VENTURE CAPITAL USAGE AND ITS STAGES G.Gayathri II MBA, Anna University Regional Campus, Coimbatore Project trainee, Technip India Limited, Guindy ABSTRACT Venture capital is long term financial assistance to projects being set up to introduce new products/ inventions/innovations or to employ or commercialize new technologies. Thus, venture capital entails high risk but has the promise of attractive returns. It is therefore also known as Risk capital. The role of venture capital institutions is very important for economic growth. Because of their assistance, new entrepreneurs and business spring up and contribute significantly to the total wealth of nation. Below this article would clearly explain about the venture capital benefits, phases and its stages. This article concludes with the venture capital institutions benefits. Keywords: financial assistance, risk capital, economic growth, new entrepreneur INTRODUCTION TO VENTURE CAPITAL: Venture capital is a type of equity financing that addresses the funding needs of entrepreneurial companies that for reasons of size, assets, and stage of development cannot seek capital from more traditional sources, such as public markets and banks. Venture capital investments are generally made as cash in exchange for shares and an active role in the invested company. Venture capital differs from traditional financing sources in that venture capital typically: Focuses on young, high-growth companies; Invests equity capital, rather than debt; Takes higher risks in exchange for potential higher returns; Has a longer investment horizon than traditional financing; Actively monitors portfolio companies via board participation, strategic marketing, governance, and capital structure. Successful long-term growth for most businesses is dependent upon the availability of equity capital. Lenders generally require some equity cushion or security (collateral) before they will lend to a small business. A lack of equity limits the debt financing available to businesses. Additionally, debt financing requires the ability to service the debt through current interest payments. These funds are then not available to grow the business. Venture capital provides businesses a financial cushion. However, equity providers have the last call against the company s assets. In view of this lower priority and the usual lack of a current pay requirement, equity providers require a higher rate of return/return on investment (ROI) than lenders receive. 114
OBJECTIVE OF THE STUDY: To study about the angel investors To learn the needs of venture capital To know the life cycle and stages of venture capital UNDERSATANDING OF VENTURE CAPITAL: Venture capital for new and emerging businesses typically comes from high net worth individuals ( angel investors ) and venture capital firms. These investors usually provide capital unsecured by assets to young, private companies with the potential for rapid growth. This type of investing inherently carries a high degree of risk. But venture capital is long-term or patient capital that allows companies the time to mature into profitable organizations. Venture capital is also an active rather than passive form of financing. These investors seek to add value, in addition to capital, to the companies in which they invest in an effort to help them grow and achieve a greater return on the investment. This requires active involvement; almost all venture capitalists will, at a minimum, want a seat on the board of directors. Although investors are committed to a company for the long haul, that does not mean indefinitely. The primary objective of equity investors is to achieve a superior rate of return through the eventual and timely disposal of investments. A good investor will be considering potential exit strategies from the time the investment is first presented and investigated. ANGEL INVESTORS: Business angels are high net worth individual investors who seek high returns through private investments in start-up companies. Private investors generally are a diverse and dispersed population who made their wealth through a variety of sources. But the typical business angels are often former entrepreneurs or executives who cashed out and retired early from ventures that they started and grew into successful businesses. These self-made investors share many common characteristics: They seek companies with high growth potentials, strong management teams, and solid business plans to aid the angels in assessing the company s value. (Many seed or startups may not have a fully developed management team, but have identified key positions.) They typically invest in ventures involved in industries or technologies with which they are personally familiar. They often co-invest with trusted friends and business associates. In these situations, there is usually one influential lead investor ( archangel ) those judgment is trusted by the rest of the group of angels. Because of their business experience, many angels invest more than their money. They also seek active involvement in the business, such as consulting and mentoring the entrepreneur. They often take bigger risks or accept lower rewards when they are attracted to the non-financial characteristics of an entrepreneur s proposal. VENTURE CAPITAL PROCESS: A startup or high growth technology companies looking for venture capital typically can expect the following process: Submit Business Plan. The venture fund reviews an entrepreneur s business plan, and talks to the business if it meets the fund s investment criteria. Most funds concentrate on an industry, geographic area, and/or stage of development (e.g., Startup/Seed, Early, Expansion, and Later). Due Diligence. If the venture fund is interested in the prospective investment, it performs due diligence on the small business, including looking in great detail at the company s management team, market, products and services, operating history, corporate governance documents, and financial statements. This step can include developing a term sheet describing the terms and conditions under which the fund would make an investment. Investment. If at the completion of due diligence the venture fund remains interested, an investment is made in the company in exchange for some of its equity and/or debt. The terms of an investment are usually based on company performance, which help provide benefits to the small business while minimizing risks for the venture fund. 115
Execution with VC Support. Once a venture fund has invested, it becomes actively involved in the company. Venture funds normally do not make their entire investment in a company at once, but in rounds. As the company meets previouslyagreed milestones, further rounds of financing are made available, with adjustments in price as the company executes its plan. Exit. While venture funds have longer investment horizons than traditional financing sources, they clearly expect to exit the company (on average, four to six years after an initial investment), which is generally how they make money. Exits are normally performed via mergers, acquisitions, and IPOs (Initial Public Offerings). In many cases, venture funds will help the company exit through their business networks and experience. VENTURE CAPITAL IN INDIA: Venture capital in India was known in ninety s era. It is now that it has successfully emerged for all the business firms that take up risky projects and have high growth prospects as well. The venture capital in India is provided as risk capital in the forms of shares, seed capital and other similar means. In 1988, ICICI emerge as a venture capital provider with unit trust of India. Financial banks like ICICI have stepped into this and have their own venture subsidies. Apart from Indian investors international companies too settled in India as a financial institute providing investment to large business firms. It is because of foreign investors that financial markets developed in India on a large scale. Introduction of western philosophies, tight contracts, focus on profitable projects and active involvement in finance was contributed by foreign investors only. The financial investment process has evolved a lot with time in India. Earlier there were only in commercial banks and some financial institute but now venture capital institutes, India has grown a lot. Business firms are now focused on expansion because they can get financial support with venture capital. The scale and quality of the business enterprises have increased in India now. With the international competition, there have been a number of growth oriented business firms that have invested in the venture capital. All the business firms that dealt with information technology, manufacturing products as well as providing contemporary services can opt for venture capital investment in India. LIFE CYCLE OF VENTURE CAPITAL: STAGES IN VENTURE CAPITAL FINANCING: Stages in venture capital investment funding in India: Angel investors are most often individuals (friends, relations or entrepreneurs) who want to help other entrepreneurs get their businesses off the ground - and earn a high return on their investment. The term "angel" 116
comes from the practice in the early 1900s of wealthy businessmen investing in Broadway productions. Usually they are the bridge from the self-funded stage of the business to the point that the business needs true venture capital. Angel funding usually ranges from $150,000 to $1.5 million. They typically offer expertise, experience and contacts in addition to money. 1. Seed - The first stage of venture capital financing. Seed-stage financings are often comparatively modest amounts of capital provided to inventors or entrepreneurs to finance the early development of a new product or service. These early financings may be directed toward product development, market research, building a management team and developing a business plan. A genuine seed-stage company has usually not yet established commercial operations - a cash infusion to fund continued research and product development is essential. These early companies are typically quite difficult business opportunities to finance, often requiring capital for pre-startup R&D, product development and testing, or designing specialized equipment. An initial seed investment round made by a professional VC firm typically ranges from $250,000 to $1 million. Seed-stage VC funds will typically participate in later investment rounds with other equity players to finance business expansion costs such as sales and distribution, parts and inventory, hiring, training and marketing. 2. Early Stage - For companies that are able to begin operations but are not yet at the stage of commercial manufacturing and sales, early stage financing supports a step-up in capabilities. At this point, new business can consume vast amounts of cash, while VC firms with a large number of early-stage companies in their portfolios can see costs quickly escalate. Start-up - Supports product development and initial marketing. Start-up financing provides funds to companies for product development and initial marketing. This type of financing is usually provided to companies just organized or to those that have been in business just a short time but have not yet sold their product in the marketplace. Generally, such firms have already assembled key management, prepared a business plan and made market studies. At this stage, the business is seeing its first revenues but has yet to show a profit. This is often where the enterprise brings in its first "outside" investors. First Stage - Capital is provided to initiate commercial manufacturing and sales. Most first-stage companies have been in business less than three years and have a product or service in testing or pilot production. In some cases, the product may be commercially available. 3. Formative Stage - Financing includes seed stage and early stage. 4. Later Stage - Capital provided after commercial manufacturing and sales but before any initial public offering. The product or service is in production and is commercially available. The company demonstrates significant revenue growth, but may or may not be showing a profit. It has usually been in business for more than three years. Third Stage - Capital provided for major expansion such as physical plant expansion, product improvement and marketing. Expansion Stage - Financing refers to the second and third stages. Mezzanine (bridge) - Finances the step of going public and represents the bridge between expanding the company and the IPO 5. Balanced-stage financing refers to all the stages, seed through mezzanine. FEATURES OF VENTURE CAPITAL IN INDIA: The following are the features of venture capital 1. It is basically financing of new companies which are finding it difficult to go to the capital market at their early stage of existence. 2. This finance can also be loan-based or in-convertible debentures so that they carry a fixed yield for the providers of venture capital. 3. Those who provide venture capital aim at capital gain due to the success achieved by the concern that borrows. 4. It is a long-term investment and made in companies which have high growth potential. The provision of venture capital will bring rapid growth for the business. 5. The venture capital provider will also take part in the business of borrowing concern whereby, the venture capital financier not merely confines to finance, but also provide managerial skill. 6. Not all the capitalists will experience high risk. But venture capital financing contains risks. But the risk is compensated with a higher return. 7. Not much of technology is involved in venture capital, it involves financing mainly small and medium size firms, which are in their early stages. With the assistance of venture capital, these firms will stabilize and later can go in for traditional finance 117
CONCLUSION: Venture capital comes from groups of wealthy investors, investment banks and other financial institutions that pool such investments or partnerships. This form of raising capital is popular among new companies, or ventures, with a limited operating history that cannot raise capital though a debt issue or equity offering. Often, venture firms will also provide start-ups with managerial or technical expertise. For entrepreneurs, venture capitalists are a vital source of financing, but the cash infusion often comes at a high price. Venture firms often take large equity positions in exchange for funding and may also require representation on the start-up's board. REFERNCES: 1. An Overview of Venture Capital and Private Equity Financing in India Dr. T. Narayana Reddy, Dr. C. Viswanatha Reddy 2. Venture Capital Financing: Key Elements Prof. P.R. Sivasankar, Mr. K. Rajaiah 3. Comparative Analysis of Sectoral Financing by VCFs and FVCIs in India. Dr. E. Lokanadha Reddy, Dr. C. Viswanatha Reddy 4. Monitoring The Performance of Venture Capital Funded Companies Dr. E. Lokanadha Reddy, Dr. A. Amruth Prasad, Dr. V.N. Jothi 5. Private Equity Investemnts in India: A Review, Dr. V Vijay Durga Prasad 6. Venture Capital Financing in India & Its Prospects. Dr. D.H. Malini Srinivasa Rao 7. Venture Capital/Private Equity (Vc/Pe) Funding in India s Education Sector: A Perspective.Gangineni Dhananjhay, Archana 8. Across the Sector Venture Capital Investments in India, Dr. P. Niranjan Reddy, Dr. J. Prakash Reddy 9. Role of Venture Capital for Growth of MSMEs A Study of SIDBI Venture Capital Limited,Dr. Sujatha Susanna Kumari D, Mr. Basavaraj 10. Development of MSMEs Through Public Private Partnership. Dr. G. Vijaya Bharathi, Ms. S. Masthani Mr. P. Harinatha Reddy. 118