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C. Venture Capital

 
Concept

Venture capital is a form of private equity and a type of financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential. Venture capital generally comes from well-off investors, investment banks and any other financial institutions. However, it does not always take a monetary form; it can also be provided in the form of technical or managerial expertise. Venture capital is typically allocated to small companies with exceptional growth potential, or to companies that have grown quickly and appear poised to continue to expand.

 
Features

  • 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
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Methods of Venture capital financing

  • Equity
  • Participating Debentures
  • Conditional Loan
  • The venture capital funding process typically involves four phases in the company’s development:

  • Idea generation
  • Start-up
  • Ramp up
  • Exit
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Step 1: Idea generation and submission of the Business Plan
The initial step in approaching a 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 on the existing and expected competitive scenario
  • Detailed financial projections
  • Details of the management of the company

There is detailed analysis done of the submitted plan, by the Venture Capital to decide whether to take up the project or no.

 
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 that 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 upon 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 time 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 three principal types of venture capital are :

  1. Early Stage Financing
  2. Expansion Financing
  3. Acquisition/Buyout Financing.

The venture capital funding procedure gets complete 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 with marketing and product development

     
  • First-Round:
  • Manufacturing and early sales funding

     
  • Second-Round:
  • Operational capital given 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

 
1. Early Stage Financing:

Early stage financing has three sub divisions seed financing, start up financing and first stage financing.

  • Seed financing is defined as a small amount that an entrepreneur receives for the purpose of being eligible for a start up loan.
  • Start up financing is given to companies for the purpose of finishing the development 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 are the major beneficiaries of the First Stage Financing.
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2. 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 for the purpose of beginning their expansion. It is also known as mezzanine financing. It is provided for the purpose of assisting a particular company 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.

 
3. 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
  • Large sum of 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, technical assistance to make a business successful
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Disadvantages of Venture Capital

  • As the investors become part owners, the autonomy and control of the founder is lost
  • It is a lengthy and complex process
  • It is an uncertain form of financing
  • Benefit from such financing can be realized in long run only
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Exit route

There are various exit options for Venture Capital to cash out their investment:

  • IPO
  • Promoter buyback
  • Mergers and Acquisitions
  • Sale to other strategic investor