Venture Capital – an indubitable  source of finance for start-ups

By February 16, 2024 No Comments
Perigeum Logo 6x2.7

Venture Capital – an indubitable  source of finance for start-ups

Shamin A. Sookia of Perigeum Capital Ltd unfolds the evolution of venture capital

over the years – explaining how, from being a source of finance for high-risk startups, it has now moved to funding lower-risk, management buy-outs – and then goes beyond to assess how it can withstand the current challenging environment to again come into its own.

While the Venture Capital (VC) world consists of funds made available for the financing of new business ventures, in practice a much wider range of activities than purely start-up situations have been financed by VC funds.

Indeed, the expansion of existing businesses and the provision of finance for management buy-outs may be funded by VC funds. Different stages of risk, different stages of investee maturity and consequently a different degree of post-investment active involvement by the venture capitalist are characteristic of these various investments.

Ultimately, venture capital is a way in which investors
support entrepreneurial talent with finance and business skills to exploit market opportunities and thus to obtain long-term capital gain. However, VC firms have been criticised to some extent for moving

CAPITAL MARKETS

away from high-risk start-up finance towards much lower risk management buy-outs (MBOs).

The provision of risk capital for young, high growth companies at an early stage in their development has, traditionally, involved venture capital. Also, VC investment in the early stages of maturity of an
investee company usually involves managerial support until the investee company is in a position to raise further finance from conventional funding sources. This aspect of “hands on” investment
distinguishes venture capital from other, more passive forms of investment.

A bit of history – the UK perspective

The acceleration in the rate of expansion of venture capital in the last decades has given the industry a much higher profile. In the UK, during the 1980s, there was a growing awareness of the rapid  emergence of funds in the US that were providing finance for early-stage investees.

The rapid growth in high-tech businesses requiring risk capital backing
resulted in the development of these funds. Also, during the economic recovery of the early to mid-eighties there was an increasing number of startups and management buy-outs. The attraction of riskier, longer-term investment increased with the increase in demand along with the general optimism of the eighties and the belief that the bull market
would be sustained. Further, in order to fuel economic recovery as well as make inroads into the unemployment figures, the UK wanted to promote new enterprises and small businesses. The developments in the capital markets were an important factor influencing growth of venture
capital as well.

A new exit route by which venture capitalists could realise the capital gains on their investments was provided by the creation of the Unlisted Securities Market and the Over-the-Counter (OTC) Market in the
UK.

Growth of the VC market and related characteristics Venture capital (VC) investment has clearly enjoyed substantial growth over the last three decades. There has been a significant shift away from start-up / early-stage finance toward MBO opportunities, although some would argue that this does not represent true VC investment as the extent of
technical and managerial input from the venture capitalist are minimal in most MBO investments. This trend has serious implications for the entrepreneur trying to raise finance for a new or immature venture.
It seems that it has become increasingly difficult to attract venture capital backing for such enterprises. It is therefore important for the entrepreneur to be fully aware of the types of investment that each fund will consider, and the methods that are utilised in appraising investment proposals, if the probability of success in security venture funding is to be maximised.

The following factors have been seen to be crucial for a VC investment to be successful:

● Investees’ managerial experience in the sector
● Marketing skills of the management team
● Projected growth turnover
● Size of the entrepreneur’s investment in relation
to means
● Financial skills of the management team
● Market sector experience

Critical measures of success versus failure

Historical data relating to businesses seeking VC backing is often perceived as having limited relevance as an indicator of potential future
performance due to the state of change of a business at a time when seeking VC investment. However,  projections which display trends that differ noticeably from any available historical trends may be treated skeptically by some funds unless there is adequate explanation of the change.

Studies conducted on VCs have revealed that in the view of the investor the major contributory factor to failure is the inability to achieve the predicted turnover. Other factors include failure to control costs,
lack of marketing skills and, often, the investees’underestimation of the time required to achieve targets.

So, in the overall evaluation, venture capitalists consider sector-specific experience amongst the investee management team to be very important.