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What is Venture Capital? How Does it Help Companies?

Written by - Marisha Bhatt

September 20, 2022 6 minutes

Venture capital is a financing route where wealthy investors invest their capital in a company, generally startups or small businesses. In return for their investment, they participate through an equity stake in the company. Venture capital firms are considered a subset of private market financing.

Let’s have a look at how it works and how companies benefit from venture capital. 

Key features of venture capital

Companies that opt for venture capital funding may have various reasons to opt for this route. Some of them include faster scaling up of the existing business or supporting the development of new products and services. 

Venture capital firms not just offer funds to new businesses but also mentor young startups. Some of the VC features that companies benefit from are:

  1. VC investors generally carry knowledge and expertise that can be shared with startups This way, they also get some control over the firm and participate in the company’s growth through decision-making.
  1. Start-ups often find it difficult to gather sufficient funds from banks. Even if they do, there is the obligation to repay the funds within the stated timelines. With VCs, businesses can focus on accelerating growth by raising enough funds and no obligation to repay. 
  1. VC firms are well-equipped to monitor the progress of startups by closely evaluating aspects like product offering, market size, and the management team’s capabilities. 

Did you know

The global corporations that we all know today, including Google, Amazon, Apple, Facebook, etc, once used to be startups. These received financial support from various venture capital firms during their early stages. Locally, companies like Zomato and Paytm attained high-scale growth through venture capital investments in their early business phases.

How does venture capital funding work for companies?

Venture capital funding is structured as per the growth stage of the company. Some of the stages that VCs prefer to fund companies are:

  1. Seed stage

This is the first stage of raising capital wherein an early stage business is funded by a VC using a relatively small about of capital. The funds are primarily used towards product development, setting up of business plan, conducting market research, etc. In this stage, investors typically get equity, preferred stock or convertible notes towards their investment. 

  1. Early stage

As businesses begin their operations after having a suitable product or service, they need additional capital for entering the markets. Venture capital firms also fund such companies that are in the development phase. This phase of VC financing is known as early stage and usually involves a larger sum as compared to the seed stage. Early stage funding rounds are demarcated as series, such as Series A, Series B, Series C and so on. 

  1. Late stage

This stage sees venture capital funding for companies that have matured in their businesses or may not be as profitable as earlier. However, since they still have growth potential and continue to be revenue generating, they can attract VC funding. Here, funding rounds are classified as Series D, Series E and Series F. There are also some late-stage funding rounds that go up to Series K. 

Top venture capital firms in India

Some of the top names in VC business in India are:

  • Sequoia Capital.
  • Saama Capital
  • Tiger Global Management.
  • Blume Ventures.
  • Kalaari Capital
  • Elevation Capital.
  • Matrix Partners
  • Accel.
  • Nexus Venture Partners

Key benefits and drawbacks of VC funding for companies

The table below shows the top benefits and drawbacks that companies may attract while opting for VC funding.

AdvantagesDrawbacks
Venture capital firms don’t just offer to fund but also do hand-holding for startups by offering guidance, managerial support, etc.VC market is highly illiquid and not many startups or small businesses get easy access to them. 
Certain aspects like legal and compliance, and taxation, can prove to be complicated for a new business. VCs can help early-stage businesses with guidance in these areas.VC firms often opt for a longer investment horizon and fund in phases. This means the business has to wait for the net funds to come in as the VCs keep evaluating company performance after every round of capital infusion.
Company founders can also gain access to the vast network of VC investors by opting for VC funding. This can help in covering future capital needs.The valuation techniques used by VCs may differ from market valuation at the time of going public. 

Conclusion

Although VCs have long been in the Indian market, almost going back to 1988, they have come into the limelight recently due to the continued influx of start-ups in the country. VC funding can be a win-win for both, the VC firm and also the company seeking the funds. If a company funded by a VC firm successfully gets acquired or goes public, the VC earns profits and the same is distributed to the firm’s limited partners. Similarly, the company benefits at all stages by getting access to funds at the right time and for the right needs.

FAQs

What is the difference between angel investors and venture capitalists?

An angel investor has substantial wealth which he/she individually invests in promising businesses. Venture capital is generally a business run by partners who pool and invest funds in companies to get an ownership stake in the business.

How is private equity different from venture capital?

Both private equity and venture capitals have the same goal of increasing business value by investing in it and selling later for a profit. The two are different forms of capital raising avenues for businesses and also differ when it comes to the types of companies they invest in when they invest, the amount of investment, etc.

How do venture capital firms make money?

Venture capital firms earn from management fees that are calculated as per the assets under management (AUM) and from performance fees that are calculated based on the profits from investment.

Do venture capital activities come under SEBI regulations?

Yes, VCs come under the SEBI regulations. They also have to follow the tax norms laid out by the IT department.

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