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Submitted to: (LOVELY INSTITUTE OF MANAGEMENT) MBA –B (3rd Sem.) (Session 2009-2011) Date- 11 Nov 2010 Submitted to: Mr Bhavdeep Singh Kochar Submitted By: Suman Tiwari Roll No. RT1902A-22 Reg. No.10904478
I would like to confer my heartiest thanks to my coordinator of Financial Institutions and Services, Mr Bhavdeep Singh Kochar for giving me the opportunity to excel and work in the field of Financial Services, and especially its practical applications. While preparing my term paper I got to have an in depth knowledge of practical applications of the theoretical concepts and definitely the things which I have learned will undoubtedly help me in future, to analyze many processes going on in our economy.
I would also like to thank all those people who directly or indirectly helped me in accomplishing this project.
In the last decade, one of the most admired institutions among industrialists and economic policy makers around the world has been the US venture capital industry [Dossani and Kenney 2002]. The sensitivity of venture capital process to government policies and other factors that influence entrepreneurship and innovation was highlighted in a study by the US General Accounting office on behalf of the Joint Economic Committee [Premus 1985]. Venture capital entrepreneurship and innovation have been closely connected. Entrepreneurs have long had ideas that require substantial capital to implement but lacked the funds to finance these projects themselves [Gompers and Lerner 2002]. Venture capital evolved as a response to this felt need. Venture capital represents one solution to financing the high risk, potentially high-reward projects [Gompers and Lerner 2002]. The experience of US, Taiwan and Israel show that technological innovation and the growth of venture capital markets are closely interrelated [Premus 1985]. It has been reported that capital markets overlook small business opportunities because of high information and transaction costs, generally known as capital gap problem [Premus 1985, Smith and Smith 2002]. Though venture capital can meet this gap to some extent, venture capital is a special form of venture financing. In the case of venture capital, the capital market has to be conducive for supporting venture funding. At some level, entrepreneurship occurs in nearby every society, but venture capital can only exist when there is a constant flow of opportunities that have great upside potential [Dossani and Kenney 2002]. This study is a country overview of the venture capital industry supported by a set of case studies.
WHAT IS VENTURE CAPITAL? The venture capital investment helps for the growth of innovative entrepreneurships in India.TOPIC: STUDY ON THE WORKING OF VENTURE CAPITAL FUNDS IN INDIA INTRODUCTION A number of technocrats are seeking to set up shop on their own and capitalize on opportunities. prudence and a clear understanding of the market are among the sought after qualities of a promoter. entertainment and services have become the cynosure of bourses worldwide. made in new or untried concepts. This is a paradigm shift from the earlier physical production and ‘economies of scale’ model. Countries across the globe are realizing that it is not the conglomerates and the gigantic corporations that fuel economic growth any more. health-care. Venture capital has developed as a result of the need to provide non-conventional. starting an enterprise is never easy. Knowledge driven industries like InfoTech. it is innovation and technical capability that are big business-drivers. business sense and a lot more. There are a number of parameters that contribute to its success or downfall. quasi-equity and sometimes debt . Experience. This is where the venture capitalist comes in.straight or conditional. with money. However. However. few ‘traditional’ business models may survive. In the highly dynamic economic climate that surrounds us today. both equity and debt. risky finance to new ventures based on innovative entrepreneurship. in the US. For example. In these sectors. which carries . Prominent among these is the timely infusion of funds. there are other factors. promoted by a technically or professionally qualified entrepreneur. It refers to capital investment. 50% of the exports are created by companies with less than 20 employees and only 7% are created by companies with 500 or more employees. The essence of any economy today is the small and medium enterprises. Venture capital is an investment in the form of equity. which lie beyond the control of the entrepreneur. Venture capital means risk capital. integrity. This growing trend can be attributed to rapid advances in technology in the last decade.
Venture capital is an important source of equity for start-up companies. MEANING OF VENTURE CAPITAL Venture capital is money provided by professionals who invest alongside management in young. foreign investors. endowment funds.substantial risk and uncertainties. Venture Economics. It is in fact nearly impossible to come across one single definition of the concept. 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 . Professionally managed venture capital firms generally are private partnerships or closely-held corporations funded by private and public pension funds. defines venture capital as 'providing seed. wealthy individuals. The European Venture Capital Association describes it as risk finance for entrepreneurial growth oriented companies. rapidly growing companies that have the potential to develop into significant economic contributors. Jane Koloski Morris. and the venture capitalists themselves. experience and contact base. 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. It is a partnership with the entrepreneur in which the investor can add value to the company because of his knowledge.. THE CONCEPT OF VENTURE CAPITAL Venture capital means many things to many people. 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. It is investment for the medium or long term return seeking to maximize medium or long term for both parties. foundations. editor of the well known industry publication. corporations.
Companies such as Digital Equipment Corporation. economic growth and international competitiveness. Venture capitalists only invest in a small percentage of the businesses they review and have a long-term perspective. with the balance coming from endowments. venture capitalists have nurtured the growth of America's high technology and entrepreneurial communities resulting in significant job creation. Microsoft and Genetech are famous examples of companies that received venture capital early in their development. Intel.• • 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. Federal Express. Venture capitalists mitigate the risk of investing by developing a portfolio of young companies in a single venture fund. (Source: National Venture Capital Association 1999 Year book) PRIVATE EQUITY INVESTING Venture capital investing has grown from a small investment pool in the 1960s and early 1970s to a mainstream asset class that is a viable and significant part of the institutional and corporate investment portfolio. foundations. For decades. They also actively work with the company's management. Currently. In addition. insurance companies. especially with contacts and strategy formulation. Compaq. Sun Microsystems. individuals and other entities who seek to diversify their portfolio with this investment class." This term can be confusing because some in the investment industry use the term "private equity" to refer only to buyout fund investing. Many times they co-invest with other professional venture capital firms. many venture partnerships manage multiple funds simultaneously. over 50% of investments in venture capital/private equity comes from institutional public and private pension funds. In any case. banks. an institutional investor will allocate 2% to 3% of their institutional portfolio for investment in alternative assets such as private equity or venture capital as part of their overall asset allocation. Recently. some investors have been referring to venture investing and buyout investing as "private equity investing. Apple.
the modern venture firm emerged as the dominant venture investment vehicle. While this type of individual investment did not totally disappear. These "angel investors" will mentor a company and provide needed capital and expertise to help develop companies. individuals have again become a potent and increasingly larger part of the early stage start-up venture life cycle. typically organized as a limited partnership that invests in companies that represent the opportunity for a high rate of return within five to seven years. Angel investors may either be wealthy people with management expertise or retired business men and women who seek the opportunity for first-hand business development. thus. in the last few years. individual investors were the archetypal venture investor. Far from being simply passive financiers. in the 1950s and 1960s. if they can’t get capital from a bank or from their own pockets. However. venture capitalists foster growth in companies through their involvement in the management. Even individuals may be venture capitalists. In truth. They are entrepreneurs first and financiers second.WHAT IS A VENTURE CAPITALIST? The typical person-on-the-street depiction of a venture capitalist is that of a wealthy financier who wants to fund start-up companies. The venture capitalist may look at several hundred investment opportunities before investing in only a few selected companies with favorable investment opportunities. In the early days of venture capital investment. strategic marketing and planning of their investee companies. These are: . FACTOR TO BE CONSIDERED BY VENTURE CAPITALIST IN SELECTION OF INVESTMENT PROPOSAL There are basically four key elements in financing of ventures which are studied in depth by the venture capitalists. The perception is that a person who develops a brand new change-the-world invention needs capital. venture capital and private equity firms are pools of capital. they enlist the help of a venture capitalist.
It is an important avenue where the venture capitalist keeps an open eye. higher is the risk and hence the return. expertise & unity of the key people on the board bring significant credibility to the company.1. The members are to be mature. experienced possessing working knowledge of business and capable of taking potentially high risks. It is often said that people decide to become entrepreneurs because they see role models in other people who have become successful entrepreneurs. Potential for Capital Gain:: An above average rate of return of about 30 . Finally. 2. 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. he sought to travel westwards instead of eastwards from Europe and so planned to reach India. nature and performance of the company in terms of scale of operations. His far-fetched idea did not find favor with the King of Portugal. Venture capitalists often relate the story of Christopher Columbus. 3. In the fifteenth century. A BRIEF HISTORY The concept of venture capital is not new. Queen Isabella of Spain decided to fund him and the voyages of Christopher Columbus are now empanelled in history. The earliest members of the organized venture capital industry had several role models. including these three: . operating profit and further costs related to product development through Research & Development. The rate of return also depends upon the stage of the business cycle where funds are being deployed. Earlier the stage. Management: The strength. Owner's Financial Stake:: The financial resources owned & committed by the entrepreneur/ owner in the business including the funds invested by family.40% is required by venture capitalists. friends and relatives play a very important role in increasing the viability of the business. Much the same thing can be said about venture capitalists. 4. The modern venture capital industry began taking shape in the post – World War II years. who refused to finance him.
private venture capital partnerships passed SBICs in total capital under management." As a response this a number of Small Business Investment Companies (SBIC) were established to "leverage" their private capital by borrowing from the federal government at below-market interest rates. The Rockefeller Family." In the 1950s. L S Rockefeller. and in particular. In 1957. by offering a degree of flexibility that SBICs lack. The Second World War produced an abundance of technological innovation. nearly 600 SBICs were in operation. a French-born military man who is considered "the father of venture capital. J. whose biggest success was Digital Equipment. for example. The 1960s saw a tremendous bull IPO market that allowed venture capital firms to demonstrate their ability to create companies and produce huge investment returns. who concentrated on conventional corporate management. he taught at the Harvard Business School. His lectures on the importance of risk capital were considered quirky by the rest of the faculty. primarily with military applications. the Federal Reserve System conducted a study that concluded that a shortage of entrepreneurial financing was a chief obstacle to the development of what it called "entrepreneurial businesses. The founder of ARD was General Georges Doroit. some of the earliest work on micro circuitry. which is now defunct but was one of the earliest commercial airlines. Indeed. J. one of whose early hits was Minute Maid juice. They include.S. when Digital Equipment went public in 1968 it provided ARD with 101% annualized Return on Investment . At the same time a number of venture capital firms were forming private partnerships outside the SBIC format. one of whose earliest investments was in Eastern Airlines. Soon commercial banks were allowed to form SBICs and within four years. Whitney & Co also formed in 1946.H. For example.American Research and Development Corporation. formed in 1946. the U. Jock Whitney is considered one of the industry’s founders. In the mid-1950s. These partnerships added to the venture capitalist’s toolkit. Within a decade. Whitney’s investment in Minute Maid was intended to commercialize an orange juice concentrate that had been developed to provide nourishment for troops in the field. federal government wanted to speed the development of advanced technologies.H.
leading to yet another downturn in venture funding. venture capital fund raising hit rock bottom in 1975. venture capital investment rose 32% from 2003. a red-hot IPO market brought over 1. but non-US venture investment is growing. In the 1970s. though. It raised US$25bn in committed capital for investments by venture firms. However. In India. who invested over US$16bn into domestic growth companies US firms have traditionally been the biggest participants in venture deals. the average long-term return on venture capital funds fell below 8%. the public markets went into a seven-year slump. Disappointed families and institutions withdrew from venture investing in droves in the 1989-91 periods. There were a lot of disappointed stock market investors and a lot of disappointed venture capital investors too. That was probably an unrealistic expectation to begin with. particularly for wealthy individuals and families. depending upon the degree of risk the firm is taking.000 venture-backed companies to market in 1968. In 1998. The consensus today is that private equity investments generally should give the investor an internal rate of return something to the order of 15% to 25%. Then in 1974. As a result of poor public market and the pension fund legislation.(ROI). it was still considered too risky for institutional investors. . the venture capital industry in the United States continued its seventh straight year of growth. by 1990. The late 1980s marked the transition of the primary source of venture capital funds from wealthy individuals and families to endowment. Many investors went into the funds anticipating returns of 30% or higher. The US$70. pension and other institutional funds. venture capital became a hot market.000 Digital invested to start the company in 1959 had a market value of US$37mn. First. As a result. The surge in capital in the 1980s had predictable results. Returns on venture capital investments plunged. venture capital suffered a double-whammy. The economic recovery and the IPO boom of 1991-94 have gone a long way towards reversing the trend in both private equity investment performance and partnership commitments. However. after Congress legislation against the abuse of pension fund money. all high-risk investment of these funds was halted. venture funding more than doubled from $420 million in 2002 to almost $1 billion in 2003. For the first half of 2004.
mostly in SME segment and has supported building technocrat/professionals all through. 1000. representing 0. Consequently the government of India promoted the venture capital during 1986-87 by creating a venture capital fund in the context of structural development and growth of small-scale business enterprises. Alternatively. INVESTMENT PHILOSOPHY Venture capitalists can be generalists. or may seek to invest in only a localized geographic area.5 per cent in countries such as Hong Kong. The venture capital investments in India at Rs. Public Sector Banks (PSBs). or various geographic locations. or may provide capital to start up a company in its first or second stages of development known as "early stage investing. which have garnered over Rs. has made a substantial contribution to economy. the venture capitalist may provide needed financing to help a company grow beyond a critical mass to become more successful ("expansion stage financing"). In India. There are around thirty venture capital funds. however." Also.1 percent of GDP." While venture firms will invest in companies that are in their initial start-up modes. venture capitalists will also invest in companies at various stages of the business life cycle. 5000 Crores. Not all venture capitalists invest in "start-ups. through its investment in high growth companies as well as companies adopting newer technologies backed by first generation entrepreneurs. investing in various industry sectors. . they may be specialists in one or two industry sectors. A venture capitalist may invest before there is a real product or company organized (so called "seed investing"). as compared to 5. In this short span it has nurtured close to one thousand ventures. and Private Banks and Private Financial companies. The Indian Venture Capital Industry (IVCI) is just about a decade old industry as compared to that in Europe and US. the potential of venture capital investments is yet to be fully realized. The VC industry.05 crore as in 1997.VENTURE CAPITAL IN INDIA Venture capital was introduced in India in mid eighties by All India Financial Institutions with the inauguration of Risk Capital Foundation (RCF) sponsored by IFCI with a view to encourage the technologists and the professional to promote new industries. Since then several venture capital firms/funds (VCFs) are incorporated by Financial Institutions (FIs). or various stages of a company’s life.
The venture capitalist may invest in a company throughout the company’s life cycle and therefore some funds focus on later stage investing by providing financing to help the company grow to a critical mass to attract public financing through a stock offering. which require funding. venture capitalists also invest in companies such as construction. There are several firms that have specialized in retail company investment and others that have a focus in investing only in "socially responsible" start-up endeavors. a venture financier is one who funds a startup company. retailing and restaurants and others that may be specialists in only one technology. A venture capitalist is not a lender. business services. Such enterprises generally do not have any major collateral to offer as security. etc. Venture capitalists are sources of expertise for the companies they finance. and the venture industry gets a lot of attention for its high technology investments. turnaround or recapitalization of public and private companies that represent favorable investment opportunities. Exit is . the venture capitalist may help the company attract a merger or acquisition with another company by providing liquidity and exit for the company’s founders. He cannot survive on minimalism. To conclude. software. some venture funds specialize in the acquisition. He is driven by maximization: wealth maximization. but are unable to access it through the conventional sources such as banks and financial institutions.S. but an equity partner. though equity is the most preferred route. These funds are then invested in several fledging enterprises. hence banks and financial institutions are averse to funding them.. The basic principal underlying venture capital – invest in high-risk projects with the anticipation of high returns. industrial products. Alternatively. Typically first generation entrepreneurs start such enterprises. Venture capital funding may be by way of investment in the equity of the new enterprise or a combination of debt and equity. There are venture funds that will be broadly diversified and will invest in companies in various industry sectors as diverse as semiconductors. At the other end of the spectrum. in most cases promoted by a first generation technocrat promoter with equity. While high technology investment makes up most of the venture investing in the U.
The funded work also involves product development to some extent. and venture funds have been credited with the success of technology companies in Silicon Valley. The entire technology industry thrives on it. This method has been extremely successful in USA. but an investment that must be made with careful diligence and expertise. but they eventually seek to exit the investment in three to seven years. .preferably through listing on stock exchanges. Second Stage:: In the Second Stage of Financing working capital is provided for the expansion of the company in terms of growing accounts receivable and inventory. so the appetite for the investment life cycle must be congruent with the limited partnerships’ appetite for liquidity. Early Stage / First Stage:: Finance is provided to companies to initiate commercial manufacturing and sales. LENGTH OF INVESTMENT Venture capitalists will help companies grow. a relatively small amount of capital is provided to an entrepreneur to conceive and market a potential idea having good future prospects. The various stages are: 1. 2. Seed Stage:: Financing is provided to complete product development and commence initial marketing formalities. while a later stage investment many only take a few years. An early stage investment make take seven to ten years to mature. 4. Pre seed Stage:: Here. 3. The venture investment is neither a short term nor a liquid investment. STAGES OF VENTURE CAPITAL FUNDING The Venture Capital funding varies across the different stages of growth of a firm.
6. they are: Equity: All VCFs in India provide equity but generally their contribution does not exceed 49 percent of the total equity capital.even point. Often. the effective control and majority ownership . METHODS OF VENTURE FINANCING Venture capital is typically available in three forms in India. This stage is met when the firm crosses the break. Thus. Third Stage: Funds provided for major expansion of a company having increasing sales volume. Bridge / Mezzanine Financing or Later Stage Financing:: Bridge / Mezzanine Financing or Later Stage Financing is financing a company just before its IPO (Initial Public Offer).5. from the proceeds of a public offering. bridge finance is structured so that it can be repaid.
The entrepreneur has to pay both interest and royalty on sales. have started introducing innovative financial securities like participating debentures. Income Note: It is a hybrid security which combines the features of both conventional loan and conditional loan. Because many businesses cannot create the growth required having an exit event within the required timeframe. Conditional Loan: It is repayable in the form of a royalty after the venture is able to generate sales. actual rate depends on other factors of the venture such as gestation period. No interest is paid on such loans. They buy shares of an enterprise with an intention to ultimately sell them off to make capital gains. venture capital is not suitable for everyone. VENTURE CAPITAL FUND OPERATION Venture capitalists are very selective in deciding what to invest in. They are only interested in ventures with high growth potential. Only ventures with high growth potential are capable of providing the return that venture capitalists expect. VCFs charge royalty ranging between 2 to 15 percent. cost-flow patterns. particularly in the private sector. riskiness and other factors of the enterprise. In India. introduced by TCFC is an example. Venture capitalists usually expect to be able to assign personnel to key management positions and also to obtain one or more seats on the company's board of directors. a phrase that has sometimes quite unfortunate implications as it was used in many accounting scandals to refer to a strategy of placing incompetent or easily bypassed individuals in .of the firm remains with the entrepreneur. A common figure is that they invest only in about one in four hundred ventures presented to them. This is to put people in place. but at substantially low rates. and structure their businesses to expect. Other Financing Methods: A few venture capitalists.
the funds that do succeed may offer returns of 300 to 1000% to investors. have been found liable in the large scale frauds that rocked American (mostly) finance in 2000 and 2001. convertibles. Investors in venture capital funds are typically large institutions with large amounts of available capital. or other forms of equity in three to ten years: this is referred to as harvesting. Many venture capitalists try to mitigate this problem through diversification. In either case. In a typical venture capital fund. Because a fund may run out of capital prior to the end of its life. two will be failures. Venture capitalists expect to be able to sell their stock.positions of due diligence and formal legal responsibility. Venture capitalists know that not all their investments will pay-off. In such a fund. Only a tiny portion of venture capitalists. Most venture capital funds have a fixed life of ten years—this model was pioneered by some of the most successful funds in Silicon Valley through the 1980s to invest in technological trends broadly but only during their period of ascendance. to cut exposure to management and marketing risks of any individual firm or its product. they work on the assumption that for every ten investments they make. the investors have a fixed commitment to the fund that is "called down" by the VCs over time as the fund makes its investments. university endowments. They expect that the two successes will pay for the time given to. Smaller firms tend . anywhere from 20% to 90% of the enterprises funded fail to return the invested capital. however. options. They invest in companies in different industries and different countries so that the systematic risk of their total portfolio is reduced. two will be successful. Others concentrate their investments in the industry that they are familiar with. The failure rate of investments can be high. Venture capital partners (also known as "venture capitalists" or "VCs") may be former chief executives at firms similar to those which the partnership funds. such as state and private pension funds. warrants. enabling others to rob stockholders blind. and six will be marginally successful. In good times. the VCs receive an annual "management fee" equal to 2% of the committed capital to the fund and 20% of the net profits of the fund. larger VCs usually have several overlapping funds at the same time—this lets the larger firm keep specialists in all stage of the development of firms almost constantly engaged. insurance companies and pooled investment vehicles. and risk exposure of the other eight.
it is important to choose the right venture capitalist. strategy is a dream". ie who can add value. including a CEO to execute the idea. Venture capitalists will insist on a professional team coming in. the vision. Otherwise the entire game would be reduced to a . It is important to distinguish the entrepreneur from the professional management team. Venture capital funds are broadly of two kinds . The standard parameters used by venture capitalists are very similar to any investment decision. Hence.to thrive or fail with their initial industry contacts—by the time the fund cashes out. However it is only in the past 12 to 18 months. have been around in India for some years now. Integrity and commitment are attributes sought for. but the team executes it. The rejection ratio is very high. assist in future rounds and help in strategy. about 10 in 100 get beyond pre evaluation stage. at a country or a regional level. The venture capitalist can provide the strategic vision. THE IDEA The idea and its potential for commercialization are critical. Venture funds look for a scalable model. whom they do not know well. putting the team together. ASSESSING VENTURE CAPITAL Venture funds. and so it is prudent to re-assess and shift industries or personnel rather than attempt to simply invest more in the industry or people it already knows. If one buys a listed security. This backing is invaluable as focused/specialized funds open doors. one can exit at a price but with an unlisted security. they have come into the limelight. an entirely new generation of technologies and people is ascending. getting the funding in place is amongst others.generalists or specialists. As a famous Silicon Valley saying goes "Success is execution. with success or failure depending on the performance of the team. It is critical for the company to access the right type of fund. The key factors which they look for in THE MANAGEMENT Most businesses are people driven. both domestic and offshore. and 1 gets funded. some key aspects of the role of the entrepreneur. exit becomes difficult. One-man armies are passe. The value of the idea. The only difference being exit.
typically carried out by an external agency. Linked to valuation is the stake. gains cannot be booked. at times angels write checks across the table. they will focus on expansion stage projects for future investments to balance the investment portfolio. In India. which the fund takes. while calculating returns. In India. For example. Any fund would discuss all exit options before closing a deal. which adds to the risk premia. Distinctive competitive advantages must exist in the form of scale. VALUATION All investment decisions are sensitive to this. In summary. brands. strategy. Most deals fail because of valuation expectation mismatch. Taxation issues come up at the time. etc which will make it difficult for competition to enter. Sometimes.manpower or machine multiplication exercise. distribution. Exit may be in the form of a strategic sale or/and IPO. This is supplemented by legal and accounting due diligence. execution and commercialization plans. the entire process takes about 6 months. PORTFOLIO BALANCING Most venture funds try and achieve portfolio balancing as they invest in different stages of the company life cycle. For example. technology. it is very easy for Hindustan Lever to double sales of Liril . venture capital funds go through a certain due diligence to finalize the deal. This includes evaluation of the management team. political instability. It is interesting to note that in USA. . The actual cash inflow might get delayed because of regulatory issues. EXIT Without exit. In India. An old stock market saying "Every stock is a buy at a price and vice versa". thus suppressing valuations. Entrepreneurs are advised to keep that in mind before looking to raise funds. a venture capital has invested in a portfolio of companies predominantly at seed stage. venture capital funds will take into account issues like rupee depreciation. while Gujarat Ambuja needs to spend at least Rs4bn before it can increase sales by 1mn ton. entrepreneurs are still uncomfortable with the venture capital "taking control" in a seed stage project.a soap without incremental capex. the fund insists on a buy back clause to ensure an exit. This would enable them to have a phased exit.
Deal origination . The Indian banking system has shown remarkable growth over the last two decades. media. the situation as regards financial outlay available to Indian software companies was poor. The situation fortunately has changed. Lack of understanding of these sectors was also responsible for the same. CONCEPTUAL FRAME WORK THE VENTURE CAPITAL PROCESS The Venture Capital Investment Process: The venture capital activity is a sequential process involving the following six steps. The rapid growth and increasing complexity of the financial markets. The services sector was ignored. and had to rely on loans or overdraft facilities to provide working capital. ensured that (ad) venture capital was easily available. manufacturing centric. especially the capital market have brought about measures for further development and improvement in the working of these markets.e. Most software companies found it extremely difficult to source seed capital. The bull markets of the 90s. IDBI and IFCI were providers of term loans for funding projects. The options were limited to conventional businesses. rather than investing in product development. working capital or even venture capital. Equity was raised from the capital markets using the IPO route. This approach forced them to generate revenue in the short term. Manufacturing companies exploited this to the full. fuelled by Harshad Mehta and the FIIs. Most software companies started off undercapitalized. etc. If we look back to 1991 or even 1992. like software.FINANCING OPTIONS IN GENERAL The possibility of raising a substantial part of project finances in India through both equity and debt instruments are among the key advantages of investing in India. Services sector was ignored because of the "collateral" issue. i. Banks and development financial institutions led by ICICI.
- Screening Due diligence Evaluation Deal structuring Post-investment activity Exit .
Venture Capital Investment Process .
industry associations. commercial orientation. Deals may be referred to VCFs by their parent organizations. The venture capitalists evaluate the quality of entrepreneur before appraising the characteristics of the product. o Preliminary evaluation: The applicant required to provide a brief profile of the proposed venture to establish prima facie eligibility. conferences. Referral system is an important source of deals. o Due Diligence: Due diligence is the industry jargon for all the activities that are associated with evaluating an investment proposal. Deal may originate in various ways. is certain intermediaries who match VCFs and the potential entrepreneurs. The size of investment. Intermediaries is used by venture capitalists in developed countries like USA. before going for an in-depth analysis. . o Screening: VCFs. Business plan contains detailed information about the proposed venture. Most venture capitalists ask for a business plan to make an assessment of the possible risk and return on the venture. long-term vision. friends etc. The evaluation of ventures by VCFs in India includes.Integrity. trade fairs. VCFs in India expect the entrepreneur to have: . seminars. or market scope. managerial skills. market or technology. o Detailed evaluation: Once the preliminary evaluation is over. active search system. the screening process may limit projects to areas in which the venture capitalist is familiar in terms of technology. trade partners. geographical location and stage of financing could also be used as the broad screening criteria. or product. the proposal is evaluated in greater detail. foreign visits etc. For example. urge to grow. carry out initial screening of all projects on the basis of some broad criteria. referral system. Another deal flow is active search through networks. the VC investor creates a pipeline of deals or investment opportunities that he would consider for investing in.o Deal origination: In generating a deal flow. and intermediaries.
VCFs in India also make the risk analysis of the proposed projects which includes: Product risk. The instruments to be used in structuring deals are many and varied. Documentation refers to the legal aspects of the paperwork in putting the deal together. legal and taxation. expiry period new or vendor shares par value partially-paid shares . The final decision is taken in terms of the expected risk-return trade-off as shown in Figure. Also the structure should take into consideration the various commercial issues (ie what the entrepreneur wants and what the venture capital would require protecting the investment). 2nd Charge. loan vs. The objective in selecting the instrument would be to maximize (or optimize) venture capital’s returns/protection and yet satisfies the entrepreneur’s requirements. one with features (warrants) 1st Charge. one needs to be knowledgeable in areas of accounting. loan stock Maturity redeemable (conditions under Company Act) Participating par value nominal shares exercise price. non. finance. Market risk. Technological risk and Entrepreneurial risk. The instruments could be as follows: Instrument Loan Preference shares Warrants Common shares Issues Clean vs secured Interest bearing vs. To do a good job in structuring. cash flow. o Deal Structuring: Structuring refers to putting together the financial aspects of the deal and negotiating with the entrepreneurs to accept a venture capital’s proposal and finally closing the deal.interest bearing convertible vs.
If the project was successful. Nowadays. They play a positive role in directing the company towards particular exit routes. It may not. Acquisition by another company 3. He also gets involved in shaping of the direction of the venture. the venture capitalist may intervene. however. Purchase of the venture capitalists shares by the promoter. .In India. The risks should be analyzed. (eg exit problems. Even for the proposed investment amount. but the venture capital comes up with his own solution. o Post Investment Activities: Once the deal has been structured and agreement finalized. the company had to pay a % age of sales as royalty and if it failed then the amount was written off. warrants are issued as a tool to bring down pricing. be desirable for a venture capitalist to get involved in the day-to-day operation of the venture. Under this. taking into consideration the stage at which the company is in and other factors relating to the project. etc). The degree of the venture capitalist's involvement depends on his policy. the company was given a conditional loan. the venture capital decides whether or not the amount requested. Purchase of the venture capitalists share by an outsider. o Exit: Venture capitalists generally want to cash-out their gains in five to ten years after the initial investment. and even install a new management team. If a financial or managerial crisis occurs. is appropriate and consistent with the risk level of the investment. the venture capitalist generally assumes the role of a partner and collaborator. straight equity and convertibles are popular and commonly used. A venture may exist in one of the following ways: 1. In structuring a deal. it is important to listen to what the entrepreneur wants. 4. Initial Public Offerings (IPO’s) 2. A variation that was first used by PACT and TDICI was "royalty on sales".
PLAYERS IN VENTURE CAPITAL INDUSTRY VENTURE CAPITAL INDUSTRY LIFE CYCLE IN INDIA .
Unfortunately. Moreover VCF is in its nascent stages in India.From the industry life cycle we can know in which stage venture capital are standing. On the basis of this management can make future strategies of their business. GROWTH OF VENTURE CAPITAL IN INDIA PROBLEMS OF VENTURE CAPITAL IN INDIA One can ask why venture funding is so successful in USA and faced a number of problems in India. The necessary capital can be . our country lacks on both fronts. The implication is to obtain adequate financing along with the necessary hitech equipments to produce an innovative product which can succeed and grow in the present market condition. The biggest problem was a mindset change from "collateral funding" to high risk high return funding. Exposure to fast growing intellectual property business and services sector was almost zero. Most of the pioneers in the industry were people with credit background and exposure to manufacturing industries. The emerging scenario of global competitiveness has put an immense pressure on the industrial sector to improve the quality level with minimization of cost of products by making use of latest technological skills.
the promoters were well-established industrial houses. including term loans from institutions and equity markets. there is an expectation of higher returns from the project. What was needed was ability to get a license and then get the project funded by the banks and DFIs. Most of the venture capital units were offshoots of financial institutions and . The payback period is also generally high (5 . Products developed for Indian markets lack scale. mature and capable management team of the company being financed. Scalability The Indian software segment has recorded an impressive growth over the last few years and earns large revenues from its export earnings. Most venture capital companies want to provide capital on a secured debt basis. Higher value addition and profitability as well as significant market presence take place at the higher end of the value chain. The other issues that led to such a situation include: License Raj and The IPO Boom Till early 90s. only commodity centric businesses thrived in a deficit situation. Within the software industry.7 years). to established businesses with profitable operating histories. experienced. under the license raj regime. venture capital is not needed. with no apparent need for funds. yet our share in the global market is less than 1 per cent. The IT industry (which is most suited for venture funding because of its "ideas" nature) in India till recently had a service centric business model. For any venture idea to succeed there should be a product that has a growing market with a scalable business model. In most cases. Mindsets Venture capital as an activity was virtually non-existent in India. The financing firms expect a sound.obtained from the venture capital firms who expect an above average rate of return on the investment. To fund a cement plant. Since the innovative project involves a higher risk. the value chain ranges from body shopping at the bottom to strategic consulting at the top. Most of these entities were capable of raising funds from conventional sources. If the industry has to grow further and survive the flux it would only be through innovation.
it is difficult for deals to reach financial closure as promoters do not agree to a valuation. the number and quality of deals available to the venture funds gets reduced . Abroad. Domestic venture funds are set up under the Indian Trusts Act of 1882 as per SEBI guidelines. which brings advantages in terms of taxation. strategic sale was also not available. Consequently. Returns. all issues were under priced. Given this. Given the dull market for mergers and acquisitions. this problem is solved by the presence of `angel investors’. such funds are made under the Limited Partnership Act. Abroad. Thanks to the software boom. In general. small companies could not hope for a BSE/ NSE listing.banks and the lending mindset continued. Given the failure of the OTCEI and the revised guidelines. Exit The exit routes available to the venture capitalists were restricted to the IPO route. while offshore funds routed through Mauritius follow RBI guidelines. most promoters have sky high valuation expectations. pricing was dependent on the erstwhile CCI regulations. The government must allow pension funds and insurance companies to invest in venture capitals as in USA where corporate contributions to venture funds are large. True venture capital is capital that is used to help launch products and ideas of tomorrow. They are typically wealthy individuals who not only provide venture finance but also help entrepreneurs to shape their business and make their venture successful. This coupled with the fancy for software stocks in the bourses means that most companies are proponing their IPO’s. Before deregulation. Taxes and Regulations There is a multiplicity of regulators like SEBI and RBI. Even now SEBI guidelines make it difficult for pricing issues for an easy exit. Valuation The recent phenomenon is valuation mismatches.
14 funds have already been registered in 1999-2000. These include Andhra Pradesh. cost of the project. Requirement of an experienced management team. PROSPECTS OF VENTURE CAPITAL FINANCING With the advent of liberalization. relationship with the suppliers and creditors. Delhi. Skills and Training required and the cost of training. Kerala and Tamil Nadu. b. Many state governments have also set up venture capital funds for the IT sector in partnership with the local state financial institutions and SIDBI. Karnataka. in the capital employed. . e. h. Major competitors and their market share. accessibility. borrowed capital. d. f. Uncertainty regarding the success of the product in the market. Questions regarding the infrastructure details of production like plant location. total amount of funds required. While only eight domestic venture capital funds were registered with SEBI during 1996-1998. The government is promoting growth in capacity utilization of available and acquired resources and hence entrepreneurship development. mortgage loans etc. The size of the market. c. transportation facilities. ratio of owners investment (personnel funds of the entrepreneur). Longer payback period. the Internal Rate of Return (IRR) of the project. The category of potential customers and hence the packaging and pricing details of the product. by liberalizing norms regarding venture capital. India has been showing remarkable growth in the economy in the past 10 . Financial considerations like return on capital employed (ROCE). labour availability etc.SOME OTHER MAJOR PROBLEMS FACING BY VENTURE CAPITALISTS IN INDIA ARE: a. Institutional interest is growing and foreign venture investments are also on the rise. g. i. Requirement of an above average rate of return on investment.12 years.
b. 2002 made by NFSIT totaled Rs 254.T. The company would be creating and marketing branded web based consumer products in the near future. FINDINGS During the preparation of my report I have analyzed many things which are following:• A number of people in India feel that financial institution are not only conservatives but they also have a bias for foreign technology & they do not trust on the abilities of entrepreneurs.T.have grown from US $ 150 million in 1998 to over US$ 1200 million in 2008. d. In a recent survey it has been shown that the VC investments in India's I. Industry (NFSIT) in association with various financial institutions of Small Industries and Development Bank of India (SIDBI). Existence of a globally competitive high technology. f.7 mn.36 mn. It does not possess the required depth in top • . Gray cell Ltd. The following points can be considered as the harbingers of VC financing in India:a. Some venture fails due to few exit options. Teams are ignorant of international standards. scientific & technical manpower in the world.In the year 2000. This is expected to give a strong boost to the non resident Indians located in the Silicon Valley and elsewhere to invest some of their capital. has recently obtained VC investment totaling about $ 1. The facts reveal that VC disbursements as on September 30.Software and services sector (including dot com companies). c. Globally competitive human resource capital.. A Bangalore based media company. e. Initiatives taken by the Government in formulating policies to encourage investors and entrepreneurs. the finance ministry announced the liberalization of tax treatment for venture capital funds to promote them & to increase job creation. Second Largest English speaking. The team usually a two or three man team. The credit can be given to setting up of a National Venture Capital Fund for the Software and I. knowledge and enterprise in these ventures. . Initiatives of the SEBI to develop a strong and vibrant capital market giving the adequate liquidity and flexibility for investors for entry and exit. Vast pool of existing and ongoing scientific and technical research carried by large number of research laboratories.
publishing. The team is often found to have technical skills but does not possess the overall organization building skills team is often short sited. the venture capitalists that have specialized knowledge in management can help sick industries. Venture capitalist could also be in line with the developments taking place in their parent companies. 2. The present situation may compel venture capitalists to opt for less risky opportunities but is against the spirit of venture capitalism. The Venture capitalists should promote entrepreneur forums. Yet another area where can play a significant role in developing countries is the service sector including tourism. technical institutes etc. It could help the rehabilitation of sick unit through people with ideas and turnaround management skill. but involving high risk. they could also provide financial assistance to people coming out of the universities. A large number of small enterprises in India because sick unit even before the commencement of production of production. clubs and institutions of learning to enhance the quality of entrepreneurship. This would encourage the entrepreneurial spirit. It is recommended that the venture capitalists should retain their basic feature that is tasking high risk. SUGGESTIONS 1. It would also be highly profitable if the venture capitalist replace management either good ones in the sick industries. It is not only initial funding which is need from the venture capitalists. • Venture capitalists in India consider the entrepreneur’s integrity &urge to grow as the most critical aspect or venture evaluation. 3. The investment should be in turnaround stage. The established fact is big gains are possible in high risk projects. There should be a greater role for the venture capitalists in the promotion of entrepreneurship. Since there are many sick industries in India and the number is growing each year. CONCLUSION Venture capital can play a more innovation and development role in a developing country like India. who wish to start their own venture with or without high-tech content. healthcare etc.management. but .
com www. but they also simultaneously provide management and marketing expertise-a real critical aspect of venture capital in developing countries. • • • 2. VARIOUS NEWS PAPERS 4.investopedia. ICFAI JOURNAL OF APPLIED FINANCE MAY.indiainfoline. MAY 2004.JUNE VIKALPA VOLULMLE 28.com www. APRI L. JOURNALS • APPLIED FINANCE VENTURE STAGE INVESTMENT PREFERENCE IN INDIA. BIBLIOGRAPHY 1. 3. Panday. VINAY KUMAR. M.vcapital. Which can improve their effectiveness by setting up venture capital cell in R&D and other scientific generation. JULY. INTERNET • • • • www.vcinstitute.they should also simultaneously provide management and marketing expertise-a real critical aspect of venture capitalists. BOOKS • • I.JUNE 2003 ICFAI JOURNAL OF APPLIED FINANCE. Panday.com www.com .venture capital the Indian experience.venture capital development process in India I. providing syndicated or consortium financing and acing as business incubators.M.AUG.