CONCEPTS OF VENTURE CAPITAL FINANCING

The venture capital financing means financing of new venture promoted by qualified entrepreneurs who lack experience and funds to materialize to their ideas. Under venture capital financing venture capitalist make the investment through purchase of the equity or debt securities from inexperienced entrepreneurs who undertake highly risky ventures with high potential for success.

Some of the features of Venture Capital Financing are:-

• It is basically an equity finance in new companies.
• It can be viewed as a long-term investment in growth-oriented small/medium firms.
• Apart from providing funds, the investor also provides support in form of sales strategy, business networking, and management expertise, enabling the growth of the entrepreneur.

venture capital financing

Some common methods of venture capital financing are as follows:

Equity financing

The venture capital undertakings normally require funds for a long term. However, they may not be able to provide returns to the investors during the early stages. Therefore, the venture capital finance is usually provided by way of equity share capital. The equity share of venture capital firm is not more than 49% of the total equity capital of venture capital undertakings so that the effective control and ownership remains with the entrepreneur.

Conditional loan

After the venture is able to generate sales, the conditional loan is repayable in the form of a royalty. No interest is paid on such loans. The actual rate of royalties depends on other factors of the venture such as gestation period, cash flow patterns, risk and other factors of the enterprise. In some cases, the choices are given by the Venture capital financiers to the enterprise of paying a high rate of interest instead of royalty on sales once it becomes commercially sounds.

Participating debenture

Such security carries charges in three phases — in the startup phase, no interest is charged, next stage a low rate of interest is charged up to a particular level of operation, after that, a high rate of interest is required to be paid.

Income note

It is a combines the characteristics of both conventional loan and conditional loan. The entrepreneur has to pay both interest and royalty on turnover but at significantly low rates.

Factors  to be considered by venture capitalist 

• The venture capitalist is expected to see that the entrepreneur bears a high degree of risk. This will assure them that the entrepreneur has the sufficient level of the commitments to project as they themselves will have a lot of loss, should the project fail.

• The venture capitalist should consider whether the development and production of new product/service should be technically feasible. They should employ experts in their respective fields to examine idea proposed by the entrepreneur.

• Most of the venture capitalist believes that the success of a new project is highly dependent on the quality of its management team. They expect that entrepreneur should have a skilled team of managers. Management also is required to show a high level of commitments to the project.

• Venture capital should ensure that entrepreneur and his team should have necessary technical ability to be able to develop and produce new product/service.

• Since the degree of risk involved in investing in the company is quite fairly high, venture capitalists should seek to ensure that the prospects for future profits compensate for the risk. Therefore, they should see a detailed business plan setting out the future business strategy.

• In case of companies, to ensure proper protection of their investment, venture capitalist should require a place on the Board of Directors. This will enable them to have their say on all significant matters affecting the business.

• The venture capitalist should seek assurance that there is actually a market for a new product. Further venture capitalists should see the research carried on by the entrepreneur.

• The venture capitalist should try to create a number of exit routes. These may include a sale of shares to the public, the sale of shares to another business, or sale of shares to original owners.