Conventional financing generally extends loans to companies, while VC financing invests in equity of the company. Conventional financing looks to current income i.e. dividend and interest, while in VC financing returns are by way of capital appreciation. Assessment in conventional financing is conservative i.e. lower the risk, higher the chances of getting loan. On the other hand VC financing is a risk taking finance where potential returns outweigh risk factors.
Venture Capitalists also lend management support and provide entrepreneurs with many other facilities. They even participate in the management process. VC generally invest in unlisted companies and make profit only after the company obtains listing. VC extend need based support in a number of stages of investments unlike single round financing by conventional financiers.
VC are in for long run and rarely exit before 3 years. To sustain such commitment VC and private equity groups seek extremely high returns.. a return of 30% in dollar terms . A bank or an FI will fund a project as long as it is sure that enough cash flow will be generated to repay the loans. VC is not a lender but an equity partner.
Venture capitalists take higher risks by investing in an early-stage company with little or no history, and they expect a higher return for their high-risk equity investment. Internationally, VCs look at an internal rate of return (IRR) north of 40% plus. In India, the ideal benchmark is in the region of an IRR of 25% for general funds and more than 30% for IT-specific funds. With respect to investing in a business, institutional venture capitalists look for average returns of at least 40 per cent to 50 per cent for start-up funding. Second and later stage funding usually requires at least a 20 per cent to 40 per cent return compounded per annum. Most firms require large portions of equity in exchange for start-up financing.
