For establishing, running or expanding a business, one requires capital. One can use one’s own capital, borrow from banks or financial institutions or raise it from the public by issuing equity. But what if the business follows a unique model? If it is a risky proposition and one cannot be sure that it will be a profitable venture? Surely, lenders would hesitate to finance such a business. In such a situation, entrepreneurs would have to resort to venture capital.
Venture capital is a form of risk capital. In other words, it is the capital required for a business where there is substantial risk to profit creation and cash flow. A person or institution providing venture capital invests in the business when a high rate of return on the investment is assured to compensate for the huge risk taken. They provide long-term capital which helps startups and unlisted companies to grow.
The following are the different situations in which venture capital is required:
A lender who has provided loans to a company has a right to interest on the loan as well as the repayment of the actual loan irrespective of whether the business venture succeeds or not. In case of venture capital, the capital provider gets a stake in the equity and his return would depend on the success of the venture.
A lender will get regular return in the form of interest. A venture capitalist gets a return on his investment only when he exits the venture by selling his Ventureholding.
Venture capitalists are interested in funding entrepreneurial businesses which have significant growth prospects within a period of 3 to 7 years. A business in the nascent stage is provided funds for a longer period of time while mature businesses are funded for a short period.
Venture Capital Firms
Venture capital firms provide funds to entrepreneurs from external sources, mostly institutional investors like pension funds and insurance companies. Before funding a business, venture capital firms first check the viability of the enterprise, its potential for growth and whether the possible reward is worth the risk taken.
Entrepreneurs find it difficult to arrange for funds for small sized ventures where the amount required is not very huge. In such situations, one cannot source from venture capital firms as they are not interested in small businesses. A bank would demand security for the loan. This is where business angels or angel investors come in.
Business angels are wealthy individuals who are interested in entrepreneurial ventures and readily provide small amounts of capital required for a business. In return, they are given a stake in the business.
They provide funding in the following circumstances:
Sourcing venture capital is the best way of funding an enterprise for people who have good business ideas but lack the funds to translate them into reality.