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Developing A Newfund: Part Art, Part Science

Adding Value through Experience and Expertise

All successful venture capital managers have one common trait: They add value to the funds ihey manage. Although lfs possible to stumble into the next Google or Microsoft, most investments need the critical evaluation and support that an experienced manager can bnng. These experienced fund managers have a history of success and failure and have learned from mistakes. The fund itself should have a specific focus, which enables the management team to be specialists in a particular field. This allows the venture capital manager to add value to the fund by cross-pollinating the portfolio or exploiting synergies across investments. Furthermore, it ensures that the manager has a firm grasp on market conditions and can better determine if a company has what it takes to be successful in that particular industry. It is also helpful in nurturing that company through its expansion phase, further allowing the fund manager to add value to its investment and increasing the chances that the fund shows favorable returns.

Finding Your Focus

Imagine the world in five years. Which markets will be hot, and which of today's markets might fade away? Are there disruptive technologies or demographics that might influence particular sectors or geographies?

Successful venture capital firms develop strategies around opportunities that may or may not yet exist. They look t> take advantage of changing market conditions, and most find real success by not following the herd. We saw many unqualified companies making foolish investments in the Internet sector in the late 1990s because they were following the examples of other venture capital investors. In deciding on the focus of the fund, you must develop a business plan, think about the opportunities available, assess the competition, and be nimble with the changing markets.

Learning from the Past

In order to continuously develop successful strategy, venture capital managers must be historians as well as forward-thin king investors. The personal strengths and experiences of individual venture capital managers will shape that team's investment strategy. Often, this leads a venture capital firm to specialize in a particular area of business or sector of investment. For instance, our firm has a depth of expenence investing in the global media sector. Thanks to a long history of many good (and even a few poor) media investments, we have gained a deep understanding of our niche that only years of expenence can bnng.

Potential investors often look for continuity of management and a history of success within a company. Therefore, venture capital managers who maintain the same successful strategy with the same team may have a more profitable fundraismg expenence. Although some qualities of the fund, such as size or geographic targets, may change for practical purposes, the focus of the fund should not be drastically modified.

Ensuring Successful Investment

When considenng a company for investment, the venture capital firm must find a target that closely fits its investment requirements and hurdles. Close examination of the management team will reveal important details about the past and potential future success of the company. In general, we look for a seasoned team who knows each other well and is led by a senal entrepreneur, someone who builds and sells businesses for a living. Further, our firm's strategy is to invest in companies that have moved from the creative stage into the production stage. We find that companies fitting these qualifications typically can best use our money and resources to maximize their value.

Abundant Opportunity

Although we actively search for investment opportunities, our expertise draws deals to us. Sometimes, companies bring funding requests directly to us. We also attend trade shows, execute marketing and public relations campaigns, and use the financial community to source our deal flow. We may consider 700 deals in an average year and invest in less than ten.

Facing Investment Challenges

Sometimes, an investment does not go as hoped. One of the most crucial decisions a venture capital manager makes is whether to reinvest in a business that has come upon difficult times. Chances are the business has not yet lived up to expectations and is burning through its capital. The job of the fund manager is to assess whether the management team will still be able to turn the business around and whether a capital infusion will actually help the investment eventually see a realization.

If the decision is made to reinvest, the money may be invested differently from the initial investment. If we invested equity the first time, we might offer some form of debt, such as a line of credit, the second time. This change allows the money source to be cut off at any point. This flexibility cushions the danger of reinvesting in a nsky business.

Target Return Goals

Our firm's return principle is to avoid investments that may decrease our historic rate of return. In order to evaluate potential return on investment, we use a dynamic two-person investment analysis team. This team scrutinizes the management, the market, the competition, the product or service, and the exit potential. Active due diligence assures the investment team that a deal will be beneficial to the fund.

Several red flag situations may curb our interest in the deal. If we begin to doubt the management team, we will not risk investing in a potentially damaging situation. If we don't think we will generate at lease three times return, it is not worth our investment. Our target return goals can certainly make or break deals.

Raising a Venture Capital Fund



The A. rt and Science of Raising a Fund

The process of developing a new fund is both an art and a science. While specific steps must be taken in the findraismg process, there is no set strategy for determining what the new fund should look like. The success or failure and make-up of the previous fund can determine the course of action.

When developing the fund, we first create an executive summary outlining the management team, the strategy, the market, and the preliminary terms of the fund. After this step, we speak to known investors, including limited partners in our current funds, about their interest in our new proposal. Based on their responses, we may fine-tune parts of the offering, such as the size or ambition of the fund, to maximize its attractiveness to potential investors.

After testing he fund's interest, we identify cornerstone investors, ideally past investors or other very large and prestigious investors. After securing these anchor investors, we seek investors in the broader marketplace and hope to complete the entire fundraising process in less than a year.

Investor Profile

Since most large investors don't want to take anymore than 10 percent of a particular fund, we must secure a bare minimum of ten investors. The smaller the group of investors, the easier it is to manage. Our ideal investors are past investors, as they already know our business and need only to be sold on the experience of the management team and the details of the market.

Capital Timeline

One of the misconceptions about venture capital is that fundraising is a quick and easy process. On the contrary, it can take anywhere from twelve to twenty-four months to raise a new fund. Although a highly successful firm on its tenth fund may only have to make a few phone calls to raise the whole fund, this is not the typical fundraising situation. Building the trust of the potential investors takes time.

Best Practices

The Functions of Leading Venture Capitalists

As a leading venture capitalist, I identify deal opportunities and serve on the investment committee, which makes decisions across all investments. Additionally, I play a role in setting and monitoring the firm's marketing policies and practices. This includes not just the public relations of our business and the development of our brand, but the attraction of deal flow. I also serve on the boards of several portfolio companies and manage the exit strategies for these companies.

To avoid the potentially dangerous herd mentality, our firm proactively searches for potential transactions. We are not afraid of refining our strategy. Rather than passively sitting back and waiting for the phone to ring, we engage in an active investment search.
In our firm, no one voice is louder or opinion stronger than another. For a portfolio company to get an investment from us, there must be a unanimous vote by the investment committee. This structure removes the ego from decision-making. Our most important focus is in dealing cautiously with our clients' money. The only way to build a business is with extreme care and without ego.

Implementing Exit Strategies

As a team, we have a tremendous amount of experience selling businesses. Often, our businesses receive offers to be acquired before we are ready to sell them. Even if the prices are aggressive, there may still be a fair amount of growth potential in these businesses. Our strategy is to maintain focus and take advantage of our expertise in assessing the state of the business.

Misconceptions about Venture Capitalism

It is a common misconception that venture capitalism is easy. On the contrary, being a venture capitalist is very difficult, risky, and time-consuming work. When money seems easy to obtain, it attracts unskilled venture capitalists, and although it is sometimes easy to raise a fund, it is never easy to generate the expected return.

Resources andA.dvice

John Door once said, "It takes $40 million to make a venture capitalist." He meant that a venture capitalist must lose $40 million before learning from his or her mistakes. Like an athlete, a venture capitalist learns more from losing than from winning.

Rather than being a jack-of-all-trades venture capitalist, it is ideal for a venture capitalist to be the master of one trade. In order to keep up the knowledge of our trade, our firm utilizes many of the trade journals, financial press, wire services, and email services. We are extraordinary consumers of media in order to be extraordinary investors in media.

Five Rales for Venture Capital Success

1. Be very focused on a particular sector and become an expert in your investment.

2. Never underestimate the importance of strong management, and stay involved with the team to ensure its continuity and compatibility.

3. Don't be afraid to walk away from an overpriced deal.

4. Only support those companies that will value the firm's resources as well as the firm's money.

5. Plan for an eventual successful exit before investing a dollar in the company.

Charles Rothstein's responsibilities at Beringea include identifying, analysing, and making investments, providing ongoing assistance and strategic advice to portfolio companies, and coordinating the investment exit process He is and has been a board member of a number ofporfolio companies and currently serves in that capacity for Miva Inc. In addition, he serves on Michigan Governor Jennifer Granholm's council of economic advisors and sits on the investment committees of Global Rights Fund II and InvestCare Partners. He is also a board member of the Venture Michigan Fund, a i-of-t Prior to establishing Beringea, Mr. Rothstein was a vice president ofcorporate finance at ].W. Korth and Company, a Michigan-based brokerjdealer where he developed the firm's public offerings, private placement, and leveraged buyout activities


Mr. Rothstein graduated from the University of Michigan with a B.B^A. in 1980 and anM.BJ{. in 1982.

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