All About Venture Capital

Venture capital is the business that provides capital, advice, networks, and support to the business and entrepreneurs who have high growth potential and who are trying. It has existed in various forms for centuries or longer. It funds from small startups to companies who want to expand but can't have access to funding yet because of high regulations of the equity market. The returns are incredibly rewarding and fantastic. Even more gratifying is personal pleasure in seeing great people they believe in creating great new businesses and products for the world. But there are always 2 sides of a coin. The startups and business backed by venture capitalists have an incredibly high rate of failure because of various variables creating uncertainties in the market which can’t be nullified or are not in their control. More importantly, they are providing unsecured loans. It’s said that out of every 10 business funded by venture capitalists, 7 businesses or ideas fail badly, out of the remaining three, two comes to break even point and the remaining 1 idea creates an enormous amount of return which surpasses and covers all the losses and in addition to that generate tons of profit. The companies in which venture capital invests is referred to as portfolio companies.

Every fund has it’s own fund manager. When venture funds invest in these funds. In exchange of funding provided they ask for equity ownership in the company, they get access to a seat on the board of the startup or of that respective business, sometimes they also play an active role in managing operations of the company. They provide assistance monetarily, by using their expertise and resources they have.

first venture capital firms was started in the America during early to mid-1900s. Frenchman named Doriot Georges moved to the U.S. to get a business degree and he became an instructor at Harvard's business school and started working at an investment bank. He found the first publicly owned venture capital firm named, American Research, and Development Corporation (ARDC). ARDC was remarkable because for the first time a startup or business could raise money from private sources other than from wealthy families. families such as the Rockefellers or Vanderbilts were the ones to provide money to businesses and startups and provided capital for expansion. ARDC had millions in its account from educational institutions and insurers.

Accounting Standards

Venture capital fund accounting may also be affected by the amount of control the fund has over an entity. For instance, under U.K. generally accepted accounting principles (GAAP), equity accounting is necessary if the investment gives the fund an influential minority (20 to 50%) stake in the company and is not held as part of a larger portfolio, while U.S. GAAP does not require equity accounting for influential minority positions. In contrast, the International Financial Reporting Standards (IFRS) requires equity accounting for influential minority positions when they are not valued fairly through a profit and loss.

Legal requirements

Venture funds form a limited partnership and various limited liability firms to get tax benefits Venture capital constitutes of, wealthy individuals, institutional buyers, insurance firms, pension funds, investment banks venture dedicated funds, corporate pension. Business owners and Entrepreneurs who can't get a loan from the bank because of their high uncertainty but quality idea usually are supported by these funds.

all the partners have partial ownership in the fund but it is the venture capital fund and its manager who gets to decide day to day operation of the company and where to invest the fund. Venture capital firm acts as the general partner while all the other act as limited partners.  The fund itself is usually structured as an LP, which hires the LLC as the GP.

Financial Statements

Statement of financial prepared for stakeholders varies accordingly as per the accounting standard. Venture capital fund has the same accounting as private equity fund. In America , they are prepared as per General Accepted Accounting Principle ( U.S GAAP). Since most of the funds are based in USA they have to follow AICPA ( AMERICAN INSTITUE OF CERTIFIED PUBLIC ACCOUNTANTS AUDIT AND ACCOUNTING GUIDE). It includes cash flow, profit and loss and balance sheet , investment schedule, other listing of financial highlights. If the venture fund is based outside of united states then they have to report as per International Financial Reporting Standards (IFRS). In which they have to submit PROFIT AND LOSS statement, Statement of Asset and Liabilities, operations statement, Statement of cashflow and Note highlights and a statement of changes in net assets.

As a result, experienced traditional VCs have had to keep pace, and many have raised larger follow-on funds — and at a faster pace — to support growing startups, where unicorns and mega-deals are having a big impact.

California, Massachusetts, and New York have the biggest venture deals. They contribute to 79 % of deals in America. For managers, 2% compensation fees of the total venture fund amount have to be paid every year. In addition to that, they get approx 20 % of profit goes to the general partner while remaining profit is distributed among limited partners as per their share of ownership.

Categorization of venture capital funding

 The formative stage.

it refers to investments made in a project in the earliest period and comprises three distinct stages:

• Angel investing: it refers to investments made very early in a firm’s life. Often the idea stage and the funds here are used for business plans and assessing market potential. The funding source can be individuals as well as managed funds.
• The seed stage: it refers to investments made for product development, marketing, and market research. This is the stage during which venture capital funds make initial investments, through ordinary or convertible preferential shares.
• Early stage: refers to an investment made to fund initial commercial production and sales.

 later stage

investment refers to a stage of development where a company already has production and sales and is operating as a commercial entity. Funds provided at this stage are typically used for expansion and increase in marketing campaign

 mezzanine stage financing

it refers to capital provided to prepare the firm for an IPO. The term refers to the timing of financing rather than a type of financing.

 developmental capital

refers to the provision of capital for business growth or restructuring. The firms financed may be public or private.

 distressed investing.

It involves buying debt in financially distressed companies. Here managers take an active role in turnaround by working with management on reorganization or to determine the direction of the company they should take.

 mergers and acquistions / sale and acquisitions

venture capital funds often sell their portfolio company if they are getting a significant return and see no other option or they may merge it with another company or if they are planning for long term benefit then they may buy another potential company whom they think will significantly benefit.

Funding

Kohlberg Kravis & Roberts (KKR), one of the top-tier alternative investment asset managers in the world, has entered into a definitive agreement to invest USD150 million (Rs 962crore) in Mumbai-based listed polyester maker JBF Industries Ltd. The firm will acquire 20% stake in JBF Industries and will also invest in zero-coupon compulsorily convertible preference shares with 14.5% voting rights in its Singapore-based wholly owned subsidiary JBF Global Pte Ltd. The funding provided by KKR will help JBF complete the ongoing projects.

Pepperfry.com, India’s largest furniture e-marketplace, has raised USD100 million in a fresh round of funding led by Goldman Sachs and Zodius Technology Fund. Pepperfry will use the funds to expand its footprint in Tier III and Tier IV cities by adding to its growing fleet of delivery vehicles. It will also open new distribution centers and expand its carpenter and assembly service network. This is the largest quantum of investment raised by a sector-focused e-commerce player in India.

Characteristics

Difficulty in estimating present value :

When looking at private equity accounting, valuation is a critical element so it is difficult to value a present value of venture capitalists portfolio companies. Venture capital funds often suffer from survivorship bias and backfill bias because portfolio companies are revalued infrequently, reported standard deviations of returns and correlations of returns with equity returns may be biased and downward. Specifically, operating and financial experience of manager, the valuation method used, incentive fees structure and draw down procedures are all important areas to investigate prior to investing.

Cycles: economic interest rates, GDP, conditions, employment levels, vary from year to year. During good years, venture funding is plenty and returns are initially low. In times of bad market, even good ideas or business find it difficult to find VC funding.

Some of the venture funds bets on startups or ideas. Their bet may get successful or it may fail badly Financial knowledge is alone not sufficient. Good fund require fund managers, therefore, require operating and financing and consulting skills

Illiquidity

Venture capital can't have easy liquidity. They can't cash out their investment during the early stages in a startup cycle. Because they need to commit their funds to a startup or a business for at least 2 years minimum to test the feasibility of an idea or that of business.

Bibliography

1. edu pristine. (2019, 4 28). Retrieved from https://www.edupristine.com/blog/venture-capital
2. investopedia. (n.d.). Retrieved 4 2, 2019, from investopedia: https://www.investopedia.com/terms/v/venturecapitalist.asp
3. investopedia.com. (n.d.). Retrieved 3 2019, from investopedia: www.investopedia.com