The term venture capital is understood in many ways. In a narrow sense, it refers to, investment in new and tried enterprises that are lacking a stable record of growth.

In a broader sense, venture capital refers to the commitment of capital as shareholding, for the formulation and setting up of small firms specializing in new ideas or new technologies. It is not merely an injection of funds into a new firm, it is a simultaneous input of skill needed to set up the firm, design its marketing strategy and organize and manage it. It is an association with successive stages of firm’s development with distinctive types of financing appropriate to each stage of development.

Meaning of venture capital

Venture capital is long term risk capital to finance high technology projects which involve risk but at the same time has strong potential for growth. Venture capitalist pools their resources including managerial abilities to assist new entrepreneurs in the early years of the project. Once the project reaches the stage of profitability, they sell their equity holdings at high premium.

Definition

A venture capital company is defined as a financing institution which joins an entrepreneur as a co-promoter in a project and shares the risks and rewards of the enterprise.

Features of venture capital

Some of the features of venture capital financing are as under:

1.Venture capital is usually in the form of equity participation. It may also take the form of convertible debt or long term loan.
2.Investment is made only in high risk but high growth potential projects.
3.Venture capital is available only for commercialization of new ideas or new technologies and not for enterprises which are engaged in trading, booking, financial services, agency, liaison work or research and development.
4.Venture capitalist joins the entrepreneur as a co-promoter in projects and shares the risks and rewards of the enterprise.
5.There is continuous involvement in business after making an investment by the investor.
6.Once the venture has reached the full potential the venture capitalist disinvests his holdings either to the promoters or in the market. The basic objective of investment is not profit but capital appreciation at the time of disinvestment.
7.Venture capital is not just injection of money but also an input needed to set up the firm, design its marketing strategy and organize and manage it.
8.Investment is usually made in small and medium scale enterprises.

Disinvest Mechanism

The objective of venture capitalist to sell of the investment made by him at substantial capital gains. The disinvestment options available in developed countries are:

i.Promoter’s buy back
ii.Public issue
iii.Sale to other venture capital funds
iv.Sale in Over the counter market
v.Management buy outs.

Scope of venture capital

Venture capital may take various forms at different stages of the project. There are four successive stages of development of a project viz., development of a project idea, implementation of the idea, commercial production and marketing and finally large scale investment to exploit the economics of scale and achieve stability. Financial institutions and banks usually start financing the project only at the second or third stage but rarely from the first stage. But venture capitalists provide finance even from the first stage of idea formulation. The various stages in the financing of venture capital are described below:

1.Development of an idea – seed finance: In the initial stage venture capitalists provide seed capital for translating an idea into business proposition. At this stage investigation is made in depth which normally takes a year or more.
2.Implementation stage - start up finance: When the firm is set up to manufacture a product or provide a service, start up finance is provided by the venture capitalists. The first and second stage capital is used for full scale manufacturing and further business growth.
3.Fledging stage – additional finance: In the third stage, the firm has made some headway and entered the stage of manufacturing a product but faces teething problems. It may not be able to generate adequate funds and so additional round of financing is provided to develop the marketing infrastructure.
4.Establishment stage – Establishment finance: At this stage the firm is established in the market and expected to expand at a rapid pace. It needs further financing for expansion and diversification so that it can reap economies of scale and attain stability. At the end of the establishment stage, the firm is listed on the stock exchange and at this point the venture capitalist disinvests their shareholdings through available exit routes.

Before investing in small, new or young hi-tech enterprises, the venture capitalists look for percentage of key success factors of a venture capital project. They prefer projects that address these problems. An idea developed for these success factors has been presented.

After assessing the viability of projects the investors decide for what stage they should provide venture capital so that it leads to greater capital appreciation.

All the above stages of finance involve varying degrees of risks and venture capital industry, only after analyzing such risks, invest in one or more. Hence they specialize in one or more but rarely all.

II. IMPORTANCE OF VENTURE CAPITAL

Venture capital is of great practical value of every corporate enterprise in modern times.

1. Advantages to investing public

1.The investing public will be able to reduce risk significantly against unscrupulous management, if the public invest in venture fund who in turn will invest in equity of new business. With their expertise in the field and continuous involvement in the business they would be able to stop malpractices by management.
2.Investors or have no means to vouch for the reasonableness of the claims made by the promoters about profitability of the business. The venture funds equipped with necessary skills will be able to analyze the prospects of the business.
3.The investors do not have any means to ensure that the affairs of the business are conducted prudently... The venture fund having representatives on the Board of Directors of the company would overcome it.

III. ADVANTAGES TO PROMOTERS

1.The entrepreneur for the success of public issue is required to convince tens of underwriters, brokers and thousands of investors but to obtain venture capital assistance; he will be required to sell his idea to justify the officials of the venture fund.
2.Public issue of equity shares has to be proceeded by a lot of efforts viz. necessary statutory sanctions, underwriting and brokers arrangement, publicity of issue etc. The new entrepreneurs find it very difficult to make underwriting arrangements require a great deal of effort. Venture fund assistance would eliminate those efforts by leaving entrepreneur to concentrate upon bread and butter activities of business.
3.Costs of public issues of equity share often range between 10 percent to 15 percent of nominal value of issue of moderate size, which are often even higher for small issues. The company is required in addition to above, to incur recurring costs for maintenance of share registry cell, stock exchange listing fee, expenditure on printing and posting of annual reports etc. These items of expenditure can be fund does not require such expenditure.
IV. GENERAL

1.A developed venture capital institutional set up reduces the time lag between a technological innovation and its commercial exploitation.
2.It helps in developing new processes/products in conducive atmosphere, free from the dead weight of corporate bureaucracy, which helps in exploiting full potential.
3.Venture capital acts as a cushion to support business borrowings, as bankers and investors will not lend money with inadequate margin of equity capital.
4.Once venture capital funds start earning profits, it will be very easy for them to raise resources from primary capital market in the form of equity and debts. Therefore, the investors would be able to invest in new business through venture funds and at the same time they can directly invest in existing business when venture fund disposes its own holding. This mechanism will help to channelise investment in hew high-tech business or the existing sick business. These business will take off with the help of finance from venture funds and this would help in increasing productivity, better capacity utilization etc.
5.The economy with well developed venture capital network induces the entry of large number of technocrats in industry, helps in stabilizing industries and in creating a new set of trained technocrats to build and manage medium and large industries, resulting in faster industrial development.