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EduPristine>Blog>Understanding Various Aspects of Venture Capital

Understanding Various Aspects of Venture Capital

April 25, 2013

Hello Friends, Today I am going to share my views about a topic that is very close to the hearts of all the budding Entrepreneurs of our country, which gives their dreams, the wings to fly and thereby making them practically possible. The Extremely popular term I am talking about is “Venture Capital”. So, the objective of this blog is to help you all in understanding the various concepts of “Venture Capital”.

What is Venture Capital?

As a Basic definition when we talk about Venture capital we talk about the Money provided by investors for business ventures (Usually startups & small firms). Venture Capitalists back high potential growth companies in the early stages by providing the funding usually in exchange for convertible debt or ownership equity. There are lots of examples of entrepreneurial tales that owe their success to investments of venture capitalists.

One such example is of our very own “Facebook”. Though it was Mark Zuckerberg who came up with the amazing idea of connecting users online through an interface; the idea saw daylight only when investors like Reid Hoffman, Mark Pincus, Kevin Efrusy foresighted the value that this idea could create and provided capital (Venture Capital) to Facebook in return of substantial shares for their firms. Facebook is now one of the biggest firms by market value; you can very well imagine the profit any of the above investors can make by selling their stake in it (These Investors earned High Rewards in return of the High Risk they took).

Venture capitalists normally invest in companies they foresee can be sold either to the public through IPO route or to larger firms in the coming years. They look for Companies who can have Rapid sales growth, can come up with Path breaking technology and have a great management team that can lead to success in the coming years.

Figure below a description of the process of Venture Capital funding in a simplistic manner:

Venture Capital

Various stages of VC Financing:

Investments by the Venture capitalists are often defined by the life cycle of the business: Seed financing, Later stage financing, Mezzanine financing etc.

Some venture capitalists popularly known as “Angel Investors” prefers to make the investments at the very start of a firm (Seed Stage) where the risk of the investment is highest but so is the potential for return. Some other venture capitalists prefer later stage financing that is aimed at the expansion of a firm.

“Mezzanine financing” is investing capital in a firm to kick start its growth until it goes public through IPO route.

Various aspects of Venture Capital Investment:

1. Illiquidity: If an investor puts his money in a small company then he is bound to wait for that company to grow and obviously cannot take his money out pretty soon.

2. Difficulty while valuing the firm: Now when an investor is looking to fund a start up firm it gets very difficult to calculate the return he can get as these firms do not have any comparables or any any cash flows.

3. Great Entrepreneurs vs. Great managers: Though an entrepreneur may be great in coming up with an idea and start a firm but they may not have the required management skills when company starts growing.

Venture Capital vs. Vulture Capital

So far we have seen how Venture Capitalists play a very important role in the success of startup firms. But with the financing from VC comes a potential danger of giving up a large portion of your ownership. Often it has been seen that Venture Capitalists quickly take majority control from the Founders and then force them to leave the firm. Such Venture Capitalists often very rightly called as "Vulture Capitalists."

So, it is of prime importance for Founders to access the motives of the Venture Capitalists before accepting the funding. They should also try to disseminate important intellectual property to the VCs for gaining access to funding.

This concludes the basic overview of the topic “Venture Capital”. For any queries or clarifications feel free to comment or drop a mail. Hope it helped you all. Ciao!!

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Trusted by Fortune 500 Companies and 10,000 Students from 40+ countries across the globe, it is one of the leading International Training providers for Finance Certifications like FRM®, CFA®, PRM®, Business Analytics, HR Analytics, Financial Modeling, and Operational Risk Modeling. EduPristine has conducted more than 500,000 man-hours of quality training in finance.

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