Why the term "Venture Capital" is a misnomer right now
"Venture Capital" refers to funding furnished to startups and small businesses that are early-stage, high-risk enterprises with high growth potential.
This type of funding is mostly by professional investment enterprises or individual investors who specialize in this field.
In an interview with Forbes, Jim McVeigh CEO of Cyndx, a fintech firm with data from over 21 million private companies from around the world, rehashed the most delinquent trends observed in the private equity market.
He says that VC firms are now funding more in established companies with remunerations between $5 million to $10 million, and less in companies that are in their early stages.
McVeigh believes the right time for Private equity firms to invest is when market valuations have fallen tremendously, allowing the investors to buy companies at a more reasonable value and increasing the chance of good returns. When the market is at a record high, the probability of good returns lessens.
According to him, this is the right time to tap the market for better investments.
He then highlighted the critical differences between Private Equity and Venture Capital.
There is a clear difference in the way Private Equity firms and VC firms invest. PE firms take controlling stakes in firms they are interested in, while VC firms only have minor stakes- between 5% to 30% on average. The main aim of VC firms is the facilitation of the growth of enterprises. However, the distinction has blurred over recent years.
Many venture capitalists today want to be a part of the scaling process and not in their early stages. According to him, 'venture capitalist' is a misnomer because there is not a lot of “venture investing.”
Another trend addressed by McVeigh was a declining interest in investing in businesses burning cash and resources. This trend is now posing an issue because of the sudden market dislocation. He says that there are four solutions to the problem.
The first way is to cut down on burning cash. The second way is raising additional capital at lower prices. The third method involves selling the company, and the fourth is declaring bankruptcy.
The firms that are in dire need of investments are those that are burning resources. But, these firms also happen to be those that the investors are least interested in. Tech companies are an apt example.SAAS companies, fintech companies, and content companies are the ones Jim says have the most deals happening.
Jim also explained how valuations of companies are based on the estimates of free cash flows- a concept dependent on several factors.
The first is the rate at which the company can accelerate or produce revenue. The second is dependent on the market- whether it allows the enterprise to increase its rates as the prices of other services increase. Lately, the increase in labor costs and cost of capital as well as goods has seen a hike. The rise in these costs is not a good dynamic, as profitability takes a hit.
The recent trends in the market and the VC and PE industry, have all contributed to the debate of the term Venture Capitalist being a misnomer.