The advantages and disadvantages of venture capital

For the launching and growing of a successful business, it is vital to devise a business plan, develop tailored strategies, and having sufficient capital. The first two stages of planning and strategy can be done by the entrepreneurs but for funding, they need to look for other sources. The entrepreneurs may have bright ideas with their services and products which may have a great potential for growth but without adequate funding, it is impossible for a new company to run smoothly. Seeking for capital from traditional methods like banks is  a lot more difficult without proven record and a lot of assurance.

So is there any other method of funding for startups to consider?

What is venture capital?

The term venture capital refers to the money that is provided to the startup in its early stages of development. The capital providers are investment companies, wealthy individuals, and venture capitalists.

With funds, the venture capitalists assist in the management and provide industry contacts for the growth of startups and in exchange, they require equity ownership in the company and the right to have control over the strategic direction.

Attributes of venture capital:

The features of venture capital are described below:

The degree of risk is high:

Investing in startup companies is highly speculative as the chance of growth and losses are almost equal. The investors usually choose the companies which have a high potential of growth in future so that they receive a high return on investment.

Equity ownership:

For trade-off, the investor requires equity participation in the company. It is the ownership of shares in the company. The purpose of the equity partnership is to gain high profits once the company becomes profitable.

Long run investment:

Investing in new companies is a long term investment. It generally takes time to earn the benefits of investment as the investors will start gaining high profits as the startup company grows.

Percentage of control in management:

As the investments are done through equity participation, the capital providers have a percentage of control in the management. Whether it’s the strategy-making or taking other company decisions, there is an active interest of the investor.

Venture capital funding varies from the stock market investing in which there is no participation in the management of the company but the only goal of the investor is to gain monetary profits.

Venture capital advantages and disadvantages:

There are many advantages and disadvantages of venture capital to both the startup and the investor. Therefore it is imperative to consider it carefully.

Advantages:

Source of quick growth:

For new businesses which have a high potential for growth, the venture capital is a good choice. In this way by having a sufficient amount in hand, the business owner is able to instantly convert the idea into real products or services and can expand the business in less time.

No paying of debt:

Venture capital is not a loan but rather it is just an investment. With this type of funding, the entrepreneurs do not need to sink in debt and do not have worries about repaying.

Help in a growing business:

Additional assistance is another benefit of venture capital. The capitalists usually have a team of professionals and experts who have knowledge in the specific industry. They can help the entrepreneurs to avoid the failures which are usually related to the new businesses.

Managerial assistance:  

As there is equity participation of the capitalists in the startup, they can effectively help in managing the business with the entrepreneurs. For example, they will make useful decisions that could be of significant benefit.

Help in the recruitment process:

As there is an investment made by the capitalists in the company, they also facilitate in hiring the best staff for the business. Capitalists have HR consultants who can help in avoiding the hiring of wrong people.

Reduced chances of fraud:

Venture capital firms are supervised by the regulatory bodies, that is why there are rare chances of dishonesty or fraudulent firms. 

Disadvantages:

Internal conflicts:

In exchange for the financial help, the capitalist desire to add a member of their team in the higher management of the new business. It can cause disputes and disagreements.

Diminished ownership:

If the percentage of equity participation is high then the venture firm gets more control over the company than the business owner. Many capitalists want more than 60% equity in the business.

Influenced decisions:

Another problem faced by entrepreneurs is the loss of authority in decision making for the company. In this case, usually, the decisions of capitalist are preferred with more influence in choosing the direction of the business as the venture capital firm has the power to reject the owner’s decisions.

Putting businesses at risk:

When a business plan is submitted for financing, the venture firms refuse to sign these due to legal ramifications. This greatly affects the business and can put the ideas at risk.

Takes longer to decide:

As there is an almost equal probability of profit or loss in a new business, the venture capitalists take long to decide for investment. They provide large investment and that’s why consider several factors before investing in a startup.

Not getting all funds in a single time:

Most of the venture forms do not provide all the needed funds beforehand. Rather, they release the funds after seeing the growth of the company. It leads to having limited funds in the hand of entrepreneurs therefore not good for the funding plans. Consequently, it may adversely affect the new business.

Do not wait long for return:

Generally, the investment firms want to deal with the desire of return on investment within a few years. For this, the firm may push to take quick decisions that could be turned as wrong for the businesses.

Conclusion:

The advantages and disadvantages of venture funding are many which do not make it suitable for everyone. Before making the decision for venture capital, it is crucial to do deep research and understand all the benefits and drawbacks of it.

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