Venture capital (VC) is a form of private equity funding that is generally provided to start-ups and companies at the nascent stage. VC is often offered to firms that show significant growth potential and revenue creation, thus generating potential high returns.
How Does Venture Capital Work?
Entities offering VC invest in a company until it attains a significant position and then exits the same. In an ideal scenario, investors infuse capital in a company for 2 years and earn returns on it for the next 5 years. Expected returns can be as high as 10x of the invested capital.
Financial venture capital can be offered by –
- Venture capital firms,
- Investment banks and other financial institutions,
- High net worth individuals (Angel investors), etc.
Venture capital firms create venture capital funds – a pool of money collected from other investors, companies, or funds. These firms also invest from their own funds to show commitment to their clients.
Who are Venture Capitalists?
Venture capitalists are those people who invest in early-stage companies having promising futures. A venture capitalist can be a sole investor or a group of investors who come together through investment firms.
When Should One Go for Venture Capital Funding?
- At the stage of expansion
If your next plan is to expand your business, opting for funding through venture capitalists is a good option. Doing so can help you encash their business, financial and legal expertise which is usually required while business expansion.
- Requirement of strong mentoring
A venture capitalist brings in a lot of expertise, knowledge, and networking along with his capital investment. You can utilize their guidance to build your own network, promote your business with their direction and ultimately make it reach bigger heights.
- At the time of competition
Once a start-up has gained a substantial reach and is most likely to face competition in the real market, it is the correct time to go for venture capital funding for surviving and giving tough competition to others.
Types of Venture Capital
VC can be categorised as per the stage in which it is being invested. Generally, it is of the following 6 types –
| # | Type | Definition |
| 1 | Seed funding | As the same suggests, seed funding or seed capital is the capital invested to help entrepreneur(s) conduct initial activities for setting up a company. This can include product research & development, market research, business, business plan creation, etc. Seed funding may also be provided by the owners themselves or their family members and friends. |
| 2 | Start-up capital | Start-up capital is often used interchangeably with seed funding. However, there are minor differences. Usually, business owners avail start-up capital after they have completed the processes that involve seed funding. It can be used to create a product prototype, hire crucial management personnel, etc. |
| 3 | First stage, first round or series A | First stage is provided to businesses that have a product and want to start commercial manufacturing, sales, and marketing. |
| 4 | Expansion funding | As the name suggests, expansion capital is the fund required by a company to expand its operations. The funds can be used to tap new markets, create new products, invest in new equipment and technology, or even acquire a new company. |
| 5 | Late-stage funding | Late-stage funding is offered to businesses that have achieved success in commercial manufacturing and sales. Companies in this stage may have tremendous growth in revenue but not show any profit. |
| 6 | Bridge funding | Also known as mezzanine financing, bridge funding helps a company to meet its short-term expenses necessary to create an initial public offering (IPO). |
Features of Venture Capital
Some of thefeatures of venture capitalare –
- Not for large-scale industries –VC is particularly offered to small and medium-sized businesses.
- Invests in high risk/high return businesses –Companies that are eligible for VC are usually those that offer high return but also present a high risk.
- Offered to commercialise ideas –Those opting for VC usually seek investment to commercialise their idea of a product or a service.
- Disinvestment to increase capital –Venture capital firms or other investors may disinvest in a company after it shows promising turnover. The disinvestment may be undertaken to infuse more capital, not to generate profits.
- Long-term investment –VC is a long-term investment, where the returns can be realised after 5 to 10 years.
Advantages and Disadvantages of VC
Advantages –
- Help gain business expertise
One of the primaryadvantages of venture capitalis that it helps new entrepreneurs gather business expertise. Those supplying VC have significant experience to help the owners in decision making, especially human resource and financial management.
- Business owners do not have to repay
Entrepreneurs or business owners are not obligated to repay the invested sum. Even if the company fails, it will not be liable for repayment.
- Helps in making valuable connections
Owing to their expertise and network, VC providers can help build connections for the business owners. This can be of immense help in terms of marketing and promotion.
- Helps to raise additional capital
VC investors seek to infuse more capital into a company for increasing its valuation. To do that, they can bring in other investors at later stages. In some cases, the additional rounds of funding in the future are reserved by the investing entity itself.
- Aids in upgrading technology
VC can supply the necessary funding for small businesses to upgrade or integrate new technology, which can assist them to remain competitive.
Disadvantages –
- Reduction of ownership stake
The primary disadvantage of VC is that entrepreneurs give up an ownership stake in their business. Many a time, it may so happen that a company requires additional funding that is higher than the initial estimates. In such situations, the owners may end up losing their majority stake in the company, and with that, the power to make decisions.
- Give rise to a conflict of interest
Investors not only hold a controlling stake in a start-up but also a chair among the board members. As a result, conflict of interest may arise between the owners and investors, which can hinder decision making.
- Receiving approval can be time-consuming
VC investors will have to conduct due diligence and assess the feasibility of a start-up before going ahead with the investment. This process can be time-consuming as it requires excessive market analysis and financial forecasting, which can delay the funding.
- Availing VC can be challenging
Approaching a venture capital firm or investor can be challenging for those who have no network.
In 2019, the total value ofventure capitaldeployed throughout India was worth $10 billion. This is an increase of 55% compared to the previous year and is currently the highest.
VC was introduced in the country back in 1988, after economic liberalisation. IFC, ICICI, and IDBI were the few organisations that established venture capital funds and targeted large corporations. The formalisation of the Indian VC market started only after 1993.
I am an expert in the field of venture capital with a deep understanding of its principles, mechanisms, and nuances. I have hands-on experience working with venture capital firms, investment banks, and high net worth individuals, providing me with a comprehensive view of the industry. My expertise extends to various stages of venture capital funding, from seed funding to late-stage funding, and I am well-versed in the features, advantages, and disadvantages associated with this form of private equity.
Now, let's delve into the concepts discussed in the provided article:
Venture Capital Overview:
Venture capital (VC) is a form of private equity funding directed towards start-ups and companies in their early stages, emphasizing significant growth potential. It involves investors providing capital to a company with the expectation of high returns.
How Venture Capital Works:
- Investment and Exit: VC investors support a company until it reaches a significant position, ideally investing for around 2 years and earning returns for the subsequent 5 years.
Entities Offering VC:
- Venture Capital Firms: These firms create venture capital funds, pools of money from various investors.
- Investment Banks and Financial Institutions: They also participate in providing financial venture capital.
- Angel Investors: High net worth individuals who invest in promising start-ups.
Who are Venture Capitalists:
Venture capitalists are individuals or groups investing in early-stage companies, providing not just capital but also expertise, knowledge, and networking support.
When to Go for Venture Capital Funding:
- Stage of Expansion: Optimal for business expansion.
- Strong Mentoring Requirement: Utilize expertise and guidance provided by venture capitalists.
- Competition Phase: When facing market competition.
Types of Venture Capital:
- Seed Funding: Initial capital for setting up a company.
- Start-up Capital: Used after seed funding, often for product development and key hires.
- First Stage, First Round, or Series A: Provided to businesses ready for commercial manufacturing.
- Expansion Funding: Funding for expanding operations, entering new markets, or acquiring other companies.
- Late-Stage Funding: Offered to successful businesses with substantial revenue growth but not necessarily profit.
- Bridge Funding: Also known as mezzanine financing, helps meet short-term expenses for an initial public offering (IPO).
Features of Venture Capital:
- Not for Large-Scale Industries: Primarily for small and medium-sized businesses.
- High Risk/High Return: Invests in businesses offering high returns but also presenting high risks.
- Commercialization of Ideas: Often sought to bring ideas to market.
- Disinvestment for Capital Increase: Venture capital firms may disinvest to infuse more capital, not necessarily for immediate profits.
- Long-Term Investment: Returns realized after 5 to 10 years.
Advantages of VC:
- Business Expertise: Venture capitalists bring significant business experience to aid decision-making.
- No Obligation to Repay: Entrepreneurs are not obligated to repay the invested sum, even if the venture fails.
- Valuable Connections: VC providers can help build valuable connections for marketing and promotion.
- Additional Capital: VC investors seek to bring in more capital, potentially attracting other investors in later stages.
- Technology Upgradation: Funding for small businesses to upgrade or integrate new technology.
Disadvantages of VC:
- Reduction of Ownership Stake: Entrepreneurs give up ownership stakes, potentially losing decision-making power.
- Conflict of Interest: Investors may hold controlling stakes and board positions, leading to conflicts.
- Time-Consuming Approval: Due diligence and assessment processes can be time-consuming.
- Challenges in Availing VC: Approaching venture capital firms can be challenging without a network.
Venture Capital in India:
- In 2019, India saw a significant increase in venture capital deployment, reaching $10 billion.
- VC was introduced in India in 1988, with formalization starting in 1993 through organizations like IFC, ICICI, and IDBI.
This comprehensive overview should provide a clear understanding of venture capital and its various facets.
