VENTURE CAPITAL FINANCING

VENTURE CAPITAL FINANCINGPresented By:Kanudarpan KaurJasmeet Kaur

VENTURE CAPITALVENTURECAPITALTo undertake a risky course of action.Funds required to establish and run a business.MEANINGVenture capital is the investment of long-term equity finance where the venture capitalist earns his return primarily in the form of capital gains.It is basically equity finance in relatively new companies when it is too early to go to the capital market to raise funds.It is a long-term investment in growth oriented small/medium firms. The acquisition of outstanding shares from other shareholders cannot be considered venture capital investment. It is a new, long-term capital that is injected to enable the business to grow rapidly.GROWTH VS. TECHNOLOGYThere is a popular misconception that high technology is the principal driving factor behind the investment decision of most of the venture capitalist. However, the true venture capitalist finances any risky idea. The venture capitalist focuses on growth; he would like to see small business growing into larger ones.FEATURES OF VENTURE CAPITALEquity participation: It is actual equity participation through direct purchase of shares, options or convertible securities with the objective of making capital gains.Long-term Investments: Venture financing is a long-term, illiquid investment which is not repayable on demand.Participation in Management: Venture financing ensures continuing participation of the venture capitalist in the management of the entrepreneurs business. This helps him to protect and enhance his investment by actively involving and supporting the entrepreneur.ContinuedHigh Risk: Different degrees of risks are involved at various stages of venture capital financing.From the entrepreneur's point of view also there are 2 kinds of risks involved: Protection of the new ideaDilution of controlNEED OF VENTURE CAPITALTo bridge the gap between capital and knowledge.

Maximum utilization of available resources.ADVANTAGESIt injects long term equity finance which provides a solid capital base for future growth.

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.

The venture capitalist may be capable of providing additional rounds of funding should it be required to finance growth.

Venture capitalists are experienced in the process of preparing a company for an initial public offering (IPO) of its shares onto the stock exchanges or overseas stock exchange such as NASDAQ.They can also facilitate a trade sale.DIFFERENCE IN APPROACHThe venture capitalists management approach differs significantly from that of a conventional banker or a lender. the banker doesn't directly get involved in the operation and management of the company. He plays safe, keeps off management of the company, remains passive and insists on security (collateral).The venture capitalist is also not exactly like the stock market investor who merely trades in the shares of a company without any relations or with knowledge of its management.In fact, the venture capitalist combines the qualities of banker, stock market investor and entrepreneur in one.ON A LEGAL NOTE In India, Venture capital funds are regulated by SEBI (Venture Capital Funds) Regulations, 1996. Through these regulations, SEBI has sought to lay down conditions within which a VCF must restrict its investments.

STAGES IN VENTURE FINANCING1. EARLY STAGE FINANCING Seed financing for supporting a concept or ideaR&D financing for product developmentStart-up capital for initial production and marketingFirst-stage financing for full scale production and marketing.2. EXPANSION FINANCING Second stage financing for working capital. Development financing for facilitating public issue.3. ACQUISITION/BUYOUT For acquiring or financing other firm for further growth. Management buyout financing for enabling operating group to acquire firm or part of its business.Turnaround financing for turning around a sick unit.BUSINESS PLAN The first step of the company (or an entrepreneur) proposing a new venture in obtaining venture capital is to prepare a business plan for consideration of a venture capitalist.Must convince the venture capitalist that the company (entrepreneur) and the management team have the ability to achieve the stated goals, within stated time.Should explain the nature of the proposed venture business.Should not be very long (not longer than 10 pages).Simple in languageAll technical details should explained without jargons.

ELEMENTS OF A BUSINESS PLANEXECUTIVE SUMMARY:Summarizes the business plan and is plced at the front of the document.Vital to give this summary significant thought and time, as it may welkl determine the amount of consideration, the venture capital investor will give to the detailed proposal.Should be clearly written and powerfully persuasive.Limited to not more than 2 pages.Includes key elements of the business plan.

BACKGROUND OF THE VENTURE: Provides a summary of the fundamental nature of the proposed venture and its activities.If an existing company proposes the venture, a brief history of the company should also be included.

THE PRODUCT OR SERVICE:Explain the ventures product or service in plain English.A non-specialist must be able to understand the plan.Emphasize the products, or services competitive edge or unique selling point.Should explain the stage of development, legal protection (such as patents) etc.MARKET ANALYSIS: The plan should convince the venture capital firm that there is a real commercial opportunity for the business and its products and services.It should:Include a clear description and analysis, including a realistic SWOT analysis.Describe the distribution channels, customers, target market.Should comment upon price sensitivity of the market.Should address to the current issues, concerns and risks affecting the business and the industry in which it operates.MARKETING: The plan should outline the companys sales and distribution strategy including companys planned sales force, strategies for different markets, distribution channels, overseas market access issues and its resolution, pricing strategy and promotion plans.BUSINESS OPERATIONS: It should explain how the company makes the products or provides the service also mentioning sources of raw material, suppliers, labour requirements, companys approach to industrial relations and also to research and development.THE MANAGEMENT TEAM: The plan should demonstrate that the company has a quality management team which is able to turn the business plan into reality. It should also identify the current and potential skills gaps and explain the method to fill them.FINANCIAL PROJECTIONSAMOUNT AND USE OF FINANCE REQUIRED AND EXIT OPPORTUNITIESTHE PROCESS OF VENTURE CAPITAL FINANCINGExit plan DEAL ORIGINATIONDeals may originate in various ways:Referral System: Deals may be referred to VCFs by their parent organizations, trade partners, industry associations, friends etc.Active Search: Another source could be active search through networks, trade fairs, conferences, seminars, foreign visits etc.Intermediaries: These match VCFs and the potential entrepreneurs.SCREENINGIn order to save time and to select the best ventures, or before going for an in-depth analysis, VCFs carry out initial screening of all projects on the basis of some broad criteria. The size of investment, geographical location, stage of financing, technology, market scope could be used a s the broad screening criteria.

EVALUATION/DUE DILIGENCEAfter initial screening, detailed evaluation process takes place. Venture capitalists ask for business plans to make an assessment of the possible risk and return of the venture. The evaluation includes:Preliminary evaluation: The applicant is required to provide a brief profile of the proposed venture to establish eligibility. Detailed evaluation: After initial evaluation, the proposal is evaluated in greater detail. VCFs expect the entrepreneur to have integrity, urge to grow, long-term vision, managerial skills, commercial orientation.

ContinuedRisk Analysis: VCFs also make a thorough analysis of risk of the proposed ventureProduct risk: In case of new or untried ideas, there's a risk whether the product can be produces and commercialized. Technically sound products may fail on commercial basis.Market risk: This may result from factors such as unexpected competition, problems of marketing channels, non acceptance by customers, quality etc.Technological risk: This arises when technology is too complex to implement. It may be an imported technology and there may be problems of assimilation and management.Entrepreneurial risk: This arises when the entrepreneur lacks managerial capabilities or when he's too optimistic or too pessimistic. Young entrepreneurs with bright ideas may fail to implement their ideas successfully. DEAL STRUCTURINGHere, the venture capitalist and the venture company negotiate the terms of the deal, the amount, form and price of the investment. This agreement includes protective covenants and earn-out arrangements. Covenants include the venture capitalist's right to control the venture company and to change its management if needed, buyback arrangements, acquisitions, IPOs etc.Earn-out arrangements specify the entrepreneurs equity share and the objectives to be achieved.

POST-INVESTMENT ACTIVITIES Here the venture capitalist assumes the role of a partner and collaborator. He get involved in shaping the direction of the venture through formal representation on the board of directors, or informal influence in improving the quality of marketing, finance and other managerial functions. The degree of his involvement depends on his policy

EXIT PLANVenture capitalists aim at making medium to long term capital gains. They generally want to cash out their gains in five to ten years after the initial investment. A venture may exit in one of the following ways:Initial public offeringsAcquisition by another companyPurchase of the venture capitalists share by the promoterPurchase of the venture capitalists share by an outsider.

METHODS OF VENTURE FINANCINGThe financing pattern of the deal is the most important element. Following are the various methods of venture financing:EquityConditional loanIncome noteOther financing methodsEQUITYAll VCFs in India provide equity. Generally, their contribution may not exceed 49 per cent of the total equity capital. Thus, the effective control and majority ownership of the firm may remain with the entrepreneur.VCFs buy shares of an enterprise with an intention to ultimately sell them off to make capital gains.The advantage of the equity financing for the company seeking venture finance is that it does not have the burden of serving the capital, as dividends will not be paid if the company has no cash flowsThe advantage to the VCF is that it can have a share in the high value of the venture and makes capital gains if the venture succeeds. But the flip side is that the VCF will lose if the venture is unsuccessful.

CONDITIONAL LOANA conditional loan 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 charged royalty ranging between 2 and 15 per cent. The actual rate depends on gestation period, cost-flow patterns, risk and other factors of the enterprise.Some VCFs give a choice to the enterprise of paying a high rate of interest (which could be well above 20 per cent) instead of royalty on sales once it becomes commercially sound.

INCOME NOTEIt was a hybrid security which combined the features of both conventional loan and conditional loan.The entrepreneur had to bay both interest on royalty on sales, but at substantially low rates.Some venture funds provided funding equal to about 80 percent of a projects cost for commercial application of indigenous technology or adapting imported technology to wider domestic applications.Funds were made available in the form of unsecured loans at a lower rate of interest during development phase and at a higher rate after development. In addition to interest charges, royalty on sales could also be charged.

OTHER FINANCING METHODSA few venture capitalists, particularly in the private sector introduced innovative financial securities. The PARTICIPATING DEBENTURE is an example of innovative venture financial. Such security carries charges in three phases: in the start-up phase, before the venture attains operations to a minimum level, no interest is charged. After this, a low rate of interest is charged up to a particular level of operation. Once the venture starts operating on full commercial basis, a high rate of interest is required to be paid. A variation could be in terms of paying a certain share of the post-tax profits of royalty.ContinuedVCFs in India provide venture finance through PARTIALLY OR FULLY CONVERTIBLE DEBENTURES AND CUMULATIVE CONVERTIBLE PREFERENCE SHARE (CPP). CPP could be particularly attractive in the Indian context since CPP shareholders do not have a right to vote. They are entitled to voting if they do not receive dividend consecutively for two years.

ContinuedIn developed countries, like the USA and the UK, the venture capital firms are accustomed to using a wide range of financial instruments. They include:Deferred shares: where ordinary share rights are deferred for a certain number of years.Convertible loan stock: which is unsecured long-term loan convertible into ordinary shares and subordinated to all creditors.Special ordinary shares: with voting rights but without a commitment towards dividends.Preferred ordinary shares: with voting rights and a modest fixed dividend right and a right to share in profits.Venture capital funds abroad also provide conventional loans, hire-purchase finance, lease finance and even overdraft finance, but the overall financial package is always tilted in favour of equity component.

DISINVESTMENT MECHANISMSThe objective of a true venture capitalist is to sell off his investment at substantial capital gains. But most venture funds in India aim to operate on commercial lines along with satisfying their developmental objectives as well and they would also like to disinvest their holdings at adequate return with a view to recycle funds. A venture capital is generally not in a position to recycle funds. A venture capital is generally not in a position to realize his investment before five to seven years.

BUYBACK BY PROMOTERS

The most popular disinvestments route in India is shares buyback by promoters. This route is suited to the Indian condition because it keeps the ownership and control of the promoter intact. The obvious limitation, is that in 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 not be in a financial position to buy them back. In India, the promoters are invariably given the first option to buyback equity of their enterprises. If the promoter fails to buyback the shares within the stipulated period, theVCFreserves the directions to divest them in any manner deemed appropriate.VCFsgenerally make disinvestments after the project has settled down to a profitable level and the entrepreneur is in a position to avail finance under conventional schemes of assistance from banks or other financial institutions.INITIAL PUBLIC OFFERINGS (IPOS)The benefits of disinvestments via initial public offerings(IPOs)route are improved marketability and liquidity, better prospects for capital gains and widely known sates 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 issues would be difficult and expensive since the first generation entrepreneurs are not known in the capital markets.Further, difficulties will be caused if the entrepreneurs business is perceived to be unattractive investment proposition by investors. Also, the emphasis by Indian investors on short-term profits and dividends may tend to make market price unattractive.

ContinuedYet another difficulty in India until recently was that the Controller of Capital Issues(CCI)guidelines for determining premium on shares took into account the book value and the cumulative averagesEPStill the date of the new issue.This formula failed to give due weightage to the expected stream of earnings of the venture firm. Thus the formula would underestimate the premium.The government has now abolished theCapital Issues Control Act, 1947and consequently, the office of the Controller of Capital Issues. The existing companies are now free to fix share prices. The public issue form of investment can involve high transaction costs because of the inefficiency of the secondary market in a country like India. Also, this option has been rendered far less feasible for small ventures on account of the higher listing requirements of the stock exchanges.

LILLIPUT CASE STUDYA recent news states a story about the legal battle of Lilliput stores with its private equity investors. The investors have forbidden the store owner to float an initial public offer (IPO) which has resulted into a legal dispute between them.Full case study is available at the following links:

http://entrepreneurindia.in/people/infocus/lilliputs-giant-problems/14206/

http://www.livemint.com/Companies/ZLmP1t0zTqqD8g5jj3fQVJ/Lilliput-seeks-outofcourt-settlement-with-PE-investors.htmlSECONDARY STOCK MARKETAn active secondary capital market provides the necessary impetus to the success of venture capital.VCFs should be able to sell their holdings, and investors should be able to trade shares conveniently and freely.The OTC exchange in India (OTCEI) was established in June 1992. It opened a new avenue for disinvestments for small and medium-size companies.

MANAGEMENT BUYOUTSThe promoter of a new venture, which has taken off, may sell to its managers. The managers will generally raise venture capital to buyout the venture. This transaction is called management buyouts.When the buyers (managers or outsiders) incur much heavy debt to buy the venture, the deal is called leveraged buyout.Management buyouts will take place in the case of those ventures which have high growth potential.DEVELOPMENT OF VENTURE CAPITAL IN INDIA

The concept of venture capital was formally introduced in India in 1987 by IDBI.

The government levied a 5 per cent cess on all know-how import payments to create the venture fund.

ICICI started VC activity in the same year

Later on ICICI floated a separate VC company - TDICI

VENTURE CAPITAL FUNDS IN INDIAVCFs in India can be categorized into following five groups:

Those promoted by the Central Government controlled development finance institutions. For example: - ICICI Venture Funds Ltd. - IFCI Venture Capital Funds Ltd (IVCF) - SIDBI Venture Capital Ltd (SVCL)Those promoted by State Government controlled development finance institutions.For example: - Punjab Infotech Venture Fund - Gujarat Venture Finance Ltd (GVFL) - Kerala Venture Capital Fund Pvt Ltd.

Those promoted by public banks.For example: - Canbank Venture Capital Fund - SBI Capital Market LtdThose promoted by private sectorcompanies.For example: - IL&FS Trust Company Ltd - Infinity Venture India Fund

Those established as an overseas venture capital fund.For example:- Walden International Investment Group - HSBC Private Equity management Mauritius Ltd.FUTURE PROSPECTS OF VC IN INDIAVC can help in the rehabilitation of sick units.VC can assist small ancillary units to upgrade their technologiesVCFs can play a significant role in developing countries in the service sector including tourism, publishing, health care etc.They can provide financial assistance to people coming out of universities, technical institutes, etc thus promoting entrepreneurial spirits

GLOBAL SCENARIOAs per the 2013 Global Venture Capital Confidence Survey, undertaken byDeloitteand the National Venture Capital Association, the United States, the worlds largest venture capital market, has seen global investor confidence increase, confidence levels in emerging markets such as China, Brazil and India have declined.The survey notes that challenges with infrastructure, legal and policy restrictions among other growing pains in the emerging markets contributed to the shift in enthusiasm for investing in the United States.

EXAMPLES:SIDBI Venture Capital LimitedSIDBI Venture Capital Limited (SVCL) is a wholly owned subsidiary of SIDBI, incorporated in July 1999. Funds managed by SVCL are: National Venture Fund for Software and Information Technology (NFSIT)SME Growth Fund (SGF)India Opportunities Fund (IOF)Samridhi Fund (SF)

PORTFOLIOSLATTICE BRIDGE INFOTECH PRIVATE LIMITED, CHENNAI.Lattice Bridge offers solutions in the Speech Technology space and empowers communication with information systems using voice commands.KMG INFOTECH LIMITED, BANGALORE.Software development company, which provides IT solutions using IBM, Java and Microsoft technologies. The Company provides software development and maintenance solutions to large and medium sized insurance, banking, financial services, healthcare and government organizations.PORTFOLIOSNATUROL BIOENERGY LIMITED, HYDERABAD.Naturol Bio Energy, is a new company setting up an integrated Bio-diesel and allied products (specialty esters for usage as bio-lubricants and phytochemicals/ neutraceuticals) manufacturing facility, with an installed capacity of 99,000 tpa.EXPRESSIT LOGISTICS WORLDWIDE LIMITED, MUMBAI.Provides Express Mail Management services in the niche premium segment of delivering security and service sensitive documents in the banking, financial services, insurance and telecom sectors.

FAQsHow does the Company approach SVCL for funding?The details of the active funds being managed by SVCL are given in the websitewww.sidbiventure.co.in. It would be preferable if the company submits the business plan in a format given in the website. Based on a preliminary assessment of the business plan, course of further interaction with SVCL can be decided.How do I submit a plan to SVCL?You can send an email toinfo@sidbiventure.co.inforwarding a copy of the executive summary of your business plan including the profile of management team. The company can simultaneously forward a hard copy of business plan along with supporting documents to enable us to make a preliminary assessment of the proposal

Continued..What sort of companies does SVCL associate with?We invest in companies engaged in wide range of growth sectors, such as life sciences, retailing, light engineering, food processing, information technology, infrastructure related services, healthcare, logistics and distribution, etc in the MSME sector. The Company should have high growth potential so that it can scale up sufficiently within 3 - 5 years of investment so as to provide a profitable exit to investors by way an IPO, Strategic Sale, Mergers & Acquisition, etcAt what stage does SVCL invest?SVCL is focusing on all stages on investment. The Company at the time of investment should be unlisted.Is there any geographic focus to SVCL?SVCL proposes to makeinvestmenton an all India basis. Both the funds being managed by SVCL are domestic fund and the investee Company must be incorporated in India. Part of the investment can be utilized for investment in opening overseas branch offices/ subsidiaries provided the investment is beneficial to the parent Company in India.

Continued..What are the instruments of finance by which VC investment is made? Does SVCL usually control ownership of a company?Investment is made by way of equity and equity type instruments. Financial structuring is done on a case to case basis keeping in view factors like risk perception, growth potential, equity base and market condition. SVCL also co-invests with other VC funds. SVCL does not take a majority stake in a Company.What is SVCL's role after an investment is made?SVCL provides "smart money" to entrepreneurs. Apart from finance, SVCL provides networking and management support as well with the objective to make the company grow rapidly. SVCL also assists investee companies to attract investment from other venture capitalists in subsequent rounds of financing.

SEQUOIA CAPITALSequoia Capital is a venture capital firm founded byDon Valentinein 1972. The Wall Street Journal has called Sequoia Capital "one of the highest-caliber venture firms" and noted that it is "one of Silicon Valley's most influential venture-capital firms". It invests between $100,000 and $1 million in seed stage, between $1 million and $10 million in early stage, and between $10 million and $100 million in growth stage.The firm has offices in the U.S., China, India and Israel.Sequoia has funded an unprecedented number of enormously successful companies including Google, Yahoo, Paypal, Electronic Arts, NVIDIA, Cisco Systems, Oracle, Apple, YouTube, Admob and Zappos.Sequoia estimates that 19% of the NASDAQ's value is made up of firms they have funded.PORTFOLIOSTRUECALLERFounded 2009. Partnered October 2013.CAF COFFEE DAYPartnered 2006JUST DIALPartnered June 2009. IPO June 2013.MICROMAX Partnered September 2010.QUICK HEALPartnered August 2010ZOMATOPartnered October 2013.

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