A STUDY ON WORKING VENTURE CAPITAL IN INDIA

A PROJECT SUBMITTED TO

UNIVERSITY OF MUMBAI

University of Mumbai for partial fulfillment of the degree of

Bachelor of Management Studies

Under tha faculty of commerce

By

SIDDIQUE SAYYADA MOHAMMAD ISHTIYAQUE

Under the Guidance of Prof.RAHUL SHAH

SWAYAM SIDDHI MITRA SANGHS DEGREE NIGHT COLLEGE BHIWANDI

Academic year 2021-2022
 SWAYAM SIDDHI MITRA SANGHS DEGREE NIGHT COLLEGE BHIWANDI
SONADEVI COMPOUND, NEAR OCTRAI NAKA,, PIPE LINE, KALYAN BHIWANDI ROAD,
TEMGHAR, BHIWANDI,Thane -421302
Tel-02522-249191 Mob no :8805249191
Email :ssms.nightdegreecollege@gmail.com Website :www.ssmseducation .com

CERTIFICATE

This is to certify that the project titled RESEARCH PROJECT REPORT ON VENTURE CAPITAL IN INDIA has been submitted in
partial fulfilment for the award of Bachelor of Management Studies (BMS), of Swayam Siddhi mitra sanghs night college
is a result of the bonafite project work carried out by Miss. SIDDIQUE SAYYADA MOHAMMAD ISHTIYAQUE under the
supervision and guidance of Prof. RAHUL SHAH no part of this report has been submitted for the award of any other
degree, diploma, fellowship or other similar titles or prizes. The work has also not been published in any journals/
Magazines.

It is her own work and facts reported by her personnel findings and investigation.

Prof. RAHUL SHAH

DATE:
 DECLARATION

I the undersigned Miss SIDDIQUE SAYYADA MOHAMMAD ISHTIYAQUE hereby declare that the work embodied in this
project work totled ‘A STUDY OF VENTURE CAPITAL IN INDIA’ forms my own contribution to the research work carried
out under the guidance PROF.RAHUL SHAH is a result of my own research work amd has not been previously submitted
to any other university for any other degree /diploma to this or any other university .

Wherever refrence has been made to previous work of other it has been clearly indicated as such and included
bibliography .

I here by further declare that all information of thid document has been obtained and presented in accordance with
academic riles and ethical conduct.

SIDDIQUE SAYYADA MOHAMMAD ISHTIYAQUE

Certified by

Prof.RAHUL SHAH
 Acknowledgements

On the very outset of this report, I would like to extend my sincere & heartfelt obligation
towards all the personages who have helped me in this endeavour. Without their active
guidance, help, cooperation & encouragement, I would not have made headway in the
project.

My deepest gratitude and special thanks to Prof. RAHUL SHAH for his guidance and
constant supervision as well as for providing necessary information regarding the
project and also for their support in completing the project. It is my radiant sentiment to
place on record my best regards, deepest sense of gratitude to my parents, my
colleagues, faculty members and my friends who have helped me in making this project.
Their precious guidance was extremely valuable for me without which this project
would not have been complete.

I perceive this opportunity as a big milestone in my career development. I will strive to use
gained skills and knowledge in the best possible way, and I will continue to work on their

improvement, in order to attain desired career objectives.

 INDEX

Sr.No Title Page No.

1 INTRODUCTION 1

2 ORIGIN OF VENTURE CAPITAL 4

3 MEANING OF VENTURE CAPITAL 6

4 ADVANTAGES AND DISADVANTAGES OF VENTURE CAPITAL 10

5 VENTURE CAPITAL IN INDIA 11

6 TYPES OF VENTURE CAPITAL INVESTORS 18

7 CLASSIFICATION OF VENTURE CAPITAL FUNDS 22

8 CORPORATE VENTURING (INVESTMENT PROCESS) 31

9 ACCESSING VENTURE CAPITAL UNDERTAKING 48

10 ACCESSING VENTURE CAPITAL FUND 51

11 EXIT ROUTES 57

12 REGULATORY FRAMEWORK FOR VENTURE CAPITAL IN INDIA 63

13 SWOT ANALYSIS OF INDIAN VENTURE CAPITAL INDUSTRY 65

14 CONCLUSION 72

15 BIBLOGRAPHY 74

16 QUESTIONNAIRE 75
 INTRODUCTION

The Venture capital sector is the most vibrant industry in the financial market today.
Venture capital is money provided by professionals who invest alongside management
in young, rapidly growing companies that have the potential to develop into significant economic
contributors. Venture capital is an important source of equity for
start-up companies.

Venture capital can be visualized as “your ideas and our money” concept of developing
business. Venture capitalists are people who pool financial resources from high net worth
individuals, corporate, pension funds, insurance companies, etc. to invest in high risk – high
return ventures that are unable to source funds from regular channels like banks and capital
markets.

The venture capital industry in India has really taken off in. Venture capitalists not only
provide monetary resources but also help the entrepreneur with guidance in formalizing his ideas
into a viable business venture.

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Five critical success factors have been identified for the growth of VC in India, namely:

The regulatory, tax and legal environment should play an enabling role as internationally
venture funds have evolved in an atmosphere of structural flexibility, fiscal neutrality and
operational adaptability.

Resources raising, investment, management and exit should be as simple and flexible as
needed and driven by global trends.

Venture capital should become as institutionalized industry that protects investors and
investor firms, operating in an environment suitable for raising the large amounts of risk
capital needed and for spurring innovation through start-up firms in a wide range of high
growth areas.

In view of increasing global integration and mobility of capital it is important that Indian
venture capital funds as well as venture finance enterprises are able to have global
exposure and investment opportunities.

Infrastructure in the form of incubators and R & D need to be promoted using

government support and private management as has successfully been done by countries
such as the US, Israel and Taiwan. This is necessary for faster conversion of R&D and
technological innovation into commercial products.

2
With technology and knowledge based ideas set to drive the global economy in the coming
millennium, and given the inherent strength by way of its human capital, technical skills, cost
competitive workforce, research and entrepreneurship, India can unleash a revolution of wealth
creation and rapid economic growth in a sustainable manner. However, for this to happen, there
is a need for risk finance and venture capital environment, which can leverage innovation,
promote technology and harness knowledge based ideas.The concept of Venture capital is very
recent as compared to USA, UK, Europe, Israel etc.

Venture Capital functions were run by development financial institutions such as the IDBI
(Industrial Development Bank of India), ICICI Bank, and State Financial corporations. Publicly
raised funds were the main source of Venture Capital. This source of financing was however
threatened by market fits/ vagaries and following the raising of minimum paid up capital
requirements for being listed at stock exchanges, problems were in store for small firms with
feasible projects

ORIGIN OF VENTURE CAPITAL :

3
The story of venture capital is very much like the history of mankind. In the fifteenth
century,Christopher Columbus sought to travel westwards instead of eastwards from Europe and
soplanned to reach India. His far- fetched idea did not find favour with the King of Portugal,
whorefused to finance him. Finally, Queen Isabella of Spain decided to fund him and the
voyages ofChristopher Columbus are now empanelled in history. And thus evolved the concept
of VentureCapital.

The modern venture capital industry began taking shape in the post World War 2. It is often
saidthat people decide to become entrepreneurs because they see role models in other people
whohave become successful entrepreneurs because they see role models in other people who
havebecome successful entrepreneurs. Much the same can be said about venture capitalists.
Theearliest members of the organized venture capital industry had several role models, including
these three:

American Research and Development Corporation:

Formed in 1946, whose biggest success was Digital Equipment. The founder of ARD was
General Georges Doroit, a French-born military man who is considered “the father of venture
capital”. In the 1950s, he taught at the Harvard Business School. His lectures on the importance
of risk capital were considered quirky by the rest of the faculty, who concentrated on
conventional corporate management.

J.H. Whitney & Co: Also formed in 1946, one of those early hits was Minute Maid juice. Jock
Whitney is considered one of the industry’s founders.

The Rockefeller Family:

L S Rockefeller, one of those earliest investments was in Eastern Airlines, which is now defunct
but was one of the earliest commercial airlines.

4
The Indian Private Equity and Venture Capital Association was established in 1993 and is based
in New Delhi, the capital of India. IVCA is a member based national organization that represents
Venture capital and Private equity firms, promotes the industry within India and throughout the
world and encourages investment in high growth companies. It enables the development of
venture capital and private equity industry in India and to support entrepreneurial activity and
innovation. The IVCA also serves as a powerful platform for investment funds to interact with
each other. In 2006, the total amount of private equity and venture capital in India reached
US$7.5 billion across 299 deals3.

IVCA members comprise Venture capital firms, Institutional investors, Banks, Business
incubators, Angel investor groups, Financial advisers, Accountants, Lawyers, Government
bodies, Academic institutions and other service providers to the venture capital and private
equity industry. Members represent most of the active venture capital and private equity firms in
India.

These firms provide capital for seed ventures, early stage companies, later stage expansion, and
growth finance for management buy-ins/buy-outs of established companies. So far, the biggest
member firm of IVCA is ICICI Ventures which currently has a $750 million fund, and has $450
million under management.

MEANING OF VENTURE CAPITAL:

5
Venture Capital is defined as providing seed, start-up and first stage finance to companies and
also funding expansion of companies that have demonstrated business potential but do not have
access to public securities market or other credit oriented funding institutions.

Venture Capital is generally provided to firms with the following characteristics:

Newly floated companies that do not have access to sources such as equity capital and/or other
related instruments.

Firms, manufacturing products or services that have vast growth potential.

Firms with above average profitability.

Novel products that are in the early stages of their life cycle.

Projects involving above-average risk.

Turnaround of companies
Venture Capital derives its value from the brand equity, professional image, constructive
criticism, domain knowledge, industry contacts; they bring to table at a significantly lower
management agency cost.

A Venture Capital Fund (VCF) strives to provide entrepreneurs with the support they need to
create up-scalable business with sustainable growth, while providing their contributors with
outstanding returns on investment, for the higher risks they assume.
The three primary characteristics of venture capital funds which make them eminently suitable as
a source of risk finance are:

 That it is equity or quasi equity investment

 It is long term investment and
 It is an active form of investment.
 Venture capitalists

When someone refers to venture capitalist, the image that comes in mind is Mr. Money bags. We
all think of venture capitalists as someone who is sitting on millions of dollars and who with the

6
wave of his magic wand turns your dreams into reality. Well, if that’s what you think is all about
run after him – “play Santa yourself”

Venture Capitalists is like any other professional who is paid for doing his job, yes, venture
capitalist is nothing but a fund manager whose job is to manage funds that are raised. A venture
capitalist gets a fee to invest in companies that interest his investors.

Difference between a Venture Capitalist and Bankers/Money Managers.

Banker is a manager of other people’s money while the venture capitalist is basically an
investor.

7
Venture capitalist generally invests in new ventures started by technocrats who generally are in
need of entrepreneurial aid and funds.

Venture capitalists generally invest in companies that are not listed on any stock exchanges.
They make profits only after the company obtains listing.

The most important difference between a venture capitalist and conventional investors and
mutual funds is that he is a specialist and lends management support and also

 Financial and strategic planning

 Recruitment of key personnel

 Obtain bank and debt financing

 Access to international markets and technology

 Introduction to strategic partners and acquisition targets in the region

 Regional expansion of manufacturing and marketing operations

 Obtain a public listing.

 VENTURE CAPITAL FLOW CHART:

8
ADVANTAGES AND DISADVANTAGES OF VENTURE CAPITAL

Some advantages of venture capital are:

1) Venture Capitalists (VCs) can provide a relatively large amount of capital before a
company goes public.

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2) Many VCs provide managerial or technical advice for companies they invest in.

3) Successful VCs bring legitimacy to new ventures they invest in.

4) VCs may attract other investors.

Some disadvantages of venture capital are:

1) he cost of venture capital is high.

2) Venture Capitalists are not patient investors; performance must meet or exceed

expectations within a specific time.

3) VCs are known to take control of under-performing companies.

VENTURE CAPITAL IN INDIA :

10
Institutionalization of VC in India

To establish the process of institutionalisation of Venture Capital Funding (VCF) in India it is

important to examine the growth of this industry within the context of the larger political and
economic system.

The development of the venture capital industry in India in the 1980’s seemed almost utopian.
India’s highly bureaucratised economy, a conservative social and business outlook and a risk
averse financial system provided little encouragement and institutional space for the venture
capital industry to advance.

The earliest mention of venture capital came in 1973. A committee appointed by the Indian
government to examine the promotion of development of SME’s highlighted the need to endorse
venture capital as a source of funding new entrepreneurs and technology. The Indian economy is
a dualistic economy, dominated by a few massive Public Sector Undertakings (PSU’s) on the
one hand and private sector industry giants such as the Tatas and Birlas on the other.

An entrepreneur starting a sunrise industry would have to do so on his own personal savings or
loans raised through personal contacts and financial institutions. In 1988, the World Bank,
encouraging economic liberalization in third world countries,undertook a study to examine the
possibility of developing venture capital funding chiefly in the private sector. Accordingly, the
Indian government issued its first guidelines to legalise venture capital operations.

11
 They allowed state controlled banks and financial institutions to establish venture capital
subsidiaries. As a result venture capital funding became an extension for developing financial
institutions such as ICICI, IDBI, SIDBI, and State Finance Corporations In the absence of an
independent and organized venture capital industry in India until almost 1998

individual investors and developmental financial institutions played the role of venture
capitalists. Entrepreneurs were largely dependent on private placements, public offerings and
lending by financial institutions.

The growth of the venture capital industry in India can be

divided into 2 :

phases.

The first phase

12
 began post –reform with liberalization of the Indian economy. The Technical Development and
Information Corporation of India (TDICI, now ICICI ventures) and the Gujarat Venture Finance
Limited (GVFL) were set up. Sources of these funds were financialinstitutions, foreign
institutional investors or pension funds and high net-worth individuals.

The second phase of venture capital growth in India began with the realization that venture
capital funding, as an industry has to be regulated. Subsequently, the Government of India issued
guidelines in September 1995 for overseas investment in venture capital in India.

In 1996, the Securities and Exchange Board of India (SEBI) came out with guidelines for venture
capital funds. The move liberated the industry from a number of bureaucratic hassles and paved
the way for greater access to capital. Moreover, competition brought professional business
practices from the mature markets in the west.

In 1997, venture capital funding became prominent in the IT sector. All venture capital funds
that were as of then being employed in other sectors, changed their focus to the IT and Telecom
industry.

With the IT boom today, the Indian venture capital industry has finally turned the curve.
However it is still striving hard to successfully and wholly take off.

During the recession from 1999 – 2001 most of the venture capitalists either closed down or
shifted focus. Almost all of them with the exception of one or two like GvFL centered on
successful firms for their growth and expansion.

13
 Venture capital firms also got engaged into funding buyouts, privatization and restructuring.
Currently, just a few firms are taking the risk of investing into the start-up technology based
companies.

The success achieved in the IT sector, has encouraged VCF in several other sectors like
biotechnology, pharmaceuticals and drugs, agriculture, food processing, telecommunications,
call centers, business process outsourcing (BPO) and services. With proper policy support and
financing of risk capital, entrepreneurship in small and medium sector can succeed.

State Governments have now started taking an active part in the venture capital Industry. States
like Andhra Pradesh have APIDC-VCL, which is a joint venture between the Ventureast Group
and the Andhra Pradesh Industrial Development Corporation funding SME’s like bio-technology
firms, pharma etc.

First-generation entrepreneurs are now finding it easier to raise venture funds. More venture
funds are now being invested in low technology enterprise as is seen in the case of ICICI
Ventures that has a stake in Shoppers Stop.

There are a number of funds, which are currently operational in India and involved in
fundingstart-up ventures. Most of them are not true venture funds, as they do not fund start-ups.

What they do is provide mezzanine or bridge funding and are better known as private equity
players. However, there is a strong optimistic undertone in the air. With the Indian knowledge
industry finally showing signs of readiness towards competing globally and awareness of venture
capitalists among entrepreneurs higher than ever before, the stage seems all set for an overdrive.

The Indian Venture Capital Association (IVCA), is the nodal center for all venture activity in the
country. The association was set up in 1992 and over the last few years, has built up an

14
impressive database. According to the IVCA, the pool of funds available for investment to its 20
members in 1997 was Rs25.6bn. Out of this, Rs10 bn had been invested in 691 projects.

Certain venture capital funds are Industry specific(ie they fund enterprises only in certain
industries such as pharmaceuticals, infotech or food processing) whereas others may have a
much wider spectrum. Again, certain funds may have a geographic focus – like Uttar Pradesh,
Maharashtra, Kerala, etc whereas others may fund across different territories. The funds may be
either close-endedschemes (with a fixed period of maturity) or open-ended. The growth of
venture capital in India from 2000-2006 is as follows:

15
As in the above chart, it is observed that venture capital had a great fall from 2000 to 2003 from
US$ 280 million to US$ 56 million. 2004 was a good start from venture capital in India. And
there more chances of increase in venture capital in India.

These are venture capital companies in India.

Accel Partners India
Artheon Ventures
Artiman Ventures
August Capital Partners
BlueRun Ventures
DFJ India
Epiphany Ventures
Helion Venture Partners

VENTURE CAPITAL IN INDIA

IFCI Venture Capital Funds

India Innovation Investors

InfraCo Asia Development Pte Ltd.

Inventus (India) Advisory Company

JAFCO Asia

Netz Capital

Nexus India Capital

Nirvana Venture Advisors

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Ojas Venture Partners

Reliance Venture

SAIF Partners

Sequoia Capital

Srijan Capital

Tuscan Ventures

Trident Capital

Veddis Ventures

VentureEast

Lambtech Ventures

TYPES OF VENTURE CAPITAL INVESTORS:

The “venture funds” available could be from

Incubators

Angel investors

Venture Capitalists (VCs)

Private Equity Players

17
 Incubators
An incubator is a hardcore technocrat who works with an entrepreneur to develop a business
idea, and prepares a company for subsequent rounds of growth & funding. E-Ventures, Infinity is
examples of incubators in India.

 Angel Investors

An angel is an experienced industry-bred individual with high net worth.

Typically, an angel investor would:

Invest only his chosen field of technology

Take active participation in day-to-day running of the company

Invest small sums in the range of USD 1-3 million

Not insist on detailed business plans

Sanction the investment in up to a month

Help company for “second round” of funding

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VENTURE CAPITAL IN INDIA

The INDUS Entrepreneurs (TiE) is a classic group of angels like: Vinod dham, Sailesh Mehta,
Kanwal Rekhi, Prabhu Goel, Suhas Patil, Prakash Agrawal, K.B Chandrashekhar. In India there
is a lack of home grown angels except a few like Saurabh Srivastava & Atul Choksey (ex-
Asianpaints).

 Venture Capitalists (VCs)

VCs are organizations raising funds from numerous investors & hiring experienced professional
managers to deploy the same. They typically:

Invest at “second” stage

Invest over a spectrum over industry/ies

Have hand-holding “mentor” approach

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Insist on detailed business plans

Invest into proven ideas/businesses

Provide “brand” value to investee

Invest between USD 2-5 million

 Private Equity Players

They are established investment bankers. Typically:

Invest into proven/established businesses

Have “financial partners” approach

Invest between USD 5- 100 million

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CLASSIFICATION OF VENTURE CAPITAL FUNDS ;

Venture funds in India can be classified on the basis of:

Base formation

Financial Institutions Led By ICICI Ventures, RCTC, ILFS, etc.

Private venture funds like Indus, etc.

Regional funds like Warburg Pincus, JF Electra (mostly operating out of Hong Kong).

Regional funds dedicated to India like Draper, Walden, etc.

Offshore funds like Barings, TCW, HSBC, etc.

Corporate ventures like Intel.

To this list we can add Angels like Sivan Securities, Atul Choksey (ex Asian Paints) and others.
Merchant bankers and NBFCs who specialized in "bought out" deals also fund companies. Most
merchant bankers led by Enam Securities now invest in IT companies.

21
Investment Philosophy

Early stage funding is avoided by most funds apart from ICICI ventures, Draper, SIDBI and
Angels. Funding growth or mezzanine funding till pre IPO is the segment where most players
operate. In this context, most funds in India are private equity investors.

Size Of Investment

The size of investment is generally less than US$1mn, US$1-5mn, US$5-10mn, and greater than
US$10mn. As most funds are of a private equity kind, size of investments has been increasing.
IT companies generally require funds of about Rs30-40mn in an early stage which fall outside.
funding limits of most funds and that is why the government is promoting schemes to fund
startups in general, and in IT in particular.

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Value Addition –

The venture funds can have a totally "hands on" approach towards their investment like Draper
or "hands off" like Chase. ICICI Ventures falls in the limited exposure category. In general,
venture funds who fund seed or start ups have a closer interaction with the companies and advice
on strategy, etc while the private equity funds treat their exposure like any other listed
investment. This is partially justified, as they tend to invest in more mature stories.

A list of the members registered with the IVCA as of June 1999, has been provided in
theAnnexure. However, in addition to the organized sector, there are a number of players
operating in India whose activity is not monitored by the association. Add together the infusion
of funds by overseas funds, private individuals, ‘angel’ investors and a host of financial
intermediaries and the total pool of Indian Venture Capital today, stands at Rs50bn, according to
industry estimates!

The primary markets in the country have remained depressed for quite some time now. In the last
two years, there have been just 74 initial public offerings (IPOs) at the stock exchanges, leading
to an investment of just Rs14.24bn. That’s less than 12% of the money raised in the previous two
years. That makes the conservative estimate of Rs36bn invested in companies through the
Venture Capital/private Equity route all the more significant.

Some of the companies that have received funding through this route include:

Mastek, one of the oldest software houses in India

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Geometric Software,a producer of software solutions for the CAD/CAM market

Ruksun Software, Pune-based software consultancy

SQL Star, Hyderabad based training and software development company

Microland, networking hardware and services company based in Bangalore

Satyam Infoway, the first private ISP in India

Hinditron, makers of embedded software

PowerTel Boca, distributor of telecomputing products for the Indian market

Rediff on the Net, Indian website featuring electronic shopping, news, chat, etc

Entevo, security and enterprise resource management software products

Planetasia.com, Microland’s subsidiary, one of India’s leading portals

Torrent Networking, pioneer of Gigabit-scaled IP routers for inter/intra nets

Selectica, provider of interactive software selection

Though the infotech companies are among the most favored by venture capitalists,
companies from other sectors also feature equally in their portfolios. The healthcare
sector with pharmaceutical, medical appliances and biotechnology industries also get
much attention in India. With the deregulation of the telecom sector,

telecommunications industries like Zip Telecom and media companies like UTV and
Television Eighteen have joined the list of favorites. So far, these trends have been in
keeping with the global course.

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However, recent developments have shown that India is maturing into a more
developed marketplace; unconventional investments in a gamut of industries have
sprung up all over the country. This includes:

Indus League Clothing, a company set up by eight former employees of readymade

garments giant Madura, who set up shop on their own to develop a unique virtual
organization that will license global apparel brands and sell them, without owning any
manufacturing units.

They dream to build a network of 2,500 outlets in three years and to be among the top three
readymade brands.

Shoppers Stop, Mumbai’s premier departmental store innovates with retailing and
decides to go global. This deal is facing some problems in getting regulatory approvals.

Airfreight, the courier-company which has been growing at a rapid pace and needed
funds for heavy investments in technology, networking and aircrafts.

Pizza Corner, a Chennai based pizza delivery company that is set to take on global
giants like Pizza Hut and Dominos Pizza with its innovative servicing strategy.

25
Consortium financing

Where the project cost is high (Rs 100 million or more) and a single fund is not in a
position to provide the entire venture capital required then venture funds might act in
consortium with other funds and take a lead in making investment decisions.

This helps in diversifying risk but however it has not been very successful in the India
case.

26
STAGES OF FINANCING BY :

VENTURE CAPITALIST:

Venture capital can be provided to companies at different stages. These include:

I. Early- stage Financing

Seed Financing:

Seed financing is provided for product development & research and to build a management team
that primarily develops the business plan.

Startup Financing:

After initial product development and research is through, startup

financing is provided to companies to organize their business, before the commercial launch of
their products.

First Stage Financing:

Is provided to those companies that have exhausted their initial capital and require funds to
commence large-scale manufacturing and sales.

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 II. Expansion Financing :

Second Stage Financing:

This type of financing is available to provide working capital for initial expansion of companies,
that are experiencing growth in accounts receivable and inventories, and is on the path of
profitability.

Mezzanine Financing:

When sales volumes increase tremendously, the company,

through mezzanine financing is provided with funds for further plant expansion, marketing,
working capital or for development of an improved product.

Bridge Financing:

Bridge financing is provided to companies that plan to go public

within six to twelve months. Bridge financing is repaid from underwriting proceeds

28
 III. Acquisition Financing

As the term denotes, this type of funding is provided to companies to acquire another company.

This type of financing is also known as buyout financing. It is normally advisable to approach
more than one venture capital firm simultaneously for funding, as there is a possibility of delay
due to the various queries put by the VC. If the application for funding were finally rejected then
approaching another VC at that point and going through the same process would cause delay.

If more than one VC reviews the business plan this delay can be avoided, as the probability of
acceptance will be much higher. The only problem with the above strategy is the processing fee
required by a VC along with the business plan. If you were applying to more than one VC then
there would be a cost escalation for processing the application. Hence a cost benefit analysis
should be gone into before using the above strategy.

Normally the review of the business plan would take a maximum of one month and disbursal for
the funds to reach the entrepreneur it would take a minimum of 3 months to a maximum of 6.
Once the initial screening and evaluation is over, it is advisable to have a person with finance
background like a finance consultant to take care of details like negotiating the pricing and
structuring of the deal.

Of course alternatively one can involve a financial consultant right from the beginning
particularly when the entrepreneur does not have a management background.

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CORPORATE VENTURING (INVESTMENT PROCESS) :

VENTURE CAPITAL PROCESS CHART :

30
Even though investor and the entire process that goes into the wooing the venture capital with
your plan.

First, you need to work out a business plan. The business plan is a document that outlines the
management team, product, marketing plan, capital costs and means of financing and
profitability statements.

The venture capital investment process has variances/features that are context specific and vary
from industry, timing and region. However, activities in a venture capital fund follow a typical
sequence. The typical stages in an investment cycle are as below:

Generating a deal flow

Due diligence

Investment valuation

Pricing and structuring the deal

Value Addition and monitoring

Exit

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I] Generating A Deal Flow

In generating a deal flow, the venture capital investor creates a pipeline of ‘deals’ or investment
opportunities that he would consider for investing in. This is achieved primarily through
plugging into an appropriate network. The most popular network obviously is the network of
venture capital funds/investors.

It is also common for venture capitals to develop working relationships with R&D institutions,
academia, etc, which could potentially lead to business opportunities. Understandably the
composition of the network would depend on the investment focus of the venture capital
funds/company.

Thus venture capital funds focussing on early stage technology based deals would develop a
network of R&D centers working in those areas. The network is crucial to the success of the
venture capital investor.

It is almost imperative for the venture capital investor to receive a large number of investment
proposals from which he can select a few good investment candidates finally. Successful venture
capital investors in the USA examine hundreds of business.

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plans in order to make three or four investments in a year.-It is important to note the difference
between the profile of the investment opportunities that a venture capital would examine and
those pursued by a conventional credit oriented agency or an investment institution.

By definition, the venture capital investor focuses on opportunities with a high degree of
innovation.

The deal flow composition and the technique of generating a deal flow can vary from country to
country. In India, different venture capital funds/companies have their own methods varying
from promotional seminars with R&D institutions and industry associations to direct advertising
campaigns targeted at various segments. A clear pattern between the investment focus of a fund
and the constitution of the deal generation network is discernible even in the Indian context.

II] Due Diligence

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Due diligence is the industry jargon for all the activities that are associated with evaluating an
investment proposal. It includes carrying out reference checks on the proposal related aspects
such as management team, products, technology and market.
The important feature to note is that venture capital due diligence focuses on the qualitative
aspects of an investment opportunity.

It is also not unusual for venture capital fund/companies to set up an ‘investment screen’. The
screen is a set of qualitative (sometimes quantitative criteria such as revenue are also used)
criteria that help venture capital funds/companies to quickly decide on whether an investment
opportunity warrants further diligence. Screens can be sometimes elaborate and rigorous and
sometimes specific and brief.

The nature of screen criteria is also a function of investment focus of the firm at that
point.Venture capital investors rely extensively on reference checks with ‘leading lights’ in the
specific areas of concern being addressed in the due diligence.

A venture capitalist tries to maximize the upside potential of any project. He tries to structure his
investment in such a manner that he can get the benefit of the upside potential ie he would like to
exit at a time when he can get maximum return on his investment in the project.

Hence his due diligence appraisal has to keep this fact in mind.

New Financing Sometimes, companies may have experienced operational problems during their
early stages of growth or due to bad management. These could result in losses or cash flow
drains on the company.

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Sometimes financing from venture capital may end up being used to finance these losses. They
avoid this through due diligence and scrutiny of the business plan. Inter-Company Transactions
When investments are made in a company that is part of a group, inter-company transactions
must be analyzed.

III] Investment Valuation

The investment valuation process is an exercise aimed at arriving at ‘an acceptable price’ for the
deal. Typically in countries where free pricing regimes exist, the valuation process goes through
the following steps:

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Evaluate future revenue and profitability

Forecast likely future value of the firm based on experienced market capitalization or
expected acquisition proceeds depending upon the anticipated exit from the investment.

Target an ownership position in the investee firm so as to achieve desired appreciation on the

proposed investment. The appreciation desired should yield a hurdle rate of return on a
Discounted Cash Flow basis.

Symbolically the valuation exercise may be represented as follows:

NPV = [(Cash)/(Post)] x [(PAT x PER)] x k, where

NPV = Net Present Value of the cash flows relating to the investment comprising outflow by
way of investment and inflows by way of interest/dividends (if any) and realization on exit.

The rate of return used for discounting is the hurdle rate of return set by the venture capital
investor.

Post = Pre + Cash

Cash represents the amount of cash being brought into the particular round of financing by the
venture capital investor.

‘Pre’ is the pre-money valuation of the firm estimated by the investor. While technically it is
measured by the intrinsic value of the firm at the time of raising capital.

It is more often a matter of negotiation driven by the ownership of the company that the venture
capital investor desires and the ownership that founders/management team is prepared to give
away for the required amount of capital

PAT is the forecast Profit after tax in a year and often agreed upon by the founders
and the investors (as opposed to being ‘arrived at’ unilaterally). It would also be the net of
preferred dividends, if any.

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PER is the Price-Earning multiple that could be expected of a comparable firm in the
industry. It is not always possible to find such a ‘comparable fit’ in venture capital situations.

That necessitates, therefore, a significant degree of judgement on the part of the venture capital
to arrive at alternate PER scenarios.

‘k’ is the present value interest factor (corresponding to a discount rate ‘r’) for the investment
horizon.

It is quite apparent that PER time PAT represents the value of the firm at that time and the
complete expression really represents the investor’s share of the value of the investee firm.

The following example illustrates this framework:

Example:

Best Mousetrap Limited (BML) has developed a prototype that needs to be

commercialized. BML needs cash of Rs2mn to establish production facilities and set up a
marketing program. BML expects the company will go public in the third year and have
revenues of Rs70mn and a PAT margin of 10% on sales. Assume, for the sake of convenience
that there would be no further addition to the equity capital of the company.

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Prudent Fund Managers (PFM) propose to lead a syndicate of like minded investors with a
hurdle rate of return of 75% (discounted) over a five year period based on BML’s sales and
profitability expectations. Firms with comparable sales and profitability and risk profiles trade at
12 times earnings on the stock exchange. The following would be the sequence of computations:

In order to get a 75% return p.a. the initial investment of Rs2 million must yield an accumulation
of 2 x (1.75)5 = Rs32.8mn on disinvestment in year 5.
BML’s market capitalization in five years is likely to be Rs (70 x 0.1 x 12) million = Rs84mn.
Percentage ownership in BML that is required to yield the desired accumulation will be (32.8/84)
x 100 = 39%

Therefore the post money valuation of BML At the time of raising capital will be equal to
Rs(2/0.39) million = Rs5.1 million which implies that a pre-money valuation of Rs3.1 million for
BML Another popular variant of the above method is the First Chicago Method (FCM)
developed by

Stanley Golder, a leading professional venture capital manager. FCM assumes three possible
scenarios – ‘success’, ‘sideways survival’ and ‘failure’. Outcomes under these three scenarios are
probability weighted to arrive at an expected rate of return:In reality the valuation of the firm is
driven by a number of factors.

The more significant among these are:

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Overall economic conditions: A buoyant economy produces an optimistic long- term outlook for
new products/services and therefore results in more liberal pre-money valuations.

Demand and supply of capital: when there is a surplus of venture capital of venture capital
chasing a relatively limited number of venture capital deals, valuations go up. This can result in
unhealthy levels of low returns for venture capital investors.

Specific rates of deals: such as the founder’s/management team’s track record, innovation/
unique selling propositions (USPs), the product/service size of the potential market, etc affects
valuations in an obvious manner.

The degree of popularity of the industry/technology in question also influences the premoney.
Computer Aided Skills Software Engineering (CASE) tools and Artificial Intelligence were one
time darlings of the venture capital community that have now given place to biotech and
retailing.

The standing of the individual venture capital Well established venture capitals who are sought
after by entrepreneurs for a number of reasons could get away with tighter valuations than their
less known counterparts.

Investor’s considerations could vary significantly. A study by an American venture capital,

‘VentureOne’, revealed the following trend.

Large corporations who invest for strategic advantages such as access to technologies, products
or markets pay twice as much as a professional venture capital investor, for a given ownership
position in a company but only half as much as investors in a public offering.

Valuation offered on comparable deals around the time of investing in the deal.

Quite obviously, valuation is one of the most critical activities in the investment process. It
would not be improper to say that the success for a fund will be determined by its ability to
value/price the investments correctly

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Sometimes the valuation process is broadly based on thumb rule metrics such as multiple of
revenue.

Though such methods would appear rough and ready, they are often based on fairly well
established industry averages of operating profitability and assets/capital turnover ratios Such
valuation as outlined above is possible only where complete freedom of pricing is available.

In the Indian context, where until recently, the pricing of equity issues was heavily regulated,
unfortunately valuation was heavily constrained.

IV] Structuring A Deal

Structuring refers to putting together the financial aspects of the deal and negotiating with the
entrepreneurs to accept a venture capital’s proposal and finally closing the deal. To do a good job
in structuring, one needs to be knowledgeable in areas of accounting, cash flow, finance, legal
and taxation.

40
Also the structure should take into consideration the various commercial issues (ie what the
entrepreneur wants and what the venture capital would require to protect the investment).

Documentation refers to the legal aspects of the paperwork in putting the deal together.
The instruments to be used in structuring deals are many and varied.

The objective in selecting the instrument would be to maximize (or optimize) venture capital’s
returns/protection and yetsatisfy the entrepreneur’s requirements. The instruments could be as
follows:

Instrumen Issues

Loan clean vs secured

Interest bearing vs non interest bearing

convertible vs one with features (warrants)

1st Charge, 2nd Charge,

Stock maturity

Preference shares redeemable (conditions under Company Act)

Participating

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 Par value

nominal shares

Warrants exercise price, expiry period

Common shares New or vendor shares

Par value

partially-paid shares

Options exercise price, expiry period, call, put

In India, straight equity and convertibles are popular and commonly used. Nowadays,
warrantsare issued as a tool to bring down pricing.

A variation that was first used by PACT and TDICI was "royalty on sales". Under this, the
company was given a conditional loan. If the project was successful,

the company had to pay a % age of sales as royalty and if it failed then the amount was written
off. In structuring a deal, it is important to listen to what the entrepreneur wants, but the venture
capital comes up with his own solution

Even for the proposed investment amount, the venture capital decides whether or not the amount
requested, is appropriate and consistent with the risk level of the investment.

The risks should be analyzed, taking into consideration the stage at which the company is in and
other factors relating to the project. (eg exit problems, etc). Promoter Shares
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As venture capital is to finance growth, venture capital investment should ideally be used for
financing expansion projects (eg new plant, capital equipment, additional working capital).

On the other hand, entrepreneurs may want to sell away part of their interests in order to lock-in
a profit for their work in building up the company. In such a case, the structuring may include
some vendor shares, with the bulk of financing going into buying new shares to finance growth.

Handling Director’s And Shareholder’s Loans Frequently, a company has existing director’s and
shareholder’s loans prior to inviting venture capitalists to invest. As the money from venture
capital is put into the company to finance growth,

it is preferable to structure the deal to require these loans to be repaid back to the
shareholders/directors only upon IPOs/exits and at some mutually agreed period (eg 1 or 2 years
after investment).

This will increase the financial commitment of the entrepreneur and the
shareholders of the project.

A typical proposal may include a combination of several different instruments listed above.
Under normal circumstances, entrepreneurs would prefer venture capitals to invest in equity as
this would be the lowest risk option for the company. However from the venture capitals point of
view, the safest instrument, but with the least return, would be a secured loan. Hence, ultimately,

what you end up with would be some instruments in between which are sold to the entrepreneur.

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V] Monitoring and Follow Up

The role of the venture capitalist does not stop after the investment is made in the project. The
skills of the venture capitalist are most required once the investment is made. The venture
capitalist gives ongoing advice to the promoters and monitors the project continuously.

It is to be understood that the providers of venture capital are not just financiers or subscribers to
the equity of the project they fund. They function as a dual capacity, as a financial partner and
strategic advisor.

Venture capitalists monitor and evaluate projects regularly. They keep a hand on the pulse of the
project. They are actively involved in the management of the of the investee unit and provide
expert business counsel, to ensure its survival and growth.

Deviations or causes of worry may alert them to potential problems and they can suggest
remedial actions or measures to avoid these problems. As professional in this unique method of
financing,

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 they may have innovative solutions to maximize the chances of success of the project. After all,
the ultimate aim of the venture capitalist is the same as that of the promoters – the long term
profitability and viability of the investee company.

VI] Exit

One of the most crucial issues is the exit from the investment. After all, the return to the
venturecapitalist can be realized only at the time of exit.

Exit from the investment varies from the investment to investment and from venture capital to
venture capital. There are several exit routes, buy-buck by the promoters, sale to another venture
capitalist or sale at the time of Initial Public Offering, to name a few. In all cases specialists will
work out the method of exit and decide on what is most profitable and suitable to both the
venture capitalist and the investee unit and the promoters of the project.

At present many investments of venture capitalists in India remain on paper as they do not have
any means of exit.

Appropriate changes have to be made to the existing systems in order that venture capitalists
find it easier to realize their investments after holding on to them for a certain period of time. T

his factor is even more critical to smaller and mid sized companies, which are unable to get listed
on any stock exchange, as they do not meet the minimum requirements for
such listings.

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Stock exchanges could consider how they could assist in this matter for listing of
companies keeping in mind the requirement of the venture capital industry.

ACCESSING VENTURE CAPITAL UNDERTAKING :

Venture funds, both domestic and offshore, have been around in India for some years now.

However it is only in the past 12 to 18 months, they have come into the limelight. The rejection
ratio is very high, about 10 in 100 get beyond pre evaluation stage, and I get funded.

Venture capital funds are broadly of two kinds – generalists or specialists. It is critical for
thecompany to access the right type of fund, i.e. who can add value. This backing is invaluable
as focused / specialized funds open doors,assist in future rounds and help in strategy.

Hence, it is important to choose the right venture capitalist.

The standard parameters used by venture capitalists are very similar to any investment decision.
The only difference being exit. If one buys a listed security, one can exit at a price but with an
unlisted security, exit becomes difficult. The key factors which they look for in.

46
The Management

Most businesses are people driven, with success or failure depending on the performance of the
team. It is important to distinguish the entrepreneur from the professional management team.

The value of the idea, the vision, putting the team together, getting the funding in place are
amongst others, some key aspects of the role of the entrepreneur. Venture capitalists will insist
on a professional team coming in, including a CEO to execute the idea. One-man armies are
passe.

Integrity and commitment are attributes sought for. The venture capitalist can provide the
strategic vision, but the team executes it. As a famous Silicon Valley saying goes "Success is
execution, strategy is a dream".

The Idea

The idea and its potential for commercialization are critical. Venture funds look for a scalable
model, at a country or a regional level.

Otherwise the entire game would be reduced to a manpower or machine multiplication exercise.
For example, it is very easy for Hindustan Lever to double sales of Liril - a soap without
incremental capex, while Gujarat Ambuja needs to spend at least Rs4bn before it can increase
sales by 1mn ton.

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Distinctive competitive advantages must exist in the form of scale, technology, brands,
distribution, etc which will make it difficult for competition to enter.

Valuation

All investment decisions are sensitive to this. An old stock market saying "Every stock is a buy
at a price and vice versa". Most deals fail because of valuation expectation mismatch. In India,
while calculating returns, venture capital funds will take into account issues like rupee
depreciation, political instability, which adds to the risk premia, thus suppressing valuations.

Linked to valuation is the stake, which the fund takes. In India, entrepreneurs are still
uncomfortable with the venture capital "taking control" in a seed stage project.

Exit
Without exit, gains cannot be booked. Exit may be in the form of a strategic sale or/and IPO.

Taxation issues come up at the time. Any fund would discuss all exit options before closing a
deal. Sometimes, the fund insists on a buy back clause to ensure an exit.

48
Portfolio Balancing

Most venture funds try and achieve portfolio balancing as they invest in different stages of the
company life cycle.

For example, a venture capital has invested in a portfolio of companies

predominantly at seed stage, they will focus on expansion stage projects for future investments to
balance the investment portfolio. This would enable them to have a phased exit.

In summary, venture capital funds go through a certain due diligence to finalize the deal. This
includes evaluation of the management team, strategy, execution and commercialization plans.
This is supplemented by legal and accounting due diligence, typically carried out by an external
agency.

In India, the entire process takes about 6 months. Entrepreneurs are advised to keep that mind
before looking to raise funds. The actual cash inflow might get delayed because of regulatory
issues. It is interesting to note that in USA, at times angels write checks across the table.

49
ACCESSING VENTURE CAPITAL FUND :

The Business Plan

The first step towards accessing venture capital funding is the preparation of the business plan.
The business plan should be able to provide information regarding the promoters, amount of
funding needed and the time period for which it is needed and how this funding is going to be
paid back to the VC. To answer the above fundamental queries of a venture capital firm
thebusiness plan is to be structured with the necessary information.

Business Plan Coverage

Executive summary

A brief description of the company and the type of business

A summary of the business nature

A description of the experience and expertise of the management team

A summary of the product/service and competition

A summary of financial history and projections

Funds required and equity offered to the investors

A description of use of proceeds

The timing of returns on investment and exit routes offered to the investor

Business background

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A brief history and nature of the business

The industry details of the business involved in

A summary of the future of the business

Product / Service

A description of the product or service

The uniqueness of the product

The present status of the product, that is a concept, prototype or product ready for
Market

Market analysis

The size of the potential market and market niche being pursued

A projection of the trends and future size of the market place

The estimated market share

A description of the competition

The marketing channel

A summary of the potential customers

The possibility of related or new markets that can be developed

Sales and marketing strategy

51
The specific marketing techniques planned to be used

The pricing plans and comparisons with pricing adopted by competitors

The planned sales force and selling strategies for various accounts and markets

The specific approaches for capitalizing on each marketing channel and comparison
With other practices within the industry

Details of advertising and promotional plans

A description of customer service- which markets will be covered by direct sales force,
which by distributors, representative or resellers

Production operations

A description of the production process

Details of the production costs, including labour force, equipment, technology involved,extent
of subcontract or outsourcing, supplier

Management

An organization chart showing the corporate structure

A summary of the board of directors and key employees and details of their skills and
experience .A list of the remuneration for all levels of staff

A proposed plan of how to retain key staff

Risk factors

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A description of the major problems and risks relating to the industry, the company and the
products market

Funds requested

A description of the type of financing, such as equity only or a combination of equity and loan,
and stock options to the investor

The capital structure and ownership before and after the financing

Return on investment and exit

Details of the timing and expected return of the investment

A summary of the exit strategies, such as initial public offering, sale to a third party or
management buyout

Use of proceeds

Specify how the capital will be spent, i.e.; what amount of capital will go to which items.

Financial summaries

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A summary of the company’s financial history and projections of three to five year period

Details of the principal accounting policies of the company and the major assumptions
made about the projections

Appendices

Resumes of key management and employees

Detailed financial forecast and assumptions

Market research report

Company literature and brochures and pictures of the product

A good business plan shows investors the quality and depth of a company’s corporate leadership
and indicates management’s ability to reach stated goals. These factors lie at the heart of the
decision of a venture capitalist to invest in the company’s future.

Selection of Venture capital fund

After the business plan is completed, the next step is to select the venture capital fund, which is
suitable to your proposal. The entrepreneur should first ascertain as to the investment strategy of
the VC with regards to the sector in which the VC is interested as well as the stage at which he
chooses to fund the project.

Based on this information the entrepreneur should shortlist the suitable VCs who match his
requirement and then approach them Financing from venture capital funds is available at various
stages and different VCs provide funding in some or all of the stages.

EXIT ROUTES :

54
After the unit has settled down to a profitable working and the enterprise is in a
position to raise funds through conventional resources like capital market, financial
institution or commercial banks, the venture capitalist liquidate their investment and
make an exit from the investee company.

The ultimate objective of a Venture Capitalist is to realize from his investment by

selling off the same at a substantial capital gain. Infect at the time of making their
investment, the venture capitalist plan their potential exit.

The investee company has to prepare and make suitable adjustments in its capital
structure at the time of realization by the venture capitalist. The convertible preference
shares and convertible loans must be converted to ordinary equity before the exit by
the venture capitalist. In case of non- convertible preference shares and loans by the
venture capitalist these are to be redeemed. At exit the special rights granted to the
venture capitalist cease to operate and venture capital firms normally withdraw their
nominees from the board of the investee company.

The venture capitalist firms have a motto ‘exit at the maximum possible profit or at
a minimum possible loss’ – in case of a failed investment. The exit can be voluntary
or involuntary. Liquidation or receivership of a failed venture is a case of involuntary
exit. The voluntary exit can have four altenative routes for disinvestment:
Buy back of shares by promoters or company.

Sale of stock (shares)

Selling to a new investor

Strategic/ Trade sale

BUY BACK / SHARES REPURCHASE

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Buy back or shares repurchase has the following forms:

The investee company has to buyback its own shares for cash from its venture
capitalist using its internal accruals

The promoters and their group buys back the equity stake of venture capitalist.

The employees’ stock trusts are formed which, in turn, buy the share holding
of the venture capitalist in the company.

The route is suited to the Indian conditions because it keeps the ownership and control
of the promoters intact. Indian entrepreneurs are often very touchy about ownership
and control of their business. Hence in India, first a buy back option is normally given
to the promoters or to the company and only on their refusal the other disinvestments
routes are looked into.

The exact price is mutually negotiated between the

entrepreneur and the venture capitalist. The price is determined considering the book
value of shares, future earning potential of the venture, Price/Earning ratio of similar
listed companies.

The companies were not allowed to buy back their shares in India; however, with
effect from the amendment in the companies act (1999) the companies can do so now.

SALE OF SHARES ON THE STOCK EXCHANGE

The venture capitalist can exit by getting the company listed on the stock exchange
and selling his equity in the primary or secondary market using any of the following
three methods:

56
Sale of shares on stock exchange after listing shares.

Venture capitalists generally invest at the start up stage and propose to disinvest their
holding after the company brings out an IPO for raising funds for expansion. This
listing on stock exchange provides an exit route from investment.

Initial Public Offer (IPO)/ Offer for sale

When the existing entrepreneurs opt out of buy back, the venture capitalists opt for
disinvesting their stocks through public offering.

Disinvestments on OTC

An active capital market supports the venture capital activities. It enables the venture
capitalists to get a suitable valuation for their investment. Besides the regular stock
exchange a well developed OTC market where dealers can trade in shares. The OTC
market enables the new and smaller companies not eligible for listing on a regular
stock exchange to be listed at an OTC exchange and thus provide liquidity to the
investors.

As per the recommendations of a number of committees, an OTC exchange was

required in India. As a result ‘Over The Counter Exchange of India (OTCEI)’ was set
up.

SELLING TO AN INVESTOR`

Many a times for their exit venture capitalist and /or the promoters locate a new
investor, a corporate body or another venture capital firm. The new investors are normally those
who find some sort of synergy between the investee company and

57
their existing operations such that the relationship is useful to both the companies.

This route is also used when the promoters want to get rid of the venture capitalist.
Some venture capitalists, as a policy concentrate their activities to startups and early
stage investments. Such venture capital funds exit paving way for the venture capital
fund specializing in the later stage investment or buy out deals.

Often a growing venture needs second stage financing, if the existing venture capitalist as a
policy does not commit funds for the second stage it normally locates another venture capitalist
that finds the investment attractive enough to enter.

CORPORATE / TRADE SALE

The venture capital firm and the entrepreneur together sell the enterprise to a third
party mostly a corporate entity. Herein the promoters also exit from the venture along
with the venture capitalist.

This is called a corporate, strategic or trade sale. The

reasons for this sale can be varied, difficulty in running the business profitability or a
perceived competition from more established big business houses having huge
resources and business synergy.

On the other hand, where operations of an existing venture are modest, a higher exit
valuation may be achieved in the market rather than by a trade sale, as the market
investors are usually swayed by the appeal of the sector in which the venture operates
rather than the quality of its specific business operations.

Modalities:

The modalities of the trade sale differ from case to case depending upon the nature of
operations, its size, the requirements of the buyer, etc.

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The sale can be in cash, against the shares of the acquiring company or the combination of the
two. The equity owners get the shares of the buyer company in lieu of the shares bein sold by
them. Such sales have the advantage that the seller does not have to pay any tax as the
transaction involves only exchange of shares.

At times, it is through a management buy- out or buy-in, which in turn may be

financed partially by another venture capital fund.

It is important to note that in India if the investee company is a listed company at the time of
trade sale, then the provisions of listing agreement are attracted besides the provisions of the
SEBI regulations of merger and acquisitions are also applicable.

Management Buy-Outs

Venture capital buy-outs are both a successful investment strategy for venture capital
investment as well as an efficient exit route. Buy-out financed by another venture
capitalist primarily by providing debt is known as leveraged buy-out. Buy-out without
participation by another investor is called management buy-out.

Here in the current management group purchases the stake of the venture capitalist. The stock
options and sweat equity have made management buy-out possible in India.

Management buy-outs are important in venture capital market for various reasons:

MBO’s provide an opportunity to managers to become entrepreneurs.

Venture capital investment in buy-out has a lower investment risk than early
stage investment.

MBO’s help smaller enterprises to adapt to technological changes.

Buy-in

is similar to buy-out but involves new management from outside and improvement in the
operations of the venture. Incoming new management is often unfamiliar with the operations of
the venture hence the acquiring company may feel that the continuity of the existing entrepreneur
will be beneficial for the business; the services of the original entrepreneur are retained.

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This helps in implementing the remaining parts of the original ideas and also provides continuity
to the venture.

PRE-REQUISITE FOR THE EFFICIENT EXIT MECHANISM

Legal framework

Smooth procedures for sale / transfer of enterprises

Efficient stock market

Mechanism for listing and trading of equity of smaller companies.

REGULATORY FRAMEWORK FOR VENTURE CAPITAL IN INDIA :

In his budget speech for 1988-89, the finance minister declared that a scheme will be formulated
under which Ventures Capital Companies / Funds will be enabled to invest in new companies
and be eligible for the concessional treatment of capital gains available to non-corporate entities.

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Such companies will have to comply with the following guidelines.

The minimum size of a venture capital company would be Rs.10 crore. If it desires to raise
fundfrom the public the promoter’s share shall be less than 10 per cent.

Venture capital assistance should go mainly to enterprises where the risk element is
comparatively high due to the technology involved being relatively new, untried or very closely
held, and/or the entrepreneur being relatively new and not affluent though otherwise qualified
and the size being modest. The assistances should be mainly for equity support though loan
support to supplement this may also be given.
Thus, venture capital assistance will be given to those entrepreneurs which satisfy the following

parameters :

Total investment not to exceed Rs.10 crores.

New or relatively untried or very closely held or being taken from pilot to commercial state or
which incorporate some significant improvement over the existing ones in India.
Relatively new, professionally or technically qualified with inadequate resources or banking to
finance the project.

A venture capital is required to invest at least 75 per cent of its funds in venture capital activity.
A venture capital is firm can raise funds through pubic issues and/or private placement to finance
VCF/VCCs. Foreign equity upto 25 per cent multilateral / international financial organizations,

development finance institutes, reputed mutual funds, etc., would be permitted provide these are
management neutral and are for medium to long-term investments.

A venture capital fund will be managed by professional such as bankers, managers and
administration and persons with adequate experience of industry, finance, accounts etc.

The changed financial and fiscal environment during post liberalization period hold out bright
future of venture capital in India. With falling tax rates equity becomes attractive, and promoters
want to put in maximum funds. In new companies today. The debt-equity ratio is generally 2:1.

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The promoter has to compulsorily contribute 25 percent of the projects cost, not just the
equity.However because industry is more competitive today promoters are willing to contribute
as much as 40 per cent of the project cost. Banks and other finance institutions being risk averse
will fund a new venture.

Under the circumstances these entrepreneurs will be left with no option but to resort to venture
capital firm, to fill the gap in their contribution to project cost.

This is very likely to continue as professional start their contribution to project cost. This is very
likely to continue as professional start their own units, ancillarisation takes place and large
companies began sourcing their requirement rather than making every thing themselves.

SWOT ANALYSIS OF INDIAN VENTURE CAPITAL INDUSTRY :

STRENGHTS WEAKNESS

An effort initiated from within – Home Faddish

grown
Increased awareness of venture capital Limited exit option

More capital under management by VCFs Uncertainties

Industry crossed learning curve.

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More experienced Venture Capitalists,
Growing number of foreign trained
professionals.
Global competition growing.
Moving towards international standards
Offshore funds bring strong foreign ties
Matured towards market system
Electronic trading – through NSE & BSE.
Valuation addition
Irreversible reform
Regulatory framework evolving
OPPORTUNITIES
Growth capital for strong companies
and Buyouts of weak companies due to
growing global
competition
Financial restructuring have over
leveraged
companies taking place.
Acquisition of quoted small/ medium cap
companies.
Pre money valuations low
Vast potential exists in turn around, MBO,
MBI.
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Policy repatriation, taxation
Bureaucratic meddling and rigid
official
Industry fragmented and polarized-
Mixed V.C culture
Smaller funds with illiquid
investments
Domestic fund raising difficult
Lack of transparency & corporate
governance
Accounting standards
Poor legal administration
Difficult due diligence
Inadequate management depth
Valuation expectations unrealistic
Technical and Market evaluation
Negligible minority protection
rights
Inadequate corporate laws
THREATS
Change in government policies with respect
1. Structuring
2. Taxation
Threats from within Explosive expansion
Greed fro very high returns.
ISSUED FACED BYVENTURE CAPITAL IN INDIA :

The Indian venture capital industry, at the present, is at crossroads. Following are the major
issues faced by this industry.

Limitation on structuring of Venture Capital Funds (VCFs):

VCFs in India are structured in the form of a company or trust fund and are required to follow a
three-tier mechanism-investors, trustee company and AMC. A proper tax-efficient vehicle in the
form of ‘Limited Liability Partnership Act’, which is popular in USA, is not made applicable for
structuring of VCFs in India. In this form of structuring, investors’ liability towards the fund is

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limited to the extent of his contribution in the fund and also formalities in structuring of fund are
simpler.

2. Problem in raising of funds:

In USA primary sources of funds are insurance

companies, pensions funds, corporate bodies etc; while in Indian domestic financial
institutions,multilateral agencies and state government undertakings are the main sources of
funds for VCFs.

Allowing Pension funds, Insurance companies to invest in the VCFs would enlarge the
possibility of setting up of domestic VCFs. Further, if Mutual Funds are allowed to invest upto 5
percent of their corpus in VCFs by SEBI, it may lead to increased availability of fund for VCFs.

3. Lack of Inventive to Investors: Presently, high net worth individuals and corporate are not
provided with any investments in VCFs. The problem of raising funds from these sources further
gets aggravated with the differential tax treatment applicable to VCFs and mutual funds.

While the income of the Mutual funds is totally tax exempted under Section 10(23D) of the
Income Tax Act income of domestic VCFs, which provide assistance to small, and medium
enterprise is not totally exempted from tax. In absence of any inventive, it is extremely difficult
for domestic VCFs to raise money from this investor group that has a good potential.

4. Absence of ‘angel investors’: In Silicon Valley, which is a nurturing ground for venture
funds financed IT companies; initial/ seed stage financing is provided by the angel investors till
the company becomes eligible for venture funding .

There after Venture Capitalist through financial support and value-added inputs enables the
company to achieve better growth rate and facilitate its listng on stock exchanges. Private equity
investors typically invest at expansion/ later stages of growth of the company with large
investments.

In contrast to this phenomenon, Indian industry is marked by an absence of angel investors.

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5. Limitations of investment instruments:

As per the section 10(23FA) of the Income Tax Act, income from investments only in equity
instruments of venture capital undertakings is eligible for tax exemption; whereas SEBI
regulations allow investments in the form of equity shares or equity related securities issued by
company whose shares are not listed on stock exchange.

As VCFs normally structure the investments in venture capital undertakings by way of equity
and convertible instruments such as Optionally/ Fully Convertible Debentures,
Redeemable Preference shares etc., they need tax breaks on the income from equity linked
instruments.

6. Domestic VCFs vis-à-vis Offshore Funds:

The domestic VCFs operations in the country are governed by the regulations as prescribed by
SEBI and investment restrictions as placed by CBDT for availing of the tax benefits.

They pay maximum marginal tax 35 percent in respect of non-exempt income such as interest
through Debentures etc.,

while off- shore funds which are structured in tax havens such as Mauritius are able to overcome
the investment restriction of SEBI and also get exemption from Income Tax under Tax
Avoidance Treaties. This denies a level playing field for the domestic investors for carrying out
the similar activity in the
country.

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7. Limitation on industry segments:

In sharp contrast to other countries where telecom, services and software bag the largest share of
venture capital investments, in India other conventional sectors dominate venture finance.

Opening up of restrictions, in recent time, on investing in the services sectors such as

telecommunication and related services, project consultancy, design and testing services, tourism
etc, would increase the domain and growth possibilities of venture capital.

8. Anomaly between SEBI regulations and CBDT rules:

CBDT tax rules recognize

investment in financially weak companies only in case of unlisted companies as venture
investment whereas SEBI regulations recognize investment in financially weak companies,
which offers an attractive opportunity to VCFs.

The same may be allowed by CBDT for availin of tax exemption on capital gains at a later stage.
Also SEBI regulations do not restrict size of an investment in a company.

However, as per Income tax rules, maximum investment in a company is restricted to less than
20 per cent of the raised corpus of VCF and paid up share capital in case of Venture Capital
Company.

Further, investment in company is also restricted upto 40 per cent of equity of Investee
Company. VCFs may place the investment restriction for VCFs by way of maximum equity
stake in the company, which could be upto 49 per cent of equity of the Investee Company.

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9. Limitations on Exit Mechanism:

The VCFs , which have invested in various ventures, have not been able to exit from their
investments due to limited exit routes and also due to unsatisfactory performance of OTCEI .

The threshold limit placed by various stock exchanges acts as deterrent for listing of companies
with smaller equity base. SEBI can consider lowering of threshold limit for public/listing for
companies backed by VCFs.

Buy-back of equity shares by the company has been permitted for unlisted companies, which
would provide exit route to
investment of venture capitalists.

10. Legal Framework:

Lack of requisite legal framework resulting in adequate penalties in case of suppression of facts
by the promoters-results in low returns even from performing companies. This has bearing on
equity investments particularly in unlisted companies.

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 CONCLUSION

It is essential that Venture Capital Funding agencies play a major role in providing
capital to industrial enterprises especially the SME’s if the Indian economy has to
grow rapidly.

There is a strong case for Venture Capital Funding for SME’s. Judgingfrom the success in the IT,
Biotechnology, Retail and Pharma sectors the VCF agencies can explore possibilities of funding
SME’s in manufacturing and other sectors also.

The government has brought in suitable regulations through the RBI, SEBI and other
institutions to facilitate Venture Capital Funding. VCF agencies should aggressively
promote funding and nurture promising SME’s

The PSB’s and FI’s in India who were reluctant to foray into venture capital funding
have now realised its potential and are willing to partner Indian VCF agencies by
providing funds.

VCF agencies should not only engage in funding but also provide managerial
guidance and support to SME’ s to compete in the present global environment and
enable them to achieve turnovers and profits, which will ultimately result in the

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enterprise going public in the shortest period.

Venture Capital supported enterprises can convert into quality initial public offerings
(IPOs), resulting in capital from pension funds and investors flowing into VC funds.

will also provide protection to investors, especially small investors. Further it will
result in substantial and sustainable employment generation by creating related
ancillary units and support services.

Finally, research laboratories under CSIR, defense laboratories, universities and

technical institutes are carrying out a lot of scientific and technical research.
A
suitable venture capital environment can help in identifying and converting some of
this research into commercial production in the Small and Medium Scale sectors.

Thus, it is apparent that venture capital funding should be encouraged to facilitate

development in small and medium enterprise which in turn leads to overall growth in the Indian
economy.

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 BIBLOGRAPHY

Reference Books & Magazines

Venture Capital, The Indian Experience by I M T Tandey

Issues Facing Indian Venture Capital Industry by H Rajurkar

Business World

India Today

Newspapers

The Times of India

Economics Times

Indian Express

Financial Express

Websites:

www.indiainfoline.com

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www.icfaipress.org

www.webcrawler.com

www.namasthenri.com

Questionnaire

Q. 1Who are the founders and key team members?

2 .What relevant domain experience does the team have?

3.What key additions to the team are needed in the short term?

4.Why is the team uniquely capable to execute the company’s business plan?

4.How many employees does the company have?

5.What do you see as the principal risks to the business?

6.What legal risks do you have? Will the business model comply with applicable
laws, including expanding privacy protections?

7.What technology risks do you have?

8.Do you have any regulatory risks?

9.Are there any product liability risks?

10 .steps do you anticipate taking to mitigate such risks?

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