How do Venture Capitals invest in Start-up ?

1. Deal Origination:

VC usually have intermediaries  through they come into contact with potential start-ups. Mainly many practicing chartered accountants  and investment advisors would work as intermediaries .  Another source of deal flow is the active search through, networks, trade fairs, conferences, seminars, foreign resist etc. 

The startup presents an Investment Memorandum(IM) which is a document consist of business models , financial plan and exit plan.

2. Screening:

Venture capitalist expects return to be in multiple and thus choose the best ventures. This is done by detailed scrutiny of all projects on the basis of certain broad criteria, such as technology or product, market scope, size of investment, geographical location and stage of financing.

3. Due Diligence:

. A detailed study of project profile, track record of the entrepreneur, market potential, technological feasibility future turnover, profitability, etc. is undertaken.

Venture capitalists in Indian factor in the entrepreneur’s background, especially in terms of integrity, long-term vision, urge to grow managerial skills and business orientation. They also consider the entrepreneur’s skills, technical competence, manufacturing and marketing abilities and experience

All the documents of current and past workings of business, its financial soundness, etc is verified. This process is usually outsourced to external party.

4. Deal Structuring:

Once the venture is found viable, the venture capitalist negotiates the terms of the deal with the entrepreneur. This it does so as to protect its interest of both start-ups and venture capitals. Terms of the deal include amount, form and price of the investment.

It also contains protective covenants such as venture capitalists right to control the venture company and to change its management, if necessary, buy back arrangements, acquisition, making IPOs. Terms of the deal should be mutually beneficial to both venture capitalist and the entrepreneur. It should be flexible and its structure should safeguard interests of both the parties.

5. Post Investment Activity:

The venture capitalist’s participation in the enterprise is generally through a representation in the Board of Directors or informal influence in improving the quality of marketing, finance and other managerial functions. Generally, the venture capitalist does not meddle in the day-to-day working of the enterprise, it intervenes when a financial or managerial crisis takes place.

If the milestone has not been achieved, the start-up has to give explanation. Start-ups will have to adhere to strong MIS, strong, budgeting system, strong corporate governance, and other covenants of the VC. Besides, VC would also ensure that professional management is set up in the company.

6. Exit Plan:

The Exit Plan for VC’s can be categorized as:

  • Sell stake to third parties like IPO or Private Placement.
  • Buy Back of VC’s stake by the promoters, generally at an IRR of 18%-25%. At any case, the promoter would get the right of buy back.
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