Small business is the driving force of the economy. However, over time a small company seeking to grow and develop economies of scale, acquire and retain a greater share of the market and so on. So, in this phase of expansion in funding or borrowed capital required. As for funds borrowing there are two possibilities: a loan or capital investment. However, most companies do not fully meet the requirements for the granting of loans, raised by financial institutions, as they can not guarantee to fulfill the obligations with the equity they have.
In terms of investment opportunities in the capital, there are two main types: venture capital (VC) and private equity (PE). Risk (RK) or private capital (PK) – is a way to have ownership of the company or part of it. This form of ownership is beneficial to entrepreneurs, but they are required to transfer shares to borrow for capital.
To take advantage of the capital loan facility entrepreneur usually has to go to the RK / PK fund that invests capital directly or acquired businesses. Usually RK / PK fund collects money and investing them in unlisted companies (ie companies whose shares are not traded on a stock exchange) by acquiring a small part of the shares conferring the right to control three to seven years. This financing benefits are often not related to invested funds and the RK / PK participation in the investment portfolio of the fund company’s Management Board, the RK / PK fund managers having a good company’s strengths and weaknesses understanding can perform a thorough inspection and also to share valuable contacts.
Investment criterias usually depends on every Venture Capital‘s (later VC) specialization, type of investment, investment amount, industry and it‘s stage of cycle, location etc. Usually there are three universal criterias: business conception, management and return. When considering a potential investment with a level of risk and long-term commitment to investment portfolios, it is necessary to do a thorough analysis before any investment decision is made.
Firstly, VC investor pick out most suitable investment offers, which is usually less than 1% of all the offers which were given. Then, some of the main criterias are taken into account: profit growth, business idea, competitive advantage and reasoned need of capital. The first three criterias are related to each other, as profit growth is directly related to business idea and competitive advantage increases that growth. Finally, after the first stage of potential investment selection, VC professionals should ask themselves a number of questions:
- Does this investment match our portfolio strategy?
- Does this investment match our specialization?
- Is this investment suitable for us?
- Is this business mature enough for our investment?
- What do we know about the industry?
If one of the answers to the questions above is negative, it is most likely that the investment offer will be declined.
Usually, PE/VC companies have funds, limited partners and common partners. PE/VC company‘s legal status is Limited Liability Company, Limited Partnership or Limited Liability Partnership. Limited Partners are institutional investors like pension funds, insurance companies, mutual funds, asset management companies and private investors. These partners usually contribute 95-99% of fund capital. Limited partners do not have voting rights and are passive investors. Common partners (fund management companies) are professionals of investment, actively managing their investment funds.
PE/VC investments are usually implemented by funds, which exist for 5 to 10 years. There are various restrictions for these investments, which may be applied depending on the industry, stage, geographical location, size of a company etc. One PE/VC company may control more than one fund.
Private equity and venture capital companies investments make significant contribution to a country‘s economy. PE/VC is the most important intermediary between small private companies and society, as it produces clarity regarding a companies quality via thorough examinations and evaluations. Venture capital companies, which take business risk, play the second most significant role in a small companies financing in growing cycle, using private investors and entrepreneurs funds. However, before applying for a bank loan, companies must have be prepared to attract funds issuing obligations or shares and funding strategic investor.
Phrases Private Equity and Venture Capital are commonly used as synonyms, when it described as investment tools, that commonly uses institutional investors and wealthy private investors, who buy a part of various companies equity capital. The main difference between PE/VC and other financing ways is source of capital and relationship with other companies that are in its portfolio. The main PE/VC source of funds for capital is institutional investors (pension and other funds, insurance companies etc) and wealthy private investors.
In Europe, generally, this whole sector is usually called Private Equity sector, and Venture Capital is deemed to be a part of this sector. However, in the US Venture Capital is understood to be the same as in Europe, but their own capital is held to be a separate investment type, which typically uses more mature companies at later stages, which are trying to reduce inefficient functioning. Usually, a companies own capital part is higher than Venture Capital part.
For institution investors and wealthy private investors both PE and VC funds offer alternative long-term investment forms with different levels of risk and opportunities, unlike equity securities. There is a certain risk for these kind of investments. Usually, PE/VC investors get financial return only when they withdraw their investments from companies. Besides common fund withdrawals there are some alternatives: companies buyouts, initial public offering (IPO) and recapitalization.