Venture capital

What is venture capital?

• Venture Capital is a private institutional investment

made to start-up companies at early stage.
• Venture capital funds are the investments made by
the investors who seek private equity stakes in
small to medium business which are potent enough
to grow.
• These investments are generally high-risk/high-
return opportunities. The ventures involve risk in
the expectation of high gain.
• The people who invest this money become the
financial partners are called venture capitalist
(VCs).
• Venture capital is the most suitable option for
funding a costly capital source for companies and
mostly for business that have capital requirement
with no other cheap alternatives.
• The most common cases of venture capital
investments are seen in the fields of Software and
other technology as the value is unproven and are
considered to be the fastest growing.
•
features:
It is a high risk investment made with an intention of making
high profits
• The investment made are based on long term goals
• The investments are made in a start-up which are potential
enough to grow
• The start-ups have lack of funding
• Investments are generally done in innovative projects like in
the fields of technology etc
• Supplier of venture capital participate in the management of
the company
 Method of Venture Capital
Financing
• Equity Financing: A firm needs funds for a longer
period to survive and grow, but as venture is a new
company the firm is not able to give timely returns
to its investors, for which equity financing proves
beneficial.
• Usually the investor’s contribution is not more than
49% of the total stake, and so the ultimate power
remains with the entrepreneur.
• Conditional Loan: Conditional loans are the one
that does not carry interest and are repayable to the
lender in the form of royalty
• after the venture capital undertaking is able to
make revenue. The royalty rate may vary from 2%
to 15%, on the basis of factors such as time period,
external risk and cash flow patterns
• Participating Debentures: The interest on
participating debentures is payable at three various
rates, as per the phase of operation:
• Start-up phase — Nil
• Initial operations phase — Low rate of interest
• After a particular level of operations – High rate of
interest
• Convertible loans: The loans which are
convertible into equity when interest on the loan is
not paid within the stipulated period.
 Stages/steps of financing

• The selection of investment by VC is closely

related to the stages and types of investment
• From analytical angle the different stages of
investments are recognized and vary as regards the
time scale, risk perception and other related
characteristics of the investment decision process
of the VC
 Early stage financing

• Seed capital :
• Start-up capital:
• Second round capital:
 Seed capital

• In this stage seed funding takes place. It is

considered as the setup stage where a person or a
venture approaches to a venture capital firm for
funding for their idea/product.
• During this stage, the person or venture has to
convince the investor why the idea/product is
worthwhile.
• The investor will investigate into the technical and
the economical feasibility of the idea.
• At this stage, the risk of losing the investment is
tremendously high, because there are so many
uncertain factors.
• The market research may reveal that there is no
demand for the product or service, or it may reveal
that there is already established companies serving
this demand.
• Research by J.C. Ruhnka and J.E. Young shows
that the risk of losing the investment for the
venture capital firm is around 66.2%
 Start-up stage

• If the idea/product/process is qualified for further

investigation and/or investment, the process will go
to the second stage
• This is the stage when commercial manufacturing
has to commence.
• Venture capital financing here is provided for
product development and initial marketing.
 Second round financing

• This represent the stage at which the product has

been already been launched in the market but the
business has not yet become profitable enough for
public offering to attract new investors.
 Later stage financing

• This stage of VCF involves establishing business which

requires additional support but cannot recourse to public
issues of capital.
• Mezzanine/development capital:
Firm is earning profit but cannot go to public/capital market
• Bridge/pre-IPO stage
In general, this is the last stage of the venture capital financing
process. The main goal of this stage is for the venture to go
public so that investors can exit the venture .
 The process of Venture Capital
Financing
• Deal origination:
• Origination of a deal is the primary step in venture capital
financing.
• It is not possible to make an investment without a deal
therefore a stream of deal is necessary however the source of
origination of such deals may be various.
• One of the most common sources of such origination is
referral system. In referral system deals are referred to the
venture capitalist by their business partners, parent
organisations, friends etc.
• Screening:
• Screening is the process by which the venture capitalist
scrutinises all the projects in which he could invest.
• The projects are categorised such as market scope,
technology or product, size of investment, geographical
location, stage of financing etc.
• For the process of screening the entrepreneurs are asked to
either provide a brief profile of their venture or invited for
face-to-face discussion for seeking certain clarifications
• Evaluation
• The proposal is evaluated after the screening and a
detailed study is done.
• Some of the documents which are studied in details are
projected profile, track record of the entrepreneur, future
turnover, etc.
• The process of evaluation is a thorough process which
not only evaluates the project capacity but also the
capacity of the entrepreneurs to meet such claims.
• Certain qualities in the entrepreneur such as
entrepreneurial skills, technical competence,
manufacturing and marketing abilities and
experience are put into consideration during
evaluation.
• Deal negotiation
• If the venture capitalist finds the project beneficial he gets
into deal negotiation.
• Deal negotiation is a process by which the terms and
conditions of the deal are so formulated so as to make it
mutually beneficial.
• Both the parties put forward their demands. Some of the
factors which are negotiated amount of investment,
percentage of profit held by both the parties, rights of the
venture capitalist and entrepreneur etc.
• Post investment activity
• Once the deal is finalised, the venture capitalist becomes a part
of the venture and takes up certain rights and duties.
• The capitalist however does not take part in the day to day
procedures of the firm; it only becomes involved during the
situation of financial risk.
• The venture capitalists participate in the enterprise by a
representation in the Board of Directors and ensure that the
enterprise is acting as per the plan.
• Exit plan
• The last stage of venture capital investment is to
make the exit plan based on the nature of investment,
extent and type of financial stake etc.
• The exit plan is made to make minimal losses and
maximum profits. The venture capitalist may exit
through IPOs, acquisition by another company,
purchase of the venture capitalists share by the
promoter or an outsider.
 history
• A venture may be defined as a project prospective converted
into a process with an adequate assumed risk and investment.
With few exceptions, private equity in the first half of the 20th
century was the domain of wealthy individuals and families.
• The Wallenbergs, Vanderbilts, Whitneys, Rockefellers, and
Warburgs were notable investors in private companies in the
first half of the century. In 1938,
• Laurance S. Rockefeller helped finance the creation of
both Eastern Air Lines and Douglas Aircraft, and the
Rockefeller family had vast holdings in a variety of companies.
• Eric M. Warburg founded E.M. Warburg & Co. in 1938, which
would ultimately become Warburg Pincus, with investments in
both leveraged buyouts and venture capital.
 Indian venture capital

Controlled and developed by central govt

• Icici venture capital ltd
• IFCI venture capital fund ltd
• SIDBI venture capital ltd
By state govt.
• Punjab infotech venture
• Gujrat venture finance limited
• Kerala venture capital fund ltd
Promoted by Public sector banks
• Canbank venture capital fund
• SBI capital market ltd
Those promoted by private sector companies.
• IL&FS Trust Company Ltd
• Infinity Venture India Fund
overseas venture capital fund.
• Walden International Investment Group
• HSBC Private Equity management Mauritius Ltd
 Incubation financing

• IF is essentially ready-to-go space and support

infrastructure for startup companies. They also may have
a full-time incubator support staff to help you and your
personnel with finance, marketing, sales, IT, strategy
and other areas of operations.
• Under one roof, entrepreneurs can have access to
professional reception and waiting area, mailboxes,
parcel pickup, office space, meeting and conference
rooms, and access to all the hardware and gadgets
needed to conduct daily business.