Why Venture Capital Firms Help Start-Ups to Grow

In a world more and more complex, the competition is tough and formidable. Everyone tries to stand up as much as possible. That is why the number of start-ups launched each year is astonishing, we are talking about more than 650,000 of them only in the UK through 2016 (Data.worldbank.org, 2019). This great amount is mostly possible thanks to Venture Capital Firms “VCF” which fund numerous of them. Undeniably, a VCF’s interest is to realise profits. But we can ask ourselves the following question: To what extent VCFs are willing to help start-ups growing?. The analysis will firstly go through the manner and reason of helping a Start-up, then it will talk about the ways of exiting them.

As we said it before, VCFs are the main funding organisation that help start-ups with the sole purpose of earning interest or generate a return on investment, “ROI”, through an eventual exit. They provide them funds gradually as long as they passed the Seed or Early stage, where they’ve been funded by angel investors, and moved on the Growth stage or Serie A Round. Thus, most of the time, VCFs owns equity of the company under the form of equity and take, just like its board members, the decisions related to the future well- being of the start-up. At the beginning, the success is not certain and the investment is not really profitable. “But as the company grows and becomes more valuable, the value of the fund’s corresponding percentage grows as well” (Rose, 2019).

Therefore, they are going to fund the start-up as long as they consider it worthy. They can help the new company providing them with strategic assistance, introductions to potential customers, partners, and employees in addition to funding them. Then, from the Growth Stage, the VCF accompany them through others rounds or stages until they opt for cutting their funds or, on the other hand, the start-up decides or is sufficiently developed to exit the so-called “sponsorship” (MPG, Madison Park Group). This can occur regarding several factors and for several reasons but most of the time, the exit plan was already planned by the VCF at the beginning after the agreement of both parties.

The exit arrangement between the VCF and the company outlines several possible scenarios, such as an initial public offering “IPO” or a buyout by a larger company which we can call a Merger & Acquisition scenario (Investopedia, 2019). When the company is wealthy enough to not rely on a VCF anymore, it decides, in the most common cases, to do an IPO. Consequently, VCFs do not need to provide help to the start-up anymore since this last is auto-sufficient. The investor will either choose to keep its ownership of the company under the form of preferred and/or common stocks, and their ROI will depend on the stock’s price at a given time; either directly sells its shares after the operation.

These scenarios are in case of a consequent growth of the company in the future, but that is not always the case. For instance, the company may get a buyout offer that is below the cost of the venture capital invested, or the stock’s value might shrink at its IPO price and never rises furthermore. In such cases, the investors get a poor return for their money. This is why VCFs hire consultants to help them know if they should pursue their investment in the company or not.. Therefore, they may decide to cut the findings of the start-up if, unfortunately, this latter doesn’t fulfil its objectives at the end of one of the stages or is not considered worthy anymore. Therefore, the VCF will rather sell their ownership and stop helping the company than suffer from further losses on their investment. Selling its equities is called a secondary purchase for another investor.

Summing it up, we have seen that VCFs behave in order to fulfil their interests and helping the new companies is part of this. They subsidize them inasmuch as they find them potentially profitable either in the long or in the short term. A soon as they don’t anymore, VCFs will stop helping them and exit sooner than predicted. But can we really consider VCF as the best investor for new start-ups as more and more alternatives may be more valuable in the market?