What is Venture Capital Firm?
A venture capital firm acts as both an investor and the manager of the fund. As an investor, the firm usually puts between 1% and 2% of its own money into the fund. This shows other investors that they care about the fund’s success.
As the manager of the fund, it is their job to find investment opportunities, new business models, or new technologies that have the potential to give the fund a high return on investment.
What is Venture Capital Fund?
Venture Capital Funds are alternate investment funds that help people buy private shares in start-ups and mid and small-sized businesses. VC funds invest in companies that have greater growth. VC funds have to follow the rules set by the SEBI. Even though investing in new projects is risky, there is higher investor interest because the growth potential from these businesses is significant.
Venture Capital Funds make sure that investors’ money goes to projects that have a chance to grow. The money that comes from this process is called ‘venture capital’. Venture capital money is given to companies based on their assets, size, and where their products are in the development process. People say that these companies have high-risk/high-return profiles because they are usually new or small.
Venture capital is a type of funding in which money is put into a company or a new business in exchange for a share of the company’s equity capital. Depending on the stage of the business, the funds from venture capital firms are used by start-ups to grow, scale up, develop new products, etc.
Apple, Facebook, and Google all started out as small businesses that venture capital firms helped to grow. With the help of venture capital investments, Indian companies like Paytm and Ola were able to grow to a large size.
Venture Capital Funds are like mutual funds in a way that they pool money from a number of investors. These investors can be high-net-worth individuals, companies, or even other funds. A venture capital firm manages the VC Fund, and the firm is not an asset management company.
How Does a Venture Capital Fund Work?
Venture Capital investments are early-stage capital, seed capital, or expansion-stage financing, depending on how old the business is and when the investment is made. But the stage of investment doesn’t change how venture capital funds work.
Before making any investments, all funds, including venture capital funds, must first raise money. Investors are given a prospectus of the fund, after which they decide whether or not to put money into it. Once the interest and commitment are shown, the people who run the fund call all the possible investors to finalize how much each one will put in.
Next, the venture capital fund looks for private equity investments that have a chance of making money for its investors. In this process, the fund managers look through hundreds of business plans to find companies that might grow quickly. The fund managers make investment decisions on the basis of the prospectus and investor interest. Once an investment is made, the fund will charge an annual management fee of about 2%.
When a company goes public or merges with another company, investors in a venture capital fund get their money back. In addition to the annual management fee, the fund keeps a portion of the profits in case the investments are profitable.
Features of Venture Capital Funds
The following are the features of venture capital funds:
- VCFs are mostly used for early-stage investments, but sometimes they can also be used for financing growth.
- Most of the time, the VCFs buy equity stakes in the businesses or companies that they fund.
- Along with the money, VCFs bring the knowledge and expertise of the investors, which aids the company’s growth.
- Sometimes, the VCFs also help the company come up with new products or services and get the most up-to-date technologies. This, in turn, helps the company work better and generate returns.
- The biggest benefit VCFs offer is network. With the help of powerful and wealthy investors, the company can get access to different networks and grow quickly.
- VCFs have the power to influence the business decisions a company may make.
- VCFs invest in a number of upcoming start-ups with the hope that at least one will grow quickly and generate returns. This is the VCFs risk mitigating technique.
Types of Venture Capital Funds
Venture Capital funds are classified as follows based on the stage in which they invest:
Early Stage Funding
Here the money is put into a company to help it get started and start making products or giving services.
There are three different kinds of early-stage funding:
- Seed funding is when a small amount is given to a business to help it get a loan.
- Start-up funding is money given to businesses to help them create new products or services.
- First-stage funding is money given to businesses that need money to get started.
Here the money is given to businesses that are growing in different ways.
There are three main types of expansion stage funding:
- Second-stage funding is given to businesses that plan to start their expansions.
- Bridge funding is a type of quick financing that helps a business meet its short-term obligations until it can get long-term funding.
- Mezzanine funding is money that is given to companies to help them through mergers and acquisitions.
Following are the types of funding under Acquisition or buyout funding:
- Acquisition funding this type of funding helps companies acquire specific areas/ expertise of other businesses.
- Management or leveraged buyout funding is given to businesses to help them buy another business or product.
Advantages of Venture Capital Funds
The following are the advantages of VCFs:
- No Repayment Obligation: One of the best advantages of venture capital funds is that the business doesn’t have to pay back the amount invested. Even if the business fails, entrepreneurs don’t have to pay back the money received as funding. This is not the case with bank loans, which are usually very hard to pay back.
- Networking: Venture capital firms have a large network that can help a new business get marketing and promotion. As a result, it gives quick market access to the business and aids its growth and success.
- Growth: VCFs can help a business grow quickly. This might not be true for any other kind of funding.
- Business Advice: Not only do VCFs have years of experience, but they also know how to manage businesses. This is important for managing people, money, and business decisions. Often young entrepreneurs may not possess these skills.
Disadvantages of Venture Capital Funds
The following are the disadvantages of VCFs:
- Long Term: Venture capital firms have to figure out if investing in a company is a good idea and if it will help them make money. This can take a long time, which can make it hard to get funding.
- Ownership and Control: By funding businesses, venture capital funds help that company make decisions. Also, venture capital firms hold a seat on the company’s board.
- Competition: With increasing competition, it may be difficult to bag VC funding.
Frequently Asked Questions
Venture capital funds are very different from mutual funds because they only invest in early-stage, expansion-stage, and acquisition-stage businesses. While mutual funds invest in publicly listed companies. All companies that get venture capital investments to have a high chance of growth are risky and have a long-time horizon. Venture capital funds are more involved in the companies they invest in. They give advice and often have a seat on the board. So, VC funds take an active and hands-on role in how the companies in their portfolio are run and managed. On the other hand, mutual funds are not get involved in companies they invest in.
Indians, foreign or Non-Resident Indians, can invest in a VC fund. However, the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 governs any investment in the VCF by someone who lives outside of India. Furthermore, most Indian VC funds take minimum investments of INR 1 crore, but some funds take a minimum of INR 3 crore or more.
There are about 186 SEBI-registered venture capital funds in India.