Question

Describe the role of venture capitalists in the economy and discuss how they reduce their risk when investing in start-up businesses. It can be argued that the decision to accept venture capital is one of the most critical decisions an entrepreneur must make. Explain why

Answer 1

Venture capitalists play an important role in the economy by providing risk capital to early-stage businesses which would otherwise find it difficult to raise capital. A vibrant, growing economy needs new business ideas, models and ventures which provide the necessary disruption, competition and growth. However, these early-stage businesses cannot raise capital from traditional sources such as banks and IPOs because they are early-stage with inadequate cash flows and thus too risky. VCs fill this gap by providing the necessary risk capital to these businesses.

VC's reduce their risk when investing in start-up businesses by :

• Taking a higher stake so that they can maintain some control over the business
• Having one of the board members of the start-up company as their nominee
• Having the start-up company issue compulsorily convertible preferred shares instead of equity

The decision to accept venture capital is one of the most critical decisions an entrepreneur must make because accepting venture capital also involves giving up significant control over the company. The venture capitalist is not just a financial investor but also provides strategic vision and mentorship. Thus, it is a very critical decision for an entrepreneur.