Tuesday, April 20, 2010

Start-up Funding in times of crisis

As a follow on to the previous post on 'V is for Vulture Capital', here is a short article I submitted to a local business magazine about funding start-ups in times of crisis, based on personal experience in Europe.

"Whether in a boom or bust part of the economic cycle, obtaining funding carries a health warning for innovative start-ups. It can involve an enormous amount of effort for little (or no) return. This is particularly the case when seeking Venture Capital.

The matching of VC funds to start-ups is an imperfect market. The money will not flow to innovative start-ups unless they have the potential of being ‘the next Netscape’ –no matter how world-changing their inventions are.

Plus, there is the funding paradox –it is easier to obtain €20 million of VC money than €1 million. Many VCs will not even look at making investments below €5 million.

In Europe, we still witness a ‘funding gap’ left by Business Angel investment and VC investment. Few investors feel confident enough to sit in between the two and pump in investment amounts of under €1 million. This forces many European start-ups to grow organically and limit international expansion –allowing competitors from outside Europe to catch up all too quickly.

In times of crisis, the funding gap is compounded by the banking sector tightening the screws on their lending procedures. Without the ability to fund working capital using bank overdrafts, loans and credit lines, a larger number of start-ups seek private investment to prop up their balance sheets. As cash is king, these private investors will in turn limit their investments to those start-ups which are themselves cash generating. This compounds the problem and creates a financing vicious circle that is difficult to break unless economic growth resumes."