Venture capital (VC) is generally used to support startups and other businesses with the potential for substantial and rapid growth. VC firms raise money from limited partners (LPs) to invest in promising startups or even larger venture funds.
What Is a Venture Capitalist?
A venture capitalist (VC) is a private equity investor that provides capital to companies with high growth potential in exchange for an equity stake. A VC investment could involve funding startup ventures or supporting small companies that wish to expand but have no access to the equities markets.
Venture capitalist firms are usually formed as limited partnerships (LPs) where the partners invest in the VC fund. A committee is usually tasked with making investment decisions. Once those promising emerging growth companies are identified, the pooled investor capital is deployed to fund these companies in exchange for a sizable equity stake.
Contrary to common belief, VCs do not normally fund a startup at its outset. Instead, VCs seek to target firms bringing in revenue and looking for more money to commercialize their ideas. The VC fund will buy a stake in these firms, nurture their growth, and look to cash out with a substantial return on investment (ROI).Venture capitalists typically look for companies with a strong management team, a large potential market, and a unique product or service with a strong competitive advantage. They also look for opportunities in industries that they are familiar with, as well as the chance to own a large percentage of the company so that they can influence its direction.
How Does Venture Capital Work?
Entities offering VC invest in a company until it attains a significant position and then exits the same. In an ideal scenario, investors infuse capital in a company for 2 years and earn returns on it for the next 5 years. Expected returns can be as high as 10x of the invested capital.
Financial venture capital can be offered by –
- Venture capital firms,
- Investment banks and other financial institutions,
- High net worth individuals (Angel investors), etc.
Venture capital firms create venture capital funds – a pool of money collected from other investors, companies, or funds. These firms also invest from their own funds to show commitment to their clients.
Venture Capital Structure
The general structure of the roles within a venture capital firm varies among firms, but they can be broken down into roughly three positions:
- Associates: These individuals usually come to VC firms with experience in either business consulting or finance and, sometimes, degrees in business. They tend to do more analytical work, analyzing business models, industry trends, and sectors. They also work with the companies in a firm’s portfolio. Although they do not make key decisions, associates may introduce promising companies to the firm’s upper management.
- Principals: A principal is a mid-level professional. They usually serve on the boards of portfolio companies and ensure that they operate without major hiccups. Principals are also in charge of identifying investment opportunities for VC firms and negotiating terms for both acquisition and exit. Principals are on a “partner track” that depends on the returns they can generate from the deals they make.
- Partners: The higher profile partners primarily identify areas or specific businesses to invest in, approve deals (whether investments or exits), occasionally sit on the board of portfolio companies, and generally represent their VC firms.
When Should One Go for Venture Capital Funding?
- At the stage of expansion- If your next plan is to expand your business, opting for funding through venture capitalists is a good option. Doing so can help you encash their business, financial and legal expertise which is usually required while business expansion.
- Requirement of strong mentoring- A venture capitalist brings in a lot of expertise, knowledge, and networking along with his capital investment. You can utilize their guidance to build your own network, promote your business with their direction and ultimately make it reach bigger heights.
- At the time of competition- Once a start-up has gained a substantial reach and is most likely to face competition in the real market, it is the correct time to go for venture capital funding for surviving and giving tough competition to others.
Types of Venture Capital
VC can be categorised as per the stage in which it is being invested. Generally, it is of the following 6 types –
| # | Type | Definition |
| 1 | Seed funding | As the same suggests, seed funding or seed capital is the capital invested to help entrepreneur(s) conduct initial activities for setting up a company. This can include product research & development, market research, business, business plan creation, etc.
Seed funding may also be provided by the owners themselves or their family members and friends. |
| 2 | Start-up capital | Start-up capital is often used interchangeably with seed funding. However, there are minor differences.
Usually, business owners avail start-up capital after they have completed the processes that involve seed funding. It can be used to create a product prototype, hire crucial management personnel, etc. |
| 3 | First stage, first round or series A | First stage is provided to businesses that have a product and want to start commercial manufacturing, sales, and marketing. |
| 4 | Expansion funding | As the name suggests, expansion capital is the fund required by a company to expand its operations. The funds can be used to tap new markets, create new products, invest in new equipment and technology, or even acquire a new company. |
| 5 | Late-stage funding | Late-stage funding is offered to businesses that have achieved success in commercial manufacturing and sales. Companies in this stage may have tremendous growth in revenue but not show any profit. |
| 6 | Bridge funding | Also known as mezzanine financing, bridge funding helps a company to meet its short-term expenses necessary to create an initial public offering (IPO). |
Features of Venture Capital
Some of the features of venture capital are –
- Not for large-scale industries – VC is particularly offered to small and medium-sized businesses.
- Invests in high risk/high return businesses – Companies that are eligible for VC are usually those that offer high return but also present a high risk.
- Offered to commercialise ideas – Those opting for VC usually seek investment to commercialise their idea of a product or a service.
- Disinvestment to increase capital – Venture capital 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.
- Long-term investment – VC is a long-term investment, where the returns can be realised after 5 to 10 years.
Advantages and Disadvantages of VC
Advantages –
- Help gain business expertise – One of the primary advantages of venture capital is that it helps new entrepreneurs gather business expertise. Those supplying VC have significant experience to help the owners in decision making, especially human resource and financial management.
- Business owners do not have to repay-Entrepreneurs or business owners are not obligated to repay the invested sum. Even if the company fails, it will not be liable for repayment.
- Helps in making valuable connections- Owing to their expertise and network, VC providers can help build connections for the business owners. This can be of immense help in terms of marketing and promotion.
- Helps to raise additional capital –VC investors seek to infuse more capital into a company for increasing its valuation. To do that, they can bring in other investors at later stages. In some cases, the additional rounds of funding in the future are reserved by the investing entity itself.
- Aids in upgrading technology- VC can supply the necessary funding for small businesses to upgrade or integrate new technology, which can assist them to remain competitive.
Disadvantages –
- Reduction of ownership stake- The primary disadvantage of VC is that entrepreneurs give up an ownership stake in their business. Many a time, it may so happen that a company requires additional funding that is higher than the initial estimates. In such situations, the owners may end up losing their majority stake in the company, and with that, the power to make decisions.
- Give rise to a conflict of interest – Investors not only hold a controlling stake in a start-up but also a chair among the board members. As a result, conflict of interest may arise between the owners and investors, which can hinder decision making.
- Receiving approval can be time-consuming – VC investors will have to conduct due diligence and assess the feasibility of a start-up before going ahead with the investment. This process can be time-consuming as it requires excessive market analysis and financial forecasting, which can delay the funding.
- Availing VC can be challenging- Approaching a venture capital firm or investor can be challenging for those who have no network.In 2019, the total value of venture capital deployed throughout India was worth $10 billion. This is an increase of 55% compared to the previous year and is currently the highest.
VC was introduced in the country back in 1988, after economic liberalisation. IFC, ICICI, and IDBI were the few organisations that established venture capital funds and targeted large corporations. The formalisation of the Indian VC market started only after 1993.
FAQs
What does VCS stand for in business?
VCS stands for Venture Capitalists or Venture Capital Funding in business. It refers to investors who provide capital to startup companies or small businesses that have the potential for long-term growth.
What do VCs look for when investing in a company?
VCs typically look for startups with innovative ideas, scalable business models, strong management teams, and a large addressable market. They also assess factors such as market demand, competitive landscape, and potential for high returns on investment.
How do VCs differ from other types of investors?
VCs typically invest in early-stage companies with high growth potential. They often take more significant risks in exchange for potential high returns on their investment. In contrast, other types of investors, such as angel investors or private equity firms, may have different investment criteria and strategies.
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