Any business needs 5 basic inputs to make it run. These are called the 5M’s of business – Men, Money, Materials, Machines, and Methods. Money or capital is one of the critical ingredients to establish and run the business. Capital investment includes funding for fixed expenditures as well as daily working capital requirements. Revenues are generated later, but the capital investments are made first in the business.
Sources of Capital Investment
Capital investments are usually arranged through multiple sources. Internal accruals and savings of the promoters are a primary source. Thereafter, long-term and short-term loans are an alternative to raise funds for capital investment. Venture capital funding is another innovative and useful form of capital investment. New business start-ups as well as existing businesses that are looking to expand are increasingly willing to look at venture capital finance to support the capital investments in the business.
Venture Capital Investments
The most common way a venture fund makes capital investments is that it infuses the initial cash into the business, but not in the form of a loan. The venture capitalist does not receive
Advantage of Venture Capital Investment over Loans
Venture capital investments have become a popular way of financing in recent years because of its inherent advantages for both the investor and the entrepreneur. In a conventional financing, the entrepreneur is likely to face a financial burden of stiff interest rates that must be paid on the loan. Many a time this can stifle the chances of growth of the business because the terms and conditions attached with the loan may be very strict. At the same time, the principal amount of the loan must be repaid within a stipulated period. Whereas, there are no guarantees how long the business may take to earn enough revenues to be in a position to pay back the loans.
In case of capital investments that are received from venture capital funds, there is no compelling condition to return back the principal amount of investment, or pay any interest to the investor on that amount. In place of that, the investor receives a stake in the company that is mutually agreed between the investor and the entrepreneur. If the company turns into a big success over a period of time, the angel investor stands to make a huge return on his initial investment. However, the key lies in matching the needs of the entrepreneur with the potential investor, so that a strong combination is created.
Capital Investments in Novel Technologies
In a majority of cases, the angel investors are looking to make capital investments in start-ups that operate in sunrise industries such as biotechnology and information and communication technologies. In such companies the investment horizon is not very long. If the technology succeeds and becomes commercially viable, the venture capitalist may be able to multiply his investment very fast, and may even choose to exit the company by selling off his stake at a high profit.
Many venture capital investors have a dedicated team with people who are experienced in advanced technologies or research. This helps them to identify promising new business projects of their choice. The key is to identify such opportunities at a very nascent stage. That is the point where the venture capitalist makes an easy and cheap entry into the new venture. It is also useful for the entrepreneur who is in desperate need of funding at that early stage.
In many cases, apart from making capital investment, the investor may also involve closely with the management of the company at least till the initial stages. This way, in addition to capital, the investor also brings along his expertise, experience and know-how into the business.
Risks in Venture Capital Investments
The promise of high returns is always associated with a proportionately high level of risk. In most cases, the start-up enterprise is only operating on the promise of a great idea, but has no proven past track record of performance. Even if the idea may be promising, but if the execution or management is below par, it may lead to a failure of the venture. Sometimes, there may be external factors that are not within anyone’s control such as emergence of a new and superior technology, or a change in consumer preferences that may cause the collapse of the business venture. In such situations, the venture capitalist stands to lose his initial investment in the start-up.
To reduce their risks, many times several investors combine together to form a common investment pool, and then make capital investments from that pool. It brings together the combined skills of various investors, and matches them against the promising new businesses or ideas with a strong potential. Angels Den, and Beer and Partners are some examples of middle agencies that are doing a great job of bringing together such investors and new entrepreneurs with successful ideas.
It is essentially a win-win situation for both the investor and the entrepreneur. This is what makes venture capital investments a highly popular and accepted form of financing for new businesses.