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Four things every aspiring entrepreneur must know about venture capital

23 February, 2017

Venture capital plays an important role in unleashing human potential. Think of this: financial capital can be a constraint for entrepreneurs raring to go, and people with the best ideas may not always be the people with enough capital to carry out their ideas. 

But here is good news: entrepreneurs everywhere have a better chance of finding venture capital than human capital, as venture capital flows more easily than human capital. 

Here are four important facts to know about venture capital:

1. Your chances at VC funding depend on where you live

The largest venture capital firms in the world are concentrated in the United States, especially in cities such as Los Angeles, San Francisco, San Jose, Seattle, New York, Boston and Washington D.C. Hence, it is not as easy for a startup in Bangalore or Gurgaon to get VC funding as it is for a startup in California. In fact, entrepreneurs in urban areas and large cities find it much easier to get VC funding, as most VC firms tend to be located there. 

This is not unique to venture capital — all kinds of innovation is geographically clustered. Yet, it is still true that venture capital funding crosses borders more easily and willingly than people do. This is a highly underrated fact, considering the crucial role venture capital has played in fostering innovation in developing countries like India. Venture capital bridges the gap between people who have capital and people who lack it. Without venture capital, many good ideas wouldn’t have become reality. Venture capital also helps in marketing products, and many other aspects of running a business. 

2. Venture capitalists are changing the world, one startup at a time

The job of a venture capitalist is unusually difficult. Venture Capitalist Marc Andreessen once said that even the most successful venture capitalists of all times fail in about half their investments. Half of the companies they invest in fail. This is not surprising, because the job of a VC firm is to invest in ideas which other people might think to be crazy. It is not easy for a VC firm to make money on tried and tested ideas, because such market segments are already well-funded. So, a successful VC firm is always investing in seemingly insane ideas, and when they do well, the world changes for the good. Imagine investments in Facebook, Uber, PayPal and Tesla? You get the drift.

3. Limited Partners (LPs) and private equity funds influence venture capital greatly

LPs invest in VC funds. The General Partners (GPs) who manage these funds actively search for startups to invest in. They evaluate the ideas, manpower and performance of these startups. GPs also enter contractual agreement with these startups. They oversee, and may even be actively involved in the management process. In the end, they exit their investments by selling their shares, and handing over the proceeds to LPs.

All this is difficult, because to make good bets, they should understand these businesses fairly well. A startup may find it difficult to grow if they are expected to explain their every decision to VCs who do not really understand the business. As startups tend to grow quickly, it is not easy for founders to get things moving if VCs are clueless. Still, getting good VCs to invest in a startup is important, because this makes it easier to hire good employees, and also to find good partners and suppliers. This is where LPs play a crucial role. 

LPs turn great ideas into reality by investing in such VCs who show good judgment year after year. To choose such VCs, LPs have to exhibit good judgment themselves. As GPs take even up to a decade to pass on the benefits to LPs, this takes great business acumen on the part of LPs. If LPs and VCs do not show sound judgment, some of the best ideas will just sit on the shelf.

4. Your list of early investors may influence your chances at venture capital funding in future

Good venture capitalists are likely to invest in a startup if early investors were good. The presence of early investors in a start-up indicates that it has already undergone rigorous assessment of its potential. With huge funds to invest, such assessment is the mandatory first step for the VCs. Their survival depends on this. Moreover, it is much easier for employees, partners, suppliers and future investors to rely on the judgment of early investors who have good judgment. 

In other words, a startup’s operations don’t have to be transparent. The reputation of VCs allows people to evaluate a startup. When it comes to startups which are not publicly listed, this is important. Publicly listed companies are expected to disclose information relevant to investors. This is not true of fledgling startups. Successful VC firms are better at this difficult task. 

Join the discussion on the emerging trends in venture capital funding in India. Sign up for the News Corp VCCircle India Limited Partners Summit on March 1-2 in Mumbai, and follow @vccircle and #LPMeet2017 on Twitter.

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Four things every aspiring entrepreneur must know about venture capital

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