08 December 2019

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Venture Capital: 'Icing on the Business Cake'

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The terms 'venture capital' and 'start-up company' are like bread and butter. But still the process seems to be mysterious to majority of entrepreneurs that we come across. Everyday new companies are born and for this same reason, entrepreneurs are facing many challenges in the market.

One of the biggest barriers of entry and the reason for many company’s downfall is lack of business capital. This is resulting in a plethora of good business ideas not seeing day lights because the founders are incapable of getting the right people and money behind their business ideas.

In this background, venture capital is another finance option for entrepreneurs who are looking to grow and expand. Venture Capital (VC) is a method of business funding for companies through a form of equity investment where the investing companies get partial ownership or control in the invested companies through shares.

Typically ‘venture capital’ refers to ‘investment funds’ or ‘partnerships through capitals’ in promising start-ups and expanding companies. The term holds a broad definition in the commercial and financial sectors today.Venture Capital is different from buying out private equities of companies which is rather an investment in companies with proven track record and revenue which realises much higher rates of returns. Venture Capital therefore is a highly risky business and runs with a strategy of “high risk high return investment” and is also called ‘risk capital’.

Venture Capital helps many budding companies with high potential in terms of management and products, but with limited operating history or those are too small to raise capitals in public markets or have not reached a point where they are able to secure a bank loan.

Typically, venture capital investments are made as cash in exchange for shares / stocks in the invested company and the venture capitalists get an ownership interest for the money invested. Beyond supplying the company with money, the venture capitalists (VCs) also provide assistance in business planning, bringing their industry knowledge and experience in growing businesses for taking the company public some day.

Most venture capital investments are done in pool formats where several investors combine their investments to a large fund and invest them in startup companies at different sectors. Venture capital thus coming from institutional investors and high net worth individuals is pooled together by dedicated investment firms. By investing in pools the venture capitalists are spreading out their risk.

Venture capitalists are generally former executives or investment bankers who have turned to raise private funds to make particular investments. Venture Capitalists concentrating particular segments for example, technology, form a group and invest their funds in that segments only.

Venture capitalists are generally interested in companies that are in early stages or those who have refined its business plan, or those who are starting to develop products and sales. Young companies with limited start-up capital, who wish to raise venture capital require a combination of multi qualities such as a well planned business model, potential for rapid growth and above all, an impressive management team.

In exchange for the high risk that venture capitalists assume by investing, VC’s usually get significant control over company decisions, in addition to a significant portion of the company’s ownership.

Points to be Taken Care of

An essential characteristic of a successful entrepreneur is the ability to raise business capital. It is not easy to sell your idea when so many competitive ideas exist and also many possible business funding partners may not share your business vision or enthusiasm.

So, beyond a business idea there should be a finished product, live client list, and a well defined need  to pitch inVC. VC’s may also fund companies with nothing more than an approximate business plan purely on the strength of the management team and the opportunity. Even if a start-up is not equipped with a core team, the enthusiasm, ambition, good ideas, persistence etc will be sufficient to pitch in a VC.

Equity investment companies get thousands of proposals on their desks every year. You need to make sure that you stand out from the pack and there is no better way of doing this than by doing your research on the venture capital firms that you wish to target before you send out your first funding request.

Venture capitalists tend to focus on particular industries and stages of company development. For instance some VC’s specialise in technology companies, some others focus on start up while some may focus on well established companies. When conducting your research for venture capitalists, you should identify the venture capitalists who are specialised in your industry There is no point in banking on venture capitalists who are outside your business funding scope.

Earlier venture capitalists were willing to take long-term perspectives. But today, this is a very rare phenomenon. Most venture capitalists expect their returns within a very short period of time.

The average lifespan of a VC fund may be about a decade. So many of the investments in venture funds tend to incorporate high growth startup companies which creates a great deal of value within a short span.

Unlike a bank, venture capitalists are interested in getting a stake in the invested company, typically in the form of equity. A VC needs the company grow very quickly so they can convert their equity back into a much bigger pile of cash. Ideally VC’s are looking for companies to move to an Initial Public Offering (IPO) or a buyout. At this point the stake in the company that the venture fund acquired will become worth far more than its original.

We should be clear that a VC’s primary motive is to make money on their intended investment and that should be the measure of any VC's past performance. In most cases VC’s want one ortwo things: a private sale of the company or to go public with the company.

The valuation of the business by the venture capitalist will be the key consideration for a company seeking venture capital financing. The higher the valuation is, the lesser "dilution" the current shareholders need to suffer with the issuance of stocks to the VC.

Sometimes there will be a gap between the company's desire for a high valuation and the venture capitalist's desire for a lower valuation. The investor is bringing the needed cash and expertise to the table for the growth of the business and at that time you shouldn't get hung up on small differences in valuation.

Also, if certain projected ends of the company are not met-like completion of a product line within the designated time period or the achievement of designated sales projections, the venture capitalist would be entitled to additional stock without extra payment.

Although this kind of investment is very advantageous for entrepreneurs who cannot find funding through regular means, some people still avoid venture capitalists for the fear that venture capitalists may use their powers to intervene and run the company will keep them aside.

Always keep in mind that the venture capital firms are only interested in one thing- return on their investment and opportunity for themselves, whereas they might convince us that they are helping the economy recover.

Venture capitalists are targeting and are hitting big on India with their investments growing five-fold in a year. According to industry players India is fastest emerging economy and is a potential destination for venture capitalists, but the country still has a long way to go before it catches up with the markets that have already established their credentials.

How to Hire a Venture Capital

One should look at one’s current business situation before deciding if venture capital financing is the wisest choice for your company at this point in its lifecycle. Don't forget, the more established your company is the greater your personal bargaining power will be. VCs get their deal flow from different sources like personal and business networks, other VCs, professional service providers, venture capital and private equity Associations and very rarely in India-through venture shows or trade shows.

Indian Venture Capital and Private Equity Association (IVCA) is a member based national organization that represents venture capital and private equity firms and is promoting the industry within India and throughout the world. IVCA members comprise of venture capital firms, institutional investors, banks, incubators, angel groups, corporate advisors, accountants, lawyers, government bodies, academic institutions and other service providers to the venture capital and private equity industry.

These firms provide capital for seed ventures, early stage companies, later stage expansion, and growth finance for management buyouts/buy-ins of established companies. IVCA’s mission as they announces is “to promote the development of venture capital and private equity industry in India” and “to support entrepreneurial activity and innovation”. IVCA is also a powerful platform for investment funds to interact with each other.

Every sector has huge potentials locked away. It's up to the entrepreneurs and investors to take risks to unearth these huge potential, harness it and shape it to a full blown and lucrative investment opportunity. It is therefore important that we should start believing in our capabilities and potentials and reach out to the wealthy investors across the country. For attaining success, it is a need to come out and declare that we are ready to play with the big boys of business investments.



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