Essay: Venture Capital - What You Need To Know.

The Importance and Risks of Venture Capital

Questions:

1. What is known about Venture Capital?

2. What is not known about Venture Capital?

3. What should to know about Venture Capital?

Venture Capital is the capital which is provided to the business firm at the starting of the business for the high potentiality of growth. Venture capital is a very important source of capital which is required at the first stage of a business. Venture capital is very risky investment for the investor because it is provided at startup position of a company and return is highly dependent on the company’s growth. Mainly wealthy investors are interested to put their money in the business towards looking long-term growth. Invest banks and some others financial institutions are also the sources of venture capital. Major decisions of business can be influenced by the venture capitalist. Some of venture capitals firm in UK are London Venture Partners, Pond Ventures, Pentech Ventures, AngelLab, Ariadne capital, OION, SPARK Ventures, ECI Capital, and Par Equity, etc.

This study is mainly based on three aspects: what is known, what is not known and what should to know about venture capital.

The history says that there were many technological firms who mainly backed by ‘classic’ venture capital. It is seen that venture capital has great impact on making and sustaining economic growth. It has also found that the ways of venture capital investment in US and Europe are different from others. Venture capital has provided to high-tech companies at early stage. According to the report of Bank of India (2001), UK is in second position in venture capital industry. US is in the first position. There were found 382 companies in UK who had financed as venture capital in 2013. Maximum portion of industry was IT sector (PitchBook, 2013).

This method of raising capital is mstly used by new companies or ventures that have a very short operating period in history, which cannot raise funds by issuing debt (Elango, Fried, Hisrich, and Polonchek 1995). The venture capital funds and nurtures firms that will yield a reasonable return on the VC’s investment in a few years not more than 7 years in addition to a small percent of the equity. Kozmetsky, Gill and Smilor (1995) postulated that venture capitalists knows that they have the right to speak on how the companies portfolio operates. Statistically in 2012, 3723 deals happened and out of that number in that year only 449 mergers and acquisition deals and 49 IPOS were successful.

Venture capital is the of money provided by a foreign investor to provide capital for starting businesses which lack access to those firms that lend out money such as banks and other private institutions (Van 1991). Equity stake is acquired through the exchange of capital that is invested for the business rather than it being given as a loan of which the investors hope it will lead to yielding a better return.

DeVries (1993) postulated that venture capital is the heart of fundingf or those business firms that are young into the world of business and other companies that have been into operation for a short period of time in history and don’t have access to capital markets. Most entrepreneurs normally know that venture capitalists are the ones that make decisions in most companies adding up to a small percentage of the equity. For investors to have or attain a large payout, a venture capital firm will look for those business that have just entered the market and the ones that are small scale businesses that will perceive a long term lifetime growth in the market. Their sizes vary from the firms that manage a small percentage of money worth investments to those venture capitalists that may have a lump sum of money worth to invest in companies around many countries (Henos 1993).

The History and Impact of Venture Capital on Economic Growth

Venture capitalist may be a group of investors, banks that invest and also cemmercial banks may be included as investors who make investments on behalf of the customers of parent firms.

 Ideally, the VC fosters growth at the company through its involvement in managerial, strategic, and planning decisions.Professional Venture Capital Firms raise money from Insurance Companies, Educational Endowments, Pension Funds and Wealthy Individuals (Bank 2002). Venture capital can also include managerial and technical expertise. In venture capital we also have what is known as crowd funding which is further defined as a process which entrepreneurs raise capital in small portions from a large group of people not expecting equity in return as a reward.

What most of us don’t know about venture capital is that it’s hardly noticed by investors since they have not specialized in venture capital corporations. Venture capital also has a hidden cost (Harvery and Lusch 1995).  As entrepreneurs always focus on where and what means we would put in practice in order to get that venture capital but at the back of our minds we forget that there are some of the things that we do not know as entrepreneurs. It is said that when you first invest in venture capital you will fail statistically. While investing your capital, in the process it becomes difficult and complicated since the companies with interest in your investment are vetted thoroughly before they take keen interest or before they are committed themselves (Cooper, Gimeno-Gascon, and Woo 1994). Entrepreneurs should know that even if the company is backed by major venture capitalists success is not always guaranteed.

. An entrepreneur can make a large amount of funding which might end up being a risk in terms of setting up a bar that is too high that makes it difficult for you to exit (Lerner 2000).  As Rosenbloom said when or if you raise too much money, you will have to swing for the fences.

What entrepreneurs don’t know also is that you as an investor you can’t fire your own venture capital. When ending up a pitch there is too many founders who abdicate their own due diligence. According to Guion (1991), venture capital firms have a general focus on specific sectors and verticals. This being taken to a scale that’s more granular, each one of the partners in each firm maintains their investments in an area of expertise. Put in mind as a thought that your venture capitalist is an outside partner in your business. Another thing about venture capital that we do not know is that there is a timeframe for ROI.  According to VentureOne Corporation (1998), typical venture funds are structured as ten year commitments for the limited partners who invest in the fund,” Tunguz said.

Share venture capital plays a vital role in the economy as it acts as a startup and provides funds to companies which are in their early stage in the economy. Not surprisingly, it’s also a constant topic of conversation within the startup community who is receiving it and the amount they are getting and how long it took them to get venture capitalists interest.

Differences Between US and Europe in Venture Capital Investment

1. Venture Funding is Not the First (or Second) Step for Your Business

Often, it can seem like incredibly profitable startups pop up and are venture funded overnight, but I can assure you this is not the case. Companies have often put in many years of work before they approach venture capital firms (Littman 1998).

Typically, startup founders first approach friends and family to raise an initial seed round. This usually occurs during the idea stage of a startup (Babbie 1990). For example, a company may have a working prototype and needs funds in order to produce an initial production run of their product. This is also a time when many startups decide to crowdfund their business transactions and sell their products again and look for investors that is from family and friends.

Angel investors provide seed funding at later stage in which the decisions they make are based on the customer traction at startup. When the startup has strongly established itself a successful and profitable business, venture capital comes into play to boost it and enable it to grow rapidly as it is in operation (Timmons, and Sapienza 1992). At this point the venture capitalist invest in the companies hoping for a better return rather than an everage one in their investment.

Venture capitalists are very selective in their investments and are looking for the highest-potential companies because they must answer to their Limited Partners mostly the ones that have invested its funds and counting on the company to make decisions that will benefit them or rather profitable (Eskew, and Jensen 1992).  With 3 out of every 4 startups failing, it’s important that a VC make a significant return on those startups that do succeed.

2. Venture Capital Pairs Well with Crowdfunding

A debate has recently emerged about the relationship between venture funding and crowd funding. It is believed that crowd funding will not replace the model of venture capital anytime soon at fundable. Entrepreneurs are granted the opportunity to gather customer traction they need to attract other investors at later date through crowdfunding since it is the perfect precursor to later funding rounds. Equity crowdfunding is a great way to gather initial investors, who in turn will continue to profit from the company’s growth especially if the company operates to a point where it cannot support itself and rather needs to be funded by venture capital.

3. Venture Capital doesn’t favour everyone.

There is not just enough venture capital for every successful startup with just about 1500 investments made by investors. Companies outside the realm of technology focused business need to seek other ways of funding in which venture capital funding is predominantly committed to those companies with an early stage in the market now a days have other tools for raising capital than before due to the legalization of crowd funding equity and other innovative ways or methods of raising the startup capital.

Most of the investors are excited to work with the companies that have a short term life period as they start the journey to funding themselves as venture capital will continue to drive or act as a force behind those companies that have been into existence for a long period of time and have succeeded well (Burrill, Steven, and Craig 1990).

Major Industry Sectors in Venture Capital Investment

4. As an entrepreneur we there are mistakes that we should know about when raising venture capital that are common.

Poor preparation occurs when most of the entrepreneurs lack to a well business plan of which investors are looking for a well, complete and solid business plan. Filling an application without a complete business plan leads to venture capital officers will not accept your application form. Management skills are also needed and having managerial aspects of business is important since loan grantors of a bank and investors are always looking for something when they meet you as an entrepreneur (Fear 1990).

Some entrepreneurs fail to understand how this venture capital works. They need to have knowledge about venture capital in general in turn this will lead them to make equity investments in startups. Entrepreneurs should avoid borrowing money that you should payback with interest.

Coming up with an unfinished business plan, has not been through enough research in the labs. This leads to failure of customer traction, ideality and production.

Lack of customer input is another factor whereby we can ask ourselves how much we have discovered the customers that we engage in day to day business activities (Frederick Lipman 1998).  You should be able to understand the pain of the customers that is their unsatisfied needs and how are the customers attending to that need today.

Having a weak or non existent go to market plan is also a factor entrepreneurs need to understand that even if they capture a certain percentage in the market even if it’s one percent they will still be successful.

Displaying symptoms of founder’s disease and this is shown by the way you as an entrepreneur appears unwilling, not determined, inflexible, not coachable and having the need to bring in new executives will scare away venture capitalists.

Not doing your homework on the specific venture capitalist (Maskus 2000). As an entrepreneur you should do enough research on the firms you will be meeting, see your interest to those venture capitalists who invest in your line of work you are to engage in or the geographical area of your industry and the stage of your growth.

There are certain ways in which venture capital works that entrepreneurs should be aware of. One of the ways is that venture capital fills a void (OECD 2003). While funding basic innovation venture capital only plays a minor role. When the company’s life begins to commercialize its innovation venture capital here plays an important role at this stage of innovations life cycle.

According to Bygrave, and Timmons (1992), venture capital fills a void between the lower cost sources of capital and those sources of funds attract innovation. In order for that void to be filled it requires the venture capital to provide a reasonable return on capital well enough to attract the private investors to provide equity funds and also returns that are attractive for its participants in order to gather rich ideas that will create high returns.

Attractive returns for the venture capitals – venture capitalists always expect a ten times return in form of capital when financing a company’s startup for about two years Gibson, Paul1999). Before the venture capitalists share the profits, they meet and agree to return the investor’s capital.

Key Aspects of Venture Capital Investment

Conclusion

Venture capital financing is important for the growth of small business, high-growth companies and especially for high technology sectors. High transaction costs are incurred at time of financing in early-stage. It is required to take step on both side (demand & supply) from realizing the benefits of growth from creation of fostering firms and entrepreneurship. Demand side includes the creation of entrepreneurial culture and supply side includes enhancing access to risk finance. There are some intangible factors which influence the entrepreneurship level such as risk-taking ability and providing easiness to new firms in penalties related with bankruptcy. New firms should come with new products and should have potential market to sell.

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