News & Events

- 13/03/2018

Venture Capital – Not just a Cinderella story for start-ups



Author: Miriam Sultana
Published on Malta Chamber 12th March 2018

The financing of a business is not a simple affair and traditionally start-ups have resorted to obtaining finance through orthodox methods; either through the capital markets or bank loans. However, there is another source of finance which may have not yet been explored to its full potential locally. The concept of venture capital has proven to be one of the most successful financing concepts in the United States, much to the envy of the rest of the world. This type of financing capital has successfully financed various world-renowned brands, venture capitalists (VC) are prepared to take risks to help nascent industries succeed in various industries and become increasingly competitive. In the past, companies such as Amazon, Facebook and Spotify, WhatsApp, Snapchat, GoPro, Nest Labs, FedEx have been funded by such set ups.

The concept of VC revolves around the establishment of financial intermediaries operating in an industry of four main players; those who need funding, investors who would like high returns, investment bankers who need companies to sell, and venture capitalists. In this scenario, the venture capitalists act somewhere in between, making life easier for the rest of the three parties. Money invested by venture capitalists is short to medium term – say between four to seven years.

Typically, VC fund entrepreneurs enter at the initial stage of their life-cycle, namely upon inception of the business. However, it also plays a pivotal role in the subsequent phase, when the company starts to develop its product or service, be it innovative or mainstream. The basic idea is to inject funds in the start-up’s balance sheet and buttress its infrastructure, up until that stage where it reaches sufficient credibility, size and return on investment. Subsequently, the venture capitalists employ diverse exit strategies, including an initial public offering, trade sale, buy back of shares originally invested or an outright sale to an investor.

So why is venture capital interesting for a start-up? Besides the injection of liquidity, the venture capitalist is typically an experienced investor, providing a valuable source of guidance, talent and consultation. Very often, they sit on the management board and assist in shaping the start-up’s strategic decisions with the ultimate aim of gaining decent returns commensurate with the risks involved. VCs act as consultants throughout their investment phase, assist in various areas including recruitment, management, business planning and marketing. Thus, venture capitalists would be providing a pivotal role in growing the business through the slippery slopes of the nursery stages.

VC is not a panacea to all types of risky investments. They take bold and courageous steps to build a close understanding of various business cycles and definitely carry their share of failures. For example, take the situation where one party in an economic transaction is more knowledgeable on the deal at stake, than the other party and obviously, this creates an unfair advantage and may lead to bad decisions. Due to such risks, venture capitalists normally invest a significant amount of time in getting to know the business and carry the necessary due diligence processes. As can be expected, in return for their higher risk, VCs typically own preference shares in the company together with a seat at the top management table.

Would this set up work locally? Not so fast. Owing to the close-knit family structure of local start-ups, these often prefer to make use of angel investors rather than reaching out to sign with VCs. The easy alternative is access to bank finance. This places the growth trajectory for start-ups in Malta at a disadvantage given that banks tend to be risk averse whilst VCs are often synonymous with financing highly innovative companies.

Three years ago, the Government started a bold initiative through the Malta Investment Management Company Limited and Malta Enterprise with the aim of creating a platform for VCs (mostly from private sources) to address requirements of start-ups. Whilst this is a step forward in the right direction, one doubts whether local investors possess the necessary expertise to adequately nurture a growing list of start-ups. Shouldn’t we put our money where our mouth is, by seeking safe opportunities in overseas liquid markets? Thin capitalisation of local SMEs is a serious drawback to internationalisation. In the short-term scenario, we need to double our contribution to research and development to meet EU obligation of investing at least 2 per cent of GDP by 2020. These questions are clearly food for thought and may be the subject of numerous debates. Nevertheless, we shouldn’t underestimate the benefit of assisting innovative entrepreneurs taking the first leap in business. This could bring awe-inspiring spill-over economic benefits, resulting in a more sustainable, innovative and diversified economy.

The financing of a business is not a simple affair and traditionally start-ups have resorted to obtaining finance through orthodox methods; either through the capital markets or bank loans. However, there is another source of finance which may have not yet been explored to its full potential locally. The concept of venture capital has proven to be one of the most successful financing concepts in the United States, much to the envy of the rest of the world. This type of financing capital has successfully financed various world-renowned brands, venture capitalists (VC) are prepared to take risks to help nascent industries succeed in various industries and become increasingly competitive. In the past, companies such as Amazon, Facebook and Spotify, WhatsApp, Snapchat, GoPro, Nest Labs, FedEx have been funded by such set ups.

The concept of VC revolves around the establishment of financial intermediaries operating in an industry of four main players; those who need funding, investors who would like high returns, investment bankers who need companies to sell, and venture capitalists. In this scenario, the venture capitalists act somewhere in between, making life easier for the rest of the three parties. Money invested by venture capitalists is short to medium term – say between four to seven years.

Typically, VC fund entrepreneurs enter at the initial stage of their life-cycle, namely upon inception of the business. However, it also plays a pivotal role in the subsequent phase, when the company starts to develop its product or service, be it innovative or mainstream. The basic idea is to inject funds in the start-up’s balance sheet and buttress its infrastructure, up until that stage where it reaches sufficient credibility, size and return on investment. Subsequently, the venture capitalists employ diverse exit strategies, including an initial public offering, trade sale, buy back of shares originally invested or an outright sale to an investor.

So why is venture capital interesting for a start-up? Besides the injection of liquidity, the venture capitalist is typically an experienced investor, providing a valuable source of guidance, talent and consultation. Very often, they sit on the management board and assist in shaping the start-up’s strategic decisions with the ultimate aim of gaining decent returns commensurate with the risks involved. VCs act as consultants throughout their investment phase, assist in various areas including recruitment, management, business planning and marketing. Thus, venture capitalists would be providing a pivotal role in growing the business through the slippery slopes of the nursery stages.

VC is not a panacea to all types of risky investments. They take bold and courageous steps to build a close understanding of various business cycles and definitely carry their share of failures. For example, take the situation where one party in an economic transaction is more knowledgeable on the deal at stake, than the other party and obviously, this creates an unfair advantage and may lead to bad decisions. Due to such risks, venture capitalists normally invest a significant amount of time in getting to know the business and carry the necessary due diligence processes. As can be expected, in return for their higher risk, VCs typically own preference shares in the company together with a seat at the top management table.

Would this set up work locally? Not so fast. Owing to the close-knit family structure of local start-ups, these often prefer to make use of angel investors rather than reaching out to sign with VCs. The easy alternative is access to bank finance. This places the growth trajectory for start-ups in Malta at a disadvantage given that banks tend to be risk averse whilst VCs are often synonymous with financing highly innovative companies.

Three years ago, the Government started a bold initiative through the Malta Investment Management Company Limited and Malta Enterprise with the aim of creating a platform for VCs (mostly from private sources) to address requirements of start-ups. Whilst this is a step forward in the right direction, one doubts whether local investors possess the necessary expertise to adequately nurture a growing list of start-ups. Shouldn’t we put our money where our mouth is, by seeking safe opportunities in overseas liquid markets? Thin capitalisation of local SMEs is a serious drawback to internationalisation. In the short-term scenario, we need to double our contribution to research and development to meet EU obligation of investing at least 2 per cent of GDP by 2020. These questions are clearly food for thought and may be the subject of numerous debates. Nevertheless, we shouldn’t underestimate the benefit of assisting innovative entrepreneurs taking the first leap in business. This could bring awe-inspiring spill-over economic benefits, resulting in a more sustainable, innovative and diversified economy.

Author: Miriam Sultana
Published on Malta Chamber 12th March 2018
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