Venture capital is a financial investment firm that invests in startups or small companies that may be profitable in the future. It is usually made up of large investors, banks and financial institutions.
The investment is not always in the form of finance, and it could also be management or technical experience. In short, venture capital is an alternative source of investment.
Although venture capital provides capital to start up or expand a business, it is not for all businesses. Venture capital is interested in investing only in those businesses or ideas that are innovative or that have the potential to grow.
Innovation does not necessarily have to be scientific – it can be a new type of product or service, or meeting a new need. The gain comes with a greater amount of risk. Hence, venture capital is a 'high return high risk' model of financing.
The United States is the cradle of venture capital. The United States started the venture capital business in 1958 by enacting the 'Small Business Investment Act'.
Venture Capital's contribution to Silicon Valley's revolution is undeniable.
Venture capital was a helping hand behind the growth of many world-famous companies like Microsoft, Starbucks, Apple, Intel, Facebook, Google, EBay, Amazon etc.
Our neighbouring country India enacted the Venture Capital Act in 1996 and Pakistan in 2001.
Bangladesh Securities and Exchange Commission (BSEC) passed the "Alternative Investment Rules" in 2015. Various venture capital and private equity companies have been established under this Act. These venture capital and private equity companies formed the "Venture Capital and Private Equity Association of Bangladesh" in 2016 with an aim of advancing this sector to work on building a local smart-up ecosystem.
How it works
Venture capital firms or companies raise 'venture capital funds' formed for specific purposes (eg IT, ITES, Biomedical etc.). Large corporations or wealthy individuals invest in these venture capital funds.
General or retail investors are discouraged from investing in such funds because the risk is high and the results come late. Venture capital firms or companies manage these funds. In return, they receive a management fee.
The average tenure of a venture fund is 5 to 15 years. Those who invest in venture funds are called Limited Partners or LP's, and those who manage and invest these funds are called General Partners or GP's.
General partners are involved in managing the funds themselves along with investing and screening startups, conducting audits or due diligence.
After the investment, it looks after the investee company as a director on their board. Venture funds invest in various companies. The venture firm or company makes this investment decision.
Investment is long term, something from three to eight years. Investments are made mainly through common shares and partial capital (quasi equity). At the end of the term, or at a convenient time, the venture firm sells the shares. Sometimes on profit and sometimes at loss. If the investee company goes bankrupt, the entire investment can be lost.
Venture capital funds at various stages of a venture. The first stage is "seed" ie, when the business is in the form of an idea in the mind of an entrepreneur.
The second stage is called the "early stage" – where the entrepreneur has started working on the business, but sales have not started. The next stage is "expansion" – where sales have started but the company is not making profits.
Finally "rising" means where the idea is tested, earnings are heading to break even or are close to it.
From the idea of an entrepreneur to the end, venture capital continues its cooperation at all stages, as required.
Venture capital vs bank loan
We know that the biggest conditions for getting bank loans in our country are:
1) The business must be profitable,
2) The business or entrepreneur should have examples of past success.
3) There should be immovable property to be mortgaged as security.
A new entrepreneur does not have any of these qualifications. Therefore, bank loans are not available. On the other hand, there is no such complication in venture capital.
Again, banks start charging interest from the time the loan is taken. But losses are normal in the initial stage of a business.
There is no such pressure on the venture capital. Rather, venture capital will also take its share of loss.
Venture capital is called smart money. It is not just about money, it is also about things like brainstorming, networking etc.
How to make venture capital popular in Bangladesh
The concept of venture capital as a guardian for a creative young entrepreneur is yet to be established in our country.
The following initiatives can be taken to make venture capital more popular and its services people-friendly:
Firstly, stamp duty should be levied on venture capital entrepreneurs. The internal resources department of the finance ministry has already reduced the stamp duty on registration of venture capital trust deeds to 0.2 percent from the previous 2 percent, to encourage alternative investment funds in the country. The maximum stamp duty on the total value of a document has been fixed at Tk10 lakh, and the minimum at Tk5,000.
In the case of venture capital, the maximum stamp duty can be set at Tk5 lakh.
Secondly, new entrepreneurs should be given income tax exemption or lower tax rates. In this case, an alternative tax system can be introduced for this sector. But there should be a rule that once the business is established or profitable, it will come under regular taxation.
Thirdly, foreign investors who are currently interested in investing in the country should be allowed to easily remit their money. If any non-resident Bangladeshi businessman or individual residing abroad wants to invest in venture funds in the country, they should be able to do it quickly and without hassle.
In this case, incentives or special concessions can be arranged to attract foreign investors.
Fourthly, it should be made mandatory for bank and insurance companies to invest in venture capital. Some banks have already formed venture capital as their subsidiary companies, while insurance companies have not made any forays in this space. If they participate, other financial institutions will be interested in investing.
Besides, new companies coming through venture capital should be encouraged to come to the capital market and its process should be simplified. In addition, the central bank should play a role as a partner in venture capital funds.
Venture capital is willing to help implement a risky new business idea. Venture capital creates direct employment, creates self-employment opportunities and is almost the only source of finance for small and new companies.
Banks are traditionally the primary source of trust for new entrepreneurs for business loans. But in many cases, banks are not willing to lend to new ventures. Hence, a viable option for new ventures can be a venture capital firm.
Rokibul Huda Majumder is a freelance contributor
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.