VENTURE CAPITAL FINANCING

VENTURE CAPITAL FINANCING Venture capital is defined as : an equity / equity related investment in a growth-oriented small / medium business to enable investees to accomplish corporate objectives , in return for minority shareholding in the business or the irrevocable right to acquire it.

 Venture capital is a way in which investors

support entrepreneurial talent with finance and business skills to exploit market opportunities and thus to obtain long term capital gains.

It is a provision of risk bearing capital , usually in the form of participation in equity , of companies with high-growth potential. It provides some value addition in the form of
management advice and contribution to overall strategy.

Distinguishing features as against other capital investments : Venture capital is basically equity finance in relatively new companies when it is too early to go to the capital market to raise funds. It is a long-term investment in growth-oriented small / medium firms. The acquisition of outstanding shares from other shareholders cannot be considered venture capital investment.

 Substantial degree of active involvement of the venture capital institution with the promoters of the venture capital undertaking .It means such finance also provides business skills to the investee firm which is termed as hand-on approach. Venture capitalist do not seek majority / controlling interest , the objective is to provide management skill only not interfere in management.

 Venture capital involves high risk-return spectrum . The returns in such financing are essentially through capital gain at the time of exit from disinvestment in the capital market.

Selection of Investment
This is the 1st step in venture capital financing decision.

Track record of the entrepreneur Market potential study Projections of future turnover Profitability Threats from technological obsolescence / competing technologies Preliminary views on preferred exits The selection of the investment proposal includes stages of financing , methods to evaluate deals and the financial instruments to structure a deal.

Stages of Financing The selection of investment by VCI is closely related to the stages and types of investment . From the analytical angle , the different stages of investments are recognized and vary as regards the: ** time-scale , ** risk perceptions and ** other related characteristics of the investment decision process of the VCIs.

I (i) Seed Capital

Early Stage Financing

This stage is essentially an applied research phase where the concepts and ideas of the promoters constitute the basis of a pre-commercialization research project usually expected to end in a prototype which may or may not lead to a business launch. This phase gradually moves towards the development phase leading to a prototype product testing and then to commercialization.

 The evaluation of the project by the VCIs has to ensure that the technology skills of the entrepreneur matches with market opportunities. The main risk at this stage is marketing related important elements of the appraisal : * the commercial acumen of the promoter to take advantage of the market opportunity , * awareness of competition , * the timing of launching the product and so on. The risk perception of investment at this stage is extremely high. Very few VCIs invest in the seed stage of product development .

(ii) Start-up This is the stage when commercial manufacturing has to commence . Venture capital financing is here provided for product development and initial marketing. The essence of this stage is that the product / service is being commercialized for the first time.

 It includes several type of new projects : * Project based on relatively new or high technology * New projects by established companies * New business in which entrepreneur has good knowledge and working experience At this stage , some indication of the potential market for the new product / service is available The risk perception is high.

(iii) Second Round Financing This represents the stage at which the product has already been launched in the market but the business has not , yet , become profitable enough for public offering to attract new investors. The promoter has invested his own funds but further infusion of funds by VCI is necessary . The time - scale for the investment is shorter than in the case of start-ups. The VCIs provide larger funds at this stage than in the early stages. This financing is partly in the form of debt to provide some income to them.

II

Later Stage Financing

This stage of venture capital financing involves established businesses which require additional financial support but cannot take recourse to public issues of capital . It includes :

a) Mezzanine / Development Capital

This is financing of established businesses which have overcome the extremely high-risk early stages Have recorded profits for a few years But have yet to reach a stage when they can go public and raise money from the capital market / conventional sources.

Use of such type of venture financing : * Purchase of new equipment / plant * Expansion of marketing and distribution facilities * Re-finance of existing debt * Penetration into new regions The development finance stage has a time frame of 1-3 years . It falls in medium risk category. It constitute a significant part of the activities of many VCIs.

b) Bridge / Expansion It represents last round of financing before a planned exit.

Such finance is used in :

* Expand business by way of growth of their own

productive asset * Acquisition of other firms / assets of other firms. This finance involves low risk perception Time frame of 1-3 years.

c)

Buyouts This refers to the transfer of management control. VCIs provide funds to enable the current operating management / investors to acquire an existing product line / business i.e. Management Buyout (MBOs) . These are funds provided to enable an outside group [ of managers] to buy an ongoing company i.e. Management Buy Ins (MBIs) MBI is more risky , because the management comes from outside and finds it difficult to assess the actual potential of the target company. Time frame of 1-3 years

d) Turnarounds These are sub-set of buyouts and involve buying the control of a sick company. Two inputs are required are money & management . The VCIs have to identify good management and operations leadership. This involves medium to high risk. Time frame of 3 to 5 years. It is gaining widespread acceptance and increasingly becoming the focus of attention.

Investment Nurturing / Aftercare Unlike the conventional financial institutions , which normally keep aloof from the management and operations of the assisted concerns VCIs have an active , intimate and constant ongoing involvement during the entire life of the investment in VCUs .

The Main Elements of investment nurturing are : After the stage of investment decision , provision of continuing guidance and support to optimize the benefits of investment to both VCIs and VCU Building of joint relationship to tackle operational and other problems of business Protection of investment / interest of the VCIs.

Nurturing Style The styles of nurturing refers to the extent of participation by VCIs in the affairs of VCUs . The style depends upon a variety of factors such as : specialization of the VCI , stage of investment , financing plan , the stage of development of the venture capital industry itself and so on . It broadly falls into three categories

I Hands on Nurturing It refers to continuous and constant involvement in the operations of the investee company which is institutionalized in the form of representation on the board of directors. Under this the VCIs provide useful guidance on aspects of long-term business planning , technology development , financial planning , marketing strategy and so on . This style is useful and essential in early stage financing , i.e. seed capital investment . This type of care is provided either by the in-house expertise or by a core group of external advisors / experts in specific areas if the former is not available in all types of projects.

II Hands off Nurturing In this the VCIs play a relatively passive role . Although they reserve the rights , they rarely have nominee directors on the board of the VCUs. They do not actively participate in formulating strategies / policy matters in spite of the right to do so . This style is appropriate in case of syndicated /joint /consortium venture financing . This is also appropriate after the initial plan of the venture is over and business is running smoothly.

III Hands Holding Nurturing This is mid way between hands on and hands off styles. Like hands-on style , the VCI has a right to have nominee on the board of directors of the VCU , But actively participates in the decision making process only on being approached by the latter. If the VCU experiences any difficulty , the VCI provides either in-house assistance or assistance from out side .

Objectives of After Care ensure proper utilization of assistance provided ensure implementation of the project within the time and cost limits in case of time and cost over-runs , assist VCU in finding additional supplementary finance provide strategic inputs in technology production , finance , marketing ,personnel and so on anticipate likely problems and advise preventive /remedial actions

 ensure that the venture does not default evaluate the performance of the project and suggest measures for improvement , if required use the feedback received during the course of nurturing the investment for studying the problem and finding suitable solution to utilize the experience gained for better appraisal of new ventures.

Techniques of After Care Personal discussion obtaining information through personal / informal discussion with the entrepreneurs. information thus collected does not have any formal sanctity it provides most comprehensive and effective insight into the working of the venture useful when the venture is facing operational problems

Plant Visits At implementation stage the objective is to : review the progress of the project to see that adequate and well-qualified personnel have been appointed to ensure that the requisite sanctions are obtained for funds from other sources , if necessary to check venture has initiated action for obtaining working capital from banks.

For projects that are complete and on which production has started : the staffing pattern operational performance of the project marketing aspects management of accounts proper costing of products and efficient control of inventory labor relations statutory requirements

Feed back through Nominee Directors nominee director is expected to effectively contribute in the management and provide requisite guidance. ensure that the business is run on the sound basis should be able to anticipate problems and suggest solutions nominee directors should have a good exposure to industry , have adequate knowledge about technological development , changes in govt policies , financial management , laws , regulations and so on.

 Periodic Reports Commissioned Studies

STRUCTURAL ASPECTS limited partnership investment company investment trust off shore investment company off shore trust

EXIT Exit depends on factors like : nature of venture the extent and type of financial stake the state of actual and potential competition market conditions style of functioning perception of VCI

Methods of exit : going public sale of shares to employees / entrepreneur himself trade sale : entire company is sold to a third party sale to a new VCI liquidation : forced exit as a result of failure