking for, how will the funds be used, and the proposed structure of the financing
  • Marketing plans including the market characteristics and competition; include information on attracting and retaining market share
  • Biographies on main players in the business
  • Contact information for primary customers and suppliers
  • Company history, including services and products, financial milestones and relationships, and employment practices
  • Outline of the proposal's advantages and notes of any potential problems that are anticipated
  • Financial statements from the previous years and Pro-forma projections for the upcoming three to five years

A venture capital firm will prepare its own proposal if, after considerable analysis, it decides to invest in the small business. The proposal from the venture capital firm will include details regarding the amount of money it plans to provide, how much stock the small business is expected to exchange, and what the required protective covenants are.

This proposal will then be presented to the small business' management team, and both sides will negotiate a final deal. The main parts of the negotiation will include:

  • Ownership
  • Control
  • Valuation
  • Annual charges
  • Final objectives

How Venture Capital Works

Those people who invest in a new or growing business typically are wealthy individuals, investment funds, or financial bank subsidiaries, and are called venture capitalists. Because of the risk involved, these people typically get significant control over business decisions and maintain a large ownership percentage in the company.

There is no way a business can guarantee it will obtain venture capital financing, but careful planning and preparation can improve its chances that a venture capital organization will at least consider the proposal. It's recommended to start planning at least a year before the business wants to seek financing.

Entrepreneurs need to do ample market research and figure out what the need is for its new product or business concept. If applicable, they should establish trade secret or patent protection and steps to form a business centered around the concept or product. They can enlist the help of other professionals like accountants, financial advisors, attorneys, and more.

Potential Disadvantages of Venture Capital

There are several potential disadvantages to consider with venture capital. These include possible loss of control over the business and potentially high costs over the long run. Venture capital can be considered a risky investment because it's hard to determine the potential earnings of a new business idea or a company that is extremely young, and these investments can be unprotected against the business failing.

Venture capital firms have strict requirements regarding the types of proposals they will consider. Some only specialize in certain industries, geographic areas, or technologies, and others may require a specific investment size. Most venture capital firms will require their clients to have proof of operating history, while a select group of others will handle startup financing for entrepreneurs who have a well-thought-out plan, an innovative product or service, and an experienced management team in place.

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