It is a private or institutional investment made into early-stage / start-up companies (new ventures). As defined, ventures involve risk (having uncertain outcomes) in the expectation of a sizeable gain. Venture Capital is money invested in businesses that are small; or exist only as an initiative but have huge potential to grow. The people who invest this money are called venture capitalists (VCs).
Venture Capital investment is also referred to as risk capital or patient risk capital, as it includes the risk of losing the money if the venture doesn’t succeed and takes a medium to long term period for the investments to fructify.
Features of Venture Capital investments
- High Risk
- Lack of Liquidity
- Long term horizon
- Equity participation and capital gains
- Venture capital investments are made in innovative projects
- Suppliers of venture capital participate in the management of the company
Methods of Venture capital financing
- participating debentures
- conditional loan
The venture capital funding process typically involves four phases in the company’s development:
Step 1: Idea generation and submission of the Business Plan
The initial step in approaching Venture Capital is to submit a business plan. The plan should include the below points:
- There should be an executive summary of the business proposal
- Description of the opportunity and the market potential and size
- Review the existing and expected competitive scenario
- Detailed financial projections
- Details of the management of the company
There is a detailed analysis done of the submitted plan, by the Venture Capital to decide whether to take up the project or not.
Step 2: Introductory Meeting
Once the preliminary study is done by the VC and they find the project as per their preferences, there is a one-to-one meeting is called for discussing the project in detail. After the meeting, the VC finally decides whether or not to move forward to the due diligence stage of the process.
Step 3: Due Diligence
The due diligence phase varies depending on the nature of the business proposal. This process involves solving of queries related to customer references, product and business strategy evaluations, management interviews, and other such exchanges of information during this period.
Step 4: Term Sheets and Funding
If the due diligence phase is satisfactory, the VC offers a term sheet, which is a non-binding document explaining the basic terms and conditions of the investment agreement. The term sheet is generally negotiable and must be agreed upon by all parties, after which on completion of legal documents and legal due diligence, funds are made available.
Types of Venture Capital funding
The various types of venture capital are classified as per their applications at various stages of a business. The three principal types of venture capital are early-stage financing, expansion financing, and acquisition/buyout financing.
The venture capital funding procedure gets completed in six stages of financing corresponding to the periods of a company’s development
- Seed money: Low-level financing for proving and fructifying a new idea
- Start-up: New firms needing funds for expenses related to marketing and product development
- First-Round: Manufacturing and early sales funding
- Second-Round: Operational capital gave for early-stage companies which are selling products, but not returning a profit
- Third-Round: Also known as Mezzanine financing, this is the money for expanding a newly beneficial company
- Fourth-Round: Also called bridge financing, 4th round is proposed for financing the “going public” process
A) Early Stage Financing:
Early-stage financing has three subdivisions seed financing, start-up financing, and first-stage financing.
- Seed financing is defined as a small amount that an entrepreneur receives to be eligiblefor a start-up loan.
- Start-up financing is given to companies to finish thedevelopment of products and services.
- First Stage financing: Companies that have spent all their starting capital and need finance for beginning business activities at the full scale arethe major beneficiaries of First Stage Financing.
B) Expansion Financing:
Expansion financing may be categorized into second-stage financing, bridge financing, and third-stage financing or mezzanine financing.
Second-stage financing is provided to companies to begin their expansion. It is also known as mezzanine financing. It is provided to assist a particularcompany to expand in a major way. Bridge financing may be provided as a short-term interest-only finance option as well as a form of monetary assistance to companies that employ the Initial Public Offers as a major business strategy.
C) Acquisition or Buyout Financing:
Acquisition or buyout financing is categorized into acquisition finance and management or leveraged buyout financing. Acquisition financing assists a company to acquire certain parts or an entire company. Management or leveraged buyout financing helps a particular management group to obtain a particular product of another company.
Advantages of Venture Capital
- They bring wealth and expertise to the company
- A large sumof equity finance can be provided
- The business does not stand the obligation to repay the money
- In addition to capital, it provides valuable information, resources, and technical assistance to make a business successful
Disadvantages of Venture Capital
- As the investors become part owners, the autonomy and control of the founder are lost
- It is a lengthy and complex process
- It is an uncertain form of financing
- Benefits from such financing can be realized in long run only
There are various exit options for Venture Capital to cash out their investment:
- Promoter buyback
- Mergers and Acquisitions
- Sale to another strategic investor
Examples of venture capital funding
Kohlberg Kravis & Roberts (KKR), one of the top-tier alternative investment asset managers in the world, has entered into a definitive agreement to invest USD150 million (Rs 962crore) in Mumbai-based listed polyester maker JBF Industries Ltd. The firm will acquire a 20% stake in JBF Industries and will also invest in zero-coupon compulsorily convertible preference shares with 14.5% voting rights in its Singapore-based wholly-owned subsidiary JBF Global Pte Ltd. The funding provided by KKR will help JBF complete the ongoing projects.
Pepperfry.com, India’s largest furniture e-marketplace, has raised USD100 million in a fresh round of funding led by Goldman Sachs and Zodius Technology Fund. Pepperfry will use the funds to expand its footprint in Tier III and Tier IV cities by adding to its growing fleet of delivery vehicles. It will also open new distribution centers and expand its carpenter and assembly service network. This is the largest quantum of investment raised by a sector-focused e-commerce player in India.