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Friday, May 13, 2016

Why Are Some Startups Wary Of Equity Venture Capital

On an average, out of every 10 startups 1 will be truly successful; 3 will completely fail; and the rest will tide along till they too collapse, or get taken over. The reasons could be numerous, ranging from weaker domain expertise to lack of planning. However, limited access to required funds still poses the biggest challenge for a budding enterprise. Once the seed capital (mostly supplied by entrepreneur’s own savings or by friends or family) runs out, the need to arrange alternative means to remain afloat becomes an imperative.

What makes businesses skeptical of equity?

While bank financing remains one of the choicest modes of financing for profitable ventures, start-ups are often packaged with more risk than a bank is willing to take. The other option can be private equity financing, where the company raises capital by issuing stocks to an early-stage investor. Sometimes, start-ups and MSMEs are doubtful about this mode, primarily because they do not want:
  • profits sharing;
  • dilution of control;
  • non-traditional options; and
  • exposure of their business ideas
In addition, most small enterprises do not know how to approach investors.

Are the doubts well founded?

Sometimes, complexities should be better left to experts. Enlisting expert help can dispel the unfounded doubts about private equity funding, helping acknowledge why venture capital is more than just funds.
Suitability of equity: While debt may be a more inexpensive form of capital, it entails regular periodic interest repayments whether the company makes profits or not. Equity interest requires distribution of profits, but does not require the payment of “standing charges” in the form of interest. Unlike debtors, equity holders have their interests tied to the success of the firm. They only have a residual claim on the firm’s profits. Therefore, equity investors do their best to aid the growth and profitability of a business they are a part of.
Management expertise: Usually, small businesses demonstrate more inflexibility and resistance to any potential dilution of control. The common sentiment is that investor “interference” in the day-to-day management can disrupt the flow of business. Except that, it cannot be more misplaced. If chosen well, investors can bring with them the kind of managerial experience that helps not only in structuring the business around its tactical goals, but also in fine tuning its strategic vision.
Unorthodox, not unfounded: Start-ups seeking equity capital cannot raise funds by IPOs, but they can go to “Angel” investors, Venture Capital firms or Strategic partnership investors. Many small businesses cannot evaluate whether their business model will find favor with investors. They lack of proper information and a structured approach towards preparing for private equity. This also explains the skepticism around the cost and complexity of the process.
Professional help takes away much of the headache of managing the process. As long as the business or idea is substantial and transparent, the right consultant can find the best suited investor and seal the deal. The process an equity investor follows to scrutinize a proposal is not very different from that followed by a bank or other lending institution. However, the end goals differ. Unlike common belief, a consultant’s fee does not really break the bank, particularly as the biggest chuck of it is payable only when the funding deal is through. Also, this fee is paid out of the newly raised capital.
Safeguard of business secrets: Many businesses are not comfortable with the idea of sharing their trade secrets and business plans with the potential investors. This is particularly because an entity has to approach multiple potential parties before a deal is finalized. However, this fear is mostly not substantive. Private equity investors are structured as professional, registered entities that follow legitimate industry practices. An investee’s insider information is required only after the initial screening stages of the investment deal process. In addition, entrepreneurs can safeguard their interests through legal contracts with non-disclosure clauses.
Equity investors bring much more on the table than just the funds, such as industry networking, incubation supports, and the much needed objectivity.

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