venture capital

Download Venture capital

Post on 07-May-2015



Economy & Finance

0 download

Embed Size (px)


venture capital



2. Concept of VentureCapital The term venture capital comprises of two words that is, Venture and Capital. Venture is a course of processing, the outcome of which is uncertain but to which is attended the risk or danger of loss. Capital means recourses to start an enterprise. To connote the risk and adventure of such a fund, the generic name Venture Capital was coined. Venture capital is considered as financing of high and new technology based enterprises. It is said that Venture capital involves investment in new or relatively untried technology, initiated by relatively new and professionally or technically qualified entrepreneurs with inadequate funds. The conventional financiers, unlike Venture capitals, mainly finance proven technologies and established markets. However, high technology need not be pre-requisite for venture 3. Concept of VentureCapital Venture capital has also been described as unsecured risk financing. The relatively high risk of venture capital is compensated by the possibility of high returns usually through substantial capital gains in the medium term. Venture capital in broader sense is not solely an injection of funds into a new firm, it is also an input of skills needed to set up the firm, design its marketing strategy, organize and manage it. Thus it is a long term association with successive stages of companys development under highly risk investment conditions, with distinctive type of financing appropriate to each stage of development. Investors join the entrepreneurs as co-partners and support the project with finance and business skills to exploit the market opportunities. 4. Concept of VentureCapital Venture capital is not a passive finance. It may be at any stage of business/production cycle, that is, start up, expansion or to improve a product or process, which are associated with both risk and reward. The Venture capital makes higher capital gainsthrough appreciation in the value of such investments when the new technology succeeds. Thus the primary return sought by the investor is essentially capital gain rather than steady interest income or dividend yield. 5. The mostflexible definition ofVenture capitalis- The support by investors of entrepreneurial talent with finance and business skills to exploit market opportunities and thus obtain capital gains. Venture capital commonly describes not only the provision of start up finance or seed corn capital but also development capital for later stages of business. A long term commitment of funds is involved in the form of equity investments, with the aim of eventual capital gains rather than income and active involvement in the management of customers business. 6. Features of VentureCapital High Risk By definition the Venture capital financing is highly risky and chances of failure are high as it provides long term start up capital to high risk-high reward ventures. Venture capital assumes four types of risks, these are: Management risk - Inability of management teams to work together. Market risk - Product may fail in the market. Product risk - Product may not be commercially viable. Operation risk - Operations may not be cost effective resulting in increased cost decreased gross margins. 7. Features of VentureCapital High Tech As opportunities in the low technology area tend to be few of lower order, and hi-tech projects generally offer higher returns than projects in more traditional areas, venture capital investments are made in high tech. areas using new technologies or producing innovative goods by using new technology. Not just high technology, any high risk ventures where the entrepreneur has conviction but little capital gets venture finance. Venture capital is available for expansion of existing business or diversification to a high risk area. Thus technology financing had never been the primary objective but incidental to venture capital. 8. Features of VentureCapital Equity Participation & Capital Gains Investments are generally in equity and quasi equity participation through direct purchase of shares, options, convertible debentures where the debt holder has the option to convert the loan instruments into stock of the borrower or a debt with warrants to equity investment. The funds in the form of equity help to raise term loans that are cheaper source of funds. In the early stage of business, because dividends can be delayed, equity investment implies that investors bear the risk of venture and would earn a return commensurate with success in the form of capital gains. 9. Features of Venture Capital Participation In Management Venture capital provides value addition by managerialsupport, monitoring and follow up assistance. It monitorsphysical and financial progress as well as marketdevelopment initiative. It helps by identifying keyresource person. They want one seat on the companysboard of directors and involvement, for better or worse,in the major decision affecting the direction of company.This is a unique philosophy of hands on managementwhere Venture capitalist acts as complementary to theentrepreneurs. Based upon the experience othercompanies, a venture capitalist advise the promoters onproject planning, monitoring, financial management,including working capital and public issue. Venturecapital investor cannot interfere in day todaymanagement of the enterprise but keeps a close contactwith the promoters or entrepreneurs to protect hisinvestment. 10. Features of VentureCapital Length of Investment Venture capitalist help companies grow, but they eventually seek to exit the investment in three to seven years. An early stage investment may take seven to ten years to mature, while most of the later stage investment takes only a few years. The process of having significant returns takes several years and calls on the capacity and talent of venture capitalist and entrepreneurs to reach fruition. 11. Features of VentureCapital Illiquid Investment Venture capital investments are illiquid, that is, not subject to repayment on demand or following a repayment schedule. Investors seek return ultimately by means of capital gains when the investment is sold at market place. The investment is realized only on enlistment of security or it is lost if enterprise is liquidated for unsuccessful working. It may take several years before the first investment starts to locked for seven to ten years. Venture capitalist understands this illiquidity and factors this in his investment decisions. 12. Stages of VentureCapital Financing 1. Early Stage Finance Seed Capital Start up Capital Early/First Stage Capital Second Stage Capital 13. Early Stage Finance 2. Later Stage Finance Expansion/Development Stage Capital Replacement Finance Management Buy Out and Buy ins Turnarounds Mezzanine/Bridge Finance 14. Early Stage Finance 1. Seed Capital It is an idea or concept as opposed to a business. European Venture capital association defines seed capital as The financing of the initial product development or capital provided to an entrepreneur to prove the feasibility of a project and to qualify for start up capital. The characteristics of the seed capital may be enumerated as follows: Absence of ready product market Absence of complete management team Product/ process still in R & D stage Initial period / licensing stage of technology transfer 15. Broadly speaking seed capital investment may take 7 to 10 yearsto achieve realization. It is the earliest and therefore riskiest stageof Venture capital investment. The new technology andinnovations being attempted have equal chance of success andfailure. Such projects, particularly hi-tech, projects sink a lot ofcash and need a strong financial support for their adaptation,commencement and eventual success. However, while theearliest stage of financing is fraught with risk, it also providesgreater potential for realizing significant gains in long term.Typically seed enterprises lack asset base or track record toobtain finance from conventional sources and are largelydependent upon entrepreneurs personal resources. Seed capitalis provided after being satisfied that the entrepreneur has used uphis own resources and carried out his idea to a stage ofacceptance and has initiated research. The asset underlying theseed capital is often technology or an idea as opposed to humanassets (a good management team) so often sought by venturecapitalists. 16. Volume of Investment Activity It has been observed that Venture capitalist seldom make seedcapital investment and these are relatively small by comparison toother forms of venture finance. The absence of interest in providinga significant amount of seed capital can be attributed to the followingthree factors: Seed capital projects by their very nature require a relatively smallamount of capital. The success or failure of an individual seedcapital investment will have little impact on the performance of allbut the smallest venture capitalists portfolio. Larger venturecapitalists avoid seed capital investments. This is because the smallinvestments are seen to be cost inefficient in terms of time requiredto analyze, structure and manage them. The time horizon to realization for most seed capital investments istypically 7-10 years which is longer than all but most long-termoriented investors will desire. The risk of product and technology obsolescence increases as thetime to realization is extended. These types of obsolescence areparticularly likely to occur with high technology investmentsparticularly in the fields related to Information Technology. 17. 2. Start up Capital It is the second stage in the venture capital cycle and isdistinguishable from seed capital investments. An entrepreneuroften needs finance when the business is just starting. The start upstage involves starting a new business. Here in the entrepreneurhas moved closer towards establishment of a goin


View more >