Chapter – 1 INTRODUCTION TO VENTURE CAPITAL FUNDS 1.1 1.2 1.3 1.4 1.5 1.

6 Introduction The Origin Background Meaning and Definition Characteristics Types of VCF

INTRODUCTION to Venture Capital
Small businesses never seem to have enough money. Bankers and Suppliers, naturally, are important in financing small business growth through loans and credit, but an equally important source of long term. Growth Capital is the venture capital firm. Venture Capital financing may have an extra bonus, for if a small firm has an adequate equity base; banks are more willing to extend credit. 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. Venture capital is capital typically provided by outside investors for financing of new, growing or struggling businesses. Venture capital investments generally are high risk investments but offer the potential for above average returns and/or a percentage of ownership of the company. A venture capitalist (VC) is a person who makes such investments. A venture capital fund is a pooled investment vehicle (often a partnership) that primarily invests the financial capital of third-party investors in enterprises that are too risky for the standard capital markets or bank loans. The term ‘Venture Capital’ is understood in many ways. In a narrow sense, it refers to, investment in new and tried enterprises that are lacking a stable record of growth. In a broader sense, venture capital refers to the commitment of capital as shareholding, for the formulation and setting up of small firms specializing in new ideas or new technologies. It is not merely an injection of funds into a new firm, it is a simultaneous input of skill needed to set up the firm, design its marketing strategy and organize and manage it. It is an association with successive stages of firm’s development with distinctive types of financing appropriate to each stage of development.

According to International Finance Corporation (IFC), venture capital is equity or equity featured capital seeking investment in new ideas, new companies, new production, new process or new services that offer the potential of high returns on investments. As defined in Regulation 2(m)of SEBI (Venture Capital Funds) Regulation , 1996 "venture capital fund means a fund established in the form of a company or trust which raises monies through loans, donations issue of securities or units as the case may be, and makes or proposes to make investments in accordance with these regulations. Thus venture capital is the capital invested in young, rapidly growing or changing companies that have the potential for high growth. The VC may also invest in a firm that is unable to raise finance through the conventional means. Professionally managed venture capital firms 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. Going forward, they actively work with the company's management by contributing their experience and business savvy gained from helping other companies with similar growth challenges.

Venture capitalists mitigate the risk of venture investing by developing a portfolio of young companies in a single venture fund. Many times they will co-invest with other professional venture capital firms. In addition, many venture partnership will 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, Yahoo, Airtel and Genentech are famous examples of companies that received venture capital early in their development. Venture Capital is the business of establishing an investment fund in the form of equity financing via investments in the common stocks, preferred stocks and convertible debentures of various companies. These companies are seen to have a high growth potential and are able to be listed on the stock exchange in order to gain the highest returns in dividends and capital gain.

1.2 The Origin of Venture Capital
In the 1920's & 30's, the wealthy families of and individuals investors provided the start up money for companies that would later become famous. Eastern Airlines and Xerox are the more famous ventures they financed. Among the early VC funds set up was the one by the Rockfeller Family which started a special fund called VENROCK in 1950, to finance new technology companies. USA is the birth place of Venture Capital Industry as we know it today. During most its historical evolution, the market for arranging such financing was fairly informal, relying primarily on the resources of wealthy families. In 1946, American Research and Development Corporation (ARD), a publicly traded, closed-end investment company was formed. ARD's best known investment was the start-up financing it provided in 1958 for computer maker Digital Equipment Corp. ARD was eventually profitable, providing its original investors with a 15.8 percent annual rate of return over its twenty-five years as an independent firm. General Doriot, a professor at Harvard Business School, set up the ARD, the first firm, as opposed to private individuals, at MIT to finance the commercial promotion of

legislation made it possible for pension funds to invest in alternative assets classes such as venture capital firms. Due to the excess of IPOs and the inexperience of many venture capital fund managers.The growth was aided in large part by the creation in 1958 of the federal Small Business Investment Company program. ARD's approach was a classic VC in the sense that it used only equity. working hard to make their portfolio companies successful. these companies were exploiting breakthroughs in electronic. ARD's investment in Digital Equipment Corporation (DEC) in 1957 was a watershed in the history of VC financing.the stock market went through the roof and there were over 100 initial public offerings for the first time in U. . Venture capital firms suffered a temporary downturn in 1974. Highs & Lows of the 1980s In 1980. VC returns were very low through the 1980s.advanced technology developed in the US Universities. 1983 was the boom year . The industry raised approximately $750 million in 1978. That year was also the year that many of today's largest and most prominent firms were founded. As a result. Slow Growth in 1960s & early 1970s. invested for long term. and was prepared to live with losers. began to boom in the late 1950s. VC firms retrenched. 1978 was the first big year for venture capital. history.S. venture capital came to be almost synonymous with technology finance. More often than not. and many remain in operation today. when the stock market crashed and investors were naturally wary of this new kind of investment fund. Hundreds of SBICs were formed in the 1960s. and the First Boom Year in 1978 During the 1960s and 1970s. eventually to be called venture capital firms. venture capital firms focused their investment activity primarily on starting and expanding companies. The work paid off and returns began climbing back up. The number of such specialized investment firms. medical or data-processing technology.

2. till 2000. dedicated pools of capital that focus on equity or equity linked investments in privately held. 1999) is still relatively in a nascent stage in India. Finally. high growth companies' (The Venture Capital Cycle. the rate of M&A activity has increased dramatically in the 1990s. Pursuant to the regulatory framework. both in the number of firms. some domestic VCFs were registered with SEBI. by far the best years for the Venture Capital Industry.3 The Background In September 1995. and in the amount of capital they have raised.200 crore (US$ 500 million) had been committed by the domestic VCFs and offshore funds . understood globally as 'independently managed. As a result. However. Government of India issued guidelines for overseas venture capital investment in India whereas the Central Board of Direct Taxes (CBDT) issued guidelines for tax exemption purposes. creating more opportunities for small. Gompers and Lerner. (The Reserve Bank of India governs the investment and flow of foreign currency in and out of India. around Rs. 1996. venture-backed companies to exit (cash out) at high prices.) As a part of its mandate to regulate and to develop the Indian capital markets. the venture capital industry. Some overseas investments also came through the Mauritius route. The engine for growth has been the favourable economic climate in the US coupled with the advent of the Internet boom. the interest rates were low and the P/Es were very high compared to historical averages. the industry has experienced extraordinary growth in the past few years.Boom Times in the 1990s The 1990s have been. The advent of the Internet as a new medium for both personal and business communications and commerce created an avalanche of opportunities for venture capitalists in the mid and late 1990s. During this decade. Figures from the Indian Venture Capital Association (IVCA) reveal that. 1. Securities and Exchange Board of India (SEBI) framed the SEBI (Venture Capital Funds) Regulations.

Funds that can be invested were less than 50 percent of the committed funds and actual investments were lower still. Institutional interest is growing and foreign venture investments are also on the increase. Chairman. SEBI decided to set up a committee on venture capital to identify the impediments and suggest suitable measures to facilitate the growth of venture capital activity in India. there is an acute need for higher investments in venture capital activities.which are members of IVCA. The setting up of this committee was primarily motivated by the need to play a facilitating role in tune with the mandate of SEBI. Chandrasekhar. to regulate as well as develop the market. due to economic liberalisation and increasing global outlook in India. Given the proper environment and policy support. At the same time. The Finance Minister. Figures available from private sources indicate that overall funds committed are around US$ 1. it was decided to associate Indian entrepreneur from Silicon Valley in the committee.. B. submitted its report on 8 January 2000. Exodus Communications Inc." He also said that the guidelines for the registration of venture capital activity with the Central Board of Direct Taxes would be harmonized with those for registration with the Securities and Exchange Board of India. an increased awareness and interest of domestic as well as foreign investors in venture capital was observed. While only 8 domestic VCFs were registered with SEBI during 1996-98. The committee headed by K.3 billion. "For boosting high tech sectors and supporting first generation entrepreneurs. more than 30 additional funds have already been registered in 2000-01. Keeping in view the need for global perspective. there is a tremendous potential for venture capital activity in India. . in the Budget 2000 speech announced.

(2) it is long-term investment. Venture capitalist pools their resources including managerial abilities to assist new entrepreneur in the early years of the project. they sell their equity holdings at high premium. and (3) it is an active from of investment. (b) Definition of the Venture Capital Company A venture capital company is defined as “a financing institutions which joints an entrepreneur as a co-promoter in a project and shares the risks and rewards of the enterprise. Once the project reaches the stage of profitability. Venture capital funds by participating in the equity capital institutionalize the process of risk taking which promotes successful domestic technology development. Investors of venture capital have no liquidity for a period of time. But a reward is thee for liquidity and waiting. First.5 Characteristics of Venture Capital The three primary characteristics of venture capital funds which may them eminently suitable as a source of risk finance are: (1) that it is equity or quasi equity investments.1.” 1. There is no security for his investment. The venture . Venture capitalist or funds hope that the company they are backing will thrive and after five to seven years from making the investment it will be large and profitable enough to sell its shares in the stock market. venture capital is equity or quasi equity because the investor assumes risk.4 (a)Meaning of Venture Capital Venture capital is long-term risk capital to finance high technology projects which involve risk but at the same time has strong potential for growth.

These features of venture capital render it eminently suitable as a source of risk capital for domestically developed technologies. Although venture capital evolved as a method of early sage financing it includes development. . venture capital investment involves participation in the management of the company. New venture proposals in high technology area are attractive because of the perceived possibility of substantial growth and capital gains.capitalists hope to sell their share for many times what they paid for. The probability distribution of expected returns for most venture capital investment is highly skewed to the right. purchase of equity shares. financing new and rapidly growing companies. Finally. assist in transformation of innovative technology based ideas into products and services. and possess a long-term perspective. Such a broad approach would help venture funds to diversify their investment and spread risks. Secondly. assume risks in the expectation of large rewards. expansion and buyout financing for units which are unable to raise funds through normal financing channels. Units in developing countries need funds for financing various stages of development. and value to company by active participation. Venture capitalist participates in the Board and guides the firm on strategic and policy matters. If the unit fails the venture capitalists losses everything. The success rate is 10-20 percent. venture capital is long-term investment involving both money and time. The features of venture capital generally are.

Venture funds in India can be classified on the basis of the type of promoters. etc. Private venture funds like Indus. Offshore funds: Barings. financial institutions. etc. etc. JF Electra (mostly operating out of Hong Kong). TCW. HSBC. Angels: high net worth individual investors.6 Types of Venture Capital Firms Venture Capital can be divided into many different types according to the characteristics of the shareholders and sources of investment -. Venture capital subsidiaries are established by major corporations.1.such as private equity firms. venture capital subsidiaries of corporations and private venture capital firms/ funds. commercial bank holding companies and other financial institutions. Regional funds dedicated to India: Draper. Regional funds: Warburg Pincus. etc. ILFS. that is. Generally there are three types of organized or institutional venture capital funds: venture capital funds set up by angel investors. the government or insurance companies. Merchant bankers and NBFCs who specialize in "bought out" deals also fund companies. • • • • • • On the basis of geographical focus • • Regional Global IT and IT-enabled services Software Products (Mainly Enterprise-focused) Wireless/Telecom/Semiconductor Banking On the basis of industry specialty • • • • . banks. high net worth individual investors. private corporations. Walden. Corporate ventures: venture capital subsidiaries of corporations. • Financial institutions led by ICICI ventures.

Credit Capital Venture Fund. (TDICI) by ICICI. (RCTFC) by IFCI and Risk Capital Fund by IDBI 2. . Risk Capital and Technology Finance Corporation Ltd. Private VCFs supported by private sector companies such as Indus Venture Capital Fund. (APVCL) by APSFC 3.• • • • • Media/Entertainment Bio Technology/Bio Informatics Pharmaceuticals Contract Manufacturing Retail On the basis of funding stage: • • • Seed/early Late/mbo Pipe The Venture Capital firms in India can be categorized into the following four groups: 1. Bank-sponsored VCFs such as Canfina and SBI Caps 4. SFC-sponsored VCFs such as Gujarat Venture Capital Ltd. (GVCL) by GIIC and Andhra Pradesh Venture Capital Ltd. All-India DFI-sponsored VCFs such as Technology Development and Information Company of India Ltd.

Chapter – 2 Development of VCF in International Arena and INDIA 2.3 Future of Venture Capital in India .2 Venture Capital in India 2.1 VCF in International Arena 2.

Andrew Carnegie and others took the initiative. JAPAN In 1963. It is often said that people decide to become entrepreneurs because they see role models in other people who have become successful entrepreneurs. The venture capital industry was started by George Detroit who collaborated in establishing Corporation at Boston. Osaka and Nagoya. which rose to 115 in 1992. The rapid growth of industry in Japan is credited to the easy availability of venture capital. In 1983. From 1965 to 1972 nearly 40 venture capital companies were formed with committed assets of $500 million. Much the same thing can be said about venture capitalists.Development of Venture Capital 2. Leading financial institutions in Japan started venture capital companies for financing high technology industrial units. 3 Government assisted companies were established in Tokyo. the US venture industry began to establish its business overseas at large. USA The history of the venture capital in US traces back to the period after World War II when a few wealthy family groups like Rockefeller. to provide venture capital t small and medium industries. British Venture Capital Association was established with a membership of 33 funds. UK In the UK. the venture capital industry has been associated with technology development. It is noted that in the US. In the 1980s.1 The International arena The modern venture capital industry began taking shape in the post – World War II years. the development of venture capital owes to the professionally managed specialist fund – Charter House – set up in 1980 for providing risk equity finance for young and growing small business. .

(TDICI) promoted by ICICI and UTI. Credit Capital Venture Fund. At the same time Gujarat Venture Finance Ltd. Though an attempt was also made to raise funds from the public and fund new ventures. and APIDC Venture Capital Ltd.2. the venture capitalists had hardly any impact on the economic scenario for the next eight years . Asian Development Bank and the Commonwealth Development Corporation viz.2 VENTURE CAPITAL IN INDIA This activity in the past was possibly done by the developmental financial institutions like IDBI. And with the minimum paid up capital requirements being raised for listing at the stock exchanges. For a long time funds raised from public were used as a source of VC. were started by state level financial institutions. The first private VC fund was sponsored by Credit Capital Finance Corporation (CFC) and promoted by Bank of India. VC financing really started in India in 1988 with the formation of Technology Development and Information Company of India Ltd. foreign institutional investors or pension funds and high net-worth individuals. Sources of these funds were the financial institutions. it became difficult for smaller firms with viable projects to raise funds from public. the need for VC was recognised in the 7th five year plan and long term fiscal policy of GOI. In India. This source however depended a lot on the market vagaries. In 1973 a committee on Development of small and medium enterprises highlighted the need to faster VC as a source of funding new entrepreneurs and technology. These institutions promoted entities in the private sector with debt as an instrument of funding. ICICI and State Financial Corporations.

contract manufacturing and retail. favourable investment opportunities. software products. This ceiling would be subject to relevant equity investment limit in force in relation to areas reserved for SSI. . biotechnology. entertainment and media. The sectors where the country attracts venture capital are IT and ITES.GROWTH OF FIRMS IN INDIA Year 1995 1996 1997 1998 1999 2000 No. An offshore venture capital company may contribute upto 100 percent of the capital of a domestic venture capital fund and may also set up a domestic asset management company to manage the fund. cost competitive workforce. banking. The automatic route is not available. PSU disinvestments. of Funds 12 6 2 3 1 2 Source: AVCJ/IVCA India is prime target for venture capital and private equity today. pharmaceuticals. Venture capital funds (VCFs) and venture capital companies (VCC) are permitted upto 40 percent of the paid up corpus of the domestic unlisted companies. Investment in a single company by a VCF/VCC shall not exceed 5 percent of the paid up corpus of a domestic VCF/VCC. owing to various factors such as fast growing knowledge based industries. of Funds 4 7 10 6 5 47 Year 2001 2002 2003 2004 2005 2006 No. booming stock markets and supportive regulatory environment among others.

2. emerging needs of new generation of entrepreneurs in the process and inadequacy of the existing venture capital funds/schemes are indicative of the tremendous scope for venture capital in India and pointers to the need for the creation of a sound and broad-based venture capital movement India. as a less intimately involved and temporary shareholder. demand for newer technology and products in India has gone up tremendously. There are many entrepreneurs in India with a good project idea but no previous entrepreneurial track record to leverage their firms. With rapid international march of technology. This will give a boost to the development of new technology and would go a long way in broadening the industrial base. the pace of development of new and indigenous technology in the country has been slack in view of the fact that several process developed in laboratories are not commercialized because of unwillingness of people to take entrepreneurial risks. Another type of situation commonly found in our country is where the local group and a multi-national company may be ready to enter into a joint venture but the former does not have sufficient funds to put up its share of the equity and the latter is restricted to a certain percentage.e. i. . Venture capital can open a new window for such entrepreneurs and help them to launch their projects successfully. venture financing assumes more significance. Venture capitalists can also lend their expertise and standing to the entrepreneurs. It can act not only act as a financial catalyst but also provide strong impetus for entrepreneurs to develop products involving newer technologies and commercialize them. the local group may not be keen to invite any one in its industry or any major private investor to contribute equity and may prefer a venture capital company. creation of jobs.3Future of Venture Capital in India Rapidly changing economic environment accelerated by the high technology explosion. provide a thrust to exports and help in the overall enrichment of the economy. In such a situation. handle customers and bankers. For the personal reasons or because of competition. risk their funds as also undergo the ordeal of marketing the products and process.

it will be desirable to establish a separate national venture capital fund tow which the financial institutions and banks can contribute. marketing. developmental an exploitation phases in the process of commercialization of the technological innovation and (ii) as may of the risk stages-development. remodeled jewellery. transfer and innovation. managerial and financial assistance and services to building entrepreneurs and be a position to offer innovative solutions to the varied problems faced by them in business promotion. The major thrust of this fund should be on the promotion of viable new business in India to take advantage of the on coming high technology revolution and setting up of high growth industries so as to take the Indian economy to commanding heights. builders of resort hotels. venture capitalists can play significant role in tapping its potentiality to the full. The fund should offer a comprehensive package of technical. retirement homes and small houses. . baby and health care market. For instance. manufacturing. In view of the above. To this end. management and growth as possible under Indian Conditions. venture capitalists can provide capital and expertise to organizations selling antique. the proposed national venture capital fund should have at its command multi-disciplinary technical expertise. which has immense growth prospects in India.In service sector. commercial. In scope and content such a national venture capital fund should cover: (i) all the aspects of venture capital financing in all the three stages of conceptual.

5 3.Chapter – 3 Venture Capital Investment Process 3.3 3.9 3.7 3.4 3.2 3.6 3.8 3.10 Investment Procedure Investment in VC by Banks Angle Corporate Venturing Consortium Financing Favourites of the Investors Promotion Strategies Incentives Initiatives Special Purpose Vehicle .1 3.

is an important tool in determining a fair pre-investment valuation. The due diligence process involves an assessment of both the microeconomic and macroeconomic factors that can affect the earnings growth of the target company. The venture capitalists view the due diligence process as a means of identifying and becoming comfortable with the risks to which their capital will be exposed. the business plan. which could potentially lead to business opportunities. This is achieved primarily through plugging into an appropriate network. Before making any investment. the market for the products and/or services. academia. . the nature of its operations. The network is crucial to the success of the venture capital investor. the goal as venture capitalists is to understand virtually every aspect of the target company: the experience and capabilities of the management team.1 Investment Procedure In generating a deal flow. including the documentation supporting any previous issuances of the company's securities. Thus venture capital funds focusing on early stage technology based deals would develop a network of R&D centers working in those areas. and other factors that may affect the outcome of the investment. the methods by which sales are made. The most popular network obviously is the network of venture capital funds/investors. the venture capital investor creates a pipeline of ‘deals’ or investment opportunities that he would consider investing in. While due diligence investigations are viewed by many as mundane and irritating tasks. its products and/or services. It is also common for venture capitals to develop working relationships with R&D institutions. the process enables venture capitalists to address areas of concern. and may help to avoid significant and otherwise unexpected liability following the investment. Understandably the composition of the network would depend on the investment focus of the venture capital funds/company. It is almost imperative for the venture capital investor to receive a large number of investment proposals from which he can select a few good investment candidates finally. etc. The due diligence process also includes a review of the corporate and legal records.Venture Capital Investment Process 3. the competitive landscape.

the odds could be as low as one in 100. It is estimated that only five business plans in 100 are viable investment opportunities and only three in 100 results in successful financing. 3. The remaining 15 per cent are looked at in more detail. Initial Evaluation: This involves the initial process of assessing the feasibility of the project. In fact. 7. More than half of the proposals to venture capitalists are usually rejected after a 20-30 minute scanning. product. And of every 10 investments made. Exit Policies: There are mainly 3 exit policies followed by VCF’s in general. But this is enough to recover investments made by the venture capital (VC) in all 10 start-ups in addition to an average 40-50% return! Securing an investment from an institutional venture capital fund is extremely difficult. Due diligence: In this stage an in-depth study is conducted to analyse the feasibility of the project. final amount for deal is decided. . 2. and 25 per cent are discarded after a lengthier review. 5. First.Only one or two business plans in 100 result in successful financing. A Venture Capitalist looks at various aspects before investing in any venture. 4. Documentation: This is the process of creating and executing legal documents to protect the interest of the venture. Deal structuring and negotiation: Having established the feasibility. but at least 10 per cent of these are dismissed due to irreconcilable flaws in the management team or the business plan. the project is monitored by executives from the venture fund and undesirable variations from the business plan are dealt with. 6. Monitoring and Value addition: In this stage. you need to work out a business plan. 1. capital costs and means of financing and profitability statements. marketing plan. the instruments that give the required return are structured. Investment valuation: In this stage. The business plan is a document that outlines the management team. only one or two are successful.

These include • • • • • • Competitive aspects of the product or service Outlook of the target market and their perception of the new product Abilities of the management team Availability of other sources of funding Expected returns Time and resources required from the venture capital firm Through this screening the venture firm builds an initial overview about the • • • Technical skills. driving forces of the market. an initial screening is carried out to satisfy the venture capitalist of certain aspects of the project. Additional studies and collection of project-based . competitors and share. temperament and ethics of the promoters The stage of the technology being used. Initial Evaluation: Before any in depth analysis is done on a project.1. the drivers of the technology and the direction in which it is moving Location and size of market and market development costs. products. It includes carrying out indepth reference checks on the proposal related aspects such as management team. experience. distribution channels and other market related issues • • • • Financial facts of the deal Competitive edge available to the the company and factors affecting it significantly Advantages from the deal for the venture capitalist Exit options available 2. Due diligence Due diligence is term used that includes all the activities that are associated with investigating an investment proposal to assess feasibility. technology and market. business sense.

technology and process In this category the type of questions asked will depend on the nature of the industry into which the company is planning to enter. The important feature to note is that venture capital due diligence focuses on the qualitative aspects of an investment opportunity. past performance and credibility of promoters Financial background and feedback about promoters from bankers and previous   lenders    • Details of Board of Directors and their role in the activities Availability of skilled labour Recruitment process Products/ are done during this stage. Areas of due diligence would include • General assessment business plan analysis contract details collaborators corporate objectives SWOT analysis Time scale of implementation       • People Managerial abilities. Some of the areas generally considered are  Technical details. manufacturing process and patent rights .

reliability of these suppliers      • Machinery to be used and its availability Details of various tests conducted regarding the new product Product life-cycle Environment and pollution related issues Secondary data collection on the product and technology. if so available Market The questions asked under this head also vary depending on the type of product. their availability and major suppliers. Some of the main questions asked are         main customers future demand for the product competitors in the market for the same product category and their strategy pricing strategy supplier and buyer bargaining power channels of distribution marketing plan to be followed future sales forecast. .  Competing technologies and comparisons Raw materials to be used.

Also the structure should take into consideration the various commercial issues (ie what the entrepreneur wants and what the venture capital would require to protect the investment). These could result in losses or cash flow drains on the company. Structuring a deal 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. 3. • Finance Financial forecasts for the next 3-5 years Analysis of financial reports and balance sheets of firms already promoted or run   by the promoters of the new venture        Cost of production Wage structure details Accounting process to be used Financial report of critical suppliers Returns for the next 3-5 years and thereby the returns to the venture fund Budgeting methods to be adopted and budgetary control systems External financial audit if required Sometimes.Market survey could be conducted to gather further more accurate and relevant data. They avoid this through due diligence and scrutiny of the business plan. companies may have experienced operational problems during their early stages of growth or due to bad management. Sometimes financing from venture capital may end up being used to finance these losses. .

expiry period. loan vs loan stock maturity exercise price. . put Preference shares Loan Warrants Options In India. expiry period exercise price.The instruments to be used in structuring deals are many and varied. The objective in selecting the instrument would be to maximize (or optimize) venture capital’s returns/protection and yet satisfy the entrepreneur’s requirements. call. Nowadays. warrants are issued as a tool to bring down pricing. straight equity and convertibles are popular and commonly used. The instruments could be as follows: Instrument Equity shares Issues new or vendor shares par value partially-paid shares redeemable (conditions under Company Act) participating par value nominal shares clean vs secured Interest bearing vs non interest bearing convertible vs one with features (warrants) 1st Charge. 2nd Charge.

would be a secured loan. Investment valuation . A number of factors affect the choice of instruments. A typical proposal may include a combination of several different instruments listed above. the venture capital decides whether or not the amount requested. future cash flows. However from the venture capitals point of view. ultimately. product life-cycle. the company had to pay a percentage of sales as royalty and if it failed then the amount was written off. If the project was successful. the safest instrument. Under normal circumstances. gestation period Macro environment Tax options on different instruments. Even for the proposed investment amount. Hence. performance track-record. is appropriate and consistent with the risk level of the investment. but with the least return. it is important to listen to what the entrepreneur wants. what you end up with would be some instruments in between which are sold to the entrepreneur. current stage of operation. willingness of promoters to dilute stake Product/Project specific Future market potential. The risks should be analyzed. Under this. such as Categories Company specific Promoter specific Factors influencing the choice of Instrument Risk. taking into consideration the stage at which the company is in and other factors relating to the project.A variation that was first used by PACT and TDICI was "royalty on sales". In structuring a deal. the company was given a conditional loan. (eg exit problems. expected profitability. etc). investment liquidity options Current financial position of promoters. entrepreneurs would prefer venture capitals to invest in equity as this would be the lowest risk option for the company. . policies adopted by competition 4. legal framework. but the venture capital comes up with his own solution.

. the product/service size of the potential market. • Demand and supply of capital: when there is a surplus of venture capital of venture capital chasing a relatively limited number of venture capital deals. This can result in unhealthy levels of low returns for venture capital investors. the valuation process goes through the following steps: 1. • The degree of popularity of the industry/technology in question also influences the pre-money. Evaluate future revenue and profitability 2.term outlook for new products/services and therefore results in more liberal pre-money valuations. Forecast likely future value of the firm based on experienced market capitalization or expected acquisition proceeds depending upon the anticipated exit from the investment. innovation/ unique selling propositions (USPs). Target ownership positions in the investee firm so as to achieve desired appreciation on the proposed investment. The appreciation desired should yield a hurdle rate of return on a Discounted Cash Flow basis.The investment valuation process is an exercise aimed at arriving at ‘an acceptable price’ for the deal. etc affects valuations in an obvious manner. valuations go up. • Specific rates of deals: such as the founder’s/management team’s track record. Typically in countries where free pricing regimes exist. 3. In certainty the valuation of the firm is driven by a number of factors. Computer Aided Skills Software Engineering (CASE) tools and Artificial Intelligence were one time darlings of the venture capital community that have now given place to biotech and retailing. The more significant among these are: • Overall economic conditions: A buoyant economy produces an optimistic long.

. revealed the following trend. Documentation It is the process of creating and executing legal agreements that are needed by the venture fund for guarding of investment.• The standing of the individual venture capital Well established venture capitals who are sought after by entrepreneurs for a number of reasons could get away with tighter valuations than their less known counterparts. There are also different agreements based on whether the agreement is with the promoters or the company. • Investor’s considerations could vary significantly. Large corporations who invest for strategic advantages such as access to technologies. A study by an American venture capital. Based on the type of instrument used the different types of agreements are • • • • Equity Agreement Income Note Agreement Conditional Loan Agreement Optionally Convertible Debenture Agreement etc. the company and the promoters. The different legal documents that are to be created and executed by the venture firm are  Shareholders agreement . 5. Venture One. for a given ownership position in a company but only half as much as investors in a public offering. products or markets pay twice as much as a professional venture capital investor. The agreement takes into account  Capital structure. • Valuation offered on comparable deals around the time of investing in the deal.This agreement is made between the venture capitalist.

dividend etc. The issues under which such cancellation or suspension takes place are default of covenants and conditions. inability to pay debts.The agreement is signed between the promoters and the venture capitalist wherein the promoter agrees not to withdraw. security of loan.It contains details of repayment.   Appointment of Board of Directors Provisions regarding suspension/cancellation of the investment. transfer.  Income Note Agreement . conversion.  Equity subscription agreement . assign. refusal of disbursal by other financial institutions. Transfer of shares: This lays the condition for transfer of equity between the equity holders. pledge. The promoters cannot sell their shares without the prior permission of the venture capitalist. and liquidation or dissolution of the company. interest.  Conditional Loan Agreement . . The promoters shall not diversify. appointment of nominee directors etc. proceedings against the company. expand or change product mix without permission. hypothecate etc their investment without prior permission of the venture capitalist. royalty.It contains details on the terms and conditions of the loan. disposal and removal of assets.This is the agreement between the venture capitalist and the company on       Number of shares to be subscribed by the venture capitalist Purpose of the subscription Pre-disbursement conditions that need to be met Submission of reports to the venture capitalist Currency of the agreement Deed of Undertaking . supply of misleading information.

they may have innovative solutions to maximize the chances of success of the project. Deviations or causes of worry may alert them to potential problems and they can suggest remedial actions or measures to avoid these problems. After all. as a financial partner and strategic advisor. They are actively involved in the management of the of the investor unit and provide expert business counsel. 6. It is to be understood that the providers of venture capital are not just financiers or subscribers to the equity of the project they fund. They function as a dual capacity. Joint and Several Personal Guarantee Power of Attorney etc. Whenever there is a modification in any of the agreements. the ultimate aim of the venture capitalist is the same as that of the promoters – the long term profitability and viability of the investor company. marketing and general management. As professional in this unique method of financing. Venture capitalists monitor and evaluate projects regularly. Indian venture capitalists do not generally involve themselves on a hands-on basis bit they do have board representations. then a Supplementary Agreement is created for the same. . The venture capitalist gives ongoing advice to the promoters and monitors the project continuously. Monitoring and follow up The role of the venture capitalist does not stop after the investment is made in the project. Deed of Hypothecation. The skills of the venture capitalist are most required once the investment is made. The various styles are: Hands-on Style suggests supportive and direct involvement of the venture capitalist in the assisted firm through Board representation and regularly advising the entrepreneur on matters of technology. Shortfall Undertaking. to ensure its survival and growth.

Firms strong in factors relating to patents. They will want to ensure that the investee company has the willingness to adopt modern corporate governance standards. Intermediate Style venture capital funds awe entitled to obtain on a regular basis information about the assisted projects. idea. EXIT strategies adopted by VCF’s: A venture capital firm enters a relationship with a company with the expectation that a significant return of investment will result when the firm exits the investment. the expertise of the venture firm in successfully exiting its investment will dictate the success of the exit for themselves and the owner of the company. The firm plans for that exit to take place within a certain amount of time. management. depending on the development stage of the company in which it is investing. While the initial public offering may be the most glamorous and heralded type of exit for the venture capitalist and owners of the company. . Again. usually from three to six years. Venture capitalists must be confident that the firm has the quality and depth in the management team to achieve its aspirations. Venture capital target companies with superior products or services focussed at fast-growing or untapped markets. most successful exits of venture investments occur through a merger or acquisition of the company by either the original founders or another company. 7. and potential are more likely to obtain VC financing and willing partners to support commercialisation activities. it will seek to exit the investment in the portfolio company. Depending on the investment focus and strategy of the venture firm.Hands-off Style involves occasional assessment of the assisted firms management and its performance with no direct management assistance being provided. Indian venture funds generally follow this approach.

become the research and development arm of larger companies who often look to buy them once their innovations can contribute to their own profitability. In an era of large companies dominating industry landscapes. almost 3000 companies financed by venture funds have gone public. usually after about two years. Mergers and Acquisitions Mergers and acquisitions represent the most common type of successful exit for venture investments.There are several common exit strategies: • • • IPO The initial public offering is the most glamorous and visible type of exit for a venture investment. Over the last twenty-five years. Once this stock is freely tradable. Smaller companies have. At public offering. In the case of a merger or acquisition. IPO Mergers and Acquisitions Redemption . in essence. but the firm is regulated and restricted in how that stock can be sold or liquidated for several years. acquisition is often the targeted and most common exit strategy. In recent years technology IPOs have been in the limelight during the IPO boom of the last six years. the venture firm is considered an insider and will receive stock in the company. the venture firm will receive stock or cash from the acquiring company and the venture investor will distribute the proceeds from the sale to its limited partners. the venture fund will distribute this stock or cash to its limited partner investor who may then manage the public stock as a regular stock holding or may liquidate it upon receipt.

an angel is an experienced industry-bred individual with high net worth. Further. .Redemption Another alternative is that the company may be required to buy back a venture capital firm's stock at cost plus a certain premium. 2. This is because they support a fledging enterprise at a very early stage – sometime even before commercialization of the product or service offering. but who play an active role in making an early-stage company work. They are people with enough hands-on experience and are experts in their fields. He also needs money to make things happen. 2. An entrepreneur needs this kind of expertise. Angels provide funding by "first round" financing for risky investments – risky because they are a young /start-up company or because their financial track record is unstable. The monetary and credit policy for the year 1999-2000 provides that the overall ceiling of investment by banks in ordinary shares. Often a venture capital firm will put a redemption clause (sometimes referred to as a "buy-back clause") in the investment terms which allows them to exit their investment in your company in the event that an IPO or acquisition does not happen within a designated time period. Typically.2 Investment in Venture Capital by Banks To encourage the flow of finance for venture capital commercial banks are allowed to invest in venture capital without any limit since April 1999. convertible debentures of corporate and units of mutual funds which is currently at 5 per cent of their incremental deposits will stand automatically enhanced to the extent of banks’ investments in venture capital. They understand the field from an operational perspective.3 Angels Angels are people with less money orientation. Angels are important links in the entire process of venture capital funding. the Monetary and Credit Policy (1999-2000) provides for the inclusion of investment in venture capital under priority sector lending. Angels bring both to the table of an entrepreneur.

This venture capital financing is typically used to prepare the company for "second round" financing in the form of an initial public offering (IPO). When choosing an 'Angel'. reputation. It is important to choose the right Angel because they will sit on your Board of Directors. prioritized objectives. • Manage portfolios ruthlessly. Example – A company may need "first round" financing to develop a new product line. abandon losers. often for the duration of their investment and will assist in getting "second round" financing. Their skills are honed for managing mature businesses and not nurturing start up companies. political concerns. Corporate managers seldom have the same freedom to fund innovative projects or to cancel them midstream. whereas abandoning ventures has never been easy for large corporations. they run into ambiguity with venture programs. it is imperative to consider their experience in a relevant industry. . Success of venture capital firms rest on the following characteristics: Focus on specific industry niches • Although corporate managers have a clear focus in their business. If a firm is to apply the venture capital model. it must understand the characteristics of the model and tailor its venture capital program to its own circumstances without losing sight of these essentials. Simply making a good financial return is not sufficient. qualifications and track record. (viz a new drug which would require significant research & development funding) or make a strategic acquisition to achieve certain levels of growth & stability. most companies find it difficult to establish systems. capabilities and cultures that make good venture capital firms. whose projects are underpinned by personal relationships. Corporate Venturing Even though corporate venturing is an attractive alternative. Their biggest challenge is to establish clear.

Multinationals led by Intel are the best examples of corporate venturing in an Indian context. Venture investing requires different mindset from typical corporate investors. decision criteria and operating procedures on those of top venture capital firms. flexible and quick to make decisions. An innovative culture cannot be transplanted but must evolve within the company. New ventures can be powerful source of revenues. Most Indian companies are yet to move up the value chain and consolidate their position as players in the global market. They tend to be small. They have flat hierarchies and rely heavily on equity and incentive pay. This helps in diversifying risk but however it has not been very successful in the India case. which launched the successful corporate ventures had created new products in the market operating at the higher end of the value chain and had attained a certain size in the market. its funding decisions were aimed at optimizing financial returns. The company should create an environment that encourages venturing. . Consortium Financing Where the project cost is high (Rs 100 million or more) and a single fund is not in a position to provide the entire venture capital required then venture funds may act in consortium with other funds and take a lead in making investment decisions. Apple Computers established a venture fund in 1986 with the dual objectives of earning high financial return and supporting development of Macintosh software. Corporate venturing models would probably benefit Indian companies who are large players in the Indian market in another five to 10 years by enabling them to diversify and at the same time help start up companies.• Venture capital firms share several attributes with start up they fund. The result was an IRR of 90 per cent but little success in improving the position of Macintosh. How relevant is corporate venturing in the Indian scenario? The firms. While they considered Macintosh as an initial screening factor. diversification and flexibility in rapidly changing environments. They structured compensation mechanisms.

these trends have been in keeping with the global course. there are a number of players operating in India whose activity is not monitored by the association.In the organized sector. a producer of software solutions for the CAD/CAM market • Ruksun Software. In the last two years. telecommunications industries like Zip Telecom and media companies like UTV and Television Eighteen have joined the list of favorites. news. there have been just 74 initial public offerings (IPOs) at the stock exchanges. That’s less than 12% of the money raised in the previous two years. . stands at Rs50bn.24bn. leading to an investment of just Rs14. companies from other sectors also feature equally in their portfolios. makers of embedded software • PowerTel Boca. etc 2. ‘angel’ investors and a host of financial intermediaries and the total pool of Indian Venture Capital today.6 Favourites of the Investors Though the InfoTech companies are among the most favored by venture capitalists. The healthcare sector with pharmaceutical. private individuals. one of the oldest software houses in India • Geometric Software. Some of the companies that have received funding through this route include: • Mastek. distributor of telecomputing products for the Indian market • Rediff on the Net. chat. according to industry estimates! The primary markets in the country have remained depressed for quite some time now. So far. Pune-based software consultancy • Hinditron. That makes the conservative estimate of Rs36bn invested in companies through the Venture Capital/Private Equity route all the more significant. Indian website featuring electronic shopping. medical appliances and biotechnology industries also get much attention in India. Add together the infusion of funds by overseas funds. With the deregulation of the telecom sector.

However, recent developments have shown that India is maturing into a more developed marketplace; unconventional investments in a gamut of industries have sprung up all over the country. This includes: Indus League Clothing, a company set up by eight former employees of readymade garments giant Madura, who set up shop on their own to develop a unique virtual organization that will license global apparel brands and sell them, without owning any manufacturing units. They dream to build a network of 2,500 outlets in three years and to be among the top three readymade brands. Shoppers Stop, Mumbai’s premier departmental store innovates with retailing and decides to go global. This deal is facing some problems in getting regulatory approvals. Airfreight, the courier-company which has been growing at a rapid pace and needed funds for heavy investments in technology, networking and aircrafts. Pizza Corner, a Chennai based pizza delivery company that is set to take on global giants like Pizza Hut and Dominos Pizza with its innovative servicing strategy. Car designer Dilip Chhabria, who plans to turn his studio, where he remodels and overhauls cars into fancy designer pieces of automation, into a company with a turnover of Rs1.5bn (up from Rs40mn today).

2.7 Promotion Strategies
• There is inadequate flow of applications for venture financing in India. The need is promotional efforts not only to increase the flow of applications but also to popularize the generic idea of venture financing. The promotion efforts of venture capital funds in India could be classified as Contacting R&D organisations • Conducting seminars and industrial meets where the salient features of venture capital schemes can be presented to prospective entrepreneurs • Creation of information services

• • •

Promotion of entrepreneurial activities Venture Fairs in which the members of the VC industry listen to entrepreneurs about their new ideas and business propositions Venture Capital Networks and Associations

2.8 Incentives
Recognizing the importance of venture capital, the government introduced major liberalisation of tax treatment for venture capital funds and simplification of procedures. These included the following:
• •

SEBI was recognized as the single nodal agency. A new clause (23FB) in Section 10 of Income Tax Act was introduced with effect from 1st March 2000. This clause stated that any income, of a venture capital company or a venture capital fund, from any investments made in venture capital undertaking, would not be included in computing the total income.

Section 115U was also introduced in the Income Tax Act with effect from the assessment year 2001-02 to establish a VC pass through. This means that the VC profits will not be taxed twice. The regulated VC Fund (with SEBI) would be exempted from tax (subject to certain conditions) but the VC investor will have to pay tax.

Earlier on, if a VCF wished to avail certain tax benefits, the VCF had to exit from investments made in a venture capital undertaking (VCU) within twelve months of the VCU obtaining a listing. However, this requirement was done away around November 2000. The Finance Bill 2001, proposes to amend section 10 (23 FB) so as to provide that a VCC / VCF will continue to be eligible for exemption under section 10 (23 FB), even if the shares of the VCU, in which the VCC / VCF has made the initial investment, are subsequently listed in a recognized stock exchange in India.

2.9 Initiatives
There have been a number of initiatives by the Government as well as the industry to pave way for a business and regulatory environment that is conducive to new venture development and to innovation at the user end. Some of the initiatives in the past have included those by the Ministry of Finance, the Securities, Exchange Board of India (SEBI), Ministry of Information Technology (formerly Department of Electronics), State Governments, Financial Institutions, the Indian Venture Capital Association. These initiatives resulted in the availability of more than US$ 500 million of venture funds for Indian ventures during 1999-2000. With the growing realisation of the immense potential offered by Indian technology companies, funding opportunities are rapidly increasing. The Government of India has already taken laudable steps to facilitate the creation of an environment that is conducive for venture capital funds and start-ups in India. These include:
• •

introduction of sweat equity, allowing venture capital funds to offset losses incurred in one company against profits from another and establishment of government facilitated venture capital funds.

However, the present regulatory framework is still not enough to provide for an environment that lays stress on • • • • • encouraging the flow of venture funds, easy exit options (for either party), mentoring, non-qualified availability of funds, and flow of public funds for enterprise building in India.

India needs to encourage the growth of risk capital by acting on three fronts: 1. The Government of India and Indian financial institutions should catalyse the process by creating Israel's Yozma-like funds. This will stimulate competition but also protect entrepreneurs from inevitable risks.

2. India should amend its regulatory framework so that the VC funds can earn a reasonable return on their risk capital. 3. India should actively promote the infusion of VC skills and capabilities, either by attracting global VC funds or attracting managers from these funds. However, the above moves need to be substantiated with the earliest implementation of the recommendations of the SEBI Committee on Venture Capital.

10 SPECIAL PURPOSE VEHICLE The Definition An account. THE ADVANTAGES Greater security for lenders improves credit rating Lowers the cost of capital THE DISADVANTAGES Less control over cash flows generated by project Tax treatment of SPV still unclear Better management of debtAdministration fees can be high repayment Enables new ventures to raise funds.2. Requires intensive monitoring by trustee . administered by a third party that holds shares bought back by themanagement in trust.

Requires intensive monitoring by trustee . THE ADVANTAGES Greater security for lenders improves credit rating Lowers the cost of capital THE DISADVANTAGES Less control over cash flows generated by project Tax treatment of SPV still unclear Better management of debtAdministration fees can be high repayment Enables new ventures to raise funds.2.11 SPECIAL PURPOSE VEHICLE The Definition An account. administered by a third party that holds shares bought back by the management in trust.

1 Role of Venture Capitalist managers/banker 4.Chapter – 4 Venture Capitalist – A key player 4.2 Difference between VC and money .

. dividend and interest. while in VC financing returns are by way of capital appreciation.e. while VC financing invests in equity of the company. higher the chances of getting loan. and they expect a higher return for their high-risk equity investment.e.VENTURE CAPITALISTS – A key player 4. Most firms require large portions of equity in exchange for start-up financing. They even participate in the management process. VCs generally invest in unlisted companies and make profit only after the company obtains listing. institutional venture capitalists look for average returns of at least 40 per cent to 50 per cent for start-up funding. VC is not a lender but an equity partner. lower the risk. With respect to investing in a business. Second and later stage funding usually requires at least a 20 per cent to 40 per cent return compounded per annum. the ideal benchmark is in the region of an IRR of 25% for general funds and more than 30% for IT-specific funds. Internationally. On the other hand VC financing is a risk taking finance where potential returns outweigh risk factors. Venture Capitalists also lend management support and provide entrepreneurs with many other facilities. To sustain such commitment VC and private equity groups seek extremely high returns… a return of 30% in rupee terms. A bank or an FI will fund a project as long as it is sure that enough cash flow will be generated to repay the loans.1 Role of venture Capitalists Conventional financing generally extends loans to companies. VCs extend need based support in a number of stages of investments unlike single round financing by conventional financiers. In India. Assessment in conventional financing is conservative i. Venture capitalists take higher risks by investing in an early-stage company with little or no history. VC’s are in for long run and rarely exit before 3 years. VCs look at an internal rate of return (IRR) north of 40% plus. Conventional financing looks to current income i.

The VCs also hand-hold and nurture the companies they invest in besides helping them reach IPO stage when valuations are favourable. indicating that most VCs in India have not started developing niches for investing with regard to the stages of projects. sharing the risks and rewards and provides strategic. The venture capitalist is a business partner. venture capitalists provide networking. start-up.95 in turnaround projects . Draper. Apart from finance.60 m in later stage projects and only Rs 82. . VCs carry out very detailed due diligence and make 2-7 year investments. ramp-up and finally in the exit. Some such VCs are: ICICI ventures. SIDBI and Angels. According to Indian Venture Capital Association. The main difficulty in early stage funding are related to lack of exit opportunities as probability of an IPO or buy out by of VC stake is less due to lack of understanding for evaluation of the knowledge based companies compared to the companies in the traditional sectors. management and marketing support as well.The VC Philosophy As against Bought out deals (BODs). operational and financial advice to the company based on experience with other companies in similar situations. Majority have invested in only three stages of investment.40 m) of the total venture capital investment is in start-up projects followed by Rs 4478. VCFs help entrepreneurs at four stages: idea generation. almost 41% (Rs 5146.

Venture capitalist generally invests in new ventures started by technocrats who generally are in need of entrepreneurial aid and funds. 4. Venture capitalists generally invest in companies that are not listed on any stock exchanges. This is partially justified. The most important difference between a venture capitalist and conventional investors and mutual funds is that he is a specialist and lends management support and also • • • Financial and strategic planning Obtain bank and other debt financing Access to international markets and technology . as they tend to invest in more mature stories. Incubator funds like e-ventures also have a similar approach towards their investment. ICICI Ventures falls in the limited exposure category. venture funds who fund seed or start ups have a closer interaction with the companies and advice on strategy. However there can be "hands off" approach like that of Chase.Management of investee firms The venture funds add value to the company by active involvement in running of enterprises in which they invest. They make profits only after the company obtains listing. Draper falls in this category.2 Difference between a venture capitalist and bankers/money managers Banker is a manager of other people's money while the venture capitalist is basically an investor. This is called "hands on" or "pro-active" approach. etc while the private equity funds treat their exposure like any other listed investment. In general.

Loan. sale to third party.• • • Introduction to strategic partners and acquisition targets in the region Regional expansion of manufacturing and marketing operations Obtain a public listing Differences Points Objective Holding period Instruments Pricing Collateral Ownership Control Venture Finance Maximize return 2-5 years Debt Finance Interest payment Short/long term Common shares. warrants Price earnings ratio. sale toLoan repayment entrepreneur . leasing options. rights protection.Covenants board members Increased leverage Impact on Balance sheetReduced leverage of financed Exit Mechanism Public offering. convertible bonds. net tangible assets Interest spread Very rare Yes Yes No Minority shareholders. factoring.

1 5.Chapter – 5 Pro’s and Quo’s of VCF 5.2 5.3 Success factors Critical factor Problems faces by VCF .

.1 Success factors of VCFs 1. 6.5. Networking with industrial partners is important since these target companies are potential clients and exit partners. 2. With respect to the returns from the fund. 5. it is vital that adequate capital is reserved for further investment in the best investment targets and for maintaining the holdings until the exit. Concentrating investments in carefully selected companies showing international promise will yield better returns than distributing the capital across several smaller investments. Networking with universities and research institutes helps identify new technologies and investment targets. 3. Industry-specific concentration of investments yields better returns than geographically concentrated investments. 4. It is crucial that venture capitalists actively support the growth and internationalisation of the companies through their industry-specific know-how and international contacts. Joint investments with partners providing added value contribute to the success of the target companies and improve the returns from the fund.

This emphasizes the facilitating and promotional role of regulation. tax and legal environment should play an enabling role. venture investors globally seek investment and exit on very flexible terms. K. Corporations are also setting up their own venture capital funds. • Investment. In US. which provides them with certain levels of protection. • With increasing global integration and mobility of capital it is important that Indian venture capital firms as well as venture financed enterprises be able to have . Chandrasekhar Committee on venture capital identified the following as critical factors for the success of VC industry in India: • The regulatory. pension funds.5. SEBI (Securities and Exchange Board of India) had set up a committee under the Chairmanship of Mr. B.9 percent in the year 1998 as compared to 2 percent in 1995. Internationally. provide a very big source of money. apart from high net worth individuals and angel investors. Similar avenues need to be identified in India also. The Report of the K. And we need to provide regulatory simplicity and structural flexibility on the same lines. Since high risk is involved in venture financing. The share of corporate funding is also increasing and it was as high as 25. This has already been done for the mutual fund industry in India. B. Such exit should be possible through IPOs and mergers / acquisitions on a global basis and not just within India. fiscal neutrality and operational adaptability. mutual funds etc. Chandrasekhar to look into the issues of venture capital in India. • There is also the need for identifying and increasing the domestic pool of funds for venture capital investment.2 Critical Factors In 1999. management and an exit option should provide flexibility to suit the business requirements and should also be driven by global trends. Venture capital investments have typically come from high net worth individuals who have risk taking capacity. There is also the need for a level playing field between domestic and offshore venture capital investors. insurance funds. venture funds have evolved in an atmosphere of structural flexibility.

automatic. Venture capital has only one common aspect that cuts across geography i. R&D also needs to be promoted by government as well as other organisations. . venture capitalists are not merely finance providers but are also closely involved with the investee enterprises and provide expertise by way of management and marketing support. The above report was well received by the Government and few issues have already been resolved. professional and sophisticated investors. This would not only enhance their ability to generate better returns but also add to their experience and expertise to function successfully in a global environment. • Venture capital should become an institutionalised industry financed and managed by successful entrepreneurs. it is risk capital invested by experts in the field. Therefore. transparent and flexible norms need to be created for such investments by domestic firms and enterprises. This involves creation of technology as well as knowledge incubators for supporting innovation and ideas.e. This industry has developed its own ethos and culture.opportunities for investment abroad. Globally. We need our enterprises to become global and create their own success stories. It is important that venture capital in India be allowed to develop via professional and institutional management • Infrastructure development also needs to be prioritised using government support and private management.

in general. especially if dealing with highly leveraged corporations. we have seen there is substantial risk associated with well established businesses as well as with start-ups. some start-ups will not succeed. have different goals.3 Problems generally associated with Venture Capital 1. venture capital companies may be the only alternative to obtain funding which. 5. Most investors have an unrealistic view of venture capital. most any level . for instance. The principal source of capital for most entrepreneurs is friends and family.have no actual "venture" or entrepreneurial experience. They expect the high returns publicized with respect to successful new ventures but do not want to take the attendant risk. Most venture fund managers come from banking. though. Consequently. 3. particularly with start-ups. 4. Entrepreneurs. such investors go into the marketplace looking for opportunities. the vast majority of venture capital company employees . Few venture capital companies want to spend the time evaluating small deals . professional money management or corporate management.5. The risk is different. claiming to offer venture capital. Despite the best efforts and intentions. and people providing true venture capital recognizes this riskreward trade-off. though. building a factory or buying a profitable going concern. Once that source runs out (if it exists at all). That is simply part of the game. 2. Consequently. are small or insufficient in comparison to the cost of. while some come directly from business school and have been employees of venture capital firms for their entire career. In today's market. The risk associated with true venture capital is greater than when providing capital to an established business. who may expect to see people like themselves as clients. but never finding an investment that meets their requirements. A lack of experience and understanding translates into a lack of comfort with the creation phase of a business and a reluctance to invest in such deals. These differences can often create a gap between the venture capitalist and the entrepreneur sufficient to result in a rejection of the business proposal irrespective of the merits of the business. motivations and personalities than bankers or corporate executives.

but none can be found. and many firms use everyone else's failures as a reason for them to avoid start-ups. That definition is guided by goals and requirements of the individual investor. Often. Many companies and individuals complain that they have money to invest in "good" projects. Despite the fact that many fund managers will say that inadequate management is the primary reason for business failure. within the constraints of their investing limits and in the same amount of time. First. 8.the projections of an established company.when. what is "good" for one person or firm may not be "good" for another. Due primarily to a lack of experience in the creation or start-up phase. 7. adequate capital and good management. they will rarely devote time to assist management to help achieve a greater likelihood of success. Consequently. which can be different than that of a large established corporation. unlike . An older investor may be looking for income while a younger investor may be looking for appreciation. (c) the presence or absence of adequate entrepreneurial management. they could participate in fewer but larger deals. 6. . (b) "adequate capital" for a start-up because traditional venture capital companies may not have the experience to understand whether the entrepreneur's goals can be achieved with the capital requested or to help the entrepreneur determine the appropriate capital requirements for a start-up. A failure of any one of these elements can doom the enterprise. venture capital companies are often lacking in their ability to evaluate and recognize: (a) a "good idea" because ideas and the projections associated with them are so intangible. Three key elements to a successful new venture are (not in order of priority): a good idea. some investments are destined to fail from the they think . those goals are unrealistic as applied to venture capital. a good example of which was the changing need of Apple Computers when it replaced Steven Jobs with John Sculley.

3 Case study-1 Case study-2 Case study-3 .Chapter-6 Case Studies 6.2 6.1 6.

The BVCA and its work The BVCA is the industry body that represents the UK private equity and venture capital industry. The industry is currently facing two major reviews . with growth comes responsibility as well as opportunity. Achieving the right outcome for the industry from the tax review and continuing to ensure regulation is appropriate and not burdensome are two vital tasks the British Venture Capital Association (BVCA) and the industry faces. but also the capital gains made by the risk-taking entrepreneurs and management team that as an industry VCF back. In addition. both in terms of the funds it has raised and the capital it manages and in the level of investment that is made.Case Studies 6. the industry makes a very significant contribution to the financial services industry and in particular plays an important role in maintaining the City of London as Europe's premier financial centre and helping to build it as the world's premier financial the FSA in the Discussion paper they recently published and by the Treasury focusing on the taxation. the press and of course the regulatory authorities. The industry has shown incredible growth over the last few years. not just of capital gains made by the industry. The growth of the industry has increased its profile and with that profile comes a legitimate interest in what the industry is doing from the public. .1 Case Study-1: Rise of UK economy The economic impact of private equity and venture capital on the UK: Keeping London and the UK the centre of the European industry Private Equity and venture capital makes a valuable contribution to the economy generally by having a positive effect on the companies in which private equity is invested.

The term buy-outs (MBO. not publicly quoted equity) and into companies that have real growth potential which can be turned around or transformed under private equity ownership as opposed to being constantly in the spotlight that having a quoted share price means for a public that the investments made in unquoted equity (i. The industry's economic impact The survey shows once again that private equity-backed companies are a significant driver in the UK economy and its global competitiveness.and hence the term private equity . MBI. The BVCA represents the whole cross section of the private equity industry in the UK . Venture capital as a term typically covers early stages of start-up or growth funding or expansion capital.Private equity means the equity financing of companies at many stages in the life of a company from start-up through expansion all the way through to buy-outs of established companies that in today's world can be very significant and large transactions.e. BVCA membership comprises well over 90% of all UK-based private equity and venture capital funds and their advisors. etc) refers to using . across the UK and in Brussels. The common threads .from small seed stage venture funds all the way through to the large private equity firms who focus almost exclusively on buy-outs and who are almost becoming household names today. Key findings of this report show once again that in the five years to 2005/2006: • The growth of employment in private equity-backed companies was faster than both FTSE 100 and FTSE 250 companies (9% pa vs 1% and 2% respectively) . The role of the BVCA is to ensure that the UK industry is properly represented to politicians and policy makers here at Westminster.private equity to finance the change in ownership of a company.

The figures in the Economic Impact Survey demonstrate clearly that private equitybacked businesses are active across all regions of the UK and are valuable contributors to the wealth of these regions. It is now estimated that companies that have received private equity funding account for the employment of around 2.8 million people in the UK. It is estimated that companies which have been private equity-backed generated total sales of £424 billion. financial advice and help with contacts were key ways in which private equity firms had helped with the development of their businesses. exports of £48 billion and contributed over £26 billion in taxes. It is also significant to note that 92% of companies that responded to the survey said that without private equity the business would not have existed at all or would have developed less rapidly. . 7% and 5%) • Exports from private equity-backed companies grew at a faster rate than the national growth rate (6% vs.• Sales grew faster in private equity-backed companies compared with FTSE 100 and 250 companies (9% vs. equivalent to 19% of UK private sector employees. The reason for this is that private equity investment is more than just the provision of capital. 2%) • Investment grew faster than the national average (18% vs 1%) It is now well established that the performance of private equity-backed companies significantly strengthens the UK economy and improves international competitiveness and creates jobs at a considerably faster rate than other private sector companies. Respondents to the survey noted that strategic direction.

3 billion. professional and business services firms providing advisory and financial support to private equity and venture capital firms.500 individuals (3.000 per head in fees.500 of which are investment professionals) employed in some 260 private equity. there are over 10. venture capital.700 executives engaged in private equity-related activities. 2005 data shows that: • Private equity-related activities generated estimated fee revenue for financial and professional services firms of over £3.The impact of the private equity industry as a UK financial service The UK private equity industry is playing an increasingly significant role as a source of revenue for firms operating within the broader financial and professional services industry. • There are more than 5.000 highly skilled professionals employed across over 1. • Taken together. there are 2. funds-of-funds and secondaries investment firms in the UK. • The UK has a network of around 750 financial. representing around 7% of the total annual turnover of the UK financial services industry. professional and other business services executives working on private equity-related mandates in 2005 generated an average of £500. • For every private equity executive investing directly in UK companies.3 full time equivalent advisors or finance executives providing specialist advice and services. They employ a full time equivalent pool of close to 6. .000 firms engaged either directly or indirectly in private equity-related activities. • Financial. contributing to the overall impetus that these industries provide to the UK economy.

And yet it is disappointing that despite the fact that the benefits of private equity as an asset class are so clear that last year 80% of BVCA investors came from overseas. • Companies financed at start-up stage increased by 9% to 208. the UK private equity and venture capital industry is a UK success story. all around the UK. In 2005. with almost £50 billion of foreign investment into UK private equity funds over the past six years. across continental Europe and around the world. • Furthermore.7 billion in 2004.3 billion. Investment activity BVCA are an industry that invests across all sectors. demonstrating a positive net inflow of capital into the UK economy. By any measure. Here are a few key figures that illustrate the scale of what we do: • Funds raised from investors reached £27. UK private equity activity increased to its highest ever levels. from start-ups to buy-outs.• Private equity-backed transactions account for a significant proportion of total M&A activity in the UK with almost 30% of all UK investment banking fees from M&A and loan financing being derived from private equity backed transactions in 2005.7 billion from £9. private equity investments made and also divestments. • 1. two-thirds of the total capital invested by UK firms over the same period was committed to companies within the UK. • The UK private equity industry has long attracted capital investment from outside its own shores. with 45% coming from the US. • Worldwide investment by UK private equity firms increased by 21% in 2005 to £11. in terms of funds raised. .535 companies were financed.

the ability to achieve change swiftly and efficiently and a complete concentration on the direction of the business. This support is much appreciated. . BVCA make major investment around the UK investing in companies. This industry has benefited from a strong cross Party consensus that understands the important role BVCA play in keeping the UK economy competitive and dynamic. and they invest across continental Europe and around the world bringing returns home for the benefit of their investors.The primary objective of the private equity industry is to drive returns to its investors and while it is a good thing that we can attract inward investment. Major investment attract into the UK from overseas. but rather as part of a life cycle of a business. The private equity model brings together absolute alignment of interest between investor and management. it is a pity that the beneficiaries of the capital gains created by this industry predominantly accrue to overseas investors. Private equity investment should not be regarded as an end in itself. UK private equity and venture capital industry is a good strong British success story. creating jobs and building businesses. This enables absolute focus on agreed purpose.

com.and nearly doubling again to $35bn in 2000. .com companies. In her view. Pets. assistance with raising more funds. wooden-beamed offices in San Francisco's newly fashionable SoMo district. and even management support. she explained what went wrong. Dot. and big companies all prepared .to back internet ventures. Venture capitalists supply the funds to budding entrepreneurs who want to start their own companies .com fall-out. And venture capital has been one of the extraordinary growth industries in the Valley. was one of the victims of the dot.2: Silicon Valley's success. bankers.had meant that too many companies had been funded and brought to the stock market too quickly. Venture capitalists also help nurture those companies to success. the increasing frenzy in the stock market for internet companies whatever their business plan or chances of profitability . Her company had backed one of the biggest and most well-known internet companies selling to consumers. which has become a beacon for dot.6.even desperate . Too many inexperienced people came into the venture capital marketplace. with $1bn in funds under fall-out Ann Winblad. with financiers. which stopped trading despite millions of dollars in private investment and an enthusiastic stock market flotation.2 Case Study. with the amount of money invested in venture capital funds rising in the decade from $1bn in 1990 to $20bn in 1999 . founder of venture capital firm Hummer Winblad. In her sleek.and 40% of such deals in the US take place in Silicon Valley. supplying introductions to potential customers or partners.

Now. Pets. she says. she says."tending to the sick and needy" in the words of the chief of one dot. with returns of 10-20 times companies selling to consumers. and e-tailers. venture capitalists began to believe that they could make a profit on nearly any company they backed. Vital role Venture capitalists will still play a vital role as catalysts for Silicon Valley's future. they expect only about one in five of the companies they back to become a major success .but those successes. Mr Knoblauch says that in the height of the euphoria one year one will touch them at and tech stocks crashed in April. But when the market woke up. $1bn a week was being offered to entrepreneurs . Profit hopes dimmed And now.and that venture capitalists will resume their role of "company coach" rather than pure deal-makers. And in future. and dot. it became impossible for even well-managed internet companies to raise additional money. But now. it is unlikely that anyone would fund any internet company for at least the next two years. the pace of investment will be slower and more measured. Obongo's John Hunt.attracting too many people who were "mercenaries not missionaries" to the world of enterprise. .com and other e-tailers needed more capital to grow .and that was no longer available at any price. taking 3-5 years to bring companies to the stage at which they can be floated on the stock market .com that has survived.Fund raising difficulties At one point. will still make the whole fund profitable. one of the factors limiting the further expansion of venture capital firms is their need to spend more time managing their existing portfolio . are the "mad cow disease" of the venture capital world . or dot.

played a central role in helping them secure their first customer.and they agreed to merge with each other 30 minutes into the meeting. It is that culture that will ensure that. Sunny outlook And Obongo's other venture capital partner. . then called Smartport. Atlas. Their understanding of the technology. Venture capitalists have played a crucial part in launching his company. Silicon Valley will remain the world's high-tech incubator. she argues. and the competition means that entrepreneurial knowledge is shared and is transferred more quickly here than anywhere else. Obongo was created in the offices of venture capital firm Sequoia. with most moving from being entrepreneurs themselves. who introduced the UK based company. despite the sharp change in market sentiment. the large US bank Citibank. It is networks like these which will secure the future of the Valley. the markets. which provides the software for electronic wallets used for shopping on the internet.It was the presence of the world's most sophisticated venture capital industry that attracted John Hunt of Obongo from the UK to San Francisco. according to historian and city planner Anna Lee Saxenian. Chabi . Nowhere else have venture capitalists such a close connection with their industry. to its Silicon Valley rival.

and Amoco did not share in the profits generated. Incentives of the various parties appear to have been improperly aligned. they had a threefold mission: to invest in firms pursuing technologies relevant to the ongoing business of Analog Devices and Amoco. it took another $12 million charge. to obtain options to acquire firms of interest to Analog’s management. ADE’s stake was so diluted by a merger that it was worth only about $2 million at the time of the offering. That very year Amoco ceased contributing capital. In this case. 2. and ADE had invested $26 million in 11 firms by 1985. ." Only one firm ultimately went public. in 1990. Analog Devices’ researchers. considerably less time than was needed to grow the early-stage companies.Case Study-3: Failure of Analog Devices Enterprises In 1980. Of the 11 firms in ADE’s portfolio. or relegated to the "living dead. and the ADE program was suspended. Analog Devices established a corporate venture program. 10 were terminated. resented the program. the ADE program exhibits all three of the classic structural failings: 1. with most of the portfolio liquidated. Analog Devices took a $7 million charge against earnings. Analog Devices Enterprises (ADE). Also. Funding was provided by Amoco. Instead. seeing scarce resources being devoted to ADE. acquired by other companies at unattractive valuations. Amoco only committed to fund the program for five years. and to generate high financial returns. Program managers were hampered by the lack of a clear objective. What went wrong? Clearly. to generate both attractive financial returns and strategic benefits in the form of licensing agreements and acquisitions. Around this time. 3. The management of Analog Ventures believed that they were insufficiently rewarded.

survey was conducted in 3 firms namely SIDBI (Small Industrial Development Bank of India). 2) How is business plan presented? A . B. calling. core plan. 3) How do VCFs define their contribution? A. A. Interpretation.Promoter – very careful. returns.Chapter . C. potential.Presentation. Promoter details. management. Business model. Presentation is done in front of Investment banker (middleman between VCF and Promoter).VCF looks for good profile and background of promoter. Following questions were asked and some of the answers given were: 1) What do VCF looks for in evaluating a new company? Most critical element VCF looks for. valuation expectation. understanding. B – Presentation.Best practices.By providing facilities through schemes like Started Investment and Smart Money. .Business potential. B. Company background. Interpretation.Business plan is presented through various ways like presentation. IDFC Equity Fund. JM Equity Fund. mgmt meeting. C – Based on business plan and industry in relation to its growth. advisors. value.Growth.7 SURVEY AND CONCLUSION  Survey: For getting about practical knowledge of working of VCFs. business potential and management for evaluating in a new company. executive. e-mail. growth. etc. etc. profile and background. whichever is more convenient for both parties. financial model. Financial model. return expected. Advice for approaching to financial market. matter of convenience to both Promoter and VCF.

C – The best sector in today’s scenario is IT sector which will be backbone for economy. A .The landmarks are decided by the VCFs and Promoter during signing of agreement between them. tie ups with government. B – It takes 10 days sometimes and also get extent up to 3-4 months.C. Interpretation. 6) What companies in VCF might make interesting investments. Financial Services. Real Estate. Interpretation. B – Same as above said sectors. 7) How long does it take to make investment or participation decision? A – Taken after a long procedure of investigation gets over from 6-8 weeks.The companies themselves shows as interested investing sectors to VCFs by their performance. 5) What are the major trends in VCF industry? A – Latest trend is interest in Bio-tech sector. 4) What are the milestones in achieving whether the company will achieve their goal? A – Milestones are laid down during agreement in top line and bottom line revenue. Term sheet documentation is signed by promoter. Interpretation. as all of them have interests in different sectors for financing. issues. C – All the milestones are noted down in shareholder’s agreement. C – Lengthy process as investigation about promoter is done. tie up with portfolio company. equipments. training.Appointment. B – Upcoming sectors like Logistics. Interpretation. B – Through companies profit numbers and total sales. venturing in new areas.Depends upon the sector which is booming at that time. C – All upcoming sectors especially Transport and Logistics. BPO. .VCFs defines their contributions by showing the Promoters correct way for taking appropriate steps. broader view and thinking. Then too it takes 3-5 months.The trends in VCFs industry depends upon type of firms.

Internal Auditor. B – Liquidity event. Right to appoint a BOD. 9) Exit policies followed by VCFs. It also sometime extents till 6 months. IPO. Drag-along & Tag-along. Interpretation.Time taken by VCFs for investment decision is from 10 days till 34 months. . B. Projects.Interpretation.The most critical features are selecting exit options. revenue. big decisions to be consulted. B – If valuation does not grow as per expectation then business plan fails. Block deal. Interpretation. C – Rights and Obligations of Promoter. exit risk. 10) Risk analysis. C. Risk in terms of promoter.The risk analysis varies as per depending on the situation. Combination of promoter’s buyback and selling stake. market.Selling to strategic. Even on potential of promoter. seat in BOD. A – Risk depends upon type of company.There are 3 basic exit options been followed by VCFs all over the world. Minority protection rights. A. Selling stake. rights and obligations of venture capitalists. Promoter’s buyback. Promoter’s buyback from VCF. Veto Right. proper investment done or not. cultural risk. 8) Critical features of an agreement between VCF and Promoter.IPO.IPO. Rights to see committee. Board seat. cost (as operating expenses). C – Scenario building. competition. Selling stake to 3rd party. Even main steps taken by promoter should be consulted by VCF. and major decisions should be consulted with VCF. A – Exit options. Interpretation.

Conclusion: Earlier patterns of growth or failure in venture capital industries in other countries and regions indicate that the evolution of venture capital seems to be either entry into a self reinforcing spiral. they were the beginnings of a process of legitimitizing venture investing and they were a training ground for venture capitalists who later established private venture capital funds. with its agenda of decreasing government regulation. or growth and stagnation. Even in 2006 the Indian government remains bureaucratic and highly regulated. It is unlikely that the venture capital industry could have been successful without the development of the software industry and a general liberalization of the economy. it is necessary to keep improving the environment by simplifying the policy and regulatory structure (including eliminating regulations that do not perform necessary functions such as consumer protection). and currency exchange policies. Though these funds experienced little success. Of course. such as occurred in Silicon Valley and Israel. since many of these affect both venture capital firms and . this is not entirely surprising. A presents SIDBI. Interpretation is short conclusion of all answers. because an institution as complicated as venture capital could not emerge without a minimally supportive environment. funded the creation of the first venture capital funds. and it is likely that the government will continue and even accelerate its efforts to encourage venture capital investing. To encourage the growth of venture capital will require further action. legal. B presents JM Equity Fund and C – IDFC Equity Funds. India still remains a difficult environment for venture capital. Given India’s wish to develop a high-technology industry funded by venture capital. as occurred in Minnesota in the 1980s or the United Kingdom until recently. This environment both permitted the evolution of the venture capital industry and simultaneously allowed it to begin changing that environment and initiating a co-evolutionary dynamic with other institutions. The World Bank. regulatory. The role of the government cannot be avoided: it must address tax.Note: As per the answers given for the following questions.

. In short.the companies that they finance. “VCF is next engine for economical growth for all countries in the World”. More mechanisms need to be developed to reduce risk if funds for venture capital must come from publicly held financial institutions managed by highly risk-averse managers.

under section 48 of the Act is not significant.Suggestions for growth of VCF: Venture capital industry is at the take off stage in India. it would be advisable that all long term capital gains earned by VCCs should be exempted from tax or subject to concessional flat rate. It can help promote new technology and hi-tech industries. Further. Section 52(E) of the Act should be amended to give effect to this. One of the major factors which contributed to the success of venture funds in the West is development of secondary and tertiary stock markets. this method may not give the best available prices to venture fund as it will not be able to consider future growth potential of the invested company. In order to ensure success of venture capital in India. the capital gains may arise only after 3 to 4 years. may not even succeed. These markets do not have listing . of investment and that the projects. capital gains reinvested in new venture should also be exempted from tax. which involve high risk but promises attractive rate of return. It can play a catalytic role in the development of entrepreneurship skill that remains unexploited among the young and energetic technocrats and other professionally qualified talents. The benefit of the capital gains. being in new risky areas. Hence. the following suggestions are offered: (i) Exemption/Concession for Capital Gains: Capital gains law represents a hurdle to the success of venture capital financing. Capital gains by corporate bodies in India are taxed at a much investment risk and long gestation period this is a deterrent to the development of VCFs. Further. The earnings of the funds depend primarily on the appreciation in stock values. However. (ii) Development of Stock Markets: Guidelines issued by finance ministry provides for the sale of investment by way of public issue at the price to be decided on the basis of book value and earning capacity.

In India. further they cannot be the single largest equity holders. the number of stock exchanges can be increased to 50. development of venture fund market was possible due to very significant role played by private sector which is often willing to put money in high risk business provided higher returns are expected. (iii) Fiscal Incentives: Fiscal incentives may be given in the form of lowering the rate of income tax. (ii) An allowance to funds similar to section 80-CC of Income Tax Act. stock market operation may be started at man by more big cities where. in India. Promotion of venture funds by private sector. In US and UK secondary and tertiary markets helped in accomplishing the above. in addition to public financial institution and banks. however. is recommended as: . may not like to promote venture fund business. permission to transact in unlisted securities with suitable regulation will ensure firsthand contact between venture fund and investors. The private sector. Success of venture capital fund depends very much upon profitable disinvestments of the capital contributed by it. (iv) Private Sector Participation In US and UK where the economy is dominated by private sector. because of this provision. Further. say 20 percent of the investment in new venture which can be allowed as deduction from the income. It can be accomplished by: (i) Application of provisions applicable to non-corporate entities for taxing long term capital gains. These stock markets provide excellent disinvestments mechanism for venture funds. promotion of such maker is not feasible in the prevailing circumstances as such laissez faire policy may attack persons with ulterior motives in the business to the determent of general public. The guidelines by finance ministry provide that non. However. However.requirements and are spread over all important cities and towns in the country.institutional promoter’s share in the capital of venture fund cannot exceed 20 percent of total capital. say. stock market is not developed beyond a few important cities.

The only investment available to the VC Finance company for investment is equity shares. expansion and growth. Amendment of Section 77 of the Companies Act is required to enable the new venture capital companies to buy back their shares at the time of disinvestments by VC Finance Companies. mergers and amalgamation. production and finance. The leading business houses will be able to raise funds from the investing public with relative ease. The scope of VC should not only be confirmed to start up finance but also be broadened to development finance. marketing. Suitable exemption should be given from Section 43 A of the companies Act to venture capital finance companies so that they are not required to comply with several provisions of the Act applicable to public limited companies. This restriction should be relaxed so that VC Finance Company can finance through preferential issues and conditional loans. Ceiling on interoperate loans and investment as specified in Section 370 and 372 of the companies Act should be relaxed in case of VC Finance Companies and Venture Capital Companies to enable them to invest suitable in newly promoted companies. . (v) Review the Existing Laws Today’s need is to review the constrains under various laws of the country and resolve the issue that could come in the way of growth of the innovative mode of financing. buyouts.Private sector is in advantageous position as compared to financial institutions and banks to provide managerial support to new ventures as leading industrial house have a pool of experienced professional managers in all fields of management viz. (vi) Limited Partnership The Practice of the limited partnership as in vogue in UK should be permitted in order to promote integration of object between the managers and contributors for the success of venture capital projects. The restriction on investment of 80% of the entire funds within a period of 3 years should be removed.

Chapter – 8 Annexure 8.2 Certificate of Registration 8.3 Tax Aspects 8.1 SEBI Guidelines and Regulations 8.4 Investment conditions and restrictions .

However. 1996. the Government of India issued guidelines in September 1995 for overseas investment in Venture Capital in India. Further. guidelines were also issued by the Central Board of Direct Taxes (CBDT) and the investments and flow of foreign currency into and out of India have been governed by the Reserve Bank of India's (RBI) requirements. a study was undertaken by the World Bank to examine the possibility of developing Venture Capital in the private sector. as a part of its mandate to regulate and to develop the Indian capital markets. In 1973 a committee on Development of Small and Medium Enterprises highlighted the need to foster venture capital as a source of funding new entrepreneurs and technology. In the late 1990s. Entrepreneurs have largely depended upon private placements.1 SEBI Guidelines and Regulations: In the absence of an organised Venture Capital industry till almost 1998.Annexure 8. individual investors and development financial institutions played the role of venture capitalists in India. Thus in 1999 a number of new regulations were . For tax-exemption purposes. Thereafter. based on which the Government of India took a policy initiative and announced guidelines for Venture Capital Funds (VCFs) in India in 1988. these guidelines restricted setting up of VCFs by the banks or the financial institutions only. Thereafter some public sector funds were set up but the activity of venture capital did not gather momentum as the thrust was on high-technology projects funded on a purely financial rather than a holistic basis. the Securities and Exchange Board of India (SEBI) framed the SEBI (Venture Capital Funds) Regulations. Later. public offerings and lending by the financial institutions. These guidelines were further amended in Apr 2000 with the objective of fuelling the growth of Venture Capital activities in India. the Indian government became aware of the potential benefits of a healthy venture capital sector.

namely:- . Thus. Normally. and the Reserve Bank of India (RBI). In early 2000. single window clearance. the 1995 Guidelines for Overseas Venture Capital Investments issued by the Department of Economic Affairs in the Ministry of Finance.promulgated. hassle-free. Perhaps the most important of these went into effect in April 1999 and allowed banks to invest up to 5 percent of their new funds annually in venture capital. all replies are sent within 21 working days from the date of getting each communication from the applicant during the process of registration. the applicant has to fulfil the following. domestic venture capitalists were regulated by three government bodies: the Securities and Exchange Board of India (SEBI). The main statutes governing venture capital in India included the SEBI’s 1996 Venture Capital Regulations. Main requirements under SEBI (Venture Capital Funds) Regulations. the total time period for registration depends on how fast the requirements are compiled with by the applicant. and the Central Board of Direct Taxes’ (CBDT) 1995 Guidelines for Venture Capital Companies (later modified in 1999). For the purpose of grant of a certificate of registration. which approves every investment. 1996: The following are the eligibility criteria for grant of a certificate of registration as per regulation 4 of SEBI (Venture Capital Funds) Regulations 1996. Registration of a venture capital fund Applicant should follow the procedure given below so as to expedite the registration process. which approves every disinvestment. However. and the CBDT. SEBI will also guide the applicant step by step after getting application for registration as a venture capital fund. the Ministry of Finance. Some of the most significant of these related to liberalizing the regulations regarding the ability of various financial institutions to invest in venture capital. For foreign venture capital firms there was even greater regulation in the form of the Foreign Investment Promotion Board (FIPB). Since SEBI is responsible for overall regulation and registration of VCF. multiple regulatory requirements should be harmonized and consolidated within the framework of SEBI Regulations to facilitate uniform.

(iv) The directors of its trustee company. been convicted of any offence involving moral turpitude or of any economic offence. (v) It is a fit and proper person. 1908 (16 of 1908). . (v) The applicant is a fit and proper person. (ii) It is prohibited by its memorandum and articles of association from making an invitation to the public to subscribe to its securities. (iv) Its director.(a) If the application is made by a company. (ii) The main object of the trust is to carry on the activity of a venture capital fund. principal officer or employee has not at any time been convicted of any offence involving moral turpitude or any economic offence. if any. (i) Memorandum of association has as its main objective. (iii) Its director or principal officer or employee is not involved in any litigation connected with the securities market which may have an adverse bearing on the business of the applicant. or any trustee is not involved in any litigation connected with the securities market which may have an adverse bearing on the business of the applicant. (iii) The directors of its trustee company. or a trustee has not at any time. (b) If the application is made by a trust (i) The instrument of trust is in the form of a deed and has been duly registered under the provisions of the Indian Registration Act. if any. the carrying on of the activity of a venture capital fund.

if any. (v) The directors or the trustees. . of such body corporate. The directors or the trustees.(c) If the application is made by a body corporate (i) It is set up or established under the laws of the Central or State Legislature. is not involved in any litigation connected with the securities market which may have an adverse bearing on the business of the applicant. as the case may be. (iii) (iv) The applicant is a fit and proper person. of such body corporate have not been convicted of any offence involving moral turpitude or of any economic offence. (d) The applicant has not been refused a certificate by the Board or its certificate has not been suspended under regulation 30 or cancelled under regulation 31. as the case may be. (ii) The applicant is permitted to carry on the activities of a venture capital fund.

Whether any winding up orders have been passed against the applicant or the intermediary. 8. A complete list of your associate companies registered with SEBI. All documents should be enclosed as specified in the form. as the case may be or its whole time director or managing partner has been convicted by a Court for any offence involving moral turpitude. fraudulent and unfair trade practices or . Whether the applicant or the intermediary. or person in management and have not been discharged. economic offence. 4. A complete list of your group companies registered with SEBI. State whether the applicant is registered with SEBI in any capacity. and also indicate the capacity in which they are registered along with the SEBI Registration number. and also indicate the capacity in which they are registered with SEBI along with their SEBI Registration number. 3.Application for Registration: An applicant should apply for registration in form a prescribed under First Schedule of SEBI (Venture Capital Funds) Regulations 1996 along with requisite fees. Whether any orders under the Insolvency Act have been passed against the applicant or any of its directors. 7. 6. 2. securities laws or fraud 5. Additional information: 1. Whether any order canceling the certificate of registration of the applicant on the ground of its indulging in insider trading. Whether any order restraining prohibiting or debarring the applicant or its whole time director from dealing in securities in the capital market has been passed by SEBI or any other regulatory authority and a period of three years from the date of the expiry of the period specified in the order has not elapsed.

has been passed by SEBI or any other regulatory authority and a period of three years from the date of the order has not elapsed. five crore as . executed copy of trust deed if the fund is being set up as a trust and main objective of constitution in case of body corporate. 1996. which are registered/ required to be registered with Reserve Bank of India (RBI) as a Banking company or Non Banking Finance Company or in any other capacity and address(es) of concerned branch office(s) of RBI. (a) Details of registration of your company/associate/group companies (to be given separately). 4) An undertaking to the effect that the fund will not enter into any venture capital activity if it fails to raise a commitment of at least Rs. Also state the target size of the fund along with the profile of the investors of the fund. if applicable. Whether any order. (b) Details of disciplinary action taken by RBI against you or any of your group/associate companies. 9. Please also inform us in case there is any default in repayment of deposits by you or any of your group / associate companies. withdrawing or refusing to grant any license/ approval to the applicant or its whole time director which has a bearing on the capital market. manipulation has been passed by SEBI and a period of three years from the date of the order has not elapsed . Applicant can submit ‘no objection certificate’ from RBI for getting registered with SEBI. Other Documents to be submitted to SEBI 1) Memorandum and Articles of Association of applicant company. to expedite the registration process. 2) Executed copy of Investment Management Agreement. 3) Disclose in detail the investment strategy as required under regulation 12(a) of the SEBI (Venture Capital Funds) Regulations.

. 6) Undertaking that the venture capital fund will not make investment in any area listed under Third Schedule to SEBI (Venture Capital Funds) Regulations. 1996. 7) Venture Capital Fund shall disclose the duration/ life cycle of the fund.required under Regulation 11(3) of SEBI (Venture Capital Funds) Regulations. Grant of Certificate of Registration Once all above requirements have been complied with and requisite fees as per Second Schedule to Regulations have been paid. SEBI will grant certification of registration as a venture capital fund. 1996. 5) Copies of letters of commitment from investors in support of the target amount proposed to be raised by the fund.

II.8. In exercise of the powers conferred by sub-section (1) of section 12 of the securities And exchange Board of India Act. The Registration Number of the venture capital fund is IN/VC/ / Date: Place: MUMBAI By order Sd/For and on behalf of Securities and Exchange Board of India Income Tax benefits In order to encourage the development of venture capital funds. the income Tax Act.2 Certificate of Registration 2006 Certificate of registration as venture capital fund I. 1961 exempts the income of a venture capital fund from Income Tax. 1992. (15 of 1992) read with the regulation made There under. . Income of a venture capital fund [section 10(23FB)] (on and from Financial Year 1999-2000) Any income of a venture capital fund (VCF) or a venture capital company (VCC) set up to raise funds for investment in a venture capital undertaking (VCU) is exempt. the board hereby grants a certificate of registration to ------------------------------------------------------------------------as a venture capital fund subject to the conditions specified in the Act and in the regulations made there under.

3.)it shall not invest more than 40 percent in the equity capital of one venture undertakings . A lock-in period of three years is however applicable for unlisted shares. The Central Board of Direct Taxes (CBDT) issued guidelines. on 18-7-1995 specifying that the prescribed authority for approval for exemption under Section 10 (23F) of Income Tax Act is Director of Income Tax (Exemption). it invest 80 percent of its total paid-up capital in acquiring equity share of the it shall not invest more than 20 percent (Budget for 1997-8 raised it from 5 to venture capital undertakings. The conditions for approval are: • it is registered with the SEBI (guidelines of 13. 8. Tax Aspects: VCFs have been provided complete income tax relaxation (July 1995) and exemption from long-term capital gains tax after they are listed on stock exchanges. VCU means a domestic company whose share are not listed in a recognized stock exchange in India and which is engaged in the business for producing services. 20 percent. production or manufacture of an article or thing but does not include activities or sectors which are specified by SEBI with a approval of the Central Government.1996 discussed below). • • • it invests 80 percent of its total monies by acquiring equity shares of venture capital undertakings. 1995 provided [Section 10 (23 F) of the IT Act] income tax exemption on any income by way of dividends or long-term capital gains of a venture capital fund or a venture capital company from investments made by way of equity shares in a venture proposal.2. Shares have to be held for at least 12 months to enjoy tax exemption.VCC means a company which has been granted a certificate of registration by SEBI and which fulfils the conditions laid down by SEBI with the approval of the Central Government. The Finance Act. To enjoy tax exemption the venture capital company has to obtain approval and satisfy prescribed conditions.

1 8. No venture capital fund shall accept any investment from any investor less than Rs5. if any. Income Tax (Exemption). shall not invest in the associated companies. All investment made or to be made by a venture capital fund shall be subject to the following conditions.2 employees or the principal officer or directors of the venture capital fund has been established as a trust employees of the fund manager or asset management company for the purpose of the se regulations. and submit audited accounts to the Director. b. 8.3 Each scheme launched or fund set up by a venture capital fund shall have firm commitment from the investors for contribution by the venture capital fund. 8. foreign or non resident Indian by way of issue of units.2. However this condition is not applicable to:8.000. and . venture capital fund shall disclose the investment strategy at the time of application for registration.2. namely:a.2. venture capital fund shall not invest more than 25% corpus of the fund in one venture capital undertaking . Investment conditions and restrictions A venture capital fund may raise money from any source.• it shall maintain books of account.4.00. whether Indian. fund raised means actual money raised from investors for subscribing to the securities of the venture capital fund and includes money that is raised from the author of the trust (in case the venture capital fund has been established as a trust) but does not include the paid up capital of the trustee company.

subscription to initial public offer of a venture capital undertaking whose shares are proposed o be listed subject to lock-in period of one year. at least 75% of the investible funds shall be invested in unlisted equity shares or equity linked instruments. debt or debt instrument of a venture capital undertaking in which the venture capital fund has already made an investment by way of equity. venture capital fund shall make investment in the venture capital undertaking as enumerated below (i). (ii). However. it shall be required to disinvest from such investments within a period of one year from the Date on which the shares of the venture capital undertaking are listed. In a recognized stock Exchange. .d. Not more than 25% of the investible fund may be invested by way of: a. if the venture capital und seeks avail of benefits under the relevant provisions of the Income Tax Act applicable to a venture capital fund. b.

11th floor 19/5 -19/6 Cunningham Road Bangalore . Basheerbagh Hyderabad . 8.400028 AIA Capital India Private Limited 9B Hansalaya Barakhamba Road New Delhi . . 2nd floor 242 Lady Jamshedji Road Mumbai . 7.400021 Acuity Strategic Financials Private Limited 14 Santosh. 11th floor Babukhan Estate. 20th Century Finance Corporation Limited Centre Point Dr.560001 2. 3. Road Bangalore . 5.110001 Alliance DLJ Private Equity Fund 404 / 405 Prestige Centre Point 7 Edward Road Bangalore . 4.G. Nariman Point Mumbai .Representative Office 2634 Oberoi Towers Nariman Point Mumbai .500001 Canbank Venture Capital Fund Limited 2/F Kareem Towers.400021 APIDC Venture Capital Limited 1102 Block A.560052 Draper International (India) Private Limited V203 Prestige Meridian -1 M.List of Venture Capital Companies in India :1. 6.Ambedkar Road Parel Mumbai .560052 Alliance Venture Capital Advisors Limited 607 Raheja Chambers Free Press Journal Road. 9.400012 AIG Investment Corporation (Asia) Limited India .

1st floor Behind Popular House Ashram Road Ahmedabad .Desai Marg Colaba Mumbai . 4th floor 17 Commissariat Road D'Souza Circle Bangalore . 1 2.110001 ICICI Securities and Finance Company Limited 41/44 Strand Palace M. 1 3. 1 6. 1 5. 3rd floor 24 Barakhamba Road New Delhi .400020 GE Capital Services India Limited AIFACS Building 1 Rafi Marg New Delhi . 1 4.1 0.400005 1 1. 1 8.380009 HSBC Private Equity Management Mauritius Limited Ashoka Estate. Small Industries Development Bank of India (SIDBI) SIDBI Venture Capital Limited .400005 ICICI Venture Funds Management Company Limited (formerly TDICI) Raheja Plaza.560025 IFB Venture Capital Finance Limited 8/1 Middletown Row Calcutta . 1 7.110001 Gujarat Venture Finance Limited Premchand House Annexe.700071 Industrial Development Bank of India IDBI Tower Cuffe Parade Mumbai . eVentures India (Consultair Investments Private Limited) Khetan Bhavan 8 Jameshedji Tata Road Churchgate Mumbai .

2 1. Tata Investment Corporation Limited Ewart House. .400021 Vista Ventures DBS Corporate Club 26 Cunningham Road Bangalore .400021 1 9.400052 2 0. 2 2.Nariman Bhavan 227 Vinay K. 3rd floor Homi Modi Street Fort Mumbai . Shah Marg Nariman Point Mumbai .400001 Templeton India Private Equity Fund 125 Free Press House Nariman Point Mumbai .560052 Walden-Nikko India Management Company Limited One Silverstone 294 Linking Road Khar (West) Mumbai . www.economicstimes.IVCA Venture Activity Websites • • • • • www. . Economic Times Times of India .Evalueserve Indian Venture Capital Association .com Newspapers • • .Bibliography Books • • Indian venture capital market.

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