Venture Capital

Chapter – 1 INTRODUCTION TO VENTURE CAPITAL FUNDS

1.1

Introduction

1.2

The Origin

1.3

Background

1.4

Meani eaning ng and Def Definiti nition on

1.5

Characteristics

1.6

Types of VCF

INTRODU INT RODUCTIO CTION N to Venture Vent ure Capital Capit al 1.1 VENTURE CAPITAL Smal Smalll bus busin iness esses es never never seem seem to have have enough enough mo money ney.. Banke Bankers rs and Suppl Supplie iers, rs, naturally, are important in financing small business growth through loans and credit,  but an equally important source of long term. Growth Capital is the venture capital firm. Venture Capital financing may have an extra bonus, for if a small firm has an adequate equity base; banks are more willing to extend credit. mone ney y prov provid ided ed by prof profes essi sion onal alss who who inve invest st alon alongs gsid idee Venture Venture capital capital is mo management in young, rapidly growing companies that have the potential to develop into signific significant ant economi economicc contribu contributor tors. s. Venture Venture capital capital is an importa important nt source source of  equity for start-up companies. Venture capital is capital typically provided by outside investors for financing of new, growing or struggling businesses. Venture capital investments generally are high risk  investments but offer the potential for above average returns and/or a percentage of  ownershi ownership p of the company company.. A venture venture capitalist capitalist (VC) is a person person who makes makes such inve invest stme ment nts. s. A vent ventur uree capi capita tall fund fund is a pool pooled ed inve invest stme ment nt vehi vehicl clee (oft (often en a  partnership) that primarily invests the financial capital of third-party investors in enterprises that are too risky for the standard capital markets or bank loans. The term ‘Venture Capital’ is understood in many ways. In a narrow sense, it refers to, investment in new and tried enterprises that are lacking a stable record of growth. In a broader sense, venture capital refers to the commitment of capital as shareholding, for the formulation and setting up of small firms specializing in new ideas or new technologies. It is not merely an injection of funds into a new firm, it is a simultaneous input of skill needed to set up the firm, design its marketing strategy and organize and manage it. It is an association with successive stages of firm’s development with distinctive types of financing appropriate to each stage of  development.

According to International Finance Corporation (IFC), venture capital is equity or  equit equity y featu featured red capi capital tal seeki seeking ng invest investme ment nt in new ideas ideas,, new compan companie ies, s, new  production, new process or new services that offer the potential of high returns on investments. As defined defined in Regulat Regulation ion 2(m)of 2(m)of SEBI SEBI (Ventur (Venturee Capita Capitall Funds) Funds) Regulat Regulation ion , 1996 "venture capital fund means a fund established in the form of a company or trust which raises monies through loans, donations issue of securities or units as the case may may be, and and make makess or propo proposes ses to make make invest investme ment ntss in accor accordan dance ce with with these these regulations. Thus venture capital is the capital invested in young, rapidly growing or changing companies that have the potential for high growth. The VC may also invest in a firm that is unable to raise finance through the conventional means. Professionally managed venture capital firms generally are private partnerships or  closely-held corporations funded by private and public pension funds, endowment funds, funds, foundat foundations ions,, corpora corporatio tions, ns, wealthy wealthy individu individuals, als, foreign foreign investor investors, s, and the venture capitalists themselves. Venture capitalists generally: •

Finance new and rapidly growing companies;

•

Purchase equity securities;

•

Assist in the development of new products or services;

•

Add value to the company through active participation;

•

Take higher risks with the expectation of higher rewards;

•

Have a long-term orientation

When considering an investment, venture capitalists carefully screen the technical and  business merits of the proposed company. Venture capitalists only invest in a small  percentage of the businesses they review and have a long-term perspective. Going forward, they actively work with the company's management by contributing their  experience and business savvy gained from helping other companies with similar  growth challenges.

Venture capitalists capitalists mitigate the risk of venture investing by developing developing a portfolio portfolio of  young companies in a single venture fund. Many times they will co-invest with other   professional venture capital firms. In addition, many venture v enture partnership par tnership will manage multiple funds simultaneously. For decades, venture capitalists have nurtured the growth of America's high technology and entrepreneurial communities resulting in signi signifi fican cantt job creat creation ion,, econo economi micc growt growth h and inter internat natio ional nal comp competi etiti tiven venes ess. s. Companies such as Digital Equipment Corporation, Apple, Federal Express, Compaq, Sun Micr Microsy osyst stem ems, s, Intel Intel,, Micr Microso osoft ft,, Yahoo Yahoo,, Airt Airtel el and Genent Genentec ech h are are famo famous us examples of companies that received venture capital early in their development. Venture Capital is the business of establishing an investment fund in the form of  equit equity y finan financin cing g via via inves investm tment entss in the the comm common on stocks stocks,, prefe preferre rred d stock stockss and convertible debentures of various companies. These companies are seen to have a high growth potential and are able to be listed on the stock exchange in order to gain the highest returns in dividends and capital gain.

1.2 The Origin of Venture Capital In the 1920's & 30's, the wealthy families of and individuals investors provided the start up money for companies that would later become famous. Eastern Airlines and Xerox are the more famous ventures they financed. Among the early VC funds set up was the one by the Rockfeller Family which started a special fund called VENROCK  in 1950, to finance new technology companies. USA is the birth place of Venture Capital Capital Industry as we know it today. During most its historical evolution, the market for arranging such financing was fairly informal, relying primarily on the resources of wealthy families. In 1946, American Research and Development Corporation (ARD), a publicly traded, closed-end investment company was formed. ARD's best known investment was the start-up financing it provided in 1958 for computer maker Digital Equipment Corp. ARD was eventually profitable, providing its original investors with a 15.8 percent annual rate of return over its twenty-five years as an independent firm. General Doriot, a professor at Harvard Business School, set up the ARD, the first firm, as opposed opposed to private private individual individuals, s, at MIT to finance finance the commerci commercial al promoti promotion on of 

advanced technology developed in the US Universities. ARD's approach was a classic VC in the sense that it used only equity, invested for long term, and was prepared to live with losers. ARD's investment investment in Digital Digital Equipment Equipment Corporation (DEC) in 1957 was a watershed in the history of VC financing. The number of such specialized investment firms, eventually to be called venture capital firms, began to boom in the late 1950s.The growth was aided in large part by the creation in 1958 of the federal Small Business Investment Company program. Hundreds of SBICs were formed in the 1960s, and many remain in operation today. Slow Growth in 1960s & early 1970s, and the First Boom Year in 1978

During the 1960s and 1970s, venture capital firms focused their investment activity  primarily on starting and expanding companies. c ompanies. More often than not, these companies co mpanies were exploiting breakthroughs in electronic, medical or data-processing technology. As a result, venture capital came to be almost synonymous with technology finance. Venture capital firms suffered a temporary downturn in 1974, when the stock market crashed and investors were naturally wary of this new kind of investment fund. 1978 was the first big year for venture capital. The industry raised approximately $750 million in 1978. Highs & Lows of the 1980s

In 1980, legislation made it possible for pension funds to invest in alternative assets classes such as venture capital firms. 1983 was the boom year - the stock market went through the roof and there were over 100 initial public offerings for the first time in U.S. history. That year was also the year that many of today's largest and most  prominent firms were founded. fou nded. Due to the excess excess of IPOs IPOs and the inexper inexperie ience nce of many many ventu venture re capit capital al fund fund manag managers ers,, VC retur returns ns were were very very low throug through h the 198 1980s. 0s. VC firm firmss retre retrench nched, ed, working hard to make their portfolio companies successful. The work paid off and returns began climbing back up.

Boom Times in the 1990s

The 1990s have been, by far the best years for the Venture Capital Industry. The engine for growth has been the favourable economic climate in the US coupled with the advent of the Internet boom. During this decade, the interest rates were low and the P/Es were very high compared to historical averages. Finally, the rate of M&A activity activity has increase increased d dramati dramaticall cally y in the 1990s, 1990s, creatin creating g more more opportun opportuniti ities es for  small, venture-backed companies to exit (cash out) at high prices. Thee adve Th advent nt of the the Inte Intern rnet et as a new new medi medium um for for both both pers person onal al and and busi busine ness ss communications and commerce created an avalanche of opportunities for venture capit capitali alists sts in the mid mid and late late 199 1990s. 0s. As a resul result, t, the indus industr try y has experi experienc enced ed extraordinary growth in the past few years, both in the number of firms, and in the amount of capital they have raised.

1.3 The Background

In Septemb September er 1995, 1995, Governm Government ent of India India issued issued guideli guidelines nes for overseas overseas venture venture capital investment in India whereas the Central Board of Direct Taxes (CBDT) issued guidelines for tax exemption purposes. (The Reserve Bank of India governs the investment investment and flow of foreign currency in and out of India.) As a part of its mandate to regulate and to develop the Indian capital markets, Securities Securities and Exchange Board of India (SEBI) framed the SEBI (Venture Capital Funds) Regulations, 1996.

Pursuant to the regulatory framework, some domestic VCFs were registered with SEBI. Some overseas investments also came through the Mauritius route. However, the ventu venture re capit capital al indust industry, ry, und unders ersto tood od global globally ly as 'indep 'independ enden entl tly y manag managed ed,, dedic dedicat ated ed poo pools ls of capit capital al that that focus focus on equit equity y or equit equity y linke linked d invest investme ment ntss in  privately held, high growth companies' (The Venture Capital Cycle, Gompers and Lerner, 1999) is still relatively in a nascent stage in India. Figures from the Indian Venture Venture Capital Capital Associat Association ion (IVCA) (IVCA) reveal that, that, till till 2000, 2000, around around Rs. 2,200 2,200 crore crore (US$ 500 million) had been committed by the domestic VCFs and offshore funds

which are members of IVCA. Figures available from private sources indicate that overall funds committed are around US$ 1.3 billion.

Funds that can be invested were less than 50 percent of the committed funds and actual investments were lower still. At the same time, due to economic liberalisation and incre increasi asing ng globa globall outloo outlook k in India India,, an incre increase ased d awar awarene eness ss and inte interes restt of  domestic as well as foreign investors in venture capital was observed. While only 8 domestic VCFs were registered with SEBI during 1996-98, more than 30 additional funds have already been registered in 2000-01.

Institutional interest is growing and foreign venture investments are also on the increase. Given the proper environment and policy support, there is a tremendous  potential for venture vent ure capital activity in India.

The Finance Minister, in the Budget 2000 speech announced, "For boosting high tech sectors and supporting first generation entrepreneurs, entrepreneurs, there is an acute need for higher  investments in venture capital activities." He also said that the guidelines for the registration of venture capital activity with the Central Board of Direct Taxes would  be harmonized with those th ose for registration with the th e Securities and Exchange Board of  India.

SEBI decided to set up a committee on venture capital to identify the impediments and suggest suitable measures to facilitate the growth of venture capital activity in India. Keeping in view the need for global perspective, it was decided to associate Indian entrepreneur from Silicon Valley in the committee. The setting up of this committee committee was primarily motivated by the need to play a facilitating facilitating role in tune with the mandate of SEBI, to regulate as well as develop the market. The committee headed by K. B. Chandrasekhar, Chandrasekhar, Chairman, Exodus Communications Communications Inc., submitted submitted its report on 8 January 2000.

(a) Meaning ning of Venture Vent ure Capital Cap ital 1.4 (a)Mea Venture capital is long-term risk  capital to finance high technology projects which

involve risk but at the same time has strong potential for growth. Venture capitalist  pools their resources including managerial abilities to assist new entrepreneur in the early years of the project . Once the project reaches the stage of profitability, they sell their equity holdings at high premium.

(b) Definition Definit ion of the Ventur Ven turee Capital Capi tal Company Comp any A venture capital company is defined as “a financing institutions which joints an entrepreneur as a co-promoter in a project and shares the risks and rewards of the enterprise.”

1.5 Characteristics of Venture Capital Thee three Th three prima primary ry chara charact cteri erist stics ics of  venture capital funds whic which h may may them them eminently suitable as a source of risk finance are: (1) that it is equity or quasi equity investments; (2) it is long-term investment; and (3) it is an active from of investment.

First, venture capital is equity or quasi equity because the investor assumes risk. There is no security for his investment. Venture capital funds by participating in the equity capital institutionalize the process of risk taking which promotes successful domestic technology development.

Investors of venture capital have no liquidity for a period of time. Venture capitalist or  funds hope that the company they are backing will thrive and after five to seven years from making the investment it will be large and profitable enough to sell its shares in the stock market. But a reward is thee for liquidity and waiting. The venture

capitalists hope to sell their share for many times what they paid for. If the unit fails the venture capitalists losses everything. The probability distribution of expected returns for most venture capital investment is highly skewed to the right. The success rate is 10-20 percent.

Secondly, venture capital is long-term investment involving both money and time.

Finally, venture capital investment involves participation in the management of the company. Venture capitalist participates in the Board and guides the firm on strategic and policy matters. The features of  venture capital generally generally are, financing new and rapidly growing companies; purchase of equity shares; assist in transformation of  innovative technology based ideas into products and services; and value to company  by active participation; participat ion; assume risks in the expectation of large larg e rewards; and possess posse ss a long-term perspective. perspective. These features of venture capital render it eminently eminently suitable suitable as a source of risk capital for domestically developed technologies.

 New venture propo proposal salss in high high techn technol ology ogy area area are are attr attract active ive becau because se of the  perceived possibility of substantial growth and capital gains. Although venture evolved d as a metho method d of early early sage sage financ financin ing g it inclu includes des devel developm opmen ent, t, capital evolve expansion and buyout financing for units which are unable to raise funds through normal financing channels. Units in developing countries need funds for financing various stages of development. Such a broad approach would help venture funds to diversify their investment and spread risks.

1.6 Types of Venture Capital Capital Firms Firms Vent Ventur uree Capi Capita tall can can be divi divide ded d into into many many diff differ eren entt type typess acco accord rdin ing g to the the characteristics characteristics of the shareholders shareholders and sources of investment -- such as private equity firms, banks, financial institutions, private corporations, the government or insurance companies. Generally there are three types of organized or institutional venture capital funds: venture capital funds set up by angel investors, that is, high net worth individual investor investors; s; venture venture capital capital subs subsidi idiarie ariess of corporat corporations ions and private private venture venture capital capital firms/ firms/ funds. funds. Venture Venture capital capital subs subsidi idiarie ariess are establi established shed by major major corporat corporations ions,, commercial bank holding companies and other financial institutions. Venture funds in India can be classified on the basis of the type of promoters. •

Financial institutions led by ICICI ventures, ILFS, etc. Private venture funds like Indus, etc.

•

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

•

Regional funds dedicated to India: Draper, Walden, etc.

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Offshore funds: Barings, TCW, TCW, HSBC, HSBC, etc.

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Corporate ventures: venture capital subsidiaries of corporations.

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Angels: high net worth individual investors.

•

Merchant bankers and NBFCs who specialize in "bought out" deals also fund companies.

On the basis of geographical focus •

Regional

•

Global

On the basis of industry specialty •

IT and IT-enabled services

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Software Products (Mainly Enterprise-focused)

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Wireless/Telecom/Semiconductor 

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Banking

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Media/Entertainment

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Bio Technology/Bio Informatics

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Pharmaceuticals

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Contract Manufacturing

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Retail

On the basis of funding stage: •

Seed/early

•

Late/mbo

•

Pipe

The Venture Capital firms in India can be categorized into the following four groups: 1. All-India All-India DFI-sponsored DFI-sponsored VCFs such as Technology Development Development and Information Company of India Ltd. (TDICI) by ICICI, Risk Capital and Technology Finance Corporation Ltd. (RCTFC) by IFCI and Risk Capital Fund by IDBI 2. SFC-sponsored SFC-sponsored VCFs such as Gujarat Venture Capital Ltd. (GVCL) by GIIC and Andhra Pradesh Venture Capital Ltd. (APVCL) by APSFC 3. Bank-sponsored VCFs such as Canfina and SBI Caps 4.

Private VCFs supported by private sector companies such as Indus Venture

Capital Fund, Credit Capital Venture Fund.

Chapter – 2 Development of VCF in International Arena and INDIA

2.1 VCF in International Arena 2.2 Venture Capital in India 2.3 Future of Venture Capital in India

Development of Venture Capital 2.1 The International arena The modern venture capital industry began taking shape in the post – World War II years. It is often said that people decide to become entrepreneurs because they see role models in other people who have become successful entrepreneurs. Much the same thing can be said about venture capitalists.

USA The history of the venture capital in US traces back to the period after World War II when a few wealthy family groups like Rockefeller, Andrew Carnegie and others took  the initi initiati ative ve.. Th Thee ventur venturee capit capital al indust industry ry was was start started ed by Georg Georgee Detr Detroit oit who who collaborated in establishing Corporation at Boston. From 1965 to 1972 nearly 40 venture capital companies were formed with committed assets of $500 million. It is noted that in the US, the venture capital industry has been associated with technology development. In the 1980s, the US venture industry began to establish its business overseas at large.

UK  In the UK, the development of venture capital owes to the professionally managed specialist fund – Charter House – set up in 1980 for providing risk equity finance for  young and growing small business. In 1983, British Venture Capital Association Association was established with a membership of 33 funds, which rose to 115 in 1992.

JAPAN In 1963, 3 Government assisted companies were established in Tokyo, Osaka and  Nagoya, to provide venture capital t small and medium industries. Leading financial institutions in Japan started venture capital companies for financing high technology indust industri rial al units. units. The rapid rapid growt growth h of indus industr try y in Japan Japan is credi credite ted d to the the easy easy availability of venture capital.

2.2 VENTURE CAPITAL IN INDIA This activity in the past was possibly done by the developmental financial financial institutions like IDBI, IDBI, ICICI ICICI and State State Financi Financial al Corpora Corporatio tions. ns. These These institut institutions ions promote promoted d entities in the private sector with debt as an instrument of funding. For a long time funds raised from public were used as a source of VC. This source however depended a lot on the market vagaries. And with the minimum paid up capital requirements being raised for listing at the stock exchanges, it became difficult for smaller firms with viable projects to raise funds from public. In India, the need for VC was recognised in the 7th five year plan and long term fiscal  policy of GOI. In 1973 19 73 a committee on Development Develop ment of small and medium enterprises highlighted the need to faster VC as a source of funding new entrepreneurs and techno technolog logy. y. VC finan financin cing g reall really y start started ed in India India in 198 1988 8 with with the the form format ation ion of  Techn Technolo ology gy Devel Developm opment ent and Inform Informat atio ion n Comp Company any of India India Ltd. Ltd. (TDIC (TDICI) I)  promoted by ICICI and UTI. The first private VC fund was sponsored by Credit Capital Finance Corporation (CFC) and promoted by Bank of India, Asian Development Bank and the Commonwealth Development Corporation viz. Credit Capital Venture Fund. At the same time Gujarat Venture Finance Ltd. and APIDC Venture Capital Ltd. were started by state level financial institutions. Sources of these funds were the financial institutions, foreign institutional investors or pension funds and high net-worth individuals. Though an attempt was also made to raise funds from the public and fund new ventures, the venture capitalists had hardly any impact on the economic scenario for the next eight years

GROWTH OF FIRMS IN INDIA Year

No. of Funds

Year

No. of Funds

1 9 95

4

20 01

12

1 9 96

7

20 02

6

1 9 97

10

20 03

2

1 9 98

6

20 04

3

1 9 99

5

20 05

1

2 0 00

47

20 06

2

Source: AVCJ/IVCA

India is prime target for venture capital and private equity today, owing to various factors factors such as fast growing growing knowled knowledge ge based based industri industries, es, favourab favourable le investm investment ent opportunities, cost competitive workforce, booming stock markets and supportive regulatory regulatory environment among others. The sectors where the country attracts attracts venture capi capita tall are are IT and and ITES ITES,, soft softwa ware re prod produc ucts ts,, bank bankin ing, g, PSU PSU disi disinv nves estm tmen ents ts,, entertainment and media, biotechnology, pharmaceuticals, contract manufacturing and retail. An offshore venture capital company may contribute upto 100 percent of the capital of a domestic venture capital fund and may also set up a domestic asset management company to manage the fund. Venture capital funds (VCFs) and venture capital companies (VCC) are permitted upto 40 percent of the paid up corpus of the domest dom estic ic unlist unlisted ed compan companie ies. s. Th This is ceil ceiling ing would would be subj subject ect to relev relevant ant equit equity y investment limit in force in relation to areas reserved for SSI. Investment in a single company by a VCF/VCC shall not exceed 5 percent of the paid up corpus of a domestic VCF/VCC. The automatic route is not available.

2.3Future of Venture Capital in India Rapid Rapidly ly changi changing ng econom economic ic enviro environm nment ent accel acceler erate ated d by the the high high techn technolo ology gy explosion, emerging needs of new generation of entrepreneurs in the process and inadequa inadequacy cy of the existin existing g venture capital funds/sc funds/schem hemes es are indicati indicative ve of the tremendous scope for  venture capital in India and pointers to the need for the creation of a sound and broad-based venture capital movement India.

There are many entrepreneurs in India with a good project idea but no previous entrepreneurial track record to leverage their firms, handle customers and bankers. Venture capital can open a new window for such entrepreneurs and help them to

launch their projects successfully.

With rapid international march of technology, demand for newer technology and  products in India has gone up tremendously. the pace of development of new and indigenous technology in the country has been slack in view of the fact that several  process developed d eveloped in laboratories are not commercialized because bec ause of unwillingness of   people to take entrepreneurial risks, i.e. risk their  th eir funds as also undergo the ordeal of  marketing the products and process. In such a situation, venture financing assumes more significance. It can act not only act as a financial catalyst but also provide strong impetus impetus for entrepr entrepreneu eneurs rs to develop develop product productss involvin involving g newer newer technol technologie ogiess and commercialize them. This will give a boost to the development of new technology and would go a long way in broadening the industrial base, creation of jobs, provide a thrust to exports and help in the overall enrichment of the economy.

Another type of situation commonly found in our country is where the local group and a multi-national company may be ready to enter into a joint venture but the former  does not have sufficient funds to put up its share of the equity and the latter is restricted restricted to a certain percentage. For the personal reasons or because of competition, competition, the local group may not be keen to invite any one in its industry or any major private investor to contribute equity and may prefer a venture capital company, as a less intimately involved and temporary shareholder. Venture capitalists can also lend their  expertise and standing to the entrepreneurs.

In service sector, which has immense growth prospects in India, venture capitalists can play significant role in tapping its potentiality to the full. For instance, venture capitali capitalists sts can provide provide capital and exper experti tise se to organ organiza izatio tions ns selli selling ng anti antique que,, remodeled jewellery, builders of resort hotels, baby and health care market, retirement homes and small houses.

In view of the above, it will be desirable to establish a separate national venture capital fund tow which the financial institutions and banks can contribute. In scope

and content such a national venture capital fund should cover:

(i) all the aspects of  venture capital financing in all the three stages of conceptual, developm developmenta entall an exploita exploitation tion phases phases in the process process of commer commercia cializa lization tion of the technological innovation and

(ii) as may of the risk stages-development, manufacturing, marketing, management and and grow growth th as poss possib ible le unde underr Indi Indian an Condi onditi tion ons. s. Th Thee fund fund shou should ld offe offerr a comprehensive package of technical, commercial, managerial and financial assistance and services to building entrepreneurs and be a position to offer innovative solutions to the varied problems faced by them in business promotion, promotion, transfer and innovation. To this end, the proposed national venture capital fund should have at its command multi-disciplinary technical expertise. The major thrust of this fund should be on the  promotion of viable new business in India to take advantage of the on coming high technology revolution and setting up of high growth industries so as to take the Indian economy to commanding heights.

Chapter – 3 Venture Capital Investment Process

3.1

Investment Procedure

3.2

Investment in VC by Banks

3.3

Angle

3.4

Corporate Venturing

3.5

Consortium Financing

3.6

Favourites of the Investors

3.7

Promotion Strategies

3.8

Incentives

3.9

Initiatives

3.10

Special Purpose Vehicle

Venture Capital Investment Process 3.1 Investment Procedure In generating a deal flow, the venture capital investor creates a pipeline of ‘deals’ or  invest investme ment nt opp opport ortuni uniti ties es that that he would would consi consider der inves investi ting ng in. Th This is is achie achieved ved  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 which could could potenti potentially ally lead lead to business business opportun opportuniti ities. es. Understa Understandab ndably ly the composition of the network would depend on the investment focus of the venture capital funds/company. Thus venture capital funds focusing 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. Befor Beforee maki making ng any any invest investme ment nt,, the goal goal as ventu venture re capit capitali alists sts is to und under ersta stand nd virtually every aspect of the target company: the experience and capabilities of the management team, the business plan, the nature of its operations, its products and/or  services, the methods by which sales are made, the market for the products and/or  services, the competitive landscape, and other factors that may affect the outcome of  the investment. While due diligence investigations are viewed by many as mundane and irritating tasks, the process enables venture capitalists to address areas of concern, is an important tool in determining a fair pre-investment valuation, and may help to avoid significant and otherwise unexpected liability following the investment.

The venture capitalists view the due diligence process as a means of identifying and  becoming comfortable with the risks to which their capital will be exposed. The due dili dilige genc ncee proc proces esss invo involv lves es an asse assess ssme ment nt of both both the the micr microe oeco cono nomi micc and and macroeconomic factors that can affect the earnings growth of the target company. The due diligence process also includes a review of the corporate and legal records, including the documentation supporting any previous issuances of the company's securities.

Only one or two business plans in 100 result in successful financing . And of every 10 investments made, only one or two are successful. But this is enough to recover  investments made by the venture capital (VC) in all 10 start-ups in addition to an average 40-50% return! Securing an investment from an institutional venture capital fund is extremely difficult. It is estimated that only five business plans in 100 are viable investment opportunities and only three in 100 results in successful financing. In fact, the odds could be as low as one in 100. More than half of the proposals to venture capitalists capitalists are usually rejected rejected after a 20-30 minute scanning, and 25 per cent are discarded after a lengthier review. The remaining 15 per cent are looked at in more detail, but at least 10 per cent of these are dismissed due to irreconcilable irreconcilable flaws in the management team or the business plan. A Venture Capitalist looks at various aspects before investing in any venture. 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. 1. Initial Evaluation: Evaluation: This involves the initial process of assessing the feasibility feasibility of  the project. 2.

Due dilige diligence nce:: In this stage stage an in-dept in-depth h study study is condu conduct cted ed to anal analyse yse the

feasibility of the project. 3. Deal Deal struct structuri uring ng and and negoti negotiati ation: on: Havin Having g estab establis lished hed the feasi feasibil bilit ity, y, the the instruments that give the required return are structured. 4.

Investment valuation: In this stage, final amount amount for deal is decided.

5.

Documentation: Documentation: This This is the process of creating creating and executing executing legal legal documents documents to

 protect the interest interes t of the venture. 6.

Monit Mo nitori oring ng and Value Value addit additio ion: n: In this stage stage,, the projec projectt is mo monit nitor ored ed by

executives from the venture fund and undesirable variations from the business plan are dealt with. 7.

Exit Policies: There are mainly mainly 3 exit policies followed by VCF’s in general.

1.

Initial Evaluation:

Before any in depth analysis is done on a project, an initial screening is carried out to satisfy the venture capitalist of certain aspects of the project. These include •

Competitive aspects of the product or service

•

Outlook of the target market and their perception of the new product

•

Abilities of the management team

•

Availability of other sources of funding

•

Expected returns

•

Time and resources required from the venture capital firm

Through this screening the venture firm builds an initial overview about the •

Technical skills, experience, business sense, temperament and ethics of the  promoters

•

The stage of the technology being used, the drivers of the technology and the direction in which it is moving

•

Location and size of market and market development costs, driving forces of  the market, competitors and share, distribution channels and other market related issues

•

Financial facts of the deal

•

Comp Competi etiti tive ve edge edge avail availabl ablee to the the the the compan company y and facto factors rs affec affecti ting ng it significantly

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Advantages from the deal for the venture capitalist

•

Exit options available

2. Due diligence Due diligence is term used that includes all the activities that are associated with investigating an investment proposal to assess feasibility. It includes carrying out indepth reference checks on the proposal related aspects such as management team,  products, technology and market. Additional studies and collection of project-based

data are done during this stage. The important feature to note is that venture capital due diligence focuses on the qualitative aspects of an investment opportunity. Areas of due diligence would include General assessment

•



business plan analysis



contract details



collaborators



corporate objectives



SWOT analysis



Time scale of implementation People

•



Managerial abilities, past performance and credibility of promoters



Financial Financial background and feedback about promoters from bankers and previous

lenders 

Details of Board of Directors and their role in the activities



Availability of skilled labour 



Recruitment process •

Products/services, technology and process

In this category the type of questions asked will depend on the nature of the industry into which the company is planning to enter. Some of the areas generally considered are 

Technical details, manufacturing process and patent rights

Competing technologies and comparisons



Raw materials to be used, their availability and major suppliers, reliability of 



these suppliers 

Machinery to be used and its availability



Details of various tests conducted regarding the new product



Product life-cycle



Environment and pollution related issues



Secondary data collection on the product and technology, if so available •

Market

The questions asked under this head also vary depending on the type of product. Some of the main questions asked are 

main customers



future demand for the product



competitors in the market for the same product category and their strategy



pricing strategy



supplier and buyer bargaining power 



channels of distribution



marketing plan to be followed



future sales forecast.

Market survey could be conducted to gather further more accurate and relevant data. •

Finance



Financial forecasts for the next 3-5 years



Analysis of financial reports and balance sheets of firms already promoted or run

 by the promoters of the new venture 

Cost of production



Wage structure details



Accounting process to be used



Financial report of critical suppliers



Returns for the next 3-5 years and thereby the returns to the venture fund



Budgeting methods to be adopted and budgetary control systems



External financial audit if required

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. 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.

3. Structuring a deal Structuring Structuring refers to putting together the financial aspects of the deal and negotiating negotiating with the entrepreneurs to accept a venture capital’s proposal and finally closing the deal. 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).

The instruments instruments to be used in structuring structuring deals are many and varied. The objective in select selectin ing g the the instru instrume ment nt would would be to maxim maximize ize (or optim optimize ize)) ventu venture re capit capital al’s ’s returns/protection and yet satisfy the entrepreneur’s requirements. The instruments could be as follows: Instrument

Issues

Equity shares

new or vendor shares  par value

Pref referen rence sh shares res

 partially-paid shares sh ares rede edeema emable ble (co (cond ndiitions ons un under der Com Compa pany ny Act)  participating  par value

Loan

nominal shares clean vs secured Interest bearing vs non interest bearing convertible vs one with features (warrants) 1st Charge, 2nd Charge, loan vs loan stock 

Warrants Options

maturity exercise price, expiry period exercise price, expiry period, call, put

In India, straight equity and convertibles convertibles are popular and commonly used. Nowadays, warrants are 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 percentage 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 amou amount nt,, the the vent ventur uree capi capita tall deci decide dess whet whethe herr or not not the the amou amount nt requ reques este ted, d, 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). 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 instruments in between which are sold to the entrepreneur. entrepreneur. A number of factors affect the choice of instruments, such as Categories

Factors influencing the choice of Instrument

Comp Compan any y spec specif ific ic

Risk Risk,, curre current nt stag stagee of opera operati tion on,, , expec expecte ted d profi profita tabi bili lity ty,, futur futuree cash cash

Prom Promot oter er spec specif ific ic

flows, investment liquidity options Curr Curren entt fina financ ncia iall posi positi tion on of prom promot oter ers, s, perf perfor orm mance ance trac trackk-re reco cord rd,,

willingness of promoters to dilute stake Product/Projec Product/Projectt specific Future market potential, potential, product life-cycle, gestation period Macr Macro o envi enviro ronm nmen entt Tax opti option onss on diff differ eren entt inst instru rume ment nts, s, lega legall fram framew ewor ork, k, poli polici cies es adopted by competition

4.

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: 1. Evaluate future revenue and profitability 2. Forecast likely future value of the firm based on experienced experienced market capitalization or expect expected ed acquis acquisit ition ion procee proceeds ds depend depending ing upo upon n the antic anticip ipate ated d exit exit from from the the investment. 3. Targ Target et owne owners rshi hip p posi positi tion onss in the the inve invest stee ee firm firm so as to achi achiev evee desi desire red d appreciation on the proposed investment. The appreciation desired should yield a hurdle rate of return on a Discounted Cash Flow basis. In certainty the valuation of the firm is driven by a number of factors. The more significant among these are: • 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: 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, innova innovati tion/ on/ unique unique selli selling ng propo proposi siti tions ons (USP (USPs), s), the the produc product/ t/se servi rvice ce size size of the the  potential market, etc affects a ffects valuations in an a n obvious manner. • The degree of popularity of the industry/technology in question also influences the  pre-money. 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 individual venture capital Well established venture capitals who are sought after by entrepreneurs entrepreneurs for a number of reasons could get away with tighter  valuations than their less known counterparts. • Investor’s considerations considerations could vary significantly. significantly. A study by an American venture capital, Venture One, revealed the following trend. Large corporations who invest for  strategic strategic advantages such as access to technologies, 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. 5.

Documentation

It is the process of creating and executing legal agreements that are needed by the venture fund for guarding of investment. Based on the type of instrument used the different types of agreements are •

Equity Agreement

•

Income Note Agreement

•

Conditional Loan Agreement

•

Optionally Convertible Debenture Agreement etc.

There are also different agreements based on whether the agreement is with the  promoters or the company. The different legal documents that are to be created and executed by the venture firm are 

Shareho Shareholde lders rs agreeme agreement nt - This This agreeme agreement nt is made made between between the venture venture

capitalist, the company and the promoters. The agreement takes into account 

Capital structure.



Transfer of shares: This lays the condition for transfer of equity between the

equity holders. The promoters cannot sell their shares without the prior permission of  the venture capitalist. 

Appointment of Board of Directors



Provisions regarding suspension/cancellation of the investment. The issues under 

which which such cancellati cancellation on or susp suspensi ension on takes takes place place are default default of covenant covenantss and conditions, supply of misleading information, inability to pay debts, disposal and removal of assets, refusal of disbursal by other financial institutions, proceedings against the company, and liquidation or dissolution of the company. 

Equity subscription subscription agreement agreement - This is the agreement between between the venture

capitalist and the company on 

Number of shares to be subscribed by the venture capitalist



Purpose of the subscription



Pre-disbursement conditions that need to be met



Submission of reports to the venture capitalist



Currency of the agreement



Deed of Undertaking - The agreement is signed between the promoters and the

venture venture capitali capitalist st wherein wherein the promoter promoter agrees agrees not to withdra withdraw, w, transfe transfer, r, assign, assign,  pledge, hypothecate etc their investment without prior permission of the venture capitalist. The promoters shall not diversify, expand or change product mix without  permission. 

Income Note Agreement - It contains details of repayment, interest, royalty,

conversion, dividend etc. 

Conditional Conditional Loan Agreement - It contains details on the terms and conditions conditions

of the loan, security of loan, appointment of nominee directors etc.



Deed of Hypothecation, Shortfall Undertaking, Joint and Several Personal

Guarantee Power of Attorney etc. Whenever there is a modification in any of the agreements, then a Supplementary Agreement is created for the same.

6.

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. continuou sly. It is to be understood that the providers of venture capital are not just financiers or  subscribers subscribers to the equity of the project they fund. They function as a dual capacity, as a financial partner and strategic advisor. Ventur Venturee capit capital alist istss mo monit nitor or and evalu evaluat atee proje projects cts regul regularl arly. y. Th They ey are acti activel vely y involved in the management of the of the investor 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, they may have innovative solutions to maximize the chances of success of the project. After all, the ultimate ultimate aim of the venture venture capitalis capitalistt is the same same as that of the promoters promoters – the long term profitability and viability of the investor company. The various styles are:

Hands-on Style suggests supportive and direct involvement of the venture capitalist in the assisted firm through Board representation and regularly advising the entrepreneur  on matte matters rs of techn technolo ology, gy, mark marketi eting ng and and genera generall manag managem ement ent.. India Indian n ventur venturee capitalists do not generally involve themselves on a hands-on basis bit they do have  board representations. represen tations.

Hands-off Style involves occasional assessment of the assisted firms management and its performance with no direct management management assistance being provided. Indian venture funds generally follow this approach. Intermediate Style venture capital funds awe entitled to obtain on a regular basis information about the assisted projects. Venture capital target companies with superior products or services focussed at fast-growing or untapped markets. Venture capitalists must be confident that the firm has the quality and depth in the management team to achieve its aspir aspirat ation ions. s. Th They ey will will want want to ensur ensuree that that the the inves investe teee comp company any has has the willingness to adopt modern corporate governance standards. Firms strong in factors relating to patents, management, idea, and potential are more likely likely to obtain obtain VC financin financing g and willing willing partners partners to supp support ort commer commercial cialisa isation tion activities.

7. EXIT strategies adopted by VCF’s: A venture capital firm enters a relationship with a company with the expectation that a significant return of investment will result when the firm exits the investment. The firm plans for that exit to take place within a certain amount of time, usually from three to six years, depending on the development stage of the company in which it is investing. Depending on the investment focus and strategy of the venture firm, it will seek to exit the investment in the portfolio company. While the initial public offering may be the most glamorous and heralded type of exit for the venture capitalist and owners of  the company, most successful exits of venture investments occur through a merger or  acquisition of the company by either the original founders or another company. Again, the expertise of the venture firm in successfully exiting its investment will dictate the success of the exit for themselves and the owner of the company.

There are several common exit strategies: •

IPO

•

Mergers and Acquisitions

•

Redemption

IPO

The initial public offering is the most glamorous glamorous and visible type of exit for a venture investment. In recent years technology IPOs have been in the limelight during the IPO  boom of the last six years. y ears. At public offering, the venture firm is considered an insider and will receive stock in the company, but the firm is regulated and restricted in how that stock can be sold or  liquidated liquidated for several years. Once this stock is freely tradable, tradable, usually after about two years, the venture fund will distribute this stock or cash to its limited partner investor  investor  who may then manage the public stock as a regular stock holding or may liquidate it upon receipt. Over the last twenty-five years, almost 3000 companies financed by venture funds have gone public. Mergers and Acquisitions

Mergers and acquisitions represent the most common type of successful exit for  venture investments. In an era of large companies dominating industry landscapes, acquisition is often the targeted and most common exit strategy. Smaller companies have, in essence, become the research and development arm of larger companies who often look to buy them once their innovations can contribute to their own profitability. In the case of a merger or acquisition, the venture firm will receive stock or cash from the acquiring company and the venture investor will distribute the proceeds from the sale to its limited partners.

Redemption

Another alternative alternative is that the company may be required to buy back a venture capital firm's stock at cost plus a certain premium. Often a venture capital firm will put a redemption clause (sometimes referred to as a "buy-back clause") in the investment terms which allows them to exit their investment in your company in the event that an IPO or acquisition does not happen within a designated time period.

2.2 Investment in Venture Capital by Banks To encourage the flow of finance for venture capital commercial commercial banks are allowed to invest in venture capital without any limit since April 1999. The monetary and credit policy for the year 1999-2000 provides that the overall ceiling of investment by  banks in ordinary shares, convertible debentures of corporate and units of mutual which h is curre currentl ntly y at 5 per cent cent of their their incre increme menta ntall deposi deposits ts will will stand stand funds whic automat automatica ically lly enhanced enhanced to the extent of banks’ banks’ investme investments nts in venture capital. Further, the Monetary and Credit Policy (1999-2000) provides for the inclusion of  investment in venture capital under priority sector lending.

2.3 Angels Angels are people with less money orientation, orientation, but who play an active role in making an early-stage company work. They are people with enough hands-on experience experience and are experts in their fields. They understand the field from an operational perspective. An entrepreneur needs this kind of expertise. He also needs money to make things happen. Angels bring both to the table of an entrepreneur. Angels are important links in the entire process of venture capital funding. This is  because they support a fledging enterprise at a very early stage – sometime even  before commercialization of the product or service s ervice offering. o ffering. Typically, an angel ang el is an experienced industry-bred individual with high net worth. Angels Angels provide provide funding funding by "first "first round" financin financing g for risky risky investm investments ents – risky risky  because they are a young /start-up company or because their financial track record is unstable.

This venture capital financing is typically used to prepare the company for "second round" round" finan financi cing ng in the the form form of an init initial ial pub publi licc offeri offering ng (IPO) (IPO).. Ex Exam ampl plee – A company may need "first round" financing to develop a new product line, (viz a new drug which would require significant research & development funding) or make a strategic acquisition to achieve certain levels of growth & stability. It is important to choose the right Angel because they will sit on your Board of  Directors, Directors, often for the duration of their investment investment and will assist in getting "second round" round" finan financi cing. ng. When When choosi choosing ng an 'Angel 'Angel',', it is imper imperat ative ive to consi consider der thei their  r  experience in a relevant industry, reputation, qualifications and track record.

Corporate Venturing Even though corporate venturing is an attractive alternative, most companies find it difficult difficult to establish systems, capabilities capabilities and cultures that make good venture capital firms. Corporate managers seldom have the same freedom to fund innovative projects or to cancel them midstream. Their skills are honed for managing mature businesses and not nurturing start up companies. If a firm is to apply the venture capital model, it must understand the characteristics of the model and tailor its venture capital program to its own circumstances without losing sight of these essentials. Success of venture capital firms rest on the following characteristics: Focus on specific industry niches • Although corporate managers have a clear focus in their business, they run into ambiguit ambiguity y with with venture venture program programs. s. Their Their biggest biggest challen challenge ge is to establis establish h clear, clear,  prioritized objectives. object ives. Simply making a good financial fin ancial return is not no t sufficient. • Manage portfolios ruthlessly; abandon losers, whereas abandoning ventures has never been easy for large corporations, whose projects are underpinned by personal relationships, political concerns.

• Venture capital firms share several attributes with start up they fund. They tend to be small, flexible and quick to make decisions. They have flat hierarchies and rely heavily on equity and incentive pay. Apple Computers established a venture fund in 1986 with the dual objectives of  earning high financial return and supporting development of Macintosh software. They structured compensation mechanisms, decision criteria and operating procedures on those of top venture capital firms. While they considered Macintosh as an initial screening factor, its funding decisions were aimed at optimizing financial returns. The result was an IRR of 90 per cent but little success in improving the position of  Macintosh.  New ventures can be powerful source of revenues, diversification and flexibility in rapidly rapidly changin changing g environm environments ents.. The company company shou should ld create create an environm environment ent that encourages venturing. An innovative culture cannot be transplanted but must evolve within within the company company.. Venture Venture investin investing g requires requires differe different nt mindset mindset from typical typical corporate investors.

How relevant is corporate venturing in the Indian scenario? Thee firms Th firms,, which which launc launched hed the the succe successf ssful ul corpor corporate ate ventu ventures res had had creat created ed new  products in the market operating oper ating at the higher end of the value chain and an d had attained a certain size in the market. Most Indian companies are yet to move up the value chain chain and consol consolid idat atee thei theirr pos posit ition ion as player playerss in the globa globall marke market. t. Corpo Corporat ratee venturing models would probably benefit Indian companies who are large players in the Indian market in another five to 10 years by enabling them to diversify and at the same time help start up companies. Multinationals led by Intel are the best examples of corporate venturing in an Indian context.

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 may 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.

In 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 overse overseas as funds, funds, priva private te indivi individua duals ls,, ‘angel ‘angel’’ inves investo tors rs and a hos hostt of finan financia ciall 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 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 • Geometric Software, a producer of software solutions for the CAD/CAM market • Ruksun Software, Pune-based software consultancy • 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

2.6 Favourites of the Investors 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, pharmaceutical, medical appliances appliances and biotechnology biotechnology industries also get much attenti ntion in

Indi ndia. With

t he

der deregul gulation ion

of

the telecom sect ector,

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

Howev However, er, recen recentt devel developm opmen ents ts have have sho shown wn that that India India is matur maturing ing into into a mo more re 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

decide decidess to go global global.. Th This is deal deal is facin facing g som somee proble problems ms in getti getting ng regul regulato atory ry 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. Car designer Dilip Chhabria, who plans to turn his studio, where he remodels and

overhauls cars into fancy designer pieces of automation, into a company with a turnover of Rs1.5bn (up from Rs40mn today).

2.7 Promotion Strategies •

There is inadequate flow of applications for venture financing in India. The need is promotional efforts not only to increase the flow of applications but also to  popularize the generic idea of venture financing. fin ancing. The promotion efforts effo rts of venture capital funds in India could be classified as Contacting R&D organisations

•

Conducting seminars and industrial meets where the salient features of venture capital schemes can be presented to prospective entrepreneurs

•

Creation of information services

•

Promotion of entrepreneurial activities

•

Venture Fairs in which the members of the VC industry listen to entrepreneurs about their new ideas and business propositions

•

Venture Capital Networks and Associations

2.8 Incentives Recogniz Recognizing ing the import importance ance of venture venture capital, capital, the governm government ent introdu introduced ced major  major  liber liberali alisat sation ion of tax tax treat treatme ment nt for ventu venture re capit capital al funds funds and and simpli simplifi ficat cation ion of   procedures. These included inc luded the following: •

SEBI was recognized as the single nodal agency.

•

A new clause (23FB) in Section 10 of Income Tax Act was introduced with effect from 1st March 2000. This clause stated that any income, of a venture capital company or a venture capital fund, from any investments made in venture capital undertaking, would not be included in computing the total income.

•

Section 115U was also introduced in the Income Tax Act with effect from the assessment year 2001-02 to establish a VC pass through. This means that the VC profits will not be taxed twice. The regulated VC Fund (with SEBI) would  be exempted from tax (subject to certain conditions) but the VC investor in vestor will have to pay tax.

•

Earlier on, if a VCF wished to avail certain tax benefits, the VCF had to exit from investments investments made in a venture capital undertaking undertaking (VCU) within twelve months of the VCU obtaining a listing. However, this requirement was done away around November 2000. The Finance Bill 2001, proposes to amend section 10 (23 FB) so as to provide that a VCC / VCF will continue to be eligible for exemption under section 10 (23 FB), even if the shares of the VCU, VCU, in whic which h the the VCC VCC / VCF VCF has has made made the the init initia iall inve invest stme ment nt,, are are subsequently listed in a recognized stock exchange in India.

2.9 Initiatives

There have been a number of initiatives by the Government as well as the industry to  pave way wa y for a business busines s and regulatory environment that is conducive to new venture development and to innovation at the user end. Some of the initiatives in the past have included those by the Ministry of Finance, the Securities, Exchange Board of India (SEBI), Ministry of Information Technology (formerly Department of Electronics), State Governments, Financial Institutions, the Indian Venture Capital Association. These initiatives initiatives resulted in the availability availability of more than US$ 500 million million of venture funds for Indian ventures during 1999-2000. With the growing realisation of the immense potential offered by Indian technology companies, funding opportunities are rapidly increasing. The Government of India has already taken laudable steps to facilitate the creation of  an environment that is conducive for venture capital funds and start-ups in India. These include: •

introduction of sweat equity,

•

allow allowin ing g ventu venture re capit capital al funds funds to offse offsett losse lossess incurr incurred ed in one compa company ny against against profits profits from another another and establis establishmen hmentt of governm government ent facilit facilitated ated venture capital funds.

However, the present regulatory framework is still not enough to provide for an environment that lays stress on •

encouraging the flow of venture funds,

•

easy exit options (for either party),

•

mentoring,

•

non-qualified availability of funds,

•

and flow of public funds for enterprise building in India.

India needs to encourage the growth of risk capital by acting on three fronts: 1. The Governm Government ent of India and Indian Indian financial financial institu institution tionss should catalyse catalyse the  process by creating creatin g Israel's Isr ael's Yozma-like Yoz ma-like funds. f unds. This will stimulate competition  but also protect entrepreneurs en trepreneurs from inevitable inevitab le risks.

2. India India should should amend amend its regulat regulatory ory framew framework ork so that that the VC funds funds can earn earn a reasonable return on their risk capital. 3. India India should active actively ly promote promote the infusion infusion of VC skills and capabili capabilities ties,, either   by attracting global glob al VC funds or attracting managers man agers from these funds. funds . However, the above moves need to be substantiated with the earliest implementation of the recommendations of the SEBI Committee on Venture Capital.

2.10 2.10 SPECI SPECIAL AL PURP PURPOS OSE E VEHI VEHICL CLE E The Definition An acco accoun unt, t, admi admini nist ster ered ed by a thir third d part party y that that hold holdss shar shares es boug bought ht back back by themanagement in trust.

THE ADVANTAGES

Greater security for lenders

THE DISADVANTAGES

Less Less cont contro roll over over cash cash flow flowss gene genera rate ted d by  project

improves credit rating Lowers the cost of capital

Tax treatment of SPV still unclear  

Better management of debtAdministration fees can be high repayment Enables Enables new ventures ventures to to raise funds. funds. Requires Requires intensive intensive monitoring monitoring by trustee

2.11 2.11 SPECI SPECIAL AL PURP PURPOS OSE E VEHI VEHICL CLE E The Definition An account, administered by a third party that holds shares bought back by the management in trust.

THE ADVANTAGES

Greater security for lenders

THE DISADVANTAGES

Less Less cont contro roll over over cash cash flow flowss gene genera rate ted d by  project

improves credit rating Lowers the cost of capital

Tax treatment of SPV still unclear  

Better management of debtAdministration fees can be high repayment Enables Enables new ventures ventures to to raise funds. funds. Requires Requires intensive intensive monitoring monitoring by trustee

Chapter – 4 Venture Capitalist – A key player

4.1 4.1

Rol Role of of Ve Vent ntu ure Cap Capital italiist

4.2 Difference between VC and money

managers/banker managers/banker

VENTURE CAPITALISTS – A key player

4.1 Role of venture Capitalists Conventional financing generally extends loans to companies, while VC financing invests in equity of the company. Conventional Conventional financing looks to current income i.e. divi divide dend nd and and inte intere rest st,, whil whilee in VC fina financ ncin ing g retu return rnss are are by way way of capi capita tall appreciation. Assessment in conventional financing is conservative i.e. lower the risk, higher the chances of getting loan. On the other hand VC financing is a risk taking finance where potential returns outweigh risk factors. Venture Capitalists also lend management support and provide entrepreneurs with many many other other faci facilit litie ies. s. Th They ey even even parti partici cipat patee in the manag managem emen entt proce process. ss. VCs VCs generally invest in unlisted companies and make profit only after the company obtains listing. VCs extend need based support in a number of stages of investments unlike single round financing by conventional financiers. financiers. VC’s are in for long run and rarely exit before 3 years. To sustain such commitment VC and private equity groups seek  extremely extremely high returns… a return of 30% in rupee terms. A bank or an FI will fund a  project as long lo ng as it is sure that enough enou gh cash flow flo w will be generated to repay the loans. VC is not a lender but an equity partner. Venture capitalists take higher risks by investing in an early-stage company with little or no history, and they expect a higher return for their high-risk equity investment. Internationally, VCs look at an internal rate of return (IRR) north of 40% plus. In India, the ideal benchmark is in the region of an IRR of 25% for general funds and more mo re than than 30% for IT-sp IT-spec ecif ific ic funds funds.. With With respe respect ct to invest investin ing g in a bus busine iness, ss, institutional venture capitalists look for average returns of at least 40 per cent to 50  per cent for start-up funding. fundin g. Second and later stage funding usually requires at least a 20 per cent to 40 per cent return return compoun compounded ded per annum. annum. Most firms firms require require large large  portions of equity in exchange for start-up sta rt-up financing.

The VC Philosophy

As against Bought out deals (BODs), VCs carry out very detailed due diligence and make 2-7 year investments. The VCs also hand-hold and nurture the companies they invest in besides helping them reach IPO stage when valuations are favourable. favourable. VCFs help entrepreneurs entrepreneurs at four stages: idea generation, start-up, start-up, ramp-up and finally in the exit. According to Indian Venture Capital Association, Association, almost 41% (Rs 5146.40 m) of the total venture capital investment is in start-up projects followed by Rs 4478.60 m in later stage projects and only Rs 82.95 in turnaround turnaround projects . Majority Majority have invested in only three stages of investment, indicating that most VCs in India have not started developing niches for investing with regard to the stages of projects.

The main difficulty in early stage funding are related to lack of exit opportunities as  probability of an IPO or o r buy out by of VC stake is less due to lack of understanding for evaluation of the knowledge based companies compared to the companies in the traditional sectors. Some such VCs are: ICICI ventures, Draper, SIDBI and Angels. Apart Apart from from finan finance, ce, ventu venture re capit capital alist istss provi provide de netw network orking ing,, manag managem ement ent and marketing support as well. The venture capitalist is a business partner, sharing the risks and rewards and provides strategic, operational and financial advice to the company based on experience with other companies in similar situations.

Management of investee firms

The venture funds add value to the company by active involvement in running of  enterprises in which they invest. This is called "hands on" or "pro-active" approach. Draper falls in this category. Incubator funds like e-ventures also have a similar  approach towards their investment. However there can be "hands off" approach like that of Chase. ICICI Ventures falls in the limited exposure category. In general, venture funds who fund seed or start ups have a closer interaction 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. 4.2 Difference between a venture capitalist and bankers/money

managers Banker is a manager of other people's money while the venture capitalist capitalist is basically basically an investor. Venture Venture capitali capitalist st generall generally y invests invests in new ventures ventures started started by technocr technocrats ats 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. Thee mo Th most st impor importan tantt diffe differe rence nce betwe between en a ventur venturee capit capitali alist st and conve conventi ntiona onall investors and mutual funds is that he is a specialist and lends management support and also

•

Financial and strategic planning

•

Obtain bank and other 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

Differences

Points

Venture Finance

Objective

Debt Finance

Interest payment  Maximize return return

Holding period

2-5 years

Instruments Pricing

Common shares, convertible bonds,Loan, factoring, leasing options, warrants Price earnings ratio, net tangible assets Interest spread

Collateral

Very rare

Yes

Ownership

Yes

No

Control

Minority shareholders, rights protection,Covenants  board members

Impact on Balance sheetReduced leverage of financed Exit Mechanism

Short/long term

Increased leverage

Public of offering, sa sale to to th third pa party, sa sale to toLoan repayment entrepreneur 

Chapter – 5

Pro’s and Quo’s of VCF 5.1

Success factors

5.2

Critical factor 

5.3

Problems fa faces by by VC VCF

5.1 Success factors of VCFs 1. Indu Indust stry ry-s -spe peci cifi ficc

conc concen entr trat atio ion n

of inve invest stme ment ntss

yiel yields ds bett better er retu return rnss

than than

geographically concentrated investments.

2. Networking with industrial partners is important since these target companies are  potential clients and exit partners.

3. Netw Networ orki king ng with with univ univer ersi siti ties es and and rese resear arch ch inst instit itut utes es help helpss iden identi tify fy new new technologies and investment targets.

4. Concentrating investments in carefully selected companies showing international  promise will yield y ield better bette r returns re turns than tha n distributing dis tributing the capital cap ital across several smaller  investments. It is crucial that venture capitalists actively support the growth and internationalisation of the companies through their industry-specific know-how and international contacts.

5. With respect to the returns from the fund, it is vital that adequate capital is reserved for furth further er invest investme ment nt in the best best invest investme ment nt targe targets ts and and for main mainta taini ining ng the holdings until the exit.

6. Joint investments with partners providing added value contribute to the success of  the target companies and improve the returns from the fund.

5.2 Critical Factors In 1999, SEBI (Securities and Exchange Board of India) had set up a committee under  the Chairmanship of Mr. K. B. Chandrasekhar to look into the issues of venture capital in India. The Report of the K. B. Chandrasekhar Committee on venture capital identified the following as critical factors for the success of VC industry in India: •

The regulatory, tax and legal environment should play an enabling role. This emphasizes the facilitating and promotional role of regulation. Internationally, venture funds have evolved in an atmosphere of structural flexibility, fiscal neutrality and operational adaptability. And we need to provide regulatory simplicity and structural flexibility on the same lines. There is also the need for a leve levell playi playing ng field field betwe between en dom domest estic ic and offsho offshore re ventu venture re capit capital al investors. This has already been done for the mutual fund industry in India.

•

Investment, management and an exit option should provide flexibility to suit the business requirements requirements and should also be driven by global trends. Venture Venture capital investments have typically come from high net worth individuals who have risk taking capacity. Since high risk is involved in venture financing, venture investors globally seek investment and exit on very flexible terms, which provides them with certain levels of protection. Such exit should be  possible through thro ugh IPOs and mergers / acquisitions on a global basis ba sis and not just ju st within India.

•

There is also the need for identifying and increasing the domestic pool of  funds funds for ventu venture re capit capital al inves investm tment ent.. In US, US, apart apart from from high high net worth worth individuals individuals and angel investors, pension funds, insurance funds, mutual funds etc. provide a very big source of money. The share of corporate funding is also increasing and it was as high as 25.9 percent in the year 1998 as compared to 2  percent in 1995. Corporations are also setting up their own venture capital funds. Similar avenues need to be identified in India also.

•

With increasing global integration and mobility of capital it is important that Indian venture capital firms as well as venture financed enterprises be able to have

opportunities for investment abroad. This would not only enhance their ability to generate better returns but also add to their experience and expertise to function successfully in a global environment. We need our enterprises to become global and create their own success stories. Therefore, automatic, transparent and flexible norms need to be created for such investments by domestic firms and enterprises. •

Venture Venture capital capital shou should ld become become an institu institution tionali alised sed industry industry financed financed and managed by successful entrepreneurs, professional and sophisticated investors. Globally, venture capitalists are not merely finance providers but are also closely involved with the investee enterprises enterprises and provide expertise expertise by way of  management and marketing support. This industry has developed its own ethos and culture. Venture capital has only one common aspect that cuts across geography i.e. it is risk capital invested by experts in the field. It is important that venture capital in India be allowed to develop via professional and institutional management

•

Infrastr Infrastructu ucture re developm development ent also needs needs to be priorit prioritised ised using using governme government nt support and private management. This involves creation of technology as well as knowledge incubators for supporting innovation and ideas. R&D also needs to be promoted by government as well as other organisations.

The above report was well received by the Government and few issues have already  been resolved.

5.3

Problems generally associated with Venture Capital

1. The risk associated associated with true venture capital is greater than when providing capital to an established established business. Despite the best efforts and intentions, intentions, some start-ups will not succeed. That is simply part of the game. In today's market, though, especially if  dealing with highly leveraged corporations, we have seen there is substantial risk  associated with well established businesses as well as with start-ups. The risk is differe different, nt, though, though, and people people providin providing g true venture capital capital recogniz recognizes es this riskreward trade-off. 2. Most investors have an unrealistic view of venture capital. They expect the high returns publicized publicized with respect to successful new ventures but do not want to take the attendant risk. Consequently, such investors go into the marketplace looking for  opportunities, claiming to offer venture capital, but never finding an investment that meets their requirements. 3. Most venture fund managers come from banking, professional professional money management or corporate management; while some come directly from business school and have  been employees of venture capital firms for their entire career. Consequently, the th e vast majority of venture capital company employees - at any level - have no actual "ventu "venture" re" or entre entrepre prene neuri urial al exper experie ience nce,, parti particul cularl arly y with with start start-up -ups. s. A lack lack of  experience experience and understanding understanding translates into a lack of comfort with the creation creation phase of a business and a reluctance to invest in such deals. 4. Entrepreneurs, in general, have different goals, motivations and personalities than  bankers or corporate executives, who may expect to see people like themselves as clients. These differences can often create a gap between the venture capitalist and the entrepreneur entrepreneur sufficient to result in a rejection of the business proposal irrespective irrespective of  the merits of the business. 5. The principal source of capital for most entrepreneurs is friends and family. Once that source runs out (if it exists at all), venture capital companies may be the only alter alternat nativ ivee to obtai obtain n fundin funding g whic which, h, mo most st like likely, ly, are sm smal alll or insuf insuffic ficie ient nt in comparison to the cost of, for instance, building a factory or buying a profitable going concern. Few venture capital companies want to spend the time evaluating small deals

when, within the constraints constraints of their investing investing limits and in the same amount of time, they could participate in fewer but larger deals. 6. Three key elements to a successful new venture are (not in order of priority): a good idea, adequate capital and good management. A failure of any one of these elements can doom the enterprise. Due primarily to a lack of experience in the creation or start-up phase, venture capital companies are often lacking in their ability ability to evaluate and recognize: (a) a "good idea" because ideas and the projections associated with them are so intangible, unlike - so they think - the projections of an established company; (b) "adequate capital" for a start-up because traditional venture capital companies may not have have the the experi experien ence ce to und unders erstan tand d wheth whether er the entrep entrepren reneur eur's 's goals goals can be achiev achieved ed with with the capit capital al reques requeste ted d or to help help the the entre entrepre preneu neurr deter determi mine ne the appropriate capital requirements for a start-up; (c) the presence or absence of adequate entrepreneurial management, which can be different than that of a large established corporation; a good example of which was the changing need of Apple Computers when it replaced Steven Jobs with John Sculley. 7. Despite the fact that many fund managers will say that inadequate management is the prima primary ry reaso reason n for busin busines esss fail failure ure,, they they will will rarel rarely y devote devote time time to assis assistt management to help achieve a greater likelihood of success. Consequently, some investments are destined to fail from the start; and many firms use everyone else's failures as a reason for them to avoid start-ups. 8. Many companies and individuals complain that they have money to invest in "good" projects, but none can be found. First, what is "good" for one person or firm may not be "good" for another. That definition is guided by goals and requirements of  the individual investor. An older investor may be looking for income while a younger  investor may be looking for appreciation. Often, those goals are unrealistic unrealistic as applied to venture capital.

Chapter-6 Case Studies 6.1

Case study-1

6.2

Case study-2

6.3

Case study-3

Case Studies 6.1 Case Study-1: Rise of UK economy The economic impact of private equity and venture capital on the UK: Keeping London and the UK the centre of the European industry Private Equity and venture capital makes a valuable contribution to the economy generally by having a positive effect on the companies in which private equity is invest invested. ed. In addit addition ion,, the indust industry ry makes makes a very very signif signific icant ant contr contribu ibuti tion on to the financial services industry and in particular plays an important role in maintaining the City of London as Europe's premier financial centre and helping to build it as the world's premier financial centre. The industry has shown incredible growth over the last few years, both in terms of the funds it has raised and the capital it manages and in the level of investment that is made, with growth comes responsibility as well as opportunity. The growth of the industry has increased its profile and with that profile comes a legitimate interest in what the industry is doing from the public, the press and of course the regulatory authorities. The industry is currently facing two major reviews - by the FSA in the Discussion  paper they recently re cently published publish ed and by the Treasury focusing on the taxation, not just of  capital gains made by the industry, but also the capital gains made by the risk-taking entrepreneurs and management team that as an industry VCF back. Achieving the right outcome for the industry from the tax review and continuing to ensure regulation is appropriate and not burdensome are two vital tasks the British Venture Capital Association (BVCA) and the industry faces. The BVCA and its work 

The BVCA is the industry body that represents the UK private equity and venture capital industry.

Private equity means the equity financing of companies at many stages in the life of a compa company ny from from startstart-up up throu through gh expans expansio ion n all all the way way throug through h to buy buy-o -outs uts of  establ establish ished ed compan companies ies that that in today today's 's worl world d can be very very signif signific icant ant and large large transactions. Venture capital as a term typically covers early stages of start-up or growth funding or  expansion capital. The term buy-outs (MBO, MBI, etc) refers to using - private equity to finance the change in ownership of a company. The common threads - and hence the term private equity - is that the investments made in unquoted equity (i.e. not publicly quoted equity) and into companies that have real growth potential which can be turned around or transformed under private equity ownership as opposed to being constantly constantly in the spotlight that having a quoted share price means for a public company. The BVCA represents the whole cross section of the private equity industry in the UK  - from small seed stage venture funds all the way through to the large private equity firms firms who who focus focus almo almost st exclu exclusiv sively ely on buy buy-ou -outs ts and and who who are almo almost st becom becoming ing household names today. BVCA membership comprises well over 90% of all UK-based private equity and venture capital funds and their advisors. The role of the BVCA is to ensure that the UK industry is properly represented to  politicians and policy p olicy makers here at Westminster, Westmins ter, across the UK and in Brussels. Bruss els. The industry's economic impact

The survey shows once again that private equity-backed companies are a significant driver in the UK economy and its global competitiveness. Key findings of this report show once again that in the five years to 2005/2006: • The growth of employment in private equity-backed companies was faster than both FTSE 100 and FTSE 250 companies (9% pa vs 1% and 2% respectively)

• Sales grew faster in private equity-backed companies compared with FTSE 100 and 250 companies (9% vs. 7% and 5%) • Exports from private equity-backed companies grew at a faster rate than the national growth rate (6% vs. 2%) • Investment grew faster than the national average (18% vs 1%) It is now well established that the performance of private equity-backed companies significantly strengthens the UK economy and improves international competitiveness and creates jobs at a considerably faster rate than other private sector companies. It is now estimated that companies that have received private equity funding account for  the employment of around 2.8 million people in the UK, equivalent to 19% of UK   private sector employees. emplo yees. It is also significant to note that 92% of companies that responded to the survey said that without private equity the business would not have existed at all or would have developed less rapidly. The reason for this is that private equity investment investment is more than just the provision of  capital. Respondents to the survey noted that strategic direction, financial advice and help with contacts were key ways in which private equity firms had helped with the development of their businesses. It is estimated estimated that companies companies which have been private equity-backed equity-backed generated total sales of £424 billion, exports of £48 billion and contributed over £26 billion in taxes. The figures in the Economic Impact Survey demonstrate clearly that private equity backed businesses are active across all regions of the UK and are valuable contributors to the wealth of these regions.

The impact of the private equity industry as a UK financial service

The UK private equity industry is playing an increasingly increasingly significant role as a source of revenue for firms operating within the broader financial and professional services industry, contributing to the overall impetus that these industries provide to the UK  economy.

2005 data shows that: • Private equity-related activities generated estimated fee revenue for financial and  professional services firms of over £3.3 billion, representing around 7% of the total to tal annual turnover of the UK financial services industry. • There are more than 5,500 individuals (3,500 of which are investment professionals) emplo employed yed in some some 260 privat privatee equit equity, y, ventur venturee capit capital al,, funds funds-of -of-fu -funds nds and secondaries investment firms in the UK. • The UK has a network of around 750 financial, professional and business services firms providing advisory and financial support to private equity and venture capital firms firms.. Th They ey emplo employ y a full full time time equiva equivale lent nt poo pooll of close close to 6,700 6,700 execut executiv ives es engaged in private equity-related activities. • Taken together, there are over 10,000 highly skilled professionals employed across over 1,000 1,000 firms firms engaged engaged either either directl directly y or indirect indirectly ly in private private equity-r equity-rela elated ted activities. • For every private equity executive executive investing directly in UK companies, companies, there are 2.3 full time equivalent advisors or finance executives providing specialist advice and services. • Financial, professional and other business services executives working on private equity-related mandates in 2005 generated an average of £500,000 per head in fees.

• Private equity-backed transactions account for a significant proportion of total M&A activity in the UK with almost 30% of all UK investment banking fees from M&A and loan financing being derived from private equity backed transactions in 2005. • The UK private equity industry has long attracted capital investment from outside its own shores, with almost £50 billion of foreign investment into UK private equity funds over the past six years. • Furthermore, two-thirds of the total capital invested by UK firms over the same  period was committed to companies within the UK, demonstrating a positive net inflow of capital into the UK economy. Investment activity

BVCA are an industry that invests across all sectors, from start-ups to buy-outs, all around the UK, across continental Europe and around the world. In 2005, UK private equity activity increased to its highest ever levels, in terms of  funds raised, private equity investments made and also divestments. Here are a few key figures that illustrate the scale of what we do: • Funds raised from investors reached £27.3 billion. • 1,535 companies were financed. • Worldwide investment by UK private equity firms increased by 21% in 2005 to £11.7 billion from £9.7 billion in 2004. • Companies financed at start-up stage increased by 9% to 208. By any measure, the UK private equity and venture capital industry is a UK success story. And yet it is disappointing that despite the fact that the benefits of private equity as an asset class are so clear that last year 80% of BVCA investors came from overseas, with 45% coming from the US.

The primary objective of the private equity industry is to drive returns to its investors and while it is a good thing that we can attract inward investment, investment, it is a pity that the  beneficiaries of the capital gains created by this industry predominantly accrue to overseas investors.

UK private equity and venture capital industry is a good strong British success story.

Major investment attract into the UK from overseas, BVCA make major investment around the UK investing in companies, creating jobs and building businesses, and they invest across continental Europe and around the world bringing returns home for  the benefit of their investors. This industry has benefited from a strong cross Party conse consensu nsuss that that und unders ersta tands nds the impo importa rtant nt role role BVCA BVCA play play in keepin keeping g the UK  economy competitive and dynamic. This support is much appreciated. Private equity investment investment should not be regarded as an end in itself, but rather as part of a life cycle of a business. The private equity model brings together absolute alignment of interest between investor and management. This enables absolute focus on agreed purpose, the ability to achieve change swiftly and effic efficie ientl ntly y and a comple complete te conce concentr ntrati ation on on the the direc directi tion on of the bus busin iness ess..

6.2 Case Study- 2: Silicon Valley's success. Venture capitalists supply the funds to budding entrepreneurs who want to start their  own companies - and 40% of such deals in the US take place in Silicon Valley. Vent Ventur uree capi capita tali list stss also also help help nurt nurtur uree thos thosee comp compan anie iess to succ succes ess, s, supp supply lyin ing g introductions to potential customers or partners, assistance with raising more funds, and even management support. And venture capital has been one of the extraordinary growth industries in the Valley, with the amount of money invested in venture capital funds rising in the decade from $1bn in 1990 to $20bn in 1999 - and nearly doubling again to $35bn in 2000. Dot.com fall-out

Ann Winblad, founder of venture capital firm Hummer Winblad, with $1bn in funds under management, was one of the victims of the dot.com fall-out. Her company had backed one of the biggest and most well-known internet companies companies selling to consumers, Pets.com, which stopped trading despite millions of dollars in  private investment and an enthusiastic stock market flotation. In her sleek, wooden-beamed offices in San Francisco's newly fashionable SoMo district, which has become a beacon for dot.com companies, she explained what went wrong. In her view, the increasing frenzy in the stock market for internet companies whatever their business plan or chances of profitability - had meant that too many companies had been funded and brought to the stock market too quickly. Too many many inexper inexperienc ienced ed people people came came into the venture venture capital capital marketp marketplace lace,, with with financiers, financiers, bankers, and big companies companies all prepared - even desperate - to back internet internet ventures.

Fund raising difficulties At one point, she says, $1bn a week was being offered to entrepreneurs - attracting too many people who were "mercenaries not missionaries" to the world of enterprise. But when the market woke up, and dot.com and tech stocks crashed in April, it  became impossible for even well-managed internet companies to raise additional money. Pets.com and other e-tailers needed more capital to grow - and that was no longer available at any price.  Now, she says, it is unlikely unlik ely that anyone an yone would fund fu nd any internet in ternet company for at least the next two years, and e-tailers, or dot.com companies selling to consumers, are the "mad cow disease" of the venture capital world - no one will touch them at all. And in future, the pace of investment will be slower and more measured, taking 3-5 years to bring companies to the stage at which they can be floated on the stock market - and that venture capitalists will resume their role of "company coach" rather than  pure deal-makers. Profit hopes dimmed And now, one of the factors limiting the further expansion of venture capital firms is their need to spend more time managing their existing portfolio portfolio - "tending to the sick  and needy" in the words of the chief of one dot.com that has survived, Obongo's Obongo's John Hunt. Mr Knoblauch says that in the height of the euphoria one year ago, venture capitalists capitalists  began to believe that they could make a profit pr ofit on nearly any company they backed. But now, they expect only about one in five of the companies they back to become a major success - but those successes, with returns returns of 10-20 times investment, investment, will still make the whole fund profitable. Vital role Venture capitalists will still play a vital role as catalysts for Silicon Valley's future.

It was the presence of the world's most sophisticated venture capital industry that attracted John Hunt of Obongo from the UK to San Francisco. Venture capitalists have played a crucial part in launching launching his company, which which provides the software for  electronic wallets used for shopping on the internet. Obongo was created in the offices of venture capital firm Sequoia, who introduced the UK based company, then called Smartport, to its Silicon Valley rival, Chabi - and they agreed to merge with each other 30 minutes into the meeting. Sunny outlook  And Obongo's other venture capital partner, Atlas, played a central role in helping them secure their first customer, the large US bank Citibank. It is networks like these which will secure the future of the Valley, according to historian and city planner  Anna Lee Saxenian. Nowhere else have venture capitalists such a close connection with with their their indus industr try, y, she argue argues, s, with with mo most st mo movi ving ng from from being being entre entrepre preneu neurs rs themselves. Their understanding of the technology, the markets, and the competition means that entrepreneurial knowledge is shared and is transferred more quickly here than anywhere else. It is that culture that will ensure that, despite the sharp change in market sentiment, Silicon Valley will remain the world's high-tech incubator.

Case Study-3: Failure of Analog Devices Enterprises In 1980, Analog Devices established a corporate venture program, Analog Devices Enterprises Enterprises (ADE), to generate both attractive financial returns and strategic strategic benefits in the form of licensi licensing ng agreeme agreements nts and acquisit acquisitions ions.. Funding Funding was provided provided by Amoco, and ADE had invested $26 million in 11 firms by 1985. That Th at very very year year Am Amoco oco cease ceased d contri contribut butin ing g capit capital, al, and the the ADE ADE progr program am was was suspen sus pended ded.. Aroun Around d this this time time,, Analo Analog g Devic Devices es took took a $7 mill millio ion n charge charge again against st earnings; in 1990, with most of the portfolio liquidated, it took another $12 million charge. Of the 11 firms in ADE’s portfolio, 10 were terminated, acquired by other  companies companies at unattractive valuations, valuations, or relegated relegated to the "living dead." Only one firm ultimately went public. In this case, ADE’s stake was so diluted by a merger that it was worth only about $2 million at the time of the offering. What What went went wrong wrong?? Clea Clearl rly, y, the the ADE ADE progra program m exhibi exhibits ts all all three three of the the class classic ic structural failings: 1. Program managers were hampered by the lack of a clear objective. Instead, they had a threefold mission: to invest in firms pursuing technologies relevant to the ongoing business of Analog Devices and Amoco, to obtain options to acquire firms of  interest to Analog’s management, and to generate high financial returns. 2. Analog Analog Devices Devices’’ researc researchers hers,, seeing seeing scarce scarce resource resourcess being being devoted devoted to ADE, ADE, resented the program. Also, Amoco only committed to fund the program for five years, considerably less time than was needed to grow the early-stage companies. 3. Incentives of the various parties appear to have been improperly aligned. The management management of Analog Ventures believed that they were insufficiently insufficiently rewarded, and Amoco did not share in the profits generated.

Chapter - 7 SURVEY AND CONCLUSION



Survey:

For getting about practical knowledge of working of VCFs, survey was conducted in 3 firms namely SIDBI (Small Industrial Development Bank of India), JM Equity Fund, IDFC Equity Fund. Following questions were asked and some of the answers given were:

1) What do VCF looks looks for in evaluating evaluating a new company? company? Most Most critical critical element element VCF looks for. A- Business potential, potential, Company Company background, background, core plan, plan, Promoter Promoter details. details. B- Growth, management, management, value, value, Business Business model, valuation valuation expectation, expectation, return return expected. C- Promoter Promoter – very very careful, careful, understanding, understanding, profile and background. background. Interpretation- VCF looks for good profile and background of promoter, business  potential and management managemen t for evaluating in a new company.

2) How is is busin business ess pla plan n presen presented ted?? A - Presentation, calling, executive, e-mail, advisors. B – Presentation, Financial model, mgmt meeting, matter of convenience to both Promoter and VCF. C – Based on business plan and industry in relation to its growth, potential, growth, returns. Presentation is done in front of Investment banker (middleman  between VCF and Promoter). Interpretation- Business plan is presented through various ways like presentation, financial model, etc. whichever is more convenient for both parties.

3) How do VCFs VCFs define define their their contribu contribution tion?? A- By providing providing facilities facilities through schemes schemes like Started Started Investment Investment and Smart Smart Money. B- Best practices, practices, Advice Advice for approachi approaching ng to financial financial market, market, etc.

C- Appointment, Appointment, issues, issues, tie ups with government government,, tie up with portfolio portfolio company, company, equipments, training, venturing in new areas, broader view and thinking. Interpretation- VCFs defines their contributions by showing the Promoters correct way for taking appropriate steps.

4) What are the milestones milestones in achieving achieving whether whether the company will achieve achieve their  their  goal? A – Milestones are laid down during agreement in top line and bottom line revenue. Term sheet documentation is signed by promoter. B – Through companies profit numbers and total sales. C – All the milestones are noted down in shareholder’s agreement. Interpretation- The landmarks are decided by the VCFs and Promoter during signing of agreement between them.

5) What are the the major major trends trends in in VCF industry industry?? A – Latest trend is interest in Bio-tech sector. B – Upcoming sectors like Logistics, BPO, Financial Services, Real Estate. C – All upcoming sectors especially Transport and Logistics. Interpretation- The trends in VCFs industry depends upon type of firms, as all of  them have interests in different sectors for financing.

6) What companies companies in VCF might make interesting interesting investmen investments. ts. A - Depends upon the sector which is booming at that time. B – Same as above said sectors. C – The best sector in today’s scenario is IT sector which will be backbone for  economy. Interpretation- The companies themselves shows as interested investing sectors to VCFs by their performance.

7) How long long does it it take to make investment investment or participat participation ion decision? decision? A – Taken after a long procedure of investigation gets over from 6-8 weeks. B – It takes 10 days sometimes and also get extent up to 3-4 months. C – Lengthy process as investigation about promoter is done. Then too it takes 3-5 months.

Interpretation- Time taken by VCFs for investment decision is from 10 days till 34 months. It also sometime extents till 6 months.

8) Critical Critical features features of an agreement agreement between between VCF and Promoter. Promoter. A – Exit options, Right to appoint a BOD, Internal Auditor, Projects. Even main steps taken by promoter should be consulted by VCF. B – Liquidity event, seat in BOD, Minority protection rights, big decisions to be consulted. C – Rights and Obligations of Promoter, Board seat, Rights to see committee, Veto Right. Interpretation- The most critical features are selecting exit options, rights and obligations of venture capitalists, and major decisions should be consulted with VCF.

9) Exit Exit polic policies ies followed followed by VCFs VCFs.. A- IPO, IPO, Selli Selling ng stake stake to to 3rd party, Promoter’s buyback from VCF, Drag-along & Tag-along. B- Selling Selling to strate strategic, gic, Block Block deal, deal, IPO. IPO. C- IPO, Promoter’ Promoter’ss buyback, Selling Selling stake, Combinat Combination ion of promoter’s promoter’s buyback  and selling stake. Interpretation- There are 3 basic exit options been followed by VCFs all over the world.

10) Risk analysis. A – Risk depends upon type of company, market, exit risk, proper investment done or not, cultural risk, competition. B – If valuation does not grow as per expectation then business plan fails. C – Scenario building. Risk in terms of promoter, revenue, cost (as operating expenses). Even on potential of promoter. Interpretation- The risk analysis varies as per depending on the situation.

Note: As per the answers given for the following questions, A presents SIDBI, B

 presents JM Equity Fund and an d C – IDFC Equity Funds. Interpretation is short conclusion of all answers.

Conclusion: Earlier patterns of growth or failure in venture capital industries in other countries and regions indicate that the evolution of venture capital seems to be either entry into a self reinforcing spiral, such as occurred in Silicon Valley and Israel, or growth and stagna stagnatio tion, n, as occurr occurred ed in Minne Minnesot sotaa in the the 198 1980s 0s or the Unite United d Kingd Kingdom om until until recently. recently. Given India’s wish to develop a high-technology industry funded by venture capital, it is necessary to keep improving the environment by simplifying the policy and regulato regulatory ry structur structuree (includi (including ng elimin eliminatin ating g regulati regulations ons that that do not perform perform necessary functions such as consumer protection).

The World Bank, with its agenda of decreasing government regulation, funded the creation creation of the first venture venture capital capital funds. funds. Though Though these these funds funds experie experienced nced little little success, they were the beginnings of a process of legitimitizing legitimitizing venture investing investing and they were a training ground for venture capitalists who later established private venture capital funds. It is unlikely that the venture capital industry could have been succ succes essf sful ul with withou outt the the deve develo lopm pmen entt of the the soft softwa ware re indu indust stry ry and and a gene genera rall liberalization of the economy. Of course, this is not entirely surprising, because an institution as complicated as venture capital could not emerge without a minimally supportive environment. This environment both permitted the evolution of the venture capital industry and simultaneously allowed it to begin changing that environment and initiating a co-evolutionary dynamic with other institutions.

India still remains a difficult environment for venture capital. Even in 2006 the Indian government remains bureaucratic and highly regulated. To encourage the growth of  venture capital will require further action, and it is likely that the government will continue and even accelerate its efforts to encourage venture capital investing. The role of the government cannot be avoided: it must address tax, regulatory, legal, and currency exchange policies, policies, since many of these affect both venture capital firms and

the companies that they finance. More mechanisms need to be developed to reduce risk if funds for venture capital must come from publicly held financial institutions manag managed ed by highl highly y risk-a risk-aver verse se mana manager gers. s. In sho short rt,, “VCF VCF is next next engi engine ne for for economical growth for all countries in the World”.

Suggestions for growth of VCF: Venture capital industry is at the take off stage in India. It can play a catalytic role in

the development of entrepreneurship entrepreneurship skill that remains unexploited among the young and energeti energeticc technocr technocrats ats and other other professi professional onally ly qualifi qualified ed talents talents.. It can help  promote new technology technolo gy and an d hi-tech industries, which involve invo lve high risk but b ut promises attracti attractive ve rate of return. return. In order order to ensure ensure success success of venture capital in India, the following

suggestions

are

o f f e r ed :

(i) Exemption/Concession for Capital Gains: Capital gains law represents a hurdle to the success of venture capital financing. The

earnings of the funds depend primarily on the appreciation in stock values. Further, the capital gains may arise only after 3 to 4 years, of investment and that the projects,  being in new risky areas, may not even succeed. Capital gains by corporate bodies in India are taxed at a much investment risk and long gestation period this is a deterrent deterrent to

th e

development

of

VCFs.

The benefit of the capital gains, under section 48 of the Act is not significant. significant. Hence, it would be advisable that all long term capital gains earned by VCCs should be exemp exempted ted from from tax tax or sub subjec jectt to conce concessi ssiona onall flat flat rate. rate. Furt Further her,, capital gains reinvested in new venture shou should ld also be exempted exempted from tax. tax. Section Section 52(E) of the Act should be amended to give effect to this.

(ii) Development of Stock Markets: Guidelines issued by finance ministry provides for the sale of investment by way of   public issue at the price to be decided decid ed on the basis of book value and an d earning capacity. However, this method may not give the best available prices to venture fund as it will not be able to consider future growth potential of the invested company. One of the major factors which contributed to the success of venture funds in the West is development of secondary and tertiary stock markets. These markets do not have listing

requirements requirements and are spread over all important cities and towns in the country. These stock markets provide excellent disinvestments mechanism for  venture funds. In India, however, stock market is not developed beyond a few important cities. Success of  venture capital fund depends very much upon profitable disinvestments of the capital contributed contributed by it. In US and UK secondary and tertiary tertiary markets markets helped in accomplishing the above. However, in India, promotion of such maker is not feasibl feasiblee in the prevail prevailing ing circums circumstanc tances es as such laissez laissez faire faire policy policy may attack   persons with ulterior motives in the business to the determent of general public. However, stock market operation may be started at man by more big cities where, say, the number of stock exchanges exchanges can be increased to 50. Further, permission to transact in unlisted securities with suitable regulation will ensure firsthand contact between venture fund and investors.

(iii) Fiscal Incentives: Fiscal incentives may be given in the form of lowering the rate of income tax. It can  be accomplished by: by : (i) Application of provisions applicable to non-corporate entities for taxing long term capital

gains.

(ii) An allowance to funds similar to section 80-CC of Income Tax Act, say 20  percent of the investment in new ne w venture which can be allowed as deduction from the income.

(iv) Private Sector Participation In US and UK where the economy is dominated by private sector, development of  venture fund market was possible due to very significant role played by private sector 

which is often willing to put money in high risk business provided higher returns are expec expecte ted. d. Th Thee guidel guidelin ines es by finan finance ce minis ministry try provi provide de that that non non-- insti institut tutio ional nal  promoter’s share in the capital of  venture fund cannot exceed 20 percent of total capital; further they cannot be the single largest equity holders. The private sector,

 because of this provision, pr ovision, may not like to promote p romote venture fund business.

Promotio Promotion n of  venture funds by priva private te secto sector, r, in addit additio ion n to pub publi licc finan financi cial al institution and banks, is recommended as:

Private sector is in advantageous position as compared to financial institutions and  banks to provide managerial manag erial support sup port to new ventures ventur es as leading industrial house have a poo pooll of experi experien enced ced profe professi ssiona onall manag managers ers in all all field fieldss of mana managem gemen entt viz. viz. marketing, production and finance. The leading business houses will be able to raise funds from the investing public with relative ease.

(v) Review the Existing Laws Today’s need is to review the constrains under various laws of the country and resolve the issue that could come in the way of growth of the innovative mode of financing. Suitable exemption should be given from Section 43 A of the companies Act to venture capital finance companies so that they are not required to comply with

several provisions of the Act applicable to public limited companies.

Amendment of Section 77 of the Companies Act is required to enable the new venture capital companies to buy back their shares at the time of disinvestments by

VC

Finance

Companies.

Ceiling on interoperate loans and investment as specified in Section 370 and 372 of  the companies Act should be relaxed in case of VC Finance Companies Companies and Venture Capital Companies to enable them to invest suitable in newly promoted companies.

The only investment available to the VC Finance company for investment is equity shares. This restriction should be relaxed so that VC Finance Company can finance through preferential preferential issues and conditional conditional loans. The scope of VC should not only be confi confirm rmed ed to start start up finan finance ce but also also be broade broadened ned to devel developm opment ent finan finance, ce, expan expansio sion n and growt growth, h, buy buyout outs, s, merge mergers rs and amal amalgam gamati ation. on. Th Thee restri restrict ctio ion n on investment of 80% of the entire funds within a period of 3 years should be removed.

(vi) Limited Partnership The Practice of the limited partnership as in vogue in UK should be permitted in order  to promote promote integrat integration ion of object object between between the manager managerss and contributo contributors rs for the success of venture capital projects.

Chapter – 8

Annexure

8.1 SEBI Guidelines and Regulations 8.2 Certificate of Registration 8.3 Tax Aspects 8.4 Investment conditions and restrictions

Annexure 8.1 SEBI Guidelines and Regulations: In the absence of an organised Venture Capital industry till almost 1998, individual investors and development financial institutions played the role of venture capitalists capitalists in India. India. Entrepr Entrepreneu eneurs rs have largely largely depended depended upon private private placeme placements, nts, public public offerings and lending by the financial institutions. In 1973 a committee on Development of Small and Medium Enterprises highlighted the need to foster venture capital as a source of funding new entrepreneurs and technolo technology. gy. Thereafter Thereafter some public public sector sector funds funds were set up but the activit activity y of  ventu venture re capit capital al did not gathe gatherr mo mome ment ntum um as the the thrus thrustt was was on highhigh-te tech chnol nology ogy  projects funded on o n a purely financial rather than a holistic basis. Later, a study was undertaken by the World Bank to examine the possibility of  developing Venture Capital in the private sector, based on which the Government of  India took a policy initiative and announced guidelines for Venture Capital Funds (VCFs) in India in 1988. However, these guidelines guidelines restricted setting up of VCFs by the banks or the financial institutions institutions only. Thereafter, Thereafter, the Government Government of India issued guidelines in September  September  1995 199 5 for overse overseas as invest investme ment nt in Vent Venture ure Capit Capital al in India India.. For For tax-e tax-exem xempti ption on  purposes, guidelines were also issued by the Central Board of Direct Taxes (CBDT) and the investments and flow of foreign currency into and out of India have been governed by the Reserve Bank of India's (RBI) requirements. Further, as a part of its mandate to regulate and to develop the Indian capital markets, the Securities and Exch Ex chan ange ge Boar Board d of Indi Indiaa (SEB (SEBI) I) fram framed ed the the SEBI SEBI (Ven (Ventu ture re Capi Capita tall Fund Funds) s) Regulations, 1996. These guidelines were further amended in Apr 2000 with the objective of fuelling the growth of Venture Capital activities in India.

In the late 1990s, the Indian government became aware of the potential benefits of a healt healthy hy ventur venturee capit capital al secto sector. r. Th Thus us in 199 1999 9 a num numbe berr of new regul regulat ation ionss were were

 promulgated. Some of the most significant of these related to liberalizing the regulations regarding the ability of various financial institutions to invest in venture capital. Perhaps the most important of these went into effect in April 1999 and allowed banks to invest up to 5 percent of their new funds annually in venture capital. Thee main Th main statu statutes tes gov gover ernin ning g ventur venturee capit capital al in India India inclu included ded the the SEBI SEBI’s ’s 199 1996 6 Venture Venture Capita Capitall Regulat Regulations ions,, the 1995 Guideli Guidelines nes for Overseas Overseas Venture Venture Capital Capital Invest Investme ments nts issue issued d by the Depar Departm tment ent of Econo Economi micc Affa Affair irss in the the Mini Ministr stry y of  Finance, and the Central Board of Direct Taxes’ (CBDT) 1995 Guidelines for Venture Capit Capital al Comp Compani anies es (lat (later er mo modi difie fied d in 199 1999) 9).. In earl early y 200 2000, 0, dom domes esti ticc ventu venture re capitalists were regulated by three government bodies: the Securities and Exchange Board of India (SEBI), the Ministry of Finance, and the CBDT. For foreign venture capital firms there was even greater regulation in the form of the Foreign Investment Promotion Promotion Board (FIPB), (FIPB), which approves every investment, investment, and the Reserve Bank of  India (RBI), which approves every disinvestment.

Since SEBI is responsible for overall regulation and registration of VCF, multiple regulatory requirements should be harmonized and consolidated within the framework  of SEBI Regulations to facilitate uniform, hassle-free, single window clearance. Registration of a venture capital fund

Applicant should follow the procedure given below so as to expedite the registration  process. However, SEBI will also guide the applicant step by step after getting application for registration as a venture capital fund. Normally, all replies are sent withi within n 21 worki working ng days days from from the date date of getti getting ng each each commu communic nicati ation on from from the appli applica cant nt durin during g the the proce process ss of registr registrat ation ion..

Thus, Th us, the tota totall time time period period for 

registration depends on how fast the requirements are compiled with by the applicant. Main requirements under SEBI (Venture Capital Funds) Regulations, 1996: The following are the eligibility criteria for grant of a certificate of registration as per  regulation 4 of SEBI (Venture Capital Funds) Regulations 1996. For the purpose of  grant of a certificate of registration, the applicant has to fulfil the following, namely:-

(a) If the application is made by a company, (i)

Memo Memora randu ndum m of of asso associ ciat atio ion n has has as its its mai main n obj objec ecti tive, ve, the the car carryi rying ng on of  the activity of a venture capital fund;

(ii) (ii)

It is proh prohib ibit ited ed by its memo memora rand ndum um and and arti articl cles es of assoc ssocia iati tion on from from making an invitation to the public to subscribe to its securities;

(iii) (iii)

Its direct director or or princi principal pal office officerr or employe employeee is not invol involved ved in in any liti litigat gatio ion n conne connect cted ed with with the the secur securit itie iess mark market et which which may may have have an adverse bearing on the business of the applicant;

(iv)

Its direct director, or, princip principal al officer officer or employ employee ee has not at any any time been been convicted of any offence involving moral turpitude or any economic offence.

(v)

It is a fit and proper person.

(b) If the application is made by a trust (i)

Thee instr Th instrum ument ent of trus trustt is is in the the form form of a deed deed and and has has been been dul duly y registered under the provisions of the Indian Registration Act, 1908 (16 of 1908);

(ii)

The main object of the trust is to carry on the activity of a venture capital fund;

(iii) (iii)

Thee direc Th directo tors rs of its its trust trustee ee comp company any,, if any, any, or any trus truste teee is not involved in any

litigation litigation connected connected with with the the securit securities ies market which

may have an adverse bearing on the business of the applicant;

(iv)

The directors directors of its trustee company, company, if any, or a trustee has not at any time, been convicted of any offence involving moral turpitude or of any economic offence;

(v)

The applicant is a fit and proper person.

(c) If the application is made by a body corporate (i) (i)

It is set set up up or esta establ blis ishe hed d under under the the laws laws of the the Cen Centr tral al or Sta State te Legislature.

(ii)

The applicant applicant is permitted permitted to carry on the activities activities of a venture capital capital fund.

(iii)

The applicant is a fit and proper person.

(iv)

The directors directors or the trustees, trustees, as the case may be, of such body corporate corporate have not been convicted of any offence involving moral turpitude or of  any economic offence.

(v)

The directors or the trustees, as the case may be, of such body corporate, if any, is not involved in any litigation connected with the securities mark market et which which may may have have an adver adverse se beari bearing ng on the the bus busin iness ess of the the applicant.

(d) The applicant has not been refused a certificate certificate by the Board or its certificate certificate has not been suspended under regulation 30 or cancelled under regulation 31.

Application for Registration: An applicant should apply for registration in form a prescribed under First Schedule of  SEBI SEBI (Ven (Ventu ture re Capi Capita tall Fund Funds) s) Regu Regula lati tions ons 199 1996 6 alon along g with with requi requisit sitee fees. fees. All All documents should be enclosed as specified in the form.  Additiona  Additionall informatio information: n:

1.

A complete complete list of your associat associatee companies companies register registered ed with SEBI, SEBI, and also indi indica cate te the the capa capaci city ty in whic which h they they are are regi regist ster ered ed alon along g with with the the SEBI SEBI Registration number;

2.

State whether the applicant is registered with SEBI in any capacity.

3. A complete complete list of your group companies companies registered registered with SEBI, SEBI, and also indicate indicate the the capac capacit ity y in which which they they are are regis registe tered red with with SEBI SEBI along along with with thei theirr SEBI SEBI Registration number. 4.

Whether the applicant applicant or the intermediary, intermediary, as the case may may be or its its whole whole time director or managing partner has been convicted by a Court for any offence involving moral turpitude, economic offence, securities laws or fraud

5. Whether Whether any winding winding up orders orders have been passed against against the applicant applicant or the intermediary. 6.

Whet Whether her any orders orders under under the Insolv Insolvenc ency y Act Act have have been been passed passed against against the applicant or any of its directors, or person in management and have not been discharged.

7.

Whether any order restraining restraining prohibiting prohibiting or or debarring debarring the applicant applicant or or its whole whole time director from dealing in securities in the capital market has been passed by SEBI or any other regulatory authority and a period of three years from the date of the expiry of the period specified in the order has not elapsed;

8. Whether any any order canceling canceling the certificate certificate of registration registration of the applicant applicant on the ground of its indulging in insider trading, fraudulent and unfair trade practices or 

market manipulation has been passed by SEBI and a period of three years from the date of the order has not elapsed ; 9. Whether any order, withdrawing withdrawing or refusing to grant any license/ approval to the applicant applicant or its whole time director which has a bearing on the capital market, market, has  been passed pass ed by SEBI or any other regulatory reg ulatory authority au thority and a period of three years from the date of the order has not elapsed. 10. (a) Details Details of registration of your company/associate company/associate/group /group companies companies (to be given separately), which are registered/ required to be registered with Reserve Bank of India

(RBI) as a Banking company or Non Banking Finance Company or in any other capacity and address(es) of concerned branch office(s) of RBI. (b) (b) Deta Detail ilss of disc discip ipli lina nary ry acti action on take taken n by RBI RBI agai agains nstt you you or any any of your  your  group/associate group/associate companies. companies. Please also inform inform us in case there is any default in repayment of deposits by you or any of your group / associate companies. Applicant can submit ‘no objection certificate’ from RBI for getting registered with SEBI, to expedite the registration process. Other Documents to be submitted to SEBI 

1) Memoran Memorandum dum and Articl Articles es of Ass Associa ociatio tion n of applica applicant nt company company,, execute executed d copy of trust deed if the fund is being set up as a trust and main objective of  constitution in case of body corporate. 2) Executed copy of Investment Management Agreement, if applicable. 3) Disclose in detail the investment strategy as required under regulation 12(a) of  the SEBI (Venture Capital Funds) Regulations, 1996. Also state the target size of the fund along with the profile of the investors of the fund. 4) An undertaking to the effect that the fund will not enter into any venture capital activity if it fails to raise a commitment of at least Rs. five crore as

requ requir ired ed unde underr Regu Regula lati tion on 11(3 11(3)) of SEBI SEBI (Ven (Ventu ture re Capit apital al Funds unds)) Regulations, 1996. 5) Copie Copiess of lett letter erss of comm commit itme ment nt from from inves investo tors rs in sup suppor portt of the target target amount proposed to be raised by the fund. 6) Undertaking that the venture capital fund will not make investment in any area listed under Third Schedule to SEBI (Venture Capital Funds) Regulations, 1996. 7)

Venture Capital Capital Fund shall disclose the duration/ life cycle of the fund.

Grant of Certificate of Registration

Once Once all all above above requir requirem emen ents ts have have been been comp compli lied ed with with and requis requisit itee fees fees as per  Second Schedule to Regulations have been paid, SEBI will grant certification of  registration as a venture capital fund.

8.2 Certificate of Registration 2006 Certificate of registration as venture capital fund I. In exercise of the powers conferred by sub-section (1) of section 12 of the securities

And exchange Board of India Act, 1992, (15 of 1992) read with the regulation made There

under,

t he

board

hereby

grants

a

certificate

of

registration

to

---------------------------------------------------------------------------------------------------------------as -----as a venture capital fund fund sub subje ject ct to the the cond condit itio ions ns spec specif ifie ied d in the the Act Act and and in the the regu regula lati tion onss made made ther theree unde under. r. II. II. The Regi Regist stra rati tion on Num Number ber of the the venture capital fund is IN/VC/ /

Date: Place: MUMBAI By order  Sd/For and on behalf of  Securities and Exchange Board of India Income Tax benefits In order to encourage the development of venture capital funds, the income Tax Act, 1961 exempts the income of a venture capital fund from Income Tax. Income of a venture capital fund [section 10(23FB)] (on and from Financial Year  1999-2000) Any income of a venture capital fund (VCF) or a venture capital company (VCC) set up to raise funds for investment in a venture capital undertaking (VCU) is exempt.

VCC means a company which has been granted a certificate of registration by SEBI and which fulfils the conditions laid down by SEBI with the approval of the Central Government.

VCU means a domestic company whose share are not listed in a recognized stock  exchange in India and which is engaged in the business for producing services,  production or manufacture of an article or thing but does not include activities or  sectors which are specified by SEBI with a approval of the Central Government.

8.3. Tax Aspects: VCFs have been provided complete complete income tax relaxation (July 1995) and exemption exemption from long-term capital gains tax after they are listed on stock exchanges. exchanges. Shares have to be held for at least 12 months to enjoy tax exemption. A lock-in period of three years is however applicable for unlisted shares. The Finance Act, 1995 provided [Section 10 (23 F) of the IT Act] income tax exemption on any income by way of dividends or long-term capital gains of a venture capital fund or a venture capital company from investments made by way

of equity shares in a venture proposal. To enjoy tax exemption the venture capital company has to obtain approval and satisfy prescribed conditions. The Central Board of Dire Direct ct Taxe Taxess (CBD (CBDT) T) issue issued d guide guideli lines nes,, on 18-7-1 18-7-1995 995 speci specifyi fying ng that that the  prescribed authority for approval for exemption under Section 10 (23F) of Income Tax Act is Director of Income Tax (Exemption). The conditions for approval are: •

it is registered with the SEBI (guidelines of 13.2.1996 discussed below); •

it invests 80 percent of its total monies by acquiring equity shares of 

venture capital undertakings; •

it invest 80 percent of its total paid-up capital in acquiring equity share of the

venture capital undertakings; •

it shall not invest more than 20 percent (Budget for 1997-8 raised it from 5 to

20 percent.)it shall not invest more than 40 percent in the equity capital of one venture undertakings

•

it shall shall main maintai tain n boo books ks of accoun account, t, and sub submi mitt audit audited ed accou accounts nts to the the

Director, Income Tax (Exemption).

8.4. Investment conditions and restrictions A venture capital fund may raise money from any source, whether Indian, foreign or  non resident Indian by way of issue of units. No venture capital fund shall accept any investment from any investor less than Rs5,00,000. Rs5,00,000. However this condition is not applicable to:8.2. 8.2.1 1

empl employ oyee eess or the princ princip ipal al offic officer er or dire direct ctor orss of the venture capital fund has been established as a trust

8.2. 8.2.2 2

empl employ oyee eess of the fund fund mana manage gerr or asset asset manag managem emen entt company for the purpose of the se regulations, fund raised means actual money raised from investors for  subscribing to the securities of the venture capital fund and includes money that is raised from the author of the trus trustt (in (in case case the the venture capital fund fund has has been been established as a trust) but does not include the paid up capital of the trustee company, if any.

8.2. 8.2.3 3

Each ach sche schem me laun launch ched ed or fund fund set set up by a venture fund shall shall have have firm firm comm commit itmen mentt from from the the capital fund investors for contribution by the venture capital fund.

All investment made or to be made by a venture capital fund shall be subject to the following conditions, namely:a.

venture capital fund shall disclose the investment strategy at

the time of application for registration;  b. venture capital fund shall not invest more than 25% corpus of  the fund in one venture capital undertaking ; shall not invest in the associated companies; and

undertaking as d. venture capital fund shall make investment in the venture capital undertaking enumerated below (i). at least 75% of the investible funds shall be invested in unlisted equity shares or  equity linked instruments. However, if the venture capital und seeks avail of benefits under the relevant provisions of the Income Tax Act applicable to a venture capital fund, it shall be required to disinvest from such investments within a period of one year from the Date on which the shares of the venture capital undertaking are listed. In a recognized stock Exchange. (ii). Not more than 25% of the investible fund may be invested by way of: a. subs subscr criiption to init nitial publ publiic off offer of a venture capital undertaking whose shares are proposed o be listed subject to lock-in period of one year;  b. debt or debt instrument of a venture capital undertaking in whic which h the the venture capital fund fund has has alread eady made ade an investment by way of equity.

List of Venture Capital Companies in India :-

1.

20th Century Finance Corporation Limited Centre Point Dr.Ambedkar Road Parel Mumbai - 400012

2.

AIG Investment Corporation (Asia) Limited India - Representative Office 2634 Oberoi Towers  Nariman Point Mumbai - 400021

3.

Acuity Strategic Financials Private Limited 14 Santosh, 2nd floor  242 Lady Jamshedji Road Mumbai - 400028

4.

AIA Capital India Private Limited 9B Hansalaya Barakhamba Road  New Delhi - 110001 5. Alliance DLJ Private Equity Fund 404 / 405 Prestige Centre Point 7 Edward Road Bangalore - 560052

6.

Alliance Venture Capital Advisors Limited 607 Raheja Chambers Free Press Journal Road, Nariman Point Mumbai - 400021

7.

APIDC Venture Capital Limited 1102 Block A, 11th floor  Babukhan Estate, Basheerbagh Hyderabad - 500001

8.

Canbank Venture Capital Fund Limited 2/F Kareem Towers, 11th floor  19/5 -19/6 Cunningham Road Bangalore - 560052

9.

Draper International (India) Private Limited V203 Prestige Meridian -1 M.G. Road Bangalore - 560001

1 0.

eVentures India (Consultair Investments Private Limited) Khetan Bhavan 8 Jameshedji Tata Road Churchgate Mumbai - 400020

1 1.

GE Capital Services India Limited AIFACS Building 1 Rafi Marg  New Delhi - 110001

1 2.

Gujarat Venture Finance Limited Premchand House Annexe, 1st floor  Behind Popular House Ashram Road Ahmedabad - 380009

1 3.

HSBC Private Equity Management Mauritius Limited Ashoka Estate, 3rd floor  24 Barakhamba Road  New Delhi - 110001

1 4.

ICICI Securities and Finance Company Limited 41/44 Strand Palace M.Desai Marg Colaba Mumbai - 400005

1 5.

ICICI Venture Funds Management Company Limited (formerly TDICI) Raheja Plaza, 4th floor  17 Commissariat Road D'Souza Circle Bangalore - 560025

1 6.

IFB Venture Capital Finance Limited 8/1 Middletown Row Calcutta - 700071

1 7.

Industrial Development Bank of India IDBI Tower Cuffe Parade Mumbai - 400005

1 8.

Small Industries Development Bank of India (SIDBI) SIDBI Venture Capital Limited

 Nariman Bhavan 227 Vinay K. Shah Marg  Nariman Point Mumbai - 400021

1 9.

Tata Investment Corporation Limited Ewart House, 3rd floor  Homi Modi Street Fort Mumbai - 400001

2 0.

Templeton India Private Equity Fund 125 Free Press House  Nariman Point Mumbai - 400021

2 1.

Vista Ventures DBS Corporate Club 26 Cunningham Road Bangalore - 560052

2 2.

Walden-Nikko India Management Company Limited One Silverstone 294 Linking Road Khar (West) Mumbai - 400052

Bibliography Books • •

Indian venture capital market, - Evalueserve Indian Venture Capital Association - IVCA Venture Activity

Websites • • • • •

www.sebi.gov.in www.wikipedia.com www.economicstimes.com www.venturecapital.com www.investopedia.com

Newspapers • •

.

Economic Times Times of India