What does Venture Capital mean? Venture Capital comprises of two words that are, “Venture” and “Capital”. Venture Capital: Introduction, Definition, Characteristics, Advantages, and Disadvantages; Meaning of Venture Capital, Introduction of Venture Capital, Definition of Venture Capital, Characteristics of Venture Capital, Advantages of Venture Capital, and Disadvantages of Venture Capital. Venture capitals a type of funding for a new or growing business. It usually comes from venture-capital firms that specialize in building high-risk financial portfolios.
The concept of Venture Capital explained by their points in Meaning, Introduction, Definition, Characteristics, Advantages, and Disadvantages.
Capital invested in a project in which there is a substantial element of risk, typically a new or expanding business. The 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 resources to start an enterprise. To connote the risk and adventure of such a fund, the generic name Venture-Capital was coined.
#Meaning of Venture Capital:
Venture capital’s a type of private equity, a form of financing that is provided by firms or funds to small, early-stage, emerging firms that are deemed to have high growth potential, or which have demonstrated high growth. This is a very important source of financing for a new business. Here money is provided by investors to start a business that has a strong potentiality of high growth and profitability. The provider of venture-capital also provides managerial and technical support. Venture-capital is also known as risk capital.
#Introduction of Venture Capital:
Venture capital’s considered the 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-capital. Venture capital has also been described as “unsecured risk financing”. The relatively high risk of venture capital’s compensated by the possibility of high returns usually through substantial capital gains in the medium term. Venture-capital in the 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 the company’s development under high-risk investment conditions, with a 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. Venture capital’s not passive finance.
It may be at any stage of the 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 gains through 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.
#Definition of Venture Capital:
“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 customer’s business.
#Characteristics of Venture Capital:
The following features/characteristics below are;
Participation In Management:
Venture-capital provides value addition by managerial support, monitoring and follow up assistance. It monitors physical and financial progress as well as a market development initiative. It helps by identifying the key resource person. They want one seat on the company’s board of directors and involvement, for better or worse, in the major decision affecting the direction of the company.
This is a unique philosophy of “hands-on management” where Venture capitalist acts as complementary to the entrepreneurs. Based upon the experience of other companies, a venture capitalist advises the promoters on project planning, monitoring, financial management, including working capital and public issue. The venture-capital investor cannot interfere in day to day management of the enterprise but keeps close contact with the promoters or entrepreneurs to protect his investment.
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.
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’s 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.
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.
Venture-capital investments are illiquid, that is, not subject to repayment on demand or following a repayment schedule. Investors seek to return ultimately by means of capital gains when the investment is sold at the market place.
The investment is realized only on enlistment of security or it is lost if the enterprise is liquidated for unsuccessful working. It may take several years before the first investment starts to lock for seven to ten years. Venture capitalist understands this illiquidity and factors this in his investment decisions.
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 the stock of the borrower or debt with warrants to equity investment.
The funds in the form of equity help to raise term loans that are a 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.
#Advantages and Disadvantages of Venture Capital:
The following advantages and disadvantages below are;
Advantages of Venture Capital:
Business expertise: Aside from financial backing, obtaining venture-capital financing can provide a start-up or young business with a valuable source of guidance and consultation. This can help with a variety of business decisions, including financial management and human resource management. Making better decisions in these key areas can be vitally important as your business grows.
Additional resources: In a number of critical areas, including legal, tax and personnel matters, a VC firm can provide active support, all the more important at a key stage in the growth of a young company. Faster growth and greater success are two potential key benefits.
The advantages of venture capital are as follows:
- New innovative projects are financed through venture-capital which generally offers high profitability in long run.
- In addition to capital, venture-capital provides valuable information, resources, technical assistance, etc., to make a business successful.
Disadvantages of Venture Capital:
Loss of control: The drawbacks associated with equity financing, in general, can be compounded with venture-capital financing. You could think of it as equity financing on steroids. With a large injection of cash and professional, and possibly aggressive, investors, it is likely that your VC partners will want to be involved. The size of their stake could determine how much say they have in shaping your company’s direction.
Minority ownership status: Depending on the size of the VC firm’s stake in your company, which could be more than 50%, you could lose management control. Essentially, you could be giving up ownership of your own business.
The disadvantages of venture capital are:
- It is an uncertain form of financing.
- Benefit from such financing can be realized in long run only.
#Know and understand the Dimensions of Venture Capital:
Venture-capital is associated with successive stages of the firm’s development with distinctive types of financing, appropriate to each stage of development. Thus, there are four stages of the firm’s development, viz., development of an idea, startup, fledgling, and establishment. The first stage of development of a firm is the development of an idea for delineating precise specification for the new product or service and to establish a business plan.
The entrepreneur needs seedling finance for this purpose. Venture capitalist finds this stage as the most hazardous and difficult in view of the fact that the majority of the business projects are abandoned at the end of the seedling phase. Start-up stage is the second stage of the firm’s development. At this stage, the entrepreneur sets up the enterprise to carry into effect the business plan to manufacture a product or to render a service.
In this process of development, venture-capitalist supplies start-up finance. In the third phase, the firm has made some headway, entered the stage of manufacturing a product or service, but is facing enormous teething problems. It may not be able to generate adequate internal funds. It may also find its access to external sources of finance very difficult.
To get over the problem, the entrepreneur will need a large amount of fledgling finance from the venture capitalist. In the last stage of the firm’s development when it stabilizes itself and may need, in some cases, establishment finance to explicit opportunities of scale. This is the final injection of funds from venture capitalists. It has been estimated that in the U.S.A., the entire cycle takes a period of 5 to 10 years.