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STUDY OF VENTURE CAPITAL IN INDIA

BACHELOR OF COMMERCE

BANKING & INSURANCE

SEMESTER V

(2010)

SUBMITTED BY:

MIRALI.H.BHUVAROLL NO. 05

UNDER THE GUIDANCE OF PROF.DR. SEETHA LEKSHMY

SIES COLLEGE OF COMMERCE AND ECONOMICS,

Plot No. 71/72, Sion Matunga Estate

T.V. Chidambaram Marg,

Sion (East), Mumbai 400022.

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STUDY OF VENTURE CAPITAL IN INDIA

BACHELOR OF COMMERCE

BANKING & INSURANCE

SEMESTER V

(2010)

Submitted

In Partial Fulfillment of the requirements

For the Award of Degree of

Bachelor of Commerce Banking & Insurance

By

MIRALI.H.BHUVA

ROLL NO. 05

UNDER THE GUIDANCE OF PROF. DR. SEETHA LEKSHMY

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C E R T I F I C

This is to certify that Shri/Miss

Banking & Insurance Semester V (2010) has successfully

completed the project on

Under the guidance of

.

Course Coordinator Principal

Project Guide/ Internal Examiner

External Examiner

DATE:

PLACE:

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DECLARATION

I, Banking & Insurance Semester V (2010) hereby declare thatI have completed the Project on

.

The information submitted is true & original to the best of my

knowledge.

D ATE: Students Signature

PLACE:

Roll No. 05

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ACKNOWLEDGEMENT

I would sincerely like to give my heartfelt

acknowledgement and thanks to my parents. Any amount of

thanks given to them will never be sufficient.

I would like to thank the University of Mumbai, for

introducing Banking and Insurance course, thereby giving

the student a platform to abreast with changing business

scenario, with the help of theory as a base and practical as

a solution.

I would sincerely like to thank our Principal MeenuThomas. I would also like to thank my project guide Prof.DR.

SEETHA LEKSHMYfor her valuable support and guidance whenever needed.

I also feel heartiest sense of obligation my library staff

members & seniors who helped in collection of Data and

materials and also in this processing as well as in drafting

manuscript.

Last, but not the least, I would like to thank my friends &

colleagues for always being there.

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indexSr. no. topic Page no.

1 Chapter 1

2 Chapter 2

3 Chapter3

4 Chapter4

5 Chapter5

6 Chapter6

7 Chapter7

8 Chapter8

9 Chapter9

10 Chapter10

11 Chapter11

12 Annexure

13 Bibliography

CHAPTER I

(a) INTRODUCTION:

Venture capital (also known as VC or Venture) is provided as seed funding toearly-stage, high-potential, growth companies and more often after the seedfunding round as growth funding round (also referred as series A round) in the

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http://en.wikipedia.org/wiki/Seed_fundinghttp://en.wikipedia.org/wiki/Growth_investinghttp://en.wikipedia.org/wiki/Seed_fundinghttp://en.wikipedia.org/wiki/Seed_fundinghttp://en.wikipedia.org/w/index.php?title=Growth_funding&action=edit&redlink=1http://en.wikipedia.org/wiki/Seed_fundinghttp://en.wikipedia.org/wiki/Growth_investinghttp://en.wikipedia.org/wiki/Seed_fundinghttp://en.wikipedia.org/wiki/Seed_fundinghttp://en.wikipedia.org/w/index.php?title=Growth_funding&action=edit&redlink=1

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interest of generating a return through an eventual realization event such as anIPO ortrade sale of the company. To put it simply, an investment firm will givemoney to a growing company. The growing company will then use this money toadvertise, do research, build infrastructure, develop products etc. The investment

firm is called a venture capital firm, and the money that it gives is called venturecapital. The venture capital firm makes money by owning a stake in the firm itinvests in. The firms that a venture capital firm will invest in usually have a noveltechnology orbusiness model. Venture capital investments are generally made incash in exchange for shares in the invested company. It is typical for venturecapital investors to identify and back companies in high technology industries,such as biotechnology and IT (Information Technology).

Venture capital typically comes from institutional investors and high net worthindividuals, and is pooled together by dedicated investment firms.

Venture capital firms typically comprise small teams with technologybackgrounds (scientists, researchers) or those with business training or deepindustry experience.

(b) REVIEW LITERATURE:

A literature review is a body of text that aims to review the critical points ofcurrent knowledge including substantive findings as well as theoretical andmethodological contributions to a particular topic. Literature reviews aresecondary sources, and as such, do not report any new or original experimentalwork.

Most often associated with academic-oriented literature, such as theses, aliterature review usually precedes a research proposal and results section. Itsultimate goal is to bring the reader up to date with current literature on a topicand forms the basis for another goal, such as future research that may be needed

in the area.

A well-structured literature review is characterized by a logical flow of ideas;current and relevant references with consistent, appropriate referencing style;proper use ofterminology; and an unbiased and comprehensive view of theprevious research on the topic.

- "Over the past decade, venture capital finance has developed into animportant source of start-up and growth financing. This volume is fascinating

reading and highly informative. Venture Capital in Europe contains thoughtfuland informative essays by several of the leading scholars in the field, and

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http://en.wikipedia.org/wiki/Initial_public_offeringhttp://en.wikipedia.org/wiki/Mergers_and_acquisitionshttp://en.wikipedia.org/wiki/Business_modelhttp://en.wikipedia.org/wiki/Biotechnologyhttp://en.wikipedia.org/wiki/Institutional_investorshttp://en.wikipedia.org/wiki/High_net_worth_individualshttp://en.wikipedia.org/wiki/High_net_worth_individualshttp://en.wikipedia.org/wiki/Secondary_sourceshttp://en.wikipedia.org/wiki/Theseshttp://en.wikipedia.org/wiki/Logicalhttp://en.wikipedia.org/wiki/Citationhttp://en.wikipedia.org/wiki/Terminologyhttp://en.wikipedia.org/wiki/Initial_public_offeringhttp://en.wikipedia.org/wiki/Mergers_and_acquisitionshttp://en.wikipedia.org/wiki/Business_modelhttp://en.wikipedia.org/wiki/Biotechnologyhttp://en.wikipedia.org/wiki/Institutional_investorshttp://en.wikipedia.org/wiki/High_net_worth_individualshttp://en.wikipedia.org/wiki/High_net_worth_individualshttp://en.wikipedia.org/wiki/Secondary_sourceshttp://en.wikipedia.org/wiki/Theseshttp://en.wikipedia.org/wiki/Logicalhttp://en.wikipedia.org/wiki/Citationhttp://en.wikipedia.org/wiki/Terminology

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provides a comprehensive picture of the structure of venture capital financing, thevaluation of investments, and the exit routes for venture capitalists. I highlyrecommend it." Luc Renneboog, Professor of Finance.

- According to Doriot, products or processes which have passed through atleast the early prototype stage and are adequately protected by patents,copyrights, or trade-secret agreements (the latter rule is often referred to asinvesting in situations where the information is "proprietary" (proprietaryinformation)

- "Despite the overall drop in funding in 2009, VCs placed more bets in thefourth quarter of 2009 than we've seen all year," said Tracy Lefteroff,global managing partner of the venture capital practice atPricewaterhouseCoopers LLP.

(c) OBJECTIVES OF THE STUDY

Understand the concept of venture capital.Venture Capital funding is

different from traditional sources of financing. Venture capitalists finance

innovation and ideas which have potential for high growth but with

inherent uncertainties. This makes it a high-risk, high return investment.

Study venture capital industry in India.Scientific, technology and

knowledge based ideas properly supported by venture capital can be

propelled into a powerful engine of economic growth and wealth creation

in a sustainable manner. In various developed and developing economies

venture capital has played a significant developmental role.

Study venture capital industry in global scenario.Venture capital has

played a very important role in U.K., Australia and Hong Kong also in

development of technology growth of exports and employment.

Study the evaluation & need of venture capital industry in India.India

is still at the level of knowledge. Given the limited infrastructure, low

foreign investment and other transitional problems, it certainly needs

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In India neither venture capital theory has been developed nor are there many

comprehensive books on the subject. Even the number of research papers

available is very limited. The research design used is descriptive in nature. (The

attempt has been made to collect maximum facts and figures available on the

availability of venture capital in India, nature of assistance granted, future

projected demand for this financing, analysis of the problems faced by the

entrepreneurs in getting venture capital, analysis of the venture capitalists and

social and environmental impact on the existing framework.)

The research is based on secondary data collected from the published material.

The data was also collected from the publications and press releases of venture

capital associations in India.

Scanning the business papers filled the gaps in information. The Economic times,

Financial Express and Business Standards were scanned for any article or news

item related to venture capital. Sufficient amount of data about the venture capital

has been derived from this project.

EXECUTIVE SUMMARY

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Venture capital is a growing business of recent origin in the area of industrial

financing in India. The various financial institution set-ups in India to promote

industries have done commendable work. However, these institutions do not

come up to benefit risky ventures when they are undertaken by new or relatively

unknown entrepreneurs. They contend to give debt finance, mostly in the form of

term loans to the promoters and their functioning has been more akin to that of

commercial banks.

Starting and growing a business always require capital. There are a number of

alternative methods to fund growth. These include the owner or proprietors own

capital, arranging debt finance, or seeking an equity partner, as is the case with

private equity and venture capital.

Venture capital is a means of equity financing for rapidly-growing private

companies. Finance may be required for the start-up, development/expansion or

purchase of a company. Venture Capital firms invest funds on a professional

basis, often focusing on a limited sector of specialization (eg. IT, Infrastructure,

Health/Life Sciences, Clean Technology, etc.).

Indian Venture capital and Private Equity Association(IVCA) is a member based

national organization that represents venture capital and private equity firms,

promotes the industry within India and throughout the world and encourages

investment in high growth companies.

IVCA member comprise venture capital firms, institutional investors, banks,

incubators, angel groups, corporate advisors, accountants, lawyers, government

bodies, academic institutions and other service providers to the venture capital

and private equity industry.

Members represent most of the active venture capital providers and private equity

firms in India. These firms provide capital for seed ventures, early stage

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companies, later stage expansion, and growth finance for manageme

buyouts/buy-ins of established companies.

Venture capitalists have been catalytic in bringing forth technological innovationin USA. A similar act can also be performed in India. As venture capital has good

scope in India for three reasons:

First: The abundance of talent is available in the country. The low cost high

quality Indian workforce that has helped the computer users worldwide in Y2K

project is demonstrated asset.

Second: A good number of successful Indian entrepreneurs in Silicon Valley

should have a demonstration effect for venture capitalists to invest in Indian

talent at home.

Third: The opening up of Indian economy and its integration with the world

economy is providing a wide variety of niche market for Indian entrepreneurs to

grow and prove themselves.

CONCEPT OF VENTURE CAPITAL

The term venture capital comprises of two words that is, Venture and capital.

Venture is a course of processing the outcome of which is uncertain but to

which is attended the risk or danger of Loss. Capital means recourses to start

an enterprise. To connote the risk and adventure of such a fund, the generic name

Venture Capital was coined.

Venture capital is considered as financing of high and new technology based

enterprises. It is said that Venture capital involves investment in new or relativelyuntried technology, initiated by relatively new and professionally or technically

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qualified entrepreneurs with inadequate funds. The conventional financiers,

unlike Venture capitals mainly finance proven technologies and established

markets. However, high technology need not be prerequisite for venture capital.

Venture capital has also been described as unsecured risk financing. The

relatively high risk of venture capital is compensated by the possibility of high

return usually through substantial capital gains in term. Venture capital in broader

sense is not solely an injection of funds into a new firm, it is also an input of

skills needed to set up the firm, design its marketing strategy, organize and

manage it. Thus it is a long term association with successive stages of companys

development under highly risky investment condition with distinctive type of

financing appropriate to each stage of development. Investors join

entrepreneurs as co-partners and support the project with finance and business

skill to exploit the market opportunities.

Venture capital is not a passive finance. It may be at any stage of business/

production cycle, that is startup, expansion or to improve a product or process,

which are associated with both risk and reward. The Venture capital gains

through appreciation in the value of such investment when the new technology

succeeds. Thus the primary return sought by the investor is essentially capital

gain rather than steady interest income or dividend yield.

The most flexible Definition of Venture Capital is:-

The support by investors of entrepreneurial talent with finance and

business skills to exploit market opportunities and thus obtain capital gains.

Venture capital commonly describes not only the provision of start up finance or

seed corn capital but also development capital for later stages of business. A

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long term commitment of funds is involved in the form of equity investments,

with the aim of eventual capital gains rather than income and active involvement

in the management of customers business.

CHAPTER2

FEATURES OF VENTURE CAPITAL

High Risk

High Tech

Equity Participation & Capital Gains

Participation In Management

Length Of Investment

Illiquid Investment

High Risk

By definition the Venture capital financing is highly risky and chances of failure

are high as it provides long term start up capital to high risk- high reward

ventures. Ventures capital assumes four type of risks, these are:

o Management risk -Inability of management teams to work together.

o Market risk -Product may fail in the market.

o Product risk -Product may not be commercially viable.

o Operation risk -Operation may not be cost effective resulting in

increased cost decreased gross margin.

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High Tech

As opportunities in the low technology area tend to be few of lower order, and hi-

tech projects generally offer higher returns than projects in more traditional area,venture capital investments are made in high tech. areas using new technologies

or producing innovative goods by using new technology. Not just

technology, any high risk ventures where the entrepreneur has conviction but

little capital gets venture finance. Venture capital is available for expansion of

existing business or diversification to a high risk area. Thus technology financing

had never been the primary objective but incidental to venture capital.

Equity Participation & Capital Gains

Investments are generally in equity and quasi equity participation through direct

purchase of share, options, convertible debentures where the debt holder has the

option to convert the loan instruments into stock of the borrower or a debt with

warrants to equity investment. The funds in the form of equity help to raise termloans that are cheaper source of funds. In the early stage of business, because

dividends can be delayed, equity investment implies that investors bear the risk

of venture and would earn a return commensurate with success in the form of

capital gains.

Participation In management

Venture capital provides value addition by managerial support, monitoring and

follow up assistance. It monitors physical and financial progress as well as

market development initiative. It helps by identifying key resource person. They

want one seat on the companys board of directors and involvement, for better or

worse, in the major decision affecting the direction of company. This is a unique

philosophy of hand on management where Venture capitalist acts complementary to the entrepreneurs. Based upon the experience other companies,

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a venture capitalist advice the promoters on project planning, monitoring,

financial management, including working capital and public issue. Venture

capital investor cannot interfere in day today management of the enterprise but

keeps a close contact with the promoters or entrepreneurs to protect his

investment.

Length of Investment

Venture capitalist help companies grow, but they eventually seek to exit theinvestment in three to seven years. An early stage investment may take seven to

ten years to mature, while most of the later stage investment takes only a few

years. The process of having significant returns takes several years and calls on

the capacity and talent of venture capitalist and entrepreneurs to reach fruition.

Illiquid Investment

Venture capital investments are illiquid, that is not subject to repayment on

demand or following a repayment schedule. Investors seek return ultimately by

means of capital gain when the investment is sold at market place. The

investment is realized only on enlistment of security or it is lost if enterprise is

liquidated for unsuccessful working. It may take several years before the first

investment starts too locked for seven to ten years. Venture capitalist understandsthis illiquidity and factors this in his investment decision.

THE VENTURE CAPITAL SPECTRUM/STAGES

The growth of an enterprise follows a life cycle as shown in the diagram below.

The requirements of funds vary with the life cycle stage of the enterprise. Even

before a business plan is prepared the entrepreneur invests his time and resources

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in surveying the market, finding and understanding the target customers and their

needs. At the seed stage the entrepreneur continue to fund the venture with his

own fund or family funds. At this stage the fund are needed to solicit the

consultants services in formulation of business plans, meeting potenti

customers and technology partners. Next the funds would be required for

development of the product/process and producing prototypes, hiring key people

and building up the managerial team. This is followed by funds for assembling

the manufacturing and marketing facilities in that order. Finally the funds are

needed to expand the business and attaint the critical mass for profit generation.

Venture capitalists cater to the needs of the entrepreneurs at different stages of

their enterprises. Depending upon the stage they finance, venture capitalists are

called angel investors, venture capitalist or private equity supplier/investor.

Venture capital was started as early stage financing of relatively small but rapidly

growing companies. However various reasons forced venture capitalists to be

more and more involved in expansion financing to support the development of

existing portfolio companies. With increasing demand of capital from newer

business, venture capitalists began to operate across a broader spectrum of

investment interest. This diversity of opportunities enabled venture capitalists to

balance their activities in term of time involvement, risk acceptance and reward

potential, while providing ongoing assistance to developing business.

Different Venture capital firms have different attributes and aptitudes fordifferent types of Venture capital investments. Hence there are different stages of

entry for different venture capitalists and they can identify and differentiate

between types of venture capital investments, each appropriate for the given stage

of the investee company, these are:-

1. Early stage Finance

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Seed capital

Start up Capital

Early/First Stage Capital

Later/Third Stage capital

2. Later Stage Finance

Expansion/Development Stage Capital

Replacement Finance

Management Buy Out and Buy Ins

Turnarounds

Mezzanine/Bridge Finance

Not all business firms pass through each of these stages in sequential manner. For

instance seed capital is normally not required by service based ventures. It

applies largely to manufacturing or research based activities. Similarly second

round finance does not always follow early stage finance. If the business grows

successfully it is likely to develop sufficient cash to fund its own growth, so does

not require venture capital for growth.

Seed Capital

It is an idea or concept as opposed to a business. European venture capital

association defines seed capital as The financing of the initial pr

development or capital provided to an entrepreneur to prove the feasibility of a

project and to qualify for start up capital.

The characteristics of the seed capital may be enumerated as follows:

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o Absence of ready product market

o Absence of complete management team

o Product/process still in R & D stage

o Initial period/licensing stage of technology transfer

Broadly speaking seed capital investment may take 7 to 10 year to achieve

realization. It is the earliest and therefore riskiest stage of Venture capital

investment. The new technology and innovations being attempted have equal

chance of success and failure. Such projects, particularly hi-tech, projects sink a

lot of cash and need a strong financial support for their adapcommencement and eventual success. However, while the earliest stage of

financing is fraught with risk, it also provides greater potential for realizing

significant gains in long term. Typically seed enterprises lack asset base or track

record to obtain finance from conventional sources and are largely dependent

upon entrepreneurs personal resources. Seed capital is provided after being

satisfied that the entrepreneur has used up his own resources and carried out hisidea to a stage of acceptance and has initiated research. The asset underlying the

seed capital is often technology or an idea as opposed to human assets (a good

management taem0 so often sought by venture capitalists.

Volume of Investment Activity

It has been observed that Venture capitalist seldom make seed capital investmentand these are relatively small by comparison to other forms of Venture finance.

The absence of interest in providing a significant amount of seed capital can be

attributed to the following three factors:-

a) Seed capital projects by their very nature require a relatively small amount

of capital. The success or failure of an individual seed capital investment

will have little impact on the performance of all but the smallest venture

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capital investments. This is because the small investments are seen to be

cost inefficient in terms of time required to analyze structure manage them.

b) The time horizon to realization for most seed capital investment is

typically 7-10 years which is longer than all but most long-term oriented

investors will desire.

c) The risk of product and technology obsolescence increases as the time to

realization I extended. These types of obsolescence are particularly likely

to occur with high technology investments particularly in the fields related

to Information Technology.

Start Up Capital

It is stage second in the venture capital cycle and is distinguishable from seed

capital investments. An entrepreneur often needs finance when the business is

just starting. The start up stage involves starting a new business. Here in the

entrepreneur has moved closer towards establishment of a going concern. Here in

the business concept has been fully investigated and the business risk now

becomes that of turning the concept into product.

Start up capital is defined as; Capital needed to finance the p

development, initial marketing and establishment of product facility.

The characteristics of start-up capital are:-

a) Establishment of company or business: the company is either being

organized or is established recently. New business activity could be based

on experts, experience or a spin-off from R & D.

b) Establishment of most but not all the members of the team: the skills

and fitness to the job and situation of the entrepreneurs team is an

important factor for start up finance.

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c) Development of business plan or idea: the business plan should be fully

developed yet the acceptability of the product by the market is uncertain.

The company has not yet started trading.

In the start up preposition Venture capitalists investment criteria shifts from idea

to people involved in the venture and the market opportunity. Before committing

any finance at this stage, venture capitalist however, assesses the managerial

ability and the capacity of the entrepreneur, besides the skills, suitability and

competence of the managerial team are also evaluated. If required they supply

managerial skill and supervision for implementation. The time horizon for start

up capital will be typically 6 or 8 years. Failure rate for start up is 2 out of 3. Start

up needs funds by way of both first round investment and subsequent follow-up

investments. The risk tends to be lower relative to seed capital situation. The risk

is controlled by initially investing a smaller amount of capital in start-ups. The

decision on additional financing is based upon the successful performance of the

company. However, the term to realization of a start up investment remains

longer than the term of finance normally provided by the majority of financial

institutions. Longer time scale for using exit route demands continued watch on

start up projects.

Volume of Investment Activity

Despite potential for secular returns most venture firms avoid investing in start-

ups. One reason for the paucity of start up financing may be high discount rate

that venture capitalist applies to venture proposals at this level of risk and

maturity. They often prefer to spread their risk by sharing the financing. Thus

syndicates of investors often participate in start up finance.

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Early Stage Finance

It is also called first stage capital is provided to entrepreneur who has a proven

product, to start commercial production and marketing, not covering market

expansion, de-risking and acquisition costs.

At this stage the company passed into early success stage of its life cycle. A

proven management team is put into this stage, a product is established and an

identifiable market is being targeted.

British Venture capital Association has vividly defined early stage finance as:

Finance provided to companies that have completed the product development

stage and require further funds to initiate commercial manufacturing and sales

but may not be generating profits.

The characteristics of early stage finance may be:-

Little or no sales revenue.

Cash flow and profit still negative.

A small but enthusiastic management team which consists of people with

technical and specialist background and with little experience in the

management of growing business.

Short term prospective for dramatic growth in revenue and profits.

The early stage finance usually takes 4 to 6 years time horizon to realization.

Early stage finance is the earliest in which two of the fundamentals of business

are in place i.e. fully assembled management team and a marketable product. A

company needs this round of finance because of any of the following reasons:-

Project overruns on product development.

Initial loss after start up phase.

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The firm needs additional equity funds, which are not available from other

sources thus prompting venture capitalist that, have financed the start up stage to

provide further financing. The management risk is shifted from factors internal to

the firm (lack of management, lack of product etc.) to factor external to the firm

(competitive pressures, in sufficient will of financial institutions to provide

adequate capital, risk of product obsolescence etc.)

At this stage, capital needs, both fixed and working capital needs are greatest.

Further, since firms do not have foundation of a trading record, finance will be

difficult to obtain and so venture capital particularly equity investment without

associated debt burden is key to survival of the business.

The following risks are normally associated to firms at this stage:-

a) The early stage firms may have drawn the attention of and incurred the

challenge of a larger competition.

b) There is a risk of product obsolescence. This is more so when the firm is

involved in high-tech business like computer, information technology etc.

Second stage Finance

It is the capital provided for marketing and meeting the growing working capital

needs of an enterprise that has commenced the production but does not have

positive cash flows sufficient to take care of its growing needs. Second stage

finance, the second trench of Early Stage Finance is also referred to as follow on

finance and can be defined as the provision of capital to the firm which has

previously been in receipt of external capital but whose financial needs have

subsequently exploded. This may be second or even third injection of capital.

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The characteristics of a second stage finance are:

A developed product on the market

A full management team in place

Sales revenue being generated from one or more products

There are losses in the firm or at best there may be a breakeven but the

surplus generated is insufficient to meet the firms needs.

Second round financing typically comes in after start up and early stage funding

and so have shorter time to maturity, generally ranging from 3 to 7 years. This

stage of financing has both positive and negative reasons.

Negative reasons include:

Cost overruns in market development

Failure of new product to live up to sales forecast.

Need to re-position products through a new marketing campaign

Need to re-define the product in the market place once the product

deficiency is revealed.

Positive reasons include:

Sales appear to be exceeding forecasts and the enterprise needs to acquire

assets to gear up for production volumes greater than forecasts.

High growth enterprises expand faster than their working capital permit,

thus needing additional finance. Aim is to provide working capital for

initial expansion of an enterprise to meet needs of increasing stocks and

receivables.

It is additional injection of funds and is an acceptable part of venture capital.

Often provision for such additional finance can be included in the original

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financing packages as an option, subject to certain management performance

targets.

Later Stage Finance

It is called third stage capital is provided to an enterprise that has established

commercial production and basic marketing set-up, typically for mark

expansion, acquisition product development etc. it is provided for market

expansion of the enterprise.

The enterprises eligible for this round of finance have following characteristics:

Established business, having already passed the risky early stage.

Expanding high yield, capital growth and good profitability.

Reputed market position and an established formal organization

structure.

Funds are utilized for further plant expansion, marketing, working capital or

development of improved products. Third stage financing is a mix of equity

with debt or subordinate debt. As it is half way between equity and debt in US it

is called mezzanine finance. It is also called last round of finance in run up to

the trade sale or public offer.

Venture capitalists prefer later stage investment vis a Vis early stage investments,as the rate of failure in later stage financing is low. It is because firms at this

stage have a past performance data, track record of management, established

procedures of financial control. The time horizon for realization is shorter,

ranging from 3 to 5 years. This helps the venture capitalists to balance their own

portfolio of investment as it provides a running yield to venture capitalists.

Further the loan component in third stage finance provides tax advantage and

superior return to the investors.

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There are four sub divisions of later stage finance:

Expansion/Development Finance

Replacement Finance

Buyout Financing

Turnaround Finance

Expansion/ Development finance

An enterprise established in a given market increases its profit exponentially by

achieving the economies of scale. This expansion can be achieved either through

an organic growth, that is by expanding production capacity and setting up proper

distribution system or by way of acquisitions. Anyhow, expansion needs finance

and venture capitalists support both organic growth as well as acquisitions for

expansion.

At this stage the real market feedback is used to analyze competition. It may be

found that the entrepreneur needs to develop his managerial team for handling

growth and managing a larger business.

Realization horizon for expansion/development investment is one to three years.

It is favored by venture capitalist as it offers higher rewards in shorter period with

lower risk. Funds are needed for new or larger factories and warehouses,

production capacities, developing improved or new products, developing newmarkets or entering exports by enterprise with established business that has

already achieved break even and has started making profits.

Replacement Finance

It means substituting one shareholder for another, rather than raising new capital

resulting in the change of ownership pattern. Venture capitalist purchase share

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from the entrepreneurs and their associates enabling them to reduce their

shareholding in unlisted companies. They also buy dividend coupon. Later, on

sale of the company or its listing on stock exchange, these are re-converted to

ordinary shares. Thus Venture capitalist makes a capital gain in a period of 1 to 5

years

Buy-out / Buy-in Financing

It is a resent development and a new form of investment by venture capitalist.

The funds provided to the current operating management to acquire or purchase a

significant share holding in the business they manage are called management

buyout.

Management Buy-in refers to the funds provided to enable a manager or a group

of managers from outside the company to buy into it.

It is the most popular form of venture capital amongst stage financing. It is less

risky as venture capitalist in invests in solid, ongoing and more mature business.

The funds are provided for acquiring and revitalizing an existing product line or

division of a major business. MBO (Management buyout) has low risk as

enterprise to be bought have existed for some time besides having positive cash

flow to provide regular returns to the venture capitalist, who structure their

investment by judicious combination of debt and equity. Of late there has been a

gradual shift away from start up and early finance towards MBO opportunities.

This shift is because of lower risk than start up investments.

Turnaround Finance

It is rare form later stage finance which most of the venture capitalist avoid

because of higher degree of risk. When an established enterprise becomes sick, it

needs finance as well as management assistance for a major restructuring to

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revitalize growth of profits. Unquoted company at an early stage of development

often has higher debt than equity; its cash flows are slowing down due to lack of

managerial skill and inability to exploit the market potential. The sick companies

at the later stages of development do not normally have high debt burden but lack

competent staff at various levels. Such enterprises are compelled to relinquish

control to new management. The venture capitalist has to carry out the recovery

process using hands on management in 2 to 5 years. The risk profile and

anticipated rewards are akin to early stage investment.

Bridge Finance

It is the pre-public offering or pre-merger/acquisition finance to a company. It is

the last round of financing before the planned exit. Venture capitalist help in

building a stable and experienced management team that will help the company

in its initial public offer. Most of the time bridge finance helps improves the

valuation of the company. Bridge finance often has a realization period of 6

months to one year and hence the risk involved is low. The bridge finance is paid

back from the proceeds of the public issue.

CHAPTER 3

VENTURE CAPITAL INVESTMENT PROCESS

Venture capital investment process is different from normal project financing. In

order to understand the investment process a review of the available literature on

venture capital finance is carried out. Tyebjee and Bruno in 1984 gave model of

venture capital investment activity with some variations is commonly used

presently. As per this model this activity is a five step process as follows:

1. Deal Organization

2. Screening

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3. Evaluation or due Diligence

4. Deal Structuring

5. Post Investment Activity and Exit

Deal Origination:

In generating a deal flow, the VC investor creates a pipeline of deals or

investment opportunities that he would consider for investing in. deal may

originate in various ways. Referral system, active search system,

intermediaries. Referral system is an important source of deals. Deals may be

referred to VCFs by their parent organizations, trade partners, indu

associations, friends etc. Another deal flow is active search through networks,

trade fairs, conferences, seminars, foreign visits etc. intermediaries is used by

venture capitalists in developed countries like USA, is certain intermediaries who

match VCFs and the potential entrepreneurs.

Screening:

VCFs, before going for an in-depth analysis, carry out initial screening of all

projects on the basic of some broad criteria. For example, the screening process

may limit projects to areas in which the venture capitalist is familiar in terms of

technology, or product, or market scope. The size of investment, geographical

location and stage of financing could also be used as the broad screening criteria.

Due Diligence:

Due diligence is the industry jargon for all the activities that are associated with

evaluating an investment proposal. The Venture capitalists evaluate the quality of

entrepreneur before appraising the characteristics of the product, market or

technology. Most venture capitalists ask for a business plan to make an

assessment of the possible risk and return on the venture. Business plan contains

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detailed information about the proposed venture. The evaluation of ventures by

VCFs in Indian includes; Preliminary evaluation: the applicant required to

provide a brief profile of the proposed venture to establish prima facie eligibility.

Detailed evaluation: once the preliminary evaluation is over, the proposal is

evaluated in greater detail. VCFs in India expect the entrepreneur to have: -

integrity, long-term vision, urge to grow, managerial skills, commerci

orientation.

VCFs in India also make the risk analysis of the proposed projects which

includes: product risk, market risk, technological risk and entrepreneurial risk.

The final decision is taken in terms of the expected risk-return trade-off as shown

in figure.

Deal Structuring:

In this process, the venture capitalist and the venture company negotiate the

terms of the deals, that are the amount form and price of the investment. This

process is termed as deal structuring. The agreement also include the venture

capitalists right to control the venture company and to change its management if

needed, buyback arrangement specify the entrepreneurs equity share and the

objectives share and the objectives to be achieved.

Post Investment Activities:

Once the deal has been structured and agreement finalized, the venture capitalist

generally assumes the role of a partner and collaborator. He also gets involved in

shaping of the direction of the venture. The degree of the venture capitalists

involvement depends on his policy. It may not, however be desirable for a

venture capitalist to get involved in the day-to-day operation of the venture. If a

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financial or managerial crisis occurs, the venture capitalist may intervene, and

even install a new management team.

Exit:

Venture capitalists generally want to cash-out their gains in five to ten years after

the initial investment. They play a positive role in directing the company towards

particular exit routes. A venture may exist in one of the following ways:

There are four ways for a venture capitalist to exit its investment:

Initial Public Offer (IPO)

Acquisition by another company

Re-purchase of venture capitalists share by the investee company

Purchase of venture capitalists share by a third party

Promoters Buy-back

The most popular disinvestment route in India is promoters buy-back. This route

is suited to Indian conditions because it keeps the ownership and control of the

promoter intact. The obvious limitation, however, is that in a majority of cases

the market value of the shares of the venture firm would have appreciated so

much after some years that the promoter would to be in a financial position to

buy them back.

In India, the promoters are invariably given the first option to buy back equity of

their enterprise. For example, RCTO participates in the assisted firms equity

with suitable agreement for the promoter to repurchase it. Similarly, Confina-

VCF offers an opportunity to the promoters to buy back the shares of the assisted

firm within an agreed period at a predetermined price. If the promoter fails to buy

back the shares within the stipulated period, Confine-VCF would have the

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discretion to divest them in any manner it deemed appropriate. SBI capital

Markets ensures through examining the personal assets of the promoters and their

associates, which buy back, would be a feasible option. GV would make

disinvestment, in consultation with the promoter, usually after the project has

settled down, to a profitable level and the entrepreneur is in a position to avail of

finance under conventional schemes of assistance from banks or other financial

institutions.

Initial Public Offers (IPOs)

The benefits of disinvestments via the public issue route are imp

marketability and liquidity, better prospects for capital gains and widely known

status of the venture as well as market control through public share participation.

This option has certain limitations in the Indian context. The promotion of the

public issue would be difficult and expensive since the first gener

entrepreneurs are not known in the capital markets. Further, difficulties will be

caused if the entrepreneurs business is perceived to be an unattractive investment

proposition by investors. Also, the emphasis by the Indian investors on short-

term profits and dividends may tend to make the market price unattractive. Yet

another difficulty in India until recently was that the Controller of Capital Issues

(CCI) guidelines for determining the premium on shares took into account the

book value and the cumulative average EPS till the date of the new issue. This

formula failed to give due weight age to the expected stream of earning of theventure firm. Thus, the formula would underestimate the premium.

government has now abolished the Capital Issues Control Act, 1947 and

consequently, the office of the controller of Capital Issues. The exis

companies are now free to fix the premium on their shares. The initial public

issue for disinvestments of VCFs holding can involve high transaction costs

because of the inefficiency of the secondary market in a country like India. Also,this option has become far less feasible for small ventures on account of the

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higher listing requirement of the stock exchanges. In February 1989, the

Government of India raised the minimum capital for listing on the stock

exchanges from Rs 10 million to Rs 30 million and the minimum public offer

from Rs 6 million to Rs 18 million.

Sale on the OTC Market

An active secondary capital market provides the necessary impetus to the success

of the venture capital. VCFs should be able to sell their holdings, and investors

should be able to trade shares conveniently and freely. In the USA, there exist

well-developed OTC markets where dealers trade in share on telephone/terminal

and not on an exchange floor. This mechanism enables new, small companies

which are not otherwise eligible to be listed on the stock exchange, to enlist on

the OTC markets and provides liquidity to investors. The National Association of

Securities dealers Automated Quotation System (NASDAQ) in the USA daily

quotes over 8000 stock prices of companies backed by venture capital.

The OTC Exchange in India was established in June 1992. The Government of

India had approved the creation for the Exchange under the Securities Contracts

(Regulations) Act in 1989. It has been promoted jointly by UTI, ICICI, SBI

Capital Markets, Can Bank Financial Services, GIC, LIC and IDBI. Since this list

of market-makers (who will decide daily prices and appoint dealers for trading)

includes most of the public sector venture financiers, it should pick up fast, and it

should be possible for investors to trade in the securities of new small and

medium size enterprise.

The other disinvestment mechanisms such as the management buy outs or sale to

other venture funds are not considered to be appropriate by VCFs in India.

The growth of an enterprise follows a life cycle as shown in the diagram below.

The requirements of funds vary with the life cycle stage of the enterprise. Even

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before a business plan is prepared the entrepreneur invests his time and resources

in surveying the market, finding and understanding the target customers and their

needs. At the seed stage the entrepreneur continue to fund the venture with his

own fund or family funds. At this stage the funds are needed to solicit the

consultants services in formulation of business plans, meeting potenti

customers and technology partners. Next the funds would be required for

development of the product/process and producing prototypes, hiring key people

and building up the managerial team. This is followed by funds for assembling

the manufacturing and marketing facilities in that order. Finally the funds are

needed to expand the business and attaint the critical mass for profit generation.

Venture capitalists cater to the needs of the entrepreneurs at different stages of

their enterprises. Depending upon the stage they finance, venture capitalists are

called angel investors, Venture capitalist or private equity supplier/investor.

CHAPTER4

METHODS OF VENTURE FINANCING

Venture Capital is typically available in three forms in India, they are:

Equity: All VCFs in India provide equity but generally their contribution

does not exceed 49% of the total equity capital. Thus, the effective control

and majority ownership of the firm remains with the entrepreneur. Theybuy shares of an enterprise with an intention to ultimately sell them off to

make capital gains.

Conditional Loan: it is repayable in the form of a royalty after the venture

is able to generate sales. No interest is paid on such loans. In India, VCFs

change royalty ranging between 2% to 15%; actual rate depends on other

factors of the venture such as gestation period, cost flow patterns, riskiness

and other factors of the enterprise.

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Income Note: it is a hybrid security which combines the features of both

conventional loan and conditional loan. The entrepreneur has to pay both

interest and royalty on sales, but at substantially low rates.

Participating Debenture: such security carries charges in 3 phases. In the

start up phase, before the venture attains operations to a minimum level, no

interest is charged, after this, low rate of interest is charged, up to a

particular level of operation. Once the venture is commercial, a high rate of

interest is required to be paid.

Quasi Equity: quasi equity instruments are converted into equity at a later

date. Convertible instruments are normally converted into equity at the

book value or at certain multiple of EPS, i.e. at a premium to par value at a

later date. The premium automatically rewards the promoter for their

initiative and hand work. Since it is performance related, it motivates the

promoter to work harder so as to minimize dilution of their control on the

company. The different quasi equity instruments are follows:

o Cumulative convertible preference shares.

o Partially convertible debentures.

o Fully convertible debentures.

Other Financing methods: a few venture capitalists, particularly in the

private sector, have started introducing innovative financial securities like

participating debentures, introduced by TCFC is an example.

CHAPTER 5

EVOLUTION OF VENTURE CAPITAL INDUSTRY

IN INDIA

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The first major analysis on risk capital for India was reported in 1983. It

indicated that new companies often confront serious barriers to entry into capital

market for raising equity finance which undermines their future prospects of

expansion and diversification. It also indicated that on the whole there is a need

to review the equity cult among the masses by ensuring competitive return on

equity investment. This brought out the institutional inadequacies with respect to

the evolution of venture capital.

In India, the Industrial Finance Corporation of India (IFCO) initiated the idea of

Venture Capital when it established the Risk Capital Foundation in 1975 to

provide seed capital to small and risky projects. However the concept of venture

capital financing got statutory recognition for the first time in the fiscal budget

for the year 1986-87.

The venture Capital companies operating at present can be divided into four

groups:

Promoted by All-India Development Financial Institutions

Promoted by State Level Financial Institutions

Promoted by Commercial Banks

Private Venture Capitalists.

Promoted by all India Development Financial Institutions

The IDBI started a Venture Capital in 1976 as per the long term fiscal policy of

government of India, with an initial of Rs. 10 Cr. which raised by imposing a

chess of 5% on all payment made for the import of technology know-how

projects requiring funds from Rs.5 Lacks to Rs.2.5Cr. Were considered for

financing. Promoters contribution ranged from this fund was available at a

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concessional interest rate of 9% (during gestation period) which could be

increased at later stages.

The ICICI provided the required impetus to Venture Capital activities in India,1986 it started providing venture Capital finance in 1998 it promoted, along with

the Unit trust of India (UTI) Technology Development and information Company

of India (TDICI) as first venture Capital company registered under the companies

act, 1956. The TDICI may provide financial assistance to venture capital

undertaking which are set up by technocrat entrepreneurs, or technol

information and guidance services.

The risk capital foundation established by the industrial finance corporation of

India (IFCI) in 1975, was converted in 1988 into the Risk Capital

Technology Finance Company (RCTC) as a subsidiary company of the IFCI the

rate provides assistance in the form of conventional loans, interest

conditional loans on profit and risk sharing basis or equity participation in

extends financial support to high technology projects for technological up

gradations. The RCTC has been renamed as IFCI Venture Capital Funds Ltd.

(IVCF)

Promoted by State Level Financial Institutions

In India, the State Level Financial Institutions in some states such as Madhya

Pradesh, Gujarat, Uttar prades, etc., have done an excellent job and have

provided venture capital to a small scale enterprise. Several succes

entrepreneurs have been the beneficiaries of the liberal funding environment. In

1990, the Gujarat Industrial Investment Corporation, promoted the Gujarat

Venture Financial Ltd (GVFL) along with other promoters such as the IDBI, the

World Bank, etc., the GVFL provides financial assistance to business in the form

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of equity, conditional loans or income notes for technologies development and

innovative products. It also provides finance assistance to entrepreneurs.

The government of Andhra Pradesh has also promoted the Andhra PradeshIndustrial Development Corporation (APIDC) venture capital ltd. to provide

venture capital financing in Andhra Pradesh.

Promoted by Commercial Banks

Canbank Venture Capital Fund, State bank Venture Capital Fund and Grindlays

bank Venture Capital Fund have been set up the respective commercial banks toundertake venture capital activities.

The State bank Venture Capital funds provides financial assistance for bought out

deal as well as new companies in the form of equity which it disinvests after the

commercialization of the project.

Canbank Venture Capital Funds provides financial assistance for proven but yetto be commercially exploited technologies. It provides assistance both in the form

of equity and conditional loans.

Private venture Capital Funds

Several private sector venture capital funds have been established in India such as

the 20th

Centure Venture Capital Company, Indus venture capital Funds

Infrastructure Leasing and financial Services Ltd.

Some of the companies that have received funding through this route include:

o Mastek, one of the oldest software house in India

o Ruskan software, Pune based software consultancy

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o SQL Star, Hyderabad based training and software developmen

consultancy

o Satyam Infoway, the first private ISP in India

o Hinditrom, makers of embedded software

o Selectia, provider of interaction software selectior

o Yantra, ITL Infosys US subsidiary, solution for supply chain management

o Rediff on the Net, India website featuring electronic shopping, news, chat

etc.

OBJECTIVE AND VISION FOR VENTURE

CAPITAL IN INDIA

Venture capitalists finance innovation and ideas which have potential for high

growth but with inherent uncertainties. This makes it a high-risk, high return

investment. Apart from finance, venture capitalists provide networking

management and marketing support as well. In the broadest sense, therefore,

venture capital connotes financial as well as human capital. In the global venture

capital industry, investors and investee firms work together closely in an enabling

environment that allows entrepreneurs to focus on value creating ideas and

allows venture capitalists to drive the industry through ownership of the levers of

control, in return for the provision of capital, skills, information

complementary resources. This very blend of risk financing and hand holding of

entrepreneurs by venture capitalists creates an environment particularly suitable

for knowledge and technology based enterprises.

Scientific, technology and knowledge based ideas properly supported by venture

capital can be propelled into a powerful engine of economic growth and wealth

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creation in a sustainable manner. In various developed and developing economies

venture capital has played a significant developmental role. India, along with

Israel, Taiwan and the United States, is recognized for its globally competitive

high technology and human capital. India has the second largest English speaking

scientific and technical manpower in the world.

The Indian software sector crossed the Rs 100 billion mark turnover during 1998.

The sector grew 58% on a year to year basis and exports accounted for Rs 65.3

billion while the domestic market accounted for Rs 35.1 billion. Exports grew by

67% in rupee terms and 55% in US dollar terms. The strength of software

professionals grew by 14% in 1997 and has crossed 1, 60000. The global

software sector is expected to grow at 12% to 15% per annum for the next 5 to 7

years.

Recently, there has also been greater visibility of Indian companies in the US.

Given such vast potential not only in IT and software but also in the field of

service industries, biotechnology, telecommunications, media and entertainment,

medical and health services and other technology based manufacturing and

product development, venture capital industry can play a catalytic role to put

India on the world map as a success story.

2009 VENTURE CAPITAL INVESTMENT IN INDIA

Venture Capital firms invested $475 million in 92 deals during 2009, down from

the $836 million invested across 153 deals in the previous year, according to a

study by Venture Intelligence and Global-India Venture Capital Association.

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Venture capital firms, however, began to increase the pace of their investments in

Indian companies in the October-December quarter, making 42 investments

worth $265 million, compared to 23 investments worth $102 million in the

comparative period a year earlier, the study said.

"The strong recovery in investment activity in the last quarter of 2009, as well the

rising interest among global investors towards emerging markets like India, is

quite encouraging for the growth of the sector," Sudhir Sethi, director of the

Global-India Venture Capital Association, said in a statement.

"During 2010, we expect significant follow-on investments into companies that

raised Series a round (first round) in the past two to three years as well as a rise in

exit activity as the global economic recovery gathers pace," he added.

NEED FOR GROWTH OF VENTURE CAPITAL IN

INDIA

People in developing countries are poor in part because they have far less capital

than people in industrial countries. Because of this shortage, workers have little

in the way of specialized machinery and equipment, and firms lack money to

obtain more equipment. As a result, productivity of workers in developing

countries is low compared with that of workers in industrial countries. Financial-

resource flows from industrial to developing countries are an obvious means toovercome this inequality. But financial resources are not enough. So

developing countries have natural resources such as oil or minerals that, when

sold on world markets, have provided large amounts of money. In many cases the

money has failed to stimulate sustained economic growth or increa

productivity and income for the average person. In part, failure to use capital

productively results from the way these resources flow. In some countries the

government gets the money, which it uses to perpetuate itself through military

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spending or through increased consumption spending. In other cases, resources

flow to wealthy individuals who use them to maintain high levels of conspicuous

consumption.

India is still developing country. In India, a revolution is ushering in a new

economy, wherein entrepreneurs mind set is taking a shift from risk adverse

business to investment in new ideas which involve high risk. The conventional

industrial finance in India is not of much help to these new emerging enterprises.

Therefore there is a need of financing mechanism that will fit with the

requirement of entrepreneurs and thus it needs venture capital industry to grow in

India.

Few reasons for which active Venture Capital Industry is important for India

include:

Innovation: Needs risk capital in a largely regulated, conservation, legacy

financial system

Job Creation: large pool of skilled graduates in the first and second tier

cities

Patient capital: Not flighty, unlike FIIs

Creating new Industry Clusters: Media, Retail, Call Centers and back

office processing, trickling down to organized effort of support services like

Office services, Catering, Transportation.

CHAPTER 6

REGULATORY AND LEGAL FRAMEWORK

At present, the Venture Capital activity in India comes under the purview of

different sets of regulations namely:

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The SEBI (Venture Capital Funds) Regulation, 1996[Regulations] lays

down the overall regulatory framework for registration and operations

of venture capital funds in India.

The Indian Trust Act, 1882 or the company Act, 1956 depending on

whether the fund is set up as a trust or a company.

The foreign investment Promotion Board (FIPB) and the RBI in case of

an offshore fund. These funds have to secure the permission of the

FIPB while setting up in India and need a clearance from the RBI for

any repatriation of income.

The Central Board of Direct Taxation (CBDT) governs the issues

pertaining to income tax on the proceed from VC funding activity. The

long term capital gain tax is at around 10% in India and the relevant

clauses to VC may be found in Section 10(sub section 23)

Overseas venture capital investments are subject to the Government of

India Guidelines for Overseas Venture Capital Investment in India

dated September 20, 1995.

For tax exemptions purposes venture capital funds also needs to comply

with the Income Tax Rules made under Section 10(23FA) of the

Income Tax Act.

MAJOR REGULATORY FRAMEWORKS FOR

VENTURE CAPITAL INDUSTRY

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Major Regulatory frameworks for venture capital industry

In addition to the above, offshore funds also require FIPB/RBI approval for

investment in domestic funds as well as in Venture Capital Undertakings (VCU).

Domestic funds with offshore contributions also require RBI approval for the

pricing of securities to be purchased in VCU likewise, at the ti

disinvestment, RBI approval is required for the pricing of the securities.

Definition of venture capital fund: The Venture Capital Fund is now defined s

a fund established in the form of a Trust, a company including a body corporate

and registered with SEBI which:

Has a dedicated pool of capital;

Raised in the manner specified under the regulations; and

To invest in venture capital undertaking in accordance with the regulation.

Definition of Venture Capital Undertaking: Venture Capital Undertaking

means a domestic company:-

Whose share are not listed on a recognized stock exchange in India

Which is engaged in business including such activities or sectors which are

specified in the negative list by the Board with the approval of the Central

SEBI (VCF) Reg.1996

SEBI(FVCI)Reg.2000

SCR Act.1956

SEBI(SAST)Reg.1997

SEBI(DIP)Guidelines,2000

SEBI Act,1992

FEMA,1999

Transfer or issueof security by aperson residentoutside Indiaregulation 2000

FDIpolicy

Investment approvals

PressNotes

IT Act, 1961

DTAA

Singapore

Mauritius

Others

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Government by notification in the Official Gazette in this behalf? The

negative list includes real estate, non-banking financial services, gold

financing, activities not permitted under the Industrial Policy of the

Government of India.

Minimum contribution and fund size: the minimum investment in a Venture

Capital Fund from any investor will not be less than Rs.5 lacks and the minimum

corpus of the fund before the fund can start activities shall be at least Rs.5 corers.

Investment Criteria: The earlier investment criterion has been substituted by

new investment criteria which has the following requirements:

Disclosure of investment strategy;

Maximum investment in single venture capital undertaking not to exceed

25% of the corpus of the fund;

Investment in the associated companies not permitted;

At least 75% of the investible funds to be invested in unlisted equity sharesor equity linked instruments;

Not more than 25% of the investible funds may be invested by way of;

o Subscription to initial public offer of a venture capital undertaking

whose shares are proposed to be listed subject to lack in period of

one year;

o Debt or debt instrument of a venture capital undertaking in which

the venture capital funds has already made an investment by way of

equity.

It has also been provided that Venture Capital Fund seeking to avail benefit under

the relevant provisions of the Income Tax Act will be required to divest from the

investment within a period of one year from the listing of the Venture Capital

Undertaking.

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Disclosure and Information to Investors: in order to simplify and expedite the

process of fund raising, the requirement of filing the Placement memorandum

with SEBI is dispensed with and instead the fund will be required to submit a

copy of Placement Memorandum/ copy of contribution agreement entered to with

the investors along with the details of the fund raiser for information to SEBI.

Further, the contents of the Placement Memorandum are strengthened to provide

adequate disclosure and information to investors. SEBI will also prescribe

suitable reporting requirement from the fund on their investment activity.

QIB status for Venture Capital funds: the venture capital funds will be eligible

to participate in the IPO through book building route as qualified Institutional

Buyer subject to compliance with the SEBI (Venture Capital Fund) Regulations.

Relaxation in Takeover Code: the acquisition of share by the company or any

of the promoters from the Venture Capital Funds under the terms of agreement

shall be treated on the same footing as that of acquisition of shares by

promoters/companies from the state level financial institutions and shall be

exempt from making an open offer to other shareholders.

Investment by Mutual Funds in Venture capital Funds: in order to increase

the resources for domestic venture capital funds, Mutual Funds are permitted to

invest up to 5% of its corpus in the case of open ended schemes and up to 10% of

its corpus in the case of close ended schemes. A part from raising the resources

for Venture Capital Funds this would provide an opportunity to small investors to

participate in venture capital activities through Mutual funds.

Government of India Guidelines: the Government of India (MOF) Guidelines

for Overseas Venture Capital Investment in India dated September20, 1995 will

be repealed by the MOF on notification of SEBI Venture Capital Fun

Regulations.

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The following will be the salient features of SEBI (foreign Venture Capital

Investors) Regulations, 2000:

Definition of Foreign Venture capital Investor: any entity incorporated andestablished outside India and proposes to make investment in Venture Capital

Fund or Venture Capital Undertaking and registered with SEBI.

Eligibility Criteria: entity incorporated and established outside India in the form

of Investment Company, Trust, Partnership, Pension Fund, Mutual Fun

University Fund, Endowment Fund, Asset Management Company, Investment

Manager, Investment Management Company or other Investment Vehicle

Incorporated outside India would be eligible for seeking registration from SEBI.

SEBI for the purpose of registration shall consider whether the applicant is

regulated by an appropriate foreign regulatory authority; or is income tax payer;

or submits a certificate from its banker of its or its promoters, track record where

the applicant is neither a regulated entity nor an income tax payer.

Investment Criteria:

Disclosure of investment strategy;

Maximum investment in single venture capital undertaking not to exceed

25% of the funds committed for investment to India however it can

invest its total fund committed in one venture capital fund;

Atleast 75% of the investible funds to be invested in unlisted equity shares

or equity linked instruments.

Not more than 25%of the investible funds may be invested by way of:

o Subscription to initial offer of a venture capital undertaking whose

shares are proposed to be listed subject to lock in period of one

year;

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o Debt or debt instrument of a venture capital undertaking in which

the venture capital funds has already made an investment by way

of equity.

Hassle Free Entry and Exit: the Foreign Venture Capital Investors proposing to

make venture capital investment under the Regulations would be granted

registration by SEBI. SEBI Registered Foreign Venture Capital Investors shall be

permitted to make investment on an automatic route within the overall sectoral

ceiling of foreign investment under Annexure III of statement of Industrial Policy

without any approval from FIPB. Further, SEBI registered FVCIs shall be

granted a general permission from the exchange control angle for inflow and

outflow of funds and no prior approval of RBI would be required for pricing,

however, there would be export reporting requirement for the amount transacted.

Trading in Unlisted Equity: the board also approved the proposal to permit

OTCEI to develop a trading window for unlisted securities where Qualified

Institutional Buyers (QIB) would be permitted to participate.

REGULATION OF THE BUSINESS OF VENTURE

CAPITAL FUND IN INDIA

Eligibility conditions for grant of license to a venture capital fund.-

(1) A venture capital fund shall not be granted license unless it fulfills the

following conditions, namely:-

a) It is incorporated as a company under the Companies Ordinance, 1984

(XLVII of 1984);

b) It is not engaged in any business other than that of investment in venture

projects;

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c) It has a minimum paid-up capital of fifty million rupees raised through

private placement; and

d) For the purpose of managing its entire business, it has entered into a

contract, in writing, with a venture capital company and a copy of which

has been filed with the Commission.

(2) The board of venture capital fund shall not have a director, who is on the

board of any venture project being financed by the fund.

Condition for grant of license.-

(1) No venture capital fund shall commence business unless a license is granted

under these rules.

(2) For obtaining a license a venture capital fund shall

a. Make an application to the Commission on Form V providing

information as sought in Annex therein, along with all the relevantdocuments;

b. Submit a bank draft payable to the Commission evidencing the

payment of non-refundable application processing fee amounting to

fifty thousand rupees; and

c. Submit an undertaking that no change in the memorandum and

articles of association and in the directors shall be made withoutprior written authorization of the Commission and that all conditions

for grant of license shall be complied with.

(3) On being satisfied that a venture capital fund is eligible for the grant of a

license and that it would be in the public interest so to do, the Commission may

grant a license in form VI.

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(4) Without prejudice to any other conditions under these rules, the Commission

may while granting license imposes any conditions, as it may deem necessary.

Terms and conditions of operation. - Unless granted a general orspecific waiver by the Commission, a venture capital fund shall

a. Not expose more than forty per cent of its equity to any single group

of companies; Explanation. - For the purposes of this rule group of

companies shall mean companies managed by the members of one

family including spouse, dependent lineal ascendants and

descendants and dependent brothers and sisters.

b. Disclose in its accounts all investments in companies and group of

companies exceeding ten per cent of paid-up capital of venture

capital fund;

c. ensure that the maximum exposure of the venture capital fund to its

directors, affiliated companies and companies in which any of the

directors and their family members including spouse, dependent

lineal ascendants and descendants and dependent brothers and sisters

hold controlling interest shall not exceed ten per cent of the overall

portfolio of venture capital; and

d. Not accept any investment from any investor, which is less than one

million rupees.

Renewal of license.

(1) The license granted to the fund under rule 10 shall be valid for one year and

shall be renewable annually on payment of a fee of twenty thousand rupees on an

application being made on Form VII.

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(2) The Commission may, after making such inquiry and after obtaining such

further information as it may consider necessary, renew the license of such fund,

one year on Form VIII on such conditions as it may deem necessary.

Private placement.-

A venture capital fund shall raise and receive monies for investment in venture

projects through private placement of such securities as may be notified by the

Commission, from time to time.

Placement memorandum.-

A venture capital fund shall, before soliciting placement of its securities, file with

the Commission a placement memorandum which shall inter alia give details of

the terms subject to which monies are proposed to be raised from such

placements.

CHAPTER 7

KEY SUCCESS FACTOR FOR VENTURE

CAPITAL INDUSTRY IN INDIA

Knowledge becomes the key factor for a competitive advantage for company.

Venture Capital firms need more expert knowledge in various fields. The various

key success factors for venture capital industry are as follow:

Knowledge about Govt. changing policies:

Investment, management and exit should provide flexibility to suit the business

requirements and should also be driven by global trends. Venture capital

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investments have typically come from high net worth individuals who have risk

taking capacity. Since high risk is involved in venture financing, venture

investors globally seek investment and exit on very flexible terms which provides

them with certain levels of protection. Such exit should be possible through IPOs

and mergers/acquisitions on a global basis and not just within India. In this

context the judgment of the judiciary raising doubts on treatment of tax on capital

gains made by firms registered in Mauritius gains significance - changing

policies with a retrospective effect is undoubtedly acting as a dampener to fresh

fund raising by Venture capital firms.

Quick Response time :

The companies have flat organization structure results in quicker decision

making. The entrepreneur is relieved of the trauma that one normally goes

through in an interface with a funding institution or a development agency. They

follow a clearly defined decision making process that works with clock like

precision, which means that if they agree on a funding schedule entrepreneur can

count on them to stick it.

Knowledge about Global Environment

With increasing global integration and mobility of capital it is important that

Indian venture capital firms as well as venture financed enterprises be able to

have opportunities for investment abroad. This would not only enhance their

ability to generate better returns but also add to their experience and expertise to

function successfully in a global environment.

Good Human Resource :

Venture capital should become an institutionalized industry financed an

managed by successful entrepreneurs, professional and sophisticated investors.

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Globally, venture capitalist are not merely finance providers but are also closely

involved with the investee enterprises and provide expertise by way

management and marketing support. This industry has developed its own ethos

and culture. Venture capital has only one common aspect that cuts across

geography i.e. it is risk capital invested by experts in the field. It is important that

venture capital in India be allowed to develop via professional and institutional

management.

Regulatory policy

Minimum contribution and fund size: the minimum investment in a Venture

Capital Fund from any investor will not be less than Rs. 5 lacs and the minimum

corpus of the fund before the fund can start activities shall be at least Rs. 5 crores.

And the foreign players can easily enter in the venture capital industry of India.

An offshore venture capital company may contribute 100% of the capital of

domestic venture capital fund. There are other hurdles to enter in the industry so

there is favorable condition for them to enter in to venture capital industry in

India.

CHAPTER 7

CHALLENGES AHEAD FOR VENTURE CAPITAL

FINANCING IN INDIA

Venture Capital is money provided by professionals who invest and manage

young rapidly growing companies that have the potential to develop into

significant economic contributors. According to SEBI regulations, venture capital

fund means a fund established in the form of a company or trust, which raisesmoney through loans, donations, issue of securities or units and makes or

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proposes, to make investments in accordance with these regulations. The funds so

collected are available for investment in potentially highly profitable enterprises

at a high risk of loss. A Venture Capitalist is an individual or a company who

provides. Investment Capital, Management Expertise, Networking & marketing

support while funding and running highly innovative & prospective areas of

products as well as services.

Thus, the investment made by Venture Capitalists generally involves

o Financing new and rapidly growing companies.

o Purchasing equity securities.

o Taking higher risk in expectation of higher rewards.

o Having a long frame of time period, generally of more than 5 - 6 years.

o Actively working with the company's management to devise strategies

pertaining to the overall functioning of the project.

o Networking and marketing of the product /service being offered.

In an attempt to bring together highly influential Indians living across the United

States, a networking society named IND US Entrepreneurs or TiE was set up in

1992. The aim was to get the Indian community together and to foster

entrepreneurs for wealth creation. A core group of 10 - 15 individuals worked

hard to establish the organization. The group (TiE) has now over 600 members

with 20 offices spread across the United States. Some of the famous personalities

belonging to this group are Vinod Dham (father of the Pentium Chip), Prabhu

Goel, and K.B. Chandrashekhar (Head of $ 200 mn. Exodus Communications, a

fibre optic network carrying 30% of all Internet content traffic hosting websites

like Yahoo, Hotmail and Amazon.)

PROBLEMS OF VENTURE CAPITAL FINANCING

IN INDIA:

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VCF is in its nascent stages in India. The emerging scenario of g

competitiveness has put an immense pressure on the industrial sector to improve

the quality level with minimization of cost of products by making use of latest

technological skills. The implication is to obtain adequate financing along with

the necessary hi-tech equipments to produce an innovative product which can

succeed and grow in the present market condition. Unfortunately, our country

lacks on both fronts. The necessary capital can be obtained from the venture

capital firms who expect an above average rate of return on the investment. The

financing firms expect a sound, experienced, mature and capable management

team of the company being financed. Since the innovative project involves a

higher risk, there is an expectation of higher returns from the project. The

payback period is also generally high (5 - 7 years). The various problems/ queries

can be outlined as follows:

o Requirement of an experienced management team.

o Requirement of an above average rate of return on investment.

o Longer payback period.

o Uncertainty regarding the success of the product in the market.

o Questions regarding the infrastructure details of production like plant

location, accessibility, relationship with the suppliers and creditors

transportation facilities, labor availability etc.

o The