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Introduction To VC Business Model

Venture capital is a form of financing provided to startups and small businesses believed to have long-term growth potential. The venture capital business model is governed by the power law, where a few investments generate outsized returns and most generate little or no returns. Top venture capital funds invest in less than 1% of deals they see and maintain discipline in follow-on funding. They receive the best deal flow from partners with entrepreneurial and functional expertise who help portfolio companies grow.

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Muhammad Shahood Jamal
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166 views

Introduction To VC Business Model

Venture capital is a form of financing provided to startups and small businesses believed to have long-term growth potential. The venture capital business model is governed by the power law, where a few investments generate outsized returns and most generate little or no returns. Top venture capital funds invest in less than 1% of deals they see and maintain discipline in follow-on funding. They receive the best deal flow from partners with entrepreneurial and functional expertise who help portfolio companies grow.

Uploaded by

Muhammad Shahood Jamal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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1 Group No.

07

Introduction to Venture Capital Business Model:


Venture capital (VC) is a form of private equity and a type of financing that investors
provide to start-up companies and small businesses that are believed to have long-term
growth potential.
Venture capital generally comes from well-off investors, investment banks, and any other
financial institutions. However, it does not always take a monetary form; it can also be
provided in the form of technical or managerial expertise. Venture capital is typically
allocated to small companies with exceptional growth potential, or to companies that have
grown quickly and appear poised to continue to expand.

The Venture Capital Market Business Model:


Firstly, we need to address the business model of venture capital (VC), and in doing so,
dispel the myth that VC is a “gamble,” where we invest and hope for the best. The business
model of more traditional investment asset classes such as private equity and asset
management is governed by the mathematical concept of outperforming on a normal
distribution graph. That means that most investments end up slightly below or ahead of the
mean/median, and those investors that outperform an index, end up with a slightly higher
weighting of their investments to the right of the mean/median. In VC, our business model is
governed by the “power law:” what this means in essence, is that out of every ten early-stage
investments, around two will create all the returns and the rest will underperform by
generating little to no returns. Once this concept has been understood, it is then easier for our
investors to understand our business model.

We are in the business of taking calculated risks investing in strong entrepreneurial teams.


The other key mathematical driver to understanding our business model is that we invest in
<1% of the deals that we see every year. That means if we see 1000 deals, which we are on
track to see this year, we will invest in <10 deals at the early stages.  It is worth noting that
we have waited four years for the MENA ecosystem to grow and mature to a level whereby
we will see 1000 deals this year. The final mathematical concept for investors to understand
is that of “discipline,” which is the discipline we have to maintain in only following on with
further funds in those teams who demonstrate strong execution amongst other business
drivers.

How The Deal Flow Works:


Top quartile VC funds generate strong returns of > 30% internal rate of returns (IRRs). The
top one percentile, meaning those that generate better returns than 99% of their peers,
generate outstanding returns of 70%, and even 90% in some cases. These top one percentile
firms invest in 0.5% of the deals they see, have three or four companies generating multiple
times the entire size of the vintage in question, and a small proportion of their dry powder
goes to the investments that don’t perform, in some cases as little as 20%, which comes down
to a rigorous and disciplined approach to deploying follow-on funds.
These top one percentile firms receive the best deal flow which comes down to having a team
of partners who hail from entrepreneurial backgrounds, being ex-founder’s matched by
functional experts, who work tirelessly to grow their ecosystem and specifically their
portfolio companies. We at BECO have configured ourselves accordingly and are building
out a family of mission-driven entrepreneurs and functional experts to make a significant

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2 Group No. 07

impact in finding and funding the best teams to build large businesses that can make a
tremendous impact on our region and make it a better place to live and work.

Figure 1- Graph

Why Your Mission Matters:


This brings us to the next extremely important matter: mission. We believe that the best
entrepreneurs are mission-driven which drives them with the passion required to obsess about
solving a big problem, no matter how hard things get.  We ourselves at BECO are mission-
driven. Our mission is to leapfrog our region to participate in the technological revolution
that is upon us and is only going to accelerate over the coming decades.

We believe that investors have bought into our vision, mission and strategy, and once on
board, they will support us when they can, but broadly, they give us the freedom to execute.
We have a strong fiduciary obligation to our shareholders and with this ensure a very high
level of governance around keeping our shareholders updated on our progress. We do this by
sending out regular business updates, newsletters, detailed semi-annual and annual reports,
audited financial statements, and we organize an annual general meeting where we present
the past, present and future with detailed updates from the BECO team, portfolio companies
and the professional service providers that we work with to produce accurate and high-quality
reporting. All this is supported by a very high-quality board of directors, who meet at least
quarterly and work tirelessly to steer, ensure shareholder value creation and
accountability through a strong best in class governance framework.

This is no different to what we as investors expect from our portfolio companies and hence,


we lead by example, and expect the same excellence.

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3 Group No. 07

Advantages of Venture Capital Market Business Model:


o Business expertise. Aside from the financial backing, obtaining venture capital financing
can provide a start-up or young business with a valuable source of guidance and
consultation. This can help with a variety of business decisions, including financial
management and human resource management. Making better decisions in these key
areas can be vitally important as your business grows.
o Additional resources. In a number of critical areas, including legal, tax and personnel
matters, a VC firm can provide active support, all the more important at a key stage in the
growth of a young company. Faster growth and greater success are two potential key
benefits.
o Connections. Venture capitalists are typically well connected in the business community.
Tapping into these connections could have tremendous benefits.

Disadvantages of Venture Capital Market Business Model:


o Loss of control. The drawbacks associated with equity financing in general can be
compounded with venture capital financing. You could think of it as equity financing on
steroids. With a large injection of cash and professional – and possibly aggressive –
investors, it is likely that your VC partners will want to be involved. The size of their
stake could determine how much say they have in shaping your company’s direction.
o Minority ownership status. Depending on the size of the VC firm’s stake in your
company, which could be more than 50%, you could lose management control.
Essentially, you could be giving up ownership of your own business.

References:
https://www.entrepreneur.com/article/276639
https://www.thehartford.com/business-insurance/strategy/business-
financing/venture-capital

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