Investments are a set of costs (financial, labor, material) that are directed to increase profits. They provide the development of the enterprise. One of the areas of financing is called venture capital. What it is?
Essence
Venture financing - this is investing to fast-growing enterprises. This type of activity is more typical for scientific research in high-tech areas where there are prospects and a high share of risk. The purpose of investing is to obtain a high income in the form of a cash refund when selling a company after its development in the market.
The word "venture" in translation from English means "risky business". Venture financing is a source of long-term investments. Usually they are allocated for 5-7 years to organizations that are at an early stage of development. Funds are provided to functioning companies in order to expand and modernize production.
To get money, you need to prepare a plan, develop a product with competitive advantages that would be of interest to the investor, and assemble a team of professionals with many years of experience in a particular industry.
Features of venture financing
This type of investment is distinguished by a number of signs:
- Investors know in advance about the risks of financial losses in case of failure of the organization. With a positive outcome, investors will receive high profits.
- This type of financing provides for a long waiting time (3-5 years), after which the investor will receive an income of 5-10 years.
- The investor owns a 25-40% stake, but has a high personal interest in the success of the institution. Therefore, he provides consulting and management services.
Stages
- Prelaunch investments. At this stage, small amounts are invested to prepare the technical and economic base.
- Start-up capital is created on its own. As the business grows, other investors will join.
- Second phase. Funds are allocated for the completion of development and initial marketing.
- The third stage. Financing the start of production. The company receives small or zero income.
- The fourth stage. Transitional investments. Working capital is provided to expand inventory and pay bills.
- The fifth stage. Acquisition of property rights to the company, its modernization in a private institution.
Financial investments come in shares. The business plan includes a schedule for achieving intermediate goals. Investors provide pre-calculated amounts sufficient to achieve the following subtotals. Such injections limit the potential losses that may occur if the company does not live up to expectations. The possibility of stopping the flow of funds at each subsequent stage motivates the entrepreneur to quickly realize the potential of the organization. Infusions are carried out at short intervals. further increased control over the organization. With each subsequent infusion of funds, the number of investor shares increases.
Sources of venture financing
There are quite a lot of them:
- Public funds. The organization is managed by an independent company.
- Partnership with venture capital. Project financing by a group of businessmen who created a company and invest in developing organizations.
- Endowment capital of corporations. Holding venture investments are one of the main sources of financing for projects in the United States.Large corporations pool their own resources by merging small funds.
- The capital of banking firms. Initially, such investors provided funds in the late stages of the formation of organizations. With the expansion of the range of services, private capital has appeared, for example, SBIC and MESBIC.
- Individual investors. Private investors were once venture pioneers. Today they are participating in the creation of "germ" capital, investing in very risky projects.
- Government. In the US, the government supports young firms. The purpose of financing is not so much making a profit as maintaining the company in the early stages of development.
The specifics of business in the Russian Federation
Venture financing in Russia lags behind that in the United States. Organizations of investors are formed at the initiative of individuals, they exist without state support. The most popular is the Moscow Business Angels Network (ISBA). Although, after financial crises, attention to this source of funding is increasing. TUSRIF, SEAF, Framlington funds appeared on the market, investing in promising companies. The Russian Technology Fund also began work, the Green Grant National Venture Fund was registered by the Russian group Rostinvest. All of them are aimed at financing developing companies.
The first funds in the Russian Federation appeared back in 1994 at the initiative of the EBRD. For three years, 78 companies were registered. In addition, financial investments in the Russian Federation also came from 16 Eastern European funds. After the events of 1998, only 15 institutions remained.
The work of funds in Russia is very difficult. There are no legislative acts stimulating the development of this direction. The question of getting out of business (selling venture capital) remains open. To solve the problem, it is not necessary to create new legislation. But you can add management elements to civil acts.
Factors
According to unofficial data, in the Russian Federation there are 10 thousand. private investors with undisclosed capabilities. In order for venture financing of innovative activity to develop, a number of conditions are necessary:
- stable situation in the country;
- the presence of scientific and technical progress, design developments;
- increase in wealth;
- narrowing of speculative income, etc.
There are factors that limit the growth of this direction:
- low degree of development of the stock market, which makes it difficult to find potential investors;
- lack of managers capable of revealing commercial opportunities for development;
- low customer demand for domestic products;
- lack of government support.
Insurance
Venture financing is a risky type of business. In no country in the world is he insured. But you can protect the property of innovative enterprises, the life and health of top managers, responsibility, etc. That is, apply the classic elements of insurance to this type of business.
Project selection
The forms of venture financing depend on the classification of companies.
1. Seed is a project, a business idea that needs to be financed at the stage of additional research, the creation of starting samples of products.
2. Start up - new companies that need resources to conduct research and launch sales.
3. Early stage - companies with their own development, located at the initial stage of product sales.
4. Expansion - organizations that need additional investments in order to expand production, conduct market research, increase capital or working capital.
Rating
Before deciding on financing, the investor and entrepreneur must agree on the value of the company. The founders set the price themselves. There is no “market" or "auction" at this stage. Investors, wanting to save money, can generally abandon the project or team up with potential competitors and make a consolidated offer to the management.That is, the price is formed during the negotiations. Most often, it is set at the level of investors' proposals. Then, the terms of financing are discussed and a preliminary agreement is created.
Next, the “pre-investment” and “post-investment” values are determined. The first is the price of the business before the infusion of resources. The second is the market value of the organization at the finish stage. The parties are discussing the share capital of the investor. Therefore, the calculations begin with the second indicator. Next, the stock price is determined.
Example
In exchange for venture financing of the project in the amount of $ 1 million, the investor wants to get 1/3 of the company. After the injections, the cost of the business will be $ 3 million. Starting price: 3 - 1 = $ 2 million.
Let's say the company placed 500 thousand shares at the initial stage. Then the investor must additionally receive 250 thousand securities in order to acquire 33.33% of the capital. The value of the share is 1,000,000: 250,000 = 4 million.
Calculation algorithm:
1. Pre-investment value = number of old securities x new price = future value - investment.
2. Post-investment value = pre-investment value + investment = infusion:% share in capital = total number of shares x price.
3. Price of securities = infusion: number of new securities = pre-investment value: number of all securities (stocks, options, guarantors).
4. Price increase = pre-investment cost of production: post-investment cost of production.
Types of financing
Venture investments are made in relation to small enterprises without receiving any collateral. Funds are allocated to equity or provided in the form of investment loan for several years at a small percentage. Representatives of the investor are involved in the management of the company.
Prior to the sale of the company, the main form of infusion is equity. Borrowed sources are attracted if the company expects an increase in capital or plans to make a profit.
Fundraising is more relevant for mature companies. But such capital may affect the share of ownership of investors, especially owners preferred shares. Therefore, permission is required to receive it.
For start-up companies, injections are carried out in the form of:
- commodity credit from suppliers;
- factoring;
- bank loans guaranteed;
- bridge financing.
The cheapest form is commodity credit. The pledge is purchased equipment, which reduces credit risks and the cost of raising funds.
Factoring - This is a loan to receivables. The service is provided by banks to firms with an established client base and predictable cash flows.
Getting line of credit in the early stages of development is impossible without guarantees. But the guarantor may demand a share in the capital of the company as compensation for risk. Debt investment is more expensive than a regular loan.
Bridge financing used if the company has used up all the funds received earlier and expects new injections. Bridge loans come from people who have already funded the company. They resort to their help when current investors cannot provide capital.
The venture financing mechanism in this case is implemented in the form of debt and convertible promissory notes. This is the product on which the coupon is paid. After completing the next stage of the infusion, the notes must be redeemed. Coupons can be exchanged for stocks. The rate on ordinary bridge notes is 8%, and on convertible notes - up to 15%.
For successful companies, this type of infusion is an intermediate step between the two stages of financing. Provides participation in the project not only new, but also existing shareholders. If the organization is experiencing cash difficulties, bridge notes become the only source of financing, then there will be a conflict of interests between holders and shareholders. The first will have an advantage.
Conclusion
Venture financing is special type of investment having a number of advantages: raising funds for the implementation of risk projects, the absence of interim dividends. But finding investors is difficult. The investor should be interested in the project and take part in the management of the organization.
