Business Finance Homework Help

For venture capital and private equity investors, the question of whether to provide capital to an existing portfolio company that needs capital for growth is often not an easy decision to make.

Read the article below and discuss how should an investor evaluate an investment in an existing portfolio company that is struggling and needs additional capital to survive. What criteria would you use to assess the risks and make a decision of either providing additional capital to that company or deny their financing request and possibly have the company run out of liquidity and cease operations?

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According to the article, one must consider whether the decision to invest is offensive; meaning one is looking to increase the investment percentage of the company to be invested in or a defensive posture; where a company has the potential but lacks the funding necessary to grow the company and investment is generally dilutive to original investors. Suppose you have a great company that is performing and needs additional capital, and there is more capital available to be invested. In that case, one should invest to ensure that they maintain a respective position in the firm. Another smart move is to buy into a company that has promise but lacks capital support. Buying into a company can diversify your portfolio and significantly increase your returns as the company has had some run time and is observable; it just lacks the support needed to grow.

Another factor that the article points out is that consideration should be given to how the company management is performing. For instance, there will be no follow-on investment if there are signs of integrity, transparency, or honesty issues. Bad judgment or decision-making was another reason one should not invest in future rounds for a company. For these reasons, I support and agree that follow-on investments are not a good idea. Also, if the company to be invested in has no proof of concept and does not appear to be closer to developing their product or service offering, one must carefully consider whether it is sensible to continue with additional investment. I believe that each of these cases demonstrates deeper issues. One cannot throw good money after bad if management is not transparent or if the company cannot deliver on their product or service.
Diversification is another factor for investors to consider. Putting all of your eggs in one basket is highly risky and could be damaging if a company that one has invested in fails. For this reason, investors should spread their wealth across multiple companies; this will increase their chances of achieving a decent return on capital and bolster their IRR.

One last point is that investor emotion at some point, investors will need to put aside their feelings and think about whether their investment will impact the company for which they are investing. For example, suppose a company has grown to where their valuation is substantial, and you as an investor do not have significant capital to make a considerable position change. In that case, there is no point in investing. One should preserve their cash for an opportunity that comes along that can stand to yield a greater return on investment. One can get caught up in supporting a firm because they always have or genuinely believe in the company. I feel that what the article suggests is accurate, and that is if the strategy doesn’t make financial sense, then one shouldn’t invest.