Venture Capiatal

Meaning of Venture Capital

Venture capital is a form of private equity and a type of financing that investors provide
to startup companies and small businesses that are believed to have long-term growth potential.

Venture capital is a form of private equity financing that is provided by venture capital
firms or funds to startups, early-stage, and emerging companies that have been deemed to have
high growth potential or which have demonstrated high growth (in terms of number of
employees, annual revenue, scale of operations, etc).

Importance of Venture Capital

1. Promotes Entrepreneurs: Just as a scientist brings out his laboratory findings to reality and
makes it commercially successful, similarly, an entrepreneur converts his technical know-
how to a commercially viable project with the assistance of venture capital institutions.
2. Promotes products: New products with modern technology become commercially feasible
mainly due to the financial assistance of venture capital institutions.
3. Encourages customers: The financial institutions provide venture capital to their customers
not as a mere financial assistance but more as a package deal which includes assistance in
management, marketing, technical and others.
4. Brings out latent talent: While funding entrepreneurs, the venture capital institutions give
more thrust to potential talent of the borrower which helps in the growth of the borrowing
concern.
5. Promotes exports: The Venture capital institution encourages export oriented units because
of which there is more foreign exchange earnings of the country.
6. As Catalyst: A venture capital institution acts as more as a catalyst in improving the
financial and managerial talents of the borrowing concern. The borrowing concerns will be
more keen to become self dependent and will take necessary measures to repay the loan.
7. Creates more employment opportunities : By promoting entrepreneurship, venture capital
institutions are encouraging self employment and this will motivate more educated
unemployed to take up new ventures which have not been attempted so far.
8. Brings financial viability: Through their assistance, the venture capital institutions not only
improve the borrowing concern but create a situation whereby they can raise their own
capital through the capital market. In the process they strengthen the capital market also.
9. Helps technological growth: Modern technology will be put to use in the country when
financial institutions encourage business ventures with new technology.
10. Helps sick companies: Many sick companies are able to turn around after getting proper
nursing from the venture capital institutions.
11. Helps development of Backward areas: By promoting industries in backward areas,
venture capital institutions are responsible for the development of the backward regions and
human resources.
12. Helps growth of economy: By promoting new entrepreneurs and by reviving sick units, a
fillip is given to the economic growth. There will be increase in the production of consumer
goods which improves the standard of living of the people.

Process of Venture Capital

1. Deal Origination:
Venture capital financing begins with origination of a deal. For venture capital business,
stream of deals is necessary. There may be various sources of origination of deals. One such
source is referral system in which deals are referred to venture capitalists by their parent
organizations, trade partners, industry association, friends, etc.

Another source of deal flow is the active search through, networks, trade fairs,
conferences, seminars, foreign resist etc. Certain intermediaries, who act as link between venture
capitalists and the potential entrepreneurs, also become source of deal origination.

2. Screening:
Venture capitalist in his endeavor to choose the best ventures first of all undertakes
preliminary scrutiny of all projects on the basis of certain broad criteria, such as technology or
product, market scope, size of investment, geographical location and stage of financing.

Venture capitalists in India ask the applicant to provide a brief profile of the proposed
venture to establish prime facie eligibility. Entrepreneurs are also invited for face-to-face
discussion for seeking certain clarifications.

3. Evaluation:
After a proposal has passed the preliminary screening, a detailed evaluation of the
proposal takes place. A detailed study of project profile, track record of the entrepreneur, market
potential, technological feasibility future turnover, profitability, etc. is undertaken.

Venture capitalists in Indian factor in the entrepreneur’s background, especially in terms

of integrity, long-term vision, urge to grow managerial skills and business orientation. They also
consider the entrepreneur’s entre-premarital skills, technical competence, manufacturing and
marketing abilities and experience. Further, the project’s viability in terms of product, market
and technology is examined.

4. Deal Negotiation:
 Once the venture is found viable, the venture capitalist negotiates the terms of the deal
with the entrepreneur. This it does so as to protect its interest. Terms of the deal include amount,
form and price of the investment.

It also contains protective covenants such as venture capitalists right to control the
venture company and to change its management, if necessary, buy back arrangements,
acquisition, making IPOs. Terms of the deal should be mutually beneficial to both venture
capitalist and the entrepreneur. It should be flexible and its structure should safeguard interests of
both the parties.

5. Post Investment Activity:

Once the deal is financed and the venture begins working, the venture capitalist
associates himself with the enterprise as a partner and collaborator in order to ensure that the
enterprise is operating as per the plan.

The venture capitalists participation in the enterprise is generally through a representation

in the Board of Directors or informal influence in improving the quality of marketing, finance
and other managerial functions. Generally, the venture capitalist does not meddle in the day-to-
day working of the enterprise; it intervenes when a financial or managerial crisis takes place.

6. Exit Plan:
The last stage of venture capital financing is the exit to realise the investment so as to
make a profit/minimize losses. The venture capitalist should make exit plan, determining precise
timing of exit that would depend on an a myriad of factors, such as nature of the venture, the
extent and type of financial stake, the state of actual and potential competition, market
conditions, etc.

At exit stage of venture capital financing, venture capitalist decides about

disinvestments/realization alternatives which are related to the type of investment, equity/quasi-
equity and debt instruments. Thus, venture capitalize may exit through IPOs, acquisition by
another company, purchase of the venture capitalists share by the promoter and purchase of the
venture capitalists’ share by an outsider.

Methods of Venture Capital Financin

1. Equity Financing: Equity financing is a fund-raising method used by start-up companies
who are in need of a large amount of capital, having a robust business plan and better
chances of high potential future growth. These firms are new to the market with irregular
income in the beginning phase due to which they are not able to give timely returns to
 investors. Under such conditions, the equity financing method proves to be the most
beneficial method for start-up businesses. Companies raise funds from investors and in return
provide them a stake in their business. The overall contribution of investors is not more than
49% such that they do not have voting rights. Entrepreneurs have full power to make critical
decisions and run the business venture.
2. Debentures: The debenture is another common method used by start-up firms for acquiring
the required amount of funds. It denotes a guarantee given by the company to fund providers
for repayment of their money once the security gets matured. The company issues a debt
paper to investors which act as an acknowledgment slip in order to raise funds for a specific
time period.
3. Conditional Loans: Conditional loans are different from bank loans which do not carry any
fixed rate of interest nor any pre-determined schedule of payment. Here, under these types of
loans, the entrepreneur pays the lender in the form of royalty once the venture starts
generating revenue. There is no payment of interest on the loan amount to the lender. The
royalty rate may be in the range of 2% to 15% which varies due to factors such as external
risks, gestation period, and patterns of cash flow.
4. Conventional Loans: Conventional loans are unlike conditional loans, where the
entrepreneurs are required to pay interest to lenders. During the initial days, the interest paid
is at a lower rate which increases with the rise in profit earned by the venture. Also, in
addition to interest paid on borrowed capital, a royalty is also paid by an entrepreneur in
accordance with profit/sales.
5. Income Notes: Income notes are a hybrid form of financing available for business ventures.
It combines the features of both conditional loans and traditional loans from banks or
NBFCs. The entrepreneur pays interest and is required to repay the principal amount within
the predetermined period of time. The royalty amount is also paid by the entrepreneur on
sales volume or profit.