An entrepreneur requires capital for establishing a business or for expansion. He may not be able to fund it himself and may have to raise the required capital or borrow loans. He can raise capital by either issuing equity or getting venture capitalists to invest in his business. He can borrow from banks, financial institutions or even take venture capital loans.
Generally, banks and financial institutions follow conservative lending policies. They hesitate to grant loans for risky ventures, preferring to lend to businesses which are ‘safe’. People with unique business ideas hence find it difficult to raise funds. Venture capitalists by providing the required money help these entrepreneurs in their ventures.
Venture capitalists are basically private financiers looking for higher returns. They may invest in the business or provide venture capital loans.
Venture capital is capital invested in a business where the risk to profit creation and cash flow is substantial. A venture capitalist invests in businesses which have high risk- high reward opportunities.
Entrepreneurs look for venture capital loans or investments in the following situations
A venture capital loan is a contractual agreement wherein the company taking the loan will have to regularly pay interest to the venture capitalist. This is in contrast to a venture capital investment where the person or organization providing venture capital is provided an equity stake in the business.
Providing venture capital loans is however as risky as venture capital investing. But if the loan is secured, then the lender will be paid ahead of other creditors in case of the business going bankrupt, though there is still the chance that he will lose the entire loan amount. The loans are generally secured by company securities. Some venture capital lenders insist on an option to convert the loan into equity shares in the future.
Not all venture capital firms provide venture capital loans. On the other hand, there are banking institutions which to not make venture capital investments but sometimes grant venture capital loans.
Advantage of obtaining Venture Capital Loans or Investments
Venture capital firms provide funds to entrepreneurs from external sources, mostly institutional investors like pension funds and insurance companies. Venture capital firms are however not interested in small businesses.
Business angels are wealthy individuals who are interested in funding business ventures and readily provide small amounts of capital required for a business. In return, they are given a stake in the business. They generally do not provide venture capital loans.
Due diligence before granting Venture Capital Loans
Before granting venture capital loans, the lender will conduct due diligence of the business. A financial feasibility study would be done to determine the possible profitability of the business. An assessment of the technology used and other technical aspects is also carried out. If the venture capital firm is satisfied, it will initiate the lending process.
Venture capital loans and investments help people who have good business ideas get access to funds required for starting and establishing their entrepreneurial ventures.