/dqc/media/agency_attachments/3bO5lX4bneNNijz3HbB7.jpg)
Follow UsVenture capital maybe new to India, but it is an old hat in
the land of its origin — the USA, where it existed even in the ’50s. It was
still in its infancy then. However, it took the information age and Silicon
Valley to propel venture capital to become the buzzword that it is today.
Basically, venture capital refers to the provision of
capital, to fund an investment in an idea or technology that is new and
therefore risky for banks or financial institutions. A venture capitalist (VC),
essentially buys a stake in an entrepreneur’s business, nurtures it to a
suitable stage of growth and then exits either by way of an IPO or through a
merger / alliance partnership. Unlike banks or financial institutions, VCs do
not ask for collateral or charge any interest whatsoever. Instead of convincing
thousands of stock market investors about his or her novel idea, the
entrepreneur may go to a VC for funds.
High risks high returns
Since the risks involved are inherently high, given the
novelty of the idea, VCs are known to expect at least a ten times return of
capital over five years. Most venture capital returns are difficult to measure
due to the complex timing of cash flows and the estimation involved in valuing
private equity. There is nothing to stop a VC from investing in the equity of a
competing business. The only sacred rule here is return on investment.
Usually, VC funds go to "growth industries" or "sunrise
industries" with strong market dynamics. In India too, there has been a
similar trend with a huge flow of venture capital funds to
the info-tech sector, as also to other attractive sectors such as media,
telecom, healthcare and of course, dotcoms as well as e-commerce
companies.According to NASSCOM estimates, India is likely to attract over $10
billion in venture capital funds by 2008, with more than $1billion expected this
fiscal year alone. Independent estimates show that current funds are controlled
by about 15 venture capital funds, operating with about $50-100 million each.
Moreover, there are a growing number of funds being set up, with large amount of
funds for supporting Internet/e-commerce related ideas.
Stages of VC funding
Venture capital is provided to an entrepreneur across various
stages in the lifecycle of an idea. First of all, the VC takes a notional stake
in the entrepreneur’s company. Immediately after this, typically, a relatively
small sum of money is advanced to the entrepreneur at what is known as the ‘seed
stage’, after the VC is convinced about a concept. The money is utilized to
hire an office, recruit staff and pay salaries.
Then follows the ‘start-up stage’ when financing is
provided to companies for use in product development and initial marketing. At
this stage, product development is usually completed and marketing takes over.
In the next stage, the VC provides more funds to generate
sales and establish marketshare. Then, working capital is provided for expansion
of market, expansion of customer base and additional product/service
development. It is during this phase of growth that the largest amount of
funding is provided by the VC.
Later on comes what is known as the ‘bridge stage’ when
the VC brings in finance for the company, which will eventually go public within
six to 12 months.
Services provided by VCs
There is a crucial difference between other financiers and
VCs. In any case, VCs are much more than providers of easy money for brilliant
ideas. In addition to providing the cash investment to launch and grow a
business idea, VCs also offer a range of additional services. VCs are known to
help hire a professional management team for the newly incubated venture,
besides providing advice on business processes, systems and MIS to be put in
place.
VCs are hard-nosed businessmen looking for high returns. They
offer these services because of their vested interest in recovering investments.
Hence they often go out of their way to ensure that the business succeeds. That
explains the handholding. Therefore, VCs also help in accessing new technology
and provide business advice on new partnerships.
How VCs make money
VCs always begin by taking a stake in the business. They ‘incubate’
it, nurture it and help the company go public. In other words, they help
companies in which they have invested, reach the IPO stage. In fact, everything
that the VC does or does not do is planned with that crucial IPO in mind. VCs
can make their killing only if they can make an exit by selling their stake in
the business, which they have financed — a case of buying cheap and selling at
a high price.
In fact, there are many cases where VCs have liked the
business so much that they have taken stakes upto 80 percent! Though they see
themselves as ‘incubators’ and ‘nurturers’, it may not be long before
cynics see them as ‘butchers’ who feed the calf to fatten it for the
slaughter day (read IPO day)!
However, as of now, entrepreneurs are not complaining as the
IPO money is flowing into their accounts too. For the same reason, they are
unlikely to take offence about VCs making money after selling the majority stake
of their company at IPO, even if it is at the expense of their business idea.
Now, that should console channel partners who would like to approach VCs to help
set up those e-commerce sites or software ventures.