Venture

Capital

Venture capital is also called Risk Capital. It is type of private capital typically provided by venture capitalist to early-stage, high-potential, and growth companies in the interest of generating a profit through an exit event such as an IPO or trade sale of the company. A venture capitalist (VC) is a person who makes such investments. Venture capital firms expects a high rate of return (20%+) and will finance the business with range between $500,000 to millions. A venture capital fund is a pooled investment vehicle (often a partnership) that primarily invests the financial capital of third-party investors in enterprises that are too risky for the standard capital markets or bank loans.

Key Factors in Attracting Venture Capital

Factors influencing Venture Capital include the size of target market, likely share and revenues of the target company, and above all, the likelihood of attracting a trade buyer or achieving IPO. VCs need at least a 3x return on their investments overall to make the economics work. Situations differ, but since some companies inevitably fail, a high risk start-up requires the potential to achieve at least a 5x return. A prospect of 10x can lead to a higher initial valuation, providing that is a credible outcome.

Different Stages of Venture Capital:

a. Seed Round: In this stage financing is a relatively small amount of capital provided to an inventor or entrepreneur for designed to research, assess and develop an idea or concept before a company has reached the start-up phase. There slit differences between Seed Round and Start-up. In Start-up phase the company will use fund for product development and initial marketing. b. Early Stage Financing: In this stage financing provides for companies completing development where products are mostly in testing or pilot production. In most of cases, product may have just been made commercially available in market. Companies may be in the process of organizing or they may already be in business for three years or less. c. Expansion Stage Financing: In this stage financing for working capital for the initial expansion of a company that is producing and shipping and has growing accounts receivables and inventories. In this stage company may or may not be showing a profit. The most of the companies uses of capital may include further plant expansion, marketing, working capital needs, or development of an improved product and services. The venture capitalists role in this stage evolves from a supportive role to a more strategic role.

d. Later Stage: Capital in this stage is provided for companies that have reached a fairly stable growth rate; that is, not growing as fast as the rates attained in the expansion stages. Again, these companies may or may not be profitable, but are more likely to be than in previous stages of development. Other financial characteristics of these companies include positive cash flow. In this stage planning to exit from the deal. Exit may happen by selling to other investors or issuing shares to public through initial public offering (IPO) or another exit strategy.

Venture Capital Structure

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Structure of Venture Capital Firms:

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Term Sheets:
A Term Sheet is a document which outlines the key financial and other terms of a proposed investment. Investors use a Term Sheet to achieve preliminary and conditional agreement to those key terms and form the basis for drafting the investment documents. With the exception of certain clauses (commonly those dealing with confidentiality, exclusivity and sometimes costs and break fees) provisions of a Term Sheet are not usually intended to be legally binding. As well as being subject to negotiation of the final legal documentation, a Term Sheet will usually contain certain conditions which need to be met before the investment is completed and these are known as conditions precedent. The Subscription Agreement will usually contain details of the investment round, including the number and class of shares subscribed for, payment terms and representations and warranties about the condition of the company and its key assets. These representations and warranties will usually be qualified by a disclosure letter and supporting documents that specifically set out any issues that the founders believe the investors should know prior to the completion of the investment. The Shareholders' Agreement will usually contain investor protections; including consent rights (see section 15, Part IV), rights to board representation and non-compete restrictions. The Constitution will include the rights attaching to the various share classes, the procedures for the issue and transfer of shares and the holding of shareholder and board meetings. Once agreed by all parties, lawyers use the Term Sheet as a basis for drafting the investment documents. The more detailed the Term Sheet, the fewer the commercial issues which will still need to be agreed during the drafting process. The process can be complex and working with lawyers who are familiar with venture capital transactions is recommended in order to minimize both timeframe and costs. Once that the provisions of the Term Sheet have been negotiated and agreed upon, a Subscription and Shareholders Agreement is drafted that outlines the provisions in a legally-binding document.

Venture Capital Investment Process:

The investment process initiates with the venture capitalist conducting an initial review of the proposal to determine if it fits with the firm's investment criteria. If so, a meeting will be arranged with the entrepreneur/management team to discuss the business plan.

Venture Capitalist Evaluation Criteria:

. Business Concept Fit: Whether the business proposal fits with the Venture Capital defined objectives, the business/technology space, stage of growth and synergy with portfolio companies. Management: Venture Capital will consider investing in business with strong management team that

shows organized and with a strong business concept having the scope to bring in strong management team along with the original entrepreneurs. Market: Venture Capital invests in companies with a focus on solving a real need within a very large and growing marketplace. Barriers to Entry: Necessary to maintain a competitive advantage. Typically, such barriers to entry include things like proprietary intellectual property, a unique understanding and experience within a market niche, or strong industry partnerships. Profitability: Businesses with a reasonable, verifiable path to profitability are favored.

Liquidity of Investment: Critical to achieving a VCs investment objectives is planning an exit strategy that provides liquidity.

Business Angels:
Business Angels are high net worth individuals who invest on their own, or as part of a syndicate, in high growth businesses. In addition to money, Business Angels often make their own skills, experience and contacts available to the company. Typically, Business Angels will invest range between $20,000 and $1,000,000 in an investment. The lead investor is sometimes referred to as the "archangel". Business Angels invest across most industry sectors and stages of business development, but especially in early- and expansion-stage businesses. Business Angels prefer to invest in companies within 100 miles of where they live or work.

How is Venture Capital different than Private Equity?

Venture capital is a type of private equity. It is a subset of private equity. Therefore all venture capital is private equity, but not all private equity is venture capital. Venture Capital is the early stage form of private equity where investors focus on investing in startup (highly risky) ventures. Private equity refers to the holding of stock in unlisted companies companies that are not quoted on a stock exchange. The funds raised through private equity can be used to develop new products and technologies, to expand working capital, to make acquisitions, or to strengthen a company's balance sheet. Categories of private equity investment include Leveraged buyout, venture capital, growth capital, angel investing, mezzanine capital and others. Financially, the key difference between how VC and PE deals are financed has to do with leverage. PE deals use lots of leverage, while VC deals do not.

Advantages of Venture Capital:

1. Venture Capital provides long term equity financing which will creates a solid capital base for the business expansion. It also brings in a host of value added services. 2. 3. 4. Venture capitalists provide companies with ongoing strategic, operational and financial advice. Having Venture capital as an investor provides lot of confidence to the stakeholders and customers. Investments from venture capital also ensure right corporate governance from the very initial stage.

5. The venture capitalist offer strong business expertise in their area of business which ultimately helps the business to respond well with the market competition. 6. The venture capitalist come with network of contacts in many areas that can add value to the company, such as in recruiting key personnel, providing readymade international markets, introductions to strategic partners, and if needed co-investments with other venture capital firms when additional rounds of financing are required. 7. The venture capitalist can also provide additional rounds of funding should it be required to finance growth.

8. Venture capitalists are experienced in the process of preparing a company for an initial public offering.

Disadvantages of Venture Capital:

1. 2. Investee Companies are required giving up controlling stake in the company. Venture capitalists tend to influence the strategic direction of the company. management is

3. Venture capitalists are generally interested in taking control of the company if the unable to drive the business.

The Venture Capital Method of Valuation:

Venture Capitalist invests in high-risk, high-return investments, with horizon of six or seven years. The Venture Capitalist final goal is to either go public (Initial Public Offering) or Trade sale. Venture Capital manage risk typically with a stage investments in which the company have to meet stated business milestones before qualifying of next financing round.