Venture capitalists play a crucial role in helping develop startups or small businesses in a country. They often fund startups, early-stage firms, and companies with growth potential. Venture Capital (VC) firms’ investments are often considered risky. Only a few investors offer funds to startups or small businesses. Since startups and small businesses still need a proven track record, investors refrain from offering funds.
Venture capitalists are willing to take risks and invest in such companies. For the same rationale, venture capitalists are essential for a nation’s economy. Besides the investment risks, VC firms face many other challenges.
Read on to understand some challenges firms face when indulging in VC Services.
Top Challenges in Venture Capital
Here are the biggest challenges in the venture capital industry:
Increased Investment Risk
More information on the past performance of startups or early-stage firms must be available. Since startups have not spent much time in the market, there is no information on past financial performance. Venture capitalists only analyze the growth potential of a company before investing. Some venture capital investment decisions are based purely on instinct. The risk level for investments in the VC industry is high for the above reasons. Venture capitalists usually have a higher risk appetite than other institutional investors.
Lengthier Investment Horizon
Venture capitalists do not look for short-term investments or returns. They invest in startups or early-stage firms and wait for years for returns. A startup might not start generating massive revenues immediately after receiving funds from a VC firm. It might take years for the startup to become an established entity and build a vast network. VC firms might also invest in corporate entities experiencing financial distress. In such a case, a VC firm might wait years for the portfolio company to make a turnaround.
Shortlisting Portfolio Companies
There are plenty of startups and early-stage firms looking for investors. It does not mean that venture capitalists can invest in any startup. VC firms screen multiple startups and select a few based on their growth potential. Analyzing large volumes of data to find the right investment opportunities is challenging for VC firms.
Many venture capitalists have considered third-party VC services to overcome this challenge. A reputed third-party research firm will have the resources to perform target screening, due diligence, and comparative analysis. For instance, Acuity Knowledge Partners is a reputed VC services firm that can help discover better investment opportunities. It has a dedicated team of analysts and researchers to help VC firms make informed investments.
Most startups and early-stage firms take time to get listed on stock exchanges. Since venture capitalists invest in private companies, they might face issues when selling their stakes. When a startup performs less than expected, a VC firm might find it challenging to sell its stakes in the company. VC firms might have to wait for acquisition, IPO issuance, and other events to sell their stakes. For the same rationale, VC firms must make informed decisions to overcome the challenge of limited liquidity.
VC firms depend on the performance of portfolio companies for returns. Economic and market fluctuations can impact the performance of portfolio companies. For instance, an economic downturn can prevent a startup from continuing its operations as earlier, affecting the stakeholder (VC firm). Fluctuating interest rates, industry trends, and many other economic/market factors can affect the ROI (Return on Investment) for VC firms.
VC firms need an infinite source to raise funds. They often have limited funds and depend on returns from earlier investments. When an investment does not perform well, it puts pressure on the VC firm. When multiple investments go haywire, VC firms might need more funds. For the same rationale, VC firms must make every investment carefully, as it can impact future decisions.
VC firms face challenges like limited liquidity, increased risk, fund management, and economic volatility. VC firms can partner with third-party research firms to overcome these challenges. A neutral and unbiased perspective can help VC firms make better investment decisions.