Financing Entrepreneurial Ventures
An assistant professor of finance at Baruch, Raj Nahata is one of nine Zicklin School professors who focus on entrepreneurship. Nahata teaches the venture capital and entrepreneurial finance course. His research is mainly in the empirical corporate finance domain, with an emphasis on financing and contracting issues facing young start-up corporations. Specific research topics include venture capital and private equity, entrepreneurial finance, corporate venture capitalists, and acquisitions.
Can you describe the relationship between investors and entrepreneurs?
RN: Finance, as we all know, is the lifeline of any business. An entrepreneur has to understand the expectations of an investor. At the same time, an investor has to evaluate how a business will do in the future.
Most of the start-ups or early-stage companies are liquidity constrained. If a venture capitalist (VC) puts money in those types of investments, it is tied up for a period that can range from about three to five years or beyond. So an investor must have a long-term outlook. Statistics show that of about 100 proposals venture capitalists receive, the VCs wind up funding one of them. They are very selective in pursuing entrepreneurial businesses. In addition, the success of investments is limited. Of every 10 investments pursued, on average only three are successful, meaning they are able to be taken public or sold.
The relationship between the investor and the company can be divided into three stages, broadly speaking. One is identifying whether this startup is worthy of investment. The second is building and managing the start-up. And the final stage is exiting from the start-up to achieve a return on the money invested by either taking the company public or selling it to an acquirer. As far as the entrepreneur is concerned, he has to anticipate the challenges of running the business and of forging a successful relationship with the investor.
What is required to make a business successful?
RN: To make a business successful, the investor takes an active role, unlike the ones in mutual funds or in large public companies. He or she has a board seat and sometimes control of the board and the right to fire the CEO or the entrepreneur. The investor tries to create proper incentives for the management, largely through equity-based compensation. The investor guides the startup and builds the human capital, including recruitment of a CEO/CTO, if required, or recruitment of a marketing manager once the product has ramped up to the proper stage. The investor then secures a battery of lawyers or auditors or investment bankers to guide the company to a level where it can become a successful public company. At this point, the VC is looking to cash out of the business.
—Bruce Felton
