In a nutshell, venture capital is simply money given to entrepreneurs in exchange for their services. It’s an important part of the process of raising financing for startup companies, since it provides the investors with significant value that comes from the companies’ ability to generate revenue. Below are five of the advantages and disadvantages associated with venture capital, listed in ascending order.
Disadvantages – Time & Resources
Venture capital funding takes time to be approved by investment bankers and other principals who make up the venture capital community. Because this type of financing usually involves large sums of money, it often takes a considerable amount of time for a successful deal to be struck.
Sometimes even the completion of the capital investment itself can take a substantial amount of time to close. This also means that the company being funded will often have to wait for the funds to come in before they are ready to launch. This added delay makes venture capital funding more expensive and takes more time to pay off than non-venture capital funds.
As a result, venture capitalists may require that the company providing the capital needs to set up operations in order to earn the additional funds necessary to begin to create a viable business. Additionally, it may take a longer period of time to bring in additional funding.
Disadvantages – Low Success Rate
Venture capital funding is typically intended to fund businesses that have a very high chance of success. The great majority of companies that receive venture capital funding will not be able to meet the projected profits and profit margins that investors expect from their businesses.
A typical venture capital investor looks for at least a 65% success rate on their investment to be able to consider the investment a success. Therefore, even if an entrepreneur does raise money from a successful investment, the company has still not fully met their projected goals.
To put this another way, an investor will not get back the money they invested unless the company that received the capital manages to start earning a decent profit. Therefore, if the venture capital funds are needed to fund an ambitious project, it could be impossible to meet the projected profit goals required for the investor to get their money back.
Disadvantages – Limited Return
Venture capital is often considered to be one of the riskier types of early stage investments. However, there are some disadvantages associated with it that help to explain why it’s considered to be such a risky venture.
Since venture capital companies often provide very high level of risk, they are extremely conservative when evaluating the merits of an investment, particularly those who wish to get into the business. For this reason, their standard of performance is often higher than average.
Of course, the standard of performance that these companies expect will vary based on their type of business. Since the investors are seeking to make high returns, this tends to mean that the standards are not as stringent as they are for private investors.
Therefore, while it’s a good idea to seek the advice of experienced entrepreneurs who have been in the industry for a number of years, it’s also a good idea to avoid the venture capital company that offers the lowest return for the highest risks. This is particularly true when you factor in the costs associated with the projects and the expenses of starting up the business.
Disadvantages are important to consider when getting into the venture capital business. However, understanding what advantages and disadvantages there are associated with the venture capital community can help to provide the entrepreneur with the knowledge and background they need to make an informed decision about whether it’s right for them.