VC funding represents financial investment in a highly risky proposition in the
hope of earning a high rate of return. Venture capital has an important role in
the financing of startup and early businesses, as well as businesses in turn around
situations. The main sources of VC funding for a company consist of equity capital,
preference capital, and debenture capital and term loans.
Equity capital means ownership capital in which equal shareholders collectively
own the company, enjoying the rewards and at the same time facing the multiple risks
of the ownership. However their liability is limited to their capital contributions.
In VC funding, the equity capital funds are permanent funds and there is no liability
for repayment. It simply enhances the creditworthiness of the company. In general,
the larger the equity base in a
VC funding, the higher the ability of the company
to obtain credit. Thus you may consider VC funding as the lifeblood of a start-up
company.
In VC funding preference capital is just a hybrid form of financing because it has
some characteristics of the equity capital and some attributes of the debenture
capital. It resembles equity in the way that the preference divided is payable only
out of distributable profits and is not an obligatory payment and is similar to
debenture capital in that the dividend rate on preference dividend is usually fixed
and preference stockholders do not normally enjoy the right to vote. When using
preference capital funds in VC funding there is no legal obligation to pay preference
dividend and there is no redemption liability in the case of perpetual preference
shares.
Debenture capital is also a part of VC funding and it is similar to promissory notes
because they are instruments for raising long-term debt capital. The holders of
debenture capital are the creditors of the company. The obligation of the company
towards its debenture holders in a company with VC funding, is similar to that of
a borrower who promises to pay interest and capital at specified times. Contrary
to the preference or equity capital the specific cost of debt capital is much lower
because the interest on debentures is tax-deductible. Debenture financing in a VC
funding does not result in dilution of control since debenture holders are not entitled
to vote. The downside for
entrepreneurs is that the capitalists with VC funding
usually get a say in company decisions, in addition to a portion of the equity.
That is why venture capital is not suitable for entrepreneurs.
Term loans, also known as term finance in a VC funding are in general a source of
debt finance that is generally repayable in more than one year but less than ten.
They are employed to finance acquisition of fixed assets and working capital margin.
Most venture capital funds have a fixed life of ten years with the possibility of
a few years of extensions to allow for private companies still seeking liquidity.
The investing cycle of VC funding for most funds is generally three to five years,
after which the focus is managing and making follow-on investments in an existing
portfolio.