The Four-Phase Model – Fundamentals in Relation to the Business Model of an Investment Company
How can an investment company be understood?
Investment companies provide equity to different enterprises – this through the non-organized capital market and regarding to a limited period of time. They acquire shares and receive in return to their capital commitment a recompense in form of a capital return through the subsequent sale of these shares. Depending on the stage of the life cycle of the capital-seeking company, there is a differentiation between the terms venture capital and private equity. The term private equity is used as a generic term for the provision of equity outside the stock exchange. To that effect, Venture capital is understood as a sub-form of private equity. The main differences are that venture capital mainly focuses on young, innovative and fast growing companies during the early stages of a company development, while private equity is more likely to be found with firmly established companies in the later stages of a company’s development. These enterprises are characterized by an appropriate market acceptance and completed products. The activities of an investment company can be summarized, as shown below, in a phase-oriented business model (Capital Acquisition, Capital Investment, Value Adding and Disinvestment).
The first phase is the capital acquisition process, also called fundraising, which represents an essential prerequisite for the investment activities of an investment company. Within the scope of the capital acquisition they endeavour to identify and attract new investors and take care of the relationships with their existing investor base. Of crucial importance is therefore the communication of the investment policy. Based on these performance contents, investors can account a possible commitment in regard to their own investment policy objectives.
As part of the investment acquisition within the investment phase, also called deal flow oriented phase, the objective of an investment company is to preselect potential joint ventures. The most qualified ventures, companies in accordance with the investment policy objectives, are then selected for a subsequent participation evaluation. Investment companies receive their participation requests in different ways. The evaluation process or screening allows them to select these requests in consideration of different criteria and regarding the highest possible degree of coverage towards their investment policy. If there is finally an intent of a cooperation between the management of the venture and the investment company, it comes to the issuing and signing of a letter of intent, whereupon the detailed evaluation starts, also known as due diligence. All in all, from then on the temporal and financial commitment but also emotional commitment of the investment company grow. The due diligence aims to increase the quality of all possible and relevant information for the decision-makers within the context of the decision process and serves as a basis for the contractual arrangement of the investment relationship. Within the participation negotiating the terms of the future cooperation will be matched. In the case of an agreement between the investment company and the management of the venture, the results of the negotiation process will be codified in an investment agreement.
After the signing of the investment agreement and a then following provision of the financial resources, the venture is accompanied entrepreneurially by the investment company according to the contractual designing towards a more active or passive investment strategy. While in a passive approach the investment company straitens itself to a more controlling role, there are several supporting services across the participation period in an active approach. The primary objective on the side of the investment company is in promoting a sustainable and positive business development and thus in increasing the enterprise value of the venture. The supporting activities, also known as Value Adding, can cover various strategic and operational tasks.
In the final phase of the model, the phase of disinvestment, the sale of the venture takes place. In addition to an immediate sale of the shares, the possibility of a successive reduction in shares can be also considered. In total, there are five so-called exit channels available for the divestiture:
Sale of the venture to an industrial company (Trade Sale)
Initial public offering (IPO)
Sale of the venture to a financial investor (Secondary-Purchase)
Share buyback by management or other shareholders (Buy-back)
Depreciation of the shares in case of an negative development or insolvency