Venture capital

Key Takeaways:

  • Venture Capital (VC) refers to an investment made into start-ups or early stage companies
  • Venture Capital investments can be through three modes: Equity, Conditional Loans and Participating Debentures
  • The Venture Capital Process can be divided into four stages:   Idea generation and business plan submission, Introductory Meeting,  Due Diligence,  and Term sheets sharing and funding

What is Venture Capital?

Venture Capital (VC) refers to an investment made into start-ups or early stage companies. Investors making such investments are called venture capitalist and are generally large institutions. Venture capital firms provide funding to small companies or start-ups which are starting to get a clear idea of their revenue stream and customers. 

Economies all over the world have started giving unprecedented attention to start-ups with a new idea, innovation or technology. Funds provided by these venture capitalists help in commercialising the innovation.

How Venture Capital works?

Venture capitalists usually pool money in a VC fund and then go about investing in prospective companies and call them their portfolio companies. The investment is expected to give returns in multiples and has less risk attached compared to seed funding.

VCs usually take an equity stake, such as with preferred shares with a host of features, in exchange for its funding, but may also provide debt funding to the company.

VC funds could help a start-up with broad market research, starting commercial operations including production and sales, or with expansion, product improvement or a marketing push.

VCs may or may not be active in the decision-making of the start-up management and may provide guidance with their inhouse vertical knowledge. It is all to add value to their own portfolio or the investment in the start-up.

Other kinds of non-public equity funding for a business are seed funding/angel investing and private equity.

The Venture Capital Process

The venture capital financing process can be divided into four phases:

1.     Idea generation and business plan submission

2.     Introductory Meeting

3.     Due Diligence

4.     Term sheets sharing and funding

Idea Generation and Business Plan submission:

The first step to avail venture capital financing is generating and developing a creative idea. After that the capital seeking firm should approach venture capitalists with a properly laid business plan. The business plan should positively have the following components.

                 i.          An executive summary

                ii.          Explanation of opportunities in the market with market size

              iii.          Description of current and expected competitive environment

              iv.          Detailed financial projections

               v.          Details regarding the company’s management

 Introductory Meeting:

Usually the business plan submitted acts as an elimination round. After analysing the business plan, VCs decide upon discussing further if they find the business idea and plan convincing. The project is discussed in detail during the one-to-one meeting. Based on the meeting, venture capitalists decide whether to move to the next step or not.

Due Diligence:

Due diligence phase varies for different business proposals. In this stage, queries relating to product strategy, business strategy, target segment are resolved and analysed.

Term Sheets Sharing and Funding:

This is the step where the contract is finalised, and financing is done. Venture Capitalist shares term sheets with the start-up which is a document explaining all the terms and conditions of the contract. The term sheet is usually negotiable and agreed upon by all the stakeholders. After doing all the legal formalities, funds are provided.

Features of Venture Capital Investments

Some features of venture capital investments are:

·   Risk in venture capital investments are high

·   Venture capital investments lack liquidity

·   Venture capital investments are usually done in innovative projects

·   Venture Capitals may also participate in company’s management

Methods of Venture Capital Funding

Venture capital investments are usually done in the following three formats:

1.     Equity

2.     Conditional Loan

3.     Participating Debentures

Know More

Pepperfry.com, in a fresh round of financing led by Zodius Technology Fund and Goldman Sachs, has raised USD100 million. It aims at using this fund in expanding its business into Tier 3 and Tier 4 cities of India by increasing the reach to these cities by adding more delivery vehicles. For a sector focussed e-commerce firm in India, this is the largest investment raised.