Venture capital is a type of private equity and financing provided by investors to start-ups and small enterprises with the potential for long-term growth. Venture capital is the name given to this type of funding, and venture capitalists are the people who invest it. Venture capital is money invested in tiny enterprises or initiatives with a lot of room to expand.
Venture capital is risky because it is illiquid (that cannot be converted into cash), but it can pay off handsomely if you invest in the right enterprise. The company's growth determines the venture capitalists' returns because it is their money involved. Venture capitalists have the potential to shape important decisions made by the companies they invest in. For businesses that don't have access to bank loans or other forms of financing, venture capital funding has become a more prevalent and even crucial source of cash.
There are various types of venture capital such as seed Capital, start-up Capital, early Stage Capital, expansion Capital, Late Stage Capital, Bridge Financing etc.:
- The most common types of venture capital funding are Seed funding is the amount of money invested to assist an entrepreneur in carrying out the initial steps of forming a business.
- Then there's start-up capital, which is sometimes conflated with seed funding and might be used to construct a product prototype or hire key management staff.
- Another most prevalent types of venture capital financing are expansion capital. It is the money that a business needs to expand its activities. The money might be used to expand into new markets, develop new goods, invest in equipment, technology, or even buy a new business.
- The next venture capital example is a late-stage investment, it is available to companies that have achieved commercial manufacturing and sales success. Companies at this level may have seen enormous revenue growth but are still losing money.
The importance of venture capital is that it promotes entrepreneurs, products, and exports, encourages customers, expands job prospects, improves financial viability, and aids technical and economic advancement.
India Venture Capital Report 2020
- Venture capital investments in India exceeded 1000 Crores in 2020, with 7,000 new start-ups being established during that time. India-focused funds raised 300 Crores in 2020, which is 40% more than in 2019. The Covid-19 pandemic, according to the research, did not hinder investment activity but rather gave further momentum.
- Consumer technology, SaaS, and fintech managed to lead lucrative markets, getting investments, contributing 75% of Venture capital in 2020 over 65% in 2019.
- Coatue Management, Avatar Venture Partners, and Inflection Point Ventures were among the new funds to invest in Indian start-ups in 2020. This, together with an increase in the number of sponsored start-ups year after year, indicates well for India's entire start-up ecosystem.” venture capital funding has been critical in building India's start-up environment.
- India's start-up economy is strong, with 12 more companies expected to achieve unicorn status in 2020, bringing the total number of unicorns in India to 37. Currently, only 9% of India's start-ups are funded, showing plenty of space for more investment.
- In 2020, the value of venture capital (VC) was estimated to be 130 Crores. According to the research, EdTech accounted for one-third of the exit value. In contrast, food-tech accounted for roughly 20%, both of which saw a surge in end-user acceptance and funding activities during the pandemic.
Essay on Venture Capital Funding in India
Venture capital is a type of investment made in a company where there is a high level of uncertainty about future profitability and cash flows. India's government has been promoting venture capital investment to bring the country up to par with developed countries. Many Indian entrepreneurs have solid project ideas but no prior entrepreneurial experience to leverage their businesses. Such entrepreneurs can benefit from venture capital by opening new doors and effectively launching their projects.
Getting venture capital differs significantly from raising debt or obtaining a loan from a bank. Whether a business succeeds or fails, lenders have a lawful authority to interest and capital payback. In exchange for an ownership part in the company, venture capital is invested. This brings to the difference between venture capitalist vs angel investor since the former are employees of risk capital companies investing other people's money. In contrast, the latter are rich people investing their own money.
Venture capitalists are one way to fund high-risk, high-reward businesses. Typically, investors have a say in managing the firm; they may even be on the board of directors. Furthermore, venture money would be required promptly to address the significant health issues that have affected many Indian companies. There are many ill firms out there that could be turned around by changing their product line or repurposing existing buildings, but they lack the finances to do so. The provision of equality to individuals with innovative ideas and the appropriate competence may preserve the ailing units from closure.
Typically, venture capital firms want to keep their money for three to seven years, if not longer. Investing in more mature enterprises, where company success is measured more quickly and easily, is generally sold sooner than investing in early-stage or technology companies, where the business strategy takes time to build.
How Venture Capital Works
The venture capital market has four key participants:
- Entrepreneurs in need of finance
- Investors looking for a high returns
- Investment bankers looking to sell companies
- Venture capitalists looking to earn money by creating a market for the other three
Essentially, affluent families, insurance firms, and pension funds with substantial sums of money contribute funding to a Venture Capital business, which is then invested in start-up’s that have a strong development potential or have already grown significantly. Start-ups frequently go through numerous stages and raise many rounds of venture capital funding as they grow.
Is Venture Capital Worth the Risk?
There is no such thing as a risk-free enterprise. Although venture capital is a risky business, we all need to be more conscious of one aspect of decision-making, regardless of the perceived risks. We must understand how venture capital works and be prepared for both positive and negative outcomes. The venture capital industry is for risk-taking investors who have an optimistic outlook on the future. They aren't generally bothered by the unfavourable consequences of their endeavour. There are some risks involved in Venture Capital Investments, such as Market trends that can impact the company's growth, Government laws that may or may not be foreseeable.
How venture capitalists make investment choices
When making investment decisions, venture capitalists consider several factors. Let's take a look at some of them:
- Venture capitalists’ desires Investors with the necessary experience, ability to implement ideas skilfully and capacity to respond to opportunities and risks. Businesses seeking venture financing must give a list of experienced, competent individuals who will play critical roles in the company's growth.
- Venture capitalists often consider companies with a distinctive product or service that offers a clear value proposition to their clients. Venture capitalists prefer to invest in products and services that are essential to their customers.
- Venture capitalists dislike competition when considering a possible investment and want to know precisely how competitors come into play. This is why they are continuously on the lookout for a market advantage.
- A large or rising market, often one that can generate 100 Crore billion or more income, is what venture capitalists seek.
- Venture capitalists prefer enterprises that have previously established a client base and have been in operation for some time.
- Investing in a business entails enough risk, so they expect the company founders to be completely honest about the types and levels of dangers the company will face.
Venture Capital Fund Legal Considerations
The field of venture capital is still in its infancy. It is, nevertheless, still a valid one with more norms and patterns. Several venture capitals groups have attempted to produce standardised documentation. Legal aspects of venture capital are as follows:
- Stock purchase agreement - The terms of buying and selling the stock to the investors are included in this agreement. This stock purchase agreement is comparable to the one used in mergers and acquisitions because it often includes Investors' and the company's warranties & representations, purchase price, closing conditions.
- Voting agreement - The shareholders reach a voting agreement. It usually contains provisions relating to the control and administration of a firm. It explains how the board is chosen as well as the board's size restrictions.
- Right of first refusal/co-sale agreement - A right of first refusal is agreed upon by the founders and maybe some or all of the present shareholders. This clause specifies that founders & shareholders will not sell their shares unless investors and, in some cases, the company have the right to buy them.
- Investors' rights agreement - An investor's rights agreement may include a wide range of terms, including information rights. These rights specify how certain firm information should be shared with shareholders. Financial information may only be disclosed with shareholders who possess a particular percentage of the company's stock, such as 10% or more. Requirements for reporting and financial disclosures, observer rights, and procedures for inspecting the company or expressing concerns may all be included in the agreement.
- Subscription agreement- Payment terms, quantity, and a class of shares, Warranties, and statements regarding a company's status are all common features of a subscription agreement.
What are the Problems with Venture Capital?
Although venture capital is a multibillion-dollar sector, it has its drawbacks like all other methods of acquiring funds.
- Inability to Think Long-Term- Many decisions taken to achieve rapid expansion are not sustainable, such as hiring a large number of salespeople or experts who do not generate enough profit to support expensive compensation. As a result, the challenge becomes reducing employees, which may stifle growth or contribute to high worker turnover due to underfunding. These businesses function with the assumption that the founders would earn a large payment if they sell. Thus they will refuse “lesser” bids. When a founder discovers they must sell at a lower price than an offer they previously received, this practice can be discouraging.
- Pressure to Expand - Venture capitalists expect to see a return on their investment. Of course, the company's founders want to see it succeed. However, investors' added pressure and insight may persuade owners to make significant decisions they'd never have usually made. It's also difficult to gauge growth in terms of numbers, such as revenue, employee size, and company size. One common misconception that leads to venture capital investments is that a start-up’s only problem is a lack of capital. As a result, the belief is that any start-up that has a great idea can achieve that goal with a cash infusion. However, money alone will not ensure that a company has a solid foundation of employees, procedures, products, management, etc.
- Venture Capital Input - The compromise made in ownership and decision-making is the most stressful and sometimes harmful component of pursuing venture capital. Seeking venture capital also increases the risk of a founder losing control of their business. Venture Capital's involvement is restricted. Hence there is a strong inclination to replicate what previous successful companies have done instead of copying the mindset that led to their success. As a result, for small firms in need of financing, partnering with a distinct capital investment type may be a preferable option. One which doesn't regard failure as a cost to be avoided, but rather as a business whose success is dependent on its own.
The due diligence process in venture capital
It is the process of examining a prospective investment opportunity. Venture capital is a type of financing that allows businesses winners to be chosen through due diligence. As a result, they must identify the major investment risks. The very first is Due diligence begins with signing a term sheet and finishes with the transfer of funds. In the interim, it's crammed with a slew of documents that the start-up has forwarded to us.
The process is collaborative, with entrepreneurs receiving assistance in finding the best solutions, resolving disputes, and renegotiating contracts, among other things. Meetings, site visits, and customer reference calls are all part of the due diligence process. It can take anywhere from a few weeks to many months to complete the process.
What Is a Venture Capital Due Diligence Checklist?
A due diligence checklist is an organised, comprehensive approach used by venture capital firms to study and comprehend a company's inner workings properly. The following information is included in the checklist.
- Resolutions and Reports of the Board of Directors: All signed resolutions, comprising formal consents of reports made to the Board of Directors, as well as their committees, are applicable.
- Shareholder Minutes: This comprises all meeting data and signed resolutions containing written consents from the Company's shareholders and members.
- Officers and Directors: List of the Company's current directors and executives (with their names, ages, positions, and lengths of service), as well as their current salaries and bonuses.
- Affiliations: Directors, creditors, officers, customers, suppliers, shareholders, and other business connections are listed in order of their business and personal links and affiliations.
- Purchase Agreements and Memoranda: Purchase agreements with the Company and any private placement memorandums or offering circulars.
- Other securities-related contracts or agreements, such as broker-dealer or selling agent agreements.
India Venture Capital Report 2021
According to the International Monetary Fund (IMF), a substantial rebound is expected in 2021, with growth returning to its long-term average of 7% to 8% from 2022 to 2025. Between January and July 2021, venture capital firms invested a total of ] 1720 Crores in the Indian start-up ecosystem. According to the report, the average amount invested in the late-stage innovation ecosystem until July 2021 was 217.57 million across 38 agreements. It also stated that India's start-up sector is thriving, with 12 more unicorn companies anticipated to emerge by 2020, bringing the total number of unicorns in India to 37. Only 9% of India's start-ups are now sponsored, indicating that there is still room for greater investment.
Read Also : What is Succession Certificate ?
What is wrong with venture capital?
Even though venture capital is a multibillion-dollar industry, it, like all other methods of raising funds, has flaws. Many decisions taken to achieve rapid expansion are not sustainable, such as hiring many salespeople or experts who do not generate enough profit to support expensive compensation.
One common misconception that leads to venture capital investments is that a start-up’s only problem is a lack of capital. As a result, the belief is that any start-up that has a great idea can achieve that goal with a cash infusion. Venture Capital's involvement is restricted. Hence there is a strong inclination to replicate what previous successful companies have done instead of copying the mindset that led to their success.
What are the pros and cons of venture capital?
Venture capital advantages and disadvantages are as follows:
The pros of venture capital are as follows:
It provides a substantial amount of equity financing.
Venture capitalists offer expertise and guidance.
A venture capitalist can also help with important issues, including legal, tax, and personal affairs.
Venture capitalists have a lot of ties in the community. Taking use of these ties would be beneficial to the company.
The company will have to wait for a stable income and financial stability source if the venture capital funds are not available.
The cons of venture capital are as follows:
A venture capitalist offers cash to a company and then takes shares in the company to exchange those funds. As a result, the prior owners' shares and ownership rights are diluted.
Obtaining funding from a venture capitalist is a time-consuming and lengthy task.
Getting financing approved from a venture capitalist is contingent on a risk assessment and market analysis, both of which can be highly uncertain.
The company is predicted to grow fast and dramatically after acquiring venture capitalist financing. If this does not occur or the strategy is not adequately implemented, growth may be slowed.
To meet their needs, the majority of start-ups and small enterprises looking for capital. The majority of the time, start-ups lack negotiating power. They can accept or reject the offer.
What are the problems faced by venture capital in India?
Reinventing communications, reimagining capital markets, pressure to grow, and a lack of long-term thinking are just a few of the primary issues that venture capitalists face. We've covered most of the issues that venture capitalists encounter in this article, and we encourage you to read through them.
What is a major drawback of accepting venture capital?
Because venture capitalists frequently move huge sums of money, capital exchanges can take time; the owners must incorporate this into their plans and work around delays. In addition, company control and earnings are shared.
Are VCs rich?
Venture capitalists are entrepreneurs; they get wealthy only if a sufficient number of the businesses they invest in prosper. If the investment outperforms the remuneration, successful venture capitalist partners are likely to be wealthy.
Does Venture Capital pay well?
Despite their reputation, not all venture capitalists have enviable pay. Analysts working in Indian venture capital organisations may be paid between INR 10 lakh and INR 15 lakh. In addition, companies will also pay associates for seeking or finding deals.
What is the success rate of venture capital?
As per a research, venture capital investments in India exceeded 1000 Crores in 2020, with 7,000 new start-ups being established during that time. India-focused funds raised 300 Crores in 2020, which is 40% more than in 2019. It is challenging to raise funds from a Venture Capital (VC) firm. Only three or four start-ups out of ten fail altogether, according to a conventional rule of thumb. Three or four more return the initial investment, and one or two more make significant returns.
How long do venture capital funds last?
VC funds are designed with the expectation that funds will be invested in new businesses for two to three years, spend nearly all of the investment within five years, & repay all capital to investors within ten years.