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Investor Sutras: Silicon Valley To Emerging Nations
While New York and London still get the lion's share of what flows from the entrepreneurial epicenter in Silicon Valley, India and China have made substantial gains
Photo Credit :
Bangalore bengaluru shutterstock_35930488
While New York and London still get the lion's share of what flows from the entrepreneurial epicenter in Silicon Valley, India and China have made substantial gains. The list also includes emerging markets of Malaysia, Vietnam, Indonesia and Philippines and investors have more than one reason to invest.
The Silicon Mecca and VC's origin
The Silicon Valley in North America derives its name from 'Santa Clara Valley' where the silicon chip innovators were traditionally settled. Eventually, it gained importance as the synecdoche of the American high-technology economic sector.
It has an intoxicating past of innovation, money, cutting-edge technology and a liberal dust of magic. Life here emerged with the venture capitalists and angel investors. When the capitalism history of entrepreneurial ventures was not funded by equity, it was funded through credit.
Nowadays, the term 'venture capitalist' is so familiar in the startup world that everybody tends to forget how it emerged? And why it is so focused on financing startups?
Venture capital in the United States began as a cottage industry, notable in the early years for investments in companies such as Intel, Microsoft, and Apple. In 1990, 100 VC firms were actively investing, with slightly less than $30 billion under management, according to the NVCA. During that era venture capital generated strong, above-market returns and performance by any measure was good.
What happened then?
During the peak of the internet boom, in 2000, the number of active firms grew to more than 1,000, and assets under management exceeded $220 billion. VC's didn't scale well. As in most asset classes, when the money flows in too much, returns fall and venture capital has not yet recovered. The number of firms and the amount of capital have declined since the boom, though they are both still far above the levels of the early and middle 1990s. And now, it should be understood that Venture capital financing is the exception, not the norm, among start-ups.
Is bigger the better?
Company founders often feel that signing a deal with a large VC firm lends cachet, just as MBA students may get special pleasure from being offered a job by a big, well-known employer. But industry and academic studies show that fund performance declines as fund size increases above $250 million. We found that the VC funds larger than $400 million in Kauffman's portfolio generally failed to provide attractive returns: Just four out of 30 outperformed a publicly traded small-cap index fund.
Agreed, that VCs take a big risk when they invest in your startup. True, they take a lot of risk with their investors' capital-but very little with their own. In most VC funds the partners' own money accounts for just 1per cent of the total. The industry's revenue model, long investment cycle and lack of visible performance data make VCs less accountable for their performance than most other professional investors. If a VC firm invests in your startup, it will be rooting for you to succeed. But it will probably do just fine financially even if you fail.
Why won't they ever fail?
Reasons 1- They are well insulated…
A standard VC fund charges an annual fee of 2 per cent on committed capital over the life of the fund-usually 10 years-plus a percentage of the profits when firms successfully exit, usually by being acquired or going public. So a firm that raised a $1 billion fund and charge a 2% fee would receive a fixed fee stream of $20 million a year to cover expenses and compensation.
Secondly, VC firms raise new funds about in every three to four years, so let's say that three years into the first fund, the firm raised a second $1 billion fund. That would generate an additional $20 million in fees, for a total of $40 million annually. These cumulative and guaranteed management fees insulate VC partners from poor returns because much of their compensation comes from fees. Many partners take home compensation in the seven figures regardless of the fund's investment performance.
Other investment professionals often do not have such safety nets and face far greater performance pressure. VCs performance is ultimately judged at the end of a fund's 10-year life, so venture capitalists are free from the level of accountability that's common in other investment realms. Personal risk than angel investors or crowd funders.
Reasons 2- The Theory of Betting on Hundred Horses…
The second reason is quite obvious. Have you ever been to a horse race?
What do you think, drives people to bet their money on horses they have met for the first time, where almost 95 per cent of the people are bound to fail!
Sadly or gladly, the truth is that most people lose at the track of a horse race- Not only the betters, but also the horse players.
Now look at the situation of the startup ecosystem in emerging nations- What if the Venture Capitalists are betting on all horses in the race? Aren't they bound to win, one way or the other. 'Hence, with Quantity, Quality will follow!'
Further, assume again- What if the VCs are not picky about each and every horse, instead they are picking up from a variety of Horse races. The sectors they list down and say they invest in only those, aren't that Horse races?
Another question that is often asked: Why are VCs investing in emerging nations start-ups?
While New York and London still get the lion's share of what flows from the entrepreneurial epicenter in Silicon Valley, India and China have made substantial gains. The list also includes emerging markets of Malaysia, Vietnam, Indonesia and Philippines and investors have more than one reason to invest. Top Reasons: -
1. As these nations are ideal testing ground for new products due to a younger and bigger size of populations.
2. These markets are not even close to be saturated and have a stream of technically trained and talented entrepreneurs.
3. Infrastructurally backward, the startup ecosystem in emerging nations is focusing heavily on digitally run businesses which means less risk involved.
4. Investors have the chance to enter underpenetrated markets that are not swarming with VC money-that way they can get the first look at some of the hottest companies.
5. The banks in most of the developed nations are not able to leverage a good rate of interest on the investments or fund deposited. For example- the average rate of interest in Japan is 0 to (-0.1%).
So, why won't anyone like to invest in emerging markets, whether primary or secondary, which are growing at faster rates?
But the underlying truth is that young entrepreneurs should take funding seriously and take care of the following things -
i) Cash Burn rate should be low
ii) Maintain good investor relationship
iii) Develop the product or service before you pitch
iv)Have a feasible monetizing model
v) Don't follow industry trends blindly.