Financial Services: Venture Capital
As defined by SEBI (Securities Exchange Board of India), venture capital fund is “an alternative investment fund which invests primarily in unlisted securities of start-ups, emerging or early-stage venture capital undertakings that are mainly involved in new products, new services, technology or intellectual property right based activities or a new business model“.
Venture Capital is a private or institutional investment made into early-stage / start-up companies (new ventures). As defined, ventures involve risk (having uncertain outcome) in the expectation of a sizeable gain. Venture Capital is money invested in businesses that are small; or exist only as an initiative, but have huge potential to grow. The people who invest this money are called venture capitalists (VCs).
Example of venture capital funding
Pepperfry.com, India’s largest furniture e-marketplace, has raised USD100 million in a fresh round of funding led by Goldman Sachs and Zodius Technology Fund. Pepperfry will use the fundsto expand its footprint in Tier III and Tier IV cities by adding to its growing fleet of delivery vehicles. It will also open new distribution centres and expand its carpenter and assembly service network. This is the largest quantum of investmentraised by a sector focused e-commerce player in India.
Features of Venture Capital investments
- 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
Methods of Venture capital financing
- Participating debentures
- Conditional loan
Steps in Venture Capital Financing:
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.
Advantages of Venture Capital
The advantages of venture capital are as follows:
i. New innovative projects are financed through venture capital which generally offers high profitability in long run.
ii. In addition to capital, venture capital provides valuable information, resources, technical assistance, etc., to make a business successful.
Disadvantages of Venture Capital
The disadvantages of venture capital are:
i. It is an uncertain form of financing.
ii. Benefit from such financing can be realized in long run only.
Types of Venture Capital funding
The various types of venture capital are classified as per their applications at various stages of a business. The three principal types of venture capital are early stage financing, expansion financing and 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 marketingand 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 calledbridge financing, 4th round is proposed for financing the “going public” process
Regulation of Venture Capital Funds
In India, VCFs are regulated by SEBI (Venture Capital Funds) Regulations, 1996. These were followed by the SEBI (Foreign Venture Capital Investor) Regulations, 2000 on the recommendation of Chandrasekhar committee for fostering growth in the industry. Through these regulations, SEBI has sought to lay down conditions within which a VCF must restrict its investments.
Registration of Venture Capital Funds
A Venture capital fund can either be a fund established as a trust under the Indian trust act or a company as defined under companies act 1956.
A company or trust (which functioned as a venture capital fund before the commencement of these regulations) shall cease to function as a venture capital fund if it does not apply to SEBI for registration within 3 months from the commencement of the regulations.