August 22, 2003

Where Money for Start-ups Really Comes From



By Arun Natarajan

Here's what the irrepressible Guy Kawasaki--former Apple executive and CEO of Silicon Valley investment bank Garage.com--says in his Forbes.com column in answer to the question "What are Venture Capitalists (VCs) doing these days?":

"Mostly VCs are looking for companies with three "provens": Proven teams, proven technology and proven sales. Ideally, they'd like a team that's sold a company to Cisco for $7 billion, won a Nobel Prize with its technology, and is profitably selling $12 million worth of stuff a year. That's an early-stage deal. Unfortunately, using these parameters, no VC would invest in anything. Oops, there goes the next Yahoo!, Google, eBay, Netscape, Apple, or Cisco... In any case, it's tough to get an investment these days."

The situation in India is not too different. "Investors like grey hairs now," says a recent Businessworld article on Private Equity investments in India (issue dated August 11, 2003). "This realization shines through once you look at the list of founders and promoters who raised money in the last year. It's a list of the grey and the grizzled--guys who have fought a hundred battles and lived to tell the tale," the article adds. Not just the experience of the founders, but the age of the company also seems to be important: Indian VCs have hardly made any first round investments over the last 18 months.

OK. Since professional venture capital is unavailable, where are entrepreneurs who are just starting out getting financing from these days?

Of the estimated 286 million entrepreneurs who started-up in 2002 (in 37 countries), only 19,000 received venture capital funding, according to the Global Entrepreneurship Monitor (GEM) study. Conducted by US-based Babson College and London Business School, the GEM study was presented to the United Nations in April this year.

So where did the money for starting up the remaining 285.981 million of these ventures come from? Answer: Friends and family.

While 43% of these "informal investors" provided less than $1,700 per investment, the total financing raised by entrepreneurs through the friends & family route amounts to a staggering $271 billion.

"Many entrepreneurs waste valuable time by prematurely seeking seed capital from formal venture capitalists and come up empty handed almost every time," says Bill Bygrave, a professor at Babson College.

Such "grass roots" investments from friends and family are the key to developing a thriving entrepreneurial economy, says the GEM study report. Interestingly, the report goes on to recommend that governments in developing countries seeking to support entrepreneurial activity, should not focus their efforts--and incentives--in trying to duplicate a US-style formal venture capital industry. Since most investment in support of new business formation comes from friends & family, these governments should focus their efforts on encouraging informal investments, such as tax reduction initiatives. "Nations with higher social security taxes, high marginal rate of income tax and high taxes on property and capital have fewer informal investors," the GEM researchers insist.

Here's hoping that the central and state government agencies in India that are busy floating and investing in venture capital funds--and simultaneously heaping rules and taxes on start-up businesses--pay serious attention to these reports!

Agree with the GEM researchers? Disagree? Do send in your thoughts to arun@tsjmedia.com

For more information:

Click Here for inks to the GEM study reports and its recommendations to the UN.

Click Here to read the full Businessworld article on Private Equity investments in India.

Click Here to read Guy Kawasaki's comments on recent VC investment trends (among other quips).