7/28/2019 Role of Venture Capitalists

1/3

Venture capitalists contribute their finances, also known as venture capital funds, to dedicated venture capital

investment firms. Venture capital firms, holding funds from investors are organised as limited partnerships. The

capital is reserved for investment in companies that promise high returns in five to seven years.

Venture capital firms employ small teams of professionals with industry experience and business training, who add

expert value to investment decisions. Investment decisions generally involve venture capital investments to small,

yet promising companies, who were rejected as potentially risky ventures for standard bank loans or capitalmarkets.

The role of venture capitalists is to:

Offer financial assistance to young and fast growing companies

Purchase equity securities for the company

Offer expertise and ideas for the development of creative products and value services

Actively participate in company management and production

Encourage high business risks to fulfil expectations of higher profits

Offer businesses a long-term association and orientation for success

If you are considering applying for venture capital, you must carefully screen the business merits of the venturecapital firm you plan to deal with. Venture capitalists will typically invest small amounts in businesses with long-

term prospects. Venture capital firms will also actively involve themselves with the companys management.

Venture capitalists also take up entrepreneurial roles in a companys management at its nascent stage. This adds

tremendous expertise to the companys management, business ventures, policies and decisions, and helps realise

higher returns. Direct involvement with the company differentiates venture capitals from buy-out private equity,

which involves investments in a company against proven profits or revenue generation.

Involving a venture capitalist in a companys management means associating with job creation and innovative

business techniques, market knowledge and expert measures for a successful business. A venture capital investor

will usually aim towards business advancement, higher profits and reaping greater benefits from businesses during

their early stages of operation.

Venture Capital investors is the ability to identify those businesses that have potential for rapid growth. This also

means generating high financial returns for the investors in the early stages of a business.

Young businesses applying for venture capital investments require a combination of the following qualities:

A well-developed strategy for new business ventures.

Rapid-growth potential

Advanced, innovative and leading-edge technology for business

A management team with impressive market experience, business training and ability to come up with fresh and

creative business models.

Venture capitalists generate profits by providing equity financing to startups that have high growth potential.

Venture capitalists buy the equity of a startup and liquidate their shares either through an IPO or through an

acquisition. Given this situation, the growth potential and the risk factor of the startup critically determine the

profits VCs generate. The success of a startup depends on a number of factors. Venture capitalists carefully

examine each factor before they decide to fund the startup.

Venture capitalistsassess the risk using the following factors:

http://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspx

7/28/2019 Role of Venture Capitalists

2/3

Founders/Management TeamCompetitive AdvantageMarket PotentialBarriers to entryExit Strategy

Founders/Management Team

Management teams typically constitute the founders along with other individuals committed to the startup idea.This team typically plays the pivotal role in executing the startups day to day operations. The management teamshould be able to steer the startup through risky and volatile situations. Therefore, Venture capitalists assess thestrength of a management team by examining the members from three different perspectives.

First, Venture capitalists look for professional experience, most notably a proven track record. Every startup isassociated with marketing and operational efforts. Therefore, venture capitalists expect the management team tocontain an experienced marketing executive along with an experienced operational executive. And if the startupidea is based on an innovative idea, VCs would like to have the inventor or a technology expert on board.

Second, Venture capitalists look for admirable personal traits in the entrepreneurs such as reliability, reputation,trustworthiness, etc. Venture capitalists want the entrepreneurs to run the show, so they would like to deal withentrepreneurs who have established credibility within the industry. Venture capitalists generally tend to invest inentrepreneurs whose reputation can be verified.

Third, Venture capitalists look for entrepreneurial abilities in the team. Heading startups is much more difficultthan heading large organizations, primarily because of the limited resources most startups generally have. Startupsare synonymous with huge risks, and the management team should not only be extremely passionate and willing topersevere about an idea, but also have the ability to take a calculated risk.

Competitive Advantage

The competitive advantage of a startup corresponds to the possession of rare core competencies that radicallycreate value to customers. A firm can truly say they have a competitive advantage if competitors cannot easilyimitate their core competences. Although it sounds very abstract, a competitive advantage is easy to articulate.The competitive advantage of a company is the unique specialty that no other company has in the market. The

competitive advantage of Toyota is that it offers reliable and quality cars at cheaper rates. The competitiveadvantage of IBM is that it is a one stop shop for all business computing needs. Similarly, the competitiveadvantage of Google (during its inception) was that it offered better search results than its competing searchengines. And the competitive advantage of any high technology startup is the underlying technology.

Startups generally commence with limited resources and aim to achieve inorganic growth and generate wealth forits shareholders. Such inorganic growths are possible only when startups have serious competitive advantages.Startups should be able to leverage their competitive advantages and become successful business organizations.Venture capitalists look at the competitive advantage a startup has before they determine the startups growthpotential. Every entrepreneur should articulate the competitive advantage of his/her business idea beforeapproaching investors.

Market Potential

A startups market potential defines the total sales that the startup can eventually make. Market potentialdepends on three individual parameters: market need, market size and market penetrability. Market needdescribes the problem the startup intends to solve. The higher the need, the higher the probability that thestartup will generate sales. Market size describes the quantity/size of the sales opportunities for the solution thatthe startup offers. A bigger market can allow the startup to generate higher revenue. Finally, market penetrabilityrefers to how easy it is to make sales and generate revenue. In other words, market penetrability refers to themarketing efforts that the startup needs to exert before it penetrates into the market. Not all markets are easy toenter in spite of the market need and size. For example, even if a startup develops a revolutionary car that gets1000 miles per gallon millage, the startup wouldnt find it any easier to penetrate into the market than a bettermarketed vehicle that gets 500 miles per gallon. The new car still has to pass several safety regulations set by the

http://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/http://www.go4funding.com/http://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/http://www.go4funding.com/http://www.go4funding.com/http://www.go4funding.com/http://www.go4funding.com/http://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/http://www.go4funding.com/http://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspx

7/28/2019 Role of Venture Capitalists

3/3

National Highway Traffic Safety Administration before it can be brought onto the market. This is a relatively timeconsuming process. And even after the governmental regulations, the car has to appeal to the general public.

Startups face several challenges in determining the size of their markets. First, researching the market requiresresources that most startups cannot afford. Second, as startups are based around radical ideas, it can be difficultto identify the target market. Third, at times, it becomes very hard to clearly define what kind of value thebusiness idea offers to customers. For example, the venture capitalists that funded Splunk (www.splunk.com) had

trouble articulating the company value offered to customers. However, Splunk turned into a successful company.

Venture capitalists closely look at the market potential for a startup idea before they decide to fund the idea.Entrepreneurs should focus on clearly defining the market before approaching investors.

Barriers to Entry

A startups barriers to entry represent the unique circumstances that thwart competitors attempts from enteringthe startups target market and capturing a major market share. The startup can establish several differentbarriers to defend itself against competitors. Such barriers include internal capabilities, government regulations,intellectual barriers, market share, partnerships, first mover advantage, brand name, economic and marketconditions, competitors' reactions, customer relations, etc.

Note: Although patent attorneys claim that patents constitute the best defense, in reality, large companies thatare not in the medical/pharma space use patents to sue each other. Although patents theoretically offerprotection to startups intellectual property, it is easy to reengineer the intellectual property and create a newproduct. For example, patents are more or less irrelevant in the IT industry. However, the role of patents in thepharmaceutical industry is completely different. Patents constitute the life line for most pharma startups.Entrepreneurs should clearly examine the pros and cons of investing in intellectual property before they approachinvestors.

Venture capitalists seriously consider barriers to entry. Entrepreneurs should clearly articulate the barriers ofentry that they wish to establish.

Exit Strategy

Startup founders should initially plan for a strategy of "cashing in" on their company allowing venture capitalists to

liquidate their shares. In general, venture capitalists prefer one of two kinds of exit strategies: IPO andacquisition. Going public is the ideal exit strategy that every venture capitalist would prefer. However, not allcompanies have the potential to go for IPOs. The exit strategy for such companies is to be acquired by a biggercompany. It is very important for entrepreneurs to articulate the exit strategy.

One of the primary goals ofstarting a business is to make money. However, it takes an undeniable amount ofcapital in order to properly launch and sustain a business.

http://www.go4funding.com/http://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/http://www.go4funding.com/http://go4funding.com/Articles/Entrepreneur/New-Business-Funding.aspxhttp://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/http://www.go4funding.com/http://www.go4funding.com/http://www.go4funding.com/http://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://go4funding.com/Articles/Entrepreneur/New-Business-Funding.aspxhttp://www.go4funding.com/http://www.go4funding.com/Articles/Venture-Capital/Venture-Capital.aspxhttp://www.go4funding.com/