Understanding Various Types of Venture Capital Funding

Published On: Apr 5, 2022Last Updated: Oct 3, 20225.5 min read

The year 2021 saw some unprecedented landmarks for Venture Capital funding in India. Indian startups raised a record $42 billion across 1,583 unique deals. For context, that number was around $11.9 billion across 953 deals in the calendar year 2020. That’s a huge jump. Seed stage funding also crossed the $1 billion mark in India for the first time with total funding of $1.1 billion in 2021.

The trend is highly affirming and encouraging for VC investors to say the least. But if you’re new to the game and want to understand what venture capital exactly means and how it all works, you’re at the right place! This article discusses all you need to know about venture capital and how VC fundings work.

What exactly is Venture Capital (VC)? 

The Oxford dictionary defines “Venture” as a risky or daring undertaking. But then daring is what you do, right?! A venture is a new startup or business with an unforeseeable future. Venture Capital is a type of funding that is provided to startups and small businesses by investors that see long-term potential for growth in them. 

Because of the risks involved, Venture Capital Investments are usually made in innovative projects that are poised for growth and success. It is also known as risk capital or patent risk capital. A very important financing tool for emerging companies, Venture Capital is becoming more and more popular – if not essential – for raising funds for startups.

What Are Venture Capital Funds? 

Investing in emerging companies involves really high risks but the potential for really high returns makes it an appealing option for investors. Venture Capital does not always have to be monetary; it can also consist of technical or management expertise provided to businesses.

The downside to VC funding is that it is a subset of private equity. This means investors get a part in the equity shares of the company in return for the Capital, and as a result, a say in business decisions. In return for the investment, the venture capitalists get decision-making power in the company. 

How Is Venture Capital Funding Beneficial For Growing Companies? 

Following is a list of benefits of raising Venture Capital funds: 

  1. Investors have expertise that emerging entrepreneurs can benefit immensely from 
  2. Venture Capital is a great way of generating Capital at the initial stage of a business 
  3. Investors can also help in providing new networking and collaboration opportunities 
  4. Risk management becomes easier 
  5. Venture Capital funding improves exposure 

Stages of Venture Capital Investments

1. Seed Stage

This is the first round of investment for gaining early-stage traction. The capital raised during the seed stage is usually used for Market Research and Product Development. 

2. Early Stage 

This stage of funding is for businesses already under their development phase. The amount of capital raised in this stage is usually higher than in the seed stage. 

3. Late Stage 

This stage of funding is for more mature companies that have shown growth potential and have started generating revenue. The capital raised at this stage can be used for further development and expansion of a venture. 

Methods of Venture Capital Funding

Funds can be raised from investors in exchange for the following:

1. Share in equity of the Company 

In exchange for a share in the equity of the company

2. Participating in Debentures 

A type of debt instrument that is not backed by any collateral but gives the investor a right to participate in the profit of the company. 

3. Conditional Loan 

These loans do not carry interest and are repayable to the investor in the form of royalty after the company seeking investment starts generating revenue. 

4. Income Notes

It is a hybrid of both; traditional loans and conditional loans, wherein the entrepreneur will have to pay both royalties and interest at a very minimal rate. 

Various Types of Venture Capital Financing

There are many modes of acquiring capital for growing entrepreneurs. The following are various types of options available if you are looking for capital for your venture. 

1. Seed Financing 

The capital acquired at this stage acts like a seed that grows into an abundant tree for new enterprises. The money raised is known as seed money and helps in preliminary entrepreneurial needs, such as market research and product development. 

2. Early Stage 

After having complete knowledge of the market, you need to start the development of products. This includes initial marketing and also manufacturing of your products. Early-stage financing helps in carrying out these expenses. 

3. First Stage Financing 

Once you have all the products/services ready, you need to start the actual operations of your business. The “Emerging stage” is the first stage of financing. Funds raised from this stage are used to begin the business operations at full scale. 

4. Expansion Financing 

Once full-fledged operations have started, Ventures also need to focus on expanding their brands. The capital raised for expansion is provided at this stage in the Venture Capital funding system. 

5. Second Stage Financing 

After the commencement of business, working capital needs start increasing. Sometimes, the positive cash flow might not be enough to handle the day-to-day operations. In such situations, you can opt for second-stage financing to meet your working capital needs. 

6. Bridge Financing 

As the name suggests, the capital raised during the bridge round of financing is used to bridge the gap between short-term and long-term capital needs. This round takes place at the stage of business when the company needs to cover the costs for a short while before landing on a large capital. At this stage, capital is raised from existing investors in exchange for some collateral. 

7. Mezzanine Financing 

This is also a type of bridge financing. However, the major difference is that mezzanine financing usually meets the growth or buyout needs of a company. Further, mezzanine financing is not backed by any collateral such as property but is backed by equity shares of the enterprise. 

Conclusion

There are many high net worth individuals and venture capital firms that are eager to invest in innovative new projects. Such high net worth individuals are often known as “Angel Investors”. If you’re a budding entrepreneur and are looking to start a company or raise funds for your business, a lot of challenges lay ahead of you. Experts at LegalWiz.in aim to help emerging entrepreneurs by providing expert advice on the best suitable modes of raising funds. Professional assistance is just one click away! 

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Diksha Shastri
About the Author

Diksha Shastri

Diksha is a lawyer and a professional content writer at LegalWiz.in with a keen interest in all things legal and tech. She believes in utilising her experience and curiosity to create content that can impact readers globally.

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