Venture Capital

Prepared by
Prof. Krunal Bhuva
JVIMS (Jamnagar)

THEORETICAL FRAMEWORK
Venture capital, as a fund-based financial service, has
emerged the world over to fill gaps in the conventional
financial mechanism, focusing on new entrepreneurs,
commercialization of new technologies and support to
small/medium enterprises in the manufacturing and
the service sectors.
Over the years, the concept of venture capital has
undergone significant changes. The growing venture
capital industry in India can profitably draw upon the
experiences of the developed countries.

Features
The characteristics features of venture capital
differentiate it from other capital investments.
It is basically equity finance in relation to new
listed companies and debt financing is only
supplementary to ensure running yield on the
portfolio of the venture capitalists/capital
institution (VCIs).
It is long-term investment in growth-oriented
small/medium firms.

 There is a substantial degree of active

involvement of VCIs with the promoters of
venture capital undertakings (VCUs) to provide,
through a
hands-on approach, managerial skills without
interfering in the management.

The venture capital financing involves high riskreturn spectrum.

It is not technology finance, though technology
finance may form a sub-set of such financing. Its
scope is much wider.

Venture capital aims at :

Fuels ambitions and dreams
Breathes life into promising business ventures
Provides foresight with a free sense of
direction
Smoothly glide over rough passages

Features
1.
2.
3.
4.
5.

Risky project
Early stage financing
Partnering
Long term
Form of finance

Venture capital terminology

1.
2.
3.
4.
5.

Venture capital
Venture capitalist
Investee companies
Seed financing
Start-up financing ( not including marketing
expenses)
6. Mezzanine financing/ growth finance
7. Follow-on financing

Mode of Investments:
Venture capital is basically an equity financing
method, the investment being made in
relatively new companies when it is too early
to go to the capital market to raise funds.
In addition, financing also takes the form of
loan finance/convertible debt to ensure a
running yield on the portfolio of the venture
capitalists.

Objective:
The basic objective of a venture capitalist is to
make a capital gain on equity investment at
the time of exit, and regular return on debt
financing.
It is long term investment in growth-oriented
small/medium firm. It is a long term capital
that is injected to enable the business to grow
at a rapid pace, mostly from the start up
stage.

Need of venture capital

There are entrepreneurs and many other people
which come up with bright ideas but lack the capital
for the investment what these venture capitals do
are to facilitate and enable the start up phase.
When there is an owner relation between the
venture capital providers and receivers, their interest
for returns will increase the firms motivation to
increase profits.

 Venture capitalists have invested in similar firms and

projects before and therefore have more knowledge
and experience. This knowledge and experience are
the outcomes of the experiments through the
successes and failures from previous ventures so
they know on what works and what not, and how it
works .
So through venture capital a firm can initiate growth,
identify problems and find recipies to overcome
them.

Venture capital process

Venture capital is an investment by venture
capitalist.
The activities in the investment process follow a
particular sequence.
1.
2.
3.
4.

Deal origination
Screening
Evaluation / Due diligence
Investment Valuation
1.
2.
3.

Projection on future revenue and profitability

Expected market capitalization
Deciding on the ownership stake based on the return expected on the
proposed investment.

5. Structuring the deal

6. Value addition
7. Exit :1. once the valuation deal has been structured and
agreement finalized, the venture capitalist
generally assumes the role of partner and
collaborator.
2. He also involves in shaping of the direction of
venture

8. IPO :- when company is making profits and market condition

is conducive, the venture capitalists offer their share holding
to the public.
9. Acquisition by another company :- another strategy is to sell
their holdings to another company who are interested to
expand their business line.
10. Repurchase the venture capitalists share by the investee
company.
11. Purchase of Venture capitalists share by a Third party:venture capitalists can sell their holding through private
placements to one or more parties. Here there is chance of
loss of control of the existing promoters.

Selection of Investment
The first step in venture capital financing is the
selection of the investment.
It includes stages of financing, methods to evaluate
deals and the financial instruments to structure a deal.
The stages of financing as differentiated in venture
capital industry are
early stage and later stage.

Included in early stage are

seed capital/pre-start-up,
start-up and
second-round financing.

 The later stage of

covers

venture

capital

financing

mezzanine/development capital,
bridge/ expansion,
buyouts and turnarounds.

The structuring of venture capital deals is a mix of the

available financial instruments: equity and debt.
The equity instruments include ordinary, non-voting,
deferred ordinary, preference, participating
preference and so on. The main types of debt
instruments are conventional loan, conditional loan,
income notes, NCDs, PCDs, zero interest bonds, secured
premium notes and deep discount bonds.

Seed money
Seed money is typically used to pay for such
preliminary operations as
market research and product development.

Investors are often the business founders themselves,

using savings, mortgage loan proceeds, or funds
borrowed from family and friends.
They may also be outside angel investors, venture
capitalists or accredited investors who are acquainted/
familiar in some way with the founders. Seed capital is
not necessarily a large amount of money. Many people
start up new business ventures with $50,000 or less.

Startup capital
Startup companies can come in all forms, but the
phrase "startup company" is often associated with high
growth, technology oriented companies.
Investors are generally most attracted to those new
companies distinguished by their risk/reward profile
and scalability.
That is, they have lower bootstrapping costs, higher
risk, and higher potential return on investment.
Successful startups are typically more scalable than an
established business, in the sense that they can
potentially grow rapidly with limited investment of
capital, labor or land.

Investment Nurturing/Aftercare
The after-care stage of venture capital financing
relates to different styles of nurturing, its
objectives and techniques. The style of nurturing
which refers to the extent of participation by VCIs
in the affairs of the venture, falls into three broad
categories: hands on, hands off and hands
holding. Some of the important techniques to
achieve the objectives are personal discussion;
plant visits, nominee directors, periodic reports
and commissioned studies.

Advantage of venture capital

1. Economy oriented
1. Helps in the industrialization of the country
2. Helps in technological development of the
country
3. Generate employment
4. Helps in developing entrepreneurial skills

2. Investor oriented
1. benefit to the investor is that they are
invited to invest only after the company starts
earning profit, so the risk is less and healthy
growth of capital market is entrusted.

3. Entrepreneur oriented
1. helps small and medium first generation
entrepreneurs to translate their ideas into
reality.
2. promotes and fosters entrepreneurship in
the country.

Disadvantages of VC
1. Securing a deal with a VC can be long and complex
process
2. Person will be required to draw a detailed business
plan, including financial projections, forecasting of
demand of the product etc.
3. Since the venture capitalist is taking risk, the
management control may get out of the
entrepreneurs.
4. He will also be forced to share profits he got from
the business with venture capitalist..