How the current capital structure for VCs can be improved
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Photo Credit: Hero Images / Getty Images Israel

It might be time to start questioning some of the industry’s long held beliefs

Tech in Asia

I have been thinking about this subject for a long time, and I came across a blog post precisely about this topic. A venture capitalist by the name of Mahesh Murthy wrote this article.

Let me summarize it quickly.

He is basically talking about a problem in the venture capital scene, that venture capitalists raise their funds from private investors, who may require the fund to basically reach “maturity” (for lack of a better word) in 8-12 years, and realise the returns of funds to the said private investors.

The funds are hopefully returned with huge and healthy capital gains.

This capital structure however has been under criticism by many entrepreneurs, especially those who understand finance well enough, and peers in the venture capital industry. Having a specific deadline forces venture capitalists to rush into projects and god forbid, forces them to sell the business prematurely via a trade sale or IPO.

This can cause companies to be unable to achieve their true potential, as their shareholders rush to exit the business via a trade sale or IPO.

However, before I state my opinion, I would like to acknowledge that the author of the above-mentioned blog post is a highly experienced venture capitalist with a seemingly decorated past of investing in companies.

I will share my thoughts here, and do forgive me if I am premature in my conclusions.

1. We don’t need 3-4 years to filter out good companies to invest in

I personally disagree with the fact that we need 3-4 years to filter out good companies to invest in. Part of the reason could be due to my background, as I have spoken to over 15,000 entrepreneurs in the last 15 years.

When the sample size of the companies being evaluated is large, I should already be able to differentiate the good from the bad, and I certainly don’t need that amount of time to filter out good companies to invest in.

A good venture capitalist perhaps just needs to have an in-depth understanding of the market and entrepreneurship scene.

2. The typical invest-advise-build-tradesale-IPO loop can tedious, here’s an alternative

The typical venture capitalist modus operandi probably takes the typical invest-advise-build-tradesale-IPO loop. However, I find that loop highly tortuous and laborious.

As investment capital converts from cash to shares certificate, the venture capitalist is forced to wait for years, or even decades, for the shares certificate to be converted back into solid cash via a trade sale or IPO exit.

What could be a good approach is a hybrid approach of waiting for company to grow, and at the same time, the venture capitalist could get immediate financial returns via sales commission from selling licenses or franchises of the companies they have invested in.

While doing that, the venture capitalist is participating in the activity that would absolutely increase the valuation of the said companies.

This is probably where the venture capital fraternity would cry foul and put me on a virtual crucifix, as entrepreneurs expect me to keep my hands to myself and wait. At the same time, many venture capitalists would also probably also tell me that the creed of venture capitalists is never to get their hands dirty.

In some of the investments I have made, I have gotten my hands dirty by being involved in the dealmaking process selling the respective franchises and licenses. It has gotten minimal success, not enough to make it a golden principle in venture capital, but has not failed enough times to conclude that this strategy a silly one.

Without strong statistics behind me, I can only say that I would continue with the hybrid model and report whatever success I have to the venture capital fraternity.

3. The request for investors to be patient is unfair to them

While I can understand why the author is appealing for investors to be patient, I think this request is unfair to the investors.

So if we need more time to get back returns for the investors, we have got to tell them how much more time, and how much more returns would they get if they were to wait. This is not going to be easy, and you are forcing them to change their expectations and habits.

The only way I know is to bridge that gap with the hybrid model proposed in the last few paragraphs. While waiting for returns, the investors should still get some returns that beat the bank interest rates.

I personally think that the way forward is not to change the habits and expectations of people. The way forward is to innovate a step that is probably forgotten/ avoided by many venture capitalists.

I welcome your comments.


This post was originally published on Tech in Asia.

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Raymond Ng

About Raymond Ng


I increase companies’ value via business model design and invest in the company. Know more about me at https://sg.linkedin.com/in/raymond-ng-978188 or http://facebook.com/raymond2

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