The potential upside to the VC Platform is a more consistent level of returns generated by allowing more investors to participate, and as a result of more capital, more entrepreneurs will be attracted. The VC Platform will not alter the fact that many new companies fail – but by monitoring and evaluating more companies, the better the VC will be at spotting potential winners.
Venture capital funds (VCs) invests in early stage companies, and generates returns to their investors by exiting the investments through IPOs or M&As. A typical VC fund (part of the private equity asset class) operates for 10-12 years, before the returns are given back to investors and a new fund is raised. The business model of a VC relies on a few successful exits – not only pay for the high failure rate of the other early stage companies in the portfolio, but also to generate high returns to both investors and the VC partners. This business model has been in effect since the VC industry experienced a high capital inflow during the tech fever of the late 1990’s (just before the IT bubble), and has been the preferred model through the 2000’s where the industry experienced another capital inflow (just before the financial crisis of 2007 and the later global economic crisis).
The financial crisis has impacted the VC industry and this impact can be classified in five main effects:
1. Fewer deals
2. Longer waits
3. No exits
4. Low returns
5. Low fundraising
When the crisis hit, stock markets collapsed and risk aversion narrowed the IPO exit. VCs typically don’t invest in a company they cannot exit, and as VCs saw exit routes narrow, they made fewer or no investments. As stock markets did not show signs of recovery, the VCs held their companies, which resulted in lower returns for their investors. When the VC cannot deliver the high returns promised at the start of the funds lifetime, it can prove difficult to convince the investors that a new fund can do what the first failed to do.
Many VC funds now face the consequences of the five effects and expect to close the fund. The number of VC funds will shrink over the coming years as their lifetime runs out. Indeed a gloomy situation for the industry – but does it mean it is the end of (ad)venture capital?
Not quite. There are VCs that have managed to generate returns to their investors, and will be able to raise new funds. Moreover, the popularity of funding entrepreneurs has increased with success stories such as Skype and Facebook. More Angel Investors have been active after the crisis, and government funds have set up operation in order to ensure funding of entrepreneurs.
VCs needs to change the process in which it generates returns – and in extension the underlying business model must be adjusted. Having an even longer investment horizon than 10-12 years can be justified if the returns are generated throughout the process, and not at the end. Furthermore, by focusing on offering further business development in-house VCs can attract more businesses and potentially increase deal flow. With increased deal flow comes a greater requirement for investor capital. This could be solved by lowering the barriers of entry to becoming a VC investor – essentially taking the private out of private equity. The returns would be generated through IPOs, M&As but also dividends from ownership – thus creating a business model that is less depending on exit routes. The VC Platform created for this project is a combination of an incubation hub for start-ups, and a marketplace for investors to invest in start-ups.
The VC Platform urges VCs to both: find, develop, invest and exit companies. This might be a tall order, and mastering both in-house development and investors is a challenge. No question. The potential upside to the VC Platform is a more consistent level of returns generated by allowing more investors to participate, and as a result of more capital, more entrepreneurs will be attracted. The VC Platform will not alter the fact that many new companies fail – but by monitoring and evaluating more companies, the better the VC will be at spotting potential winners. This will not only benefit both entrepreneurs and investors, but also contribute positively to economic growth and global recovery.
Meet other experts on the topic, and check out their ideas in the following video: http://bit.ly/19kDyYC
Interested in finding out more about building a creative economy? Be sure to attend the MA Innovation Management Grad Show June 19-23 at Central St. Martins College of Arts & Design.