Define Venture Capital

Introduction

Venture Capital is a form of “risk capital” which is invested in a project or a business where there is a substantial element of risk relating to the future creation of profits and cash flows. Risk capital is invested as shares (equity) rather than as a loan and the investor requires a higher “rate of return” to compensate him for his risk.

Concept

Venture capital provides seed capital or funding for expansion of companies in the form of share capital, to help unquoted companies grow and succeed. If an entrepreneur is looking to start-up, expand, buy-into a business, buy-out a business in which he works, turnaround or revitalize a company etc., venture capital could help do this. Obtaining venture capital is substantially different from raising a debt or a loan from a lender. Lenders have a legal right to interest on a loan and repayment of the capital, irrespective of the success or failure of a business.

Venture capital is invested in exchange for an equity stake in the business. As a shareholder, the venture capitalists’ return is dependent on the growth and profitability of the business. This return is generally earned when the venture capitalist “exits” by selling its shareholding when the business is sold.

Origin

Venture capital funding is first originated in the UK in the late 18th century, when European entrepreneurs and merchant bankers were helping the growth of industry in USA, South Africa and India. This informal method of financing became an industry in the late 1970s and early 1980s when a number of venture capital firms were founded. There are now over 100 active venture capital firms in the UK, which provide several billion pounds each year to unquoted companies mostly located in the UK. The venture capital funds are active in UK in the form of Clearing bank captive funds,

Funds sponsored by savings and investment institutions and merchant bankers

Business expansion scheme funds

Corporate, academic and other private sector Semi-State bodies (both Central and Local Government).

Venture Capital and Development Capital

Venture capital is advanced for ventures using a new technology or new innovation. The venture capital company remains interested in the overall management of the project due to the high risk involved in the venture. Funds are made available throughout the project, commencing from commercial production to the successful marketing of products, to ensure continuous revenue earnings, enhanced worth of the investments and finally making available a proper exit route for liquating the investments.

Development capital is generally granted in the form of loans for setting up industrial units, and also for expansion and modernization. The lender takes special care in ensuring the end use of the credit and requires prompt payment of interest and repayment of the loan amount.