Introduction
The provision of venture capital (VC) funding is essential for developing innovative businesses. Although venture capitalists support less than one-quarter of 1% percent of companies overall, around half of all real initial public offerings are funded by venture capital. There is a correlation between venture capitalists’ measures to generate value and the success of the firms that they assist financially (Gompers et al., 2020). Venture capitalists are remarkably useful at solving a major challenge in market economies, which is the problem of connecting innovators with brilliant business ideas but no financial resources with investors who have finances but lack ideas. This paper advises entrepreneurs on how to approach venture capitalists by enabling them to understand their tactics during their investment and how they can become successful investors.
Venture Capitalists’ tactics
Deal Sourcing
Venture capitalists source for investment with high return potential. Venture capitalists consider deal selection and sourcing the most crucial drivers of investment returns. According to Gompers et al. (2020), venture capitalists enjoy great value if they have a wide funnel of promising investments. Therefore, they obtain investors from a variety of sources. For instance, they source investors from professional networks, referrals, and self-generated investors.
Investment Selection
After deal sourcing, the organization might be presented with hundreds or thousands of potential investors. Therefore, venture capitalists must narrow the investors to manageable investments (Gompers et al., 2020). The venture capitalists examine the entrepreneur’s business model, the level of competition the organization faces, its products and technology, market and industry, and the quality of the organization’s management team.
Deal Valuation
To determine whether an investment can contribute significant profits, venture capitalists conduct a valuation of the entrepreneurs to assess their potential.
Valuation methods
Investors must understand how venture capitalists undertake the deal valuation. In this light, venture capitalists use several strategies to determine organizations’ value. For instance, they may apply Discounted Cash Flow and Net Present Value methods to determine the organizations’ values and worth (Lahr & Mina, 2020). Additionally, they may use the Internal Rate of Return to examine an organization’s potential profitability. However, most venture capitalists (63%) use the Multiple of Invested Capital metric for valuation.
Forecasting
For an effective valuation using the Internal Rate of Return, the Multiple Invested Capital Metric, and Discounted Cash Flow metrics, venture capitalists should forecast the underlying cash flows of an organization. However, Gompers et al. (2020) state that most venture capitalists do not conduct projections. Instead, they want to understand how organizations monetize their products while other venture capitalists construct detailed business or revenue models.
Valuation Considerations
During valuation, venture capitalists must take several factors into account. For instance, most valuators consider exit considerations as the most significant factor for determining the worth of an organization (Gompers et al., 2020). Secondly, they consider the comparable company’s valuation rank and the desired ownership. Additionally, the venture capitalist may consider the comparable pressure exerted by other investors, although it is not very important. The investors rarely use target ownership and the investment amount as valuation criteria.
Deal Structure
One aspect of the negotiation process between prospective VC investors, current investors, and entrepreneurs is valuation. The complex contract provisions that Venture Capitalists negotiate in their investments, such as cash flow, control, liquidation, and employee rights, are another important factor. Gompers et al. (2020) developed a model to determine the factors that would induce entrepreneurs’ and venture capitalists’ interests in a contract. According to Gompers and colleagues, venture capitalists prefer less flexible deals except for dividends (Gompers et al., 2020). In this light, venture capitalists desire deals that offer them more benefits.
Post Investment Tactics
Not only do venture capitalists provide crucial benefits to entrepreneurs, but they also offer value-added benefits after the investment. Venture capitalists are essential in structuring an organization’s board of directors. In this light, they help entrepreneurs hire managers and directors to aid in running the organizations. Additionally, since the venture capitalists work in a cluster-like environment with an enhanced connection to the whole supply chain, they help the entrepreneurs attract customers.
Attitudes and Experiences that Makes Entrepreneurs Successful
Competitiveness
Venture Capitalists prefer to invest their money into leading goods and services with a reliable competitive advantage. They seek entrepreneurs that provide superior products to the market or commodities that are far more affordable. Venture capitalists seek a market advantage before competitors join and reduce revenues. Additionally, they want their portfolio businesses to generate maximum sales and profits (Jeong et al., 2020). Therefore, investors prefer innovators who can maximize profits in the market due to their innovative nature.
Solid Team Management
Management is the most crucial factor that venture capitalists consider before making investments. Venture Capital firms invest mostly based on the management potential to undertake the organization’s objectives (Gompers et al., 2020). Businesses seeking venture capital should provide names of qualified personnel and managers to the investors (Jeong et al., 2020). Entrepreneurs that do not have adequate qualified managers should bring in outside candidates to fill the gap. Additionally, investors will support entrepreneurs with poor management potential by replacing their managers with qualified and experienced managers.
Innovativeness and risk-taking
Risk-taking is a venture capitalist’s primary duty, and they want to understand the challenges they may face when investing in a young company. A spectacularly profitable, high-return investment can have its benefits tarnished by a money-losing venture. Therefore, before investing in any opportunity, venture capitalists invest much time in determining the success potential of an investment (Amit et al., 2017). They want to understand the scope of the market potential, the managers’ competence, and the products’ viability. Additionally, they aim to lessen the opportunity’s risk (Gompers et al., 2021). They will want to know what the company has achieved and what still needs to be done as they interact with the company’s founders or examine the business plan. Venture Capitalists may employ various methods to assess, measure, and attempt to limit risk. However, they aim to reduce risk while generating significant investment returns (Jeong et al., 2020). Therefore, investors must be innovative to develop quality business plans and initiate a business with limited risks and high-profit potential while seeking venture capital. Additionally, they should develop risk mitigation strategies to induce investors’ interest in venturing into their business.
Conclusion
Venture capital is essential for startups and established firms in financing businesses. Like entrepreneurs, venture capitalists are in business and aim to maximize profits. Therefore, they develop strategies to ensure that they invest their resources in profitable ventures that pose limited risks to their aspirations. This paper has illuminated venture capitalists’ tactics when dealing with entrepreneurs. Furthermore, the paper enables entrepreneurs to understand the qualities and experience they should possess to be successful in business.
References
Amit, R., Brander, J., & Zott, C. (2017). Venture capital financing of entrepreneurship: Theory, empirical evidence, and a research agenda. The Blackwell Handbook of Entrepreneurship, 259-281. Web.
Gompers, P. A., Gornall, W., Kaplan, S. N., & Strebulaev, I. A. (2020). How do venture capitalists make decisions?Journal of Financial Economics, 135(1), 169–190. Web.
Jeong, J., Kim, J., Son, H., & Nam, D. I. (2020). The role of venture capital investment in startups’ sustainable growth and performance: Focusing on absorptive capacity and venture capitalists’ reputation. Sustainability, 12(8), 3447. Web.
Lahr, H., & Mina, A. (2016). Venture capital investments and the technological performance of portfolio firms. Research Policy, 45(1), 303-318. Web.