Benefits And Drawback of Venture Capital For StartUps
Technology is continually evolving. With the changing preferences of consumers, the growth of technology is continuously changing the shape and pace of the innovations. We cannot understate the role of venture capitalists in driving technological innovations, especially in this information era. Venture capitalists provide funding to the innovative entrepreneurs expecting a higher return in a long time, along with inherent risk in the short term. For innovative startups that have progressed their journey to the growth stage with their own funds, venture funding is like a boon. Here in this article, we would talk about everything regarding the importance and disadvantages of venture capital for a startup business.
The sustenance of startups for carrying forward their innovations is only possible with the providence of a stable infusion of capital. The stability provided by the funding source enables startups to have a solid footing in the market. It is because of the funding that startups can keep on rolling out innovative feature sets for scaling-up and expanding their growth. And, this infusion of money is done by venture capital companies.
For sure, venture capital is the need of the hour for any startup business. But what exactly is venture capital? How does it affect the working of a startup company? How does a venture capital-backed company look like? Let us ponder these questions.
Venture capitalization is the infusion of money in an innovative startup company having a very high potential of growth but experiencing footprints so small that it cannot obtain a loan from a financial institution. Venture capital is also known as seed money because the funding company acquires equity in a startup company by way of investment. Along with that, a venture capital company get a controlling stake over the decisions of the startup.
Renowned Costa Rican venture capitalist Dale Wood says venture financing firmly establishes a startup’s footing within its industrial domain. Its absence results in startup not being able to realize its full potential and scalability. When there is such a tight competition and a constant increment in aspirations, venture capital makes impression visible in the starting stage of a company. Let us talk about the specific benefits and disadvantages of venture capital financing for the life cycle of a startup idea.
Benefits
Encouragement To Entrepreneurship And Risk-Taking
As the old saying goes, no risks no gains, venture capital is the catalyst that results in the encouragement of entrepreneurship and risk-taking without which no profit could be materialized. If a business owner is not inclined to take risks, he would have to settle for the ordinary! Venture capital is crucial for providing direct encouragement for a worthwhile business idea in the form of funding and expertise.
Startup Promotion
The promotion of the startup is one of the most crucial functions of a venture capital company. With the help of venture capital companies, an entrepreneur performs many services such as the inception of the business idea, gathering information about the industrial domain, selecting the right location, planning layout preparation, registration and regulation of the enterprise, and allied legal formalities. Without the help of a venture capital company, even a very promising startup idea can die in its infancy.
Creation Of More And Better Employment Opportunities
In the previous three decades, venture capital companies have become a dominant power in the capitalization of innovative companies worldwide, especially in the United States. Right from FedEx to Intel to Google, startup ideas backed by venture capital firms have immensely contributed to the enlargement of the United States economy. By the active promotion of entrepreneurship, venture capital institutions are not only encouraging the self-employment opportunities but also inspire educated but skilled unemployed people to foray into untapped avenues.
Imparting Expertise And Guidance
Not just capital financing, but venture capital is a tremendous source of consultation, expertise, and guidance. Generally, an expert from the venture capital company is appointed as a board member of a startup company. It enables the active participation of venture capital firms into the day-to-day activities of a startup company, whereby it imparts rigorous guidance, expertise, and consultation. Because venture capitalist companies possess the requisite experience of expanding and building startup entrepreneurs, the value they add to the startup is of immense importance. Sometimes they help make technical strategies, industrial know-how, strategies on expansion and growth, and acquiring the right talent pool. Without these, a startup idea cannot become a success.
Repayment Obligation Does Not Exist
In the unfortunate scenario of a startup firm shutting down or failing, there is no obligation of repaying the investment of a venture capital company. Because there is no requirement of paying back the investment company, the startup is not burdened from the surging of the interest as it happens in the case of bank financing. Startup company can operate with much financial independence if a venture capital firm finances it. All this makes venture capital an ideal capitalization plan.
Venture Investment Is Based On The Potential Of A Startup Idea
In comparison with banking institutions, venture capital companies can obtain funding based on their future potential rather than the demonstrated profitability. Generally, it happens that startup entrepreneurs have great future potential, yet they lack demonstrated profitability in terms of achieved revenue. The future potential of a company is based on a great business plan that makes it eligible for venture capital financing. For a small entrepreneur having a great business plan in mind, venture capital acts as the savior when all banking institutions shut their doors. For scaling startup ideas to its rightful potential, venture capital financing is a must.
Disadvantages
Erosion Of Control And Ownership
Venture capital companies are instrumental in providing substantial capital investment to the startups enabling them to scale up and grow; however, it also dilutes ownership and control for the entrepreneur. If the startup idea becomes a success, then a venture company earns tremendously. Venture capital companies usually appoint one of their representatives on the board of the startup company. Such representatives often become active participants in the day to day decision makings. Because venture capital firms would not be wanting to lose their investment in the startup idea, they may often act in a way that may seem cynic to the founders of the startup. Also, any difference in the views between venture capital and the startup may make the situation tumultuous because significant decisions require the unanimous consent of all the investors.
Complicated And Tiresome Process Of Venture Financing
The process of obtaining venture capital starts with the startup's owner presenting a detailed business plan. After that, a personal one-on-one meeting is done to discuss the project in detail. Later on, even if the venture capital company gives the tentative go-ahead with the capitalization, another thorough process of due diligence is conducted. After this process is over, the venture capital company offers a sheet containing all the terms and conditions. The whole process is very complicated and tiresome, making startup companies lose patience and abandon venture financing altogether.
Venture Capital Companies Expecting Huge Returns On Their Investment Too Early
Some venture capital companies do not have the patience to watch and let a startup idea become a full-fledged company. These venture capitalists start expecting enormous profits in less time, for instance, a cycle of 3 or 6 years. If the startup owner believes that his idea of entrepreneurship would take more time to generate profits than expected by the venture capital company, then going for venture capital firm for financing is not a good idea. Constant expectations of higher returns on investment may result in enhanced stress in a company's decisions that can derail its natural progression.
Alternatives of Venture Financing
For sure, venture financing is just one of the many ways to fund your startup. If you feel that venture financing may strangulate your decision making in terms of what you think should be the best way to grow and bloom your business, then other financing options can be tried. Let's go through these, one by one.
Financing Through Equity
Financing through equity means selling of the shares of your ownership of the business. While you can receive additional capital required for scaling up, yet you would no longer be able to remain the majority shareholder of your company, resulting in erosion of control.
Crowdfunding
Crowdfunding enables you to propagate your business idea through various channels, and you ask regular individuals to invest as partners. However, there is no debt or paying back involved, yet it is very uncertain means as you cannot be sure of getting sufficient money you require.
Angel Investment
Angel investors are those groups of individuals who finance a significant corpus of money to a startup idea without expecting a payback. Yet they might want to control many crucial aspects of your business. Moreover, such investors can't provide enough funds as per your expectation.
Industrial Loans
Frankly, banking institutions cannot be called an excellent option for financing startup organizations as its disadvantages outperform its benefits. Startup company has to prove its profitability in the current times to obtain loans rather than its future potential, which is rarely the case with startup companies.
