Venture Capital - Definition, Types, Advantages and Disadvantages
When you start a business, you need financing to set things up. You need money to set up the business location, hire staff, purchase inventory, etc. Since many lending institutions do not lend money to startups, most entrepreneurs look for venture capital that is easier to obtain. Many investors finance promising startups, hoping to earn money from their profits. However, if the business fails, the investors also have to bear the loss.
The following sections will discuss venture capital's meaning, features, types, pros and cons, risks, and other information you must know.
What is Venture Capital (VC)?
Venture capital is a type of financing that startups and early-stage companies use to finance their initial setup and growth stages. When a company is in its initial stages, most lending institutions may not approve its Business Loans. That is when it seeks VC investors to provide the required finance for investment in the business.
Who are Venture Capitalists?
Venture capitalists are individuals or firms who invest money in startups. In return, they claim a certain percentage of the business's profits. Apart from financing, venture capitalists also provide mentorship and guidance to startups, thus increasing their chances of success. Since their profit is also attached to the business's success, they use all their resources, experience, and network to support the company.
How Does Venture Capital Work?
Venture capital typically involves investing in businesses that want to raise money through external investors. Large corporations, investment firms, and high-net-worth individuals invest in these companies as venture capitalists. Venture capital typically funds companies with high growth potential. In return for their investment, investors acquire a stake in the company for a fixed period.
Types of Venture Capital
| Type of Capital | Description | Purpose |
|---|---|---|
| Seed Capital | Startups raise seed capital to establish their initial product or service offering. | Sourced from angel investors, family, and friends. |
| Startup Capital | Meant for businesses post-seed funding, used to hire personnel and create a product line. | Hiring staff, product creation, and business growth. |
| Early-Stage Capital | For companies with a strong business plan wanting to develop and test products or services. | Product or service development and testing. |
| Expansion Capital | For successful companies seeking funds for marketing, product development, or staff hiring. | Expansion in marketing, development, and operations. |
| Late-Stage Capital | For businesses with commercial success looking to scale further in manufacturing and sales. | Business scaling and market expansion. |
| Bridge Financing | Provides short-term funding to close the financial gap between two funding rounds. | Short-term capital to maintain operations between funding rounds. |
Importance of Venture Capital
- Funds startups, small and medium enterprises with high growth potential
- Provides financial support, industrial expertise, and strategic guidance
- Helps overcome the challenges of establishing and growing a business
- Drives innovation and supports economic growth
- Creates jobs in various industries
- Suitable for budding industries and businesses
- Fills the gap and provides a chance to flourish
- Caters to companies with no business experience or poor financial history
When Should One Go for Venture Capital Funding?
- Rapid Growth Potential: When your business model shows promise for rapid growth and scalability.
- Product Development: To fund the development of new products or services.
- Market Expansion: When entering new markets requires significant capital investment.
- Competitive Advantage: If you need to enhance technology or resources to gain a competitive edge.
- Building a Team: To attract and hire top talent essential for growth.
Features and Benefits of Venture Capital
- VC investors primarily focus on young businesses that need support entering the capital market.
- VC investments are typically equity-based rather than loan-based or inconvertible debt securities that provide fixed returns to investors.
- Investors seek equity profits from the business's success.
- These are long-term investments that investors place in businesses with promising growth potential.
- Capital providers have personal benefits in the business's success. So, they also provide managerial experience and network benefits.
Steps to Get Venture Capital Funding
- Deal Origination: Sourcing opportunities through referrals, industry networks, or direct pitches to VC firms.
- Screening: Proposals are assessed based on the size of the market, the degree of innovation, and the financial needs of the business.
- Evaluation: Investors evaluate the business plan, the leadership team, and financial outlook to establish the likelihood of success.
- Negotiation: The terms of the investment are negotiated and agreed to, including size of equity stake, investment amount, and involvement in the business.
- Due Diligence: Investors conduct thorough checks to confirm that they are dealing with a viable investment opportunity.
- Post-Investment Support: If the investment is made, venture capitalists often provide ongoing support through strategic advice, contacts, and even board seats (when appropriate).
- Exit Strategy: Investors have a planned exit strategy through initial public offerings, acquisitions, or selling their shares, in order to realize their investment return.
What are the Advantages and Disadvantages of Venture Capital?
| Advantages | Disadvantages |
|---|---|
| Investors may invest a substantial amount of money | Difficult to secure |
| No commitment to repay the invested capital | Venture capitalists may take time to decide |
| Helps a new company build a team | Searching for investors requires due diligence and time |
| Brings the benefits of guidance and networking from the investors | A performance schedule is necessary for the fund release. |
Risks of Venture Capital
- Professional Risks: Startups are at high risk of failure and can lead to wasted capital.
- Liquidity Risk: VC capital requires more balance, and we need to have a quicker and easier way to liquidate.
- Loss of Ownership: The business operator still takes on the ownership risk of dilution of ownership with each round of financing.
- Regulatory & Legal risks: Like it or not VC investments come with regulatory compliance and statutory obligations.
- Market volatility: VC investments are risky for a reason because they are subject to market conditions.
How Entrepreneurs Use Business Loans to Kickstart their Venture Capital Journey?
Kickstarting the venture capital journey with a Business Loan is extremely advantageous. It helps you in the following ways:
- Start as an Angel Investor: Venture capitalists often prefer business owners who invest their own money into their companies, showcasing their commitment and confidence.
- Join a Fund: Participating in an established fund allows you to build a track record, which is essential for attracting venture capital investors.
- Partner with a Beginning VC Firm: Emerging VC firms may seek operational partners, providing an opportunity for entrepreneurs to leverage their industry experience and insights.
How to Apply for a Business Loan?
Applying for a Business Loan from Hero FinCorp is much easier than attracting VC investments. The process includes the following steps:
- Visit the Business Loan page on the Hero FinCorp website and click Apply Now.
- Fill in the required fields and upload relevant documents.
- Enter the desired loan amount and tenure.
- If you meet the criteria, you will receive a reference number.
- A representative will contact you for any additional information.
- After verification, you will receive a personalised loan offer.
- Once accepted, the loan amount will be disbursed to your bank account.
Conclusion
Venture capital shapes the startup ecosystem and brings the right combination of finance, support, and mentorship to a startup. However, if you need quick funding without any profit-sharing, you can get a Business Loan of up to Rs 40 Lakh from Hero FinCorp at an attractive business loan interest rate and flexible repayment tenures.
Frequently Asked Questions
1. How does venture capital differ from traditional bank loans?
Venture capital is not a loan. You do not have to repay the investors. In return for their investment they take a share of your business profit.
2. Can a company receive multiple rounds of venture capital funding?
A business can receive multiple rounds of VC, depending on performance and needs.
3. What is a typical investment period for venture capital?
The investment period for VC is typically five to seven years.
4. What is a venture capital fund?
A venture capital fund is a fund which investors add their money to in order to finance the next stage startup/consumption for their ownership of the company.
5. What is venture capital in simple words?
Venture capital is investment placed in promising startups by people who believe in the startup's potential. In a way it is a mixture of risk, hope, and excitement, all for creating something substantial from nothing.
6. What is venture capital examples?
A good example of venture capital is early investors funding companies like AirBNB or Uber. They were providing financial backing and support, when those companies were early startups before they were successful, in return for equity.
