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Venture Capital funding - Pros and Cons

Posted in Finance Articles, Total Reads: 4499 , Published on May 31, 2011

As the India is growing, it has led to rise of young entrepreneurs who are willing to go that extra mile.  But as they tread their path, there is always hindrances in terms of funding required for starting up or expanding the already existing operations.  It is very difficult for such start ups to get loans from the banks as they do not have sufficient operating history to qualify for traditional loans. Venture capital firms help in financing needs of such startups. In most cases, start ups are required to provide the venture capital company with a form of profit sharing by providing equity in the company. It is not easy to convince a venture capital company to fund your business unless you demonstrate high rate of returns.  Let’s understand what are the pros and cons of venture capital funding:

Venture Capitalist-Are you ready ?

Pros of VC

Business Consultations: Many venture capital companies have business professionals who have vast experience in the markets. They can provide the right insights about the business and guide them to face the competition.  They can also help a start up firm avoid many pitfalls that are often associated with start up business ventures.

Management Consultations: Not all entrepreneurs are good at management. Most of the venture capital firms require some portion equity and hence have a say how the start up is managed. For a non management founder, this can be really helpful.

Human Resources: During the initial phase, it’s really difficult to attract high quality talent to work in the startup firm.  Venture capital firms provide the strength and credibility to attract quality talent. They often provide consultants who are specialists in hiring and this can help start up avoid pitfalls of hiring the wrong people for their company.

Additional Resources: Starting a company requires all kinds of additional resources like expertise on legal matters, payroll matters, tax issues etc. Venture capital firms provide resources to manage these as they have vested interest in the success of the company.

Cons of VC

Most of the venture capital firms have their representative in the management of the startup. This is generally to ensure that the company can be successful though it sometimes creates internal problems

Equity Position: Most of the times, venture capital firm require company give up an equity position to them in return for their funding. Sometimes it is more than 50% of the equity.  This means that founder is not controlling the business but it is controlled by the venture capital firm

Decision Making: One of the biggest problems that many entrepreneurs face when they agree to accept venture capital is they often are giving up many key decisions in how their company will operate. Many times founder’s goals conflict with venture capital firm as venture capital firms are looking for short term gains (3-5 years) while founder has long term vision which results in clash of interests.

Whenever a financing decision is made most of the banks or financing companies sign non disclosure agreement. This is not the case in most venture capital firms. Venture capital firms will nearly always refuse to sign a non-disclosure agreement due to the legal ramifications of doing so. This can put ideas from an entrepreneur at risk.

Venture capital funds are released on basis of milestones and targets. If a particular milestone is not achieved, venture capital firm may exit the investment even though the founder has complete faith in the turnaround. 

Venture capital funds are not for all. Venture capital firms generally tend to focus on high growth potential industries. You should always research and analyze pros and cons before approaching venture capital firms.

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