Venture capital, once the sole source of funding for nearly every business start-up, has evolved and diversified in recent years, pushed by the demands of entrepreneurs in Silicon Valley and beyond. With new, more streamlined and innovative funding approaches now on the table, opportunities abound for today’s pioneers keen to get their new businesses off the ground.
Why venture capital?
Venture capital (VC), which is a form of private investment provided to start-ups with long-term potential, usually in exchange for equity, grew in popularity during the early 2000s.
The huge potential for returns often outweighed the risk for investors, resulting in a surge in venture capitalists, capital investment firms and angel investors – and consequently, an explosion in new business ventures. It was venture capital that spurred the likes of Facebook and LinkedIn on to huge success.
Without access to capital markets, bank loans or other debt instruments, this venture capital model was just about the only option for entrepreneurs in this period.
The start-up boom continued into the 2010s, leading to the development of new fund mechanisms, with many businesses achieving investments which would have previously been unlikely. This opened up a fund model opportunity for keen-eyed VC businesses; a model made up of a pool investors with a general partner responsible for performing the financial checks and raising the funds.
Meanwhile, other VC firms found a way round the legal restriction which had prohibited fundraising online for equity. By referring to investments as donations and rewarding donors with gifts, they sidestepped the need to exchange equity.
Not only did these changes create more investors and investor syndicates, they opened up the market for new start-up funding.
“The alternative investments industry is reshaping, and with this, new sources of capital are emerging. Those new capital sources have significant effects on both the capital supply side – by shaking up existing industry structures – and the capital demand side – by enabling products and services that better meet the needs of new and existing customers.”1
— World Economic Forum Report, 2020
Transforming the template
To entrepreneurs scarred by – or wary of – VC, this subtle shift was not enough. Under the traditional VC model, start-ups were often neglected by their investors if their company wasn’t delivering rapid growth. On the flip side of this, where the start-up had proved successful, the size of the investment meant control of their company was compromised.
In response to this, new models of investment have been developed, swapping the VC-first, maximum growth mindset for a flexible, sustainable and healthier approach – one in which both parties would benefit.
Reducing or foregoing the equity stake, investors in these new financial models take fixed annual payments or a percentage of gross revenue. Founder support programme, Indie.vc operates in an even more entrepreneurial-friendly way, whereby investors only receive a cut when the company decides to pay a dividend. For example, they could receive 80% of the dividend until they get twice their investment, after which point they get 20%, until they achieve five times their return.
Australia-based Pick & Shovel Ventures was one of the first businesses outside California to offer an alternative to VC. The firm makes an up-front investment with the start-up founder and takes 5% of monthly recurring revenue after a 12-month holiday period. The founder later pays back the venture funding either through revenue or an exit option.
Hinting at the future of investment, new AI-based algorithms are being introduced by investment firms to evaluate and identify consumer start-up potential, as well to measure the share in future revenue.
Think small, think niche
The aforementioned VC-alternatives allow entrepreneurs to thoughtfully develop their company, while maintaining ownership. This is music to the ears of many entrepreneurs. So are the falling costs of starting an internet-based business. Another alternative to VC is to avoid the investments businesses altogether.
As indicated by the increasing number of highly successful niche internet businesses, thinking small, at least at first, is another valid option for start-ups. By focusing on niche markets, such as e-commerce and services, you can attract the same high margins, streamlined distribution and scalability as you would through VC-funded arrangement, but without the same equity and economical stakes.
Finding your own path
Whether it is VC or one of the newer, alternative forms of investment, capital is crucial to developing any fledgling business, as is entrepreneurial drive and ambition. As well as exploring and evaluating different funding models, the University of Bath’s Entrepreneurship Management and Innovation online MSc will encourage you to pursue your ambitions, helping you forge the skills you need to bring your innovative ideas to fruition.
Begin your own journey of lifelong enterprise and apply to study an Entrepreneurship Management and Innovation online MSc at the University of Bath today.