How VC funding works


By: Vignesh

 

vc1

“Startup gets multi million valuation” screamed ET. “Startups made richer by VCs” pitched in BS. In this age of entrepreneurship which by the way is a free word that is used, misused and abused quite a lot these days. Entrepreneurship or in contemporary urbane dictionary-startups ( I am inclined to use this simply to avoid typing such a long French word!) is an echo that we cannot shut us off from. Every blue eyed kid graduating from college dreams of being-from the top of list and in that order- Steve ,the apple guy; Larry, the google guy; Mark, the facebook guy; Jeff, the amazon guy; and that twitter guy, that whatsapp guy and so on and on. We are abound with stories of their beginnings in a dorm or a garage or on the streets and grow up to become big guys.

But how did these startups grow up to be so big?

In the era of competition where ideas get crushed instantly under the wheels of financial deficiency, the capability to be in the race is necessitated on having pockets deep enough to be able to tide over waves and fires and come out unscathed.

These deep pockets become mentors sometimes for these future giants. They are called Venture Capitalists or VCs.

vc2
VCs might be a term of recent origin but not the job of VCs. VCs have been flourishing since ages even in India. Across Indian business history many business communities have an inherent mechanism to be VCs. It could be flourishing businessmen or religious institution sponsoring a new venture, they all fall into this category.

The objective here is to understand how the system works.  An idea is formed and turns actionable. A startup initiates its operations with help from credit and savings of the founders. Once the initial euphoria dies down it stares at competition and increasing costs. At this time many startups are vulnerable, either shutting shop or eaten up by other bigger rivals. It is here that many startups hold the hands of VCs. The VCs have enormous resources to be deployed and they want returns on it. No one will like their money to be idle. They are in constant lookout for better returns. They might as well be content with post office savings but these guys have a huge risk appetite. They are willing to take big risks to gain big returns. It’s a classic “all-in-or-nothing” moment. They scout for such infant businesses with potential for returns in three to four years. The startups are happy naturally. Their deficiency is bridged. They have the backing that will help them to take big risks and expand their business. But there is a catch. There are no free lunches here. If the VCs are investing they also expect to be in the decision making of startups. The startups are answerable to these VCs. These startups lose their independence to a degree depending. The right mix of this understanding between VC and startups is necessary. Often it is compared to marriage and it cannot be more right.

One of the most successful partnerships between VC and startup is Google. Its VC a famous and established name Kleiner Perkin Caufield & Byers (KPCB) and Seqoiua capital. These VCs funded Larry Page’s and Sergy Brin’s search engine to grow into a huge monster of a company just within a decade. They also held a portion of stock and with it voting rights. Now it could be imagined the returns these companies made on their bet.

vc3
Another question that could arise in one’s mind is that if the objective was to raise funding then the startups could have gone “public” ;but that’s even bigger a risk. An unknown company in the market with improper valuations and uncertain returns could be suicidal. But ultimately these startups when they grow big, they go public but with the backing of VCs. Since they have had their funding these startups since have grown to be corporations and VCs are laughing all the way to banks.  So VCs arrive at that crucial phase and see through till end. Some VCs sell their stakes once their returns are realize, some like KPCB and sequoia hold their seats in corporations like Google.

Like VCs there are individuals who like to commit a small amount in comparison and are called angel investors. They don’t expect to be on board and don’t hold voting rights. They are on their own in terms of sponsoring an idea and expecting returns. But they perform an important function in terms of nurturing talent which can be taken up by large VCs.

This year alone India has witnessed pumping in of 4bn USD into startups in different sectors. Some of the recent and notable startups to have gained traction among VCs are flipkart, snapdeal, paytm, etc. Like what happened in US in last decade, the question in our minds is are we poised to see  VCs spotting the next Google in India?

 

2 thoughts on “How VC funding works

  1. Venture capitalists themselves dont launch IPOs. IPO is launched by the company concerned. The VCs facilitate it. Investment bankers help sell the stock of the company to other investors thus making money in form of increased commissions. Very true in the sense that IPOs may or may not be successful so is every thing in financial world sir!

  2. Query-How do Venture Capitalists launch IPOs if they don’t have voting rights on the board ? And how do Investment Bankers benefit from these IPOs ? IPOs may or may not be successful depending on the repute of the startup.

Comments are closed.