Venture Capital has become a solution for many entrepreneurs for over ten years. However, not everything that corresponds to the topic has benefits. Between a business idea and an investor, some risks must be evaluated.
From a business perspective, venture capital brings benefits according to business results. Certain fundamentals should never be skipped; therefore, this article’s purpose is the definition, advantages, and disadvantages.
What Is Venture Capital?
These are transactions in which a financial entity temporarily generates a stake in a non-financial company. This type of capital is an investment considered proper to the object of capital activity.
Like other types of economic investments, this capital has evolved. Venture capital began at least two decades ago. A venture capital fund has financed many well-known companies.
Venture capital is a cycle that begins with the creation of the fund. Then the fund is capitalized, monitoring is carried out, and it must end when the yield is obtained. Many venture capital funds come from pension funds, donations, and contributions from people with high purchasing power.
For definitional terms, risk capital is also known as Venture capital. Generally, this type of capital goes to companies that have or will have great success. The injection of investment is what makes money recover quickly.
Why Is Venture Capital Famous?
Quite simply, venture capital has reached very high standards due to the opportunity it offers innovative businesses. Startups are more inclined to react to constant change. By taking advantage of new opportunities, they will have a greater possibility of growth.
A new company’s main obstacle is the lack of financial resources. Therefore, financing is an appropriate way to achieve what is desired. Many financial entities do not allow new ideas due to the uncertainty it generates.
The idea of venture capital is to act as a refuge for new companies in exchange for a quick capital return.
Characteristics of Venture Capital
- It is an equity financing of new projects.
- They are resorted to when conventional sources do not provide support.
- It is temporary financing, so it accompanies the company in its maturation time.
- His model is profitable due to the results obtained by disinvesting the capital.
- Investment funds most often come from private financial organizations.
- The success of obtaining it depends directly on the connectivity of the business and its future profitability.
A management entity governs the characteristics, and the investment funds are usually private.
Managing Entity
When the entrepreneur finds that he cannot go to conventional entities, he considers other strategies. It is there where the equity investment will join the risk. The risks are defined by the innovative characteristics and the lack of trajectory of the project.
The management entity is aware that it will join a project expecting 5 to 7 years for the return on investment. For the investor to do this, he is offered a significant capital gain.
Generally, the participants of a new business look for the managing entity because it is about new technologies. Companies or entities divide the money into several projects, so the risk decreases considerably. If a business dies, the others can recover the money because they will be successful.
Then the managing entity is in charge of:
- Optimize the chances of success of a new business.
- Boost investments with fundraising.
- Select only the projects that are expected to be most successful.
- Channel funds for approved projects.
- Realize capital gains for investors.
- Provide advice and management to new businesses.
In some cases, the investor assumes a large part of the management of the idea, and in others, they are limited to minimal supervision.
Source of Funds
Venture capital funds come from 6 main types of sources. These sources are:
- Financial entities.
- Societies.
- Insurance companies.
- Pension fund.
- Physical persons.
- Public investors.
Natural persons generally take the lead in venture capital. It is easier for them to risk investing only on a hunch.
What To Do To Get a Venture Capital Investment?
An entrepreneur must never forget that this activity does not consist exclusively of injecting financial resources. This is because it provides all the skills for the establishment.
Additionally, the management entity contributes a part to the organization and management of the business. To get an investment of this type, four phases must be fulfilled.
Seed Financing
The company is not created. The entrepreneur has a novel idea, but it is not fully defined. To define it, you need to develop commercial and technical aspects.
It is a challenging phase, so the idea must seem good enough. When financing the future entrepreneur, help with the business plan and prospecting should be provided. As the project does not have a good appreciation, very few investors come to it.
Creation Financing
In this case, it is more feasible to get an investor. Venture capital intervention is much clearer. All you have to do is start a business.
For this, an already known product must likely be produced. Success remains uncertain, but in this case, the investor can evaluate. Evaluating the business plan provides management skills for the operation’s success.
Youth Financing
The product or service already exists in a small market. However, it lacks brand margin or competitive production. For this phase, the approval evaluation is almost immediate.
The investment of the venture capital entity is essential. It serves as a financing element and a provider of new knowledge. Thanks to both contributions, it will become a viable business.
Establishment Financing
It is made for the standard installation of the company. As the company already exists, it only merits positioning it in the market. The investment is made to increase production capacity.
It also serves to exploit distribution and make it more competitive. For this phase, the disinvestment is made with the capital gains index.
No matter what phase the entrepreneur is in, the ideal for these businesses to receive investment is to have clear ideas. They are hesitating before financial entities will never be a good idea. During all four phases, the venture capital entity has direct participation.
The decision is the effect that will make a business proposal go through each of the phases or die trying. Every entrepreneur must provide essential information in their business plan, defining:
- Budget and maturity period.
- The plan presents the weaknesses.
- Measures to solve weaknesses.
What Do Financial Entities Evaluate To Approve Venture Capital?
They carry out an economic-financial analysis. The entity’s staff does this analysis. Only in specific cases do independent institutions act in the evaluation.
The evidence of the viability of an investment is made mainly by:
- Prototyping.
- Lab tests.
- Reports or others.
Whoever seeks investment must be responsible for carrying out a project. When evaluating, the quality of the people involved (entrepreneurs and associates) also intervenes.
Other aspects that are also considered are:
- Characteristics of the innovation element.
- Projects that innovate and are beneficial for technological development.
- Projects that target growth markets.
- Influence on market development.
- Definition of a competitive item.
What Is The Distribution of a Venture Capital Investment?
- Equipment and machinery.
- Medical care.
- Publications.
- Wholesale and retail sales under the distribution system.
- Computers.
- Advanced manufacturing techniques.
- Energy and natural resources.
- Finance.
- Chemistry and plastics.
- Amusements.
- Insurance and goods.
- Hotels.
- Robotic processes.
- Agriculture.
- Forest services.
Computers are the most used venture capital projects. This indicates that technology makes it possible to find new economic opportunities.
What Is The Divestment Process In Venture Capital?
Venture capital is only about temporary investments. Therefore, when the business is mature, the stake is divested. There are three divestment methods, and each one has pros and cons. The methods are:
- Sale to the entrepreneur.
- Sale to a third party.
- Sale in the bag.
The important thing is not divestment but the precise terms of them. Before there is an investment, the return process must be discussed.
Advantages And Disadvantages of Venture Capital
Advantage
- Faster cash flow.
- Immediate source of financing.
- Fast growth.
- It has no return, but part of the benefits is offered.
- The investor provides advice and improvements to the business plan.
- Connections with the market that strengthen our own investment in the future.
Drawbacks
- Risks of losing guarantees.
- Part of the company is exchanged for financing.
- Excessive legal terms.
- Delays can end in lawsuits.
What Are The Measures That The Financial Entity Takes To Safeguard Your Investment?
The appreciable degree of risk means that the financial entity intelligently covers itself in case of loss. In addition to capital gains, entities make other types of precautions. The measures can be:
- Excessive capital gains.
- Total loss of control due to breach of contract.
- Return time before maturation.
Forecasts should always be taken as entrepreneurs and present the margins of capital gains that are convenient. Each financial institution has its investment policies. What is clear is that no guarantee is needed in risk capital.
Every evaluation company takes into account these prevention measures:
- Liquidity withdrawal studies.
- Current availability studies.
- Warranty study.
- Maneuver background.
- Financial, economic profitability.
- ROA.
- ROE.
- Quality.
- Indebtedness.