A Vibrant Early Stage VC Market

Venture Capital

Startup businesses having a growth possibility requires a notable amount of investment. Such startups with a potential of long-term growth attracts rich investors, who would happily invest their capital in these businesses. The financing, which these investors provide to the small companies and startup businesses, which are anticipated to have possibility of long-term growth, is termed as venture capital (VC). Wealthy investors, financial institutions and investment banks usually provide this venture capital to the startup companies.


Changes in the traditional VC Industry:

VC industry is facing disruption and going under change all over the world. In terms of Setting up a business and operating; Startups now are simpler, faster, cheaper, and smarter than they used to be. The most affected sector is the technology sector where startup cost is lower, and number of users/Bandwidth is larger with better transaction costs. Time required to attain user feedback and bring innovation in products have decreased dramatically with measured user behavior techniques and direct contact with the end users. Businesses have found their ways to go around the overly regulated traditional approach of building fortunes and so as the funding landscape. The changes in the industry have also triggered changes in the funding landscape with an introduction of more collaborative schemes.



The Emergence of Micro Venture Capital Funds (or Super-Angels)

Micro venture capital funds (or super angel funds) first emerged in the United States, are becoming more and more established in the venture capital industry in Middle East and Europe. In general, these funds are managed by former entrepreneurs. In contrast to traditional angel investors operating alone or with other angels, micro venture capital funds also attract other investing interests from wealthy individuals, family offices, foundations and corporate investors that are often looking for innovative investment opportunities. The managers of micro venture capital funds typically contribute a significant amount of capital to the fund, making the organization of the fund more of a collaborative nature than a typical ‘general partner – limited partner’ relationship. Most notable micro-venture capital funds in Europe shows that these funds are currently able to secure capital commitments in the amount of $20 million to $100 million, an amount that is rapidly growing. Indeed, investing with proven entrepreneurs is very appealing. Since they are extremely well connected in their former line of business, micro funds are often better positioned than traditional venture capitalists to pick out winners at a seed or early stage. Also they are able to mentor them through the very early start-up phases, increasing the possibility of follow-on investments from ‘traditional’ venture capital funds and corporate venture funds. Their position between the traditional angel investors and venture capital funds arguable make these micro venture capital funds a perfect collaborator (as a co-investor and a follow-on investor).




Micro Venture Capital

A new source of funding for startups at seeding phase has established and rapidly secured a primary position in the startup ecosystem over the past few years. This newer variety of investor has been categorized as a micro venture capital funding, also known as seed venture funding. The firms those offer micro funding are usually a small sized venture firms. These firms mainly make investment in emerging companies at a seeding phase of growth. The fund size of micro venture capital is often less than 50 million U.S dollars and usual range of investment lies in between $50,000 to $500,000 in a given startup. Most of the micro venture capitals are administered by existing venture capitalists, earlier entrepreneurs. Other larger venture firms also keep funds equal to micro venture capital, which the use to target the similar startups at their seeding phase and aims for upcoming prospects for their larger venture funds.

Micro Funds are defined principally by their size, but they also typically have two other characteristics.

  • A proportion of the fund comes from a government source
  • They specialize in early stage investing.


Importance for Entrepreneurial Growth

Importance of Venture Capital

Entrepreneurial growth companies often attain equal to or more than 50 percent annual compound growth rate. Because growth demands working capital and ongoing investments in fixed assets, the requirement of cash by such rapidly growing companies outgrow the cash they generate. In case the company does not have sufficient funding in place, this speedy growth could lead to bankruptcy. Mostly entrepreneurial growth companies are focused towards converting to public ownership either by selling out to a bigger company or through an initial public offering (IPO). This change demands external equity funding more than the large and old companies do. Precisely, entrepreneurial growth companies experience a rapid growth and require a huge amount of cash that is mostly obtained through external sources also known as venture capital. Therefore, venture capital is of high importance in entrepreneurial growth. Major examples of importance of venture capital for entrepreneurial growth are success of Souq, Careem, HolidaMe, Fetchr and Amazon.com to name a few. In February 2016, Souq closed a funding round of over $275 million (bringing the total amount of venture capital backing to $425 million) and it’s not hard to see why venture capitalists continue to invest. Today, Souq is the most visited shopping destination in the whole of the Middle East, seeing 1.5 million visitors per day to its website. The Careem story truly is an advert for just how much venture capital funding can accelerate a business. Just over a few years’ time, Careem successfully achieved their goal of expansion. With the company now operating in 14 cities throughout the Middle East and Asia -including Beirut, Cairo and Lahore- it secured $10 million in a second round of funding. The exciting history of Amazon.com forms a classic case study of facilitation by venture capital firms in a quick and initial development and demonstrates the potential and risks of funding entrepreneurial growth companies. Additionally, the IPO of Facebook in 2012 was the largest for an internet company, valuing the company at 104 billion U.S. dollars. It drove many of the top venture capital firms, among them Accel Partners remained at top with early stage investments of 722 million U.S dollars in other 28 deals in communications and networking, consumer durables, healthcare technology systems, media and software in United States and Europe.


Importance of Micro Venture Capital

The nature of micro venture capital funds is appropriate to satisfy the investor demands for funding controlled by environmental or social factors. Micro venture capitals works relatively near to the ground level as a function of necessity. This prospect allows them to recognize and reach out to less significant opportunities typically in the evolving countries around the globe. This is the major cause that micro venture capital funds got the opportunity to become an important fragment of ranges from another course of actions advancing for not only probable performance but also for contentment of progressively established objective based investment among social, economic and educational fields. Micro venture capital, being a smaller fund would exhibit significant role in providing capital for progress in communities across the globe by proposing a larger amount of consideration as compared to large sized funding, as an outcome of being exceedingly dedicated.

A major example of importance of micro venture capital for entrepreneurial growth is demonstrated by the fact that early-stage funding contribution by micro venture capital has extended noticeably within a couple of years. The value of micro venture capital firms reached at 627 million U.S dollars among 242 deals across the globe alone in first quarter of 2014. Micro Ventures have developed a platform for both accredited and non-accredited investors to reach startups and it has generated about 85 million U.S. dollars since its inception in 2009. It has helped startups and small businesses to raise capital through Regulation D Rule 506 and Regulation Crowd funding. To name a few, Micro Venture has 500 Startups and DreamitVentures on board. Both are a new kind of seed fund and startup accelerator that focuses on early-stage companies, invests further in the most successful companies’ follow-on rounds as they continue to grow, and provides funding ranging from $25K to $250K to early stage startups.


Kind Of Businesses, Micro Venture Capital and Venture Capital Invest In

Venture capital is always aimed to be invested in such businesses, which are more competitively tolerant than the market as a whole. In the recent days, more than 25 percent of the venture capital funding has shown interest towards the internet based businesses. Venture capital funding always targets towards a segment, which tends to grow rapidly and its capability is assured to be constrained over the period of coming five years. Venture capital firms invest in the businesses that would allow them to exit the company and industry before it tops out because their objective is to earn high profits at comparatively lower level of risk.

Internet and mobile businesses dominates the micro venture capital investments at the sector level. It has captured 85 percent of the unique business funding by micro venture capital since 2011. Business intelligence and sales and marketing technology, advertising and analytics and performance management, within the internet sector witnessed the maximum percentage of deals across sub-industries. Additionally, with education technology rounding out the top five widely popular businesses, e-commerce industry, clothing, and accessories businesses were positioned at the top for micro venture capital investments. Micro venture capital offered the required funding to the startup because it focused to earn the rewards on getting an early hold on the next big ideas.

Since 2006 in Asia, some new VCs are also operating at the SME level, such as Helion Venture PartnersErasmic Venture Fund (Accel India Venture Fund), Seed Fund, and Upstream Ventures. While technology remains the most sought after investment fields, interest has been shifting from internet companies to other types of operations—especially ICT enabled services and bio-technology.

A few VCs also operate at the early-stage, including Erasmic Venture Fund, Seed Fund, Infinity Venture, IFI sponsored facilities such as Swiss Tech VCF, and the government schemes such as SIDBI VC and Gujarat VF. Early stage VCs seek smaller deals, typically in the US$ 1 – 3 million range. However, they rarely go below the half million dollar mark, where there is a strong appetite for financing, but very few opportunities. Possible sources of smaller investments are represented by local public-sector facilities, business angels, business incubators funds, and isolated cases of seed VCFs, such as the microventure schemes like Aavishkaar India Micro Venture Capital Fund (AIMVCF).


Convertible Notes

Considering the nature of micro venture capital funding, a convertible note would be beneficial for micro venture capital. Equity note is always more complicated, expensive, and time consuming than a convertible note. One of the key advantages of issuing convertible notes is that the valuation issue is kicked down. As the micro venture capital firms usually acts as angel investors or silent partners therefore a convertible note is beneficial, as it does not requires giving any control to the investors.


Key Success Factors to Build a Sustainable Venture Capital Ecosystem

An ecosystem encompasses a number of interrelated key factors that persistently act together and reciprocally support each other. Venture capital funding has a significant part to play in the improvement of sustainable startups. The key success factors to build a sustainable venture capital ecosystem include business model innovation, collaborations and a strong business case. An innovative business model tends to assure the acceptance from the potential venture capital firms. Collaboration between the entrepreneur and venture capital firms is another important factor in building a sustainable ecosystem. Final important factor is a strong business case, which would ensure a profitable startup to benefit both, entrepreneur company growth and venture capital firm.

One reason offered is that government venture capital initiatives are often targeted toward the funding gaps in specific industries and development stages in the venture’s life cycle. Australia provides a number of good examples including the Renewable Energy Equity Fund, the Pre-Seed Fund and the Innovation Investment Follow-on Fund that were established respectively in 2000, 2002 and 2009. What then determines the success or failure of government interventions? Whilst there is no single answer, incentive design and the connectivity to other stakeholders in the venture capital ecosystem appear to play an important role. Let’s have a closer look at several features of the Australian government funds that have arguably contributed to the success of these funds. Indeed, recent research indicates that the Australian initiatives were successful in spurring innovation and entrepreneurship. What is probably most suggestive here is that the funds operate as ‘public-private partnerships’ in which public funds are pooled with capital from private investors. The funds are managed by private sector fund managers who are not only in a better position to pick ‘winners’, but also ensure that the funds are connected to the existing venture capital industry. Venture capital fund managers and private investors are thus essential for the success of the government programs. In essence, the government acts as a strategic investor. Its main objective and interest is the development of a robust venture capital ecosystem. In order to continue to make investments in the future, the government initiatives are organized as ‘revolving programs’, which means that the government needs to participate in the distributions of returns and interests from initial investments in order to be able to reinvest the proceeds and ensure the long term sustainability of the government program. Indeed, profit distribution arrangements require the fund managers to first return the invested capital to the government and private investors before venture capital fund managers participate in the upside. Often there is even an additional hurdle rate in place to ensure that the investors first receive their paid-in capital and their cost of capital. However, unlike most government support programs, the Australian program is designed to attract and incentivize private investors. The remaining profits (if and when realized) are split disproportionally with the government receiving 10 per cent and 90 per cent going to the private investors.


European policymakers also show a mounting interest in public-private partnerships. Consider again, the High Tech Gründerfonds in Germany. Interestingly, the fund is designed to meet two key components:


  • Access to venture capital
  • Connectivity to other advisors and investors


First, the German public-private partnership currently manages in excess of €550 million of committed capital 24 over two fund generations (€272 million in Fund I and €301.5 million in Fund II) and invests mainly in emerging SMEs in Germany. The German Federal Ministry of Economics and Technology as well as KfW Banking Group are the ‘strategic’ anchor investors in the two funds. As for the connectivity, the High-Tech Gründerfonds gives access to an impressive network of coaches, such as university professors, angel investors and venture capital funds. These coaches do not only offer value-added services to existing portfolio companies, but are also responsible for providing investment opportunities (Brandkamp, 2011).

It follows from the above discussion that properly structured public-private partnerships that build on ingredients that are already available in the market are probably the strongest tool to develop a sustainable venture capital industry. However, one challenge remains in Europe as well as in Middle East: the local or regional focus of both the government programs and the venture capital funds (or to put it differently: the lack of cross-border focus.

It would be beneficial to expand the reach of successful models (such as the High-Tech Gründerfonds) to other European countries and target interested investors, such as family offices and cash rich investors from the United States that are already showing their willingness to invest more and more in start-up companies globally.

A vibrant venture capital industry needs a complete ecosystem to thrive and achieve sustainable growth. A non-intrusive regulatory framework coupled with funding and business coaching system to develop entrepreneurs are the cornerstones of a strong VC ecosystem.

Developing such an ecosystem takes time and effort, governments should be ready to take an initial loss and have a long-term view in actioning such investments. Once the system starts maturing, the fruition of these vehicle will produce desired outcomes such as job creation, diversification of the economy and development of local companies that can potentially compete internationally.


Tariq Linjawi

Founder/ Head of Investment Advisory