Understanding Venture Capital
Venture capital investment is just one form of a larger category of private equity investment. While private equity also encompasses hedge funds and buyout funds that invest in mature companies, venture capitalists are generally distinguished by their interest in investing in startups and entrepreneurs with varying levels of risk. They’re also distinct from angel investors, who are typically former entrepreneurs providing seed funding and mentorship to an entrepreneur at an even earlier stage, to help them get their company running.
Within venture capital, there are firms that specialize in specific industries, as well as in different stages of business. A firm might focus on early-stage businesses, providing seed capital to start a business from scratch; mid-stage venture capital, to grow a company’s sales development or complete its product line; or late-stage capital for a company on the way to profitability, to expand the product line and grow into new markets.
Venture capitalists typically take a meaningful minority or majority shareholding position in the startup. The venture capitalist’s goal is to grow the company to a point where it can make an “exit” by taking the company public or selling it to a larger company at a price that greatly exceeds the amount of capital invested.
High-Risk, High-Reward
As with any change, however, some in the industry are likely to feel threatened, Ward says. “There’s, I’m sure, the old school, that doesn’t want to change and doesn’t want to evolve,” he says. “If they’re hanging onto an old technology, they’re going to get eventually passed by.”
The venture capital model also is not right for every company. While every investor is different, venture capitalists typically fund businesses with the idea of exiting the investment through a sale or public offering in a set time frame, often three to five years, says François-Xavier (FX) Souvay, president and CEO of LED luminaire manufacturer Lumenpulse. For an entrepreneur, he says, the risk is that their company may never go as far as it could have if the entrepreneur had remained more independent. Lumenpulse, in fact, was seeded with money Souvay earned from a previously owned company, and he raised funding for market expansion from private investors rather than venture capitalists. Young entrepreneurs who use venture capital should try to think about their exit plan ahead of time and find a strategic partner who will help them continue to drive innovations, he says.
Entrepreneurs should also make sure their goals are in line with the goals of venture capital before taking their investments, Rob Day says. A mentor who has been through the process can help them know what to expect.
“A horror story for an entrepreneur is that they have something that they want to grow into a good, steady business, and they’ve taken money from VCs who want to drive this thing to be just a huge win or a swing and a miss,” Day says. “I would absolutely encourage entrepreneurs who think that they have a huge, world-changing idea to go for venture capital, and I would absolutely discourage entrepreneurs who think they want to grow a good business for them and their family from trying to go get venture capital.”
A necessary corollary of the high-risk, high-reward venture capital mind-set is that not every venture will succeed. “Especially in this cleantech area, you get investors who come in and don’t understand a market yet,” Day says. Some of their efforts bear fruit, he says, “but some of them fall flat on their face[s].”
Designer Due Diligence
The potential volatility of startup lighting companies means that lighting designers and distributors must be wary of companies without a long track record. At lighting distributor Wiedenbach-Brown, director of technology and national account executive Lara Cordell launched a program called LED PASS (short for Product Assessment and Screening System) that reviews and qualifies LED products and manufacturers.
Venture capital backing can be a positive or a negative for a manufacturer, she says. “From a positive standpoint, if they’ve got the VC and it’s sizable, then I see them sustaining themselves for the near term, and we don’t worry about them ramping up” to meet the needs of a large client.
“The potential negative is, if they are to sell, will the product still be supported the same?” she says. Large clients are often unwilling to risk trying a new product unless they know someone is backing it, she says, so if she’s working with a company that’s brand-new to the market, she’ll ask for an insurance policy to back the product warranty in the event that the company ceases to exist, or they get purchased and the new company does not uphold the warranty terms.
In general, however, Cordell says she’s not concerned about working with a startup as long as it is driven by an inventor or engineer with unique, proprietary lighting technology and is financially solvent. “As long as the company doesn’t get too big too quick and lose who it is, then we can hope innovation will remain their focus,” she says. “If a company is based on venture capital only, that’s when I get concerned about their market objective and ultimate longevity.”
Venture capital has helped to transform lighting from a mature industry to a growth market. For designers and manufacturers alike, adapting to the changing environment will be key to claiming their share of that growth.
