The role of venture capitals has to be much more than selecting a good business to provide funding and should extend to value-creation
The importance of start-ups in an economy cannot be undermined as they are technological revolutionaries, disruptors and creators. They create new industries, provide jobs, increase income levels, improve quality of life and play a critical role in the changing the image of a nation. With as many as 50,000 startups, of which a significant increase is from tier-II and tier-III cities like Kochi, Ahmedabad and Pune, India is now considered world’s 3rd largest ecosystem, according to Startup India portal.
However, failure is the other side of Startup industry. In a study conducted by Oxford Economics and IBM’s Institute of Business Value, it was found that 90% of India’s startups fail due to lack of innovation. In fact, according to KPMG report, in 2020, revenue of atleast 30 percent of Indian startups declined by about 80 percent, whereas 70 percent of them had the probability of running for the next three months only.
Apart from business environment created by government and a robust banking network, a strong venture capital industry is one of the crucial requirements to develop successful startups. Overall, the success of start-ups is a collaborative effort of both entrepreneurs and venture capitalists.
Venture capitalists work in a highly competitive environment and yet typically generate a mediocre return. Add to this the high failure rate of entrepreneurs, a better working strategy is a critical need of the hour for venture capitalists. The type of financing provided by venture capitalists is unique and very different from that provided by private equity funds or commercial banks. These organizations provide funds in the form of corporate lending to firms that are established and have a proven track record of operations and profitability. On the other hand, venture capitalists provide funding to new, high risk, technology-oriented companies that operate in a fast and volatile environment with constantly changing paradigms. They work with entrepreneurs with an idea but fairly less experience about implementing the idea, identifying and putting together a competent team and developing the customer base. The lack of experience and an established record of performance of startups make investments in them extremely risky and uncertain. According to Harvard Business School’s entrepreneurship professor Shikhar Ghosh, about three-quarters of startups backed by venture capitalists are not successful enough to return cash to their investors. Therefore, the role of venture capitals has to be much more than selecting a good business and provide funding and should extend to value-creation. In addition to providing strategic direction, most venture capitalists are already extending their support to various functional aspects of start-ups. Firstly, venture capitalists help in team building in start-ups by identifying and recruiting appropriate talent, which is the most important asset of a start-up. Secondly, providing support to the administrative activities like accounting, legal and other routine organizational responsibilities can free up founders’ time which can be further used for growing business. Thirdly, venture capitalists help start-ups in building the right skills for all employees and the leadership team. Fourthly, probably the most important, is providing strategic focus by defining the target market, underlining the scope of the product or service, identifying the competitive advantage and providing appropriate strategic direction. Additionally, support to building a customer base is an essential encouragement. And lastly, the most important aspect of venture capitalist and entrepreneur relation is access to its network. Venture capitalists also provide performance metrics to startups to monitor, measure and report their performance at their early stage.
So, on what basis should a venture capital fund decide the extent of its involvement in a startup - at a very basic level, the participation is only financial; the next level is mentorship and guidance; and the advanced level is operational. The decision is ought to be made by analyzing its assets and resources. The most common and important resource of a VC is cash that represents the absolute amount of funds available. If the cash resources are strong, VCs would invest in an administrative function that would add value to a startup, and in case the cash resources are not strong, VCs can introduce the startups to their network which can meaningfully assist them. Brand resources are also very important for a VC which can be evaluated by the frequency of their citing in print, electronic and social media. Network resources are perhaps the most crucial of all contributions towards the growth of startups. Introductions to members of personal networks can help startups in either time-savings or cost-savings or both.
(The writer is Associate Professor at Amity University, Noida. The views expressed are personal.)