Definition: Venture Capital can be defined as the financing for startup companies and small enterprises, that involves a considerable amount of risk but are supposed to have long-term growth potential, i.e. the project can earn a high rate of return.
A budding company, which is not yet ready to raise funds from the financial market through public offering may seek venture capital. It implies a financial statement that aims at supporting new and expanding firms, during their primary stages.
A Venture Capitalist, invest in the equity or debt of the firm promoted by new professionally or technically qualified but an unproven entrepreneur, whose business idea is relatively unique, but does not possess financial backing.
Venture Capitalist Company (VCC) is quite interested in entrepreneurial businesses with high growth prospects managed by an experienced team who have the potential to turn the business plans into reality.
Method of Venture Capital Financing
- Equity Financing: A firm needs funds for a longer period to survive and grow, but as venture capital firm is a new company the firm is not able to give timely returns to its investors, for which equity financing proves beneficial. The investor’s contribution is not more than 49% of the total stake, and so the ultimate power remains with the entrepreneur.
- Conditional Loan: Conditional loans are the ones that do not carry interest and are repayable to the lender in the form of royalty after the venture capital undertaking is able to make revenue. The royalty rate may vary from 2% to 15%, on the basis of factors such as gestation period, external risk and cash flow patterns.
- Income Note: A form of hybrid financing, that combines the characteristics of the traditional loan and conditional loan, on which the venture capital firm pays both royalty and interest, but at low rates.
Participating Debentures: The interest on participating debentures is payable at three various rates, as per the phase of operation:
- Start-up phase — Nil
- Initial operations phase — Low rate of interest
- After a particular level of operations – High rate of interest
- Convertible loans: The loans which are convertible into equity when interest on the loan is not paid within the stipulated period.
Venture Capital provides long term funding to unquoted companies to grow and succeed. Raising venture capital is a bit different from borrowing money from lenders because lenders have the right to interest on the loan and capital repayment. On the other hand, venture capital investment provides equity stake to the investor, and the return on investment relies on the growth and profitability.