Venture Capital Funding : A Long-Term Gamble

I. INTRODUCTION

Venture capital funding is the knight in shining Armor for potential businesses that may provide a huge return in the future. Venture capital funding is crucial for new/growing businesses as this funding can act as seed funding or growth funding. Venture capital funding provides a fund for investing in early-stage start-ups that have a great potential for returns but also a high level of risk. Investors in the fund are often high-net-worth people or institutions, and a venture capital firm manages it. It is the funding given by an outside investor to support a fledgling, expanding, or struggling company. The investor in venture capital offers the money aware that there is a considerable risk involved with the company’s potential future earnings and cash flow. Instead of being provided as a loan, capital is invested in return for an ownership share in the company. Venture Capital funding creates Venture Capital funds that are used by potential companies for running out their business. The investors for venture capital can be an individual having a high net worth, companies, firms or any other funds. In general, a venture capital fund is managed by a venture capital firm.

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II. TYPES OF VENTURE CAPITAL FUNDING

Venture Capital funding can be classified into different categories based on the stage of the business on which the entrepreneur seeks it, i.e. the level at which the business needs such funding.
The types of funding are as follows:
1. Early Stage Financing
2. Expansion Financing
3. Acquisition or Buyout Financing

III. EARLY STAGE FINANCING

Early stage financing refers to the funding that an entrepreneur seeks when the business has just started or is about to start or the funding is needed for any product range or the company’s initial funds have been exhausted and funds are needed to carry out the business.

These funding can be further classified as follows:

• Seed Funding: A small seed is what it takes to grow into a tree, likewise, seed funding is what it takes to start a business. Seed funding is the initial funding that Venture Capitalists provide to the potential entrepreneur.
• Start-up Funding: It refers to the funding received by the business owners to start/develop the goods or services or both that the business aims to provide.

• First Stage Funding: When the business has been set up the product and service have also been developed and the entire funds have been exhausted. This creates a necessity to gain funds as the business has to run at its full scale. This funding received by the business is called the first stage funding.

IV. EXPANSION FUNDING

After the business has been set up and is running on full scale and needs to expand its operations or wants to increase its market, the business will require funding, this type of funding is called expansion funding. The Expansion Funding is categorized as follows:

• SECOND-STAGE FUNDING: The funds that a business seeks from Venture Capitalists to expand the business by expanding its operations and market is termed second-stage funding.

• BRIDGE FUNDING: It refers to the funds that are obtained by the business owners to meet the small expenses that occur by the time big funding is received for the expansion of the business.

• MEZZANINE FUNDING: The expansion of the business can require merging with other businesses or acquiring another business, hence the funds that are gained from the Venture Capitalists for this purpose are called mezzanine funding.

V. CHARACTERISTICS OF VENTURE CAPITAL: THE PROS AND CONS

The PROS of Venture Capital are as follows:

• The fact that the firm is not required to repay the investment amount is one of the main benefits of venture capital funds.
• Entrepreneurs are under no need to repay the invested money even if the business fails, which is typically quite troublesome in the case of bank loans.
• A start-up might benefit from venture capital companies’ extensive network to receive the crucial marketing and advertising it needs to finally establish itself.
• A corporation may grow rapidly and massively with the aid of VCFs. This might not apply to other forms of funding.
• VCFs contribute years of experience in addition to funding. This is critical for managing human resources, finances, and company decisions—areas where new entrepreneurs may fall short.

The CONS of Venture Capital are as follows:

• The viability and potential for favourable returns of an investment in a company must be determined by venture capital firms. Funding may be delayed if this takes a long period.
• Venture funds participate in a company’s decision-making process by investing. A seat on the board is also held by venture capital firms, hence complete control over the business is lost.
• Securing a VCF could be difficult because of the rising quantity of start-ups.

VI. LEGAL EVOLUTION OF VENTURE CAPITAL FUNDING IN INDIA

Venture Capital Funding play a pivotal role in the setting up of a business entity and the survival of the business entity. Over the period the laws about Venture Capital Funding have come a long way. It was not until 1988 that Venture Capital Funding started in India and before that financial institutions did the venture capital in India. Financial Institutions used debt as an instrument to invest in potential businesses or innovative business ideas. Credit Capital Finance Corporation (CFC) sponsored and marketed Credit Capital Venture Fund, the first private venture capital fund, along with the Bank of India, Asian Development Bank, and Commonwealth Development Corporation. At present, Venture Capital Funding in India is governed via the SEBI Act, 1992 and SEBI (Venture Capital) Regulations, 1996 which states that any business or trust wishing to engage in venture capital fund activity must obtain a certificate from SEBI.

VII. LEGAL COMPLIANCES FOR VENTURE CAPITAL FUNDING

Venture Capitalists are required to comply with the laws to make any capital funding and the same applies to the business owners who seek investment. These are compliances are as necessary as the due diligence that these investors conduct before making any investment in any potential business or business idea. The compliances are as follows:

• VENTURE CAPITAL FUNDING IN RETURN FOR EQUITY

It is well established that venture capitalists get equity in the business entity that they invest in. Hence equity is given to the capitalist equivalent to the investment they make and it may only be supported by a private limited business or a limited company. Therefore, if not already done, incorporating a company should be the first step in the fundraising process. It is crucial to make sure that the company’s Memorandum of Association and Articles of Association are written in such a way that they can accommodate an equity investment without needing to be changed after incorporation.

• COMPANIES ACT COMPLIANCES

The business must keep a statutory register and must have complied with the requirements of the 2013 Companies Act. Following a company’s incorporation, many major compliances must be followed, including the appointment of an auditor, holding board meetings, filing statutory annual returns, and maintaining a statutory register. The aforementioned factors relating to ROC compliance will be checked during the investment due diligence.

VIII. TAXATION AND VENTURE CAPITAL FUNDING

Under Section 10(23FB) of the Income Tax Act, 1961, Indian Venture Capital Funds get tax repayment. Any revenue made by a venture capital fund registered with SEBI, whether it be a trust or a corporation, and created to raise money for investments in venture capital undertakings is tax-exempt. Businesses that engage in the area of services must register for the service tax, pay the service tax, and submit service tax reports.

IX. FOREIGN VENTURE CAPITAL FUNDING – COMPLIANCES AND GOVERNANCE BY SEBI AND RBI

Upon meeting the eligibility requirements and other conditions outlined in the SEBI Foreign Venture Capital Investor Regulations, a foreign venture capital investor who plans to engage in venture capital activity in India may register with SEBI. The following investing parameters are stipulated by the SEBI Foreign Venture Capital Investor Regulations and may influence the overall financing strategies of foreign venture capital funds.
The firm must provide the following information to the Reserve Bank of India (RBI) in an advance reporting form after receiving funds from overseas investors.
• overseas investors’ names and addresses
• the date on which the money was received, as well as the rupee equivalent
• information about the bank or authorised dealer that received the money, including name and address
• Details of the government approval, if any
• KYC reports for the non-resident investor are obtained from the foreign bank that is sending the specified amount of money.
After obtaining cash, the share issue procedure must be finished within 180 days. Failure to do so might lead to a breach of the FEMA regulation governing interchange management.

X. CONCLUSION

Today’s venture capitalists have established themselves as the primary source of funding for creative business owners, offering the necessary remedy. The venture capital funding model was developed by the Indian legal system and industrial jurisprudence as a “sanjivni” for new business entities. Positioning of the legal system is intended to encourage ever more invitations to innovative and fresh ideas. Additionally, tax burdens have been lessened to encourage young involvement in national advancement. Venture capital will soon be the leading source of funding for the emerging business community.

Author: Mudit Saxena and Ajay Kacher, in case of any queries please contact/write back to us at support@ipandlegalfilings.com or   IP & Legal Filing.