Difference between Hire-Purchase and Venture Capital

Hire-Purchase

Hire Purchase is a loan or contract that involves an initial deposit, linked to a specific purchase, which is a way of obtaining the use of an asset before payment is completed. The payments of the HP are in monthly installments, plus interest within which at the end of the agreement. Finance companies usually offer the facility of leasing as well as hire-purchase to their clients.

The main features of a hire-purchase arrangement are as follows:

– The hiree (the counterpart of the lessor) purchases the asset and gives it on hire to the hirer (the counterpart of the lessee).

– The hirer pays regular hire-purchase installments over a specified period of time. These installments cover interest as well as principal repayment. When the hirer pays the last installment, the title of the asset is transferred from the hiree to the hirer.

– The hiree charges interest on a flat basis. This means that a certain rate of interest, usually around 8 percent is charged on the initial investment (made by the hiree) and not on the diminishing balance.

– The total interest collected by the hiree is allocated over various years. For this purpose, the ‘sum of the year’s digits’ method is commonly employed.

Venture Capital

Venture capital is a source of financing for new businesses. Venture capital funds pool investors’ cash and loan it to startup firms and small businesses with perceived, long-term growth potential. This is a very important source of funding for startups that do not have access to other capital and it typically entails high risk (and potentially high returns) for the investor.

Venture capital provides long-term, committed share capital, to help unquoted companies grow and succeed. If an entrepreneur is looking to start-up, expand, buy-into a business, buy-out a business in which he works, turnaround or revitalize a company, venture capital could help do this. Obtaining venture capital is substantially different from raising debt or a loan from a lender. Lenders have a legal right to interest on a loan and repayment of the capital, irrespective of the success or failure of a business. Venture capital is invested in exchange for an equity stake in the business. As a shareholder, the venture capitalist’s return is dependent on the growth and profitability of the business. This return is generally earned when the venture capitalist “exits” by selling its shareholding when the business is sold to another owner.

Venture capitalist prefers to invest in “entrepreneurial businesses”. This does not necessarily mean small or new businesses. Rather, it is more about the investment’s aspirations and potential for growth, rather than by current size. Such businesses are aiming to grow rapidly to a significant size. As a rule of thumb, unless a business can offer the prospect of significant turnover growth within five years, it is unlikely to be of interest to a venture capital firm. Venture capital investors are only interested in companies with high growth prospects, which are managed by experienced and ambitious teams who are capable of turning their business plans into reality.

Venture capital firms usually look to retain their investment for between three and seven years or more. The term of the investment is often linked to the growth profile of the business. Investments in more mature businesses, where the business performance can be improved quicker and easier, are often sold sooner than investments in early-stage or technology companies where it takes time to develop the business model.

Just as management teams compete for finance, so do venture capital firms. They raise their funds from several sources. To obtain their funds, venture capital firms have to demonstrate a good track record and the prospect of producing returns greater than can be achieved through fixed interest or quoted equity investments. Most UK venture capital firms raise their funds for investment from external sources, mainly institutional investors, such as pension funds and insurance companies.

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