VENTURE CAPITAL

1. Definition and Basics of Venture Capital (ASHLEY)

Venture capital is financing that investors provide to startup companies and small
businesses that are believed to have long-term growth potential. Venture capital
generally comes from well-off investors, investment banks and any other financial
institutions. However, it does not always take a monetary form; it can also be provided
in the form of technical or managerial expertise.

Though it can be risky for investors who put up funds, the potential for above-average
returns is an attractive payoff. For new companies or ventures that have a limited
operating history (under two years), venture capital funding is increasingly becoming a
popular – even essential – source for raising capital, especially if they lack access to
capital markets, bank loans or other debt instruments. The main downside is that the
investors usually get equity in the company, and, thus, a say in company decisions.

Basics of Venture Capital

In a venture capital deal, large ownership chunks of a company are created and sold to
a few investors through independent limited partnerships that are established by
venture capital firms. Sometimes these partnerships consist of a pool of several similar
enterprises. One important difference between venture capital and other private
equity deals, however, is that venture capital tends to focus on emerging companies
seeking substantial funds for the first time, while private equity tends to fund larger,
more established companies that are seeking an equity infusion or a chance for
company founders to transfer some of their ownership stakes.

2. History of Venture Capital (DEANNA)

Venture capital is a subset of private equity (PE). While the roots of PE can be traced
back to the 19th century, venture capital only developed as an industry after the
Second World War. Harvard Business School professor Georges Doriot is generally
considered the "Father of Venture Capital". He started the American Research and
Development Corporation (ARDC) in 1946 and raised a $3.5 million fund to invest in
companies that commercialized technologies developed during WWII. ARDC's first
investment was in a company that had ambitions to use x-ray technology for cancer
treatment. The $200,000 that Doriot invested turned into $1.8 million when the
company went public in 1955.

Location of the VC

Although it was mainly funded by banks located in the Northeast, venture capital
became concentrated on the West Coast after the growth of the tech ecosystem.
Fairchild Semiconductor, which was started by the traitorous eight from William
Shockley's lab, is generally considered the first technology company to receive VC
funding. It was funded by east coast industrialist Sherman Fairchild of Fairchild Camera
& Instrument Corp.

Help From Innovations

A series of regulatory innovations further helped popularize venture capital as a

funding avenue. The first one was a change in the Small Business Investment Act (SBIC)
in 1958. It boosted the venture capital industry by providing tax breaks to investors. In
1978, the Revenue Act was amended to reduce the capital gains tax from 49.5% to
28%. Then, in 1979, a change in the Employee Retirement Income Security Act (ERISA)
allowed pension funds to invest up to 10% of their total funds in the industry.

Called the Prudent Man Rule, it is hailed as the single most important development in
venture capital because it led to a flood of capital from rich pension funds. Then the
capital gains tax was further reduced to 20% in 1981. Those three developments
catalyzed growth in venture capital and the 1980s turned into a boom period for
venture capital, with funding levels reaching $4.9 billion in 1987. The dot com boom
also brought the industry into sharp focus as venture capitalists chased quick returns
from highly-valued Internet companies. According to some estimates, funding levels
during that period peaked at $119.6 billion. But the promised returns did not
materialize as several publicly-listed Internet companies with high valuations crashed
and burned their way to bankruptcy.

3.Types of Venture Capital funding (KARLA)

The various types of venture capital are classified as per their applications at various
stages of a business. The three principal types of venture capital are early stage
financing, expansion financing and acquisition/buyout financing.
The venture capital funding procedure gets complete in six stages of financing
corresponding to the periods of a company’s development

 Seed money: Low level financing for proving and fructifying a new idea
 Start-up: New firms needing funds for expenses related with marketing and
product development
 First-Round: Manufacturing and early sales funding
 Second-Round: Operational capital given for early stage companies which are
selling products, but not returning a profit
 Third-Round: Also known as Mezzanine financing, this is the money for
expanding a newly beneficial company
 Fourth-Round: Also called bridge financing, 4th round is proposed for financing
the "going public" process

A) Early Stage Financing:

Early stage financing has three sub divisions seed financing, start up financing and first
stage financing.
  Seed financing is defined as a small amount that an entrepreneur receives for
the purpose of being eligible for a start up loan.
 Start up financing is given to companies for the purpose of finishing the
development of products and services.
 First Stage financing: Companies that have spent all their starting capital and
need finance for beginning business activities at the full-scale are the major
beneficiaries of the First Stage Financing.

B) Expansion Financing:
Expansion financing may be categorized into second-stage financing, bridge financing
and third stage financing or mezzanine financing.
Second-stage financing is provided to companies for the purpose of beginning their
expansion. It is also known as mezzanine financing. It is provided for the purpose of
assisting a particular company to expand in a major way. Bridge financing may be
provided as a short term interest only finance option as well as a form of monetary
assistance to companies that employ the Initial Public Offers as a major business
strategy.

C) Acquisition or Buyout Financing:

Acquisition or buyout financing is categorized into acquisition finance and
management or leveraged buyout financing. Acquisition financing assists a company to
acquire certain parts or an entire company. Management or leveraged buyout
financing helps a particular management group to obtain a particular product of
another company.
4. Venture capitalists and types (WILLIANA)
A venture capitalist is a person who makes venture investments, and these venture
capitalists are expected to bring managerial and technical expertise as well as capital
to their investments. A venture capital fund refers to a pooled investment vehicle (in
the United States, often an LP or LLC) that primarily invests the financial capital of
third-party investors in enterprises that are too risky for the standard capital markets
or bank loans. These funds are typically managed by a venture capital firm, which often
employs individuals with technology backgrounds (scientists, researchers), business
training and/or deep industry experience.

A core skill within VC is the ability to identify novel or disruptive technologies that have
the potential to generate high commercial returns at an early stage. By definition, VCs
also take a role in managing entrepreneurial companies at an early stage, thus adding
skills as well as capital, thereby differentiating VC from buy-out private equity, which
typically invest in companies with proven revenue, and thereby potentially realizing
much higher rates of returns. Inherent in realizing abnormally high rates of returns is
the risk of losing all of one's investment in a given startup company. As a consequence,
most venture capital investments are done in a pool format, where several investors
combine their investments into one large fund that invests in many different startup
companies. By investing in the pool format, the investors are spreading out their risk to
many different investments instead of taking the chance of putting all of their money
in one start up firm.

Types

Venture capitalist firms differ in their motivations and approaches. There are multiple
factors, and each firm is different.

Venture capital funds are generally three in types: 1. Angel investors 2. Financial VCs 3.
Strategic VCs

Some of the factors that influence VC decisions include:

 Business situation: Some VCs tend to invest in new, disruptive ideas, or

fledgling companies. Others prefer investing in established companies that
need support to go public or grow.
 Some invest solely in certain industries.
 Some prefer operating locally while others will operate nationwide or even
globally.
 VC expectations can often vary. Some may want a quicker public sale of the
company or expect fast growth. The amount of help a VC provides can vary
from one firm to the next.

5.The Venture Capital Process (STEFFANIE)

The venture capital funding process typically involves four phases in the company’s
development:

 Idea generation
 Start-up
 Ramp up
 Exit

Step 1: Idea generation and submission of the Business Plan

The initial step in approaching a Venture Capital is to submit a business plan. The plan
should include the below points:

 There should be an executive summary of the business proposal

 Description of the opportunity and the market potential and size
 Review on the existing and expected competitive scenario
 Detailed financial projections
 Details of the management of the company
There is detailed analysis done of the submitted plan, by the Venture Capital to decide
whether to take up the project or no.

Step 2: Introductory Meeting

Once the preliminary study is done by the VC and they find the project as per their
preferences, there is a one-to-one meeting that is called for discussing the project in
detail. After the meeting the VC finally decides whether or not to move forward to the
due diligence stage of the process.

Step 3: Due Diligence

The due diligence phase varies depending upon the nature of the business proposal.
This process involves solving of queries related to customer references, product and
business strategy evaluations, management interviews, and other such exchanges of
information during this time period.

Step 4: Term Sheets and Funding

If the due diligence phase is satisfactory, the VC offers a term sheet, which is a non-
binding document explaining the basic terms and conditions of the investment
agreement. The term sheet is generally negotiable and must be agreed upon by all
parties, after which on completion of legal documents and legal due diligence, funds
are made available.