All you need to know about Venture Capital Financing

There are different ways of funding your business. In case you don’t have money to fund the entire business or, so to say, any of the business, venture capital can be a great option to go ahead. In this article, we shall discuss about Venture Capital Financing.

What is Venture Capital?

Venture capital can be defined as the long term equity investments in the business which has potential for significant growth and financial return. A person who invests on risky projects for gaining high returns is called a Venture Capitalist. Such person usually invests in new and risky projects.

Venture capital can come from following sources:

• Individual investors with lot of money;
• Investment banks^[1];
• Financial institutions.

Features of Venture Capital Financing

The following points may be noted:

• In a new and innovative project, promoters are competent, capable, and technically qualified to undertake the venture, but they lack adequate funds for venture investment;
• The ventures have innovation in terms of technology, process/products, which puts the venture in an advantageous position;
• The venture capital investment is highly risky, and high return investment as products/processes or technology is new and provides advantage over other alternatives for investment;
• The investment is for longer time and is illiquid during the take-off stage of venture/project. Therefore the investors are prepared to lock investment commercialization through expansion and increasing sales volume of venture; and
• The investment is long term equity financing wherein the venture capitalist earns return by capital gain.

Schemes of Venture Capital Financing in India

There are three schemes of Venture Capital Financing. They are as follows:

• Equity financial;
• Conditional loans; and
• Income notes.

The investment in a firm in the equity form is restricted to a maximum of 10% of the size of the fund, and the participation limited to 49% of the Equity Share Capital of project. In this case, the ownership would be in the hand of the promoters who put their idea, data, time, technology, and money in the project.

A conditional loan carries a royalty between 4 to 15% after the venture is capable of earning profit. There isn’t any payment interest clause in the conditional loan. On the other hand, income notes has interest payment clause with it but on a lower rate.

Advantages and Disadvantages of Venture Capital Financing

Advantages-

• Financial Backing-

Without a financial backing, it would be difficult for a company to get around. It can also be challenging to grow at a desired level. With financial backing, you can put your plan into overdrive.

• Business expertise-

By choosing this route, you don’t just get the money you need but also gain wisdom of someone or group of people. You can get guidance and consultation on business decisions.

• Connections-

With the right person with you, you would get access to their connections. You can get a lot from these connections and can use them for better results.

Disadvantages-

• You could lose control of the company-

Depending on how much money is invested, you would find that some investors would want to have a bigger stake in the company, but if you are not alert, they might run away with the company.

• Risk of becoming a minority owner-

Another disadvantage is that in case the firm or investor decide that they require a large portion of the company, this can leave as a minority owner. This would result in you no longer owning the company ultimately.

Steps for Venture Capital Financing

The steps for VCF are as follows:

• Prepare a proper business plan

A proper business plan or growth strategy should be made, and it should be made in a way that it presents their business proposal clearly. The business plan should address areas such as Management team, Market, and Finance.

• Shortlist venture capital funds

Once the business plan is made, search an appropriate Venture Capital firm. It not only provides appropriate capital but also apprise the project and infuse professional knowledge.

• Negotiate Financing Terms and Conditions

Negotiate regarding the valuation of venture and terms and conditions of subscription and shareholder’s agreement. Venture valuation is the most essential task to provide proper and actual value of efforts of promoters.

• Capital Structuring

The capital structuring require most attention so that the matters related to Exit options, ESOPs, and IPO is addressed in advance.

• Build team

After funding, build a well-educated and an experienced team of management to execute venture.

• Defining exit options

Venture capital firms invest in a venture to make multiple gains. They insist on clearly defined time frame and exit mode from the venture.

Conclusion

Venture capital financing boosts the industry growth of sectors that need technology appreciation and knowledge-based funding. With such financing, it would be difficult for the particular sector to work to the best of its potential.

Read our article:Matters Concerning the Investment Decisions of Venture Capital