Venture Capital & Entrepreneurial Management
Most new entrepreneurial ventures require outside investors in order to successfully bring their innovations to the marketplace and create a sustainable, viable organization. There are several sources of funding available for start-up firms, but one of the most popular is venture capital firms. These firms invest in the entrepreneurial organization for substantial equity in the company and with an eye toward a quick and high return on investment. To help minimize the risk inherent in such investments, venture capital firms analyze the entrepreneurial organization's potential for success. Through a good business plan, the entrepreneur can show not only the viability of the innovative product or service but also the viability of the management team that will help guide that product or process to the marketplace. Venture capital firms look for organizations whose management processes and structures are scalable and will allow them to meet the changing demands of the market while still supporting continued creativity and innovation.
Keywords Business Plan; Management; Organizational Structure; Return on Investment; Risk; Scalability; Venture Capital
Entrepreneurship: Venture Capital
Turning a new venture into a viable business requires more than an innovative idea; it also requires money to provide the infrastructure necessary to successfully realize the idea and bring it to the marketplace. However, most entrepreneurs exhaust their own funds before their fledgling businesses reach this point. To succeed, therefore, they need to acquire outside funding. Although there are a number of different sources of funding available to the entrepreneur once the business is up and running, start-up organizations frequently do not qualify for debt capital. Young companies in this situation have three major sources of investors: family or friends, angel investors (wealthy investors who expect a higher return on investment and who can typically invest more capital than the entrepreneur's acquaintances), and venture capital firms that may invest more money but expect an even higher return on investment. Increasing numbers of entrepreneurs turn to venture capital as a way to keep the organization running while bringing the new concept to market. Some well known companies whose initial success was enabled by venture capital include Amazon.com, Federal Express, Genentech, Intel, Netscape, and Yahoo!.
Venture capital is funding provided to expand business within entrepreneurial firms that exhibit great growth potential. Wealthy investors commit money as limited partners to a pool of funds that is professionally managed in exchange for equity in the new company and with the expectation of a quick and high rate of return on their investment. The funds are professionally managed by general partners in exchange for a fee and a percentage of the return on the investments.
The investment of capital in new ventures is by definition a risky proposition and comes at a cost not only to the venture capital firm but to the entrepreneurial venture as well. Typically, venture capital firms seek a high return on investment (often 50 to 60 percent) and significant equity to compensate for the risk of investing in a start-up company. In return for equity in the company, venture capital firms frequently provide not only money to the start-up firm but also other help, which may include introductions to other businesses and individuals that may be of use to the entrepreneurial company in the future (e.g., banks and financial institutions, potential suppliers) and advice on how to grow the organization from an innovative start-up to a viable, successful venture. Such advice can be invaluable to the start-up firm because the venture capital firms typically have had experience with the pitfalls and processes of starting a new company and know what leads to success — or a lack thereof — in the marketplace.
In order to attract the interest of a venture capital firm, the entrepreneur needs to have a well-crafted business plan. This plan should set out the start-up organization's operational and financial objectives as well as detailed supporting plans and budgets to show how these objectives will be achieved. However, the business plan is not just about the innovative idea that the entrepreneur wishes to market. Venture capital firms prefer to invest in organizations that have complete, well-balanced founding teams. Therefore, the business plan should help the venture capital firm better understand the potential of the entrepreneurial company both from the point-of-view of its product or service and also from the point-of-view of whether or not it has the managerial and administrative resources in place to be successful. It is important that the management of an entrepreneurial organization takes the time and effort necessary to write a good business plan. Venture capital firms typically will also investigate both the potential of the organization to yield a quick and high return on investment as well as whether or not it is structured in a way that can sustain it during the transition from being a mere good idea to being a successful organization.
Traditionally, entrepreneurs have been characterized not only as innovators but also as poor managers. The stereotypical entrepreneur is seen as creative, egocentric, and individualistic, interested more in the creation of the new idea than in the day-to-day running of a business. Another assumption frequently made is that entrepreneurs lose their edge when they become successful. Rather than viewing the entrepreneurial organization as one that can continue to create and develop new innovations that can be brought to the marketplace, this stereotype assumes that the entrepreneur will change when his or her business becomes successful, settling down to become the head of an organization whose goal is to maintain and survive rather than to innovate.
As with most stereotypes, there are some individuals who can be characterized in this way. However, an increasing number of entrepreneurs do not fit this mold. Rather than changing the culture of the organization from entrepreneurial to maintaining, an increasing number of entrepreneurial organizations today strive for sustainable innovation. Under this paradigm, entrepreneurs continue to develop products or processes that are new or significant improvements over previous products or processes and successfully introduce them in the marketplace. To be successful in continuing innovation, entrepreneurs rely not on luck but on continued observation and analysis of market and industry trends that allow for the strategic planning necessary to make additional innovations. Such innovations allow the organization to remain on the leading edge in the industry and to be a successful business venture. In order to support sustainable innovation, however, the entrepreneurial management team must not only consider the creative and innovative side of the organization, but the management and administrative side of the organization as well.
Under this paradigm, the management team of entrepreneurial firms needs two kinds of skills. First, sustainable innovation requires strategic skills. These include the ability to synthesize market data and identify and extrapolate trends to anticipate new products and markets. These data can be used in the development of a sound business plan that will be of interest to potential venture capital firms. In addition to being able to identify innovative ideas that have the potential to be very successful in the marketplace, entrepreneurial firms need to be able to show that they have the organizational skills necessary to implement these plans. Venture capital firms look for both these characteristics when reviewing entrepreneurial business plans.
It is the intent of venture capital firms to invest in entrepreneurial organizations in order to see a high, quick return on their investment. Although venture capital firms are by nature in the business of taking risks, they apply the principles of good risk management in order to increase the probability that both the entrepreneur and their investors will be successful.
Risk is the quantifiable probability that a financial investment's actual return will be lower than expected. Higher risks mean both a greater probability of loss and a possibility of a greater return on investment. Venture capital firms assess the risk of investing in an entrepreneurial organization by determining the potential loss and probability of loss of the organization's objectives. This risk assessment is the first step in risk management. Venture capital firms then seek to manage that risk through the process of analyzing the objectives of the organization, planning ways to reduce the impact if the predicted normal course of events does not occur, and implementing reporting procedures so that problems are discovered earlier in the process rather than later.
One of the factors that venture capital firms look at when evaluating the potential for success of an entrepreneurial team is the...
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