What is Venture Capital

Venture capital is financing that investors provide to startup companies and small businesses that
are believed to have long-term growth potential. Venture capital generally comes from well-off
investors, investment banks and any other financial institutions. However, it does not always take
just a monetary form; it can be provided in the form of technical or managerial expertise.

Though it can be risky for the investors who put up the funds, the potential for above-average
returns is an attractive payoff. For new companies or ventures that have a limited operating
history (under two years), venture capital funding is increasingly becoming a popular – even
essential – source for raising capital, especially if they lack access to capital markets, bank loans
or other debt instruments. The main downside is that the investors usually get equity in the
company, and thus a say in company decisions.

Angel Investors

For small businesses, or for up-and-coming businesses in emerging industries, venture capital is
generally provided by high net worth individuals (HNWIs) – also often known as ‘angel
investors’ – and venture capital firms. The National Venture Capital Association (NVCA) is an
organization composed of hundreds of venture capital firms that offer funding to innovative
enterprises.

The Venture Capital Process

The first step for any business looking for venture capital is to submit a business plan, either to a
venture capital firm or to an angel investor. If interested in the proposal, the firm or the investor
must then perform due diligence, which includes a thorough investigation of the company's
business model, products, management and operating history, among other things.

Since venture capital tends to invest larger dollar amounts in fewer companies, this background
research is very important. Many venture capital professionals have had prior investment
experience, often as equity research analysts; others have Masters in Business Administration
(MBA) degrees. Venture capital professionals also tend to concentrate in a particular industry. A
venture capitalist that specializes in healthcare, for example, may have had prior experience as a
healthcare industry analyst.

Once due diligence has been completed, the firm or the investor will pledge an investment of
capital in exchange for equity in the company. These funds may be provided all at once, but
more typically the capital is provided in rounds. The firm or investor then takes an active role in
the funded company, advising and monitoring its progress before releasing additional funds.

The investor exits the company after a period of time, typically four to six years after the initial
investment, by initiating a merger, acquisition or initial public offering (IPO).
How it works (Example):

There are three general types of venture capital: seed capital, for ideas that have not yet come to
market; early-stage capital, for companies in their first or second stages of existence; and
expansion-stage financing, for companies that need to grow beyond a certain point to become
truly successful. Venture capital can also help a company merge with or acquire other
companies.

Why it Matters:

Venture capital is an important and necessary form of investment because it fosters

entrepreneurship, especially in high-tech and other innovative industries. This in turn promotes
job creation and economic growth. At the investment level, venture capital can be tremendously
lucrative because it allows investors to get in at the ground level of what could be some of
tomorrow's leading companies.
 
However, venture capital is not without risk. In fact, it is one of the riskiest investments available
because many new companies fail or underperform. Venture capital firms anticipate this by
diversifying their investments and hoping that their successful investments more than
compensate for their losses. Nonetheless, venture capitalists must be willing to take significant
long-term risks for what can be high returns.

What is a Merchant Bank

A merchant bank is a company that deals mostly in international finance, business loans for
companies and underwriting. These banks are experts in international trade, which makes them
specialists in dealing with multinational corporations. A merchant bank may perform some of the
same services as an investment bank, but it does not provide regular banking services to the
general public.

How Merchant Banks Facilitate Trade

A merchant bank can provide the funds to make the purchase using a letter of credit (LOC). The
sellers in Germany receive an LOC issued by the merchant bank as payment for the purchase.
Merchant banks can also help the purchaser work through the legal and regulatory issues
required to do business in Germany.

If a multinational corporation operates in many different countries, a merchant bank can finance
business operations in all those countries and manage the currency exchanges as funds are
transferred.

The Differences Between Investment Banks and Merchant Banks

A merchant bank typically works with companies that may not be large enough to raise funds
from the public through an initial public offering (IPO), and these banks use more creative forms
of financing. Merchant banks help corporations issue securities through private placement, which
require less regulatory disclosure and are sold to sophisticated investors.

Investment banks, on the other hand, underwrite and sell securities to the general public through
IPOs. The bank’s clients are large corporations that are willing to invest the time and expense
necessary to register securities for sale to the public. Investment banks also provide advice to
companies regarding potential mergers and acquisitions, and provide investment research to
clients. Both investment banks and merchant banks strive to build relationships with corporations
so that the institution can provide a variety of services.

Regardless of how a company sells securities, there are some minimum disclosure requirements
to inform investors. Both IPOs and private placements require a company audit by an outside
CPA firm, which provides an opinion on the financial statements. The audited financial
statements must include several years of historical financial data, along with footnote
disclosures. All this information is provided to inform the potential investor about the risks and
potential rewards of buying the securities.

It offers a range of financial and consultancy services, to the customers, which are related to:

 Marketing and underwriting of the new issue.

 Merger and acquisition related services.
 Advisory services, for raising funds.
 Management of customer security.
 Project promotion and project finance.
 Investment banking
 Portfolio Services
 Insurance Services.

Merchant banking helps in reinforcing the economic development of the country, by acting as a
source of funds and information to the business entities.