According to the Global entrepreneur monitor, nearly 13% of the Americans are starting or running a new business. The value of the venture capital investments in the United States amounted to $58.59 billion in 2016. VC plays a pivotal role in the startup companies. Entrepreneurs do face problems in raising funds for innovative projects. Venture capital is a type of equity investment that subsists the needs of startup companies. In the view of the potential role of the VC in the entrepreneurism, USA and Europe nations have accorded top priority to this mode of investment.
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Here we will discuss, what is eminence of the venture capital in entrepreneurship?
What is venture capital?
With straightforward meaning and conception, venture capital is a form of private equity financing. This financing is provided to startup and small-medium enterprise that have long-term growth potential. The venture capitalist can be well-off investors, private banks and other financial institutions. The assistance is not only in the monetary form but can be provided in form of technical or managerial proficiency.
The element of risk is evident because of the limited operating history of the companies. Despite all these constraint, this mode is becoming popular source of raising capital. Currently, there are 4,520 venture capital firms who are dealing in the USA.
Types of venture capital
The different categories are based on distinctions like; the timing of the investment, specific purpose and life of the target company. There are three basic classifications:
1) Early stage financing
Divided into further three sub-divisions, start up financing, seed financing and first stage financing. Seed money comes with the idea of facilitating small amount for proving and fructifying a new idea. Start-up idea meeting the needs of expenses related to the marketing and development of the product. Finally, the borrowers of first stage financing are those entrepreneurs who need funding for the cause of beginning business activities at the full scale.
2) Expansion financing
As the name is suggesting, this financing is for the purpose of expansion of business activities. Expansion financing can be further categorized into second-stage, bridge or third- stage financing.
Second stage financing is also called mezzanine financing with the impetus to assist a target company to expand their business activities in a major way. Bridge financing comes with the base to pledge monetary assistance to those companies that need funds to employ the initial public offer as a major business category.
3) Acquisition and buyout financing:
Within the scope of the knowledge, leveraged buyout financing and management assist a particular management group to acquire a particular product or the entire company.
What are the risks in venture capital investing?
Before we discuss possible risks faced by an entrepreneur. Below are some highlights from a survey that is conducted to show the interest of entrepreneurs in venture capital:
Importance of Assistance in VCAverage rating/5 1 VC provides funds for business 4.29 2 VC improves the brand image of company 3.70 3 VC helps in strategic planning 3.08 4 VC helps in marketing the products 3.99 5 VC comes up with technical assistance 2.52 6 VC provides operational help 2.49 7 Do it helps to improve the corporate governance 2.74
Entrepreneurism is all about dealing with the perils and venture capital is one of them. According to a data presented by fundable, major startup funding comes from personal loan and credit with 57% and VC measly contribution of .05% only. Economic, market, financial and legal risks are some of the factors that cause such a low rate.
Loans are too expensive:
Most of the loans are carrying the high rates, a 30% to 50% annual rate of return. Unlike banks and other lenders, the venture capitalist takes equity position as well. It means you have to give a portion of your own equity in exchange for VC's backing.
Preferred stock is also on the demand list form VC's. The preferred stock fixed dividend is an interest payment and secondly, its payment takes priority before common equity holders.
Entrepreneurs lose control:
VC's not only wanting equity but also the control of the entrepreneurs business. Losing equity and management control at the beginning may not feel like a big sacrifice but the fact is, you are dealing with a huge concession. Entrepreneurs wants to be in-charge but VC's take firm control of the management and internal affairs of the business. Then, Business obligations will become a rigid task for a small trader.
How to mitigate risks?
Start your idea with the right people
Gaining access to the right people is the biggest challenge faced by the entrepreneurs when pursuing funds. Submitting a business plan or dropping some random emails is not dapper idea. Business plan must be endorsed by the known entrepreneurs, lawyers and accountants. The endorsement will make a positive intuition rather than throw an unannounced emails.
Entrepreneur learns to grow small business
Relationships with the investors are valuable but a focused strategy is equally critical. Venture capitalist normally prefers those companies whose IPOs will be offered in next two or three years. So, you always need to grow; how?
It was July 2003 and a second-year Harvard student called Mark Zuckerberg had been playing around with a pet project.
He had no commercial aspirations for it. It was just fun to code. It uniasiageneral was a "hot or not" photo comparison site. He called it FaceMash and his friends loved it. Then it found its way onto the main Harvard servers and Zuckerberg's education as a young entrepreneur began.
Facemash showed how an idea can go wrong, how an idea can be snuffed out, not because people don't like it. They did. Its first four hours online attracted 450 students and 22,000 photo views. Facemash was snuffed out due to rules. It was deemed inappropriate by the Harvard administration.
As the Harvard Crimson reported in November 2003, "The charges against you are for security, copyright and privacy violations and you're staring down the barrel of expulsion from Harvard." There was also an angry backlash from women, in particular, not least the Association of Harvard Black Women.
The charges were subsequently dropped but the experience taught him that an idea is just the start. Although Facemash wasn't a startup per se, if it had been, the regulatory issues and the backlash from women would have strangled it at birth. The idea that it generated, Facebook, would need to overcome significant obstacles, regulatory, financial, staffing, competition and so much more.
Survival of the fittest didn't just apply to biological life. It applied to startups too.
Zuckerberg and Facebook went on to achieve great things but why do nine out of ten startups fail?
You have solid ideas. You know your markets. You know your ideas can make money. So what happened to your vision?
Neil Patel offers an insider's insight into what happens in his article, 90% Of Startups Fail: Here's What You Need To Know About The 10%.
Patel summarises that, if a startup is already attracting a lot of customers like Facemash, you don't really need a business plan until you go out and get funding. Otherwise, it's vital. Planning from the start is among the key reasons your startup company will fail early. Planning sets the scene on your entire vision. Know your market universe. Know your strategy.
Bill Gross of IdeaLab also wanted to know why so many companies fail. He looked into some of his own successes and disappointments at IdeaLab and some of the where-are-they-now companies of recent times and he discovered something he didn't expect.
Your timing, when you launch, at 42%, was by far the most important factor between a project that succeeded and one that didn't.
"Your timing is vital," said Gross. "Are you too early? Do you need to educate the market first? Or are you bang on time? Airbnb launched at the height of the recession when people found it really useful to rent a room or two out and draw in a little extra money. Or are you too late, there are already too many competitors?"
Second in the list was your team at 32%. Your people. The people who make the whole thing tick, their adaptability, the all-important customer experience. Gross says a company has to be prepared to be shouted at by unhappy customers. Things will go wrong. It's how a company reacts that defines the company.
Gross quotes Mike Tyson, former world heavyweight boxing champion.
"Everyone has a plan until they get punched in the face."
The uniqueness of the idea came in 3rd at 28%.
Gross said he wasn't surprised by Business Planning (24%) and Funding (14%) if a startup already has some traction. If your customers are demanding what you're producing, you can develop a plan later and intense funding can easily follow.
If you've got no market traction yet, like the vast majority of startups, The Business Planning and Funding pieces are vital to your survival.
Your business plan will tell an investor if you and your idea are up to it, but more importantly, it will tell YOU if you're up to it. "It's at this point," says Gross, that "...sensible people see a bad idea play out on the page and just leave it alone right there."
In three years time, what are your startup's projected sales? How much do you need to spend to get those sales? How many people will you need to employ and train, how much server space? What are the costs of giving away the free version before you monetise it?
"You will find there's a lot more than you thought," says Gross.
Out of your business plan will emerge a map. Suddenly there's a real business opportunity. Your business plan covers it all, revenue models, ad campaigns and how to design a seamless customer experience. And how to time it all to hit the market at the right time. It will tell an investor two things:
So, now you're funded, you take a moment to enjoy the feeling. You give someone a hug. Can this be your dreams coming true? You're dizzy with the buzz it gives you. As Chris Herd writes on Hackernoon, "Welcome to the most exciting time in your life."
Now it's time for you to crank up the engines. You do all the things you said you would in the business plan. There are deadlines, people to find, marketing agencies to meet, prices to negotiate.
Neil Patel says, "It's now time to focus harder than ever. Ideas spring up everywhere but, unless it's a free energy idea or London to Sydney in six minutes, do not bother your current strategy with it. Focus. Keep your eye on the ball. You've still got so many more obstacles to come."
Before long, your idea will be copied. Products will hit the market that are cheaper than yours, maybe have a few nice ideas yours doesn't. It's inevitable. That's why you chose the blitzkrieg option, saturate, colonise and cling on to your market share with all you've got.
The nice ideas on those other sites? You were first to market. You're the market leader. Build them into your future releases. You were the first, so set yourself as the first right from the start. Keep improving it, keep inventing, keep creating new products with your brand all over them.
There is another factor that so many entrepreneurs ignore or simply don't believe is important. And it's the fundamental essence of 'survival of the fittest'.
If you invent a machine that can produce free energy, what are the big power companies going to do? Insist quite strongly you sell it all to them? Tie you up in lawsuits till you lose the will to live? It doesn't matter if it's the biggest energy company in the world or a company just a bit bigger than you. If they lose market share, they'll want you stopped. Life was just fine before you came along.
Patel says, "This is the stage where your whole vision can be torn up and stamped on and this is the stage where it's most damaging. This is where all that hard work can vanish down the plughole overnight."
Your competition is fighting for its survival. You're under attack. That photo of you on Facebook doing something nefarious, your less-than-exemplary school record. It all finds its way into the media and your brand suffers. When the co-founder of Facebook, Eduardo Saverin, underwent a week-long induction ritual at Harvard, he had to take a chicken with him everywhere he went, he couldn't imagine later being accused of animal cruelty but, eventually, the negative publicity was used as one of the reasons to write him out of Facebook. Zuckerberg had learnt well from his Facemash experience.
This is survival of the fittest in its most corporate form.
It's not fair, you say. It's all going so well. Everything is on-plan. You didn't do anything wrong.
Or did you? You didn't see it coming but you should have. And where in the business plan did it mention anything was fair?
Ever heard of a CDO? It's a Chief Defence Officer. In Sean Lyon's book, Corporate Defence and the Value Preservation Imperative, Lyons explains how to Bulletproof your Corporate Defences. "These problems are very real," he says. "If you haven't addressed it, you have a significant weakness."
Your CDO needs to engage anti-hacking measures and have strategic contingencies in place for anything that comes after you. It could be industrial espionage, a negative PR campaign. The bigger you are, the nastier the things they say about you. You will even need to watch out for sabotage from within.
Lyons says, "It's not paranoid. It happens. It's real. If you want your baby to get past childhood, realise what sort of world we're in and get ahead of it."
So why do nine out of ten startups fail?
According to some of the most successful entrepreneurs in the world, including Neil Patel and Bill Gross, it's bad planning, you took your eye off the ball and natural selection wasn't considered.
Bill Gross said, "The startup is one of the greatest ways we've go to make the world a better place. If you take a group of people with the right equity incentives, and organise them in a startup, you can unlock human potential in a way never before possible. And to do that, you must miss nothing."
Mark Zuckerberg's human potential was unlocked with Facebook but Geoffrey James, writing for Inc.com had one more word of advice for all the future Mark Zuckerbergs out there.
"There is one thing and one thing alone that every great entrepreneur absolutely must possess: Courage. When all's said and done, you can plan and strive and do all you can but if you don't also have the pig-headed courage of an entrepreneur, you won't be an entrepreneur."
If Mark Zuckerberg had had a business plan for Facemash in 2003, he would have learned about woes about to befall him.
Whether he would have done anything differently, only he can say.