VC 101.1 - What is Venture Capital and how does it fit into the world of financing? (Newsletter 9/5/2019)

May 9, 2019

We've been on a journey these past 4 years and would like to share some of our learnings and successes. We have launched ‘SMART VC’, a channel to share with you:

  • The basics of Venture Capital (VC) in our 'VC101' series

  • Innovation news from Africa and the developing world in our 'Local Innovation' series

  • More about the dynamic and vibrant world of innovation in our 'VC Culture' series

  • Announcements on our work and the way we approach investing in the 'Our Deals' and 'What We Think' series.

We're kicking off with 'VC101'. We've all heard of the unicorns of VC like Amazon, Uber, AirBnB, Facebook, PayPal and Africa’s recent "start-up” IPO Jumia, valued at $3.9bn, but let's start at the beginning. What exactly is Venture Capital anyway?

 

What is Venture Capital and how does it fit into the world of financing?

 

Invention, innovation and entrepreneurship drive the economy. And in order to invent, grow and become profitable, entrepreneurs need capital. 
 
The conventional banking system, however, is not geared to finance the unchartered world of start-ups and early stage businesses. In the world of finance there are two broad types of funding: debt and equity. Debt financing refers to loans that are paid back with interest. Equity financing refers to capital provided in exchange for a stake in the company.
 
Banks generally only provide finance to clients with conventional business models or to the extent that there are hard assets against which to secure a loan. In the prevailing information-based economy, most entrepreneurs and young ventures have big ideas - promising intellectual property - but few hard assets, and so someone with an idea or a new technology often has no institution to which to turn. Enter the venture capitalist. Venture capitalists are instrumental in realising the power of entrepreneurial ideas, by providing capital (along with investment knowledge, operating experience and strategic guidance) to develop young businesses with high growth potential, in exchange for equity in the business in which it invests.

Venture capital is not synonymous with seed capital, which refers exclusively to investment in start-ups. In fact, the majority of money invested by venture capitalists goes toward businesses that have a proven concept and that are in the adolescent and high growth phase. Capital is allocated to building the infrastructure required for the business to mature.

Venture capitalists generally invest and remain involved in a business for a limited time only. The view is not long-term but to provide capital and back a company until it becomes sufficiently mature to be sold to a corporation or to be listed in the public-equity market. In essence, the venture capitalist buys a stake in an entrepreneur’s idea, nurtures it for a period of time, and then exits at a profit.

The venture capital industry further provides a conduit for private and institutional investors who look for investments in the alternative asset universe with the potential of alpha returns (above average).  Astute venture capitalists offer investors the potential of attractive returns through deep investment knowledge, ability to curate a strong portfolio of high potential businesses in high growth industries, expert advisory and mentoring capability and the ability to raise capital to grow these young businesses.
 

How the Venture Capital Industry in the US Works
The venture capital industry has four main players: entrepreneurs who need funding; investors who want high returns; investment bankers who need companies to sell; and the venture capitalists who make money for themselves by making a market for the other three.

 

Venture capital thus fills the gap that exists in the world of finance - between traditional banking that provide lower-cost sources of capital available to companies with established business models and sources of funds for innovation provided by corporations, government bodies, and the entrepreneur’s friends and family. To do this successfully, the venture capitalist must provide attractive returns for its own investors, and sufficient upside potential to entrepreneurs to attract high-quality ideas that will generate high returns. Our challenge is to earn consistently superior returns on investments in inherently risky business ventures. HAVAÍC's smart and experienced team is deeply invested in doing just that.

We look forward to sharing the journey - and the returns.

Kind Regards
Ian Lessem
Managing Partner

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