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Venture Capital Funds

Venture Capital is "An Investment in a Start-up business that is perceived to have excellent growth prospects but does not have access to Capital markets. Type of financing sought by early-stage companies seeking to grow rapidly."

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"Venture capital is money provided by professionals who invest alongside management in young, rapidly growing companies that have the potential to develop into significant economic contributors. Venture capital is an important source of equity for start-upcompanies."

How is Extending Venture Capital for an Endeavour is Different from Extending Term Loan
for a Conventional Commercial Project?

A commercial project is undertaken by an entrepreneur for a productive activity, which has already been recognised and similar projects of the same type executed by others. Everything about the project is well-known. Financing such a project involves moderate or normal risks. The applicant seeking finance may be a new entrepreneur or an established businessman. The project can be assessed with relative ease through well-established yardsticks and risk areas identified. Taking a decision on financing based on the feasibility and viability of the project is comparatively an easier process. The financier assesses the cost of the project against the return it is anticipated to generate to satisfy that the return generated over a period of time would fully liquidate the loan given with interest.

In contrast an applicant for venture capital primarily possesses expert knowledge, which if translated into activity promises to provide rich dividends, however with inherent uncertainties. The project is innovative and has not been set up earlier. Venture capital financing involves higher risk than conventional loans to industry and business. While in a conventional term loan 90 to 95% of the projects may come through, a few with time and cost escalation, in financing start-up or innovative ventures, the rate of failures may at times be more than that of success. Pricing of venture capital financing must take this factor into consideration. Projects indicating higher risks, but with the potential for very large return, when successful alone can be covered under venture financing. Venture capital firms may generally provide soft loans (equity participation) and may charge the payment of royalty on the turnover of the recipient company over a specified period of time.

Conventional Project financing is like journeying in a familiar territory, while venture capital financing is like surveying in an unknown region.

An applicant for venture capital possesses superior knowledge-capital or knowledge-assets, and he seeks to enter entrepreneurship. The Wright Brothers at the dawn of the 20th Century, prepared the blue print for a machine that could fly. One that would come forward to finance the project for execution of the blue-print to produce a flying machine is a provider of venture capital, and resources extended to Wright brothers for the purpose is Venture Capital.

Similarly Christopher Columbus in the Nineties of the 15th Century prepared a plan to discover a route to India by sailing from Spain in the western direction, though India it was known was located towards the east of Spain. The plan to be executed needed resources, ships, sailors and other material needed for the long voyage. Resource so provided is eligible to be called Venture Capital. "His (Columbus') far-fetched idea did not find favor with the King of Portugal, who refused to finance him. Finally, Queen Isabella of Spain, decided to fund him and the voyages of Christopher Columbus are now empanelled in history."
[ source: website "www.indianinfoline"]

Stages in the Evolution of Venture Capital Financing

The different stages are depicted in the table below:

S. No Stages Development
1 Persoal borrowing Credit allowed purely on the strength of the security offered. No other questions asked.
2 Commercial borrowing
(working Capital)
Liquidity(current ratio) and solvency (debt-equity ratio) are considered. Turn-over of the business & Profitability verified. Loan given after obtaining collateral.
3 Term Loan - Developmental Borrowing Technical Feasibility & Financial Viability of the activity to be financed looked into through detailed project appraisal. Loan given obtaining collaterial & with a host of terms & conditions.
4 Venture Capital Finance (Technology Development Purpose) VC Financier looks at the projet as a intending partner will examine a proposition that is high-risk oriented, but with potential for large reward and accepts to participate in the venture and in its financing if satisfied.

Venture capital financing is commonly associated with provision of equity investment for a time period in small/medium business with high growth potential and high reward but which could entail high risk. Simply stated, Venture Capital (VC) is high-risk, high-return investing in support of business creation and growth. It is money provided, often by professionals, who invest alongside innovative entrepreneurs in young, rapidly growing companies that have a reasonable, though not assured, potential to develop into significantly profitable ventures.

Naturally, venture capital financing is very different from traditional sources of investing such as lending and borrowing, develop-mental financing or stock market investing. Venture capital financing fills a void left by the traditional financial institutions in high risk, high potential and innovative ventures. In fact, venture capital business demands. skills, attitudes and systems very different from those of traditional financial intermediaries.

Such ventures are mostly promoted by what may be called 'Ideas-People' and are generally in new and high technology areas. So, providers of venture capital invest money and also assist with managerial or marketing inputs which the Ideas-People usually need.

A venture capitalist often invests before there is a real product or company, though capital to start up a company in its first or second stages of development is also common. We need not rule out financing expansion of companies that are already selling their product. Some venture funds specialise in acquisition, turnaround or recapitalisation of public and private companies that represent favourable investment opportunities.

In brief, there are in this business, clearly two pillars, viz., venture capitalist who comes forward with flexible financing arrangement and Ideas-People who come forward with high-risk, potentially high-return business opportunities.

There is a third pillar also, viz., size. Large sized enterprises can internalise the risk and return. Hence, typically, this business is identified with financing of small and medium size units.

Basic Attributes of Venture Capital Financing

Today innovative knowledge is the driving force of economic development and social progress. Young entrepreneurial talents if promoted and encouraged with adequate support bring forth astounding rewards. Entrepreneurs develop ideas for new business models and hope to one day receive value in return. However innovation by its very nature is difficult to finance, in the absence of collateral, which the innovative entrepreneur is seldom is able to provide. On the one hand there is higher risk and no collateral and on the other is the scope for very large returns in successful projects. It is the role of the venture capitalist to screen entrepreneurial projects and provide the financial backing. Without such financing of innovations the world will remain stagnant revolving through existing activities without marching towards progress and growth.

As we consider equity capital as risk capital, can we term venture capital as "risk-oriented-credit". To some extent only because venture capital is more by way of a participating investment, than a mere extension of a credit facility. It may be provided by way of equity participation.

A thoughtful exposition of the venture capital industry and its indispensable function in the economy is provided in" The Money of Invention: How Venture Capital Creates New Wealth" by Paul A. Gompers and Josh Lerner (Harvard Business School Press). Their premise and conclusion:

"No matter how we look at the numbers, venture capital clearly serves as an important source for economic development, wealth and job creation, and innovation. This unique form of investing brightens entrepreneurial companiesí prospects by relieving all-too-common capital constraints. Venture-backed firms grow more quickly and create far more value than their nonventure-backed firms. Similarly, venture capital generates a tremendous number of jobs and boosts corporate profits, earnings, and workforce quality. Finally, venture capital exerts a powerful effect on innovation."
[Source: The Money of Invention: How Venture Capital Creates New Wealth, by Paul A. Gompers and Josh Lerner (Harvard Business School Press,]

Venture Capital has been the important element behind innovation and wealth creation in the U.S. economy for the past 20 years. It has also played an increasing role in developed and developing countries elsewhere around the world.

Young budding entrepreneurs with talent for research and taking ideas from the lab to the field for commercial exploitation of scientific inventions cannot be financed through normal channels. Venture Capitals screen entrepreneurial projects and provide the financial backing. Without these activities many entrepreneurs would never attract the resources they need to quickly turn their ideas into commercial success.

"This growing trend can be attributed to rapid advances in technology in the last decade. Knowledge driven industries like infotech, health-care, entertainment and services have become the cynosure of bourses worldwide. In these sectors, it is innovation and technical capability that are big business-drivers. This is a paradigm shift from the earlier physical production and 'economies of scale' model.

"However, starting an enterprise is never easy. There are a number of parameters that contribute to its success or downfall. Experience, integrity, prudence and a clear understanding of the market are among the sought after qualities of a promoter. However, there are other factors, which lie beyond the control of the entrepreneur. Prominent among these is the timely infusion of funds. This is where the venture capitalist comes in, with money, business sense and a lot more.

"Professionally managed venture capital firms generally are private partnerships or closely-held corporations funded by private and public pension funds, endowment funds, foundations, corporations, wealthy individuals, foreign investors, and the venture capitalists themselves.

Venture capitalists generally:

  • Finance new and rapidly growing companies,

  • Purchase equity securities,

  • Assist in the development of new products or services,

  • Add value to the company through active participation,

  • Take higher risks with the expectation of higher rewards, and

  • Have a long-term orientation."

"When considering an investment, venture capitalists carefully screen the technical and business merits of the proposed company. Venture capitalists only invest in a small percentage of the businesses they review and have a long-term perspective. They also actively work with the company's management, especially with contacts and strategy formulation."
[Source - ""]

Venture capitalists mitigate the risk of investing by developing a portfolio of young companies in a single venture fund. Many times they co-invest with other professional venture capital firms. In addition, many venture partnerships manage multiple funds simultaneously. For decades, venture capitalists have nurtured the growth of America's high technology and entrepreneurial communities resulting in significant job creation, economic growth and international competitiveness. Companies such as Digital Equipment Corporation, Apple, Federal Express, Compaq, Sun Microsystems, Intel, Microsoft and Genentech are famous examples of companies that received venture capital early in their development.
[Source: National Venture Capital Association 1999 Yearbook].

Categorization of VC Investors

  • Incubators

  • Angel Investors

  • Venture Capitalists (VCs)

  • Private Equity Player

Incubators: An incubator is a hardcore technocrat who works with an entrepreneur to develop a business idea, and prepares a Company for subsequent rounds of growth & funding. eVentures, Infinity are examples of incubators in India.

Angel Investors: An angel is an experienced industry-bred individual with high net worth.

Typically, an angel investor would:

  • invest only his chosen field of technology

  • take active participation in day-to-day running of the Company

  • invest small sums in the range of USD 1 - 3 million

  • not insist on detailed business plans

  • sanction the investment in up to a month

  • help company for "second round" of funding

The IndUS Entrepreneurs (TiE) is a classic group of angels like: Vinod Dham, Sailesh Mehta, Kanwal Rekhi, Prabhu Goel, Suhas Patil, Prakash Agarwal, K.B. Chandrashekhar. In India there is a lack of home grown angels except a few like Saurabh Srivastava & Atul Choksey (ex-Asian Paints).

Venture Capitalists (VCs):VCs are organizations raising funds from numerous investors & hiring experienced professional mangers to deploy the same.

They typically:

  • invest at "second" stage

  • invest over a spectrum over industry/ies

  • have hand-holding "mentor" approach

  • insist on detailed business plans

  • invest into proven ideas/businesses

  • provide "brand" value to investee

  • invest between USD 2 - 5 million

Private Equity Players: They are established investment bankers. Typically:

  • invest into proven/established businesses

  • have "financial partners" approach

  • invest between USD 5 -100 million

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[ last updated on 30.09.2004 ]<>[ chkd-apvd-ef ]