Introduction - By investing in robots, massive cloud computing, artificial intelligence (AI), and molecular and biological science applications, venture capital have transformed significant global industries and generated enormous economic prospects. It is time for the Indian Economy to be at par with the leading developed economies in the world concerning the venture capital market. This blog gives an overview of how venture capital works.
India hasn't historically been a market for venture capital, but with the development of the startup scene, it is now an essential component of the entire process. Venture capital firms are privately held investment enterprises that pool capital from HNIs, institutional investors, and financial institutions. They invest in startups with a short operating history but significant growth and value-creation potential. Investing in a startup carries a substantial risk because they haven't yet demonstrated their worth and are more reliant on market conditions than an established company. A venture capital firm works by its predetermined investment thesis or strategy, encapsulating different aspects they consider before investing in a company. Investors in venture capital (VC) businesses make investments after considering various variables and tactics the firm has established as a part of its thesis.
VC investments are often high-risk, high-reward investments made in exchange for stock holdings in a firm. Venture capitalists typically look for new products or services when evaluating startups for investment. One of the critical characteristics of venture capital investing is that it frequently involves mentoring and strategy development in addition to actual investment for startups.
Venture Capital firms in India are regulated by SEBI (AIF) Regulations 2012 and are classified as Alternative Investment Funds.
VC financing involves the following stages:
• Pitch: The startups provide the VC firm with their pitch or business strategy (s). Startups should conduct due diligence to confirm that the objectives and tactics of the VC are compatible with their company and sector. Investors can now approve, reject, or request further information about the company.
• Deep Dive: This stage is typically reached if the venture capitalist thinks favorably of the startup pitch. The investment company may go in-depth with the companies it deems attractive or investable.
• Negotiation: A VC firm would design a contract and share the term sheet/memorandum with the startup if and when they decided to invest in a company. The Terms & Conditions, amount of investment, and business value are all described in this document.
• Due Diligence: The VC companies do a thorough due diligence investigation after accepting the term sheet to verify the deal's accuracy and validity and to ensure good administration.
• Definitive Documentation: The VC company develops and distributes final documents following successful and thorough due diligence. This is the last step before the business receives an investment, subject to any precedent or follow-up conditions that may be established during the due-diligence process.
Stages Of Venture capital investing:
• Seed Round: Entrepreneurs are in the early stages of developing their business strategies and need funding for R&D. This round has more substantial involvement from angel investors.
• Early Stage Round: The first round of finance, often known as Series A funding, can be raised once the business plan is complete and scalable. They can then pursue series B and C.
• Late Stage: The company can raise additional funds later to create ideal market circumstances for its earlier investors as it develops and is ready for an IPO or an M&A.
A VC firm often takes part in all essential investment rounds to get more stock shares and raise the credibility of an emerging company. Businesses benefit because it lessens risk and diversification of work.
How do Venture Capital Funds make money?
When investing, a typical VC firm assesses the startup's growth to plan a profitable exit and maximize returns. While it is ideal for venture capital firms to exit a business at its height, they may improvise exit plans at various stages of the company. Following are a few methods through which venture capitalists withdraw from a corporation to realize their returns:
- IPO
A public offering in which a firm's shares are sold to institutional investors and typically also to retail investors is known as an initial public offering (IPO) or stock launch. Usually, one or more investment banks underwrite it and make arrangements for the shares to be listed on one or more stock exchanges. Investors wait for the most advantageous time to launch an IPO to ensure they receive the best potential return.
- Secondary Market
A secondary market strategy is where a venture capitalist sells their stake to a third party, typically other venture capitalists, in a secondary market (where investors buy securities or assets from other investors). The critical point is that if the venture investor is eager to exit or take returns, the third party will acquire the shares at a reduced cost.
- Share Buyback
In this tactic, the company's founders purchase the shares from venture capital firms. While it facilitates the investor's speedy exit from a company, it also benefits the company by raising earnings per share.
- Acquisition
The acquisition is when you give up your ownership to the company that buys it from you. In this scenario, the acquiring business issues a tender offer to all shareholders to buy their shares, generally in cash, at a premium above what the investors paid.
Conclusion: Venture capital is an exciting field to be taken seriously by entrepreneurs. Professionals with a risk appetite can pursue this field as a career path. India is yet to see the full potential of venture capitalism. We need to support new businesses, ideas, and innovations to make a difference and build a better world for the coming generation.
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