Kaushal Kurapati\’s blog

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Archive for December, 2006

Stock Exchange for Start-ups: good or bad?

Posted by kaushalkurapati on December 4, 2006

Rajesh Jain has insightful posts on his blog usually and I am a regular reader. One of his latest posts is about creating a stock exchange of sorts for start-ups to raise capital in order to address the inefficiencies in the Indian VC market to be able to fund fledgling entrepreneurs. From my experiences in advising friends’ startups and having seen their trials & tribulations in getting the venture funded and flying, I am not sure I agree that a financial marketplace is the right way to fund start-ups. Here are my counter points:

  1. No VC Rolodex Power: Start-ups get funding from VCs for sure but they need hand-holding early on to allow their strategy, product vision to mature. A good VC often provides such ombudsman like guidance and more importantly opens doors/introductions to potential customers, partners through their rolodex network. A stock exchange type setting may help the young company raise capital but it may not be able to provide invaluable contacts to generate those important first customers and cash flow necessary for the working capital of the company.
  2. Syndicating further rounds of funding: VCs typically can get other VCs to get to invest in the company as syndicates in future rounds of funding. This is another example of VC-rolodex-power. Stock-exchange based investors cannot provide that kind of future investment potential.
  3. Capital Stability: VCs provide capital, but typically wait 5+ years before they start to look for exit routes for their portfolio companies. They provide that somewhat longterm umbrella of capital stability. Exchange based investors could be fickle. They have been trained on regular stock markets of the world, which are focussed on earnings growth. Such investors lack the patience that start-ups need from their investors. Seeing no cash flow or foreseeable earnings, they would want a quick exit from the company thereby draining the company financially and forcing the company to focus on short-term financial vagaries of investors instead of getting a solid product to the market.
  4. Market liquidity: robust stockmarkets are highly liquid. Start-up marketplaces could be devoid of liquidity and may not provide individual investors with exit-routes when they want to get out of a stock. The investors could be harmed themselves with such exchanges.

It is hard for entrepreneurs to raise capital and this is true anywhere, US or India. The US VC market may be more deep enabling higher risk taking from VC funds, which means more ventures get funded. Lack of depth/variety in venture business plans themselves could be a reason for VC firms/funds in India not funding as many ventures as their US cousins. Lack of entrepreneur track-record is a major reason I’d suspect VC firms in India may not invest easily. This takes time to mature. Especially as technology penetrates many facets of Indian life, more and more people will create ventures to address the needs of a large market and further, the VCs will now fund those start-ups as the market is now big enough to support the 5x, 10x, 100x returns VCs crave for. As some of these ventures achieve success, executives cashing out from such ventures spawn out and create new ventures — now, with success on their resume, they should find it easier to raise capital than the first time around.

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Posted in Innovation, Management, Technology | 1 Comment »