Venture Capital or VC as we call it found its origins somewhere in the 1970’s, popularly known as the decade in which most of the VC giants as we know set up shop. The likes of Sequoia Capital, Kleiner Perkins and a few others came into existence through the decade. Then later in the 1970s and 1980s brought in some success for these VCs and created the biggest companies of today like Microsoft, Apple, FedEx and Electronic Arts to name a few. So there’s no doubt that Venture Capital could play a big role in your company making it up there with the other giants we know of today.
But before we get carried away, this article is here to help understand the importance of venture capital, when it makes sense for a business and along the way help you understand VC in a better light and possibly in a better situation to take a decision on opting for it or otherwise. Let’s start with the basics,
What is Venture Capital
VC is a form of financing but more specifically a form of private equity. Put simply it is a type of investment provided to startups and small businesses that are believed to have long term growth potential. Backing these VCs are usually well off investors, investment banks and any other financial institution. Having said that Venture Capital does not necessarily need to be in monetary form, it could also be provided in the form of technical and managerial expertise.
VC has become a very popular option for young companies with an operational experience of under 2 years. In some cases it’s even become essential for companies that lack access to bank loans, capital markets or other debt instruments. It does come with a price and that’s losing out in the form of equity in your company. VCs usually take equity as a collateral for their investment in the company and that translates to having a say in business decisions as well.
Now that the definition is clear, let's move onto the next big question:
What is the cost of Capital?
There are 2 ways to look at it one from the perspective of the company and the other is from the lense of the investors. Companies use the cost of capital metric to judge whether a project is worth the utilisation of resources. Investors on the other hand use this metric to determine whether an investment is worth the risk compared to the return.
At some point in time a company must decide when and for what purpose it needs to raise capital. Apart from deciding how much money it needs, it must also decide what method would deem fit to acquire these funds.
Understanding this concept will play a crucial role in negotiating with Venture Capitalists on the equity you give away for the investment and on the flipside will be the yardstick for the VCs to measure their return on investment.
This leads us to the next thing you should check off your list, which is, does your company need venture capital to move ahead or
When should a founder look for Venture Capital?
The answer to this question isn’t that simple and it’s an option you should take only if it's absolutely necessary. Let’s start ticking off the boxes and that should give you a better idea on whether you need it or if it can be pushed to a later stage.
You require a large sum of money and traditional financing methods won’t cut it: Let's say you’re at a stage where you need to make some big investments. Invest in a factory or production line, procure new machinery or maybe hire a larger workforce to help boost your business. If that’s the case, the VC makes sense for your business.
You need the expertise to take your business to the next level: Venture Capitalists bring a lot more than just money to the table. With them on your board of directors you can make use of all the contacts and expertise they have. So take for example you’re the brains behind the product and you need help taking the product to market, or you’re business savvy and you lack the expertise in running a supply chain, the VCs will most likely help you fill in these gaps for your business ensuring your company is capable of making it to the next level.
You’re sitting on a gold mine: If your business has the potential to be the next big giant, chances are that you’re probably better off looking for a VC. Every once in a while there comes a unique product or solution in the market and if that’s you, it’s best to get started before people start ripping off your idea. VC will help you get to market faster and fill in the gaps that you potentially have in your business. In this case VCs are a no-brainer.
So if you’ve ticked off two or more boxes off your list, you have your answer but I urge you to weigh in some of the
Advantages and Disadvantages of Venture Capital
Top 8 Advantages of Venture Capital in 2022:
Raise large amounts of money: Compared to your traditional means of financing, the upper hand with VCs is that you could potentially raise a large round of funding that could set your business up for success. While some would argue that bootstrapping your business will pay off in the long run, VCs could give you an advantage over the competition.
No Monthly Payments: VCs invest in your company because they get a share of your equity when the business is sold. This ensures you don’t need to make loan payments and consequently frees up money for you to invest in your business. Even if your startup does not make it you’re not under the radar to pay it back. Since it isn’t a loan there’s no obligation to pay it back.
Your Assets aren’t at risk: Unlike traditional bank loans and other methods of funding from financial institutions, where you have to place assets like your home as collateral, in a VC funding there’s no need to pledge your assets.
Experience and Leadership Advice: With VCs you can be sure that this isn’t their first gig. They come with tons of experience and expertise in business. This means having them on your board of directors ensures they fill in the gaps you have in your business and could help you take crucial strategic decisions. Having someone to help you out when an unfamiliar problem arises is always a benefit.
Networking opportunities: While you as an entrepreneur may not have the time to dedicate to building a professional network that’s a crucial asset for their business. Venture firm partners on the other hand spend 50% of their time broadening their network, to help the companies they’re investing in. This could potentially lead up to future rounds of funding, building partnerships or even adding to the customer base.
Recruiting: A VC backed company stands a higher chance of recruiting top tier talent compared to a bootstrapped one. It shows that your company has potential as well as the funds to ensure their financial and career growth.
Better Publicity: VC firms usually have a Public Relations Department and multiple media contacts for your company to leverage. The publicity that comes with it could ensure you get noticed by prospects, clients, partners and employees.
Help raise future funding rounds: It’s in the VC firm's best interest that you raise additional funding at a higher valuation, since it strengthens their financial position. This means they’ll be more than happy to introduce you to other venture capitalists.
The Disadvantages :
Find out the major 6 disadvantages of venture capital in 2022.
Funding is often scarce: VC firms receive thousands of proposals for every four startups/companies they fund. So the chances of you bagging a funding isn’t easy to come by. While a great idea and growing business may improve your chances, it will still not guarantee funding.
Reduced Ownership: Like I've said before, you’re putting your company’s equity up as collateral and that means you're losing a bit of stake in your company. Depending on the deal the Venture firm might end up with a majority share of your company (more than 50%) which means you'll lose management control.
Takes time: Finding investors is a time consuming process, so it is best to start months in advance to ensure you have time to continue growing your business and raise enough to fund that growth.
Venture Financing is Expensive: In the long run, venture financing will cost you more than a business loan. You might skip on the monthly payments and interest but the cost based on the equity will add up to a higher amount when you sell your business.
You will need a board of directors: When you receive venture capital financing you will need to set up a board of directors and tighter internal restructure will be required. This is done to ensure transparency but can also eat away at the control you have in your own business.
You’re expected to grow rapidly: A startup that seeks VC funding should be planning for an exit. Which means either an IPO or an acquisition. If these are not the plans you have for your business then you’re better off without it.VC firms expect rapid growth in your business to ensure they make up for their investment. This may add more pressure on you to push your business to perform.
Having said that if you’re still uncertain or maybe Venture Capital is not for you, it would be best to look at
The best alternatives to venture capital in 2022 :
Angel Investment: An angel investment is a good alternative to Venture Capital. They are mostly individuals with surplus cash looking to invest in upcoming startups. They also work in groups of networks to collectively screen applications before investing. This form of investing usually takes place in the early stages of the company and you have the likes of Google and Yahoo, which were initially funded by angel investors. Like VCs, they take a share in the equity of the company and on the bases of the amount raised could ask for upto 30% stake in the business. They do not bring in as much money as Venture Capital firms but definitely are a good place to get started. Being backed by an Angel Investor could improve your chances of raising venture capital in the future.
Bank Loans: Banks can be a good source of financing for companies. They usually provide 2 types of financing offered by banks. One is a working capital loan which is the loan required to run one complete cycle of revenue generating operations and the limit for this is decided based on valuing the stocks and debtors. The other type is funding which involves sharing the business plan and the valuation details along with the project report, based on which the loan is sanctioned. There are several different schemes from multiple banks in India that offer collateral free business loans. You obviously need to pay back the loans in instalments with interest. Oftentimes your credit scores will determine how much money you can borrow.
Subscription Based Financing: This is a relatively new form of financing your business but has picked up in popularity in recent years. It allows recurring revenue companies to raise funds without diluting their equity by trading subscription revenue for upfront capital instantly. For an investor, the predictable cash flows and maturity of the recurring revenues makes it similar to a fixed income-yielding asset profile
Get Business loans from Microfinance providers or NBFCs: If you aren’t eligible for bank loans, microfinancing could be a good alternative, they may not provide large sums like banks but it works well for smaller requirements. Non Banking Financial Corporations are also a good source for financing that provide similar services to your traditional banks minus the hassle of meeting legal requirements stated as per regular banks.or having an excellent credit score.
Government Programs that offer startup Capital: Depending on where your company is based, it could make good use of the government schemes put in place to help the startup industry. It’s worthwhile signing your startup for one of these programs at least in the early stages of business.
Business Incubators and accelerator programs: This is a great option for early stage businesses and startups. While incubators help startups in nurturing and growing their business. The accelerator programs on the other hand help businesses take the next step towards exponential growth. While there is some monetary benefit that companies can get out of these programs, the majority is in terms of a working space and the tools to ensure the business is up and running. Another major benefit is being able to network and make connections with the right people, investors and companies that could come in handy for the business. These programs could last anywhere in between 4 to 8 months.
Friends and Family:The easiest way and the safest alternative to any of the other financing methods is taking some help from friends and family. What better way to back your business up than the people that want to watch you succeed. Having said that, it could bite you in the back when you least expect it. Sure you might not be able to raise as much and the terms of settlement may be ambiguous. But tread carefully, it’s not the most recommended option.
Bootstrapping your startup: This option is higher up on the list as it is a method that involves financing your own business. It involves investing your own money or maybe mortgaging your home. Thai works for new startups and is suitable only for the initial stages of your business.
Crowdfunding: This is a relatively newer form of funding that has been gaining traction off late.This involves listing your product or business or a crowdfunding platform. You will also need to list down the goals for your business including a sound plan for achieving it as well as the amount you need to raise. The people investing in you will probably do so with an online pledge of pre-ordering your product or in the form of a donation. These crowdfunding platforms are usually a competitive place and it requires your business to be in good shape to expect any returns out of it. It also doubles up as great marketing for your company so it could be a win win if you play your cards right. In India the options are Indiegogo, Wishberry,Ketto, Fundlined and Catapooolt.
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