This project was done as a part of our course curriculum of ³Management of Financial Services´. We are highly grateful to our Department for sanctioning the grant to carry out this project. We express our sincere thanks to Mr. Prem Sibbal, Faculty- Management of Financial Services at Lal Bahadur Shastri Institute of Management, for his encouragement and support in pursuing this project.


Table of Contents
Serial Number 1 Particulars Acknowledgement Page Number


Concept of Venture Capital


The Venture Capital Spectrum


Current Industry Trends


VC Industry in India


Factors Affecting Venture Capital


Venture Capitalists: Scenario 2010


Case Study


Concept of Venture Capital
The term venture capital comprises of two words that is, ³Venture´ and ³Capital´. Venture is a course of processing, the outcome of which is uncertain but to which is attended the risk or danger of ³loss´. ³Capital´ means recourses to start an enterprise. To connote the risk and adventure of such a fund, the generic name Venture Capital was coined. Venture capital is considered as financing of high and new technology based enterprises. It is said that Venture capital involves investment in new or relatively untried technology, initiated by relatively new and professionally or technically qualified entrepreneurs with inadequate funds. The conventional financiers, unlike Venture capitals, mainly finance proven technologies and established markets. However, high technology need not be prerequisite for venture capital. Venture capital has also been described as µunsecured risk financing¶. The relatively high risk of venture capital is compensated by the possibility of high returns usually through substantial capital gains in the medium term. Venture capital in broader sense is not solely an injection of funds into a new firm, it is also an input of skills needed to set up the firm, design its marketing strategy, organize and manage it. Thus it is a long term association with successive stages of company¶s development under highly risk investment conditions, with distinctive type of financing appropriate to each stage of development. Investors join the entrepreneurs as co-partners and support the project with finance and business skills to exploit the market opportunities. Venture capital is not a passive finance. It may be at any stage of business/production cycle, that is, start up, expansion or to improve a product or process, which are associated with both risk and reward. The Venture capital makes higher capital gains through appreciation in the value of such investments when the new technology succeeds. Thus the primary return sought by the investor is essentially capital gain rather than steady interest income or dividend yield. The most flexible definition of Venture capital is-


areas using new technologies or producing innovative goods by using new technology. Venture capital assumes four types of risks.Inability of management teams to work together.Product may not be commercially viable. A long term commitment of funds is involved in the form of equity investments. Venture capital is available 4 .  Management risk  Market risk  Product risk  Operation risk 2. . Not just high technology. these are: .1 High Risk By definition the Venture capital financing is highly risky and chances of failure are high as it provides long term start up capital to high risk-high reward ventures.2. . Features of Venture Capital 2. .Product may fail in the market. with the aim of eventual capital gains rather than income and active involvement in the management of customer¶s business.Operations may not be cost effective resulting in increased cost decreased gross margins. venture capital investments are made in high tech. any high risk ventures where the entrepreneur has conviction but little capital gets venture finance.´ business Venture capital commonly describes not only the provision of start up finance or µseed corn¶ capital but also development capital for later stages of business.2. and hi-tech projects generally offer higher returns than projects in more traditional areas.³The support by investors of entrepreneurial talent with finance and skills to exploit market opportunities and thus obtain capital gains.2 High Tech As opportunities in the low technology area tend to be few of lower order.

for expansion of existing business or diversification to a high risk area.2. convertible debentures where the debt holder has the option to convert the loan instruments into stock of the borrower or a debt with warrants to equity investment. Venture capital investor cannot interfere in day today management of the enterprise but keeps a close contact with the promoters or entrepreneurs to protect his investment. It monitors physical and financial progress as well as market development initiative. because dividends can be delayed. Thus technology financing had never been the primary objective but incidental to venture capital.4 Participation In Management Venture capital provides value addition by managerial support.5 Length of Investment Venture capitalist help companies grow. This is a unique philosophy of ³hands on management´ where Venture capitalist acts as complementary to the entrepreneurs. a venture capitalist advise the promoters on project planning. equity investment implies that investors bear the risk of venture and would earn a return commensurate with success in the form of capital gains. Based upon the experience other companies. including working capital and public issue. while most of the later stage investment takes only a few years. financial management. 2. monitoring and follow up assistance. 2. options.3 Equity Participation & Capital Gains Investments are generally in equity and quasi equity participation through direct purchase of shares. 2. The funds in the form of equity help to raise term loans that are cheaper source of funds.2.2. monitoring. An early stage investment may take seven to ten years to mature. They want one seat on the company¶s board of directors and involvement. The process of having significant 5 . but they eventually seek to exit the investment in three to seven years. It helps by identifying key resource person. for better or worse. In the early stage of business. in the major decision affecting the direction of company.

The investment is realized only on enlistment of security or it is lost if enterprise is liquidated for unsuccessful working.3. The criteria for investment are proven track record of company and its promoters. 6 . In majority of cases it is in the form of loan capital and proportion of equity is very thin. not subject to repayment on demand or following a repayment schedule.6 Illiquid Investment Venture capital investments are illiquid. It may take several years before the first investment starts to locked for seven to ten years.1 Venture Capital Vs Development Funds Venture capital differs from Development funds as latter means putting up of industries without much consideration of use of new technology or new entrepreneurial venture but having a focus on underdeveloped areas (locations).returns takes several years and calls on the capacity and talent of venture capitalist and entrepreneurs to reach fruition. Difference between Venture Capital & Other Funds 2. and sufficient cash generation to provide for returns (principal and interest). Venture capitalist understands this illiquidity and factors this in his investment decisions. They have no say in working of the enterprise except safeguarding their interest by having a nominee director. 2. entering into production and making available proper exit route for liquidation of the investment. regular board meetings.2. They do not play any active role in the enterprise except ensuring flow of information and proper management information system. Investors seek return ultimately by means of capital gains when the investment is sold at market place. The development bank safeguards its interest through collateral. adherence to statutory requirements for effective management control where as Venture capitalist remain interested if the overall management of the project o account of high risk involved I the project till its completion. Development finance is security oriented and liquidity prone. As against this fixed payments in the form of installment of principal and interest are to be made to development banks. that is.

including Public .2.3. Unlike Venture capital Seed capital provider is satisfied with low risk-normal returns and lacks any flexibility in its approach.2 Venture Capital Vs Seed Capital & Risk Capital It is difficult to make a distinction between venture capital. As a result on one hand the success rate of units assisted by Seed capital/Risk Finance has been lower than those provided with venture capital. Seed capital is normally in the form of low interest deferred loan as against equity investment by Venture capital. Unlike Venture capital. 15 Lac (Max) Normal 20 percent Nil Nil Sell back to promoters 7 Up to 40 percent of promoters¶ equity Skilled and specialized 30 percent plus Highly flexible Multiple ways Several . seed capital. The seed capital is provided to conventional projects on the consideration of low risk and security and use conventional techniques for appraisal. On the other hand the return to the seed/risk capital financier had been very low as compared to venture capitalist. Seed Capital Scheme Basis Beneficiaries Income or aid Very small entrepreneurs Venture capital Scheme Commercial viability Medium and large entrepreneurs are also covered Size of assistance Appraisal process Estimates returns Flexibility Value addition Exit option Rs. The seed capital and risk funds in India are being provided basically to arrange promoter¶s contribution to the project. Seed capital providers neither provide any value addition nor participate in the management of the project. Risk capital is also provided to established companies for adapting new technologies. The objective is to provide finance and encourage professionals to become promoters of industrial projects. and risk capital as the latter two form part of broader meaning of Venture capital. Difference between them arises on account of application of funds and terms and conditions applicable. Herein the approach is not business oriented but developmental.

Further unlike Venture capital they do not provide equity finance at different stages of the enterprise. 8 .offer Funding sources Syndication Tax concession Success rate Owner funds Not done Nil Not good Outside contribution allowed Possible Exempted Very satisfactory Table 2.1: Difference between Seed Capital Scheme and Venture capital Scheme 2.3 Venture Capital Vs Bought Out Deals The important difference between the Venture capital and bought out deals is that boughtouts are not based upon high risk.3. However both have a common expectation of capital gains yet their objectives and intents are totally different.high reward principal.

venture capitalists are called angel investors. hiring key people and building up the managerial team. At the seed stage the entrepreneur continue to fund the venture with his own or family funds. Early Stage Finance Seed Capital Start up Capital 9   . Venture capital was started as early stage financing of relatively small but rapidly growing companies. while providing on going assistance to developing business. Next the funds would be required for development of the product/process and producing prototypes. Venture capitalists cater to the needs of the entrepreneurs at different stages of their enterprises.The Venture Capital Spectrum The requirements of funds vary with the life cycle stage of the enterprise. Depending upon the stage they finance. finding and understanding the target customers and their needs. These are:- 1. With increasing demand of capital from newer business. Hence there are different stages of entry for different Venture capitalists and they can identify and differentiate between types of Venture capital investments. Finally the funds are needed to expand the business and attaint the critical mass for profit generation. meeting potential customers and technology partners. Venture capitalists began to operate across a broader spectrum of investment interest. Different venture capital firms have different attributes and aptitudes for different types of Venture capital investments. each appropriate for the given stage of the investee company. Even before a business plan is prepared the entrepreneur invests his time and resources in surveying the market. venture capitalist or private equity supplier/investor. risk acceptance and reward potential. At this stage the funds are needed to solicit the consultant¶s services in formulation of business plans. However various reasons forced venture capitalists to be more and more involved in expansion financing to support the development of existing portfolio companies. This diversity of opportunities enabled Venture capitalists to balance their activities in term of time involvement. This is followed by funds for assembling the manufacturing and marketing facilities in that order.

If the business grows successfully it is likely to develop sufficient cash to fund its own growth.  2. Similarly second round finance does not always follow early stage finance.      Early/First Stage Capital Later/Third Stage Capital Later Stage Finance Expansion/Development Stage Capital Replacement Finance Management Buy Out and Buy ins Turnarounds Mezzanine/Bridge Finance Not all business firms pass through each of these stages in a sequential manner. Financing Stage Early stage finance Seed Start up First stage Second stage Later stage finance Period (funds locked in years) 7-10 Risk perception Extreme Activity to be financed For supporting a concept or idea or R & D for product development 5-9 Very high High Sufficiently high Medium Initializing operations or developing prototypes Start commercial production and marketing Expand market & growing working capital need Market expansion. acquisition & product 3-7 3-5 1-3 10 . For instance seed capital is normally not required by service based ventures. It applies largely to manufacturing or research based activities. The table below shows risk perception and time orientation for different stages of venture capital financing. so does not require venture capital for growth.

while the earliest stage of financing is fraught with risk. The asset 11 . However. The characteristics of the seed capital may be enumerated as follows:     Absence of ready product market Absence of complete management team Product/ process still in R & D stage Initial period / licensing stage of technology transfer Broadly speaking seed capital investment may take 7 to 10 years to achieve realization.Financing Stages 2.4. European Venture capital association defines seed capital as ³The financing of the initial product development or capital provided to an entrepreneur to prove the feasibility of a project and to qualify for start up capital´. The new technology and innovations being attempted have equal chance of success and failure. commencement and eventual success. Seed capital is provided after being satisfied that the entrepreneur has used up his own resources and carried out his idea to a stage of acceptance and has initiated research.2: Venture Capital. it also provides greater potential for realizing significant gains in long term.1 Seed Capital It is an idea or concept as opposed to a business. It is the earliest and therefore riskiest stage of Venture capital investment. particularly hi-tech.development for profit making company Buy out-in Turnaround Mezzanine 1-3 3-5 Medium Medium to high Low Acquisition financing Turning around a sick company 1-3 Facilitating public issue Table 2. Typically seed enterprises lack asset base or track record to obtain finance from conventional sources and are largely dependent upon entrepreneur¶s personal resources. Such projects. projects sink a lot of cash and need a strong financial support for their adaptation.

The success or failure of an individual seed capital investment will have little impact on the performance of all but the smallest venture capitalist¶s portfolio. An entrepreneur often needs finance when the business is just starting.2 Start up Capital It is stage 2 in the venture capital cycle and is distinguishable from seed capital investments. This is because the small investments are seen to be cost inefficient in terms of time required to analyze. 2. ³ 12 . Here in the entrepreneur has moved closer towards establishment of a going concern. initial marketing and establishment of product facility. Larger venture capitalists avoid seed capital investments. structure and manage them. These types of obsolescence are particularly likely to occur with high technology investments particularly in the fields related to Information Technology. The start up stage involves starting a new business. Volume of Investment Activity It has been observed that Venture capitalist seldom make seed capital investment and these are relatively small by comparison to other forms of venture finance. Start up capital is defined as: ³Capital needed to finance the product development. Here in the business concept has been fully investigated and the business risk now becomes that of turning the concept into product.4. c) The risk of product and technology obsolescence increases as the time to realization is extended. The absence of interest in providing a significant amount of seed capital can be attributed to the following three factors: a) Seed capital projects by their very nature require a relatively small amount of capital.underlying the seed capital is often technology or an idea as opposed to human assets (a good management team) so often sought by venture capitalists. b) The time horizon to realization for most seed capital investments is typically 7-10 years which is longer than all but most long-term oriented investors will desire.

The decision on additional financing is based upon the successful performance of the company. Start up needs funds by way of both first round investment and subsequent follow-up investments. However. Development of business plan or idea. Longer time scale for using exit route demands continued watch on start up projects. Before committing any finance at this stage. Volume of Investment Activity Despite potential for specular returns most venture firms avoid investing in start-ups. besides the skills. ii. experience or a spinoff from R & D. One reason for the paucity of start up financing may be high discount rate that venture capitalist 13 . The skills and fitness to the job and situation of the entrepreneur¶s team is an important factor for start up finance. Establishment of company or business. If required they supply managerial skills and supervision for implementation. The company has not yet started trading. In the start up preposition venture capitalists¶ investment criteria shifts from idea to people involved in the venture and the market opportunity. The risk is controlled by initially investing a smaller amount of capital in start-ups. suitability and competence of the managerial team are also evaluated. Establishment of most but not all the members of the team. assesses the managerial ability and the capacity of the entrepreneur. iii. The time horizon for start up capital will be typically 6 or 8 years. The business plan should be fully developed yet the acceptability of the product by the market is uncertain.The characteristics of start-up capital are:i. the term to realization of a start up investment remains longer than the term of finance normally provided by the majority of financial institutions. The company is either being organized or is established recently. The risk tends t be lower relative to seed capital situation. New business activity could be based on experts. Venture capitalist however. Failure rate for start up is 2 out of 3.

14 . They often prefer to spread their risk by sharing the financing.    The early stage finance usually takes 4 to 6 years time horizon to realization.e.4. A small but enthusiastic management team which consists of people with technical and specialist background and with little experience in the management of growing business. British Venture Capital Association has vividly defined early stage finance as: ³Finance provided to companies that have completed the product development stage and require further funds to initiate commercial manufacturing and sales but may not be generating profits. Early stage finance is the earliest in which two of the fundamentals of business are in place i. Thus syndicates of investor¶s often participate in start up finance. Cash flow and profit still negative. to start commercial production and marketing. At this stage the company passed into early success stage of its life cycle. a product is established and an identifiable market is being targeted. not covering market expansion.  Short term prospective for dramatic growth in revenue and profits. de-risking and acquisition costs. fully assembled management team and a marketable product. A proven management team is put into this stage.3 Early Stage Finance It is also called first stage capital is provided to entrepreneur who has a proven product. 2. A company needs this round of finance because of any of the following reasons:  Project overruns on product development.´ The characteristics of early stage finance may be: Little or no sales revenue.applies to venture proposals at this level of risk and maturity.

have financed the start up stage to provide further financing. in sufficient will of financial institutions to provide adequate capital. 15 . The following risks are normally associated to firms at this stage: a) The early stage firms may have drawn the attention of and incurred the challenge of a larger competition. This may be second or even third injection of capital. risk of product obsolescence etc.) to factors external to the firm (competitive pressures. which are not available from other sources thus prompting venture capitalist that. 2. finance will be difficult to obtain and so Venture capital particularly equity investment without associated debt burden is key to survival of the business. b) There is a risk of product obsolescence. lack of product etc. Initial loss after start up phase. This is more so when information technology etc. since firms do not have foundation of a trading record. capital needs. the second trench of Early State Finance is also referred to as follow on finance and can be defined as the provision of capital to the firm which has previously been in receipt of external capital but whose financial needs have subsequently exploded.4. Further. The firm needs additional equity funds. The management risk is shifted from factors internal to the firm (lack of management. Second stage finance. The characteristics of a second stage finance are: the firm is involved in high-tech business like computer.) At this stage. both fixed and working capital needs are greatest.4 Second Stage Finance It is the capital provided for marketing and meeting the growing working capital needs of an enterprise that has commenced the production but does not have positive cash flows sufficient to take care of its growing needs.

II Failure of new product to live up to sales forecast. subject to certain management performance targets. 2.4. typically for market expansion. A developed product on the market  A full management team in place  Sales revenue being generated from one or more products  There are losses in the firm or at best there may be a break even but the surplus generated is insufficient to meet the firm¶s needs. II High growth enterprises expand faster than their working enterprise to meet needs of increasing stocks and receivables. acquisition. product 16 capital permit.5 Later Stage Finance It is called third stage capital is provided to an enterprise that has established commercial production and basic marketing set-up. Negative reasons include: I Cost overruns in market development. Aim is to provide working capital for initial expansion of an . thus needing additional finance. It is additional injection of funds and is an acceptable part of venture capital. Often provision for such additional finance can be included in the original financing package as an option. Positive reasons include: I Sales appear to be exceeding forecasts and the enterprise needs to acquire assets to gear up for production volumes greater than forecasts. generally ranging from 3 to 7 years. campaign. This stage of financing has both positive and negative reasons. Second round financing typically comes in after start up and early stage funding and so have shorter time to maturity. III Need to re-position products through a new marketing IV Need to re-define the product in the market place once the product deficiency is revealed.

 Expansion / Development Finance  Replacement Finance  Buyout Financing  Turnaround Finance Expansion / Development Finance An enterprise established in a given market increases its profits exponentially by achieving the economies of scale. Expanding high yield. This helps the venture capitalists to balance their own portfolio of investment as it provides a running yield to venture capitalists. Established business. II. This expansion can be achieved either through an organic growth. working capital or development of improved products. It is provided for market expansion of the enterprise. Venture capitalist s prefer later stage investment vis a vis early stage investments. ranging from 3 to 5 years. I. Reputed market position and an established formal organization structure.development etc. The enterprises eligible for this round of finance have following characteristics. There are four sub divisions of later stage finance. established procedures of financial control. It is also called last round of finance in run up to the trade sale or public offer. ³Funds are utilized for further plant expansion. capital growth and good profitability. It is because firms at this stage have a past performance data. Anyhow.´ Third stage financing is a mix of equity with debt or subordinate debt. The time horizon for realization is shorter. having already passed the risky early stage. As it is half way between equity and debt in US it is called ³mezzanine´ finance. as the rate of failure in later stage financing is low. marketing. track record of management. expansion needs finance and venture capitalists support both organic growth as well as acquisitions for expansion. 17 . III. that is by expanding production capacity and setting up proper distribution system or by way of acquisitions. Further the loan component in third stage finance provides tax advantage and superior return to the investors.

developing new markets or entering exports by enterprise with established business that has already achieved break even and has started making profits. Funds are needed for new or larger factories and warehouses.At this stage the real market feedback is used to analyze Financing It is a recent development and a new form of investment by venture capitalist. production capacities. developing improved or new products. It is favored by venture capitalist as it offers higher rewards in shorter period with lower risk. rather than raising new capital resulting in the change of ownership pattern. They also buy ordinary shares from non-promoters and convert them to preference shares with fixed dividend coupon. Thus Venture capitalist makes a capital gain in a period of 1 to 5 years.out / Buy . Management Buy-in refers to the funds provided to enable a manager or a group of managers from outside the company to buy into it. these are re-converted to ordinary shares. Later. Realization horizon for expansion / development investment is one to three years. It is the most popular form of venture capital amongst later stage financing. Venture capitalist purchase shares from the entrepreneurs and their associates enabling them to reduce their shareholding in unlisted companies. Buy . The funds are provided for acquiring and revitalizing an existing product line or division of a major 18 . It may be found that the entrepreneur needs to develop his managerial team for handling growth and managing a larger business. It is less risky as venture capitalist in invests in solid. Replacement Finance It means substituting one shareholder for another. ongoing and more mature business. on sale of the company or its listing on stock exchange. The funds provided to the current operating management to acquire or purchase a significant share holding in the business they manage are called management buyout.

The venture capitalist has to carry out the recovery process using hands on management in 2 to 5 years. Unquoted company at an early stage of development often has higher debt than equity. MBO (Management buyout) has low risk as enterprise to be bought have existed for some time besides having positive cash flow to provide regular returns to the venture capitalist. This shift is because of lower risk than start up investments. Bridge finance often has a realization period of 6 months to one year and hence the risk involved is low. Venture capitalist help in building a stable and experienced management team that will help the company in its initial public offer. The bridge finance is paid back from the proceeds of the public issue. Venture Capital Investment Process 19 .business. it needs finance as well as management assistance foe a major restructuring to revitalize growth of profits. Of late there has been a gradual shift away from start up and early finance to wards MBO opportunities. who structure their investment by judicious combination of debt and equity. Such enterprises are compelled to relinquish control to new management. When an established enterprise becomes sick. Turnaround Finance It is rare form later stage finance which most of the venture capitalist avoid because of higher degree of risk. Bridge Finance It is the pre-public offering or pre-merger/acquisition finance to a company. Most of the time bridge finance helps improves the valuation of the company. its cash flows are slowing down due to lack of managerial skill and inability to exploit the market potential. It is the last round of financing before the planned exit. The sick companies at the later stages of development do not normally have high debt burden but lack competent staff at various levels. The risk profile and anticipated rewards are akin to early stage investment.

Deal Structuring 5. Screening 3.Venture capital investment process is different from normal project financing. Evaluation or due Diligence 4. Post Investment Activity and Exit 20 . Deal Organization 2. In order to understand the investment process a review of the available literature on venture capital finance is carried out. Tyebjee and Bruno in 1984 gave a model of venture capital investment activity which with some variations is commonly used presently. As per this model this activity is a five step process as follows: 1.

Figure 2.2: Venture Capital Investment Process 21 .

is certain intermediaries who match VCFs and the potential entrepreneurs. Due Diligence: Due diligence is the industry jargon for all the activities that are associated with evaluating an investment proposal. the screening process may limit projects to areas in which the venture capitalist is familiar in terms of technology. Most venture capitalists ask for a business plan to make an assessment of the possible risk and return on the venture. trade partners. Another deal flow is active search through networks. foreign visits etc. For example. active search system. seminars. Intermediaries is used by venture capitalists in developed countries like USA. Deals may be referred to VCFs by their parent organisaions. the VC investor creates a pipeline of deals or investment opportunities that he would consider for investing in. The size of investment. friends etc. and intermediaries. trade fairs. Screening: VCFs. referral system. Preliminary evaluation: The applicant required to provide a brief profile of the proposed venture to establish prima facie eligibility. industry associations. conferences. The venture capitalists evaluate the quality of entrepreneur before appraising the characteristics of the product. or market scope. before going for an in-depth analysis. The evaluation of ventures by VCFs in India includes. Business plan contains detailed information about the proposed venture. or product. Deal may originate in various ways. market or technology. geographical location and stage of financing could also be used as the broad screening criteria.Deal origination: In generating a deal flow. carry out initial screening of all projects on the basis of some broad criteria. 22 . Referral system is an important source of deals.

Deal Structuring: In this process. The final decision is taken in terms of the expected risk-return trade-off as shown in Figure. Market risk. If a financial or managerial crisis occurs. urge to grow. the venture capitalist and the venture company negotiate the terms of the deals. It may not. He also gets involved in shaping of the direction of the venture. Technological risk and Entrepreneurial risk. the venture capitalist generally assumes the role of a partner and collaborator. however. A venture may exit in one of the following ways: There are four ways for a venture capitalist to exit its investment: 23 . The degree of the venture capitalist's involvement depends on his policy. the amount. VCFs in India also make the risk analysis of the proposed projects which includes: Product risk. making initial public offerings (IPOs). They play a positive role in directing the company towards particular exit routes. Earned out arrangements specify the entrepreneur's equity share and the objectives to be achieved. long-term vision. commercial orientation. Post Investment Activities: Once the deal has been structured and agreement finalised. and even install a new management team. that is. the venture capitalist may intervene. form and price of the investment.Detailed evaluation: Once the preliminary evaluation is over. etc. VCFs in India expect the entrepreneur to have:. acquisition. the proposal is evaluated in greater detail. The agreement also include the venture capitalist's right to control the venture company and to change its management if needed. Exit: Venture capitalists generally want to cash-out their gains in five to ten years after the initial investment. buyback arrangements.Integrity. be desirable for a venture capitalist to get involved in the day-today operation of the venture. This process is termed as deal structuring. managerial skills.

Also. difficulties will be caused if the entrepreneur¶s business is perceived to be an unattractive investment proposition by investors. Further. In India. the promoters are invariably given the first option to buy back equity of their enterprises. Canfina-VCF offers an opportunity to the promoters to buy back the shares of the assisted firm within an agreed period at a predetermined price. If the promoter fails to buy back the shares within the stipulated period. The promotion of the public issue would be difficult and expensive since the first generation entrepreneurs are not known in the capital markets. would be a feasible option. however. which buy back. usually after the project has settled down. Initial Public Offers (IPOs) The benefits of disinvestments via the public issue route are. Initial Public Offer (IPO)  Acquisition by another company  Re-purchase of venture capitalist¶s share by the investee company  Purchase of venture capitalist¶s share by a third party Promoter¶s Buy-back The most popular disinvestments route in India is promoter¶s buy-back. This route is suited to Indian conditions because it keeps the ownership and control of the promoter intact. Similarly. Canfina-VCF would have the discretion to divest them in any manner it deemed appropriate. in consultation with the promoter. improved marketability and liquidity. GVFL would make disinvestments. For example. to a profitable level and the entrepreneur is in a position to avail of finance under conventional schemes of assistance from banks or other financial institutions. This option has certain limitations in the Indian context. SBI capital Markets ensures through examining the personal assets of the promoters and their associates. is that in a majority of cases the market value of the shares of the venture firm would have appreciated so much after some years that the promoter would not be in a financial position to buy them back. RCTC participates in the assisted firm¶s equity with suitable agreement for the promoter to repurchase it. The obvious limitation. the emphasis by the Indian investors on short-term profits and 24 . better prospects for capital gains and widely known status of the venture as well as market control through public share participation.

Since this list of market-makers (who will decide daily prices and appoint dealers for trading) includes most of the public sector venture financiers. The OTC Exchange in India was established in June 1992. it should pick up fast. Thus. there exist well-developed OTC markets where dealers trade in shares on telephone/terminal and not on an exchange floor. this option has become far less feasible for small ventures on account of the higher listing requirement of the stock exchanges. to enlist on the OTC markets and provides liquidity to investors. the formula would underestimate the premium. The existing companies are now free to fix the premium on their shares. The Government of India had approved the creation for the Exchange under the Securities Contracts (Regulations) Act in 1989. GIC. In February 1989. The initial public issue for disinvestments of VCFs¶ holding can involve high transaction costs because of the inefficiency of the secondary market in a country like India. VCFs should be able to sell their holdings. In the USA. SBI Capital Markets. the office of the controller of Capital Issues. 1947 and consequently. small companies which are not otherwise eligible to be listed on the stock exchange. and it should be possible for investors to trade in the securities of new small and medium size enterprises. Also. Sale on the OTC Market An active secondary capital market provides the necessary impetus to the success of the venture capital. This formula failed to give due weight age to the expected stream of earning of the venture firm. Yet another difficulty in India until recently was that the Controller of Capital Issues (CCI) guidelines for determining the premium on shares took into account the book value and the cumulative average EPS till the date of the new issue. The National Association of Securities Dealers Automated Quotation System (NASDAQ) in the USA daily quotes over 8000 stock prices of companies backed by venture capital. the Government of India raised the minimum capital for listing on the stock exchanges from Rs 10 million to Rs 30 million and the minimum public offer from Rs 6 million to Rs 18 million. The Government has now abolished the Capital Issues Control Act. This mechanism enables new. and investors should be able to trade shares conveniently and freely. It has been promoted jointly by UTI.dividends may tend to make the market price unattractive. Can bank Financial Services. 25 . ICICI. LIC and IDBI.

venture capitalists are called angel investors. hiring key people and building up the managerial team. venture capitalist or private equity supplier/investor. The growth of an enterprise follows a life cycle as shown in the diagram below. finding and understanding the target customers and their needs. At this stage the funds are needed to solicit the consultant¶s services in formulation of business plans. The players There are following groups of players: · Angels and angel clubs · Venture Capital funds Small Medium Large · Corporate venture funds · Financial service venture groups 26 .The other disinvestments mechanisms such as the management buyouts or sale to other venture funds are not considered to be appropriate by VCFs in India. Depending upon the stage they finance. Venture capitalists cater to the needs of the entrepreneurs at different stages of their enterprises. Next the funds would be required for development of the product/process and producing prototypes. meeting potential customers and technology partners. This is followed by funds for assembling the manufacturing and marketing facilities in that order. At the seed stage the entrepreneur continue to fund the venture with his own or family funds. Finally the funds are needed to expand the business and attaint the critical mass for profit generation. Even before a business plan is prepared the entrepreneur invests his time and resources in surveying the market. The requirements of funds vary with the life cycle stage of the enterprise.

They often operate internationally and finance deals up to USD 500 million The large funds will try to improve their position by mergers and acquisitions with other funds to improve size. Examples are: · Artemis Comaford · Abbell Venture Fund · Acacia Venture Partners  Medium Venture Funds The medium venture funds finance all stages after seed stage and operate in all business segments. There will be mergers and acquisitions leading to a concentration of capital. In 27 . They can form angel clubs to coordinate and bundle their activities. reputation and their financial muscle. As for the small and medium Venture Capital funds strong competition will clear the marketplace. angels often provide their personal knowledge. The so called "Boutique firms" are often specialised in certain industries or market segments.000 to USD 500. Dinner Club . Only the more successful funds will be able to attract new money.· Angel's Forum  Small and Upstart Venture Capital Funds These are smaller Venture Capital Companies that mostly provide seed and start-up capital. Angels and angel clubs Angels are wealthy individuals who invest directly into companies. Funds specialised in different business areas will form strategic partnerships. Single funds have up to USD 5 billion under management. Besides the money. They provide money for deals up to USD 250 million. An example is Accel Partners  Large Venture Funds As the medium funds. With average deals sizes from USD 100. Examples for angel clubs are · Media Club. Their capitalization is about USD 20 to USD 50 million (is this deals size or total money under management or money under management per fund?) .000 they finance companies in their early stages. experience and contacts to support their investees. large funds operate in all business sectors and provide all types of capital for companies after seed stage.

Examples are: · AIG American International Group · Cap Vest Man · 3i  Corporate Venture Funds These Venture Capital funds are set up and owned by technology companies. Possible areas to enter are other financial services by means of M&As with financial services corporations and the consulting business. In addition they will to diversify.addition they will to diversify. Their aim is to widen the parent company's technology base in an win-win-situation for both. The large funds will try to improve their position by mergers and acquisitions with other funds to improve size. the investor and the investee. For the latter one the funds have a rich resource of expertise and contacts in house. Examples are: · Oracle · Adobe · Dell · Kyocera As an example. reputation and their financial muscle. For the latter one the funds have a rich resource of expertise and contacts in house. such as Cascade Systems Inc and Lantana Research 28 . In a declining market for their core activity and with lots of tumbling companies out there is no reason why Venture Capital funds should offer advice and consulting only to their investees. In a declining market for their core activity and with lots of tumbling companies out there is no reason why Venture Capital funds should offer advice and consulting only to their investees. corporate funds invest in growing or maturing companies. Possible areas to enter are other financial services by means of M&As with financial services corporations and the consulting business. In general. The average deals size is between USD 2 million and USD 5 million. Adobe systems launched a $40m venture fund in 1994 to invest in companies strategic to its core business. often when the investee wishes to make additional investments in echnology or product development.

 Financial funds: A solution for financial funds could be a shift to a higher securisation of Venture Capital activities.has been successfully boosting demand for its core products. the success of such products will depend on the overall climate and expectations in the economy.. However. As long as the sownturn continues without any sign of recovery customers might prefer less risky alternatives. 29 . That means that the parent companies shift the risk to their customers by creating new products such as stakes in an Venture Capital fund. so that Adobe recently launched a second $40m fund.Corporation.

   30 . and the subsequent downturn. the healthcare pool has grown consistently over the last several years. In emerging market like China. Cumulative investment has declined in similar amounts. Since 2003. it dropped 67% since 2004. driven by investment in biopharmaceuticals and medical devices. Key observations on the pool of private companies by industry:The information and technology pool has declined by just 6% since 2002. In mature countries. 20-25% in second round. particularly due to increasing Interest in WEB 2. The business. the IT pool has decreased by 27% in Europe and since 2004 17% in Israel.In Israel. the round distribution is very different as 68% in early stage round and 25% in second round. consumer and retail industries.Current Industry Trends Round Class Distribution The distribution of financing rounds by round class in mature markets is typically 30-40% in the early stage rounds. The healthcare pool. In US the number had fallen 54% since 2002 and 54% in Europe since 2003 . Industry shifts It is perhaps no surprise that the contraction is mostly concentrated in information technology and the business. both in terms of number of companies and cumulative dollars invested. consumer and retail category has faced the steepest declines across the board. and 35-40% in later rounds. the investments are made at early start up or product development phase.0 innovations. give the huge number of companies financed in the technology and Internet boom of 1999 -2000. has actually grown to some degree in the different geographies .In United States.

Changes in economic and financial landscape are creating a significant regional shifts in IPO activity.A new breed of global company is emerging from developing countries and redefining industries through low-cost advantage. although the number of companies dropped by 9%in Europe since 2003 and 9% in Israel since 2004. India.S. since 2002 by 27% and the capital risen 30% in last five years. The number of healthcare companies has grown in U.With the globalization and increasingly complex regulatory environment. and vast customer databases in their home countries. These changes have also sparked global consolidation alliances among stock exchanges. and Russia.  Transformation of the CFO¶s role and function:. The beginning of venture capital activity has been seen in others countries such as Indonesia. Capital investment to the pool of healthcare companies in Europe and Israel has also climbed. Encompassing energy. China.Clean technology is poised to become the first break through sector of 21st century. Turkey and Vietnam. Korea. industrial efficiency 31 . CFOs have a wider range of responsibilities and finance function has been transformed to face broader mandates.A new wave of fast growing economies is joining the global growth leaders like Brazil. These companies are potential acquirers of developed market companies at all stages of growth.  Mega trends Several global mega trends will likely have an impact on venture capital in the next decade: Beyond the BRICs: . There were 262 clean technology companies with a cumulative invested venture capital of US $38 billion in 2007. Clean technology is a small but increasing element of the pool.  Globalization of capital:. modern infrastructure.  Clean Technology: . air and water treatment.  The new multinationals: .

with 45 percent of respondents from the United States and 31 percent from Europe. and Africa. The 2007 Global Venture Capital Survey was sponsored by Deloitte & Touche LLP in conjunction with the National Venture Capital Association and other venture capital associations* throughout the world. Asia Pacific. the Middle East. It was administered in April and May 2007 to venture capitalists (VCs) in the Americas.i t new material and waste management et are playing very vital role globally because of which VC investors are enjoying rewards.1 Primary focused location for investment (APAC) respondents The breadth of assets under management by these respondents was varied. A complete geographic breakdown of respondents is as follows: Fi 3. 35 percent managed assets between $100 million and $4 million. Europe. 12 percent managed assets between $500 million to $1 billion. and 11 percent more than $1 billion in assets under management 32 . There were 52 responses from general partners. The highest number of respondents²42 percent²had managed assets totaling less than $100 million.

S. other Asia. Rather. but the venture capital community is not broadly embracing global investment. but growth is slow and cautious. respondents) 33 . We may live in a global economy. RESPONDENTS) 46 54 YES NO Figure: 3. Global VC investment increasing. India. as demonstrated by this year¶s survey data.S.2 Percentage of venture capitalist currently investing outside home country (U. Japan.There are 13 % respondents from APAC in which China. South Korea. % OF VENTURE CAPITALISTCURRENTLY INVESTING OUTSIDE HOME COUNTRY(U. roughly half of the venture community has made a commitment to a global investment strategy and those firms are implementing that strategy slowly and cautiously. are modest at best. The intentions for growth of foreign investment. 45% respondents from Middle East include Israel and other area of Middle East.

they need to understand local culture. actual growth in terms of percentage of venture investors investing globally is occurring much more slowly than is commonly believed. 54 percent indicated that they would be expanding their investment focus outside of their home country or region in the next five years. 4 percent of them have developed strategic alliances with a foreign-based firm and 51 percent invest only with othe investors r who have a local presence. but dipping a toe in with one or two deals. a i Among those VCs who are currently investing abroad. and to do s they must have a local presence o in their target countries to take advantage of in -country expertise. To this end. Adequate deal flow in their home country was the reason indicated most for not wanting to expand globally. evaluate how their strategy may need to be adjusted and how critical challenges. This cautious approach allows the venture firms to further assess the investment environment.3 Percentage of venture capitalist currently investing outside home country (Non U. And. for a lot of firms. Some venture investors are certainly taking advantage of opportunities outside their home countries. they¶re not diving deep into investing in other countries.S. This underscores the need in venture capital to be physically close to the portfolio companies in order to work with management. they also are 34 . respondents) Among U.S. Firms also indicated that to succeed.Fi 3. such as tax and intellectual property issues impact overall performance. investors.

S. and Canada.S. Israel. Israel and Canada are primary target countries for U. making only one to two investments thus far. 35 £ invest only strategic acquire require require w ith other alliances foreign partners to partners to w ith foreign investors based firm s travel m ore transfer to that have a firm s foreign local location presence relocate Q of portfolio co. However.S. Current business practises used by venture capitalist to manage foreign investment focus global US Non US 33 3 29 30 20 10 0 11 1 7 China.S.hiring investment staff with expertise in target countries (41 percent) and requiring their partners to travel more (58 percent). respondents are essentially dabbling. firms who have invested globally are making investments in China. venture capitalists There continues to be a consensus among U. expertise in w ith target significant countries operations outside country ¢ 0   0 0 1 3           0 8 ¡ 0 ¡ 1 ¡¡ 0 ¡ 8 8 ¢ 70 3 2 1 33 ¡ ¡      ¢   ¡ .to be near our firm ¢ ¢ 7 8 8 12 open new offices in foreign location hire im vest in investm ent local staff w ith portfolio co. venture capitalists regarding where the most opportunities exists globally. Most of the U. even in these countries. India. the majority of U. India.

S. Survey results indicate that there will not be significant change during the next five years.S. firms alike for the most part represent less than 5 percent of capital invested overseas in fewer than three to five deals.FOREIGN INVESTMENT CURRENTLY HELD BY FIRMS % % % 6- 53% ¤ 3% 11-15 i v m 16+ i v m Figure: 3. and non-U.i v m 3-5 i v ¥         § ¤ ¦ m i v m . 36         ¨           ©¨ .5 Foreign investment currently held by firms Allocations by U.

India is the second choice for the global investors. res ondents) 5% 4% 6% 9% 7% canda china India 34% UK & Ireland Israel other Asia 11% 24% other Europe others Figure: 3.6 Primary focused location for investment (U. 37 . RESPONDENTS Prim r l i where i vestors woul like to ex and investment ocus (U.S.S) respondents Here from the above chart we can see that the highest percent of respondents are interested in China for setting up their businesses.RESPONSE FROM U.S.

7 Primary focused location for investment (APAC) respondents While China.S. INDIA 18 MIDDLE EAST SOUTH KOREA 27 JAPAN Figure: 3. and Canada are by far the most seductive target markets for investment by U. with the remainder focused on the Middle East. Most of APAC 38 .S. venture capitalists in non-US countries have a different focus. firms. but looked primarily inward to other Asian countries (78 percent). India.RESPONSE FROM (APAC) RESPONDENTS PRIMARY LOCATION WHERE INVESTOR WOULD LIKE TO EXPAND INVESTMENT FOCUS (APAC) RESPONDENTS 3 3 3 CHINA 9 37 OTHER ASIA U. Asian respondents had a similar level of interest in the United States (18 percent). there¶s still a desire to remain somewhat close to home and do business with cultures close to theirs. investors are interested in making deals outside of their home countries. who indicated a strong preference for investing in other parts of Europe (67 percent) and the United States (17 percent). This data shows that while non-U. Israel. with the remainder focused on Asia.S. By far the greatest contrast is among European respondents.

39 . There is 3% ready to invest in South Korea. Japan and South Korea.respondents like to investment china and other Asia.

It indicated that new companies often confront serious barriers to entry into capital market for raising equity finance which undermines their future prospects of expansion and diversification. 10 cr which raised by imposing a cess of 5% on all payments made for the import of technology know. In India. along with the Unit Trust of India (UTI) Technology Development and Information Company of India (TDICI) as the first VC company registered under the companies act.5 lacs to rs 2.  Promoted by all India development financial institutions The IDBI started a VC fund in 19876 as per the long term fiscal policy of government of India. The TDICI may provide financial assistance to venture 40 . the Industrial finance Corporation of India (IFCI) initiated the idea of VC when it established the Risk Capital Foundation in 1975 to provide seed capital to small and risky projects. it started providing VC finance in 1998 it promoted. However the concept of VC financing got statutory recognition for the first time in the fiscal budget for the year 1986-87. This brought out the institutional inadequacies with respect to the evolution of venture capital. It also indicated that on the whole there is a need to revive the equity cult among the masses by ensuring competitive return on equity projects requiring funds from rs.VC Industry in India The first major analysis on risk capital for India was reported in 1983. The ICICI provided the required impetus to VC activities in India. 1956. The Venture Capital companies operating at present can be divided into four groups: y Promoted by All ± India Development Financial Institutions y Promoted by State Level Financial Institutions y Promoted by Commercial banks y Private venture Capitalists. Promoter¶s contribution ranged from this fund was available at a concessional interest rate of 9% ( during gestation period) which could be increased at later stages.5 cr were considered for financing. 1986. with an initial capital of Rs.

capital undertakings which are set up by technocrat entrepreneurs, or technology information and guidance services. The risk capital foundation established by the industrial finance corporation of India (IFCI) in 1975, was converted in 1988 into the Risk Capital and Technology Finance company (RCTC) as a subsidiary company of the ifci the rctc provides assistance in the form of conventional loans, interest ±free conditional loans on profit and risk sharing basis or equity participation in extends financial supoort to high technology projects for technological upgradations. The RCTC has been renamed as IFCI Venture Capital Funds Ltd.(IVCF) 

Promoted by State Level Financial Institutions In India, the State Level financial institutions in some states such as Madhya Pradesh, Gujarat, Uttar Prades, etc., have done an excellent job and have provided VC to a small scale enterprises. Several successful entrepreneurs have been the beneficiaries of the liberal funding environment. In 1990, the Gujarat Industrial Investment Corporation, promoted the Gujarat Venture Financial Ltd.(GVFL) along with other promoters such as the IDBI, the World Bank, etc. The GVFL provides financial assistance to businesses in the form of equity, conditional loans or income notes for technologies development and innovative products. It also provides finance assistance to entrepreneurs. The government of Andhra Pradesh has also promoted the Andhra Pradesh Industrial Development Corporation (APIDC) venture capital ltd. To provide VC financing in Andhra Pradesh. 

Promoted by commercial banks Canbank Venture Capital Fund, State Bank Venture Capital Fund and Grindlays bank Venture Capital Fund have been set up by the respective commercial banks to undertake vc activities.


The State Bank Venture Capital Funds provides financial assistance for bought ±out deal as well as new companies in the form of equity which it disinvests after the commercialization of the project. Canbank Venture Capital Fund provides financial assistance for proven but yet to b commercially exploited technologies. It provides assistance both in the form of equity and conditional loans. 

Private Venture Capital Funds Several private sector venture capital funds have been established in India such as the 20th Centure Venture Capital Company, Indus Venture Capital Fund, Infrastructure Leasing and Financial Services Ltd. Some of the companies that have received funding through this route include:
y y y y y y y y

Mastek, on of the oldest softwear house in India Ruskan software, Pune based software consultancy SQL Star, Hyderabad-based training and software development consultancy Satyam infoway, the first private ISP in India Hinditron, makers of embedded software Selectia, provider of interactive software selectior Yantra, ITLInfosy¶s US subsidiary, solution for supply chain management Rediff on the Net, Indian website featuring electronic shopping, news,chat etc.



From the industry life cyle we can know in which stage we are standing. On the basis of this management can make future strategies of their business.




: 4.1 Industry life cycle

The growth of VC in India has four separate phases: I - Formation of TDICI in the 0¶s and regional funds as GVFL & APIDC in the

4.2.1 Pha early 0s.

The first origins of modern venture capital in India can be traced to the setting up of a Technology Development Fund in the year 1 7 , through the levy of access on all technology import payments. Technology Development Fund was started to provide fina ncial support to innovative and high risk technological programmes through the Industrial Development Bank of India. The first phase was the initial phase in which the concept of VC got wider acceptance. The first period did not really experience any sub stantial growth of VCs¶. The 1 0¶s were marked by an increasing disillusionment with the trajectory of the economic system and a 43

The first stage of the venture capital industry in India was plagued by in experienced management. Government of India controlled them rigidly. in the process of being taken from pilot to commercial stage or incorporate some significant improvement over the existing ones in India  Promoters / entrepreneurs using the technology should be relatively new. Though the venture capital funds should operate as open entities. The liberalization process started in 1985 in a limited way. Most of these were operated more like a financing operation. very closely held. relatively untried. The most important feature of the 1988 rules was that venture capital funds received the benefit of a relatively low capital gains tax rate which was lower than the corporate rate. professionally or technically qualified. mandates to invest in certain states and sectors and general regulatory problems. with inadequate resources to finance the project. The concept of venture capital received official recognition in 1988 with the announcement of the venture capital guidelines. Many public issues by small and medium companies have shown that the Indian investor is becoming increasingly wary of investing in the projects of new and unknown promoters. Till 1995. One of the major forces that induced Government of India to start venture funding was the World Bank. VCs became operational in India before the liberalization process started. During 1988 to 1992 about 9 venture capital institutions came up in India. The 1988 guidelines stipulated that VC funding firms should meet the following criteria:  Technology involved should be new. The main feature of this phase was that the concept got accepted. All these followed the Government of India guidelines for venture capital activities and have primarily supported technology oriented innovative businesses started by first generation entrepreneurs. The context was not fully ripe for the growth of VCs. The initial funding has been provided by World Bank. 44 . the VCs operated like any bank but provided funds without collateral.belief that liberalization was needed. Between 1988 and 1994 about 11 VC funds became operational either through reorganizing the businesses or through new entities.

2 Phase II . The power to control venture funds has been given to SEBI only in 1995 and the notification came out in 1996. Consequently. the investing in India came ³crashing down´ when NASDAQ lost 60% of its value during the second quarter of 2000 and other public markets (including those in India) also declined substantially. The new regulations in 1996 helped in this.2.(2000 onwards) . the VCs started investing less money and in more mature companies in an effort to minimize the risks. the development of venture capital continued to be inhibited because of the regulatory regime and restricted the FDI environment.2. SEBI appointed a committee to recommend the changes needed in the VC funding context. The new regulations became the harbinger of the second phase of the VC growth. venture funds were dominated by Indian firms. 4. Though the changes proposed in 1996 had a salutary effect. any organization requiring to start venture funds have to forward an application to CCI. This decline broadly continued until 2003. In other words.Global VCs firms actively investing in India 45 . Subsequent to the liberalization of the economy in 1991. VC growth and IT growth co-evolved in India 4.The liberation of the economy and toning up of the capital market changed the economic landscape.3 Phase III . 1992 empowers SEBI under section 11(2) thereof to register and regulate the working of venture capital funds. According to 1988 VC guideline.Entry of Foreign Venture Capital funds (VCF) between 1995 -1999 The second phase of VC growth attracted many foreign institutional investors. during 2001-2003. This was done in 1996. Till this time.VC becomes risk averse and activity declines: Not surprisingly. through a government notification.4 Phase IV ± 2004 onwards . the office of CCI was abolished in May 1992 and the powers were vested in Securities and Exchange Board of India. The Securities and Exchange Board of India Act. 4.2. The decisions relating to issue of stocks and shares was handled by an office namely: Controller of Capital Issues (CCI). This coincided with the IT boom as well as the success of Silicon Valley start-ups. To facilitate the growth of venture funds.During this period overseas and private domestic venture capitalists began investing in VCF.

have been growing at 12%-14% a year. including the services sector and the high-end manufacturing sector. The total deal value in 2007 is 14234 USD Million.2 Growth of Venture capital in india The venture capital is growing 43% CAGR. However. of deals are increasing year by year. 4. of deals in 2006 only 56 and now in 2007 it touch the 387 deals. investors renewed their interest and started investing again in 2004.Since India¶s economy has been growing at 7%-8% a year.3 Growth of venture capital in India Growth of VC in India USD Million 16000 14234 14000 12000 299 10000 8000 6000 146 4000 2000 0 2000 2001 2002 2003 2004 2005 2006 2007 1st half of 2008 1160 110 78 937 591 56 1650 470 71 2200 280 250 7500 6390 170 150 100 50 0 200 387 400 350 300 No. and since some sectors. The introduction stage of venture capital industry in India is completed in 2003 after that growing stage of Indian venture capital industry is started. several specific VC funds are setting up shop in India. The number of deals and the total dollars invested in India has been increasing substantially. The no. with the year 2006 having been a landmark year for VC funding in India. 46 . of Deals 450 Value of deals No. The NO. in spite of the venture capital scenario improving.of deals Figure: 4.

Creating entrepreneurship and stimulating innovation in clusters have to become a major concern of public policy makers. of venture capital firms increase by only 14. the reason is crashdown of capital market by 51% from January to November 2008. telecom. Bio-technology. VCs prefer clusters because the information costs are lower. 47 . But in 2008 no. Clusters support innovation and facilitates risk bearing. This is essential because only when the cultural context is conducive for risk management venture capital will take-of. starting of R&D centres. strategic review 2008 published by (National Association of Software and Service Companies) Venture capital growth and industrial clustering have a strong positive correlation. Policies for promoting dispersion of industries are becoming redundant after the economic liberalization. The venture capital firm invest their money in most developing sectors like health care. In 2006 it is only but in 2007 the number of venture capital firms are 146.. Entry costs are also lower in clusters. availability of venture capital and growth of entrepreneurial firms are getting concentrated into five clusters.There are 160 venture capital firms/funds in India.nasscom. The reason is good position of capital market. Media& Entretainment. shipping & ligistics etc. 2000 841 2001 77 2002 78 2003 81 2004 86 2005 89 2006 105 2007 146 2008 160 www. especially for innovation. The No. Foreign direct investment. The cost of monitoring and the cost of skill acquisition are lower in clusters. of venture capital funds are increasing year by year.

the venture capital industry is also grow. The top most player in the industries are ICICI venture capital fund.2007 VC INVESTMENTS BY INDUSTRY TOTAL US$14. 48 . Now due to growth of this sector. Canbank. IL&FS venture capital fund. Avishhkar venture capital fund.2Bn 1284 1839 685 616 1101 478 1628 Manufactur ng Eng & Construction Energy Shipping&Logistics Others  ! 1638 3979 IT&ITES BFSI Healthcare & lifesciences Media&Entertinment Telecom Sou "! : TSJ Ventu e Intelligen e India Figure: 4.3 Total sector wise venture capital investment-2007 Now venture capital is nascent stage in india.

The latest numbers take the total VC investments in the first nine months of 2008 to $661 million (across 108 deals) as against the $648 million (across 97 deals) during the corresponding period in 2007. VC Investments by Industry 49 . Venture Capital firms invested $274 million over 49 deals in India during the three months ending September 2008.4. 2008. 4.1 Top Investments The largest investment reported during Q3 2008 was the $18 million raised by online tutoring services provider TutorVista from existing investors Sequoia Capital India and LightSpeed Ventures. The VC investment activity during the period was significantly higher compared to the same quarter last year (which had witnessed 36 investments worth $252 million) as well as the immediate previous quarter ($165 million invested across 28 deals).Venture Capital investment Q3. 4.2 Investments by Industry Information Technology and IT-Enabled Services (IT & ITES) industry retained its status as the favorite among VC investors during Q3 ¶08.4.

2 Venture capital investment by industry Led by the $12 million investment by Bellwether and others into Chennai-based microfinance firm Equitas. Other microfinance firms that attracted investments during Q3 ¶08 included Kolkata-based Arohan Financial Services (which raised funding from Lok Capital and others) and Guwahati-based Asomi Finance (IFC and Aavishkaar Goodwell). of Deals YTD** Value Q3¶ 08 147 34 23 4 (US $ M) YTD IT & ITES BFSI Engg & Construction Healthcare & Life Sciences Education Other Services Manufacturing Media Energy Travel & Transport Retail Telecom 25 5 3 6 58 8 4 12 361 54 33 52 2 1 2 2 2 1 - 3 6 2 5 6 2 1 1 17 15 13 11 6 4 - 23 29 13 19 48 14 10 5 Table: 4. BFSI emerged as the second largest (in value terms) for VC investments during the period.Industry Volume Q3 µ 08 No. 50 .

2008 51 .4 investment by industry Q3.INVESTMENT BY INDUSTRY (Q3 ' 08) 6% 6% 2% 8% 5% 4% 2%1% 54% 12% IT & ITES Engg & Construction Education Manufacturing Energy BFSI Healthcare & Life Sciences Other Services Media Travel & Transport Figure: 4.

3 Investment by Stage About 67% of VC investments during Q3 µ08 were in the early stage segment.4.3 Venture investment by stage STAGE WISE INVESTMENT 33% 67% EARLY LATER 52 .4. VC Investments by Stage Stage of Company Development Q3 '08 Early Growth 33 16 YTD 67 41 Q3 '08 172 102 YTD 339 322 Volume Value Table: 4.

Call Centers and back office processing. wherein entrepreneurs mind set is taking a shift from risk averse business to investment in new ideas which involve high risk. transportation Media. trickling down to organized effort of support services like office services.5 Need for growth of venture capital in India In India. The conventional industrial finance in India is not of much help to these new emerging enterprises. Retail. Therefore there is a need of financing mechanism that will fit with the requirement of entrepreneurs and thus it needs venture capital industry to grow in India. conservative. 53 . a revolution is ushering in a new economy.Figure: 4. legacy financial system large pool of skilled graduates in the first  Innovation :  Job creation: and second tier cities Patient capital: Not flighty.5 Stage wise investment 4. Few reasons for which active Venture Capital Industry is important for India include: needs risk capital in a largely regulated. unlike FIIs   Creating new industry clusters: catering.

1 15.6 4.3 3.6 110.2 66.0 29.616.3 177.397.7 139.4 7.8 19.3 10.0 18.7 171.3 207.7 3.810.9 211.1 28.721.6 4.5 179.0 119.607.0 9.351.084.8 5.3 83.3 Average M&AsDeal Size($M) 2002 2003 2004 2005-1 2005-2 2005-3 2005-4 2005 2006-1 2006-2 2006-3 2006-4 2006 2007-1 2007-2 2007-3 2007-4 2007 2008-1 2008-2 318 290 339 81 81 101 87 350 107 105 94 62 368 82 87 100 86 355 70 50 52.1 107.8 100.137.6 156.5 92.4 2.894.1 63.916.2 54 .056.5 3.7 216.594.5 128.540.440.9 4.5 4.0 96.972.0 376.Factors Affecting Venture Capital ECONOMIC FACTORS:  MERGER & ACQUISITION : Venture backed liquidity events by year 2001-2008 through M&A Quarter/Y ear Total M&A Deals M&A Deals with Disclosed Values 152 122 186 45 34 48 39 166 52 40 42 26 160 29 36 52 43 160 28 14 Total Disclosed M&A Value ($M) 7.727.602.406.725.018.0 5.0 2.

Due to this V/C is directly affected negatively because M&A is the exit route for Venture capital industry.7 142. The reason behind decreasing No. of Deals Figure: 5.999.7 120 180 160 No.9 www. of M&A deals is crashdown of SENSEX by 51% 55 .OF DEALS 140 120 100 80 60 40 20 0 Value of Deals No. 14 of which had an aggregate deal value of $2. 50 venture-backed M&A deals were completed.thomsonreuters.3 Venture backed M & A deals  MERGERS AND ACQUISITIONS VOLUME DECLINES In the second quarter of 2008. The average disclosed deal value for the quarter was $171.2 million.2008 120 42 5.1 Venture backed liquidity events by year 2001-2008 through M&A VENTURE BACKED LIQUIDITY BY EVENTS 9000 VALUE OF DEALS 8000 7000 6000 5000 4000 3000 2000 1000 0 FIRST TWO QUARTER OF FIRST TWO QUARTER OF 2007 2008 Table: 5. M&A volume of 120 transactions in the first half of 2008 was down 28 percent from the first half of 2007 when 169 transactions were completed.6 169 5999.4 billion.

7 54.8 56 .485.10 4.4 72.7 92.10 ($M) 95.8 118.7 714.8 1.10 5.2 78.8 81.No.4 76.1 105.90 720.022.of IPO's Total Offer Amount Average IPO Offer Amount Quarter/Year ($M) 2002 2003 2004 2005-1 2005-2 2005-3 2005-4 2005 2006-1 2006-2 2006-3 2006-4 2006 22 29 93 10 10 19 18 57 10 19 8 20 57 2.117.1 71.10 1.631.9 69.458.6 89.2 1.592.8 116.10 2.014.00 540.00 934.70 11.

5 www. of IPO in 1st two quarter of 2007 are 43 and in first two quarter of 2008 are only 5 IPO. The no.80 945.043.7 121.  INFLATION RATE 57 .2 3. of IPO is decreased in first two quarter of 2008 as compared to first two quarter of previous two years. It comes a barrier for venture capital to exist from a venture Table: 5.7 165.9 78. Because due to crash down of IPO nobody like to bring IPO.thomsonreuters.8 98. IPO is the exist route for venture capital company.60 4.30 282.2007-1 2007-2 2007-3 2007-4 2007 2008-1 2008-2 2008 18 25 12 31 86 5 0 5 2.1 n/a 56.2 120.7 0 282.2 Number of IPOs during 2002-2008 Here the No.80 10.

Now in June 2008 the inflation rate was 11.rbi. Due to increase in inflation rate the people will going to spend more. And in October the inflation touch the 13.  GDP GROWTH RATE 58 .91 200 150 100 of deal in first two quarter in 2008 was 170 and value of deal was 6390 US$mn and in third quarter of 2008 there was only four deals.01%. annual statement on monetary policy.06 300 VC GROWTH RAT 250 240. now due to growth of any sector will attract new entrepreneur to enter in the industry.4 251. First Quarter Review 2008-09 Figure: 5. So more money will come into the market and demand of the products will increase continuously.9 and the NO.33 0 4. Macroeconomic and Monetary For that they must need funds.8 INFLATION RATE VC GROWTH RATE Source : www. Thus.06% in 2004. their savings will decrease.33% in 2005 from 251.5 3.5 in 2005 from 7. From the above chart we can conclude that inflation and VC has positive relationship. At same time the growth of VC is also declining to 33.2 7.4 in 2004.4 Inflation V/S Venture capital growth rate IMPACT In above chart the inflation rate is decreased to 4.79 2 1 0 2004 2005 2006 2007 50 33.INFLATION v/s VC GROWTH RATE 8 7 INFLATION RAT 6 5 4 3 89. So there is a great opportunity for venture capital industry to attract this new entrepreneur.

Since about $1. GDP of India is US$ 3787.33 2006 2007 50 0 VC GR WTH RAT ( ) GDP GR WTH RAT VC GR WTH RAT Source :CII (Confederation of Indian Industry) July 2008 Presentation Figure: 5.06 . 240. 7.79% from 240. Taking Indian Purchasing Power Parity (PPP) into consideration.GDP / GDP GR WTH RAT ( ) 12 10 251. 250 200 150 9.91% in 2006 but here the value of deal was increasing.3 billion in PPP terms. this would be equivalent to $22 billion worth of investment in the US. India is the 4th largest economy in terms of PPP.79 100 33.91 9. 6 4 2 0 2004 2005 C GR WTH RAT 300 9. In 2008 the growth rate is 9% and project the next year GDP 8% to 9%.4 billion) has been already raised.2 billion is raised by December 2006. even if only $2.75 billion (or approximately 40% of $4. So there is a hope. the growth of VC industry can be increased. But in 2007 the growth of VC was decline to 89.5 GDP V/S Venture capital growth rate IMPACT In above chart there was a positive relation ship there was between GDP growth rate. 59 .

and consumer Internet.87 8. This will be especially true if the VCs continue to invest only in currently favourite sectors such as IT. BPO. In 1991 the contribution of service and industry sectors are 41% and 27% and now in 2008 it is 54% and 27% respectively. Presentation Figure: 5. IMPRESSIVE GROWTH IN INDUSTRY SECTOR : Items Industry Mining and Quarrying Manufacturing Electricitym gas water supply 2004-05 9.1 4.7 7.5 2005-06 10. telecom.15 4. software and hardware products.6 Contribution of sector in GDP In Indian GDP growth rate the contribution of service and manufacturing sectors are increasing.8 6.3 60 .Evalueserve cautions that there will be a glut of VC money for earlystage investments in India.  CONTRIBUTION OF SECTOR IN GDP: GDP COM POSITION 19% 54% 27% AGRICULTURE INDUSTRY SERVICES Source : CII (Confederation of Indian Industry) July 2008.68 2006-07 11 5.98 4.7 8.7 12 6 2007-08(AE) 8.8 7.5 8.

Construction 14. transport. BIFS etc.1 16.0 11. social and personal services 2005-06 10. This shows an impressive growth year by year. bio-technology.8 Items Services Trade.7 12.3 IMPRESSIVE GROWTH IN SERVICES SECTOR : Source : Confederation of Indian Industry. communication. This are emerging sectors for venture capital industry.  SENSEX CRASHDOWN 61 .41 2006-07 11. hotels.9 11.21 6.34 11.8 7.51 11. July 2008 Most of the venture capital industry invest their money in IT companies. real estate & business services Community.9 7.8 13.9 2007-08(AE) 10. hotels.46 12 9. transport & communication Financial.

7 SENSEX in 2008 IMPACT The SENSEX is down by 51% from January 2008 to Nov 2008.4 and in first two quarter of 2008 there is only 5 IPO and value is only Figure: 5.7 through VC company go for exit.bseindia. It is also favorable for venture capital company because no one try to come up with IPO so they must go to the venture capital for money  SMALL SCALE INDUSTRIES 62 N V .SENSEX IN 2008 20000 18000 1 000 17 1 000 12000 10000 8000 000 000 2000 0 17 78 72 17287 31 8 71 1 13 1 1 3 9788 0 1 1 7 1 3 7 128 0 3 9092 72 N IL H G E AY EB LY C N PR JU U AR SE M JU A P M A www. IPO in first two quarter of 2007 is 43 and value of IPO is 6337. Because IPO is one of the exit route for Venture capitalist from the company. So one company is try to come up with IPO.

MSME.42 299 118. and marketing. infrastructure.No. of eals Source: www.chapter 8 Figure: 5.49 56 1 # 2003 2004 $ 2005 % 2006 No. cluster-based of M s & 200 No.8 No. fiscal support. 000 crore.59 113. To boost the micro and small enterprise sector. The Central Bank said that it is also working on a similar refinance facility for the National Housing Bank (NHB) of an amount of Rs 4. A ³Package for Promotion of Micro and Small Enterprises´ was announced in February 2007. of deals V/S No. deals V/S No. of SMEs IMPACT VC. This includes measures addressing concerns of credit. of SMEs 450 400 350 300 250 200 150 100 50 0 # needs to concentrate its investment in small and medium enterprises. 2010.  INTEREST RATE : 63 # 128. SMEs have been allowed to manage their direct/indirect exposure to foreign exchange risk by booking/canceling/roll over of forward contracts without prior permission of RBI. Economiv Survey 2007-08. technology. which will be available up to March 31. Capacity building of MSME Associations and support to women entrepreneurs are the other important features of this package. to be able to contribute to developing entrepreneurship in India.44 38 130 125 120 115 110 105 100 . the bank has decided to refinance an amount of 7000 crore to the Small Industries Development Bank of India.95 146 109.

venture capital firms generally borrow from banks now if interest rates are increasing interest cost of venture capital firms will also increase which led reduce the profitability of Venture Capital firms.73 9. Here increase in bank rates affect Venture Capital firms in both ways from the suppliers as well as buyers side.23 8.INTEREST RATE PERCENTA 10 7.11% in March-2006 and now in July 2008 it is 9.9 Interest Rate IMPACT : The interest rate increase year by year.11 6 4 2 0 7.11%.11 MA MA MA JUNE-RCH--06 RCH--07 RCH--08 08 JULY-08 Sources:. It is 6. so here if they will maintain their own profits they will have to give less return to investors then investors will go for other options.98 8 6.The Macro economic and monetary development annual statement on monetary policy. First Quarter Review 2008-09 Figure: 5. 64 . Because if anyone is investing in any option he will look for good return.

200706 07 08 45.2006.73 48. It is directly affected to venture capital company because IPO is one way for exist.200404 05 2005.87 44.  Indian venture capital are concentrated on global level due to increasing opportunity in global level. 65 .01 Figure: 5.  In second way .200201 02 03 2003. They make a deal with global company. Now due to globalization venture capital firms are entering at global level. CURRENCY RISK : Exchange Rate(INR/US$) EXCHANGE RATE 60 50 40 30 20 10 0 2000.10 Exchange Rate(INR/US$) IMPACT From the above chart we can see that exchange rate is highly fluctuated.95 44. Foreign institutional investor incest their money Indian stock market and nowadays due to crash down of market the investment of FII is decreasing.2001.11 40. Nowa for a particular country currency risk can be defined in two ways. Nowadays the exchange rate touches to 50 Rs.09 45.42 45.75 47. So there is directly affect the movement of exchange rate. Per dollar. Due to this nobody like to bring IPO.

8 52.1 185. So it is an opportunity for venture capital.5 US dollars in billions 2002-03 2003-04 2004-05 EX ORT ' 2005-06 IM ORT ' 2006-07 2007-08 Figure: 5.5 61.2 126. On the other side when company going to export the company must have good contact with other country¶s company.4 63.4 111. In 2002-03 the value of import and export are 52. It means industry need more money for import and export.7 US$bn.7 78.1 83.11 Value of export and import IMPACT : The value of Import and export are increasing year by year.7 149.7 155. So for that venture capital industry is useful because they have good contact and affiliation network with other country¶s company. 66 .6 103. EXPORT AND IMPORT VALUE OF EX ORT AND IM ORT 200 180 160 140 120 100 80 60 40 20 0 185.7 and 185.7 and 61.4 US$bn respectively and in 2007-08 the value of import and export are 155.

partly because the Indian economy was a ³socialistic and closed´ economy and partly because Indian entrepreneurs are not as proficient at business development as their counterparts in the US. Indian start-ups lack financial transparency and often have limited experience in implementing effective financial processes.  LACK OF FINANCIAL TRANSPERANCY AND OTHER PROCESSES : Again. And most of the Venture Capital companies invest their money in real estate sector. but also in helping the start-up grow rapidly. It is directly affect the home loan rate. The rate of home loan is reduced so it is very helpful for real estate sector. This usually makes the task of the Venture Capital much more difficult not only during the due-diligence phase.5 from 8. There is an improve the flow of credit to productive sectors of the economy. REPO RATE The Repo Rate is now reduced to 6.IPO INFLATION RATE FAVOURABLE UNFAVOURABLE BOTH ¥ ¥ ¥ ¥ ¥ ¥ GDP GROWTH RATE SENSEX CRASHDOWN SMALL SCALE INDUSTRIES INTEREST RATE 67 . FACTOR MERGER& ACQUISITION.5 in july 2008.

3 SOCIAL FACTORS:  Demographic factor:  AGE: Population Demographic Shift Age % of population Under 15 years Between 15-59 years Above 60 years 1997 37.3 Result of Economic factors 5.20% 56.10% 06.30% 07.00% 62.2.4 Population Demographic Shift 68 .CURRENCY RISK : EXPORT & IMPORT REPO RATE ¥ ¥ ¥ Table: 5.90% 2007 30.50% 59.50% Table: 5.30% 06.60% 2002 33.

Earlier the young working peoples are 56.8 9. Young people out of total population.3 62.9 7.  UNEMPLOYMENT RATE: UNEMPL YMENT RATE 10 PERCENTAGE 8 6 4 2 0 2002 2003 2004 2005 2006 2007 2008 8.3%.2% in 2008.3 (Source: Planning Commission Projection data) Figure: 5.5 9.2 8.8 7.12 population demographic shift between 15-59 years In above chart we can see young working people in India is increasing rapidly. The average young age in India is 25 upto year 2025.2 ( www.13 Unemployment rate In India the unemployment rate is very high. It is 9. 69 .1 59.indexmundi.5% in 2004 and now it is 7. No doubt it is decreasing year by year.AGE BETWEEN 15-59 YEARS 64 PERCENTAGE 62 60 58 56 54 52 1997 2002 2007 56. Here there is a great opportunity for Venture capital firm because there is a huge untapped market and they require amount fr strting the Figure: 5.8 8.1% out of total population and nowadays it is 62.

But out of this 80. 70 . Ministry of SSI & ARI.According to one survey by National Entrepreneurship Development Board (NEBD).2% people have future plan to become entrepreneur for starting the business and 80. of India. and training for business and management. on µEntry barriers to entrepreneurship as perceived by youth¶. project idea. So here there is a great opportunity for venture capital firms. Govt.3% person are ready for becoming entrepreneurship if they get help in finance.8% persons 58.8% persons are not ready for business. In this survey out of 1625 respondents 19.

For one thing. VC has never recovered from the commercialization of the internet. What¶s more. which in turn funded too many inexperienced VC partnerships competing for portfolio companies. Wilson believes that VC funds need to generate gross investment multiples of 3 71 . Instead of marketing their operational expertise. ³Combine that with the fact that many internet services companies have low capital needs. Further weakening the VC proposition to investors is the lengthening time to liquidity² owing in part to the credit crunch and stricter post-boom revenue requirements for start-ups (see the exhibit ³Long Waits´). To be an attractive investment category. venture capital needs to off er competitive returns to alternatives on a risk adjusted basis. loweryield investment opportunities. This has dramatically thrown out of whack investment multiples and returns industry-wide. a VC industry expert.´ says the CEO of the VC-backed Silicon Valley firm. Why go to big firm when a business angel can cover financing and give more personalized attention?´ What¶s happening to the industry is. frankly. ³The perception is that top fi rms have too much money to waste time on small investments. VCs are losing their ability to attract the entrepreneurs that will generate better returns. and the personalized attention they can offer. their well-developed networks of experts. deal activity has dried up. ³a train wreck in slow motion. calls the VC math problem. The total number and value of investments in 2009 reached their lowest points since 1997 (see the exhibit ³Few Deals´). then VCs will need to pay the premium and IRR.He calculates how much cash VCs need to generate from liquidity exit events to recoup even a minimum return for investors. will fall. IRR rose spectacularly.Venture Capitalists: Scenario 2010 But the value proposition of the VC industry toward its two clients²investors and entrepreneurs²have since weakened.´ And whether the train can get back on the track is. Meanwhile. many VC firms have resorted to peddling wildly attractive financing options. thanks to what Fred Wilson. Part of that risk adjustment should include a premium for non liquidity. That means VCs are now in the unenviable position of offering investors higher-risk. They¶ve fallen short in marketing their relevance to entrepreneurs who don¶t need capital as much as they need guidance. but perversely this attracted too much capital too quickly from too many investors. which brought a staggering 250% increase in deals between 1997 and 2000 and a quintupling of investment dollars. ceteris paribus. If IPOs are harder to create and take longer to achieve. an open question. as one VC insider puts it.

´ Is Downsizing the Answer? Whether these changes are structural or cyclical is a matter of ongoing vigorous debate. we don¶t think about how to sell it. ³[The attrition has] already started.´ The only truly safe firms are the small number of top-tier firms in the VC industry. and thus the industry must ³downsize to get returns back on track. They will continue to set the terms for investment. ³When we enter an investment. a leading European VC firm.´ said the CEO of a VC backed firm. too many people bidding up valuations and reducing returns for the top guys. ³We see the thoughtful.´ says Bernard Liautaud. of course.(or 2. risk-taking investors. He estimates that the industry is returning a multiple of only 1.´ says a VC partner in San Francisco with more than $840 million in active investments. Venture capitalists must return to their roots of being patient. and ³it will be significant both in number of firms and number of investment professionals per firm. Wilson argues that the venture capital asset class does not scale. Many will likely perish. and cofounder of Business 72 . ³Every VC I know thinks there are too many VCs. ³This shift in strategy dictates that the marketing and fund-raising process must change. above all. I think a 50% decrease in industry size is a fair estimate. But to make the math work in the current climate. while returning healthy dividends to deep-pocketed. a partner at Balderton Capital. the VC industry must. Too many²except. generally meaning 2. What industry veteran Gailen Krug calls the ³spray and pray´ approach²investing in dozens of firms in hopes of a few hits²is on the wane. handson consultancies that nurture their start-ups until they are sustainable.5 after accounting for management expenses). who asked to remain anonymous to protect his funding.6 on investors¶ capital.5% in management fees and 30% in carried interest. the road ahead for VCs appears to be retro. get smaller. The next tier will have to negotiate harder for their terms and will have to accept lower management fees and stakes. Essentially. more fundamentally sound companies with a higher potential for success. ³This is the story. too much dumb money. which translates to about a 10% annual IRR.´ In a sense. The rest will have an even tougher time raising new funds unless they are able to establish uniquely specialized strategies. themselves!´ But it¶s not just size that counts.´ says Krug. quality VCs moving to a more focused approach of investing larger amounts of capital into fewer.

Objects.´ Liautaud says.´ 73 . they evolve.³We think about how to help the entrepreneur build a great company.´ How a VC firm accomplishes that goes well beyond handing over a pile of cash. ³I believe in a Darwinian VC ecosystem where the ones who adapt will succeed. ³Forwardthinking VC funds do not stay still. one of the most successful VC-backed firms of this decade.

74 .

75 y . VCs affect selection both by acting as a scout able to identify future potential and as a coach that can help realize it. The question to be asked is are VCs are good scouts adept at identifying exceptionally promising start-ups ventures or that they are good coaches skilled at injecting expertise and sound business judgment into start-ups ventures. Alliance advantages are particularly strong when timely access to knowledge or resources is essential or when ambiguous technologies force reliance on indirect indicators to assess firm performance. It is generally taken-for-granted that VCs are expert scouts and coaches. Prior research implicates three broad types of signals that may affect VCs¶ assessments of start-ups: y Alliance Capital.Case Study Picking Winners or Building Them? Selection Criteria in New Venture Financing and Performance In the entrepreneurial setting. start-ups characteristics that attract VC investment should also enhance their future performance. Moreover. But only a fraction of the firms VCs fund succeed. while research shows VC-backed start-ups outperform comparable non-VCbacked start-ups (Megginson and Weiss 1991). If VCs build winners. and may even impede it. Intellectual Capital. start-ups characteristics that attract VC investment need not be associated with future start-ups performance. If VCs pick winners. The ability to stake technological claims is a critically important early signal of a start-up¶s future potential. and so the ways in which VCs actually enhance start-ups performance are not well understood (Shepherd and Zacharakis 2001). Existing research thus offers little insight into how VCs create value. A start-up¶s alliances provide signals both of access to valuable resources and knowledge critical to early performance. financial intermediaries such as venture capital firms (VCs) are perhaps the dominant source of selection shaping the environment within which new ventures evolve. as well as serving as external endorsements. most achieving an average rate of return on invested capital (Gifford 1997). By signalling innovative capabilities. suggesting that the start-up has earned positive evaluations from other knowledgeable actors. research has rarely sought to identify whether these results are attributable to inherent differences between VC-backed and non-VC-backed start-ups or to post-investment benefits that accrue to VC-backed firms.

S. and in some cases the alliance effects are detrimental to performance. the largest magnitude effects are associated with human capital. Top management team experience and skills are the most frequent selection criteria selfreported by VCs. Given the large impact of human capital on VC financing decisions. the human capital variables have limited impact on start up performance. although the effects for upstream alliances are generally weaker. A research done on the above by analyzing VC financing and performance of Canadian biotechnology start-ups. in the empirical setting. = $6. While smaller. human capital effects appear to predominate in VC financing decisions. increasing its chances of obtaining VC financing. in particular. One standard deviation increases in the size of a start-up¶s top management team and its president¶s number of other presidencies increased the estimated value of VC financing by C$800K900K annually. Notably. the effects of alliance and intellectual capital are also large relative to the mean value of annual VC financing ($879K. increasing the likelihood that they will obtain VC financing.patents and patents pending help start-ups possessing them to acquire additional resources. A start up whose president currently acted as president for one other biotechnology startup is estimated to raise nearly $4M more in VC financing per year. The appropriability regime surrounding biotechnology patents is particularly strong because patented compounds are difficult to circumvent (Lerner 1995). y y The alliance variables generally have significant effects on performance. the weak link between human capital and start up performance is surprising. that they look ³for people who have high levels of energy. The Conclusions were as follows: 76 . In contrast. and are still hungry for success´ (Byrne 2000: 96). 1991 to 2000 gave the following results: All three µcapitals¶ are implicated in VC financing decisions. are willing to work around the clock. and the few significant effects are split equally between enhancing and impeding performance. y Human Capital. VCs report that ³nothing is more important than people«´ and. The identity and background of top management are widely regarded as important signals of a start-up¶s future potential.3M).D. Nevertheless.

and divergent influence of these factors on start-ups¶ revenue growth and survival point to a combined logic of scouting out start-ups with the right technological and relational µstuff¶ and coaching troubled startups to which. the convergent influence of alliance. VCs offer the greatest potential value postinvestment. Start-ups may thus need to increase their short-term risk of failure in order to attract VCs capable of enhancing their long-run prospects. they are naturally attracted to more risky start-up.Taken together. Our findings may also reflect VCs¶ emphasis on picking portfolios of start-ups in which to invest. given their technological potential. rather than considering investments independently. and consequently a start up that is at low risk of failure may also offer a return too low to interest a VC. intellectual and human capital on VCs¶ financing decisions and start-ups¶ technological performance. 77 . This account is also consistent with classic notions of risk and return ± since VCs traditionally seek extremely high returns.

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