Startup financing has been a huge issue in the business world, particularly over the last decade. With tech valuations exploding over the years, billion dollar companies keep emerging out of nowhere. Analysts and investors alike have raised several questions about whether the present models of startup valuation and investing are proper.
Village Capital is the latest firm to weigh in on this matter. In its report titled Capital Evolving: Alternative Investment Strategies to Drive Inclusive Innovation, its answer is simple: startup financing models are not good enough.
The report observed that despite record funding rounds achieved globally, much of these financing goes to “a tiny, and wealthy, portion of the global population.”
#HowWeInvest is just as important as what we invest in. Village Capital is lifting up three new strategies for more inclusive innovation: https://t.co/VbljgKaw5b … written by @rossbaird @vefram @robtashima @heather_strach and the @villagecapital team pic.twitter.com/vcrGlIVIfO
— VilCap Investments (@VilCapInvest) December 3, 2018
In the report, the VC company explained that the current capital structures are “restrictive” and are inherently skewed as financing options favour high growth tech companies.
“Today’s venture capital model was designed to be ‘one size fits all’ by favoring businesses that require as few resources as possible to scale up as quickly as possible.”
Venture firms are concentrate on high growth firms because they represent the quickest route to liquidation. The scenario is: pump some money into a tech company with growth potentials, then after a few years, make an exit either through IPO or acquisition.
But Village Capital argues that this pattern of investment makes it hard for capital to reach other companies operating in other sectors. Many business sectors don’t experience exploding valuations or growth like tech. And in many of these sectors and in many countries, company acquisition is extremely rare.
Meanwhile, there are a whole lot of investable ventures operating across several verticals and located in different countries of the world.
Lack of investor funding pushes startups to raise funds via debt offerings or bank loans. But this is a risky route for startups many of which chart unproven business models.
Village Capital Suggests Three New Financing Models for Startups
But surveying over 200 investors, fund managers, and entrepreneurs, Village Capital shares three new capital options for investors and companies (tech and otherwise). The idea is to provide an array of options that makes it easy for startup capital formation and quality returns as well as impact for VC funding.
Are you looking for ways to invest more inclusively? Read @villagecapital’s new report with @macfound on alternative investment strategies, based on interviews with 200 investors and asset managers https://t.co/Zj4eigW27C #HowWeInvest
— Bree (@wangarib) December 4, 2018
The first option which received the most positive feedback from investors is revenue sharing. Rather than give equity in return for funding, startups can reach revenue sharing models with investors instead. It reduces the risk of outright borrowing for startups, and also guarantees a “liquid structure” for investors. This approach significantly improves investors’ understanding about the startup’s growth potentials.
Revenue sharing involves deploying capital which is subsequently repaid from a share in the revenue of a growing business.
Really excited to dig into this report by the good folks @villagecapital Especially to explore the bold idea of an alternative funding mechanism somewhere between debt & equity – revenue sharing. https://t.co/wwNHRcXc26
Feature image also feature’s @Mimshachking of @vplatformhub pic.twitter.com/bJ2fo0W7ga
— Kola Aina (@kola_aina) December 3, 2018
Place-Based Multi-Asset-Class Fund or Community Investing
A second option suggested by the report is place-based multi-asset-class fund or community investing. Now this option is aimed purely at investors. This option recommends investments in a diverse range of interdependent assets in a specific geographical area. In other words, investors should split their investments to fund various ventures in a particular location. It could be investment in public utilities while also investing in real estate or other ventures. The aim here is to create an ecosystem providing quality jobs, while developing fast growing ventures. This option could work well in emerging markets where infrastructures needed for growth in many sectors are seriously lacking.
Peer-Based Decision Making
A third option is peer-based decision-making. Now this is a tricky route. This approach suggest VC firms make investment choices by leveraging advice and due diligence provided by other startup entrepreneurs. It’s tricky because it aims to see whether entrepreneurs can help identify business opportunity in other companies better than traditional investment approach. It leverages on their lean and agile approach to identifying problems and underserved markets to make investment choices.
— Ross Baird (@rossbaird) November 29, 2018
Village Capital says it has been using this option for while via accelerator programmes. During these programmes, it gets the startups to analyse one another’s innovation to identify growth potentials in them.
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