How Venture Capital is Destroying the Economy?

Uber has recently launched an Initial Public Offer (IPO). The company is trying to sell $10 billion worth of shares for close to $90 billion! This is despite the fact that the company has negative cash flow and is yet to make a profit. What makes matters even more complicated is that fact that Uber itself has admitted that it is likely that the company may never turn profitable! This strange situation that Uber is it makes one wonder what the game plan of companies like Uber and their investors is. Why are venture capitalists investing vast sums of money into companies which may never be able to recover the loss?

Uber is not the only big tech company to be vying a huge IPO. There are many others which have similar profiles and similar aspirations. In this article, we will try and understand why venture capitalists are funding companies like Uber. We will also try to understand how this is negatively impacting the entire economy.

Venture Capital Diverts Finances

Capital markets are supposed to allocate capital to the most efficient businesses. This is because it is widely believed that private investors, in pursuit of their individual profit, will end up selecting the most profitable businesses from the list of opportunities accorded to them. However, this does not see, to be the case now. Venture capitalists seem to have found the loophole in the system. They seem to have realised that the business they invest in does not actually need to make money. The business may be unprofitable to its owners and shareholders. However, it could still be very profitable to the venture capitalists. Modern venture capital is about creating hype. It is more about creating rock star brands, which regular people are willing to invest in because they have heard so much about the company in the newspapers and via other media sources. In the process of creating this hype, venture capitalists end up giving huge rounds of funding to firms which may not deserve them. Hence, they end up diverting the finances of the entire economy.

The best example is Uber. Since Uber has received billions of dollars in investor funding, other companies have not. Had these other companies received more funding, maybe they would have been able to add more to the economy in real terms.

Venture Capital Hurts Small Businesses

The billions of dollars which are mindlessly pumped into a handful of companies also causes grave losses to small businesses which are the backbone of any economy. Most companies which are funded by venture capitalists are only surviving because they are constantly receiving reimbursements for cash which they are burning while trying to generate business. Consumers are having a good time because they are getting unbelievable deals on all goods and services which are being sold by these start-ups.

The problem is that the start-ups which are funded by venture capitalists have an almost unlimited capacity for bearing losses. The small and medium enterprises lack this ability. Hence, as start-ups resort to predatory pricing, smaller businesses are left with no option but to pack their bags and leave if they donít want to get driven into a price war.

Venture Capital Diverts Human Resources

Since venture capitalists have access to huge sums of money, they also have access to some of the best human resources in the country. Once again, since the underlying business itself is not viable, all the effort spent on improving it turns out to be a waste of time. If some of the best and brightest people in the world were not engaged in helping venture capitalists create public relations campaigns, they could actually be involved in solving real-life problems through meaningful entrepreneurship.

Venture Capital Causes Losses to Retail Investors

Last but not least, venture capitalists have been trying to make money at the expense of the retail investors. Their whole game revolves around creating hype. After a significant amount of hype is created around a company, venture capitalists launch an IPO. This IPO is wherein most of the venture capitalists cash out. For instance, in the case of Uber, most venture capitalists are likely to walk out with huge sums of money. This will happen despite the fact that Uber management has admitted that it is unlikely that the company will make any money.

The end result is that retail investors buy shares at the IPO because of the hype which has been created by the venture capitalists. Once the dust settles down, people tend to realise that the start-up is not going to make much money. This is when the prices start to fall and more often than not it is retail investors who have to bear the brunt.

The reality is that venture capitalists have found a way to scam the system. Instead of picking the best possible entrepreneurship ventures, these firms are instead trying to follow the greater fool theory. They make a foolhardy investment into a flop business. However, they still make money because they find a greater fool and offload their stake at a higher price!

From the above-mentioned points it is clear that venture capital does need some kind of regulation. The allure of easy money is being used by venture capitalists to snatch away hard earned savings of the common public. The regulation should prevent misuse of venture capital without compromising on the economic freedom of individuals as well as companies.

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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to and the content page url.

Managerial Economics