INTRODUCTION TO VENTURE CAPITAL: WHAT YOU NEED TO KNOW

What is Venture Capital?

Venture capital is a private equity fund that provides funding for young ventures or small business enterprises that are likely to demonstrate long-term growth potential. 

This type of finance is normally provided at the seed or an early stage in the development of a company. 

Other than investment capital, venture capitalists also offer management experience and other technical skills which companies require to overcome challenges that exist at introduction stages. 

In return, VC firms receive equity and also acquire controlling powers over the business decisions. The innovation in VC is about scaling up and pushing growth within the industry through the venture capital firms. 

Venture capital also comes from HNWIs who are called as Angel investors, who majorly fund the start-ups for equity purposes. 

Unlike VC firms, that is a pool of capital sourced from various sources, an angel investor normally invests his own money. 

Most angel investors are successful entrepreneurs or retired executives who want to invest in firms they think will show potential growth opportunities and are well managed. Venture capitalists and angels are both critical stakeholders in funding. 

What does a Venture Capital do?

VC is essentially selling the ownership stakes to a few limited investors, often through limited partnerships. 

While private equity focuses much of its efforts on established businesses, VC focuses on emerging firms to offer them funding at a point when they cannot raise funds from usual traditional financing, such as bank loans or capital markets.

VC investments are bought and sold based on equity, not schedulable repayments like a traditional loan. 

There is significant risk involved in a venture capitalist investment because so many investments will fail, but the hope is that several successful ventures will yield large returns, sometimes as much as 10 times over. 

This type of funding is essential for creating innovative ways, jobs, and new business models that could help in overall growth of the industry.

VC not only helps in funding but also counsel, mentor and gives access to startups on their vast network of mentors, talent or business.

 A more significant advantage is that the startups are free of the risk of repayable liabilities such as loans because funds from VC are not payable even if the business fails. 

Thus, Venture capital significantly assists growing companies in getting a foothold in competitive markets.

Types of Venture Capital

1) Seed capital

Seed capital or seed funding is the capital investment to help an emerging entrepreneur in performing preliminary activities for founding a company. 

Seed funding helps in product research & development; market research, business, business plan formulation, etc. 

Seed funding can also be given by the owners themselves and even their direct family members and friends.

2) Startup capital

Most of the time, people use this term interchangeably with seed funding but there are minor differences. 

Normally, business owners seek startup capital after completing the stages involved in securing seed funding. This can be used to create a product prototype, hiring crucial management personnel etc.

3) The first stage, first round, or series A

This stage is to help businesses that have a product and wish to venture into commercial manufacturing, sales, and marketing.

4) Expansion fund

Expansion capital is that amount of fund required by the company to expand its scope of operations. 

5) Late stage funding

This type of funding is provided to companies that have succeeded during the commercial manufacturing and sales. The firms at this stage might record tremendous growth in revenue but are still not profitable.

6) Bridge Funding

Often called mezzanine financing, this is funding that would help complete all the short-term expenses necessary to create an IPO.

How to Secure VC Funding

Securing venture capital (VC) funding involves a number of Key Steps and considerations. First, you must submit a detailed business plan to a VC firm or angel investor. 

They will then do due diligence, giving an extremely close analysis of your business model, products, management team, and track record. 

If satisfied, the investor will provide you with funds in exchange for equity, usually delivered in stages. They will also join the board and advise on major decisions in order to protect their investment.

A VC wants a significant return on investment, thus seeking an exit typically within four to six years through a merger, acquisition, or an initial public offering. 

The process can be quite long-drawn and, with you having to develop a proper pitch, seek the right investor, and then go through rounds of meetings to finalize terms.

Despite problems with VC funding, including the risk of ownership dilution, approval on decisions by investors, and high return expectations within a given framework, it can be essential for the startup that requires an investment with a high cost or requires an unnecessarily long period to bring a commercialized product to market.

Characteristics of Venture Capital

1. Not meant for large scale industries : VC is highly accessible to small and medium sized businesses.

2. Invest in high-risk, high-return business: Companies that qualify for VC are usually those which offer high return but come with a risk.

3. Offered to commercialize ideas: Those seeking VC, have chosen to raise investment to commercialize their idea of a product or service.

4. Long term investment: VC is a long-term investment where returns could be realized after 5 to 10 years.

5. Disinvestment to increase capital: VC firms or other investors may disinvest in a company after it shows promising turnover. The disinvestment may be undertaken to infuse more capital, not to generate profits.

Advantages and Disadvantages of VC

Advantages:

1. Business experience: The key benefits of VC is that it allows new entrepreneurs to obtain business experience. Suppliers of VC are experienced enough and help the owners at all stages of decision-making.

2. Business owners do not pay back: The amount invested is not to be repaid to the entrepreneur or business owner. The owner will not be liable in case the business fails.

3. They can provide valuable networking: Since they have knowledge and networking, the VC providers can create networking for business owners. This will help businesses in marketing and promotion.

4. Enables Venturing to raise additional capital: The VC investors if desired can pump more money into a firm to create more value. For doing that, they can bring in more investors during later stages.

5. It helps update technology: VC could supply the seed capital that small businesses may need to modernize or integrate new technology which might be able to keep them ahead.

Disadvantages

1. Low ownership equity: Entrepreneurs often have to give away ownership to the VC in their business. If a company requires additional funding that is way more than the initial estimates then the owners might end up losing their majority stake in the company, and with that power to make decisions.

2. Create conflict of interest: Investors have a controlling stake in the start-up, and also become one of the board members. Due to this there can be conflict of interest between the owners and investors which may prevent decisive action sometimes.

3. Receiving approvals is a time-consuming process: VC investors will have to do due diligence and assess whether the idea of a startup will be viable or not before investing there. This may take some time because it involves market analysis and financial forecasting and thus funding can be delayed.

4. There is difficulty in accessing venture capital: For someone with  no-networks will face difficulty to approach a venture capital firm or investor. 

Conclusion

Venture capital deals with new startups by providing them with funds, in return for some ownership stake in the company. 

It also helps businesses to grow by its expertise and mentorship. Taking the right amount of calculated risks on high-potential businesses helps push growth, foster innovation, and create new industries that eventually enhance economic development along with technological advancement.