venture capital

What is Venture Capital?

Venture capital means the early stage financing of new and young enterprises seeking to grow rapidly. It usually involves an involvement of venture capitalist in the manage of the the firm. Some also associate venture financing with financing of high and new technology based enterprises. So, in broader term, Venture Capital  is the investment of long term equity finance where the venture capitalist earns the returns in the form of capital gains.

In venture financing, entrepreneur and the venture capitalist acts in the interest of the business. Moreover, it is the commitment of capital for the formation and setting up of small scale enterprise which has new and unique business plan. The main focus is on the growth of the enterprise or business.

Features of Venture Capital

Long Term Investment – It is the long term liquid as well as illiquid investment which is not repayable on demand. This type of investment requires a long term commitment that necessitates the venture capital firms to wait for a long period in order to make profits.

Equity Participation – Venture financing is the actual or potential equity participation in the firm through direct purchase of the shares. The main purpose is to make capital gains by selling off the investments once the organisation starts making hefty profits.

Participation in Management – This mode of financing involves the continuing participation of the venture capitalist in the business of the enterprise. This helps him protecting and enhancing his investment. Apart from finance, he also gives his marketing, technology, planning and management skills to the firm.

Stages in Venture Capital

Early Stage Financing

  • Seed financing for supporting a new and unique business idea.
  • Research and Development financing for product development.
  • Start- up capital for initial production and marketing.
  • First stage financing for full scale production and marketing.

Expansion Financing

Acquisition/ Buyout Stage

  • Acquisition financing for acquiring another firm for further growth.
  • Management buyout financing for the enterprise to acquire firm or part its business back.
  • A turnaround financing for turning a sic company to a profitable one.

Process of Venture Capital Financing

Step 1 – Deal Origination

For this business, continuous flow of deal is very necessary. Deals basically originate in three ways –

  • Referral system
  • Active search
  • Intermediaries

Step 2 – Screening

This step involves the carrying out of the screening of each and every projects on the basis of some broad criteria. For example, a venture capitalist is familiar of technology and marketing, he will limit the project to these areas.

 Step 3 – Due Dilligence

This step involves the comprehensive evaluation of the firm. They evaluate the quality of entrepreneur before any interrogation into product, technology or marketing. Hence they ask for a business plan to make an assessment of the possible risk and return on the venture.

Step 4 – Deal Structuring

Once the due diligence has been done, the venturing firm and the venture company negotiates the term of the deal in terms of amount, form and price of the investment.

Step 5 – Post Investment Activities

Once the deal has been structured and the agreement finalized, the venture capitalist generally assumes the role of a partner and collaborator. He gets involve in shaping the direction of the venture.

Step 6 – Exit Plan

Venture capital main aim in financing a venture is aim at medium to long term financing. They generally want to cash out their gains in 5 to 10 years. A venture may exist in one of the following ways –

  • Initial Public offerings (IPO)
  • Acquisition by another company
  • Purchase of venture capitalist’s share by promoter of the company
  • Purchase of venture capitalist share by an outsider.