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Methods of Venture Capital Financing
Methods of Venture Capital Financing
EQUITY
All Venture Capital Firms(VCF) provide equity. Their contribution may not exceed 49% of the total equity capital. The effective control and majority ownership of the firm may remain with the entrepreneur. The Venture capitalist becomes entitled to a share in the firms profits as much as he is liable for the losses. The advantage to the VCF is that it can share in the high value of the venture and make capital gains if the venture succeeds.
CONDITIONAL LOAN
This is a form of loan finance without any pre-determined repayment schedule or interest rate. A conditional loan is repayable in the form of a royalty after the venture is able to generate sales. No interest is paid on such loans. In India , VCFs charge royalty ranging from 2% to 15% ,the actual rate depends on factors of the venture such as gestation period, cost-flow patterns, risk involved. Some VCFs give a choice to the enterprise of paying a high rate of interest(above 20%) instead of royalty on sales once it becomes commercially sound. Some funds recover only half of the loan if the venture fails.
CONVENTIONAL LOAN
Conventional loans carry lower interest initially which increases after commercial production commences. A small royalty is additionally charged to cover the interest foregone during the initial years. The repayment of the principal is based on a pre-stipulated schedule, Venture Capital Institutions usually do not insist upon mortgage/other security.
INCOME NOTES
Income notes are instruments which carry a uniform low rate of interest plus a royalty on sales. It combines the features of both conventional and conditional loan. The principle is repaid according to a stipulated schedule.
DEBENTURES
NON-CONVERTIBLE DEBENTURES These carry a fixed rate of interest. Redeemable at par/premium. Secured and can be cumulative or non-cumulative. PARTLY CONVERTIBLE DEBENTURES A convertible portion converted into equity shares at par/premium. A non-convertible portion earns interest till redemption. COUPON BONDS/DEBENTURES These can be either convertible or non-convertible with zero/no interest rate.
TRADE SALES
The entire company is sold to another company/third party.
LIQUIDATION
This is an involuntary exit forced on the VCI as a result of a totally failed instrument. The VCIs can use this exit method when the venture is not performing well and has reached a stage beyond recovery due to stiff competition, technology failure/obsolescene of technology, poor management.