FINANCE: VENTURE CAPITAL PART II

In a previous article we studied what is Venture Capital.   In this article, we shall take a look at how it works.

How It Works:  Adam Kowalski is a Polish immigrant to U.S.A.   He is one of those millions of to-be-legends that came to New York with less than 50 Dollars in his pocket, and a brilliant idea in his mind.   Back in Warsaw, Poland, Adam was fascinated with cars, as a child.   But one thing that bothered him about cars was the fumes they spewed, that made him sick.   So he resolved, one day, to do something about it.   That ’something’ took the shape of a chemical treatment process for the car’s silencer that could reduce carbon monoxide emissions by about 25%!  

 The silencer is the last part of the machine from where the carbon monoxide laden fumes exit into the atmosphere.   Adam’s process cleansed the fumes before they ejected into the atmosphere, thereby reducing the carbon monoxide content by about 25%.   He conducted several experiments in his modest ‘lab’ in Warsaw, and was convinced that he was on to something with great potential.   The problem was how to get if off the lab table and into the real world.   That would be the real test for his ‘baby’.

So Adam, like millions around the world, packed his bags, and landed in New York, and started working to realize his dream.   To cut a long story short, Adam came in touch with one Mr. John Anderson, who ran a Venture Capital firm by name, Jack, Jones, and Associates.   The firm had contributors drawn from wealthy individuals, and a few mid size firms based in New York.  

 Anderson realized that Adam’s idea was brilliant, and had great potential for growth and profits.   However, it was equally risky.   In effect, this tecnology would mean, that every eleven cars on the road would spew out carbon monoxide equal to that of only ten cars.  That meant one car off the road for every ten fitted with this mechanism, in terms of carbon monoxide emissions.

But there were hurdles to be crossed before this product could see the light of the day.   It depended on how the car manufacturers would receive the new product, that  would mean investing additional dollars into the manufacture, and consequently increasing the cost of the machine to the consumer.   While an average car buyer would appreciate technology that would give him better mileage and save him some dollars,  to convince him to pay more for the car to ’save’ the environment was quite another thing.  

Moreover the political environment was also not favorable.   The Bush Administration was opposed to the Kyoto Protocol on Climate Change, and generally not in favor of any legislation, that was against the ‘American way of life’.   But Anderson knew that this technology had a lot of promise for growth and profits.   And the Bush Administration was on its last legs.   Soon there would be a change and things would look up, and cleaner and greener technologies would get a boost from the new Administration.

So, Anderson decided to back the project and helped set up a company called Greener America, and committed 50 million dollars of his V.C. firm’s money to it.    In return, he got a 50% share in the new venture, apart from say in the most important decisions of the new company, especially those related to finances, and recruitment.

As it so happened, the Bush Gang got a drubbing in the ensuing elections, and soon America was treading a new, uncertain path that held great promise, and potential, but was equally risky.   Just the kind of situation for a Venture Capitalist, in politics!

Anderson patted himself on the back for a wise decision taken.   He estimated that the new company would break even in about 2 year’s time, and thereafter, it would be ripe for either a sale, or public equity.

This is an example of how venture capital works.   To sum up, venture capital fills a need for financing of new ventures that are not mature enough for either Bank financing or public participation through IPOs.   Though the entreprenuer may not get the best deal possible, at least his idea becomes a reality, and brings him glory and money.

                                                                               Concluded