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Merchant Banking, Private

Equity And Venture Capital

Unit 3
Finacial Services


Dayalbagh, Agra


The term Merchant Banking has its origin in the trading methods of countries in the late 18 th and
early 19th century when trade-taking place was financed by bill of exchange drawn by
merchanting houses. At that time the merchants were merely financing their own activities. As
international trade grew and other lesser-known names wanted to import goods from abroad, the
established merchants lent their names to the newcomers by agreeing to accept bills of
exchange on their behalf. The acceptance houses would charge a commission for this service and
thus there grew up the business of accepting bills of finance trade not merely of themselves, but
of others.

The second historical of Merchant Banks was the raising of capital for foreign Government. In
many cases, the Merchant Banks have been trading in the countries concerned and gained the
confidence of Governments and other authorities in those countries. Thus the second principal
ingredient of Merchant Banking became and still is rising of capital through the issue of stocks
and bonds. Therefore, Merchant Banks can be accepting houses or issuing houses or both.
Merchant Banking started in the beginning of 20 thcentury in UK and USA. More recently, the
services offered by Merchant Banks have entered into the other areas of operations. Their role is
wide ranging and they can now provide most of the financial services required by a company,
touching almost all aspects of establishing and running of industrial units on sound financial

Dictionary meaning of merchant bank refers to an organization that underwrites corporate

securities and advises such clients on issues like corporate mergers, etc. involved in the
ownership of commercial ventures.


During the seventeenth and most of the eighteenth century international finance was centered on
Amsterdam. Consequently Amsterdam merchants became the first masters of the various
financial techniques and developments which, in the course of time, became identified with the
emergent profession of Merchant Bankers.
Commercial Banking and Investment Banking are often confused with Merchant Banking.
In many ways, there may be similarities in their functions. However, in certain ways, Merchant
Banking is distinctly different from commercial Banking and Investment Banking.
The primary function of a commercial bank is to receive deposits from the public and lend
the same to others. Commercial Banks can undertake some of the merchant banking activities
like Issue Management whereas Merchant Banking Units can not undertake commercial banking
activities. However, the functions of Merchant Banking may not widely vary from Investment
Banking. The Merchant Banker mainly deals with Issue Management, post issue services,
corporate adviser services etc. the Investment Banker undertaken trading in securities,
Investment advises and Bought out deals which are not the main activities of Merchant Bankers.
In todays Scenario the Merchant banker and management consultants undertake advisory
services to the corporate sector. The Merchant Banker advices corporation and firms relating to
opening of issues, receiving loans etc, which the management consultants also do. The
management consultant have a wide area operations like production, Marketing, Personnel
Relations, of finance etc. but they lack statutory recognition to undertake capital market related
activities which has enabled the merchant banker to cater to the needs of the Corporate Sector.
A merchant bank may be considered as an institution which centers its operation on all or most
of the following activities.
(1) Corporate financial advice, on such diverse matters as new share and bond issues,
capital reconstructions, mergers and acquisitions;
(2) The taking of deposits and currency, money market operations including foreign
exchange dealing;
(3) Medium-term lending and syndication of loans;
(4) Acceptance credits and all forms of export finance
(5)The holding and dealing in quoted and unquoted investment; and
(6) Fund management on behalf of clients, most typically pension funds, unit trust,
investment trusts and wealthy individuals.


The first authoritative definition for the term Merchant Banker has been given in the Rule 2 (e)
of SEBI (Merchant Bankers) Rules, 1922. Accordingly,
A Merchant Banker means any person who is engaged in the business of Issue
Management either by making arrangements regarding selling, buying or subscribing to
Securities as Manager, Consultant, Adviser of rendering Corporate Advisory Service in
relation to such Issue Management.
Sec/5 (b) of the Banking Regulation Act, 1949 defines Banking as

Accepting, for the purpose of lending or investment of deposits of money from the public,
repayable on demand or otherwise and withdrawable by cheque, draft, and order or
In other words,

Merchant Banking may be defined as an institution which covers a wide range of activities such
as underwriting of shares, portfolio management,Project counselling, insurance etc. They all
renderthese service for a fee. Both commercial and investment banks may engage in merchant
banking activities. The originalpurpose of merchant banks was to facilitate and/orfinance
production and trade of commodities and hencethe name "merchant.
Merchant Banker

A merchant banker is one who is a criticallink between a company raising fund and the
investors.Merchant banker is one who underwrites corporate securities and advices on issues like
corporate mergers.The merchant banker may be in theform of a bank, a company, firm or even a
proprietary concern.Merchant Banker understands therequirements of the business concernand
arranges finance with the help offinancial institutions, banks,stock exchanges and money market.


India has entered the 21st century as one of the Asias most dynamic economies. This is the
part of the assessment made by International Financial and Capital Market Institutions based on
Indias economic and financial reforms initiated in 1991 and brought to fruition in various
The progress of any economy mainly depends on the efficient financial system of the
country. Indian economy is no exception financial system of the country. The importance of the
financial sector reforms affirms an effective means for solving the problems of economic,
financial and social in India and elsewhere in the developing nations of the world. The progress
of the Securities Industry of any country depends mainly on the flow of funds. In fact, capital
generation is the lifeblood of the capital market without which the health and soundness of the
financial system cannot be geared and for which well-developed capital market as well as money
market is essential.

Indias capital market is among the largest in the developing world. The market is
comprised of 24 stock exchanges transacting long-term debt; debentures and equity shares both
electronic and physical forms. Derivatives financial instruments are also be added to the market
shortly. The number of firms listed on the Indian Stock Exchange is more than the USA. Market
Capitalization of listed firms is 1980s was similar to Brazil, Malaysia, Singapore and Denmark.

The capital market of the country, however, underwent dramatic changes since the beginning of
1980s basically because of a progressive realization that the command economy on which the
emphasis was placed could not lead to higher levels of economic development and that a slant
towards a market-oriented economy is necessary.
It is in the context of fast expanding economy and a liberalized and deregulated atmosphere that
the growth of the Indian Stock Market activities has to be viewed. No wonder that the markets
have registered a quantum jump judge by any standards.


In India prior to the enactment of Indian Companies Act, 1956,managing agents acted as
issue houses for securities, evaluated project reports, planned capital structure and to some extent
provided venture capital for new firms. Few share broking firms also functioned as merchant
The need for specialized merchant banking services was felt in India with the rapid growth
in the number and size of the issues made in the primary market. The merchant banking services
were started by foreign banks, namely the National Grindlays Bank in 1967 and the City
Bank in 1970. The Banking Commission in its report in 1972 recommended the setting up of
merchant banking institutions. This marked the beginning of specialized merchant banking in
To begin with, merchant banking services were offered along with other traditional banking
services. In the mid-Eighties, the Banking Regulation Act was amended permitting commercial
banks to offer a wide range of financial services through the subsidy rule. The State Bank of
India was the first India Bank to set up merchant Banking division in1972. Later ICICI set
up its Merchant Banking division followed by Bank of India, Bank of Baroda, Canada Bank,
Punjab National Bank and UCO Bank. The merchant banking gained prominence during 1983-
84 due to new issue boom.

Many banks entered merchant banking in the 1960s to take advantage of the economies of
scope produced when private equity investing is added to other bank services, particularly
commercial lending. As lenders to small and medium-sized companies, banks become
knowledgeable about individual firms products and prospects and consequently are natural
providers of direct private equity investment to these firms. As mentioned above, commercial
banks were the largest providers of venture capital in the 1960s. In the middle to late 1980s, the
decision to enter merchant banking was thrust on other banks and bank holding companies by
unforeseen events. In those years, as a result of the LDC (less-developed-country) debt crisis,
many banks received private equity from developing nations in return for their defaulted loans.
At that time, many of these banks set up merchant banking subsidiaries to try to get some value
from this private equity.

Also at about that time, most commercial banks began refocusing their private equity
investments to middle-market and public companies (often low-tech, already profitable
companies) and, rather than providing seed capital, financed expansion or changes in capital
structure and ownership. Most particularly, they took equity positions in LBOs, takeovers, or
recapitalizations or provided subordinated debt in the form of bridge loans to facilitate the
transaction. Often they did both. Commercial banks financed much of the LBO activity of the
1980s.Then, in the mid-1990s; major commercial banks began once again focusing on venture
capital, where they had substantial expertise from their previous exposure to this kind of
investment. Some of these recent venture-capital investments have been spectacularly successful.
For example, the Internet search engine Lycos was a 1998 investment of Chase Manhattans
venture-capital arm. Commercial banks are permitted to report either realized or unrealized gains
on their merchant-banking portfolios, as long as they are consistent in the reporting. This option
makes it difficult for one to compare different entities financial results and could lead to an
overly liberal reporting of profits.

Important reason for the growth of merchant banking is due to exerting excess demand on the
sources of funds forever expanding industry and trade.

Corporate sector had the only alternative to avail of the capital market services for meeting
their long-term financial requirements through capital issues of equity and debentures

With the growing demand for funds there was pressure on capital market that enthused the
commercial banks, share brokers and financial consultancy firms to enter into the field of
merchant banking and share the growing capital market.

In India have opened their merchant banking windows and are competing in this field, and
also doing advisory functions as merchant bankers as well as managing public issues in
syndication with other merchant bankers.

Merchant banks can play highly significant role in mobilizing funds of savers to investible
channels assuring promising return on investments activity.

With the growth of merchant banking profession corporate enterprises in both public and
private, sectors would be able to meet the growing requirements for the funds for establishing
new enterprises, undertaking expansion/modernization/diversification of the existing

Merchant banks have been procuring impressive support from capital market for the
corporate sector for financing their projects.

In view of multitude of enactments, rules and regulations, guidelines and offshoot press
release instructions brought out by the Government from time to time imposing statutory
obligations upon the corporate sector to comply with all those requirements prescribed
therein, the need of skilled agency existed which could provide counseling.

Merchant bankers advise the investors of the incentives available in the form of tax reliefs,
other statutory relaxations, good return on investment and capital appreciation in such
investment to motivate them to invest their savings in securities.

Thus, the merchant bankers help industry and trade to raise funds, and the investors to invest
their saved money in sound and healthy concerns with confidence, safety and organizations
for higher yields.
Functions Of Merchant Banks

Promotional Activities Merchant Banks helps the entrepreneur in conceiving an idea,

identification ofprojects, preparing feasibility reports, obtainingGovernment approvals
and incentives etc.

Issue Management - Management of issues refers toeffective marketing of corporate

securities viz., equityshares, preference shares and debentures or bonds byoffering them
to public. Merchant banks act asintermediary whose main job is to transfer capitalfrom
those who own it to those who need it.

Credit Syndication - Credit Syndication refers toobtaining of loans from single

development financeinstitution or a syndicate or consortium. MerchantBanks help
corporate clients to raise syndicatedloans from commercials bank.

ProjectCounseling- It includes preparation ofprojects reports, deciding upon the

financingpattern, appraising the project relating to itstechnical, commercial and financial
viability. Itincludes filling up of application forms for obtainingfunds from financial

Issue Management - Management of issues refers toeffective marketing of corporate

securities viz.,equity shares, preference shares and debentures orbonds by offering them
to public. Merchant banksact as intermediary whose main job is to transfercapital from
those who own it to those who need it.

Portfolio Management- It refers to the effectivemanagement of Securities i.e., the

merchant bankerhelps the investor in matters pertaining toinvestment decisions. Taxation
and inflation aretaken into account while advising on investment indifferent securities.
The merchant banker alsoundertakes the function of buying and selling ofsecurities on
behalf of their client companies.Investments are done in such a way that it
ensuresmaximum returns and minimum risk.

Leasing and FinanceMany merchant bankersprovide leasing and finance facilities.

Some of themeven maintain venture capital funds to assist theentrepreneurs. They also
help companies in raisingfinance by way of public deposits.

Servicing Issues Merchant Bankers helps inservicing the shareholders and debenture
holders indistributing dividends, debenture interest.

OtherSpecializedServices Merchant Banks alsoprovide corporate advisory services on

issues likemergers and amalgamations, tax matters,recruitment of executives and cost
andmanagement audit etc.

The role of merchant banker is dynamic in the wake of diverse nature of merchant banking
services. Merchant bankers dynamism lies in promptly attending to the corporate problems and
suggests ways and means to solve it. The nature of merchant banking services is development
oriented and promotional to help the industry and trade to grow and survive. Merchant banker is,
therefore, dedicated to achieve this objective through his dynamism.
He is always awake to renew his skills, develop expertise in new areas so as to equip
himself with the knowledge and techniques to deal with emerging new problems of corporate
business world.
He has to keep pace with the changing environment where Government rules, regulations
and policies affecting business conditions frequently change; where science and technology
create new innovations in production processes of industries envisaging immediate renovations,
diversification, modernizations or replacements of existing plant and machinery or other
equipments putting new demands for finances and necessitating overhauling of the capital
structure of the firms.
To discharge the above role, a merchant banker has t be dynamic. For this reason, a
merchant banker is sometimes, called M.B i.e. Moving Bottom, i.e., one who never sits at one
place, always moving- attending meetings and meeting clients and
constituents, doing business and getting business by attending meetings and conferences,
imparting knowledge to others and acquiring new knowledge to maintain his supremacy in
possession of latest information. His role depicts a personality cult, which is unique and envious
to be followed by others.
In the days ahead, merchant bankers have very significant role to play tuning their activities
to the requirements of the growth pattern of corporate sector, the industry and the economy as a
whole, which is, in it, a challenging task and to meet these challenges merchant bankers will
have to be more vigorous and strategic in playing their role. They will have also to adopt new
ways and means in discharging their role.

The Securities and Exchange Board of India (SEBI) has stated that merchant bankers must
be involved more closely in the market making process as share brokers do not have the requisite
expertise to evaluate the fundamentals of the scrips before taking over the role of market makers.
Further, share brokers generally being partnership; firms do not have the financial clout which is
necessary for market making activity. Resultantly, the SEBI has suggested that any member of
the stock exchange along with one merchant banker registered with SEBI could act as a market
The SEBI has felt that to ensure liquidity of scrip it was necessary to facilitate greater
movement, which could only be achieved through the institution of market makers. Market
makers would also create a market for the scrips by offering two way quotes to the investors. A
minimum of ten scrips has been proposed by SEBI for the market makers.
As determined by the Finance Ministry, Government of India, Merchant Bankers are
eligible to charge commission / fee from their clients as detailed below:
(i) A Merchant Banker can charge 0.5% as the maximum as commission for whole of the
(ii) They can charge project appraisal fees.
(iii) A lead manager can claim a commission of 0.5% up to Rs.25 crore and 0.2% in excess of
Rs.25 crore.
(iv) Underwriting Commission.
On amount
On amount
Type of Security Devolving on
subscribed by public
1.Equity shares
2.50 2.50
2.Preference share/debentures
(a) Upto Rs. 5 lakh
2.50 1.50
(b) Excess of Rs. 5 lakh
2.00 1.00

(v) Brokerage commission 1.5%.

(vi) Other expenses like advertising, printing, Registrars expenses, stamp duty etc., in
connection with the issue can be reimbursed from its clients.


There are differences in approach, attitude, and areas of operations between commercial
banks and merchant banks. The differences between merchant banks and commercial banks are
summarized below:


Basically deal in debt related finance Basically they deal with mainly
and their activities are appropriately funds raised through money market
arrayed around credit proposals, credit and capital market and the area of
appraisal and loan sanctions. activity is equity and equity related

Are asset oriented and their lending Are management oriented

decisions are based on detailed credit
analysis of loan proposals and the value
of security offered against loans.

They generally avoid risks. They generally are willing to accept

risks of business.
They are merely financiers. There activities include project
counseling, corporate counseling in
areas of capital restructuring,
amalgamations, mergers, takeovers
etc., discounting and rediscounting
of short term paper in money
markets, managing, underwriting
and supporting public issues and
new issue market and acting as
brokers and advisers on portfolio
management in stock exchange. This
activity has impact on growth,
stability and liquidity of money


Formal merchant banking activity in India was originated in 1969 with Merchant Banking
Division set up by the Grindlays Bank, the largest foreign bank in the country. The main service
offered at that time to the corporate enterprises by the merchant banks included the management
of public issues and some aspects of financial consultancy. Other foreign banks like City Bank,
Chartered Bank also assumed the merchant banking activity in India. State Bank of India
started merchant banking in 1973 followed by ICICI in 1974. Both these Indian merchant
bankers emerged as leaders in merchant banking having done significant business during the
period of 1974-1987 in comparison to foreign banks.
The early and mid-seventies witnessed a boom in the growth of merchant banking
organizations in the country with various commercial banks, financial institutions, and brokers
firms entering in to the field of merchant banking.
The early growth of merchant banking in the country is assigned to the Foreign Exchange
Regulation Act, 1973 (FERA) where under large number of foreign companies operating in India
were required to dilute their foreign holdings in order to continue business in the country.
This had caused two-pronged effect viz. firstly, in the form of spate in Foreign Exchange
Regulation Act Issues eliciting interest of the investors by creating massive awareness about
capital markets amongst the new class of investing public, secondly, merchant banking activity
became attractive to banks and the firms of consultants and share brokers who entered into this
fields vigorously to reap the advantages of the expanding capital markets.
1. SEBI guidelines have authorized merchant bankers to undertake issue related activities only with
an exception of portfolio management. These guidelines have made the merchant bankers either
to restrict their activities or think of separating these activities from the present one and float new
subsidiary and enlarge the scope of its activities.

2. SEBI guidelines stipulate a minimum net worth of Rs.1 crore for authorization of merchant
bankers. Small but professional and specialized merchant bankers who do not have a net worth
of Rs.1 crore may have to close down their business. The entry is denied to young, specialized
professionals into merchant banking business.
3. Non co-operation of the issuing companies in timely allotment of securities and refund of
application money is another problem of merchant bankers. The guidelines have put the
responsibility on the merchant bankers. They have to seek the co-operation of the issuing
company to shoulder the responsibility.
Merchant banking is an area that we need to build and grow in the years to come. As India
forms part of the global village, it becomes increasingly necessary for us to look at this business
in a more holistic manner.

Obviously, international players with strong domestic partners such as DSP Merrill Lynch,
JM Morgan Stanley, Kotak Mahindra Capital, together with experienced organizations like Enam
and institutional backed investment bankers such as ICICI Securities, etc., are the ones who have
expertise, muscle, and placement power in a greater measure than relatively new entrants.

The red hot economy is the obvious starting point. India is likely to end the year with GDP
growth in excess of 7 percent. Companies and private equity investors are sitting on large piles of
cash. In 2006 deal activity was largely restricted to the IT and Telecom sectors.


Merchant Banking activity was formally initiated into the Indian capital markets when
Grindlays Bank received the license from Reserve Bank in 1967. Grindlays which started with
management of capital issues recognized the needs of emerging class of entrepreneurs for diverse
financial services ranging from production planning and system design to market research. Apart
from meeting specially, the needs of small-scale units it provided management constancy
services to large and medium sized companies. Following Grindlays Bank, Citi Bank set-up its
Merchant Banking division in 1970. The division took up the task of assisting new entrepreneur
and existing units in the evaluation of new projects and raising funds through borrowing and
issue of equity. Management consultant services were also offered. Consequent to the
recommendations of Banking Commission in1972, that Indian bank should start Merchant
Banking Division in 1972.
The economic reforms initiated by the Government since July 1991 in the files of industry,
trade and financial sector have paved the way for rapid development of the economy. Several
projects have been conceived since then and almost all the major groups in the country that have
announced their intentions to set-up mega projects in infrastructure sector envisaging investment
of thousands of crores. With several large projects been set-up and many more on the drawing
board, the demand for a complete range of Merchant Banking services encompassing project
advisory services, issue management and financial advisory services for corporate sector has
increased considerably. This has led to a sharp growth in the Merchant Banking business in the
last 2 years.

The Merchant Banking scenario in developed countries like USA and UK are different
from Indian Merchant Banking activities. The Merchant banker is also called as Investment
Bankers. A brief outline of Merchant Banking in USA and UK has shown in the following

Merchant Banks in UK

In United Kingdom, Merchant Banks came on the scene in the late eighteenth century and
early nineteenth century. Industrial revolution made England into a powerful trading nation.
Rich merchant houses that made their fortunes in a colonial trade diversified into banking. Their
principle activity started with the acceptance of commercial bills pertaining to domestic as well
as international trade. The acceptance of the trade bills and their discounting gave rise to
acceptance houses, discount houses, and issue houses. Merchant Bankers initially included
acceptance houses, discount houses and issue houses. A Merchant Banker was primarily a
merchant rather than his customers entrusted banker but him with funds. Merchant Banks in UK:

Finance foreign trade,

Issue capital,

Manage individual funds,

Undertake foreign security business, and

Foreign loan business.

They also used to finance sovereign government through grant of long-term loans. Since
the end of Second World War commercial banks in Western Europe have been offering multiple
services including Merchant Banking services to their individual and corporate clients. British
banks set-up division or subsidiaries to offer their customers Merchant Banking services.
Merchant Banking in USA

Merchant banks make the primary markets in USA, arrange mergers and acquisitions,
undertake global, custody, proprietary trading and market making, niche business, fund
management and advisory services to governments and firms.

The increased regulation and control of domestic operations gave a fillip to large US banks
to undertake Merchant Banking functions in international capital markets. The US investments
Banks have extended their operations to the international level. They are largely responsible for
the development of the Euro-dollar market in the securities and globalization of capital markets.
They have a prominent presence in London and other European financial centers. Merchant
Banks have today a strong parent, a strong balance sheet and a strong international network to
play a global role.


In India, merchant banks operate in the form of Divisions of Indian and Foreign banks and
financial institutions, subsidiary companies established by banks like SBI Capital Markets Ltd.,
can Bank Financial Services Ltd., PNB Capital Services Ltd., Indian Bank Merchant Banking
services Ltd., etc., the firm organized by the stock brokers, stock exchange dealers, the financial
and technical consultants and chartered accountants. Securities and Exchange Board of India
(SEBI) has divided merchant bankers into four categories, which are as follows: -


To carry on the activity of issue

management and to act as adviser,
Category I Rs.1crore
consultant, manager, underwriter,
portfolio manager.

To act as adviser, consultant, co-manager,

Category II Rs.50 lakhs
underwriter, portfolio manager.

To act as underwriter, adviser or

Category III Rs. 20 lakhs
consultant to an issue.

To act only as adviser or consultant to an

Category IV Nil

Merchant Bankers are classified into 4 categories as shown in the above table having
regard to their nature and range of activities and their responsibilities to SEBI, investors and
issuers of securities. The minimum net worth and initial authorization fee depends on the
category. The first category consists of merchant bankers who carry on any activity of issue
management, determining financial structure, tie-up of financiers, advisor or consultant to an
issue, portfolio manager and underwriter. The second category consists of those authorized to
act in the capacity of co-manager/advisor, consultant, and underwriter to an issue or portfolio
manager. The third category consists of those authorized to act as underwriter, advisor or
consultant to an issue. The fourth category consists of merchant bankers who act as advisor or
consultant to an issue.

Merchant bankers are individual experts who organize and manage the merchant banks.
The operations of merchant banks are, therefore, influenced by the personality trait of these
individuals. For the success of merchant banks operations, the qualities which merchant
bankers should have are discussed below:-
Merchant banker should possess all relevant skills, update knowledge to interact with the clients
and effectively communicate. Leadership is synonymous with followers who follow the one who
Aggressiveness is a personality trait of a good leader but in merchant banking it has a wider
connotation. Aggressive merchant bankers are always looking for new business. Once a business
opportunity has been located, the merchant banker has got to obtain the mandate for the
merchant banking assignment from the clients at once which will depend upon his own
communication skills, persuasiveness and the background of the organization to which he
belongs. A good merchant banker is one who does not allow his client to think anything outside
except what has been advised.
These two characteristics are the symbols of good leadership but it hardly needs to be stressed
that cooperation and friendliness coupled with persuasiveness are the main instruments with
which a merchant banker mixes with the people, gathers information, obtains business mandate
and renders satisfactory services to the clients. Business of an honest business merchant banker
spreads with geometrical propagation when he shares the thoughts of his clients with
sympathetic gestures and offers pragmatic suggestions without greed or favours. Very often,
rude, intemperate and indifferent disposition or blunt out burst withdrew fortunate business
opportunities forever. Friendliness and cooperation must flow as natural traits in the merchant
banker to win the trust of the clients.
Success of merchant banker depends upon his sociable nature and the richness of wider contacts.
A merchant banker is supposed to be acquainted deeply with all the constituents of merchant
banking. The scope of contact encompasses intimate contiguity and acquaintances within his
own organization, Central and State Government Offices where compliances under various
relevant enactments are to be reported, Indian and foreign banks, financial institutions at Central
and State levels, promoters/directors/owners and chief executives of the private and public
enterprises which would be prospective beneficiaries of merchant banking services, printers,
advertising agencies, brokers and stock exchange dealers, advocates and solicitors and members
of the press whose services are availed of in executing merchant banking assignments. Merchant
bankers should widen contacts and references and continue to maintain them with goodness,
honour and humor by meeting people.
The most important personality trait of a merchant banker is his attitude towards problem
solving. Even client coming to him has got to return fully satisfied having consulted a merchant
banker. Positive approach to understand the view points of others, their difficulties and their
adverse circumstances is possible only when a person is skilled in human relations particularly
the inter-personal and intra-personal behavior. Effective communication and proper feedback are
the pre-requisite for creating a positive attitude towards problem solving. Many persons are
effective in this trait without any training for reasons of cultivating a habit from environment in
which they have been brought up at home, in school, college and office. This is so important that
it must be treated as a separate objective quality of a good merchant banker.
Merchant bankers lice on their wits they earn by giving information to needy clients. Therefore,
they should keep abreast with latest information in the area of the service product, they market.
This is possible if merchant bankers possess the quality of inquisitiveness.
The above qualities of a merchant banker are only illustrative. All good qualities in merchant
bankers are difficult to be defined so elaborately. Nevertheless, merchant banker should possess
super business acumen, managerial abilities, administrative capacities and salesmanship so as to
understand the problems and sell the service product to the needy clients.

To the Investors
Investor protection is fundamental to a healthy growth of the Capital Market. Protection is
not to be conceived as that of compensating for the losses suffered. The responsibility of the
Merchant Banker in ensuring the completeness of the disclosures is of paramount importance
in view of the fact that entire reliance is based on offer Document either Prospectus or Letter
of Offer because an independent agency like a Merchant Banker has done the scrutiny.

Capital structuring
The Merchant Bankers while designing the capital structure take into account the various
factors such as Leverage effect on earnings per share, the project cost and the gestation
period, cash flow ability of the company, the cost of capital, the considerations of
management control, size of the company, and general economic factors. These exercise are
done mainly in order to meet the fund requirement of the company taking due cognizance of
the investors preference.

Project Evaluation and due Diligence

Due diligence and project evaluation is another major responsibility of the Merchant Banker.
Where the project has already been appraised by a bank/financial institution, the Merchant
Banker relies on the said appraisal before accepting an assignment. However, where the
project has not been appraised by as bank/financial institution, the Merchant Bank undertakes
a detailed evaluation of the project before taking up an assignment for issue management.
Legal aspect
The factors that are looked into in case of the legal aspects are:
Compliance with the SEBI guidelines and the various guidelines issued by the Ministry
of Finance and Department of Company Affairs.
Pending litigations towards tax liabilities or any criminal/civil prosecution any of the
directors for any offenses.
Fair and adequate disclosures in the prospectus.

Pricing of the Issue

The Merchant Banker looks into the various factors while pricing the issue. Some of the
factors are past financial performance of the company, Book value per share, stock market
performance of the shares. The Merchant Banker has a vital role to play in pricing of the

Marketing of the Issue

Marketing of the issue is a vital responsibility of the Merchant Banker. The first stage is Pre-
issue marketing for placement of the issue with the financial institutions, banks, mutual
funds, FIIs and NRIs. The second stage is the marketing of the issue to the general public
through various vehicles such as press, brokers, etc.

Bought out Deals

The concept of wholesale but out of public offerings by the Merchant Bankers started off
with over the Counter Exchange of India where a Merchant banker acts also as a sponsor and
either takes up the entire issue to be offered wholly of jointly with other co-investors and off-
loads the same to the public at a later date by an offer for sale. Major amendments were made
to the SEBI regulations regarding Merchant Bankers. The duration of this transaction period
has not officially been announced.
The term Merchant Banking originated in the 18 th and early 19th centuries in the United
Kingdom when trade between countries was financed by bills of exchange drawn on the
principal merchant houses. With the increase in international trade, the established merchants
started the practice of lending their names to the new comers and accepting the bills of exchange
on their behalf. They would charge a commission for the purpose and thus acceptance business
became the hallmark of Merchant Bankers. Once these banks had gained the confidence of the
government, they also entrusted with the job of issuing bonds in the London market.
Although Merchant Banking activity ushered in two decades ago, it was only in 1992, in
India, after the formation of SEBI that is defined and a set of rules and regulations governing it
are in place. In fact, the origin of Merchant Banking is to be traced to Italy in late medieval
times and France during the seventeenth and eighteenth centuries. Merchant Banker invested
accumulated profits in all kinds of promising activities. Since they added banking business into
the profession of Merchant activities and became a Merchant Banker. A distinction was existed
in banking systems between moneychanger and exchanger. Moneychangers concentrate on the
mutual exchange of different currencies, operated locally and later accepted deposits for security
reasons. Passage of time money changers evolved into public or deposit banks whereas
exchangers, who operated internationally, engaged in bill-broking that raising foreign exchange
and provision of long-term capital for public borrowers. The exchanges were remitters and
Merchant Bankers. In the seventeenth century, a Merchant Banker was a dealer in bills of
exchange who operated with correspondents abroad and speculated on the rate of exchange.
Initially, Merchant Bankers were not banks at all and a distinction was drawn between banks,
Merchant Banks and other Financial Institutions. Among all these, Institutions it was only banks
that accepted deposits from public. No person s allowed carrying out any activity as a Merchant
Banker unless he or she holds a certificate grated by SEBI. Registration with SEBI is mandatory
to carry out the business of merchant banking in India.
Among the important financial intermediaries are the merchant bankers. The services of
Merchant bankers have been identified in India with just issue management. It is quite common to
come across reference to merchant banking and financial services as though they are distinct
categories. The services provided by merchant banks depend on their inclination and resources -
technical and financial. Merchant bankers (Category 1) are mandated by SEBI to manage public
issues (as lead managers) and open offers in take-over. These two activities have major
implications for the integrity of the market. They affect investors' interest and, therefore,
transparency has to be ensured. These are also areas where compliance can be monitored and
Merchant banks are rendering diverse services and functions, which are as follows:

The public issue of securities is the core of merchant banking function. At one time it
was constructed as the sole function. Merchant bankers were identified as issue houses. It was
later perceived that they provide other financial services. When companies seek to raise
resources for implementation of a new project or finance expansion or modernization or
diversification of an existing unit or fund long term working capital requirement, they retain the
services of a merchant banker. To a large extent the type of issue would vary with the purpose
for which funds are raised. Merchant bankers when retained as managers to issue will have to
assist the company in all the stages connected with public issue.
The merchant bankers help corporate to raise money from the markets through the issue
of shares, debentures, bonds etc. They are designated as managers to the issue. Their main
business is to attract public money to capital issues.
They usually render the following services:
Obtaining consent/acknowledgement from SEBI.
Appointing bankers, underwriters, brokers, advertisers, printers etc.
Obtaining the consent of all the agencies involved in the public issue.
Deciding the pattern of advertising.
Deciding the branches where application money should be collected.
Deciding the dates of opening and closing of the issue.

In India, the pricing of issues is now freely decided by the company, with valuable
inputs from the merchant bankers, who have to sell the issue at the decided price. The
pricing of the issue especially in a public issue is very important. The pricing has to be such
that the investors will be attracted to invest in the issue at that price, at the same time the
company should get the premium that it is looking for. After all, the premium can play a
very role in deciding the companys capital structure, as larger the premium lesser will be
the requirement for borrowed funds.
The promoter also needs to decide whether to go in for a fresh issue or to go for a
rights issue. However this will depend mainly on the quantum of funds that the company
needs to raise. The success of the issue is dependent on the selection of the right type of
security. In this matter, the expert advice of merchant bankers is of immense importance.
In the issue management the merchant bankers have to coordinate the various agencies to
the issue. The success of the issue depends on the cooperation of all the agencies involved.
The merchant bankers offer following services during the public issues:

Preparing an action plan and budget for the total expenses for the issue.
Preparation of application to SEBI and assistance in obtaining the consent from SEBI.
Drafting of the prospectus.
Selection of underwriters, Brokers etc.
Selection of bankers to the issue.
Selection of advertising agency for publicity.
Companies are free to appoint one or more agencies as Managers to an issue. SEBI
guidelines insist that all issues should be managed by at least one authorized merchant
banker, functioning either as the sole or lead manager to the issue. Ordinarily, not more than
two merchant bankers should be associated as lead managers, advisors and consultants to a
public issue. In issues of over Rs. 100 crores, the number could be up to a maximum of

Underwriting is like insurance against the failure of an issue. It is a guarantee to the

issuing the company, that the money that it requires for its project will definitely be raised.
It means that even if the issue is not fully subscribed to by the public, the underwriters will
make up the short fall.
Underwriting involves the underwriter agreeing to subscribe directly, or to procure
subscription for the unsubscribe portion of the issue, which is not taken up. For the risk that
the underwriter takes, he is paid commission. New companies entering the markets for the
first time, always face number of problems in raising funds from the market. One of the
biggest problems of course that the company is not well known to the investors and many of
them will be unwilling to invest their money in such ventures. Many a times even existing
companies may find it difficult to raise money, due to some reasons. Issuing companies
therefore approach different underwriters with a request to underwrite the issue.
Underwriters on their part need to satisfy themselves about the viability of the project
and also about the integrity of the promoters of the company. It must be noted that when an
issue is under subscribed, the underwriters will pick the shares and only if the project is
good enough, then in future they can sell the shares in the market and get not only their
money back, but can also make a decent profit as well.
It is obligatory for the merchant bankers to accept a minimum 5% underwriting in the
issue subject to a ceiling. By taking underwriting in an issue managed by them, they show
their full commitment to the issue that they are managing.
Mergers and acquisitions (M&A) and corporate restructuring are a big part of the
corporate finance world. Every day, Wall Street investment bankers arrange M&A
transactions, which bring separate companies together to form larger ones. When they're not
creating big companies from smaller ones, corporate finance deals do the reverse and break
up companies through spin-offs, carve-outs or tracking stocks.
Role of Merchant Banker
Mergers & Acquisitions is an area where Merchant Bankers act as intermediaries in
negotiating on one with corporate interested in hiring of divisions/companies which are not
within the purview of the long-term business strategy of the group/company, and on the
other hand for Corporate interested in non organic growth by acquiring companies/units for
reason strategic or non strategic in nature. Mergers can be beneficial for both the entities, as
due to competition the companies unable to survive or prosper on their own may like to
merge and face competition and achieve growth targets. Takeovers may be hostile or
friendly in nature, hostile takeovers are without the consent of the company and company
being takeover may work out an anti takeover strategy to counter the threat.
Merchant Bankers provide following services in M&A: -

Identification of potential takeover targets.

Financial & Technical appraisal of the merger/takeover proposal.
Negotiation with the parties for arriving at the suitable price or exchange ratio.
Assistance in obtaining necessary approval & addressing procedural & legal issues.


Project counseling is very important and lucrative merchant banking services which
only very few merchant bankers having advantages of knowledge, skills and experience
over others are able to render satisfactorily. The corporate seek advice in respect of
identification of profitable investment opportunities in the related business areas (like
forward/backward integration) or as part of diversification process. The merchant bankers
carry out detailed studies on product demand patterns, cost structures, etc., to enable the
corporate in preparation of feasibility study may involve arrangement of a foreign
collaboration, advice on technical parameters and also legal issues.

Scope of services
Project counseling services are needed by industrial entrepreneurs in India in the
following areas: -
Preparation of project report
Deciding upon the financing pattern to finance the cost of the project.
Aspects of project appraisal with financial institutions/banks.
Project report
Project report purpose
Grant of industrial license to undertake specified industrial activity.
Foreign investment and technology tie-up.
Grant import license for importing raw material, plant, machinery and equipments.
Grant of foreign exchange allocation for import of capital goods or raw materials, etc.


It refers to assistance rendered by merchant banks to get mainly term loans for
projects. Such loans may be obtained from a single development finance institution or a
syndicate or consortium as in the case of large term loans. Merchant banks can also help
corporate clients to raise syndicated loans from commercial banks.
Merger & Acquisition transaction -- Merchant banks' services not taxable

The Finance Ministry has excluded services provided by merchant banks and other
agencies in a merger and acquisition (M&A) transaction from the scope of taxable services
provided by a `management consultant.'

The rationale accorded is that the role of such agencies is limited to compliance of any
statute or regulation -- such as takeover regulations of the Securities and Exchange Board of
India (SEBI) -- and not governed by any contractual relationship with the advisee company.

Merchant banks do not provide any consultancy on an M&A transaction, but merely verify
and submit a report to the authorities concerned, according to the Central Board for Excise and
Customs (CBEC).

Barring the services of merchant banks, any service rendered in relation to an M&A
transaction will be covered under the scope of taxable service provided by the management
consultant and will be liable to service tax, the Board has ruled. Industry representatives held that
services provided in respect of M&A cannot be construed as a management consultancy service,
but were in the nature of financial advisory service.

They further opined that acquisition or divesting of shareholdings was a purely financial
transaction and distinct from the advice or service provided prior to taking a decision to divest,
merge or acquire an organisation.


The surging stock market is creating an unusual problem: Mergers & Acquisitions (M&A)
deals are becoming tougher to close as the two parties to a deal keep looking over their shoulders
to figure out how the market is pricing their shares. The key to any deal is valuation. And when
the market booms, agreed valuations for proposed M&A are thrown into disarray.

In this scenario, M&A rankings will change depending on who has been able to close deals
faster. In the first nine months of 2005, (ended September), Kotak Mahindra/Goldman Sachs
topped the heap by executing 13 deals valued at $2.53 billion (about 11,000 crore). This bank
was ranked No. 4 last year in the process; the investment bank has increased its share by 420
basis points from 13.1% for last year to 17.3% now. Morgan Stanley retained its No 2 position,
having sewn up 11 deals worth $2.23 billion so far. Its market share is up 50 basis points to
15.2%. Stock prices have gone up because of profitability. Indian companies are also looking at
overseas opportunities. M&A are also getting hit because more & more companies are opting for
the global depository receipts/foreign currency convertible bonds issue to sate their capital needs.
The analyst sees pharmaceuticals, information technology & engineering specifically auto
ancillaries as the areas where an increasing amount of M&as will take place in India.

Rapid valuation changes do cause some delays, but in the end, the deals go through if there
are benefits to both parties. Infrastructure related business, airlines and the auto component
sectors as being prime for acquisitions.


PLAYERS Rank Rank Mkt Mkt Value Deals
05 share share ($m)
04 05 04

Kotak/Goldman Sachs 1 4 17.3 13.1 2,534 13

Morgan Stanley 2 2 15.2 14.7 2 ,227 11

Merrill Lynch & Co. 3 3 12.1 14 1,771 12

Standard Chartered 4 9 6.7 4.8 981 5

Ernst & Young 5 1 6.7 16.9 980 37

Citigroup 6 6 6.6 11 962 8

Ambit Corporate Fin 7 8 6.4 4.9 936 21

DBS Group 8 - 4.8 - 704 1

ICICI Securities 9 5 4.4 12.2 649 10

UBS 10- - 3.8 - 550 3

Rankings based on deals in up to 30th September, 2008.



ENAM was founded in1984 to provide knowledge-driven financial services at the time when
Indian economy investors faced a bewildering array of options. ENAM is the one of the largest
underwriters in India. ENAM offers promising & exciting companies the opportunity of
assessing the public market equity finances. ENAMs long-term association with capital markets
& primary markets has provided it with deep insights of the functioning of Indian financial

The merchant banking services provided by ENAM are: -

Equity debt/syndication: Raising capital through a private placement of a companys

securities is an effective & timely offering to a public offering. ENAM represents the clients
in the private placement of debt and equity with institutional & high net worth investors.

Corporate Restructuring: - ENAM provides client with strategic and practical solutions to
financial challenges. Their restructuring services includes Mergers & Acquisitions,
Takeovers, Debt restructuring, Buyers services etc.

ENAM also provide the seed stage services, value creation services and IPOs advisory
services which are represented below:

ICICI Securities Limited is a leader across the spectrum of Merchant Banking. We are
experienced in every aspect of the business from domestic and international capital markets
advisory, to M&A advisory, Private Equity syndication, Restructuring and infrastructure
advisory. Our investment banking team, based across key cities in India and New York, London,
and Singapore consists of professionals with expertise across a range of industries.

ICICI SECURITIES provide following services:

Mergers and Acquisitions: - ICICI Securities Limited is amongst the first Indian investment
Banks to form a dedicated M&A practice and continues to be a leader by providing
innovative and unique solutions to achieve varied objectives of the client. They offer a full
range of advisory services, which include joint ventures, mergers, acquisitions, and

Equity Capital Markets: - ICICI Securities Limited is at the forefront of capital markets
advisory having been involved in most major book building and fixed price offerings over
the last decade. It is amongst the leading underwriters of Indian equity and equity-linked

Infrastructure Advisory: - ICICI Securities Limited has a dedicated infrastructure vertical

focused on assisting clients in identifying and capitalising on the opportunities thrown up by
the all pervasive boom in the Indian infrastructure sector.

Dealing with Bulls and Bears: - ICICI Securities Limited assists global institutional
investors to make the right decisions through insightful research coverage and a client
focused Sales and Dealing team. The equity group leverages research and distribution reach
to domestic and foreign institutional investors in case of public offerings.

Thus the quality of analysis and client servicing standards, are a testimony to the quality of ICICI


Kotak Securities Limited, a subsidiary of Kotak Mahindra Bank, is the stock broking and
distribution arm of the Kotak Mahindra Group. The company was set up in 1994. Kotak
Securities is a corporate member of both The Bombay Stock Exchange and the National Stock
Exchange of India Limited. Its operations include stock broking and distribution of various
financial products - including private and secondary placement of debt and equity and mutual
funds. Currently, Kotak Securities is one of the largest broking houses in India with wide
geographical reach.

The company has four main areas of business:

Kotak Institutional Equities: - Kotak Institutional Equities, among the top institutional
brokers in India. It mainly covers secondary market broking and the marketing of equity
offerings, including IPOs, to domestic and foreign institutional investors.

Structured Finance (Project Finance & Advisory Business): -KMCC has developed
expertise in various vertical segments in the infrastructure sector including power, oil, gas,
ports, automobiles, steel & metals and hotels, by offering structured finance solutions. Some
of the transactions executed by this team include:

Advisor to Ford on financial closure for its Car project in India.

Advisor to one of the largest LNG projects on the Western coast of India.

Financial advisors and loan syndications to British Gas and GAIL.

Mergers & Acquisitions: -In the area of Mergers & Acquisitions, we provide our clients
expertise and a comprehensive set of services that help them achieve their strategic and
financial objectives. Our spectrum of services include:


Spin-Offs / Restructuring & Joint Ventures / Strategic Alliances


Citigroup Corporate and Investment Banking achieve the extraordinary for our clients around the
world. No financial institution is more committed to advancing the goals of its clientsour
diverse and talented staff in more than 100 countries advises companies, governments and
institutions on the best ways to realize their strategic objectives. We create solutions for and
provide the broadest possible capital and market access to thousands of issuer and investor
clients. And no institution better executes the increasingly complex payment and cash
management solutions required in today's global economy. The features Citigroup are as follows:

Over the years, Citigroup has established a track record of outstanding business milestones
such as Cash Management, pioneered by Citigroup in 1986 and utilized by over 900
Corporates with through-puts totaling around $ 35 billion (8% of India's GDP).

It is India's largest foreign bank in the FX (foreign exchange) market with a 14 per cent
market share.
As the leading custodian, Citibank has over $22 billion of custody assets under management.


DSP Merrill Lynch Limited (DSPML), among India's leading investment banking and Brokerage
Company, is a culmination of a long standing relationship between DSP Financial Consultants
Ltd., and Merrill Lynch & Co., the leading international capital raising, financial management
and advisory company. DSPML is a full service investment bank and broking company with
leadership position in M&A, Capital

Raising, Securities Research, Equity & Debt Brokering, and Investment Advisory services. Euro
money Magazine has ranked DSPML as the "Best Domestic Securities firm in India" for the last
four consecutive years. This Transaction heralds DSPML as a key player in the private equity
market. The service features of DSPML are as follows: -

DSPML has consistently been rated as one of India's leaders in origination, distribution, and
trading of equity and debt securities.

A diverse client base made up of India's most prestigious private and public sector
corporations and multinational corporations have rendered DSPML a commanding presence
in the Indian capital market.

Through direct market's group, DSPML offers investors access to every major initial or
subsequent public offering.

DSP Merrill Lynch is the leading underwriter of Indian equity and equity-linked offerings
across domestic and international markets. By leveraging their extensive knowledge of local
markets and global resources, they have delivered innovative and customized solutions to
their clients.


Time and again the Merchant banking Industry in India witnessed experienced and
underwent significant changes. The very purpose for which these firms are commences their
services should be taken care of and they should mould their policy decision and activities to
move in tune with the main objectives of Investors protection and to create healthy environment
in capital markets. No doubt, Merchant Banking firms are subject to a host of control measures,
regulations and rules framed and guided by SEBI. To some extent, frequent changes and /or
amendments to policies and control measures, though needed for smooth working of the
securities Industry, proves to be detrimental to the very existence of the Merchant Banking
system in the country. The SEBIs Act 1992 confers power upon SEBI to supervise and control
the affairs of the Merchant Banking firms in India.

The various studies which had been undertaken in India for evaluating the performance of
Merchant Banking firms and the implications of these on securities industry. No single study has
been emerged so far pertaining to the evaluation of Merchant Banking firms and in-depth study
on their activities as well as operational and financial performance in the light of changing
regulatory environment.

In recent past, the small investor has turned his back on the primary capital market. Issue
after issue as failed to capture his imagination, rekindle his enthusiasm, and reinforce his faith.
He has lost all hopes of appreciation of his investment. And this when all these years millions
have though capital market, ate capital market and dreamt capital market. It needed an
extraordinary effort and skill the drive the small investor away! High premiums, false premiums
and gray market operations. The professed protector of his interests first laid down the dictum of
proportionate allotment, then of minimum subscription, all working against his interests. This
would make an observant student of the stock market infer that there is some game plan afoot to
dethrone the small investor from his prominent; he was believed to be the king.

With the coming to SEBI, an organisation that was ostensibly brought into existence to
guard the interest of the small investor, hopes ran high that the small investor would now have a
safe playing field. But these hopes were soon belied. Far from guarding the interests of the
investing public, SEBI embarked on a course of action, which has positively hurt them. The
latest fiat of EBI bans corporate advertising after the receipt of acknowledgement card by a
company wanting to go public. SEBIs this action has caused the closure of an information
window. Now 50 million potential investors are deprived of official and authentic information
given by the Issuer. It is hard to understand reasons for this drastic and totally uncalled for
action. While there has been no official explanation for this fiat, there is reason to believe that it
may be based on a wrong perception of the role for corporate advertising.

All this has been done perhaps because the corporate and intermediaries is to follow the
practices of Western capital markets here, oblivious of the fact that our capital markets are
altogether different in structure, in systems and in the number of participants Freedom of
commercial expression could be exploited by some to serve their own ends, just a s freedom of
speech and expression could be abused but this has not led our Government to put arbitrary
restrictions on our freedom.

Merchant Bankers have reason to believe they will be handicapped without the marketing
support. But the worst sufferer would be the investor, especially the small investor it is this
class, which forms the backbone of the capital market. As a result of the ban, the small investor
would be deprived of the opportunity to study the corporate profile of the Issuer. In the absence
of adequate information, they will have to depend on manipulated facts and information fed by
unreliable sources.

Besides, there are larger issuers arising out of SEBIs action. From the point of view of
liberalisation of the economy, SEBI has taken a retrograde step. A market economy flourished
through bigger markets, higher sales and lesser profits. To achieve this performance, a company
needs an aggressive marketing plan and advertising effort is the main thrust to such a plan. No
marketing plan can be worthwhile unless it is backed by an effective advertising plan. The ban
imposed by SEBI nips the marketing plan in the bud.

The Indian primary capital market is basically a retail market. It consists of innumerable
investors who take own individual investment decisions. Whatever, the system, it is this market
that will bring in the funds. If these markets destabilized, the investors will look for alternative
avenues to invest their funds. SEBI in its one of the first documents on SEBI and Investor
Protection, Development and Regulation of Securities Market clearly specifies significance of
regulating capital market and its future plans for fulfilling the twin objectives viz., Development
of capital market and investor protection are explained in introductory paragraphs. It speak out
that, The decade of the 1980 witnessed a phenomenal growth and development of the securities
market, demonstrated its potential not only to mobilize the savings of the horses hold sector but
also to allocate it with some degree of efficiency for industrial development. The dilution of the
holdings of the multinational companies at affordable prices in the latter part of the 1970s had
generated considerable interest, which was, carries well into the next decade. Several
companies came in the early part of the 1980s and successfully raised large resources from the
market especially through debt instruments, which further sustained investor interest. There
were several changes in Government policy, which significantly influenced industry and aided
the market. India was then entering the phase of liberalization and decontrol which was to
accelerate and gather momentum in the 1980s.

By the end of the decade, the securities market in India came to be firmly integrated with
the financial system of the country. With the corporate sector increasingly relying on the
securities market for meeting their long-term requirement of funds, the securities market their
long-term requirement of funds; the securities market competed on equal terms with the
Development Financial Institutions, which were the traditional purveyors of long-term capital.
The emergence of the securities markets into the main stream of the financial system of the
country was thus one of the major economic processes of the 1980s an inevitable outcome of
the maturing process of the financial system. They brought about notable changes in the capital
structure of the companies across industries, gave birth to new intermediaries and institutions in
the securities market and created a new awareness and interest in investment opportunities in the
securities market among investor. In spite market, its quality lagged far behind and there was
absence of adequate professionalism and fair competition among the various players in the
market. Besides, the regulatory framework then prevailing was fragmented difficult, if not


The merchant banker plays a vital role in channelizing the financial surplus of the society
into productive investment avenues. Hence before selecting a merchant banker, one must decide
what the services for which he is being approached are. Selecting the right intermediary who has
the necessary skills to meet the requirements of the client will ensure success.
It can be said that this project helped me to understand every details about Merchant
Banking and in future how its going to get emerged in the Indian economy. Hence, Merchant
Banking can be considered as essential financial body in Indian financial system.
Market development is predicated on a sound, fair and transparent regulatory framework.
To sustain the growth of the market and crystallize the growing awareness and interest into a
committed, discerning and growing awareness and interest into an essential to remove the trading
malpractice and structural inadequacies prevailing in the market, and provide the investors an
organized, well regulated market place in future.
Some Example of Merchant Banker

SBI Capital Marketltd

Fin Invt& Leas Compn Mrh Bnkg
L& T Capital Ltd
Merc. Banking Co. Corp Fina
Ind Bank Merchant Services Ltd
Merchant Bank
Allianz Securities Ltd
Merchant Banker
Tata Finance Merchant Bankers Ltd
Finance Solutions

Private equity

In finance, private equity is an asset class consisting of equity securities in operating companies
that are not publicly traded on a stock exchange.

A private equity investment will generally be made by a private equity firm, a venture capital
firm or an angel investor. Each of these categories of investor has its own set of goals,
preferences and investment strategies; however, all provide working capital to a target company
to nurture expansion, new product development, or restructuring of the companys operations,
management, or ownership.

Bloomberg Businessweek has called private equity a rebranding of leveraged buyout firms after
the 1980s. Among the most common investment strategies in private equity are: leveraged
buyouts, venture capital, growth capital, distressed investments and mezzanine capital. In a
typical leveraged buyout transaction, a private equity firm buys majority control of an existing or
mature firm. This is distinct from a venture capital or growth capital investment, in which the
investors (typically venture capital firms or angel investors) invest in young or emerging
companies, and rarely obtain majority control.

Private equity is also often grouped into a broader category called private capital, generally used
to describe capital supporting any long-term, illiquid investment strategy.
The strategies private equity firms may use are as follows, leveraged buyout being the most

Leveraged buyout

Leveraged buyout, LBO or Buyout refers to a strategy of making equity investments as part of a
transaction in which a company, business unit or business assets is acquired from the current
shareholders typically with the use of financial leverage. The companies involved in these
transactions are typically mature and generate operating cash flows.

Leveraged buyouts involve a financial sponsor agreeing to an acquisition without itself

committing all the capital required for the acquisition. To do this, the financial sponsor will raise
acquisition debt which ultimately looks to the cash flows of the acquisition target to make
interest and principal payments. Acquisition debt in an LBO is often non-recourse to the
financial sponsor and has no claim on other investment managed by the financial sponsor.
Therefore, an LBO transaction's financial structure is particularly attractive to a fund's limited
partners, allowing them the benefits of leverage but greatly limiting the degree of recourse of that
leverage. This kind of financing structure leverage benefits an LBO's financial sponsor in two

(1) the investor itself only needs to provide a fraction of the capital for the acquisition, and
(2) the returns to the investor will be enhanced (as long as the return on assets exceeds the cost of
the debt).
As a percentage of the purchase price for a leverage buyout target, the amount of debt used to
finance a transaction varies according the financial condition and history of the acquisition
target, market conditions, the willingness of lenders to extend credit (both to the LBO's financial
sponsors and the company to be acquired) as well as the interest costs and the ability of the
company to cover those costs. Historically the debt portion of a LBO will range from 60%90%
of the purchase price, although during certain periods the debt ratio can be higher or lower than
the historical averages.[7] Between 20002005 debt averaged between 59.4% and 67.9% of total
purchase price for LBOs in the United States.

Simple example

A private equity fund, ABC Capital II, borrows $9bn from a bank (or other lender). To this it
adds $2bn of equity money from its own partners and from limited partners (pension funds,
rich individuals, etc.). With this $11bn it buys all the shares of an underperforming company,
XYZ Industrial (after due diligence, i.e. checking the books). It replaces the senior management
in XYZ Industrial, and they set out to streamline it. The workforce is reduced, some assets are
sold off, etc. The objective is to increase the value of the company for a fast sale. The
stockmarket is experiencing a bull market, and XYZ Industrial is sold two years after the buy-out
for $13bn, yielding a profit of $2bn. The original loan can now be paid off with interest of say
$0.5bn. The remaining profit of $1.5bn is shared among the partners. Taxation of such gains is at
capital gains rates. Note that part of that profit results from turning the company around, and part
results from the general increase in share prices in a buoyant stockmarket, the latter often being
the greater component.

The lenders (the people who put up the $11bn in the example) can insure their loans
against default, at a cost, by buying credit derivatives, including credit default swaps
(CDSs) and collateralised loan obligations (CLOs), from other institutions.
Often the loan/equity ($11bn above) is not paid off after sale but left on the books of the
company (XYZ Industrial) for it to pay off over time. This can be advantageous since the
interest is typically offsettable against the profits of the company, thus reducing, or even
eliminating, tax.

Growth capital

Growth Capital refers to equity investments, most often minority investments, in relatively
mature companies that are looking for capital to expand or restructure operations, enter new
markets or finance a major acquisition without a change of control of the business.

Companies that seek growth capital will often do so in order to finance a transformational event
in their life cycle. These companies are likely to be more mature than venture capital funded
companies, able to generate revenue and operating profits but unable to generate sufficient cash
to fund major expansions, acquisitions or other investments. Because of this lack of scale these
companies generally can find few alternative conduits to secure capital for growth, so access to
growth equity can be critical to pursue necessary facility expansion, sales and marketing
initiatives, equipment purchases, and new product development.[10] The primary owner of the
company may not be willing to take the financial risk alone. By selling part of the company to
private equity, the owner can take out some value and share the risk of growth with partners.
Capital can also be used to effect a restructuring of a company's balance sheet, particularly to
reduce the amount of leverage (or debt) the company has on its balance sheet.
A Private investment in public equity, or PIPEs, refer to a form of growth capital investment
made into a publicly traded company. PIPE investments are typically made in the form of a
convertible or preferred security that is unregistered for a certain period of time.
The Registered Direct, or RD, is another common financing vehicle used for growth capital. A
registered direct is similar to a PIPE but is instead sold as a registered security.

Mezzanine capital

Mezzanine capital refers to subordinated debt or preferred equity securities that often represent
the most junior portion of a company's capital structure that is senior to the company's common
equity. This form of financing is often used by private equity investors to reduce the amount of
equity capital required to finance a leveraged buyout or major expansion. Mezzanine capital,
which is often used by smaller companies that are unable to access the high yield market, allows
such companies to borrow additional capital beyond the levels that traditional lenders are willing
to provide through bank loans. In compensation for the increased risk, mezzanine debt holders
require a higher return for their investment than secured or other more senior lenders.Mezzanine
securities are often structured with a current income coupon.

Venture capital

Venture capital is a broad subcategory of private equity that refers to equity investments made,
typically in less mature companies, for the launch, early development, or expansion of a
business. Venture investment is most often found in the application of new technology, new
marketing concepts and new products that have yet to be proven.

Venture capital is often sub-divided by the stage of development of the company ranging from
early stage capital used for the launch of start-up companies to late stage and growth capital that
is often used to fund expansion of existing business that are generating revenue but may not yet
be profitable or generating cash flow to fund future growth.

Entrepreneurs often develop products and ideas that require substantial capital during the
formative stages of their companies' life cycles. Many entrepreneurs do not have sufficient funds
to finance projects themselves, and they must therefore seek outside financing. The venture
capitalist's need to deliver high returns to compensate for the risk of these investments makes
venture funding an expensive capital source for companies. Being able to secure financing is
critical to any business, whether its a startup seeking venture capital or a mid-sized firm that
needs more cash to grow. Venture capital is most suitable for businesses with large up-front
capital requirements which cannot be financed by cheaper alternatives such as debt. Although
venture capital is often most closely associated with fast-growing technology and biotechnology
fields, venture funding has been used for other more traditional businesses.

Distressed and special situations

Distressed or Special Situations is a broad category referring to investments in equity or debt

securities of financially stressed companies. The "distressed" category encompasses two broad
sub-strategies including:
"Distressed-to-Control" or "Loan-to-Own" strategies where the investor acquires debt
securities in the hopes of emerging from a corporate restructuring in control of the
company's equity;

"Special Situations" or "Turnaround" strategies where an investor will provide debt and
equity investments, often "rescue financing" to companies undergoing operational or
financial challenges.

In addition to these private equity strategies, hedge funds employ a variety of distressed
investment strategies including the active trading of loans and bonds issued by distressed


Secondary investments refer to investments made in existing private equity assets. These
transactions can involve the sale of private equity fund interests or portfolios of direct
investments in privately held companies through the purchase of these investments from existing
institutional investors. By its nature, the private equity asset class is illiquid, intended to be a
long-term investment for buy and hold investors. Secondary investments provide institutional
investors with the ability to improve vintage diversification, particularly for investors that are
new to the asset class. Secondaries also typically experience a different cash flow profile,
diminishing the j-curve effect of investing in new private equity funds. Often investments in
secondaries are made through third party fund vehicle, structured similar to a fund of funds
although many large institutional investors have purchased private equity fund interests through
secondary transactions. Sellers of private equity fund investments sell not only the investments in
the fund but also their remaining unfunded commitments to the funds.

Other strategies

Other strategies that can be considered private equity or a close adjacent market include:

Real Estate: in the context of private equity this will typically refer to the riskier end of
the investment spectrum including "value added" and opportunity funds where the
investments often more closely resemble leveraged buyouts than traditional real estate
investments. Certain investors in private equity consider real estate to be a separate asset
Infrastructure: investments in various public works (e.g., bridges, tunnels, toll roads,
airports, public transportation and other public works) that are made typically as part of a
privatization initiative on the part of a government entity.

Energy and Power: investments in a wide variety of companies (rather than assets)
engaged in the production and sale of energy, including fuel extraction, manufacturing,
refining and distribution (Energy) or companies engaged in the production or
transmission of electrical power (Power).
Merchant banking: negotiated private equity investment by financial institutions in the
unregistered securities of either privately or publicly held companies.

Fund of funds: investments made in a fund whose primary activity is investing in other
private equity funds. The fund of funds model is used by investors looking for:

Diversification but have insufficient capital to diversify their portfolio by

Access to top performing funds that are otherwise oversubscribed
Experience in a particular fund type or strategy before investing directly in funds
in that niche
Exposure to difficult-to-reach and/or emerging markets
Superior fund selection by high-talent fund of fund managers/teams

History and development History of private equity and venture capital

Early history and the development of venture capital

Main articles: History of private equity and venture capital and Early history of private equity

The seeds of the US private equity industry were planted in 1946 with the founding of two
venture capital firms: American Research and Development Corporation (ARDC) and J.H.
Whitney & Company.[39] Before World War II, venture capital investments (originally known as
"development capital") were primarily the domain of wealthy individuals and families. In 1901
J.P. Morgan arguably managed the first leveraged buyout of the Carnegie Steel Company using
private equity.[40] Modern era private equity, however, is credited to Georges Doriot, the "father
of venture capitalism" with the founding of ARDC and founder of INSEAD, with capital raised
from institutional investors, to encourage private sector investments in businesses run by soldiers
who were returning from World War II. ARDC is credited with the first major venture capital
success story when its 1957 investment of $70,000 in Digital Equipment Corporation (DEC)
would be valued at over $355 million after the company's initial public offering in 1968
(representing a return of over 500 times on its investment and an annualized rate of return of
101%). It is commonly noted that the first venture-backed startup is Fairchild Semiconductor
(which produced the first commercially practicable integrated circuit), funded in 1959 by what
would later become Venrock Associates.

Origins of the leveraged buyout

The first leveraged buyout may have been the purchase by McLean Industries, Inc. of Pan-
Atlantic Steamship Company in January 1955 and Waterman Steamship Corporation in May
1955 Under the terms of that transaction, McLean borrowed $42 million and raised an additional
$7 million through an issue of preferred stock. When the deal closed, $20 million of Waterman
cash and assets were used to retire $20 million of the loan debt. Similar to the approach
employed in the McLean transaction, the use of publicly traded holding companies as investment
vehicles to acquire portfolios of investments in corporate assets was a relatively new trend in the
1960s popularized by the likes of Warren Buffett (Berkshire Hathaway) and Victor Posner (DWG
Corporation) and later adopted by Nelson Peltz (Triarc), Saul Steinberg (Reliance Insurance) and
Gerry Schwartz (Onex Corporation). These investment vehicles would utilize a number of the
same tactics and target the same type of companies as more traditional leveraged buyouts and in
many ways could be considered a forerunner of the later private equity firms. In fact it is Posner
who is often credited with coining the term "leveraged buyout" or "LBO"

The leveraged buyout boom of the 1980s was conceived by a number of corporate financiers,
most notably Jerome Kohlberg, Jr. and later his protg Henry Kravis. Working for Bear Stearns
at the time, Kohlberg and Kravis along with Kravis' cousin George Roberts began a series of
what they described as "bootstrap" investments. Many of these companies lacked a viable or
attractive exit for their founders as they were too small to be taken public and the founders were
reluctant to sell out to competitors and so a sale to a financial buyer could prove attractive. Their
acquisition of Orkin Exterminating Company in 1964 is among the first significant leveraged
buyout transactions. In the following years the three Bear Stearns bankers would complete a
series of buyouts including Stern Metals (1965), Incom (a division of Rockwood International,
1971), Cobblers Industries (1971), and Boren Clay (1973) as well as Thompson Wire, Eagle
Motors and Barrows through their investment in Stern Metals. By 1976, tensions had built up
between Bear Stearns and Kohlberg, Kravis and Roberts leading to their departure and the
formation of Kohlberg Kravis Roberts in that year.

Private equity in the 1980s

In January 1982, former United States Secretary of the Treasury William Simon and a group of
investors acquired Gibson Greetings, a producer of greeting cards, for $80 million, of which only
$1 million was rumored to have been contributed by the investors. By mid-1983, just sixteen
months after the original deal, Gibson completed a $290 million IPO and Simon made
approximately $66 million.

The success of the Gibson Greetings investment attracted the attention of the wider media to the
nascent boom in leveraged buyouts. Between 1979 and 1989, it was estimated that there were
over 2,000 leveraged buyouts valued in excess of $250 million

During the 1980s, constituencies within acquired companies and the media ascribed the
"corporate raid" label to many private equity investments, particularly those that featured a
hostile takeover of the company, perceived asset stripping, major layoffs or other significant
corporate restructuring activities. Among the most notable investors to be labeled corporate
raiders in the 1980s included Carl Icahn, Victor Posner, Nelson Peltz, Robert M. Bass, T. Boone
Pickens, Harold Clark Simmons, Kirk Kerkorian, Sir James Goldsmith, Saul Steinberg and Asher
Edelman. Carl Icahn developed a reputation as a ruthless corporate raider after his hostile
takeover of TWA in 1985. Many of the corporate raiders were onetime clients of Michael
Milken, whose investment banking firm, Drexel Burnham Lambert helped raise blind pools of
capital with which corporate raiders could make a legitimate attempt to take over a company and
provided high-yield debt ("junk bonds") financing of the buyouts.

One of the final major buyouts of the 1980s proved to be its most ambitious and marked both a
high water mark and a sign of the beginning of the end of the boom that had begun nearly a
decade earlier. In 1989, KKR (Kohlberg Kravis Roberts) closed in on a $31.1 billion takeover of
RJR Nabisco. It was, at that time and for over 17 years, the largest leverage buyout in history.
The event was chronicled in the book (and later the movie), Barbarians at the Gate: The Fall of
RJR Nabisco. KKR would eventually prevail in acquiring RJR Nabisco at $109 per share,
marking a dramatic increase from the original announcement that Shearson Lehman Hutton
would take RJR Nabisco private at $75 per share. A fierce series of negotiations and horse-
trading ensued which pitted KKR against Shearson and later Forstmann Little & Co. Many of the
major banking players of the day, including Morgan Stanley, Goldman Sachs, Salomon Brothers,
and Merrill Lynch were actively involved in advising and financing the parties. After Shearson's
original bid, KKR quickly introduced a tender offer to obtain RJR Nabisco for $90 per sharea
price that enabled it to proceed without the approval of RJR Nabisco's management. RJR's
management team, working with Shearson and Salomon Brothers, submitted a bid of $112, a
figure they felt certain would enable them to outflank any response by Kravis's team. KKR's
final bid of $109, while a lower dollar figure, was ultimately accepted by the board of directors
of RJR Nabisco.[55] At $31.1 billion of transaction value, RJR Nabisco was by far the largest
leveraged buyouts in history. In 2006 and 2007, a number of leveraged buyout transactions were
completed that for the first time surpassed the RJR Nabisco leveraged buyout in terms of
nominal purchase price. However, adjusted for inflation, none of the leveraged buyouts of the
20062007 period would surpass RJR Nabisco. By the end of the 1980s the excesses of the
buyout market were beginning to show, with the bankruptcy of several large buyouts including
Robert Campeau's 1988 buyout of Federated Department Stores, the 1986 buyout of the Revco
drug stores, Walter Industries, FEB Trucking and Eaton Leonard. Additionally, the RJR Nabisco
deal was showing signs of strain, leading to a recapitalization in 1990 that involved the
contribution of $1.7 billion of new equity from KKR. In the end, KKR lost $700 million on RJR

Drexel reached an agreement with the government in which it pleaded nolo contendere (no
contest) to six felonies three counts of stock parking and three counts of stock manipulation. It
also agreed to pay a fine of $650 million at the time, the largest fine ever levied under
securities laws. Milken left the firm after his own indictment in March 1989. On 13 February
1990 after being advised by United States Secretary of the Treasury Nicholas F. Brady, the U.S.
Securities and Exchange Commission (SEC), the New York Stock Exchange and the Federal
Reserve, Drexel Burnham Lambert officially filed for Chapter 11 bankruptcy protection.

Age of the mega-buyout 20052007

The combination of decreasing interest rates, loosening lending standards and regulatory changes
for publicly traded companies (specifically the Sarbanes-Oxley Act) would set the stage for the
largest boom private equity had seen. Marked by the buyout of Dex Media in 2002, large multi-
billion dollar U.S. buyouts could once again obtain significant high yield debt financing and
larger transactions could be completed. By 2004 and 2005, major buyouts were once again
becoming common, including the acquisitions of Toys "R" Us, The Hertz Corporation, Metro-

As 2005 ended and 2006 began, new "largest buyout" records were set and surpassed several
times with nine of the top ten buyouts at the end of 2007 having been announced in an 18-month
window from the beginning of 2006 through the middle of 2007. In 2006, private equity firms
bought 654 U.S. companies for $375 billion, representing 18 times the level of transactions
closed in 2003. Additionally, U.S. based private equity firms raised $215.4 billion in investor
commitments to 322 funds, surpassing the previous record set in 2000 by 22% and 33% higher
than the 2005 fundraising total The following year, despite the onset of turmoil in the credit
markets in the summer, saw yet another record year of fundraising with $302 billion of investor
commitments to 415 funds Among the mega-buyouts completed during the 2006 to 2007 boom
were: Equity Office Properties, HCA, Alliance Boots and TXU

In July 2007, turmoil that had been affecting the mortgage markets, spilled over into the
leveraged finance and high-yield debt markets. The markets had been highly robust during the
first six months of 2007, with highly issuer friendly developments including PIK and PIK Toggle
(interest is "Payable In Kind") and covenant light debt widely available to finance large
leveraged buyouts. July and August saw a notable slowdown in issuance levels in the high yield
and leveraged loan markets with few issuers accessing the market. Uncertain market conditions
led to a significant widening of yield spreads, which coupled with the typical summer slowdown
led many companies and investment banks to put their plans to issue debt on hold until the
autumn. However, the expected rebound in the market after 1 May 2007 did not materialize, and
the lack of market confidence prevented deals from pricing. By the end of September, the full
extent of the credit situation became obvious as major lenders including Citigroup and UBS AG
announced major writedowns due to credit losses. The leveraged finance markets came to a near
standstill during a week in 2007. As 2007 ended and 2008 began, it was clear[according to
whom?] that lending standards had tightened and the era of "mega-buyouts" had come to an end.
Nevertheless, private equity continues to be a large and active asset class and the private equity
firms, with hundreds of billions of dollars of committed capital from investors are looking to
deploy capital in new and different transactions.

Investments in private equity

Although the capital for private equity originally came from individual investors or corporations,
in the 1970s, private equity became an asset class in which various institutional investors
allocated capital in the hopes of achieving risk adjusted returns that exceed those possible in the
public equity markets. In the 1980s, insurers were major private equity investors. Later, public
pension funds and university and other endowments became more significant sources of capital.
[75] For most institutional investors, private equity investments are made as part of a broad asset
allocation that includes traditional assets (e.g., public equity and bonds) and other alternative
assets (e.g., hedge funds, real estate, commodities).

Most institutional investors do not invest directly in privately held companies, lacking the
expertise and resources necessary to structure and monitor the investment. Instead, institutional
investors will invest indirectly through a private equity fund. Certain institutional investors have
the scale necessary to develop a diversified portfolio of private equity funds themselves, while
others will invest through a fund of funds to allow a portfolio more diversified than one a single
investor could construct.

Returns on private equity investments are created through one or a combination of three factors
that include: debt repayment or cash accumulation through cash flows from operations,
operational improvements that increase earnings over the life of the investment and multiple
expansion, selling the business for a higher multiple of earnings than was originally paid. A key
component of private equity as an asset class for institutional investors is that investments are
typically realized after some period of time, which will vary depending on the investment
strategy. Private equity investments are typically realized through one of the following avenues:
an Initial Public Offering (IPO) shares of the company are offered to the public, typically
providing a partial immediate realization to the financial sponsor as well as a public market into
which it can later sell additional shares;

a merger or acquisition the company is sold for either cash or shares in another company;
a Recapitalization cash is distributed to the shareholders (in this case the financial sponsor) and
its private equity funds either from cash flow generated by the company or through raising debt
or other securities to fund the distribution.

Liquidity in the private equity market

Diagram of a simple secondary market transfer of a limited partnership fund interest. The buyer
exchanges a single cash payment to the seller for both the investments in the fund plus any
unfunded commitments to the fund.

The private equity secondary market (also often called private equity secondaries) refers to the
buying and selling of pre-existing investor commitments to private equity and other alternative
investment funds. Sellers of private equity investments sell not only the investments in the fund
but also their remaining unfunded commitments to the funds. By its nature, the private equity
asset class is illiquid, intended to be a long-term investment for buy-and-hold investors. For the
vast majority of private equity investments, there is no listed public market; however, there is a
robust and maturing secondary market available for sellers of private equity assets.

Increasingly, secondaries are considered a distinct asset class with a cash flow profile that is not
correlated with other private equity investments. As a result, investors are allocating capital to
secondary investments to diversify their private equity programs. Driven by strong demand for
private equity exposure, a significant amount of capital has been committed to secondary
investments from investors looking to increase and diversify their private equity exposure.

Investors seeking access to private equity have been restricted to investments with structural
impediments such as long lock-up periods, lack of transparency, unlimited leverage, concentrated
holdings of illiquid securities and high investment minimums.
Secondary transactions can be generally split into two basic categories:

Sale of Limited Partnership Interests The most common secondary transaction, this
category includes the sale of an investor's interest in a private equity fund or portfolio of
interests in various funds through the transfer of the investor's limited partnership interest in
the fund(s). Nearly all types of private equity funds (e.g., including buyout, growth equity,
venture capital, mezzanine, distressed and real estate) can be sold in the secondary market.
The transfer of the limited partnership interest typically will allow the investor to receive
some liquidity for the funded investments as well as a release from any remaining unfunded
obligations to the fund.

Sale of Direct Interests Secondary Directs or Synthetic secondaries, this category refers to
the sale of portfolios of direct investments in operating companies, rather than limited
partnership interests in investment funds. These portfolios historically have originated from
either corporate development programs or large financial institutions.

Private equity firms

According to an updated 2011 ranking created by industry magazine Private Equity International,
the largest private equity firm in the world today is TPG, based on the amount of private equity
direct-investment capital raised over a five-year window. As ranked by the PEI 300, the 10
largest private equity firms in the world are:
1. TPG Capital
2. Goldman Sachs Principal Investment Area
3. The Carlyle Group
4. Kohlberg Kravis Roberts
5. The Blackstone Group
6. Apollo Global Management
7. Bain Capital
8. CVC Capital Partners
9. First Reserve Corporation
10. Hellman & Friedman

Because private equity firms are continuously in the process of raising, investing and distributing
their private equity funds, capital raised can often be the easiest to measure. Other metrics can
include the total value of companies purchased by a firm or an estimate of the size of a firm's
active portfolio plus capital available for new investments. As with any list that focuses on size,
the list does not provide any indication as to relative investment performance of these funds or
Additionally, Preqin (formerly known as Private Equity Intelligence), an independent data
provider, ranks the 25 largest private equity investment managers. Among the larger firms in that
ranking were AlpInvest Partners, AXA Private Equity, AIG Investments, Goldman Sachs Private
Equity Group and Pantheon Ventures. The European Private Equity and Venture Capital
Association ("EVCA") publishes a yearbook which analyses industry trends derived from data
disclosed by over 1, 300 European private equity funds. Finally, websites such as
provide lists of London-based private equity firms.
Versus hedge funds

The investment strategies of private equity firms differ to those of hedge funds. Typically private
equity investment groups are geared towards long-hold, multiple-year investment strategies in
illiquid assets (whole companies, large-scale real estate projects or other tangibles not easily
converted to cash) where they have more control and influence over operations or asset
management to influence their long-term returns. Hedge funds usually focus on short or medium
term liquid securities which are more quickly convertible to cash, and they do not have direct
control over the business or asset in which they are investing.[78] Both private equity firms and
hedge funds often specialize in specific types of investments and transactions. Private equity
specialization is usually in specific industry sector asset management while hedge fund
specialization is in industry sector risk capital management. Private equity strategies can include
wholesale purchase of a privately held company or set of assets, mezzanine financing for start-up
projects, growth capital investments in existing businesses or leveraged buyout of a publicly held
asset converting it to private control.

Private equity funds

Private equity fundraising refers to the action of private equity firms seeking capital from
investors for their funds. Typically an investor will invest in a specific fund managed by a firm,
becoming a limited partner in the fund, rather than an investor in the firm itself. As a result, an
investor will only benefit from investments made by a firm where the investment is made from
the specific fund in which it has invested.

Fund of funds. These are private equity funds that invest in other private equity funds in
order to provide investors with a lower risk product through exposure to a large number of
vehicles often of different type and regional focus. Fund of funds accounted for 14% of
global commitments made to private equity funds in 2006.

Individuals with substantial net worth. Substantial net worth is often required of investors by
the law, since private equity funds are generally less regulated than ordinary mutual funds.
For example in the US, most funds require potential investors to qualify as accredited
investors, which requires $1 million of net worth, $200,000 of individual income, or
$300,000 of joint income (with spouse) for two documented years and an expectation that
such income level will continue.

As fundraising has grown over the past few years, so too has the number of investors in the
average fund. In 2004 there were 26 investors in the average private equity fund, this figure has
now grown to 42 according to Preqin ltd. (formerly known as Private Equity Intelligence).

The managers of private equity funds will also invest in their own vehicles, typically providing
between 15% of the overall capital.
Often private equity fund managers will employ the services of external fundraising teams
known as placement agents in order to raise capital for their vehicles. The use of placement
agents has grown over the past few years, with 40% of funds closed in 2006 employing their
services, according to Preqin ltd (formerly known as Private Equity Intelligence). Placement
agents will approach potential investors on behalf of the fund manager, and will typically take a
fee of around 1% of the commitments that they are able to garner.

The amount of time that a private equity firm spends raising capital varies depending on the level
of interest among investors, which is defined by current market conditions and also the track
record of previous funds raised by the firm in question. Firms can spend as little as one or two
months raising capital when they are able to reach the target that they set for their funds
relatively easily, often through gaining commitments from existing investors in their previous
funds, or where strong past performance leads to strong levels of investor interest. Other
managers may find fundraising taking considerably longer, with managers of less popular fund
types (such as US and European venture fund managers in the current climate) finding the
fundraising process more tough. It is not unheard of for funds to spend as long as two years on
the road seeking capital, although the majority of fund managers will complete fundraising
within nine months to fifteen months.

Once a fund has reached its fundraising target, it will have a final close. After this point it is not
normally possible for new investors to invest in the fund, unless they were to purchase an interest
in the fund on the secondary market.

Size of the industry

Private equity assets under management probably exceeded $2.0 trillion at the end of March
2012, and funds available for investment totalled $949bn (about 47% of overall assets under

Some $246bn of private equity was invested globally in 2011, down 6% on the previous year and
around two-thirds below the peak activity in 2006 and 2007. Following on from a strong start,
deal activity slowed in the second half of 2011 due to concerns over the global economy and
sovereign debt crisis in Europe. There was $93bn in investments during the first half of this year
as the slowdown persisted into 2012. This was down a quarter on the same period in the previous
year. Private-equity backed buyouts generated some 6.9% of global M&Avolume in 2011 and
5.9% in the first half of 2012. This was down on 7.4% in 2010 and well below the all-time high
of 21% in 2006.

Global exit activity totalled $252bn in 2011, practically unchanged from the previous year, but
well up on 2008 and 2009 as private equity firms sought to take advantage of improved market
conditions at the start of the year to realise investments. Exit activity however, has lost
momentum following a peak of $113bn in the second quarter of 2011. TheCityUK estimates total
exit activity of some $100bn in the first half of 2012, well down on the same period in the
previous year.
The fund raising environment remained stable for the third year running in 2011 with $270bn in
new funds raised, slightly down on the previous years total. Around $130bn in funds was raised
in the first half of 2012, down around a fifth on the first half of 2011. The average time for funds
to achieve a final close fell to 16.7 months in the first half of 2012, from 18.5 months in 2011.
Private equity funds available for investment (dry powder)totalled $949bn at the end of q1-
2012, down around 6% on the previous year. Including unrealised funds in existing investments,
private equity funds under management probably totalled over $2.0 trillion.

Private equity fund performance

Due to limited disclosure, studying the returns to private equity is relatively difficult. Unlike
mutual funds, private equity funds need not disclose performance data. And, as they invest in
private companies, it is difficult to examine the underlying investments. It is challenging to
compare private equity performance to public equity performance, in particular because private
equity fund investments are drawn and returned over time as investments are made and
subsequently realized.

An oft-cited academic paper (Kaplan and Shoar, 2005) suggests that the net-of-fees returns to
PE funds are roughly comparable to the S&P 500 (or even slightly under). This analysis may
actually overstate the returns because it relies on voluntarily reported data and hence suffers from
survivorship bias (i.e. funds that fail won't report data). One should also note that these returns
are not risk-adjusted. A more recent paper (Harris, Jenkinson and Kaplan, 2012) found that
average buyout fund returns in the U.S. have actually exceeded that of public markets. These
findings were supported by earlier work, using a different data set (Robinson and Sensoy, 2011).

Commentators have argued that a standard methodology is needed to present an accurate picture
of performance, to make individual private equity funds comparable and so the asset class as a
whole can be matched against public markets and other types of investment. It is also claimed
that PE fund managers manipulate data to present themselves as strong performers, which makes
it even more essential to standardize the industry.

Two other findings in Kaplan and Schoar (2005): First, there is considerable variation in
performance across PE funds. Second, unlike the mutual fund industry, there appears to be
performance persistence in PE funds. That is, PE funds that perform well over one period, tend to
also perform well the next period. Persistence is stronger for VC firms than for LBO firms.

Recording private equity

There is a burgeoning debate of the purpose behind private equity, a common misconception to
treat private equity separately from foreign direct investment (FDI). The difference is blurred on
account of private equity not entering the country through the stock market. Private equity
generally flows to unlisted firms and to firms where the percentage of shares is relatively smaller
than the promoter or investor held shares (also known as free-floating shares).
The main point of contention behind differentiating private equity from FDI is that FDI is used
solely for production whereas in the case of private equity the investor can reclaim their money
after a revaluation period and make speculative investments in other financial assets.

Presently, most countries report private equity as a part of FDI.


Venture capital
Venture capital (VC) is financial capital provided to early-stage, high-potential, high risk, growth
startup companies. The venture capital fund makes money by owning equity in the companies it
invests in, which usually have a novel technology or business model in high technology
industries, such as biotechnology, IT, software, etc. The typical venture capital investment occurs
after the seed funding round as growth funding round (also referred to as Series A round) in the
interest of generating a return through an eventual realization event, such as an IPO or trade sale
of the company. Venture capital is a subset of private equity. Therefore, all venture capital is
private equity, but not all private equity is venture capital.
In addition to angel investing and other seed funding options, venture capital is attractive for new
companies with limited operating history that are too small to raise capital in the public markets
and have not reached the point where they are able to secure a bank loan or complete a debt
offering. In exchange for the high risk that venture capitalists assume by investing in smaller and
less mature companies, venture capitalists usually get significant control over company
decisions, in addition to a significant portion of the company's ownership (and consequently
Venture capital is also associated with job creation (accounting for 2% of US GDP), the
knowledge economy, and used as a proxy measure of innovation within an economic sector or
geography. Every year, there are nearly 2 million businesses created in the USA, and 600800
get venture capital funding. According to the National Venture Capital Association, 11% of
private sector jobs come from venture backed companies and venture backed revenue accounts
for 21% of US GDP.
It is also a way in which public and private actors can construct an institution that systematically
creates networks for the new firms and industries, so that they can progress. This institution helps
in identifying and combining pieces of companies, like finance, technical expertise, know-hows
of marketing and business models. Once integrated, these enterprises succeed by becoming
nodes in the search networks for designing and building products in their domain.[4]Contents
A venture may be defined as a project prospective of converted into a process with an adequate
assumed risk and investment. With few exceptions, private equity in the first half of the 20th
century was the domain of wealthy individuals and families. The Vanderbilts, Whitneys,
Rockefellers, and Warburgs were notable investors in private companies in the first half of the
century. In 1938, Laurance S. Rockefeller helped finance the creation of both Eastern Air Lines
and Douglas Aircraft, and the Rockefeller family had vast holdings in a variety of companies.
Eric M. Warburg founded E.M. Warburg & Co. in 1938, which would ultimately become
Warburg Pincus, with investments in both leveraged buyouts and venture capital.

Origins of modern private equity

Before World War II, money orders (originally known as "development capital") were primarily
the domain of wealthy individuals and families. It was not until after World War II that what is
considered today to be true private equity investments began to emerge marked by the founding
of the first two venture capital firms in 1946: American Research and Development Corporation
(ARDC) and J.H. Whitney & Company.
ARDC was founded by Georges Doriot, the "father of venture capitalism" (former dean of
Harvard Business School and founder of INSEAD), with Ralph Flanders and Karl Compton
(former president of MIT), to encourage private sector investments in businesses run by soldiers
who were returning from World War II. ARDC's significance was primarily that it was the first
institutional private equity investment firm that raised capital from sources other than wealthy
families although it had several notable investment successes as well. ARDC is credited with the
first trick when its 1957 investment of $70,000 in Digital Equipment Corporation (DEC) would
be valued at over $355 million after the company's initial public offering in 1968 (representing a
return of over 1200 times on its investment and an annualized rate of return of 101%).
Former employees of ARDC went on and established several prominent venture capital firms
including Greylock Partners (founded in 1965 by Charlie Waite and Bill Elfers) and Morgan,
Holland Ventures, the predecessor of Flagship Ventures (founded in 1982 by James Morgan).[10]
ARDC continued investing until 1971 with the retirement of Doriot. In 1972, Doriot merged
ARDC with Textron after having invested in over 150 companies.
J.H. Whitney & Company was founded by John Hay Whitney and his partner Benno Schmidt.
Whitney had been investing since the 1930s, founding Pioneer Pictures in 1933 and acquiring a
15% interest in Technicolor Corporation with his cousin Cornelius Vanderbilt Whitney. By far
Whitney's most famous investment was in Florida Foods Corporation. The company developed
an innovative method for delivering nutrition to American soldiers, which later came to be
known as Minute Maid orange juice and was sold to The Coca-Cola Company in 1960. J.H.
Whitney & Company continues to make investments in leveraged buyout transactions and raised
$750 million for its sixth institutional private equity fund in 2005.
Early venture capital and the growth of Silicon Valley
A highway exit for Sand Hill Road in Menlo Park, California, where many Bay Area venture
capital firms are based
One of the first steps toward a professionally-managed venture capital industry was the passage
of the Small Business Investment Act of 1958. The 1958 Act officially allowed the U.S. Small
Business Administration (SBA) to license private "Small Business Investment Companies"
(SBICs) to help the financing and management of the small entrepreneurial businesses in the
United States.
During the 1960s and 1970s, venture capital firms focused their investment activity primarily on
starting and expanding companies. More often than not, these companies were exploiting
breakthroughs in electronic, medical, or data-processing technology. As a result, venture capital
came to be almost synonymous with technology finance. An early West Coast venture capital
company was Draper and Johnson Investment Company, formed in 1962 by William Henry
Draper III and Franklin P. Johnson, Jr. In 1965, Sutter Hill Ventures acquired the portfolio of
Draper and Johnson as a founding action. Bill Draper and Paul Wythes were the founders, and
Pitch Johnson formed Asset Management Company at that time.
It is commonly noted that the first venture-backed startup is Fairchild Semiconductor (which
produced the first commercially practical integrated circuit), funded in 1959 by what would later
become Venrock Associates. Venrock was founded in 1969 by Laurance S. Rockefeller, the
fourth of John D. Rockefeller's six children as a way to allow other Rockefeller children to
develop exposure to venture capital investments.
It was also in the 1960s that the common form of private equity fund, still in use today, emerged.
Private equity firms organized limited partnerships to hold investments in which the investment
professionals served as general partner and the investors, who were passive limited partners, put
up the capital. The compensation structure, still in use today, also emerged with limited partners
paying an annual management fee of 1.02.5% and a carried interest typically representing up to
20% of the profits of the partnership.
The growth of the venture capital industry was fueled by the emergence of the independent
investment firms on Sand Hill Road, beginning with Kleiner, Perkins, Caufield & Byers and
Sequoia Capital in 1972. Located in Menlo Park, CA, Kleiner Perkins, Sequoia and later venture
capital firms would have access to the many semiconductor companies based in the Santa Clara
Valley as well as early computer firms using their devices and programming and service
Throughout the 1970s, a group of private equity firms, focused primarily on venture capital
investments, would be founded that would become the model for later leveraged buyout and
venture capital investment firms. In 1973, with the number of new venture capital firms
increasing, leading venture capitalists formed the National Venture Capital Association (NVCA).
The NVCA was to serve as the industry trade group for the venture capital industry.[15] Venture
capital firms suffered a temporary downturn in 1974, when the stock market crashed and
investors were naturally wary of this new kind of investment fund.
It was not until 1978 that venture capital experienced its first major fundraising year, as the
industry raised approximately $750 million. With the passage of the Employee Retirement
Income Security Act (ERISA) in 1974, corporate pension funds were prohibited from holding
certain risky investments including many investments in privately held companies. In 1978, the
US Labor Department relaxed certain of the ERISA restrictions, under the "prudent man
rule,"[16] thus allowing corporate pension funds to invest in the asset class and providing a
major source of capital available to venture capitalists.
The public successes of the venture capital industry in the 1970s and early 1980s (e.g., Digital
Equipment Corporation, Apple Inc., Genentech) gave rise to a major proliferation of venture
capital investment firms. From just a few dozen firms at the start of the decade, there were over
650 firms by the end of the 1980s, each searching for the next major "home run". The number of
firms multiplied, and the capital managed by these firms increased from $3 billion to $31 billion
over the course of the decade.
The growth of the industry was hampered by sharply declining returns, and certain venture firms
began posting losses for the first time. In addition to the increased competition among firms,
several other factors impacted returns. The market for initial public offerings cooled in the mid-
1980s before collapsing after the stock market crash in 1987 and foreign corporations,
particularly from Japan and Korea, flooded early stage companies with capital.
In response to the changing conditions, corporations that had sponsored in-house venture
investment arms, including General Electric and Paine Webber either sold off or closed these
venture capital units. Additionally, venture capital units within Chemical Bank and Continental
Illinois National Bank, among others, began shifting their focus from funding early stage
companies toward investments in more mature companies. Even industry founders J.H. Whitney
& Company and Warburg Pincus began to transition toward leveraged buyouts and growth
capital investments.
The venture capital boom and the Internet Bubble (1995 to 2000)
By the end of the 1980s, venture capital returns were relatively low, particularly in comparison
with their emerging leveraged buyout cousins, due in part to the competition for hot startups,
excess supply of IPOs and the inexperience of many venture capital fund managers. Growth in
the venture capital industry remained limited throughout the 1980s and the first half of the 1990s,
increasing from $3 billion in 1983 to just over $4 billion more than a decade later in 1994.
After a shakeout of venture capital managers, the more successful firms retrenched, focusing
increasingly on improving operations at their portfolio companies rather than continuously
making new investments. Results would begin to turn very attractive, successful and would
ultimately generate the venture capital boom of the 1990s. Yale School of Management Professor
Andrew Metrick refers to these first 15 years of the modern venture capital industry beginning in
1980 as the "pre-boom period" in anticipation of the boom that would begin in 1995 and last
through the bursting of the Internet bubble in 2000.[20]
The late 1990s were a boom time for venture capital, as firms on Sand Hill Road in Menlo Park
and Silicon Valley benefited from a huge surge of interest in the nascent Internet and other
computer technologies. Initial public offerings of stock for technology and other growth
companies were in abundance, and venture firms were reaping large returns.
The private equity crash (2000 to 2003)
The technology-heavy NASDAQ Composite index peaked at 5,048 in March 2000, reflecting the
high point of the dot-com bubble. The Nasdaq crash and technology slump that started in March
2000 shook virtually the entire venture capital industry as valuations for startup technology
companies collapsed. Over the next two years, many venture firms had been forced to write-off
large proportions of their investments, and many funds were significantly "under water" (the
values of the fund's investments were below the amount of capital invested). Venture capital
investors sought to reduce size of commitments they had made to venture capital funds, and, in
numerous instances, investors sought to unload existing commitments for cents on the dollar in
the secondary market. By mid-2003, the venture capital industry had shriveled to about half its
2001 capacity. Nevertheless, PricewaterhouseCoopers's MoneyTree Survey[21] shows that total
venture capital investments held steady at 2003 levels through the second quarter of 2005.
Although the post-boom years represent just a small fraction of the peak levels of venture
investment reached in 2000, they still represent an increase over the levels of investment from
1980 through 1995. As a percentage of GDP, venture investment was 0.058% in 1994, peaked at
1.087% (nearly 19 times the 1994 level) in 2000 and ranged from 0.164% to 0.182% in 2003 and
2004. The revival of an Internet-driven environment in 2004 through 2007 helped to revive the
venture capital environment. However, as a percentage of the overall private equity market,
venture capital has still not reached its mid-1990s level, let alone its peak in 2000.
Venture capital funds, which were responsible for much of the fundraising volume in 2000 (the
height of the dot-com bubble), raised only $25.1 billion in 2006, a 2%-decline from 2005 and a
significant decline from its peak.
Obtaining venture capital is substantially different from raising debt or a loan from a lender.
Lenders have a legal right to interest on a loan and repayment of the capital, irrespective of the
success or failure of a business. Venture capital is invested in exchange for an equity stake in the
business. As a shareholder, the venture capitalist's return is dependent on the growth and
profitability of the business. This return is generally earned when the venture capitalist "exits" by
selling its shareholdings when the business is sold to another owner.
Venture capitalists are typically very selective in deciding what to invest in; as a rule of thumb, a
fund may invest in one in four hundred opportunities presented to it,[citation needed] looking for
the extremely rare, yet sought after, qualities, such as innovative technology, potential for rapid
growth, a well-developed business model, and an impressive management team. Of these
qualities, funds are most interested in ventures with exceptionally high growth potential, as only
such opportunities are likely capable of providing the financial returns and successful exit event
within the required timeframe (typically 37 years) that venture capitalists expect.
Because investments are illiquid and require the extended timeframe to harvest, venture
capitalists are expected to carry out detailed due diligence prior to investment. Venture capitalists
also are expected to nurture the companies in which they invest, in order to increase the
likelihood of reaching an IPO stage when valuations are favourable. Venture capitalists typically
assist at four stages in the company's development:
1. Idea generation;
2. Start-up;
3. Ramp up; and
4. Exit
Because there are no public exchanges listing their securities, private companies meet venture
capital firms and other private equity investors in several ways, including warm referrals from
the investors' trusted sources and other business contacts; investor conferences and symposia;
and summits where companies pitch directly to investor groups in face-to-face meetings,
including a variant known as "Speed Venturing", which is akin to speed-dating for capital, where
the investor decides within 10 minutes whether he wants a follow-up meeting. In addition, there
are some new private online networks that are emerging to provide additional opportunities to
meet investors.
This need for high returns makes venture funding an expensive capital source for companies, and
most suitable for businesses having large up-front capital requirements, which cannot be
financed by cheaper alternatives such as debt. That is most commonly the case for intangible
assets such as software, and other intellectual property, whose value is unproven. In turn, this
explains why venture capital is most prevalent in the fast-growing technology and life sciences
or biotechnology fields.
If a company does have the qualities venture capitalists seek including a solid business plan, a
good management team, investment and passion from the founders, a good potential to exit the
investment before the end of their funding cycle, and target minimum returns in excess of 40%
per year, it will find it easier to raise venture capital.
Financing stages
1. There are typically six stages of venture round financing offered in Venture Capital, that
roughly correspond to these stages of a company's development.
2. Seed Money: Low level financing needed to prove a new idea, often provided by angel
3. Crowd funding is also emerging as an option for seed funding.
4. Start-up: Early stage firms that need funding for expenses associated with marketing and
product development
5. growth (Series A round): Early sales and manufacturing funds
6. Second-Round: Working capital for early stage companies that are selling product, but
not yet turning a profit
7. Expansion : Also called Mezzanine financing, this is expansion money for a newly
profitable company
8. exit of venture capitalist : Also called bridge financing, 4th round is intended to finance
the "going public" process
Between the first round and the fourth round, venture-backed companies may also seek to take
venture debt.
Venture capital firms and funds
Venture capitalists
A venture capitalist is a person that makes venture investments, and these venture capitalists are
expected to bring managerial and technical expertise as well as capital to their investments. A
venture capital fund refers to a pooled investment vehicle (in the United States, often an LP or
LLC) that primarily invests the financial capital of third-party investors in enterprises that are too
risky for the standard capital markets or bank loans. These funds are typically managed by a
venture capital firm, which often employs individuals with technology backgrounds (scientists,
researchers), business training and/or deep industry experience.
A core skill within VC is the ability to identify novel technologies that have the potential to
generate high commercial returns at an early stage. By definition, VCs also take a role in
managing entrepreneurial companies at an early stage, thus adding skills as well as capital,
thereby differentiating VC from buy-out private equity, which typically invest in companies with
proven revenue, and thereby potentially realizing much higher rates of returns. Inherent in
realizing abnormally high rates of returns is the risk of losing all of one's investment in a given
startup company. As a consequence, most venture capital investments are done in a pool format,
where several investors combine their investments into one large fund that invests in many
different startup companies. By investing in the pool format, the investors are spreading out their
risk to many different investments versus taking the chance of putting all of their money in one
start up firm.
Venture capital firms are typically structured as partnerships, the general partners of which serve
as the managers of the firm and will serve as investment advisors to the venture capital funds
raised. Venture capital firms in the United States may also be structured as limited liability
companies, in which case the firm's managers are known as managing members. Investors in
venture capital funds are known as limited partners. This constituency comprises both high net
worth individuals and institutions with large amounts of available capital, such as state and
private pension funds, university financial endowments, foundations, insurance companies, and
pooled investment vehicles, called funds of funds
Venture Capitalist firms differ in their approaches. There are multiple factors, and each firm is
Some of the factors that influence VC decisions include:
1. Business situation: Some VCs tend to invest in new ideas, or fledgling companies. Others
prefer investing in established companies that need support to go public or grow.
2. Some invest solely in certain industries.
3. Some prefer operating locally while others will operate nationwide or even globally.
4. VC expectations often vary. Some may want a quicker public sale of the company or
expect fast growth. The amount of help a VC provides can vary from one firm to the next.
Within the venture capital industry, the general partners and other investment professionals of the
venture capital firm are often referred to as "venture capitalists" or "VCs". Typical career
backgrounds vary, but, broadly speaking, venture capitalists come from either an operational or a
finance background. Venture capitalists with an operational background tend to be former
founders or executives of companies similar to those which the partnership finances or will have
served as management consultants. Venture capitalists with finance backgrounds tend to have
investment banking or other corporate finance experience.

Although the titles are not entirely uniform from firm to firm, other positions at venture capital
firms include:
1. Venture partners Venture partners are expected to source potential investment
opportunities ("bring in deals") and typically are compensated only for those deals with
which they are involved.
2. Principal This is a mid-level investment professional position, and often considered a
"partner-track" position. Principals will have been promoted from a senior associate
position or who have commensurate experience in another field, such as investment
banking, management consulting, or a market of particular interest to the strategy of the
venture capital firm.
3. Associate This is typically the most junior apprentice position within a venture capital
firm. After a few successful years, an associate may move up to the "senior associate"
position and potentially principal and beyond. Associates will often have worked for 12
years in another field, such as investment banking or management consulting.
4. Entrepreneur-in-residence (EIR) EIRs are experts in a particular domain and perform
due diligence on potential deals. EIRs are engaged by venture capital firms temporarily
(six to 18 months) and are expected to develop and pitch startup ideas to their host firm
although neither party is bound to work with each other. Some EIRs move on to
executive positions within a portfolio company.
Need of venture capital
There are entrepreneurs and many other people who come up with bright ideas but lack the
capital for the investment. What these venture capitals do are to facilitate and enable the start up
When there is an owner relation between the venture capital providers and receivers, their mutual
interest for returns will increase the firms motivation to increase profits.
Venture capitalists have invested in similar firms and projects before and, therefore, have more
knowledge and experience. This knowledge and experience are the outcomes of the experiments
through the successes and failures from previous ventures, so they know what works and what
does not, and how it works. Therefore, through venture capital involvement, a portfolio firm can
initiate growth, identify problems, and find recipes to overcome them.
Structure of the funds
Most venture capital funds have a fixed life of 10 years, with the possibility of a few years of
extensions to allow for private companies still seeking liquidity. The investing cycle for most
funds is generally three to five years, after which the focus is managing and making follow-on
investments in an existing portfolio. This model was pioneered by successful funds in Silicon
Valley through the 1980s to invest in technological trends broadly but only during their period of
ascendance, and to cut exposure to management and marketing risks of any individual firm or its

In such a fund, the investors have a fixed commitment to the fund that is initially unfunded and
subsequently "called down" by the venture capital fund over time as the fund makes its
investments. There are substantial penalties for a limited partner (or investor) that fails to
participate in a capital call.
It can take anywhere from a month or so to several years for venture capitalists to raise money
from limited partners for their fund. At the time when all of the money has been raised, the fund
is said to be closed, and the 10-year lifetime begins. Some funds have partial closes when one
half (or some other amount) of the fund has been raised. "Vintage year" generally refers to the
year in which the fund was closed and may serve as a means to stratify VC funds for comparison.
This[28] shows the difference between a venture capital fund management company and the
venture capital funds managed by them.
From investors' point of view, funds can be: (1) traditional--where all the investors invest with
equal terms; or (2) asymmetric--where different investors have different terms. Typically the
asymmetry is seen in cases where there's a investor that has other interests such as tax income in
case of public investors.
Venture capitalists are compensated through a combination of management fees and carried
interest (often referred to as a "two and 20" arrangement):

Management fees an annual payment made by the investors in the fund to the fund's
manager to pay for the private equity firm's investment operations.[30] In a typical
venture capital fund, the general partners receive an annual management fee equal to up
to 2% of the committed capital.
Carried interest a share of the profits of the fund (typically 20%), paid to the private
equity funds management company as a performance incentive. The remaining 80% of
the profits are paid to the fund's investors[30] Strong limited partner interest in top-tier
venture firms has led to a general trend toward terms more favorable to the venture
partnership, and certain groups are able to command carried interest of 2530% on their

Because a fund may run out of capital prior to the end of its life, larger venture capital firms
usually have several overlapping funds at the same time; doing so lets the larger firm keep
specialists in all stages of the development of firms almost constantly engaged. Smaller firms
tend to thrive or fail with their initial industry contacts; by the time the fund cashes out, an
entirely-new generation of technologies and people is ascending, whom the general partners may
not know well, and so it is prudent to reassess and shift industries or personnel rather than
attempt to simply invest more in the industry or people the partners already know.

Main alternatives to venture capital

Because of the strict requirements venture capitalists have for potential investments, many
entrepreneurs seek seed funding from angel investors, who may be more willing to invest in
highly speculative opportunities, or may have a prior relationship with the entrepreneur.
Furthermore, many venture capital firms will only seriously evaluate an investment in a start-up
company otherwise unknown to them if the company can prove at least some of its claims about
the technology and/or market potential for its product or services. To achieve this, or even just to
avoid the dilutive effects of receiving funding before such claims are proven, many start-ups seek
to self-finance sweat equity until they reach a point where they can credibly approach outside
capital providers such as venture capitalists or angel investors. This practice is called
There has been some debate since the dot com boom that a "funding gap" has developed between
the friends and family investments typically in the $0 to $250,000 range and the amounts that
most VC funds prefer to invest between $1 million to $2 million. This funding gap may be
accentuated by the fact that some successful VC funds have been drawn to raise ever-larger
funds, requiring them to search for correspondingly larger investment opportunities. This gap is
often filled by sweat equity and seed funding via angel investors as well as equity investment
companies who specialize in investments in startup companies from the range of $250,000 to $1
million. The National Venture Capital Association estimates that the latter now invest more than
$30 billion a year in the USA in contrast to the $20 billion a year invested by organized venture
capital funds.
Crowd funding is emerging as an alternative to traditional venture capital. Crowd funding is an
approach to raising the capital required for a new project or enterprise by appealing to large
numbers of ordinary people for small donations. While such an approach has long precedents in
the sphere of charity, it is receiving renewed attention from entrepreneurs such as independent
film makers, now that social media and online communities make it possible to reach out to a
group of potentially interested supporters at very low cost. Some crowd funding models are also
being applied for startup funding such as those listed at Comparison of crowd funding services.
One of the reasons to look for alternatives to venture capital is the problem of the traditional VC
model. The traditional VCs are shifting their focus to later-stage investments, and return on
investment of many VC funds have been low or negative.
In industries where assets can be securitized effectively because they reliably generate future
revenue streams or have a good potential for resale in case of foreclosure, businesses may more
cheaply be able to raise debt to finance their growth. Good examples would include asset-
intensive extractive industries such as mining, or manufacturing industries. Offshore funding is
provided via specialist venture capital trusts, which seek to utilise securitization in structuring
hybrid multi-market transactions via an SPV (special purpose vehicle): a corporate entity that is
designed solely for the purpose of the financing.

In addition to traditional venture capital and angel networks, groups have emerged, which allow
groups of small investors or entrepreneurs themselves to compete in a privatized business plan
competition where the group itself serves as the investor through a democratic process.[32]
Law firms are also increasingly acting as an intermediary between clients seeking venture capital
and the firms providing it.
Geographical differences
Venture capital, as an industry, has originated in the United States, and American firms have
traditionally been the largest participants in venture deals, and the bulk of venture capital has
been deployed in American companies. However, increasingly, non-US venture investment is
growing, and the number and size of non-US venture capitalists have been expanding.
Venture capital has been used as a tool for economic development in a variety of developing
regions. In many of these regions, with less developed financial sectors, venture capital plays a
role in facilitating access to finance for small and medium enterprises (SMEs), which in most
cases would not qualify for receiving bank loans.
In the year of 2008, while VC fundings were still majorly dominated by U.S. money ($28.8
billion invested in over 2550 deals in 2008), compared to international fund investments ($13.4
billion invested elsewhere), there has been an average 5% growth in the venture capital deals
outside the USA, mainly in China and Europe.[34] Geographical differences can be significant.
For instance, in the U.K., 4% of British investment goes to venture capital, compared to about
33% in the U.S.[35]
United States
Venture capitalists invested some $29.1 billion in 3,752 deals in the U.S. through the fourth
quarter of 2011, according to a report by the National Venture Capital Association. The same
numbers for all of 2010 were $23.4 billion in 3,496 deals.[36] A National Venture Capital
Association survey found that a majority (69%) of venture capitalists predicted that venture
investments in the U.S. would have leveled between $2029 billion in 2007.[citation needed]
As of 2010, Israel led the world in venture capital invested per capita. Israel attracted $170 per
person compared to $75 in the USA.[37] About two thirds of the funds invested were from
foreign sources, and the rest domestic.
Canadian technology companies have attracted interest from the global venture capital
community as a result, in part, of generous tax incentive through the Scientific Research and
Experimental Development (SR&ED) investment tax credit program.[citation needed] The basic
incentive available to any Canadian corporation performing R&D is a refundable tax credit that
is equal to 20% of "qualifying" R&D expenditures (labour, material, R&D contracts, and R&D
equipment). An enhanced 35% refundable tax credit of available to certain (i.e. small) Canadian-
controlled private corporations (CCPCs). Because the CCPC rules require a minimum of 50%
Canadian ownership in the company performing R&D, foreign investors who would like to
benefit from the larger 35% tax credit must accept minority position in the company, which
might not be desirable. The SR&ED program does not restrict the export of any technology or
intellectual property that may have been developed with the benefit of SR&ED tax incentives.
Canada also has a fairly unique form of venture capital generation in its Labour Sponsored
Venture Capital Corporations (LSVCC). These funds, also known as Retail Venture Capital or
Labour Sponsored Investment Funds (LSIF), are generally sponsored by labor unions and offer
tax breaks from government to encourage retail investors to purchase the funds. Generally, these
Retail Venture Capital funds only invest in companies where the majority of employees are in
Canada. However, innovative structures have been developed to permit LSVCCs to direct in
Canadian subsidiaries of corporations incorporated in jurisdictions outside of Canada.
Europe has a large and growing number of active venture firms. Capital raised in the region in
2005, including buy-out funds, exceeded 60 billion, of which 12.6 billion was specifically
allocated to venture investment. The European Venture Capital Association[38] includes a list of
active firms and other statistics. In 2006, the top three countries receiving the most venture
capital investments were the United Kingdom (515 minority stakes sold for 1.78 billion),
France (195 deals worth 875 million), and Germany (207 deals worth 428 million) according
to data gathered by Library House.
European venture capital investment in the second quarter of 2007 rose 5% to 1.14 billion from
the first quarter. However, due to bigger sized deals in early stage investments, the number of
deals was down 20% to 213. The second quarter venture capital investment results were
significant in terms of early-round investment, where as much as 600 million (about 42.8% of
the total capital) were invested in 126 early round deals (which comprised more than half of the
total number of deals).[40] Private equity in Italy was 4.2 billion Euros in 2007.
Further information: Indian Venture Capital Association and China Venture Capital Association
India is fast catching up with the West in the field of venture capital and a number of venture
capital funds have a presence in the country (IVCA). In 2006, the total amount of private equity
and venture capital in India reached $7.5 billion across 299 deals.[41] In the Indian context,
venture capital consists of investing in equity, quasi-equity, or conditional loans in order to
promote unlisted, high-risk, or high-tech firms driven by technically or professionally qualified
entrepreneurs. It is also defined as "providing seed", "start-up and first-stage financing".[42] It is
also seen as financing companies that have demonstrated extraordinary business potential.
Venture capital refers to capital investment; equity and debt ;both of which carry indubitable risk.
The risk anticipated is very high. The venture capital industry follows the concept of high risk,
high return, innovative entrepreneurship, knowledge-based ideas and human capital intensive
enterprises have taken the front seat as venture capitalists invest in risky finance to encourage

China is also starting to develop a venture capital industry (CVCA).

Vietnam is experiencing its first foreign venture capitals, including IDG Venture Vietnam ($100
million) and DFJ Vinacapital ($35 million)
Middle East and North Africa
The Middle East and North Africa (MENA) venture capital industry is an early stage of
development but growing. The MENA Private Equity Association Guide to Venture Capital for
entrepreneurs lists VC firms in the region, and other resources available in the MENA VC
Southern Africa
The Southern African venture capital industry is an early stage of development, mostly centered
in South Africa. Funds are difficult to come by and very few firms have managed to get fundings
despite demonstrating tremendous growth potential. Generally the climate for the venture capital
industry is poor.
Confidential information
Unlike public companies, information regarding an entrepreneur's business is typically
confidential and proprietary. As part of the due diligence process, most venture capitalists will
require significant detail with respect to a company's business plan. Entrepreneurs must remain
vigilant about sharing information with venture capitalists that are investors in their competitors.
Most venture capitalists treat information confidentially, but as a matter of business practice,
they do not typically enter into Non Disclosure Agreements because of the potential liability
issues those agreements entail. Entrepreneurs are typically well-advised to protect truly
proprietary intellectual property.
Limited partners of venture capital firms typically have access only to limited amounts of
information with respect to the individual portfolio companies in which they are invested and are
typically bound by confidentiality provisions in the fund's limited partnership agreement.
Popular culture
Robert von Goeben and Kathryn Siegler produced a comic strip called The VC between the years
1997-2000 that parodied the industry, often by showing humorous exchanges between venture
capitalists and entrepreneurs.[45] Von Goeben was a partner in Redleaf Venture Management
when he began writing the strip.[46]
Mark Coggins' 2002 novel Vulture Capital features a venture capitalist protagonist who
investigates the disappearance of the chief scientist in a biotech firm in which he has invested.
Coggins also worked in the industry and was co-founder of a dot-com startup.[47]
In the Dilbert comic strip, a character named 'Vijay, the World's Most Desperate Venture
Capitalist' frequently makes appearances, offering bags of cash to anyone with even a hint of
potential. In one strip, he offers two small children with good math grades money based on the
fact that if they marry and produce an engineer baby he can invest in the infant's first idea. The
children respond that they are already looking for mezzanine funding.
Drawing on his experience as reporter covering technology for the New York Times, Matt
Richtel produced the 2007 novel Hooked, in which the actions of the main character's deceased
girlfriend, a Silicon Valley venture capitalist, play a key role in the plot.[48]
In the TV series Dragons' Den, various startup companies pitch their business plans to a panel of
venture capitalists.
In the 2005 movie, Wedding Crashers, Jeremy Grey (Vince Vaughn) and John Beckwith (Owen
Wilson) are two bachelors who create appearances to play at different weddings of complete
strangers, and a large part of the movie follows them posing as venture capitalists from New
A documentary, Something Ventured, chronicled the recent history of American technology
venture capitalists.
In the ABC Reality Show "Shark Tank", in which Venture Capitalists ("Sharks") invest in