Venture Capital Financing

Chapter 10 Financial Services MY Khan

Venture Capital - Meaning

A form of equity financing , designed specially for funding high risk and high reward projects . Plays a significant role in financing high tech Projects & helping Research and Development projects to turn into commercial production. A typical private equity investment, in a growth oriented small/medium business to enable the investors to accomplish their goals .

Venture Capital Meaning..

Long term investment in high risk industrial projects, with high reward possibilities is also called venture Capital. The investment may take place at any stage of the project between start up and commencement of commercial production. Thus venture capital implies high level of risk implicit in the investment of funds.

Definition

Dr. Neil Cross : Venture capital investment is defined as the provision of high risk bearing capital, usually in the form of a participation in equity, to companies with high growth potential. The venture company also provides some value added service, in the form of management advice and contribution to overall strategy. Bank of England Quarterly Bulletin : Venture capital is an activity by which investors support entrepreneurial talent with finance and business skills to exploit market opportunities and thus obtain long-term capital gains.

Features

New Ventures Continuous involvement Mode of Investment Objective Hands on Approach High Risk-return ventures. Liquidity Nature of the firms

Venture Capital - India

Still in its infancy. Some venture Capital funds in India are: Risk Capital Foundation: Set up by IFCI, aimed at supplementing promoters equity with a view to encouraging technologists and professionals to promote new industries. Seed Capital Scheme : Established by IDBI in 1976, with the same objective. PACT : ICICI undertook the Program for application of commercial technology aided by U.S. Aid , which aims at financing specific needs of the corporate sector industrial units. VECAUS : UTI sponsored Venture Capital Unit Scheme ,since 1989. Technology Development and Information company of India ltd. Was appointed as managers.

Venture Capital and other capital funds

Venture Capital and Development Capital: - VCC remains interested in the overall management till commencement to production and efficient marketing of the products, thus finally making available an exit route for the liquidating the investments. Development capital is granted in the form of loans for setting up industrial units, and for expansion also. The lender takes special care to ensure the end use of the loan, and requires prompt payment of interest.

Venture capital , Seed Capital and Risk Capital

No tangible differences between venture capital, seed capital and Risk capital. Both are components of Venture Capital. Seed and Risk Capital provided by all India financial institutions in the form of promoters contribution to the project.

Seed Capital

This is an early stage financing Involves primarily for R & D Financing serious risk for the financiers, Plus continuous infusion of funds in order to sustain the Research and Development The venture Capitalists consider the following for safeguarding their interests:
Successful performance record, entrepreneurs previous experience in similar products, technology , market. Qualities of business management, technical innovation , clear future prospects for which seed capital is required.

Start up Financing
Financing

at the product development, stage, includes providing finance for initial marketing, and the establishment of product facilities. Provided to projects which have been selected for commercial production, and where the potential to fulfill effective demand is there.

Follow on Financing
A

later stage of venture capital financing. Provision of capital to a firm, who has previously received external capital, but whose financial needs have subsequently expanded. Considered to be the most attractive stage of venture capital financing.

Later stage financing .. Other forms

Expansion financing : - the finance provided to fund the expansion or growth of a company which is breaking even or trading at a small profit. - here venture capitalists provide funds for adding production capacity. Replacement Financing: Also known as money out deal, whereby venture capitalists extend financing for the purchase of the existing shares from an entrepreneur or their associates in order to reduce their holdings in the unlisted company.

Later stage financing .. Other forms

Turnaround financing : - provided by venture capitalists in the event of an enterprise becoming unprofitable after the launch of commercial production. Provided in the form of a relief package with specialist skills to recover. Management Buy Outs (MBOs) acquisition of a company from the existing owners by a team of existing management/employees. The team acquiring is actively involved in running the venture. The owners may or may not be actively involved in running the firm. The venture capitalists provide funds to the acquiring team.

Management Buy Ins

Involves

bringing in management team who are outsiders. Defined as Funds provided to enable a manager or group of managers from outside the company to buy-in the company with the support of venture capital investors.

Mezzanine Finance

Is supplied as a layer which ranks behind secured lending but before ordinary share capital. So supplied either as debt or as high ranking equity(preference shares). It is intended as a bridge finance and has a maturity period of less than 2 years.While structuring an MBO the mezzanine finance helps the management to retain greater share of the business, than what they could otherwise afford.

Key appraisal factors for Venture Capitalists

The Track record : - management performance record, capacity of owners to handle proposed business plan successfully. Performance Assumptions : -technical performance assumptions of the product/service. - the technical strength of the process. Market Potential : market size, growth, potential Cost Structure : profitability projection on realistic cost assumptions. Time Schedule: evaluation of time schedule given for completion of the plan on realistic basis.

Financial sources

Venture Capitalists in India , besides using their own funds, use other sources like, India financial Institutions, Foreign Institutional Investors, Multilateral Development Agencies, banks, foreign investors. Some debt instruments used are NCDs, Partly convertible debentures, deep discount bonds, conditional loans etc.

EXIT MECHANISM

Venture capital investment is usually liquidated after accomplishment of the purpose of the venture. The time of exit is decided in advance, sometimes even at the time of financing. Factors considered are financial stake, potential competition, market condition etc. methods of exit may be- IPO method, sale of shares , Puts and Calls method, Trade sales through MBOs and MBIs., or liquidation.