vcpe industry in india

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Dayalbagh Educational Institute, Agra

2012-14

Venture capital andPrivate equity Industry in

IndiaVenture capital funding for social enterprises

Neeraj sajwan


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1 Venture Capital and Private Equity Industry in India

Faculty of Social Sciences - Dayalbagh Educational Institute Page 1

Acknowledgement

“No Learning is proper and effective without Proper Guidance”

Every study is incomplete without having a well plan and concrete exposure to the

student. Management studies are not exception. Scope of the project at this level is

very wide ranging. On the other hand it provide sound basis to adopt the theoretical

knowledge and on the other hand it gives an opportunities for exposure to real time

situation.

This study is an internal part of our MBA program and to do this project in a short

period was a heavy task.

Intention, dedication, concentration and hard work are very much essential to

complete any task. But still it needs a lot of support, guidance, assistance, co-

operation of people to make it successful.

I bear to imprint of my people who have given me, their precious ideas and times to

enable me to complete the research and the project report. I want to thanks them for

their continuous support in my research and writing efforts.

I wish to record my thanks and indebtedness to Miss Reena Ahuja, whose

inspiration, dedication and helping nature provided me the kind of guidance

necessary to complete this project.

I would also like to acknowledge my parents and my batch mates for their

guidance and blessings.


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EXECUTIVE SUMMARY

2009, the year, which shook the entire globe, left an unforgettable impression on the

history of the financial world. Even though India is predominantly a domestic

consumption driven economy, it suffered from global volatility and uncertainty.

During the year, there has been a slowdown in the economy across the board.

The Indian banking system has shown remarkable growth over the last two decades.

The rapid growth and increasing complexity of the financial markets, especially the

capital market have brought about measures for further development and

improvement in the working of these markets.

Venture capital is money provided by professionals who invest alongside

management in young, rapidly growing companies that have the potential to develop

into significant economic contributors. Venture capital is an important source of

equity for start-up companies. There are basically four key elements in financing of

ventures which are studied in depth by the venture capitalists stated as

Management, Potential for Capital Gain, Financial requirements & Projections and

Owner’s Financial Stake.

The growth drivers on Venture Industry would be:

• Development of Technology especially IT and Communication

• Development of Financial Markets

• Development of political climate for the economy, globalization

In India, however, the potential of venture capital investments is yet to be fully

realized. There are around thirty venture capital funds, which have garnered over Rs.

5000 Crore. The venture capital investments in India at Rs. 1000.05 crore as in

1997,representing 0.1 percent of GDP, as compared to 5.5 percent in countries such

as Hong Kong.


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CONTENTS

ACKNOWLEDGEMENT

EXECUIVE SUMMARY

Chapter-1 Introduction

Chapter-2 Objective of the study

Chapter-3 Review of l i terature

Chapter-4 Research Methodology

Chapter-5 Data Analysis and Interpretation

Chapter-6 Conclusion

Chapter-7 Findings and suggestions

Chapter-8 Limitations

Bibliography


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Growth of the Indian VCPE industry

VCPE, made a slow start in India in the late 1960s, encouraged by development

financial institutions such as Industrial Development Bank of India, now merged into

IDBI Bank Ltd, Industrial Finance Corp. of India, which became IFCI Ltd, and

Industrial Credit and Investment Corp. of India Ltd, the earlier avatar of ICICI Bank

Ltd. Technology Development and Investment Corp. of India Ltd, or TDICI, and

Gujarat Venture Finance were also among the pioneers in the venture capital space.

These two institutions are still around with different names— ICICI Venture Funds

Management Co. Ltd and GVFL Ltd, respectively—and three of their earliest

employees are today the oldest still-active private equity fund managers in the

country, all having moved on to larger roles at larger funds.

Over the last few years, India has become one of the leading destinations for

Venture Capital and Private Equity (VCPE) investments. Though the concept of

VCPE investment prevailed in the country in one form or the other since the 1960s,

the growth in the industry was mainly after the economic reforms in 1991. Prior to

that, most of VCPE funding were from public sector financial institutions, and was

characterized by low levels of investment activity.

VC investing activity gained momentum sometime in the mid-1990s which saw the

entry of players such as HSBC Private Equity (Asia), Schroder’s Plc., Warburg

Pincus LIC., CDC Group Plc.(now Actis), Baring Private Equity Partners Group,

Citibank (the PE arm for emerging markets is now CVCI) and many others. Still, the

scale of funds as well as investments continued to be modest.

The contours of the PE industry have changed most significantly over the last 10

years. The scale of investments has also changed dramatically since 2004, when PE

as an asset class started getting significant attention. The years between 1995 and

2000 were the turning points in terms of PE regulations as SEBI (Securities and

Exchange Board of India) introduced VC fund regulations and framed guidelines that

were more conducive to VC/PE. Investors in VC funds, if registered with SEBI were

provided the benefit of single-point taxation for the income generated from

investments.


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The IPO (initial public offering) of Bharti Televentures Ltd (now Bharti Airtel Ltd) in

2002 and the successful divestment by Warburg Pincus which had funded Bharti

changed the “tonnage” of success...in India. For its investment of around $300

million during 1999-2001, it was estimated to have realized over four times its

investment. Until then, while the multiples made by the likes of ICICI Venture and

CDC on their investments ranged between 20 and 50 times, the pile of cash on each

of these investments always ended up being a couple of tens of million dollars as the

initial investments were small.

In recent years, VCPE commitments and investments in India have grown at a rapid

pace. Venture Economics data indicate that during the period 1990 – 99, India’s

ranking was 25 out of 64 and various VCPE fundraised $945.9 million forinvestments in India. But during the next decade, 2000 – 09, India’s ranking rose to

13 out of 90 countries and the funds raised $16,682.5 million for investments in

India. This represents a growth of 1664%over the previous decade. The trend is

even more encouraging for the most recent five year period 2005 – 09,during which

India’s ranking was 10 out of 77 countries, and various funds raised $15,073.6

million for VCPE investments in India. Funds raised during 2005 – 09, represented a

growth rate of 837% as compared to funds raised over the previous five year period2000 – 04.

The growth rate in investments made by various VCPE funds has been equally

strong. During five year period 2004-2008, the industry growth rate in India was the

fastest globally and it rose to occupy the No. 3 slot worldwide in terms of quantum of

investments. The amount invested by VCPE funds grew from US$ 1.8 billion in 2004

to US$22 billion in 2007 before tapering off to US$ 8.1 billion in 2008. During the five

year period ending 2008, VCPE investments in India grew from 0.4% of GDP in 2004

to more than 1.5% of GDP in 2008.

While it is unfortunate to be caught in this unprecedented financial environment, this

will bring in discipline among private equity players on investment processes and

valuations. We had seen unprecedented euphoria and excesses in PE investing in

India during the last three years. At least 70% of investments in private equity over

the past three years is estimated to have gone into PIPEs (private investment in

public equity) and pre-IPO placements. The short- to medium-term growth could be


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significantly lower than that projected at the time of investment and PE funds will

have to work with the management teams to cut costs and bring about operational

improvements to achieve the returns.

What is Venture Capital?

The venture capital investment helps for the growth of innovative entrepreneurships

in India. Venture capital has developed as a result of the need to provide non-

conventional, risky finance to new ventures based on innovative entrepreneurship.

Venture capital is an investment in the form of equity, quasi-equity and sometimes

debt - straight or conditional, made in new or untried concepts, promoted by atechnically or professionally qualified entrepreneur. Venture capital means risk

capital. It refers to capital investment, both equity and debt, which carries substantial

risk and uncertainties. The risk envisaged may be very high may be so high as to

result in total loss or very less so as to result in high gains

Venture capital means many things to many people. It is in fact nearly impossible to

come across one single definition of the concept.

Jane Koloski Morris, editor of the well known industry publication, Venture

Economics, defines venture capital as 'providing seed, start-up and first stage

financing' and also 'funding the expansion of companies that have already

demonstrated their business potential but do not yet have access to the public

securities market or to credit oriented institutional funding sources.

The European Venture Capital Association describes it as risk finance for

entrepreneurial growth oriented companies. It is investment for the medium or long

term return seeking to maximize medium or long term for both parties. It is a

partnership with the entrepreneur in which the investor can add value to the

company because of his knowledge, experience and contact base.

Venture capital is money provided by professionals who invest alongside

management in young, rapidly growing companies that have the potential to develop

into significant economic contributors. Venture capital is an important source of

equity for start-up companies. Professionally managed venture capital firms


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generally are private partnerships or closely-held corporations funded by private and

public pension funds, endowment funds, foundations, corporations, wealthy

individuals, foreign investors, and the venture capitalists themselves.

Venture capitalists generally:

Finance new and rapidly growing companies

Purchase equity securities

Assist in the development of new products or services

Add value to the company through active participation

Take higher risks with the expectation of higher rewards

Have a long-term orientation

When considering an investment, venture capitalists carefully screen the technical

and business merits of the proposed company. Venture capitalists only invest in a

small percentage of the businesses they review and have a long-term perspective.

They also actively work with the company's management, especially with contacts

and strategy formulation.

Venture capitalists mitigate the risk of investing by developing a portfolio of young

companies in a single venture fund. Many times they co-invest with other

professional venture capital firms. In addition, many venture partnerships manage

multiple funds simultaneously. For decades, venture capitalists have nurtured the

growth of America's high technology and entrepreneurial communities resulting in

significant job creation, economic growth and international competitiveness.

Companies such as Digital Equipment Corporation, Apple, Federal Express,

Compaq, Sun Microsystems, Intel, Microsoft and Genetech are famous examples of

companies that received venture capital early in their development.

Advantages of Venture capital:

• It injects long term equity finance which provides a solid capital base for future

growth.


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• The venture capitalist is a business partner, sharing both the risks and rewards.

Venture capitalists are rewarded by business success and the capital gain.

• The venture capitalist is able to provide practical advice and assistance to the

company based on past experience with other companies which were in similar

situations.

• The venture capitalist also has a network of contacts in many areas that can add

value to the company, such as in recruiting key personnel, providing contacts in

international markets, introductions to strategic partners, and if needed co-

investments with other venture capital firms when additional rounds of financing are

required.

• The venture capitalist may be capable of providing additional rounds of funding

should it be required to finance growth.

Private Equty

Private equity is an asset class consisting of equity securities in operating companies

that are not publicly traded on a stock exchange. Investments in private equity most

often involve either an investment of capital into an operating company or theacquisition of an operating company. Capital for private equity is raised primarily

from institutional investors. There is a wide array of types and styles of private equity

and the term private equity has different connotations in different countries. Typically

these are investments by organizations rather than by individuals. While the investor

is looking for higher than market returns in QuickTime, the company is looking for

large amounts of capital to fund expansion and growth. The fund requirements would

typically be too large and the risks may be high to take the loan route. The company

may also not yet be ready to go public. Private equity investments are typically

against a minority stake (and a seat on the board).

The PE fund can be considered to be a serial investor, who is making a short-term

investment in an established company. As the Indian markets saw a revival, the

country‘s private equity industry got some breathing space. But to succeed, PE

investments must be carefully planned and fully supported with a regional presence

in order to identify attractive potential opportunities and understand competitivethreats to Western companies. Indian equity market witnessed exit by several private


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equity firms and venture capital companies since the rally in equities gathered

momentum.

Overview of current conditions

Global private equity investment showed no significant increase in 2012, continuing

2011's trend towards flat growth. North America was the strongest-performing

market, while activity in Asia fell around 20% over 2011.

India saw deal activity fall from $14.8 billion in 2011 to $10.2 billion in 2012. Thenumber of deals, however, increased from 531 to 551 over this period, highlighting a

fall in average deal size. Not surprising, limited partners (LPs) are showing

increasing caution this year when allocating funds. In fact, 2012saw 55 funds with a

mandate to invest in India, but the total fund value allocated to India was only $3.5

billion, down from $6.8 billion in 2011. All this has been driven by the fact that 2012

was an uncertain year in India both politically and economically. Reported lapses in

governance, coupled with a lack of clarity in regulation, raised considerable concernsabout India's attractiveness as an investment destination. Despite these challenges,

the market is showing signs of maturity with all key stakeholders becoming more

comfortable with the idea of private equity (PE) funding. The latter half of 2012 also

saw the government become more proactive and bring forward some key pieces of

legislation to create greater transparency in the regulatory environment.

Fund-raising

India received only $3.5 billion of the $320 billion funding raised globally in 2012,

according to UK research firm Preqin. General partners (GPs) also adopted a

cautious approach, holding back to observe the performance of existing investments

in a turbulent environment. In 2012, 80% of funding came from overseas investors, a

theme that has been observed since the early days of private equity investment in

India. There are no indicators that this trend will change soon, with traditional

sources of PE capital in India, such as insurance companies and pension funds,

inhibited by regulation from participating in this asset class. Nonetheless, while 2013


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undoubtedly holds several challenges for PE firms, raising capital is unlikely to be

one of them. Our survey reveals that a majority of GPs rate "difficulty raising capital"

as seventh out of 11 challenges, far below concerns such as difficulty in exiting and

mismatch in valuations. What is clear is that GPs will need to differentiate

themselves to attract investors and prove they can deliver. They can do this by

demonstrating a quality track record in investing and exiting.

Deal making

The volume of deals grew only slightly, from 531 in 2011 to 551 in 2012. At 4%, this

increase is very low, in line with the overall mood of caution in the market last year.

This restraint, coupled with a decline in the total funds invested, saw deal size

significantly impacted, with average deal size falling from $28 million in 2011 to

$18.4 million in2012. Early-stage growth and venture capital (VC) have played a

critical role in deal making in 2012, with the number of early-stage deals under $10

million almost doubling to 244. Also, the top 25 deals made up only $4.3billion, as

opposed to $5.9 billion in 2011, and the average deal size at the top 25 dropped by

almost a quarter to $175million per deal last year.

Sectors that attracted the most investment last year were healthcare and IT/ITES.The majority of deals under $10million were made in the e-commerce space, which

was a sector highlighted in Bain's India Private Equity Report

2012 . The subsector continues to grow in 2013, following on the nearly doubling of

deals valued at less than $10million in the e-commerce space, from 12% in 2011 to

23% in 2012 of the total deals.

Expectations about deal activity in 2013 remain cautious but still positive on the

whole. Our interviews suggest that deal activity will see moderate growth in 2013

throughout the industry. The steps taken towards improving India's legislative

framework have made investors a bit more upbeat , and GPs suggest that more

deals will close in 2013.

Advantages of Private Equity

1) Funds gotten through private equity are crucial for the growth of industry and the

development of innovative products.


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2) Private equity funds are used for expanding working capital.

3) Private equity funds are helpful when it comes to facilitating mergers and

acquisitions.

4) Private equity funds make a company‘s balance sheet stronger, and help it

develop.

5) Private equity funds are a great way to obtain funds for small businesses and

start-ups that have not been able to get loans or grants.

6) The general partner runs the company, so the investing partner, or the limited

partner, cannot interfere in the management of the company.

For companies:-

managers

For private equity firms:-

the key is the‖ Buy- to- sell ― philosophy

pressure to perform

measured

ash value generated for fund

investors and managerial incentives


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customers among Invest in businesses and influence their managers to produce

better results e.g. GE

n businesses and influence their managers to produce better results and

build synergies among portfolio businesses, e.g. P&G, Nestle

short/medium term or keep them in the long run.

businesses that are not closely linked

investing and in streamlining operations their businesses. In

contrast, a lot of time is wasted by corporate centers of public companies

Constant buying and selling by private equity firms result in learning curve

advantages

Different types of VCPE :-

1. Early Stage Finance

Seed Capital

Startup 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


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Turnarounds

Mezzanine/Bridge Finance

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

instance seep 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

The table below shows risk perception and time orientation for different stages of

venture capital financing.

Seed up Capital


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It is an idea or concept as opposed to a business. European Venture Capital

Association defines seed capital as ‘’the financing of the initial product development

or capital provided to an entrepreneur to prove the feasibility of a project and to

qualify for startup capital.’’

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

Absence of ready product market

Absence of complete management team

Product/Process still in R&D stage

Initial period/Licensing stage of technology transfer

Broadly speaking seed capital investment may take 7 to 10 years 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 adaptation, commencement 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 entrepreneur’s personal resources. Seed

capital is provided after being satisfied that the entrepreneur has used up his own

resources and carried out his idea 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 team) so often sought by venture

capitalists.

Volume of Investment Activity

It has been observed that venture capitalist seldom make seed capital investment

and these are relatively small by comparison to other forms of venture finance. The


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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 capitalist’s portfolio. Larger

venture capitalists avoid seed capital investments. This is because the small

investments are seen to be cost inefficient in terms of time required to analyze,

structure and manage them.

b) The time horizon to realization for most seed capital investments 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 is 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 2 in venture capital cycle and is distinguishable from seed capitalinvestments. An entrepreneur often needs finance when the business is just starting.

The startup 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.

Startup capital is defined as: ‘’capital needed to finance the product development,

initial marketing and establishment of product facility.’’

The characteristics of start-up capital are:-

i. 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.


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ii. Establishment of most but not all the members of the team- The skills

and fitness to the job and situation of the entrepreneur’s team is an important

factor for startup finance.

iii. 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 startup 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 andthe capacity of the entrepreneur, besides the skills, suitability and competence of the

managerial team are also evaluated. If required they supply managerial skills and

supervision for implementation. The time horizon for startup capital will be typically 6

or 8 years. Failure rate for startup 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 basedupon 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 specular 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

investor’s often participate in startup 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.

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 factors external to the firm (competitive

pressures in sufficient will of financial institutions to provide adequate capital, risk ofproduct obsolescence etc.) At this stage, capital needs, both fixed and working


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

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 firm’s 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:


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I. Cost overruns in market development.

II. Failure of new product to live up to sales forecast.

III. Need to re-position products through a new marketing campaign.

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

deficiency is revealed

.

Positive reasons include:

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

assets to gear up for production volumes greater than forecasts.

II. 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.

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 market expansion,

acquisition, product development etc. It is provided for market expansion of theenterprise. The enterprises eligible for this round of finance have following

characteristics.

I. Established business, having already passed the risky early stage.

II. Expanding high yield, capital growth and good profitability.

III. Reputed market position and an established formal organization structure.


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“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 inthird stage finance provides tax advantage and superior return to the investors.

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 profits exponentially byachieving 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.


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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 new markets 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 shares from

the entrepreneurs and their associates enabling them to reduce their shareholding in

unlisted companies. They also buy ordinary shares from non-promoters and convert

them to preference shares with fixed 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 recent 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 later 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 to wards MBO opportunities. This shift is because of lower

risk than start up investments.


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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 foe a major restructuring to 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 areakin 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 thecompany. 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.

Factors to be considered by VCPE in selection of investmentproposal

1. Management-: The strength, expertise & unity of the key people on the board

bring significant credibility to the company. The members are to be mature,

experienced possessing working knowledge of business and capable of taking

potentially high risks.

2. Potential for capital gain-: An above average rate of return of about 30 - 40% is

required by venture capitalists. The rate of return also depends upon the stage of the


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business cycle where funds are being deployed. Earlier the stage, higher is the risk

and hence the return.

3. Realistic Financial Requirement and Projections- The venture capitalist

requires a realistic view about the present health of the organization as well as future

projections regarding scope, nature and performance of the company in terms of

scale of operations, operating profit and further costs related to product development

through Research & Development.

4. Owner’s Financial Stake-: The financial resources owned & committed by the

entrepreneur/ owner in the business including the funds invested by family, friends

and relatives play a very important role in increasing the viability of the business. It is

an important avenue where the venture capitalist keeps an open eye.

Social enterprises and impact investments: Overview

The need for social innovation

Innovation is among the most important functions of any business enterprise.Constant innovation and generation of ideas is critical for all aspects of business - be

it to respond to competition and changing trends or to improve efficiencies or to

attract new customers. Companies like Apple, Microsoft and Google are popular

examples where innovation has been the order of the day. That said, innovation and

generation of new ideas are anything but easy. This process becomes even more

complex in a social enterprise, because of the constraints in funding and difficulties

involved with creating a market where demand does not already exist.

The compulsion to reduce negative impacts of the product/service on the intended

beneficiaries and the concern that donors may not fund risky innovations are major

challenges faced by the social entrepreneurs. Nevertheless, small but significant

steps in innovation are definite must-haves in the social sector. While there is vast

information on innovation in conventional businesses, the discussion on innovation in

the social sector has been comparatively limited. In general, social sector seeks to

address major challenges - be it in providing better food, housing and healthcare,

improving lifestyles, reducing poverty levels, providing education, catering to


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financial needs, or protecting the environment. As ‘for -profit’ companies in the social

sector strive to create the desired social impact as well as earn financial returns, it

becomes imperative to find new ways of doing business, improve efficiencies, cut

down costs, reach a larger audience and keep up with changing market dynamics.

Innovation calls for high investment and continuous financial support. Governments

and philanthropic organizations have tried to improve the lifestyle of people living at

the Base of the Pyramid (BoP) by providing grants and other forms of support for

decades. However, grants, subsidies, donations, and other forms of philanthropic

capital have not been effective in supporting innovation. This gap in innovation

funding for the social sector has led to the emergence of a new class of capital -

Social Venture Capital (SVC) or impact investing. Like the traditional venture

capitalists, the SVC’s not only provide capital, but also encourage innovation and

play a vital role in guiding and mentoring the social entrepreneur.

Research Methodology

REDMEN & MORY defines, “Research as a systematized effort to gain now

knowledge.”

It is a careful investigation for search of new facts in any branch of knowledge. The

purpose of research methodology section is to describe the procedure for conduction

the study. It includes research design, sample size, data collection and procedure of

analysis of research instrument.

Research always starts with a question or a problem. Its purpose is to find answers

to questions through the application of the scientific method. It is a systematic and

intensive study directed towards a more complete knowledge of the subject studied.

RESEARCH DESIGN:

Acc . to Kerl inger, “Research design is the plan structure & strategy of investigation

conceived so as to obtain answers to research questions and to control variance.

Acc . to Green and Tul l , “A research design is the specification of methods and

procedures for acquiring the information needed. It is the overall operational pattern

or framework of the project that stipulates what information is to be collected from

which sources by what procedures.

Its found that research design is purely and simply the framework for a study thatguides the collection and analysis of required data.


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Research design is broadly classified into

Exploratory research design

Confirmatory research

Descriptive research design Casual research design

This research is a Confirmatory research. The major purpose of this research is

description of state of affairs as it exists at present.

DATA COLLECTION

Secondary data

Secondary data is the data which is already collected by someone and complied for

different purposes which are used in research for this study. It includes:-

Internet

Magazine

Journal

Newspaper

The social enterprise

Broadly, enterprises that are engaged in the making of products or services that

benefit people from the low-income or BoP segments in a cost effective and

sustainable manner can be called as social enterprises. They are engaged in a

range of activities: from reducing poverty levels to improving living standards, from

providing affordable housing to financial solutions, and from improving education

levels to providing healthcare to people in the BoP.

Social enterprises are increasingly being set up as entities incorporated under the

Companies Act, 1956. When set up as a corporate form they can either be a non-

profit enterprise or a ‘for -profit’ enterprise. ‘For -profit ‘social enterprises aim to build a

profitable business in addition to creating a social impact. A company structure also

enables to get investment from external sources of capital such as venture capital

funds.

Compare the salient features of different sources of capital for social enterprises.

The choice of funding depends on various factors such as the sector, background of


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the entrepreneur, stage of the enterprise, nature of business model, and the outputs

of the enterprise.

Sources of capital

Parameter Banks Grants & Donations Promoter equity Venture capital

Quantum of

finance

Limited - depends

on credit rating and

amount of equity in

capital structure

Limited Depends on thefinancial capacity

of the promoter

Large - depends on

Company

performance, social

impact achieved

and valuation

Financing need Depends on type offinance - term loan

or working capital

Project specific Any business

need

Any business need

Tenure of

funding

Long term and

short

term

Long term and

short term

Long term Long

term (6 - 8 years)

Repayment Interest andprincipal

to be serviced

promptly

Not applicable Own source -hence repayment

has no timeline

By secondary sale

of

shareholding

Effect on cash

outflows

Regular cash

outflow

to meet interest

payments

Not applicable No effect No effect

Dilution of

entrepreneur’s

shareholding

No equity dilution No equity dilution Not applicable Equity stake to begiven up by the

entrepreneur

Loss of control

in decision

making

To a limited extent No loss of control No loss of control Major decisionsmay have to be

approved by the

investor

Mentoring and

business

advice

Banks normally do

not get involved in

Providing

mentoring or

advice

Limited Not applicable Investors play anactive role in

mentoring and

advising post

investment

Enhanced

company

visibility

Limited Limited High High


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Social entrepreneurs, those who start social enterprises, can be broadly classified

into three categories based on their background. The first type would comprise an

entrepreneur who is actually from the BoP. An entrepreneur of this type wishes to

create a change in the society and his conviction comes from having been part of the

problems that the social enterprise seeks to address. Founders of Bangalore-based

SnehadeepTrust for the Disabled are three visually impaired individuals who wish to

address problems which are similar to what they faced in life through their social

enterprise. The second type is one who has had a successful career in the past, and

is financially well off. The objective of starting a social enterprise for such an

entrepreneur is to contribute something back to the society. Bangalore-based

Janaagraha is an example of this. The third type is one who is in the early stages of

his professional career or is a first generation entrepreneur, who identifies a

business opportunity in the social sector and enters this space as a social

entrepreneur on the expectation of good commercial returns. Since such

entrepreneurs may not have the necessary financial resources, they usually seek

external capital from other sources as venture capital, grant bodies, etc.

Venture capital funding for social enterprises

The objective of the VC investors in the social sector is to create a social impact

through the investment, while expecting to earn financial returns from the investment

made. There are some organizations like Michael & Susan Dell Foundation which

was earlier working only on the grants model, but has now started making equity

investments in the organizations that they support. Such organizations, which have

been supporting the social sector for long by means of grants, have started adopting

the venture style of investing to make their investments more effective.

Common terminologies of social venture funding

SVC funding is known by several other names in different parts of the world.

According to the Monitor Institute on social impact investing, SVC funding is alsoknown as Socially Responsible Investing, Blended Value, Impact Investing, Mission-


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Driven Investing, Mission-Related Investing, Triple-Bottom Line, Social Investing,

Values-Based Investing, Program Related Investing, Sustainable and Responsible

Investing, Responsible Investing, Ethical Investing and Environmental, Social, and

Governance Screening. Sometimes, this kind of investment is also known as ‘Patient

Capital’, as the investment timeframe of social sector venture capitalists can be

longer than what it is for traditional venture capitalists. Some terms such as Impact

Investing cover a wider universe of asset classes such as equity, debt, working

capital lines and loan guarantees. However, impact investments are structured

similar to venture capital investments, and hence the term is often used

synonymously. Despite differences between these forms, there is a common theme

that cuts across all of these forms of investment, thereby enabling them to be

grouped under the broader umbrella of social venture investing.

The following are some definitions of Social Sector VC funding:

Socially Responsible Investing:

(a) Socially responsible investing, also known as sustainable, socially conscious,

"green" or ethical investing, is any investment strategy which seeks to consider both

financial return and social good.

(b) Socially responsible investing is an investment strategy employed by individuals,

corporations, and governments looking for ways to ensure their funds go to support

socially responsible firms. Such funds deploy negative screening criteria, i.e., not

invest in companies that qualify certain social criteria – such as companies in

tobacco, alcohol, or gambling.

Blended Value: Blended value refers to a business model that combines a

revenue-generating business with a component which generates social-value

.

Impact Investing: Impact investments are investments made into companies,

organizations, and funds with the intention to generate measurable social and

environmental impact alongside a financial return. These funds tend to have

inclusive, rather than exclusive mandates – for example, they will only invest in

companies impacting the BoP in certain regions.


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Mission-Driven Investing: Investing that has a double bottom line focused on

achieving both financial and social returns

.

Mission-Related Investing: Mission related investing (MRI) is the term used to

describe investments made by philanthropic entities in the pursuit of both financial

and social returns. MRI implies proactively seeking investment opportunities that

produce a blend of financial returns and social impact that are in line with the

philanthropy’s mission.

Triple-Bottom Line: (a) The triple bottom line (abbreviated as TBL or 3BL, and also

known as people, planet, profit or "the three pillars") captures an expanded spectrum

of values and criteria for measuring organizational (and societal) success: economic,

ecological, and social.

(b) Financial, social, and environmental effects of a firm's policies and actions that

determine its viability as a sustainable organization.

Values-Based Investing: Values-Based investing is an investment philosophy that

considers criteria based on social and environmental values alongside financial

returns when selecting an investment opportunity.

Program Related Investing: Program-related investments are investments made by

foundations to support charitable activities that involve the potential return of capital

within an established time frame.

Responsible Investing: Responsible investment is an investment strategy which

seeks to generate both financial and sustainable value. It consists of a set of

investment approaches that integrate environmental, social and governance and

ethical issues into financial analysis and decision-making.

Ethical Investing: Ethical investing gives individuals the power to allocate capital

toward companies that are in line with their personal views, whether they are based

on environmental, religious or political precepts.


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Environmental, Social, and Governance Screening: Environmental, social and

corporate governance, also known as ESG, describes the three main areas of

concern that have developed as the central factors in measuring the sustainability

and ethical impact of an investment in a company or business.

Differences between mainstream VC funding and social VC funding

Social venture funding can happen from any of the following sources: venture funds

that are dedicated for investments only in the social sector (for example Acumen

Fund), venture funds that also incidentally invest in social businesses (for example

Ventureast), and other sources that are not structured as a traditional VC fund

partnership, but follow a style of investing practiced by VC investors (for example,

Dell Foundation). The basic theme of investing by SVC funds and mainstream VC

funds is the same - that is, investing in companies which help them earn attractive

financial returns. The biggest difference between these two forms of investing is that

SVC’s invest with the aim of creating an impact in the low income or BoP segments

(synonymously referred to as social impact in this report), while conventional

investors do not explicitly consider the social impact for their investment decisions. In

order to make the funding a success for both the investor as well as the

entrepreneur, SVC funds need to adapt the conventional venture industry practices

to meet the requirements of their target segments.

Parameter Mainstream VC funding Social VC funding

Investment

selection

Based on company financials,

company growth prospects, sector

growth prospects, management

quality and the risk involved in the

investment.

Based on the social impact

created, financial returns

expected, company growth

prospects, sector growth

prospects, management quality

and the risk involved in the

investment.

Investment

monitoring

Financial performance and

business related non-financial

factors like client additions,

Monitoring the social impact in

addition to all the other

parameters of a mainstream VC


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expansion benchmarks etc.

Exit routes Exit route of VC investor can be bymeans of a stake sale to other

investors, a trade sale or a

strategic sale, sale of investor’sshares back to the company

or an Initial Public Offer (IPO).

Sale to other investors and

strategic sale are more popular

exit routes compared to IPO.

Typical investment range Between $2 - $10 million = $1 million. However some funds

also make larger investments

Typical duration of Investment 4 to 6 years 6 to 8 years; Sometimes longer(Acumen Fund

invests for up to 15 years)

Typical return expectations IRR of 25% IRR of 15% - 18% in addition to

social returns from the investment

Risk tolerance Lower than social VC investors Higher than mainstream VCinvestors

Typical Investors in theVC fund 99% by Limited Partners (LPs)which can be pension funds,

insurance companies, hedge funds,

endowments, corporates, high

net-worth individuals or

Governments. 1% by General

Partners, who are the actual

venture capitalists who manage

the fund

Donations and investments from

philanthropic institutions,

individuals and foundations, high

net-worth individuals and

institutional investors. Some funds

raise monies from banks, NABARD,

commercial organizations and

retail individual investors

Fund Life Generally 10 years with investinglife cycleof 3-5 years for each fund

Generally long-term and more

than 10 years

Returns to thefund

Management fee (rangingbetween 1.5% and 2.5% of funds

under management) and a profit

share or carried interest (ranging

between 15% - 25% of profits).

The size and success of the fund

usually determine which end of

the spectrum they can demand

from the investors

Management fee paid to the VCfund is normally in the range of

1%-1.9% due to the lower returns

from the investments made

Table 1.2: Key differences between mainstream and social VC fu $


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Global trends in social venture funding

With Governments across the world finding it increasingly difficult to fund social

sector activities, private capital have become more and more popular in recent times.

According to a report by the Monitor Group in2009, the impact investing industry was

estimated to grow from $50 billion to $500 billion in assets within a decade. This

translates to a CAGR of 25% for the global impact investing industry. The long

debatable issue and a source of criticism of impact investing was that the two factors

of creating social impact and earning commercial returns do not go hand in hand and

that one has to be compromised for the other. However, this need not be the case

always. JP Morgan, Rockefeller Foundation and the Global Impact Investing Network

(GIIN) brought out a report in November 2010 which estimated that the potential

profit for impact investors globally across five sub-sectors (housing, rural water

delivery, maternal health, primary education and financial services) could range

between $183 billion - $667 billion over the next 10 years for an invested capital of

$400 billion - $1 trillion. Last year, The Aspen Network of Development

Entrepreneurs (ANDE) counted about 199 impact investing funds globally. The

popular social venture capital firms include Acumen Fund, First Light, Gray Ghost

Ventures, Root Capital, TBL Capital, and Underdog Ventures among others. Most of

these funds look at the developing and underdeveloped world, as these regions have

a large potential as well as need for social development. In fact, many global social

VC funds have dedicated funds looking at investing in different countries of Africa

and Asia. As the sector is growing and more opportunities for funding are being

thrown open, new social VC funds coming up in different parts of the world every

year. Worldwide, the social sector and social sector investing has been a constant

source of innovation. New securities linking social impact to financial returns and

new tools of finance are being created to earn returns out of social activities.

Specialized agencies like Endeavor and Social Finance help social entrepreneurs

gain access to global markets. Social impact bonds are another invention by many

Government agencies in UK, USA, Canada, Australia and Israel, which reward

investors according to results achieved. These involve investments of private capital

from either philanthropists or commercial investors to fund social sector initiatives.

After a specified time limit, the social impact is measured. If the social impactachieved is as desired, the investors are rewarded; if not, investors lose the invested


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capital. It is believed that social VC funding is an effective way of unlocking private

capital and directing the much needed funds to the social sector across the globe.

Current status of social venture funding in India

Measurement of poverty in India has been a debatable issue for long as there is no

standard measure of poverty in the country. Different sources give out different

statistics with regard to poverty numbers. World Bank indicated that 32.7% of the

country’s population lived below the international poverty line of $1.25 per day in

2010, while 29.8% of the country’s population was below the national poverty line in

the same year. The Tendulkar Committee in India held 37% of the country’s

population to be below the poverty line in 2010, which has been accepted by the

Planning Commission as well. Irrespective of the actual proportion of the

population living below the poverty line, it is apparent that the number of people who

are poor is large in India. What is more shocking is that 8 Indian states (including the

states of Bihar, Uttar Pradesh and West Bengal) have more poor people than the

total poor people living in 26 of Africa’s poorest nations With such a large proportion

of people living below the poverty line in India and the vast amount of development

possible in both rural as well as urban areas, the potential for social venture

investing is considered promising. India’s social sector venture funding has gained

popularity in recent years, thanks predominantly to the microfinance sector. Though

impact investing has become popular in India in recent years, it still falls significantly

behind traditional venture capital and private equity investments, with the amount

invested being very low compared to traditional VC funding. A senior advisor in

investment banking firm Resurgent India opines that in India, it will take at least

another 7-9 years before impact investing reaches levels where traditional venture

capital and private equity investments are today According to the Planning

Commission, India has about 17 funds which operate in this sector. However, if

alone-off investments are considered it is estimated that there are more than 100funds operating in this segment in India. The most popular funds are Aavishkaar, Lok


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Capital, Acumen Fund, Bellwether, Grassroots, Michael and Susan Dell Foundation,

Omidyar Networks, Oasis Fund, Gray Matters Capital and Units among others. VC

funds specializing in social sector investments have their own preferences in

balancing social returns and financial returns. Table captures the key parameters of

important social VC funds in India.

Illustrative list of some popular social VC funds operating in India

Fund name Aavishkaar Lok Capital AcumenFund

Unitus Oasis Fund Gray MattersCapital

Sector

focus

Agriculture and

Dairy,Education,Energy

,

Handicrafts,

Health, Water

and Sanitation,

Technology for

Development

and

Microfinance and

Financial

Inclusion

Financial

inclusion,education,

healthcare

and

technology

Health,

water,energy,

education

and

agriculture

Rural

distribution,Microfinance

and financial

inclusion, IT

services and

Education

Affordable

housing,healthcare,

education,

energy,livelih

ood

opportunities,

water and

sanitation

Information,

communication

and

technology

space to

bridge

the urban-

rural

digital gap

Investment

size

(million)

$0.05 - 9 $0.2 - $5 $0.3 - $2.5 $ $0.6 - $15 $3 - $7 Informationnot available

Fund

investors

Development

Finance

Institutions,

Apex Indian

Banks,

Corporates,

Foundations

and retail

individualIndian investors

Information

not

available

Philanthropi

c

donations

from local

and foreign

individuals,

institutions,

foundations

Information

not available

Managed by

Bamboo

Finance;

Targets high

net worth

and

institutional

investors for

funds

Foundations

like Rockdale,

Rockefeller

and

Global

Investment

Initiative,

among others

Aim of

investment

Invest into early

and growth

stage companies

that provide

products or

services to Tier

2 and lower

towns,

semiurban

and rural

parts of India

To promote

inclusive

growth by

supporting

the

developmen

t of social

enterprises

to deliver

basic

services toserve the

Potential to

create

significant

social

impact,

show

financial

stability

within 5-7

years and

potential toachieve

To reduce

global poverty

through economic

selfempowerment

To create

significant

social impact

while earning

attractive

financial

returns

Look at

opportunities

considering

market

demand and

social impact


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BoP

segment

scale

Stage of

Investment

Early stage Across all

stages

Across all

stages

Across all

stages

Across all

stages

Information

not available

Instrument Generally a mix

of common

equity and

convertible

debentures.

When

appropriate,

other venture

capital

instruments are

used

Equity Equity or

Debt or

Quasi-

Equity

instruments

Equity or Debt

or Structured

Products

Equity Information

not available

Number ofFunds 4

2 + 1charitable

trust

Informationnot

available

4 Informationnot available

Informationnot available

Number of

Investment

s

>45 Information

not available

16 39 7 3

Table 1.3: Illustrative list of some popular social VC funds operating in India

Benefits of social venture funding

Social VC funds are essentially early stage risk capital investors, funding social

enterprises when no other source of finance looks feasible. The crucial role of VC

funding in starting Servals Automation (a company that manufactures energy

efficient burners) was highlighted by the founder Mukundan. He said, “If Aavishkaar

hadnot invested, probably there wouldn’t have been a major activity. Frankly I would

not have got into it”. Aunique feature of the VC funding at this stage is that theinvestment is made when there is no proven product or service. Although grants

have been the most popular source of finance for social enterprises for long, they are

not considered as scalable and does not help the social enterprise to grow quickly.

As Vortex Engineering’s (a company that manufactures ATM's for rural areas)

founder Kannan stated, “ Grants are not repeatable and not scalable. Normally the

grant giving agency has the mandate to disburse certain amount of money, and the

decision makers there are concerned about doing the disbursals on some

acceptable quality projects. But they do not have a larger commitment to it”.


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On the other hand, by making larger investments, VC investments help their investee

companies to scale faster. This leads to a scaling of the impact created by these

companies as well. For example, Bihar based Husk Power Systems has received

investment from a number of investors since it started operations in 2008. The

company, which started with serving one village in Bihar, as a result of the funding,

has today expanded operations to 848 Information

not available other villages across Bihar, and is planning to expand to other parts of

India and Africa.45Further, an increased network also facilitates investments from

mainstream VC investors when the company achieves scale. Presence of a VC

investor also helps the investee company to command a better valuation for

subsequent financing rounds. VC funding helps to increase the equity base of the

company, which can then be leveraged to attract debt capital. Because the

investment is in the form of equity, VC funding also indirectly helps the investee

company by meeting the eligibility criteria requirements of large projects. As

indicated by Water life India’s (a company that supplies drinking water to rural and

peri-urban areas) founder Sudesh, "Increase in equity also makes the company bid

for some large projects, which would not have been possible at lower levels of

equity". Further rounds of investments are also scalable, with each round seeing a

higher infusion than the previous round. For example, Vortex Engineering, which

received Rs. 30 lakhs from its first investor in 2005, saw a progressive increase in

investment amounts in every subsequent round, with the company raising up to Rs.

37 crores in December 2011. The long duration of the VC investment also helps in

building trust among all stakeholders of the company. A key benefit of venture

investors is their ability to provide management inputs in the company they have

invested. Since venture funds invest in the form of equity, such managerial inputs

and value additions help in increasing the valuation of their investee companies,

which in turn help the investors to achieve a better return on their investments. VC

funding is a valuable source of motivation and support at different stages of the

innovation lifecycle. A VC firm comes with extensive experience on the back of

investing in companies across different sectors and businesses. and is able to

provide the entrepreneur valuable inputs on different fronts. VC funds help in

strengthening internal systems and processes, assist in building a strong team and

help in strategizing and taking business decisions. In short, VC funding gives thesocial enterprise a partner for both the risks and rewards of the business. Vortex


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Engineering’s CEO Vijay Babu agreed, “….In fact we would not be where we are

without the active investment by the investors and the trust the investors had in the

product and the team. It’s a huge risk that the investors had taken…without them it

would be impossible to develop such a product”.

Yet another key benefit of VC funding is increased visibility and networking. Many

social sector companies are confined to a particular area and are unable to scale

and succeed despite having exceptional business models. VC funds help their

companies to get increased visibility and recognition through their network of

contacts. This also automatically increases the social entrepreneur’s professional

network, helping him explore newer markets and opportunities. Vortex Engineering’s

Kannan opined, “With VC funding, you become a part of abrader fraternity, which

gives you access to networks. Moreover, it gives you credibility, than if you are a

lone ranger trying to prove that you are a credible person. And when you need to

meet some potential customer or you need to raise additional finance, the kind of

investor you are already associated with, what that investor has to say about his

conviction in your business model - all these definitely help a great deal”. A similar

thought was expressed by Servals Automation’s Sujatha when she said, "Having a

[social] VC investor on board is a good endorsement of the mission of the business

itself. The investor is like a brand ambassador. This is an intangible, but good

marketing collateral. You cannot say that with banks; you can say that with social

investors”.

VC funding helps the social enterprise to improve their corporate governance

practices. Companies are often required to set right the books and accounts and

have proper legal documentation, which help in overall improvement in regulatory

compliance. A VC firm undertakes detailed due diligence of a prospective investee

firm before making an investment. It is said that going through the process of due

diligence in itself helps the company in strengthening their internal processes. This

was corroborated by Vortex Engineering’s CFO Indira, “their [VC's] due diligence

process helped us identify the business structure we need to put in place; from a

situation where we would struggle to provide the social impact matrix required by

various investors every quarter, we are now in a position to send it ahead of them

[the VC's] asking us”.

Concerns of exuberance in social venture investments


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Over the past few years, impact investing has increasingly come under the limelight,

both internationally and in India. The increasing popularity and expectations from

impact investments has led many to believe that a bubble is building up, as was

already witnessed in the microfinance space. It is problems in the society can be

solved if a company receives funding from impact investors. As Aavishkaar's founder

Vineet Rai puts it, “The hype around impact investing far outweighs reality ”. There

are also cases when entrepreneurs show impact targets which are highly unrealistic,

simply to secure funds. However, the societal problems require years of work before

the intended results can be achieved. The gap between what is promised and what

is being delivered is being seen in several impact investments across the country,

resulting in problems within the sector. The focus and spotlight on the sector

increased considerably in 2010, when JP Morgan classified impact investments as a

separate asset class. The study also highlighted huge profit potential for such

investments, resulting in an increased outcry against the concept of impact

investments. With an increasing number of impact investments, the industry has

came under criticism that this strong momentum could result in a conflict between

social and financial objectives. In fact, this is one of the main challenges seen in

social VC investments. Although a social VC fund gives importance to the social

impact created, financial performance of the investment assumes equal importance

in most cases. As a result, critics are of the view that the social entrepreneur’s intent

may get stifled by the investor’s aspiration to earn higher returns. This is especially

true when the entrepreneur dilutes a majority stake in his company to secure the

funding, resulting in marginalisation of his interests. When the entrepreneur begins to

follow the investors’ directives to increase financial returns, it could dilute the long

term objectives of the social enterprise, leading to sub-optimal levels of impact

creation. Besides, the increasing focus on returns can also result in a pressure to

scale and grow fast. However, social venture capital is also known as patient capital,

meaning that this form of investing requires time and patience. As in the case of the

microfinance sector, the desire to earn high profits in a short time can hamper the

entire industry. The pressure to scale can also sometimes de-motivate the social

entrepreneurs, as indicated by

Servals Automation’s founder Mukundan, “…the relentless pursuit of scaling, can

liquidate the passion of the entrepreneur”.


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Another concern in this space is that it is extremely difficult to measure social

returns. As social investors also look at the social impact created, it becomes

imperative to measure the social returns created by the investment. Most SVC funds

follow a proprietary model to measure social impact, as there is no uniform standard

available. The new Impact Reporting and Investment Standards which is being

developed by theGlobal Impact Investing Network seeks to develop a standardized

framework for measuring the social performance of impact investments. Comparison

across investment performance should be possible as moreand more investors

adopt this approach.

Summary

The need to marry social motive and commercial gains often leaves social

entrepreneurs grappling with several issues and challenges. Social enterprises

usually operate in challenging market conditions, dealing with a difficult customer

base with limited resources and suppliers with limited capabilities. Products and

services offered are usually in the ‘push category’, requiring extensive marketing.

Attracting and retaining human resources could be a lot more challenging for social

enterprises as the sector offers a lower pay as compared to corporate. A social

enterprise is bound by far higher regulations and legislations compared to traditional

business as the products and services offered are targeted at the low income and

BoP segments, which constitute a majority of the country’s electorate. Regulatory

hurdles and setbacks are common in a social setup and social entrepreneurs often

require in-depth knowledge to overcome these challenges. Because of the

aforementioned challenges, social ventures find it very difficult to obtain investments

from commercial capital sources in the early stage. Traditional sources of finance for

the social sector like bank debt, grants, donations and promoters’ equity come with

their own limitations. The difficulties in acces sing long-term capital have restricted

growth for many social enterprises, resulting in confining their operations to a

restricted geographical area. SVC funds have resulted in the emergence of a new

source of capital for the social enterprises. Apart from providing capital, SVC funds

have provided valuable management to the social enterprise such as mentoring

vcpe industry in india

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