Venture Capital

Introduction to Venture Capital

Venture capital is a highly discussed and often sought-after topic in the entrepreneurial world. It represents a significant source of funding for startups, with daily news of companies raising substantial amounts of capital through VC. This module aims to demystify venture capital by explaining what it is, when and for whom it is suitable, how to access it, and what venture capitalists look for. It will also cover valuation, a closely related concept, and how companies are valued and can increase their valuation.

Public Equity vs. Private Equity

Before delving into venture capital, it's essential to understand the distinction between public and private equity:

• Public Equity: This refers to ownership stakes in companies that are publicly traded on a stock exchange. Examples include large corporations like Mahindra or Infosys. Individuals can easily buy and sell shares in these companies, becoming partial owners. The price of these shares is readily available and established in the market.
• Private Equity: This involves purchasing stakes in companies that are not publicly traded; these are privately held companies. Ownership is typically held by institutional investors, founders, or families.

Defining Venture Capital

Venture capital (VC) is a specialized subclass within the broader category of private equity. It focuses specifically on investments in:

• Very Small, Early-Stage Companies: These are typically startups that are still in their formative stages.
• High Growth Potential: The companies targeted by VCs are expected to grow rapidly and achieve significant scale.

Key Differences Between Public and Private Equity Investment

Investing in a privately held firm, particularly through venture capital, differs significantly from investing in a publicly traded firm in three main ways:

1. Price Determination:

   • Public Equity: The price per share is publicly known, established by the market, and transparent (e.g., you can look up Mahindra's stock price instantly).
   • Private Equity: The price is not fixed or publicly known; it is typically negotiated between the investor and the company.

2. Liquidity:

   • Public Equity: Highly liquid. Shares can be bought and sold quickly, often within a day, allowing investors easy access to their capital.
   • Private Equity: Illiquid. Once an investment is made in a privately held company, it is difficult to quickly sell the stake and retrieve the money. The investment is typically held for a longer, "reasonable period."

3. Regulation and Information Disclosure:

   • Public Equity: Publicly traded firms are heavily regulated by bodies like SEBI and are subject to extensive scrutiny. They are required to make frequent and detailed disclosures, including quarterly and annual results, and adhere to strict governance standards (e.g., having independent directors on their board). A lot of information about them is widely known due to these legal requirements.
   • Private Equity: While privately held firms have some reporting requirements (e.g., to the MCA annually), they are not subjected to the same rigorous level of monitoring or disclosure demands as publicly listed companies. This lower level of information and oversight is even more pronounced for very young firms.

Venture Capital on the Risk-Return Spectrum

Venture capital, as an asset class, sits at the very top-right of the risk-return spectrum, indicating very high risk and very high potential return.

• Low Risk, Low Return (e.g., Savings Accounts): Savings accounts in banks offer very low risk (principal is assured, highly liquid) but also very low returns (minimal interest).
• Slightly Higher Risk/Return (e.g., Fixed Deposits): Fixed deposits offer slightly higher returns than savings accounts but are marginally less liquid (penalties for early withdrawal).
• Increasing Risk/Return (e.g., Pension Funds, Bonds, Real Estate, Public Equity, Hedge Funds): As one moves up the spectrum, investments like pension funds, bonds, real estate, public equity shares, and hedge funds present progressively higher risks (e.g., potential for depreciation in real estate, market fluctuations in stocks) and varying degrees of liquidity, but also offer the potential for higher returns.
• Very High Risk, Very High Return (Venture Capital & Private Equity): VC and PE investments carry extremely high risk because they involve early-stage, privately held companies that are still navigating significant uncertainties. There's a high chance of losing the entire investment. However, if these ventures succeed, they can yield extraordinary returns.