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MEANING

Venture capital refers to an equity/equity-related investment in a growth oriented small/medium business to enable the investors to accomplish corporate objectives, in return for monetary shareholding in the business or the irrevocable rights to acquire it. Venture capital is a typical ‘private equity investment.’

Venture capital is a popular method by which investors support entrepreneurial talent with finance and business skills to exploit market opportunities with a view to obtaining long-term capital gains. It involves the provision of risk-bearing capital, usually in the form of equity participation, to companies with high growth potential, besides providing more value addition in the form of management advice and contribution to overall strategy.

Long-term investment, generally in high-risk industrial projects with high reward possibilities, is called ‘venture capital.’ The investment may take place at any stage of implementation of the project, between the start-up and commencement of commercial production. Venture capital is also invested in financing the new business and professional activities that carr y a higher degree of success and failure as well. Venture capital implies a high level of risk implicit in the investment of funds.

DEFINITION According to the of 1984, “Venture capital

investment is defined as an activity by which investors support entrepreneurial talent with finance and business skills to exploit market opportunities and thus obtain long-term capital gains.”

RATIONALE The rationale for venture capital arises on account of the fact that there is high expectation for large gains for an entrepreneur which acts as the motivation behind taking up

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spectacular returns. Venture capitalists continuously involve themselves with the client’s investments.net/t583/ . high-technology oriented companies Project Source URL http://www. Many of these fir ms are new. FEATURES Venture capital investment is generally made in new enterprises that use new technology to produce new products. until they are established and are able to raise finance from the conventional industrial finance market. In addition. Venture capital is basically an equity financing method. financing also takes the form of loan finance/convertible debt to ensure a running yield on the portfolio of the venture capitalists.mbaguys. to investee firms. etc. They do not interfere in the management of the firms nor do they acquire a majority /controlling interest in the investee firms. in expectation of high gains or sometimes. It is long-term capital that is injected to enable the business to grow at a rapid pace. Venture capital institutions take an active part in providing value added services such as providing business skills. Some of the ventures yield very high return in order to compensate for the heavy risks related to the ventures. mostly from the start-up stage. either by providing loans or managerial skills or any other support. The rationale for the extension of hands-on management is that venture capital investments tend to be highly non-liquid. Venture capital investmen is made with the objective of obtaining equity ownership in such enterprises initially. Venture capitalists usually finance small & medium sized firms during the early stages of their development. Venture capitalists usually make huge capital gains at the time of exit. Venture capitalists finance high risk-return ventures. and to take part in the growing prospects in the form of capital appreciation subsequently. and regular return on debt financing. It is a long-term investment in growth oriented small/medium firms. the investment being made in relatively new companies when it is too early to go to the capital market to raise funds.Contributed by members of www. The basic objective of a venture capitalist is to make a capital gain on equity investment at the time of exit.mbaguys.net risky investments that carry high return profiles.

mbaguys. It was the Bhatt Committee (Committee on Development of Small & Medium Entrepreneurs) in the year 1972. The committee urged the need for providing such capital to help new entrepreneurs and technologists in setting up industries. aided by U. 4. It prescribed guidelines for achieving technological self-reliance through commercialization and exploitation of technologies. This venture capital fund was launched by IDBI in 1976. which recommended the creation of venture capital. with the same Venture capital funding obtained official patronage with the announcement by the Central Government of the ‘Technology Policy Statement’ in 1983. to encourage new technocrats in the private sector to enter new fields of high technology with inherent high risk. The program Project Source URL http://www.AID with an initial grant of USD 10 million. ORIGIN & GROWTH OF VENTURE CAPITAL IN INDIA Venture capital that originated in India very late is still in its infancy. The ICICI undertook the administration of Program for Application of Commercial Technology (PACT).mbaguys. an all India financial institution in the private sector set up a Venture capital scheme in 1986. 2. The fund.S. The scheme aimed at allocating funds for providing assistance in the form of venture capital to economic activities having risk.net Liquidity of venture capital investment depends on the success or otherwise of the new venture or product.Contributed by members of www.net/t583/ . A brief description of some of the venture capital funds in India is as follows: 1. The Industrial Finance Corporation of India (IFCI) launched the first venture capital fund in the year 1975. Accordingly there will be higher liquidity where the new ventures are highly successful. 3. objective in mind. ‘Risk Capital Foundation’ (RCF) aimed at supplementing ‘promoter’s equity’ with a view to encouraging technologists and professionals to promote new industries. The ICICI. but also high profit potential.

In 1991. as nodal agency. and venture capital operations of ICICI were taken over by it with effect from July 1. 7. In the year 1990.Contributed by members of www. (TDICI) was founded. to ensure continuous revenue earnings. Technology Development and Information Company of India ltd. 1986. viz.mbaguys. 1988. lump sum payments for foreign collaboration and payment for designs and drawings under the R&D Cess Act. VECAUS-I. Funds are made available throughout the project. including royalty payments. in addition to the management of other financing technology development schemes and venture capital fund. an ICICI sponsored company. 8.mbaguys. administers the venture capital fund created by the Central Government with effect from 1 st April. The levy was used as a source of funding the venture capital fund. Technology Development and Information Company of India Ltd. and finally making available a proper exit route for liquidating the investments. In 1988. It took over the activities of RCF. The Risk Capital Foundation (RCF) sponsored by IFCI was converted into Risk Capital and Technology Finance Corporation Ltd. (RCTFC) in the year 1988.net/t583/ . The government started imposing a Research & Development (R & D) levy on all payments made for the purchase of technology from abroad. the corporation was also entrusted with the responsibility of managing another UTI sponsored venture fund entitled ‘VECAUS-II’. 1986. UTI launched VECAUS-III and RCTC was appointed as fund manager. the UTI sponsored “Venture Capital Unit Scheme” was launched in the year 1989. 5. Project Source URL http://www. VENTURE CAPITAL & OTHER FUNDS Venture capital funds are different from other capital funds in man y respects as shown below: Venture capital is advanced for ventures using new technology or new innovation. commencing from commercial production to the successful marketing of products.net aims at financing specific needs of the corporate sector industrial units along the lines of venture capital funding. (TDICI) was appointed as its managers. 6. enhanced worth of the investments. IDBI. In this type of financing the venture capital company remains interested in the overall management of the project due to the high risk involved in the venture.

seed capital & risk capital. was established in 1987. Seed capital and risk capital are provided by all.net Development capital.mbaguys. is generally granted in the form of loans for setting industrial units. with the emphasis on providing interest free finance to encourage professionals to become promotees of industrial projects.net/t583/ .mbaguys. administered by SIDBI. The lender takes special care in ensuring the end use of the credit and requires prompt payment of interest and repayment of the loan amount. and also for expansion and modernization. Both seed capital & risk capital are components of venture capital. in the rural as well as urban areas.India financial institutions in the form of promoter’s contribution to the project. There are no tangible differences between venture capital. with the object of providing seed capital assistance to small entrepreneurs. The National equity fund. with a population below 5 Lakhs. STAGES OF VENTURE CAPITAL FINANCING Setting up a new venture Seed Capital Project Source URL http://www.Contributed by members of www. on the other hand.

net Early stage financing Follow on financing Expansion financing Replacement financing Turnaround financing Exit IPO Sale of shares Puts & Calls This is the early stage of financing.net/t583/ . This stage involves primarily R & D financing .mbaguys.mbaguys.Contributed by members of www. This stage requires constant infusion of funds in order to Project Source URL http://www. This stage involves serious risk. idea & process pertaining to high technology or innovation. as there is no guarantee for the success of the concept.The European venture capital financing defines seed capital as “the financing of the initial product development or capital provided to an entrepreneur to prove the feasibility of a project for start up capital.

mbaguys. which have been selected for commercial production . Venture capitalists provide finance with the view to take advantage of the capital gain arising from equity appreciation on completion of such projects & marketing of its product. Project Source URL http://www. Qualities of business management & technical innovation in the enterprise. competence etc of the entrepreneur before making investments. 2. entrepreneur’s previous experience in similar products. technology & market. Venture financing constitutes financing of ideas developed by R & D wings of companies or at university centers. experience. Successful performance record. 3. initial marketing & establishment of product facilities “.Contributed by members of www. Venture capital finance is provided to the projects. going into the commencement of commercial production & marketing. Brief history of business or project. Chances of success in hi – tech projects are meager. Description of product / service to be manufactured. 1.net/t583/ . realistic business plan with the clear future projects for which seed capital is required.the activity may be one emanating from R & DS stage. This too falls under the category of early stage financing . or arising from transfer of technology from overseas – based business.net sustain the R & D work & establish the process of successful adaptation. The European venture capital association defines start up financing as “the capital needed to finance the product development. The entrepreneur should furnish the following details to the venture capitalists: 1. The venture capital fund considers the following points to safeguard its own interests. The venture capitalists on their part take into consideration such factors as the managerial ability. capacity.the term ‘start up’ refers where a new activity is launched . A synoptic note on career history of entrepreneur & key managers. 2.mbaguys.The activity chosen for funding has the potential for fulfilling effective demand.

& the experience gained by the venture capitalist/merchant bankers from other projects. : The track record of the promoter / entrepreneur /management team / skilled staff resource is analyzed to evaluate the management performance record. evaluation state of domestic competition & international competition is also carried out. Description of technical process involved & technology to be followed in the manufacturing process. : the technical performance assumptions about the product/process/service. cash flows & borrowings over at least a two yr period. Degree of technological obsolesce in technical process. growth prospects in the share market etc.net 4.mbaguys. Project Source URL http://www.mbaguys. 8. : overall completion time is ascertained by evaluating the time schedule given by client for completion of the plan on a realistic basis . : Market potential. 2.in addition. : An analysis in order to evaluate profitability projections on realistic cost assumptions & competitive price setting is under taken. 6. Finance history & forward projections of turnover profits. 3. 7.Contributed by members of www. & then judge the realistic expectation of gains. growth & penetration are analyzed . capacity of the entrepreneur to handle the proposed business plan successfully.net/t583/ . Proposed deal structure for the funding being sought. 4. 1. 5. Description of product /service with existing /future state of competition. ability. as part of venture financing. relating to market size. Venture capitalists appraise projects by taking the following key factors into consideration with the basic objective of assessing the risk involved in financing. 5. the technical strength of the proposed process service with reference to product life cycle are also analyzed.

They will not be generating profit”. it is considered to be the most attractive stage for venture capital financing. whereby venture capitalists extend financing for the purchase of the existing shares from an entrepreneur or their associates in order to reduce their holdings in the unlisted company. The European Venture capital Association defines expansion capital as “the finance provided to fund the expansion or growth of a company which is breaking even or trading at small profit “. The need for additional funds arises when the project encounters cost & time over – runs or when the completed projects starts making losses. & faces increased demand for the product. Financing is also made available for acquisition or takeover.It is required immediately after the start up stage of a project.K & U. Later stage.A. This sale of shares may be by Project Source URL http://www. & the business is growing.mbaguys. Expansion or growth of a company will be used to finance increased production capacity. This is the kind of financing required fro completing the project .net/t583/ . particularly in U. once it has successfully gained a market share. This is one of the later stage financing methods.S. also know as ‘money – out deal’. whereby finance is provided by the venture capitalists for adding production capacity. in a project at this stage promises to be a attractive in terms of earning potential. at this point in the project. thus necessitating the infusion of equity type funding. A later stage financing method.mbaguys. is preferred by venture capitalists around the world. is know as ‘replacement financing ‘. The European venture capital association defines follow on financing or second round finance as “ the provision of capital to a firm which has been in receipt of external capital but whose financial needs have subsequent expanded “.net The European venture capital Association defines early stage finance as “ finance provided to companies that have completed development stage & require further funds to initiate commercial manufacturing & sales. market or product development to provide additional working capital. This type of funding may also be required when the start up has been successful.Contributed by members of www. Financing.

This is provided in the form of a relief package from the existing the exiting venture capital investors.net/t583/ . Such shares may be converted back into ordinary shares if the company is listed & can thereafter be sold. directors & existing shareholders.The finance may also be provided to sustain the current operations of the enterprise. & the enterprise is provided with specialist skills to recover. This type of financing provided by the venture capitalists in the event of an enterprise becoming un profitable after the launch of commercial production. experience. Analyzing venture capital financing proposals – criteria Fundamental analysis refers to an examination of the aspects of the business without which the investor cannot even begin to make an informed decision.S finance is made available to a unlisted & non profitable venture in need of equity funds to allow for turn around .mbaguys.The venture capitalists may buy ordinary shares from vendors and may convert them into preference shares bearing a fixed dividend coupon. including date in incorporation & summary of progress.mbaguys.net persons other than entrepreneurs or their associate’s . As part of fundamental analysis the following f actors are considered : A brief history of the company. : The quality. : A complete description of the company’s products or services. strategy & motivations of management. Project Source URL http://www. This form of financing is popular in the U.Contributed by members of www.

potential competition & unique selling points. Likely impact on cash flow. the proposed investment must be an acceptable addition to the Project Source URL http://www. Analysis of the financial risks & managements plans to cope with these.mbaguys. : Manufacturing & operational aspects of the business. Portfolio analysis consists in examining the venture capitalist portfolio balance at the time the investment proposal is being considered.mbaguys.net/t583/ . access to sources of supply. Likely time – lag between investment & return . Expected value of the company at the notional time of divestment. manufacturing capacity & premises owned or occupied . including a description of the technology used. According. including size & nature of the industry . : An objective analysis of the fundamental risks & management‘s plans to cope with the same. The purpose of financial analysis is to set out the financial implications of a company’s strategy & to measure its performance.Contributed by members of www. Following aspects are considered by venture capitalists to determine the financial viability of the project: Earnings growth potential.location & characteristics of customer base .net : The market which the company serves. Sensitivity of earnings to sales & margins.

mbaguys. investment & tax environment. Divestment calls for venture capitalists to have a clear idea about the method.The basic principle of a successful international investment policy is it join a syndicate with local fund. some companies in a development stage & others in the mature phase of its life cycle. which will have a superior understanding of the market. a competitor wishing to buy the investor’s market share or production capacity. its geographic location & its industry sector. : A venture capital portfolio will typically of some companies. many funds will go in search of foreign investments .net venture capitalists portfolio.mbaguys. : the amount of money per investment has a significant impact on the size of the portfolio. i. is referred to as ‘trade sale ‘. Project Source URL http://www. hands on management will be difficult. & also the social. : In order to reach an acceptable level of portfolio diversity & volume.Contributed by members of www.e. such as MBO investments. if the venture capitalist builds up a large portfolio. a supplier intending to integrate forward. in terms of its size of development. : This is the fourth in the portfolio diversification. the timing & valuation of the company upon divestment.net/t583/ . which are in the start up phase. A trade sale is in the form of an unexpected & unsolicited bid. There are 4 principal means by which venture capitalists realize investments: : The process of selling the investment to a compan y in the trade. or a customer trying to integrate backward or tie up source of supply. Venture capitalists attempts to diversify the portfolio in order t offset problematic or slow growth investments. Moreover.

Under this agreement.net/t583/ . b) . another venture capitalist. Under this method.mbaguys. the company must have a good & complete management team. Issue of securities is made in the stock market. or a management holding company is know as ‘take out’. where the company invites the public to subscribe to its shares at a fixed price. In order to float.Contributed by members of www. which is underwritten. by way of private placement with a major institutional investor such as an insurance company or pension fund manager. c) . where the public is invited to name the number of shares & price it will pay. a) . : I this method. Project Source URL http://www. the venture capital investment is realized through the entrepreneur buying back the venture capitalist shares with the proceeds of the project . typically. The methods of floatation may var y as shown below. where the company‘s shares are placed with prearranged buyers. only the venture capital company will sell its shares while the entrepreneur retains his stake.net : The process of selling the investment to another professional investor. : This is the final exit route for the venture capital investment.mbaguys.For their purpose the entrepreneur is given the option at the time of investment. with a minimum price underwritten.