Venture Capital

07/07/2020 3 By indiafreenotes

This is a very important source of financing for a new business. Here money is provided by investors to start a business that has strong potentiality of high growth and profitability. The provider of venture capital also provides managerial and technical support. Venture capital is also known as risk capital.

Concept of Venture Capital

Narrowly speaking, venture capital refers to the risk capital supplied to growing companies and it takes the form of share capital in the business firms. Both money provided as start-up capital and as development capital for small but growing firms are included in this definition.

In developing countries like India, venture capital concept has been understood in this sense. In our country venture capital comprises only seed capital, finance for high technology and funds to turn research and development into commercial production.

In broader sense, venture capital refers to the commitment of capital and knowledge for the formation and setting up of companies particularly to those specializing in new ideas or new technologies. Thus, it is not merely an injection of funds into a new firm but also a simultaneous input of skills needed to set the firm up, design its marketing strategy, organize and manage it.

In western countries like the USA and UK, venture capital perspective scans a much wider horizon along the above sense. In these countries, venture capital not only consists of supply of funds for financing technology but also supply of capital and skills for fostering the growth and development of enterprises.

Much of this capital is put behind established technology or is used to help the evolution of new management teams. It is this broad role which has enabled venture capital industry in the West to become a vibrant force in the industrial development. It will, therefore, be more meaningful to accept broader sense of venture capital.

Features of Venture Capital

Venture capital has the following features:

  • Venture capital investments are made in innovative projects.
  • Benefits from such investments may be realized in the long run.
  • Suppliers of venture capital invest money in the form of equity capital.
  • As investment is made through equity capital, the suppliers of venture capital participate in the management of the company.

Advantages of Venture Capital

The advantages of venture capital are as follows:

  • New innovative projects are financed through venture capital which generally offers high profit­ability in long run.
  • In addition to capital, venture capital provides valuable information, resources, technical assistance, etc., to make a business successful.

Disadvantages of Venture Capital

The disadvantages of venture capital are:

  • It is an uncertain form of financing
  • Benefit from such financing can be realized in long run only.

Characteristics of Venture Capital

Venture capital as a source of financing is distinct from other sources of financing because of its unique characteristics, as set out below:

  1. Venture capital is essentially financing of new ventures through equity participation. However, such investment may also take the form of long-term loan, purchase of options or convertible securities. The main objective underlying investment in equities is to earn capital gains there on subsequently when the enterprise becomes profitable.
  2. Venture capital makes long-term investment in highly potential ventures of technical savvy entrepreneurs whose returns may be available after a long period, say 5-10 years.
  3. Venture capital does not confine to supply of equity capital but also supply of skills for fostering the growth and development of enterprises. Venture capitalists ensure active participation in the management which is the entrepreneur’s business and provide their marketing, technology, planning and management expertise to the firm.
  4. Venture capital financing involves high risk return spectrum. Some of the ventures may yield very high returns to more than Compensates for heavy losses on others which may also have earning prospects.

In nut shell, a venture capital institution is a financial intermediary between investors looking for high potential returns and entrepreneurs who need institutional capital as they are yet not ready/able to go to the public.

Dimensions of Venture Capital

Venture capital is associated with successive stages of the firm’s development with distinctive types of financing, appropriate to each stage of development. Thus, there are four stages of firm’s development, viz., development of an idea, start up, fledgling and establishment.

The first stage of development of a firm is development of an idea for delineating precise specification for the new product or service and to establish a business-plan. The entrepreneur needs seedling finance for this purpose. Venture capitalist finds this stage as the most hazardous and difficult in view of the fact that majority of the business projects are abandoned at the end of the seedling phase.

Start-up stage is the second stage of the firm’s development. At this stage, entrepreneur sets up the enterprise to carry into effect the business plan to manufacture a product or to render a service. In this process of development, venture capitalist supplies start-up finance.

In the third phase, the firm has made some headway, entered the stage of manufacturing a product or service, but is facing enormous teething problems. It may not be able to generate adequate internal funds. It may also find its access to external sources of finance very difficult. To get over the problem, the entrepreneur will need a large amount of fledgling finance from the venture capitalist.

In the last stage of the firm’s development when it stabilizes itself and may need, in some cases, establishment finance to explicit opportunities of scale. This is the final injection of funds from venture capitalists. It has been estimated that in the U.S.A., the entire cycle takes a period of 5 to 10 years.

Importance of Venture Capital

Venture Capital institutions lets entrepreneurs convert their knowledge into viable projects with the assistance of such Venture Capital institutions.

  • It helps new products with modern technology become commercially feasible.
  • It promotes export-oriented units to earn more foreign exchange.
  • It not only provides the financial institution but also assist in management, technical and others.
  • It strengthens the capital market which not only improves the borrowing concern but also creates a situation whereby they can raise their own capital through capital market.
  • It promotes modern technology through the process where financial institutions encourage business ventures with new technology.
  • Many sick companies get a turn around after getting proper nursing from such Venture Capital institutions.

Types of Venture Capital fund:

Type of Funding Objective & Amount of Funding
Pre-seed funding 1.    Pre-seed funding is in the range of $100,000 – $200,000

2.    Funding provided when a startup is less than a year old.

3.    Supports R&D, Market Research.

4.    Recruit new members.

Seed Capital 1.    Funding will be in the range of $ 1million – $ 2 million

2.    Start-up company will need a product that will be viable in the market

Series A funding 1.    Funding will range in between $ 2 million – $ 15 million

2.    The start-up company needs to have a market-proven product that will help in scaling up fast.

Series B funding 1.    Funding can range between $ 7 million – $ 20 million.

2.    This round is considered to be less risky.

3.    Funding is used for Business Development, advertising.

Series C funding 1.    Funds for developing more products and services, acquiring another company

2.    Funding received is usually in the range of $ 25 million.

Series D funding 1.    Few start-ups reach this stage.

2.    Positive reasons could be the company wants to stay private for some more time or they need to go for more expansion before going for IPO.

3.    The negative reason could be the company did not hit the expected growth plans.

4.    This is down round funding as trust in the companies abilities has been eroded.