Venture Capital

By:
Soumya Mishra
Roll: 14MBA021
Introduction

A project or activity that The money or fund

involves risk
needed business

The capital invested in a project

in which there is a substantial
element of risk, typically a new
or expanding business.
Venture Capital

• Venture capital is a type of private equity capital

typically provided by professional, outside investors to
new, growth businesses .
• The SEBI has defined Venture Capital Fund in its
Regulation 1996 as ‗a fund established in the form of a
company or trust which raises money through loans,
donations, issue of securities or units as the case may be
and makes or proposes to make investments in
accordance with the regulations‘.
Venture Capitalist

• A venture capitalist (VC) is a person who makes such investments,

these include wealthy investors, investment banks, other financial
institutions other partnerships.

• Venture Capitalists generally:

– Finance new and rapidly growing companies

– Purchase equity securities

– Assist in the development of new products or services

– Add value to the company through active participation.

Features of Venture Capital
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. Venture capital assumes four types of risks, these
are:
• Management risk - Inability of management teams to work together.
• Market risk - Product may fail in the market.
• Product risk - Product may not be commercially viable.
• Operation risk - Operations may not be cost effective
resulting in increased cost decreased
gross margins.
2. Equity Participation & Capital Gains
In the early stage of business, because dividends can be delayed, equity
investment implies that investors bear the risk of venture and would earn a return
commensurate with success in the form of capital gains.
3. Participation In Management
Based upon the experience other companies, a venture capitalist advise
the promoters on project planning, monitoring, financial management, including
working capital and public issue. 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.
4.Length of Investment
The process of having significant returns takes
several years and calls on the capacity and talent of venture
capitalist and entrepreneurs to reach fruition.
5.Illiquid Investment
Venture capital investments are illiquid, that is, not subject to
repayment on demand or following a repayment schedule. Investors seek return
ultimately by means of capital gains when the investment is sold at market
place. The investment is realized only on enlistment of security or it is lost if
enterprise is liquidated for unsuccessful working.

6.High-tech
Venture capital finance caters largely to the needs of first-
generation entrepreneurs who are technocrats, with innovative
technological business ideas that have not so far been
tapped in the industrial field .
 Stages of Venture Capital
Period Risk
Financial Meaning (Funds Percep Activity to be financed
Stage locked in tion
years)
For supporting a
Seed Low level financing needed to 7-10 Extreme concept or idea or R&D
Money prove a new idea. for product
development
Early stage firms that need Initializing operations or
Start Up funding for expenses 5-9 Very High developing prototypes
associated with marketing
and product development.

Start commercials
First Stage Early sales and manufacturing 3-7 High production and
funds. marketing
Financial Meaning Period Risk Activity to be financed
Stage (Funds Percepti
locked on
in
years)
Working capital for early stage Expand market and
Second companies that are selling 3-5 Sufficien growing working capital
Stage product, but not yet turning a tly need
profit . high

Also called Mezzanine financing, Market expansion,

this is expansion money for a acquisition & product
Third newly profitable company . 1-3 Medium development for profit
Stage making company

Fourth Also called bridge financing, it is 1-3 Low Facilitating public issue
Stage intended to finance the "going
public" process .
 Buy – out / Buy – in Financing
• It is a recent development and a new form of investment by venture
capitalist. 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.
• 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.
• It is the most popular form of venture capital amongst later stage financing. It is
less risky as venture capitalist in invests in solid, ongoing and more mature
business. The funds are provided for acquiring and revitalizing an existing product
line or division of a major business. 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, who structure their
investment by judicious combination of debt and equity. Of late there
has been a gradual shift away from start up and early finance
towards MBO opportunities. This shift is because of lower
risk than start up investments.
 Turnaround Finance
It is rare form later stage finance which most of the venture capitalist avoid
because of higher degree of risk. When an established enterprise becomes sick, it
needs finance as well as management assistance foe a major restructuring to
revitalize growth of profits. Unquoted company at an early stage of development
often has higher debt than equity; its cash flows are slowing down due to lack of
managerial skill and inability to exploit the market potential. The sick companies
at the later stages of development do not normally have high debt burden but
lack competent staff at various levels. Such enterprises are compelled to
relinquish control to new management. The venture capitalist has to carry out the
recovery process using hands on management in 2 to 5 years. The risk profile and
anticipated rewards are akin to early stage investment.
Methods of Venture Financing

• A pre-requisite for the development of an active venture capital industry

is the availability of a variety of financial instruments which cater to the
different risk-return needs of investors. They should be acceptable to
entrepreneurs as well.

• Venture capital financing took in forms of

– Equity and quasi equity
– Conditional Loan
– Income notes
– Convertible Debentures
– Cumulative Convertible Preference Share
• Equity: All VCFs in India provide equity but generally their
contribution does not exceed 49 percent of the total equity capital.
Thus, the effective control and majority ownership of the firm remains with
the entrepreneur. They buy shares of an enterprise with an intention to
ultimately sell them off to make capital gains.
• Quasi Equity: A form of finance that combines some of the benefits of
equity and debt
• Conditional Loan: It is repayable in the form of a royalty after the
venture is able to generate sales. No interest is paid on such loans. In
India, VCFs charge royalty ranging between 2 to 15 percent; actual rate
depends on other factors of the venture such as gestation period, cost-
flow patterns, riskiness and other factors of the enterprise.
• Income Note : It is a hybrid security which combines the features of
both conventional loan and conditional loan. The entrepreneur has to
pay both interest and royalty on sales, but at substantially low rates.
• Other Financing Methods: A few venture capitalists,
particularly in the private sector, have started introducing
innovative financial securities like participating debentures,
introduced by TCFC is an example.
Process of Venture Financing

Deal origination

Screening

Due diligence (Evaluation)

Deal structuring

Post investment activity

Exit plan
1. Deal origination
A continuous flow of deals is essential for the venture capital business.
Deals may originate in various ways. Referral system is an important
source of deals. Deals may be referred to the VCs through their parent
organizations, trade partners, industry associations, friends etc.
2. Screening
VCFs carry out initial screening of all projects on the basis of some
broad criteria. For example the screening process may limit projects to
areas in which the venture capitalist is familiar in terms of technology,
or product, or market scope. The size of investment, geographical
location and stage of financing could also be used as the
broad screening criteria.
3. Due Diligence
Most venture capitalists ask for a business plan to make an assessment of the possible
risk and return on the venture. Business plan contains detailed information about the
proposed venture. The evaluation of ventures by VCFs in India includes;

– Preliminary evaluation: The applicant required to provide a brief profile of the

proposed venture to establish prima facie eligibility.

– Detailed evaluation: Once the preliminary evaluation is over, the proposal is

evaluated in greater detail. VCFs in India expect the entrepreneur to have:-
Integrity, long-term vision, urge to grow, managerial skills, commercial
orientation.

– VCFs in India also make the risk analysis of the proposed projects which
includes: Product risk, Market risk, Technological risk and Entrepreneurial

risk. The final decision is taken in terms of the expected

risk-return trade-off.
4. Deal Structuring
In this process, the venture capitalist and the venture company negotiate the
terms of the deals, that is, the amount, form and price of the investment. This process is
termed as deal structuring. The agreement also include the venture capitalist‘s right to
control the venture company and to change its management if needed, buyback
arrangements, acquisition, making initial public offerings (IPOs), etc. Earned out
arrangements specify the entrepreneur‘s equity share and the objectives to be achieved.

5. Post Investment Activities

Once the deal has been structured and agreement finalized, the venture
capitalist generally assumes the role of a partner and collaborator. He also gets involved
in shaping of the direction of the venture. The degree of the venture capitalist‘s
involvement depends on his policy. It may not, however, be desirable for a venture
capitalist to get involved in the day-to-day operation of the venture.
If a financial or managerial crisis occurs, the venture capitalist may
intervene, and even install a new management team.
6.Exit

• Venture capitalists generally want to cash-out their gains in five to ten

years after the initial investment. They play a positive role in directing
the company towards particular exit routes. A venture may exit in one of
the following ways:

• There are four ways for a venture capitalist to exit its investment:
– 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

Venture Capital in India

• The concept of venture capital was formally introduced in India in

1987 by IDBI.

• The government levied a 5 per cent cess on all know-how import

payments to create the venture fund.

• ICICI started VC activity in the same year.

• Later on ICICI floated a separate VC company – TDICI.

Venture capital funds in India
VCFs in India can be categorized into following five groups:

1) Those promoted by the Central Government controlled development finance

institutions. E.g.: - ICICI Venture Funds Ltd.

- IFCI Venture Capital Funds Ltd (IVCF)

- SIDBI Venture Capital Ltd (SVCL)

2) Those promoted by State Government controlled development finance

institutions.

e.g. : - Punjab Infotech Venture Fund

- Gujarat Venture Finance Ltd (GVFL)

- Kerala Venture Capital Fund Pvt Ltd.

- Orissa Venture Capital Fund

3) Those promoted by public banks.

e.g. : - Canbank Venture Capital Fund

- SBI Capital Market Ltd

4)Those promoted by private sector

companies.

e.g.: - IL&FS Trust Company Ltd

- Infinity Venture India Fund

5)Those established as an overseas venture capital fund.

e.g.: - Walden International Investment Group

- HSBC Private Equity management Mauritius Ltd

 SEBI (Venture Capital Fund)
Regulations, 1996
• VCF – ―Venture Capital Fund‖ means a fund established in the form of a trust or a
company including a body corporate and registered under these regulation which—
(i) has a dedicated pool of capital;

(ii) raised in a manner specified in the regulations; and

(iii) invests in accordance with the regulations;

• VCU -―Venture Capital Undertaking‖ means a domestic company—

i. whose shares are not listed on a recognized stock exchange in India;

ii. which is engaged in the business for providing services, production or

manufacture of article or things or does not include such activities or

sectors which are specified in the negative list by the Board with the

approval of the Central Government by notification in the

Official Gazette in this behalf.

Obligations of Venture Capital fund:

• Venture Capital fund shall not carry out any other activity than that of

venture capital fund .

• Venture capital shall disclose investment strategy at the time of making

investments

• VCF shall disclose the duration of the life cycle of the fund

• VCF shall not get its units listed on any recognized stock exchange till the

expiry of three years from the date of issuance of units by VCF

• VCF cannot invite offers from the public for subscribing for its units and shall

only receive monies by the way of private placement of the units

• VCF shall enter into the placement memorandum and subscription

agreement which contains terms and conditions subject to which

money is proposed to be raised from the investors. A copy of the

placement memorandum and subscription agreement will be placed

with the Board along with the actual money collected

• VCF shall maintain its books of accounts, records and

documents for a period of 8 years

Minimum Investment in Venture Capital:

• Venture Capital Fund may raise money from Indian, foreign, non-

resident Indian, by way of issue of units

• Investments below Rs.5 lakhs from any investor shall not be accepted

other than employees, principal officer, directors of venture capital fund

or employees of fund manager or asset management company

• Venture capital fund shall invest minimum of Rs.5 crores in each of the

schemes launched or fund set up

Scheme of VCF can be wound up in the following circumstances:
• In case of trust
 Period of scheme mentioned in the placement memorandum is
over
 In the opinion of the trustees and in the interest of the investors
scheme should be wound up
 75% of the investors in the scheme pass a resolution that the
scheme should be wound up
 If SEBI so directs in the interest of the investors.

• In case of company: wound up in accordance with the provisions of the

Companies Act, 1956
• In case of a body corporate: wound up as per the
statute under which it is incorporated
SEBI (Foreign Venture Capital Investor)
Regulations, 2000
• Registration: Application to be made to the Board in Form A with the
application fee. The applicant should be granted the necessary permission
by RBI to make investments in India. The certificate of registration is granted
in Form B by the Board
• Investment criteria:
 Investor shall disclose his investment strategy
 Can invest all his funds in one venture capital
• Obligations:
 Maintain books of account and records for a period of 8 years
 The foreign investor shall appoint a custodian for custody of the securities ƒ
Custodian shall monitor the investment ƒFurnish periodic reports to the Board ƒ
Furnish information as required/ called for by the Board
 enter into an agreement with a designated bank for
operating the foreign currency account
Future scopes of VC in India
• VC can help in the rehabilitation of sick units.
• VC can assist small ancillary units to upgrade their
technologies
• VCFs can play a significant role in developing countries
in the service sector including tourism, publishing, health
care etc.
• They can provide financial assistance to people coming
out of universities, technical institutes, etc. thus
promoting entrepreneurial spirits.