Venture capital funds are pooled investment vehicles that primarily invest the money of third-party investors in startups and small-to-medium sized enterprises that have the potential for strong growth. Venture capital funds are somewhat similar to mutual funds – they pool money from several investors who seek private equity stakes in entrepreneurial or small companies. Here is everything about venture capital funds, including top 10 venture capital funds in India.
How Venture Capital Funds Work
Venture capital funds are a type of equity financing that help startups and or other small companies raise funding before they have started earning revenues or profits. VCFs seek to invest in firms that have potential for significant growth and ability to generate high ROI in the long run. Since they invest in new ventures, firms receiving venture capital investments have high-growth potential, but are risky and have a long long investment horizon.
VCFs differ fundamentally from mutual funds and hedge funds because they focus on a very specific type of early-stage investment. Venture capital funds take a more active role in their investment, provide guidance and often hold a board seat.
Like other pooled investment funds, venture capital funds also raise money from outside investors and then make investments of their own. The fund’s manager or managers review hundreds of business plans, searching for potentially high-growth companies. They invest money in multiple companies at once in a view that a few among them will be able to produce high returns and offset the losses incurred by others, if any.
Venture Capital Fund Returns
Investors of a venture capital fund make returns at the time a portfolio company exits, either in a merger and acquisition or an IPO. If profits are made off the exit, the funds keep a percentage of the profits in addition to the annual management fee. VCFs aim for a gross internal rate of return (IRR) around 30%. However, expected return varies depending on the industry and risk profile.
Types of Venture Capital Funds
Mainly venture capital funds are classified in 3 categories based on their utilization at different stages – early stage financing, expansion financing and acquisition financing or buyout financing.
Early Stage Financing
There are three types of early stage financing – seed financing, startup financing, and first stage financing. Seed funding is small funding extended to the entrepreneur to be eligible for a startup loan. Startup financing is a funding that companies receive to complete the development of its products and services. Companies need first stage financing to operate their business activities in full swing.
Expansion Financing
Expansion financing is further categorized into second stage financing, bridge financing, and third stage financing. Companies can get second and third stage financing to begin large expansion. Bridge financing is extended to companies in the form of monetary support to apply for Initial Public Offerings (IPO) as a principal business strategy.
Acquisition Financing
Acquisition financing is the funding a company gets for the purpose of acquiring another company or parts of a company. Leveraged buyout financing helps the management of a company to acquire another company’s particular product.
Pros and Cons of VCFs
Pros
Companies that raise funds from venture capital firms can get the following benefits:
- No obligation for repayment: One of the key advantages of venture capital funds is that an entrepreneur doesn’t have to repay the capital it received. Hence, even if a venture fails, the company is under no obligation to repay the invested fund.
- Essential for business expansion: Venture capital funds help a startup company expand the business quickly.
- Helpful for creating connections: Venture capital firms pool funds from several investors and invest in hundreds of companies. They have a widespread business network, which can help startups in marketing and promotions to establish themselves.
- Business insights: VCFs have years of market experience, which can help entrepreneurs in financial management, human resource management, and business management.
Cons
The following are disadvantages of VCFs:
- Lengthy process: Venture Capital firms assess the growth potentials of a company, which is a lengthy and complex process. The entire process of venture capital financing can take prolonged time and eventually delay funding.
- Forfeiture of complete control and autonomy: By investing in startups or small companies, venture capital firms partly become the owners of the company and take part in business’ decision making. As a result, founders lose their control and autonomy.
- Challenge in securing funding: With growing number of entrepreneurs, securing venture capital funds may be challenging.
Top 10 Venture Capital Firms in India
- Sequoia Capital
- Accel
- Blume Ventures
- Elevation Capital
- Tiger Global Management
- Kalaari Capital
- Matrix Partners
- Nexus Venture Partners
- Indian Angel Network
- Omidyar Network India
Final Words
The Indian Venture Capital market has become a hot investment destination. Investors made 25-30% annual returns in the last 5-6 years by investing in Pre-IPOs. However, it may be risky to invest your hard-earned money without market research and investment guidelines. SBNRI is an online platform exclusively designed to cater investment and transactional needs of NRIs living around the world. The investment experts at SBNRI guide NRIs throughout the investment process.
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