Dharmik venture capital


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Dharmik venture capital

  2. 2. K.E.S. SHROFF COLLEGE Page 2 CHAPTER-1 ORIGIN OF VENTURE CAPITAL The story of venture capital is very much like the history of mankind. In the fifteenth century, Christopher Columbus sought to travel westwards instead of eastwards from Europe and so planned to reach India. His far- fetched idea did not find favour with the King of Portugal, who refused to finance him. Finally, Queen Isabella of Spain decided to fund him and the voyages of Christopher Columbus are now empanelled in history. And thus evolved the concept of Venture Capital. The modern venture capital industry began taking shape in the post World War 2. It is often said that people decide to become entrepreneurs because they see role models in other people who have become successful entrepreneurs because they see role models in other people who have become successful entrepreneurs. Much the same can be said about venture capitalists. The earliest members of the organized venture capital industry had several role models, including these three : American Research and Development Corporation: Formed in 1946, whose biggest success was Digital Equipment. The founder of ARD was General Georges Doroit, a French-born military man who is considered “the father of venture capital”. In the 1950s, he taught at the Harvard Business School. His lectures on the importance of risk capital were considered quirky by the rest of the faculty, who concentrated on conventional corporate management. J.H. Whitney & Co: Also formed in 1946, one of those early hits was Minute Maid juice. Jock Whitney is considered one of the industry‟s founders. The Rockefeller Family: L S Rockefeller, one of those earliest investments was in Eastern Airlines, which is now defunct but was one of the earliest commercial airlines.
  3. 3. K.E.S. SHROFF COLLEGE Page 3 CHAPTER-2 VENTURE CAPITAL MEANING Venture Capital is defined as providing seed, start-up and first stage finance to companies and also funding expansion of companies that have demonstrated business potential but do not have access to public securities market or other credit oriented funding institutions. Venture Capital is generally provided to firms with the following characteristics: Newly floated companies that do not have access to sources such as equity capital and/or other related instruments. Firms, manufacturing products or services that have vast growth potential. Firms with above average profitability. Novel products that are in the early stages of their life cycle. Projects involving above-average risk. Turnaround of companies Venture Capital derives its value from the brand equity, professional image, constructive criticism, domain knowledge, industry contacts; they bring to table at a significantly lower management agency cost. A Venture Capital Fund (VCF) strives to provide entrepreneurs with the support they need to create up-scalable business with sustainable growth, while providing their contributors with outstanding returns on investment, for the higher risks they assume. The three primary characteristics of venture capital funds which make them eminently suitable as a source of risk finance are:  That it is equity or quasi equity investment  It is long term investment and  It is an active form of investment.
  4. 4. K.E.S. SHROFF COLLEGE Page 4 CHAPTER-3 VENTURE CAPITALISTS When someone refers to venture capitalist, the image that comes in mind is Mr. Money bags. We all think of venture capitalists as someone who is sitting on millions of dollars and who with the wave of his magic wand turns your dreams into reality. Well, if that‟s what you think is all about why run after him – “play Santa yourself” Venture Capitalists is like any other professional who is paid for doing his job, yes, venture capitalist is nothing but a fund manager whose job is to manage funds that are raised. A venture capitalist gets a fee to invest in companies that interest his investors. Difference between a Venture Capitalist and Bankers/Money Managers. Banker is a manager of other people‟s money while the venture capitalist is basically an investor. Venture capitalist generally invests in new ventures started by technocrats who generally are in need of entrepreneurial aid and funds. Venture capitalists generally invest in companies that are not listed on any stock exchanges. They make profits only after the company obtains listing. The most important difference between a venture capitalist and conventional investors and mutual funds is that he is a specialist and lends management support and also  Financial and strategic planning  Recruitment of key personnel  Obtain bank and debt financing  Access to international markets and technology  Introduction to strategic partners and acquisition targets in the region  Regional expansion of manufacturing and marketing operations  Obtain a public listing
  5. 5. K.E.S. SHROFF COLLEGE Page 5 Factor to be considered by venture capitalist in selection of investment proposal There are basically four key elements in financing of ventures which are studied in depth by the venture capitalists. These are: 1. Management: The strength, expertise & unity of the key people on the board bring significant credibility to the company. The members are to be mature, experienced possessing working knowledge of business and capable of taking potentially high risks. 2. Potential for Capital Gain: An above average rate of return of about 30 - 40% is required by venture capitalists. The rate of return also depends upon the stage of the business cycle where funds are being deployed. Earlier the stage, higher is the risk and hence the return. 3. Realistic Financial Requirement and Projections: The venture capitalist requires a realistic view about the present health of the organization as well as future projections regarding scope, nature and performance of the company in terms of scale of operations, operating profit and further costs related to product development through Research & Development. 4. Owner's Financial Stake: The financial resources owned & committed by the entrepreneur/ owner in the business including the funds invested by family, friends and relatives play a very important role in increasing the viability of the business. It is an important avenue where the venture capitalist keeps an open eye. STAGES OF FINANCING BY VENTURE CAPITALIST Venture capital can be provided to companies at different stages. These include: I. Early- stage Financing Seed Financing: Seed financing is provided for product development & research and to build a management team that primarily develops the business plan. Startup Financing: After initial product development and research is through, startup financing is provided to companies to organize their business, before the commercial launch of their products. First Stage Financing: Is provided to those companies that have exhausted their initial capital and require funds to commence large-scale manufacturing and sales.
  6. 6. K.E.S. SHROFF COLLEGE Page 6 II. Expansion Financing Second Stage Financing: This type of financing is available to provide working capital for initial expansion of companies, that are experiencing growth in accounts receivable and inventories, and is on the path of profitability. Mezzanine Financing: When sales volumes increase tremendously, the company, through mezzanine financing is provided with funds for further plant expansion, marketing, working capital or for development of an improved product. Bridge Financing: Bridge financing is provided to companies that plan to go public within six to twelve months. Bridge financing is repaid from underwriting proceeds. III. Acquisition Financing As the term denotes, this type of funding is provided to companies to acquire another company. This type of financing is also known as buyout financing. It is normally advisable to approach more than one venture capital firm simultaneously for funding, as there is a possibility of delay due to the various queries put by the VC. If the application for funding were finally rejected then approaching another VC at that point and going through the same process would cause delay. If more than one VC reviews the business plan this delay can be avoided, as the probability of acceptance will be much higher. The only problem with the above strategy is the processing fee required by a VC along with the business plan. If you were applying to more than one VC then there would be a cost escalation for processing the application. Hence a cost benefit analysis should be gone into before using the above strategy. Normally the review of the business plan would take a maximum of one month and disbursal for the funds to reach the entrepreneur it would take a minimum of 3 months to a maximum of 6 months. Once the initial screening and evaluation is over, it is advisable to have a person with finance background like a finance consultant to take care of details like negotiating the pricing and structuring of the deal. Of course alternatively one can involve a financial consultant right from the beginning particularly when the entrepreneur does not have a management background.
  7. 7. K.E.S. SHROFF COLLEGE Page 7 CHAPTER-4 CHARACTERISTICS OF VENTURE CAPITAL Ideas and innovations, which have potential for high growth but has inherent uncertainties, are financed by Venture capitalists. Further, venture capitalists provide networking, management and marketing support as well. Therefore, venture capital refers to risk finance as well as managerial support. This blend of risk financing and handholding of entrepreneurs by venture capitalists creates an environment particularly suitable for knowledge and technology based enterprises. Start ups, where fund is needed most, are seldom funded by Venture capitalist. However, a rare combination of product opportunity, market opportunity, and proven management may attract venture fund even in Start ups. Though the fundamental principle underlying the operations of a venture capital fund is “No return without risk and greater the risk, greater will be the returns”, the ultimate aim of the venture capitalist is the same as that of the promoters, i.e., the long-term profitability and viability of the invested company. Venture capitalists play dual role; that of strategic advisor and financial partner. In the process, they continuously monitor and evaluate the projects till their exit. As partners, they get involved in the management of the invested unit where they bring expertise and drive which ensures the survival and growth of the enterprise. They, generally, have wider horizon and innovative solutions which maximize the chances of the project success. In India, Venture capitalists have followed a broad approach in funding the enterprise. They have supplied funds to new, high risk, not necessarily high tech ventures, and have also extended management, marketing and financial skills to assisted ventures. In the beginning, they supported high tech unproven technologies but with the experience of the first few years, it has been broad based now. They (a) expect a very high growth rate in the assisted enterprise, (b) bring management and business skills, (c) expect medium term gains (5-10 years), and (d) do not insist for any collateral to cover the capital provided.
  8. 8. K.E.S. SHROFF COLLEGE Page 8 CHAPTER-5 VENTURE CAPITAL ADVANTAGES Venture capital has a number of advantages over other forms of finance, such as: Finance - The venture capitalist injects long-term equity finance, which provides a solid capital base for future growth. The ven ture capitalist may also be capable of providing additional rounds of funding should it be required to finance growth. Business Partner - The venture capitalist is a business partner, sharing the risks and rewards. Venture capitalists are rewarded by business success and the capital gain. Mentoring - The venture capitalist is able to provide strategic, operational and financial advice to the company based on past experience with other companies in similar situations. Alliances - The venture capitalist also has a network of contacts in many areas that can add value to the company, such as in recruiting key personnel, providing contacts in international markets, introductions to strategic partners and, if needed, co-investments with other venture capital firms when additional rounds of financing are required. Facilitation of Exit - The venture capitalist is experienced in the process of preparing a company for an initial public offering (IPO) and facilitating in trade sales. Venture capitalist combines risk capital with entrepreneurial management and advance technology to create new products, new companies and new wealth. Risk finance and venture capital environment can bring about innovation, promote technology, and harness knowledge- based ventures. In this sense, venture capital is different from other types of financing such as  development finance,  seed capital, (At times Venture Capitalist provide)  term loan / conventional financing,  passive equity investment support, and  R&D funding sources. Ventur e capital is a source of investment in the form of seed capital in unproven areas, products or start-up situations. The concept of venture capital is relatively new to the Indian economy, and is gaining prominence in the recent years.
  9. 9. K.E.S. SHROFF COLLEGE Page 9 CHAPTER-6 TYPES OF VC INVESTORS The “venture funds” available could be from Incubators Angel investors Venture Capitalists (VCs) Private Equity Players Incubators An incubator is a hardcore technocrat who works with an entrepreneur to develop a business idea, and prepares a company for subsequent rounds of growth & funding. E-Ventures, Infinity is examples of incubators in India. Angel Investors An angel is an experienced industry-bred individual with high net worth. Typically, an angel investor would: Invest only his chosen field of technology Take active participation in day-to-day running of the company Invest small sums in the range of USD 1-3 million Not insist on detailed business plans Sanction the investment in up to a month Help company for “second round” of funding The INDUS Entrepreneurs (TiE) is a classic group of angels like: Vinod dham, Sailesh Mehta, Kanwal Rekhi, Prabhu Goel, Suhas Patil, Prakash Agrawal, K.B Chandrashekhar. In India there is a lack of home grown angels except a few like Saurabh Srivastava & Atul Choksey (ex- Asian paints).
  10. 10. K.E.S. SHROFF COLLEGE Page 10 Venture Capitalists (VCs) VCs are organizations raising funds from numerous investors & hiring experienced professional managers to deploy the same. They typically: Invest at “second” stage Invest over a spectrum over industry/ies Have hand-holding “mentor” approach Insist on detailed business plans Invest into proven ideas/businesses Provide “brand” value to investee Invest between USD 2-5 million Private Equity Players They are established investment bankers. Typically: Invest into proven/established businesses Have “financial partners” approach Invest between USD 5- 100 million
  11. 11. K.E.S. SHROFF COLLEGE Page 11 CLASSIFICATION OF VC FUNDS Venture funds in India can be classified on the basis of: Base formation Financial Institutions Led By ICICI Ventures, RCTC, ILFS, etc.  Private venture funds like Indus, etc.  Regional funds like Warburg Pincus, JF Electra (mostly operating out of Hong Kong).  Regional funds dedicated to India like Draper, Walden, etc.  Offshore funds like Barings, TCW, HSBC, etc.  Corporate ventures like Intel. To this list we can add Angels like Sivan Securities, Atul Choksey (ex Asian Paints) and others. Merchant bankers and NBFCs who specialized in "bought out" deals also fund companies. Most merchant bankers led by Enam Securities now invest in IT companies. Investment Philosophy Early stage funding is avoided by most funds apart from ICICI ventures, Draper, SIDBI and Angels. Funding growth or mezzanine funding till pre IPO is the segment where most players operate. In this context, most funds in India are private equity investors. Size Of Investment The size of investment is generally less than US$1mn, US$1-5mn, US$5-10mn, and greater than US$10mn. As most funds are of a private equity kind, size of investments has been increasing. IT companies generally require funds of about Rs30-40mn in an early stage which fall outside funding limits of most funds and that is why the government is promoting schemes to fund start ups in general, and in IT in particular.
  12. 12. K.E.S. SHROFF COLLEGE Page 12 Value Addition- The venture funds can have a totally "hands on" approach towards their investment like Draper or "hands off" like Chase. ICICI Ventures falls in the limited exposure category. In general, venture funds who fund seed or start ups have a closer interaction with the companies and advice on strategy, etc while the private equity funds treat their exposure like any other listed investment. This is partially justified, as they tend to invest in more mature stories. A list of the members registered with the IVCA as of June 1999, has been provided in the Annexure. However, in addition to the organized sector, there are a number of players operating in India whose activity is not monitored by the association. Add together the infusion of funds by overseas funds, private individuals, „angel‟ investors and a host of financial intermediaries and the total pool of Indian Venture Capital today, stands at Rs50bn, according to industry estimates! The primary markets in the country have remained depressed for quite some time now. In the last two years, there have been just 74 initial public offerings (IPOs) at the stock exchanges, leading to an investment of just Rs14.24bn. That‟s less than 12% of the money raised in the previous two years. That makes the conservative estimate of Rs36bn invested in companies through the Venture Capital/private Equity route all the more significant. Some of the companies that have received funding through this route include:  Mastek, one of the oldest software houses in India  Geometric Software, a producer of software solutions for the CAD/CAM market  Ruksun Software, Pune-based software consultancy  SQL Star, Hyderabad based training and software development company  Microland, networking hardware and services company based in Bangalore  Satyam Infoway, the first private ISP in India  Hinditron, makers of embedded software  PowerTel Boca, distributor of telecomputing products for the Indian market  Rediff on the Net, Indian website featuring electronic shopping, news, chat, etc  Entevo, security and enterprise resource management software products  Planetasia.com, Microland‟s subsidiary, one of India‟s leading portals  Torrent Networking, pioneer of Gigabit-scaled IP routers for inter/intra nets  Selectica, provider of interactive software selection Though the infotech companies are among the most favored by venture capitalists, companies from other sectors also feature equally in their portfolios. The healthcare sector with pharmaceutical, medical appliances and biotechnology industries also get much attention in India. With the deregulation of the telecom sector, telecommunications industries like Zip Telecom and media companies like UTV and Television Eighteen have joined the list of favorites. So far, these trends have been in keeping with the global course.
  13. 13. K.E.S. SHROFF COLLEGE Page 13 However, recent developments have shown that India is maturing into a more developed marketplace; unconventional investments in a gamut of industries have sprung up all over the country. This includes: Indus League Clothing, a company set up by eight former employees of readymade garments giant Madura, who set up shop on their own to develop a unique virtual organization that will license global apparel brands and sell them, without owning any manufacturing units. They dream to build a network of 2,500 outlets in three years and to be among the top three readymade brands. Shoppers Stop, Mumbai‟s premier departmental store innovates with retailing and decides to go global. This deal is facing some problems in getting regulatory approvals. Airfreight, the courier-company which has been growing at a rapid pace and needed funds for heavy investments in technology, networking and aircrafts. Pizza Corner, a Chennai based pizza delivery company that is set to take on global giants like Pizza Hut and Dominos Pizza with its innovative servicing strategy. Consortium financing Where the project cost is high (Rs 100 million or more) and a single fund is not in a position to provide the entire venture capital required then venture funds might act in consortium with other funds and take a lead in making investment decisions. This helps in diversifying risk but however it has not been very successful in the India case.
  14. 14. K.E.S. SHROFF COLLEGE Page 14 CHAPTER-7 VENTURE CAPITAL IN INDIA Research and Development Cess Act, 1986 introduced in the fiscal budget for the year 1986-87, is the precursor of the concept of venture capital as a new financial service in India. This Act imposed 5 per cent cess on all know-how import payments to create a pool of funds for, inter alia, venture capital activities. Technology Development Fund (TDF) was set up in the year 1987 -88, through the levy of this cess on all technology import payments. TDF was meant to provide financial assistance to innovative and high-risk technological programs through the Industrial Development Bank of India. This measure was followed up in November 1988, by the issue of guidelines by the (then) Controller of Capital Issues (CCI). These stipulated the framework for the establishment and operation of funds/companies that could avail of the fiscal benefits extended to them. However, another form of venture capital which was unique to Indian conditions also existed. That was funding of green –field projects by the small investor by subscribing to the Initial Public Offering (IPO) of the companies. Companies like Jindal Vijaynagar Steel, which raised money even before they started constructing their plants, were established through this route. In March 1987, Industrial Development Bank of India (IDBI) had become the first to introduce Venture Capital Fund (VCF) scheme for financing ventures seeking development of indigenous technologies / adapta tion of foreign technology to wider domestic applications. Thereafter, Industrial Credit and Investment Corporation of India (ICICI) started financing technology oriented innovative companies. ICICI in association with Unit Trust of India (UTI) formed a venture capital subsidiary called TDICI - Technology Development and Information Company of India - with headquarters at Bangalore, for taking up venture capital activity. Industrial Finance Corporation of India (IFCI) formed Risk Capital and Technology Finance Corporation (RCTC), with headquarters at New Delhi. TDICI is now known as ICICI Venture Funds Management Company Ltd. or ICICI Venture; and RCTC is now known as IFCI Venture Capital Funds Ltd. (IVCF). Their main focus is on development and commercialisation of viable indigenous, often, untried technologies. Almost at the same time, Credit Capital Venture Finance Limited was started in the private sector. This has mobilised funding from global funding agencies, with the joint sponsorship of Commonwealth Development Corporation, London (U.K.), Credit Capital Finance Corporation, Asian Development Bank (ADB), and Bank of India, a public sector bank in India. Government of India, in November 1988, announced the first venture capital guidelines in the Parliament. These guidelines provided venture financing of technology start-ups, promoted primarily by first generation entrepreneurs. Soon thereafter in 1989, four institutions were selected by the World Bank under its Industrial Technology Development Project to start venture capital activities in different parts of the country. ICICI at Mumbai, Gujarat Industrial Investment Corporation (GIIC) in Ahmedabad, Andhra Pradesh Industrial Development Corporation (APIDC) in Hyderabad, and Canara Bank in Bangalore were selected under this scheme. IFCI at New Delhi, and Infrastructure Leasing and Financial Services Ltd. (IL & FS) at Mumbai were added later under the scheme.
  15. 15. K.E.S. SHROFF COLLEGE Page 15 These institutions formed separate companies for handling venture capital activity and have been following Government of India guidelines. Venture Capital Funds promoted under the scheme and their parent organization are tabulated below. Parent Institution Venture Fund Promoted ICICI TDICI, renamed as ICICI Venture Funds Management Company or ICICI Venture IFCI RCTC, renamed as IFCI Venture Capital Funds Ltd. (IVCF) IL & FS Pathfinder GIIC Gujarat Venture Capital Finance Ltd. (GVCFL), with all India coverage APIDC APIDC Venture Capital Ltd., with coverage as Andhra Pradesh Canara Bank Canfina - VCF, with focus on southern states The venture capital industry has grown manifold over the last decade and a half. The number of venture capital funds increased from 12 in 1990 to 31 in 1997, and 45 in 2000. The total corpus increased from Rs.200 crore in 1990 to Rs.4, 000 crore in 1997, and Rs.5, 000 crore in 2000. There has been very slowgrowth in the domestic funds, whereas 19 offshore private equity funds have started making investment in Indian companies. Inflow of venture capital from offshore funds has been quite substantial from 2001 onwards. This may be the effect of the implementation of the recommendations of the Report of the Working Group on Structure of Venture Capital Funds, chaired by K.B. Chandrasekhar, a NRI (Non-Resident Indian) from Silicon Valley, U.S.A. State Bank of India (SBI) and Canara Bank took the lead in promoting venture financing among the public sector banks. SBI Capital Markets, promoted by SBI is operating VCF. Later several PSU Banks started venture financing. From 1996, there has been an increased level of activity in the venture capital industry. More funds have been set up both by existing companies and by new ones in the public and private sectors. There has also been an increased availability of foreign funds for Indian venture capital investments. World Bank has been instrumental in the development of Venture Capital industry in the country. It provided initial support by providing funds as well as giving international exposure. Further it contributed in developing manpower resources and networking among venture capital companies in India to foster cohesiveness. This resulted in professionalisation of venture capital companies. The venture capital industry started maturing and in 1992, twelve domestic VCFs formed the Indian Venture Capital Association (IVCA). The association took vigorous steps and influenced Government of India to streamline the guidelines for venture capital industry in the country. The Indian Venture Capital Association (IVCA) became the nodal center for all venture activity in the country. It has built up an impressive database. According to the IVCA, the pool of funds available for investment to its 20 members in 1997 was Rs25.6 billion. Out of this, Rs10 billion had been invested in 691 projects. Certain venture capital funds are Industry specific i.e. they fund enterprises only in certain industries such as pharmaceuticals, infotech or food processing whereas others may have a much wider spectrum. Again, certain funds may have a geographic focus – like Uttar Pradesh, Maharashtra, Kerala, etc whereas others may fund across different territories. The funds may be either close-ended schemes (with a fixed period of maturity) or open-ended.
  16. 16. K.E.S. SHROFF COLLEGE Page 16 The Venture funds in India can be classified on the basis of: a) Genesis Financial Institutions Led By ICICI Ventures, RCTC, ILFS, etc. Private venture funds like Indus, etc. Regional funds like Warburg Pincus, JF Electra (mostly operating out of Hong Kong). Regional funds dedicated to India like Drap er, Walden, etc. Offshore funds like Barings, TCW, HSBC, etc. Corporate ventures like Intel. To this list we can add Angels like Sivan Securities, Atul Choksey (ex Asian Paints) and others. Merchant bankers and NBFCs who specialized in "bought out" deals also fund companies. Most merchant bankers led by Enam Securities now invest in IT companies. b) Investment Philosophy Early stage funding is avoided by most funds apart from ICICI ventures, Draper, SIDBI and Angels. Funding growth or mezzanine funding till pre IPO is the segment where most players operate. In this context, most funds in India are private equity investors. c) Size of Investment The size of investment generally varies between less than US$1mn, US$1 -5mn, US$5-10mn, and greater than US$10mn. As most funds are of a private equity kind, size of investments has been increasing. IT companies generally require funds of about Rs30-40mn in an early stage which fall outside funding limits of most funds and that is why the government is promoting schemes to fund start ups in general, and in IT in particular. d) Value Addition The venture funds can have a totally "hands on" approach towards their investment like Draper or "hands off" like Chase. ICICI Ventures falls in the limited exposure category. In general, venture funds who fund seed or start ups have a closer interaction with the companies and advice on strategy, etc while the private equity funds treat their exposure like any other listed investment. This is partially justified, as they tend to invest in more mature stories.In addition to the organized sector, there are a number of players operating in India whose activity is not monitored by the association. Add together the infusion of funds by overseas funds, private individuals, „angel‟ investors and a host of financial intermediaries and the total pool of Indian Venture Capital today, stands at Rs. 50 billion, according to industry estimates! Despite availability of funds, 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 Rs. 14.24 billion. That‟s less than 12% of the money raised in the previous two years. That makes the conservative estimate ofRs36bn invested in companies through the Venture Capital/Private Equity route all the more significant.
  17. 17. K.E.S. SHROFF COLLEGE Page 17 Classification of Venture Capital Funds in India The VCFs can be classified into domestic & offshore and private & public funds. Domestic Funds The majority of domestic venture capital funds created their funds under the Indian Trust Act, 1882.The industry has either a two or three tier structure. In the two tier structure, an Asset Management Company (AMC) is formed which also acts as a trustee to the funds. The funds are settled as close ended funds. In the three tier structure, an asset management company and a separate Trustee Company are formed. The policy guidelines to the AMC for making investments and disinvestments are provided by the Board of Trustees. This facilitates launching of more funds, each with a different objective or focus by the VC companies which normally act as the AMC. Both the structures are very similar to the Limited Partnership Act which is the structure through which VC funds are operated in U.S.A. and U.K as well. IDBI operated its venture capital activities through a separate division. SIDBI, which also operated VC earlier through a separate division, has formed an asset management company and a Trustee Company in 1999 - 2000 to operate venture capital activities. Offshore Funds Post liberalization, from 1991, mobility of international funds in India has steadily increased. The funds are set up outside India in many countries like U.S.A., Hong Kong, Singapore, Mauritius etc. These are very large funds, and make large investments. They generally invest in existing big companies. The fund is set up usually either with the sole contribution from one company or with contributions channeled through the foreign investors. Most of the funds have created the fund in Mauritius for investment exclusively in India. These offshore funds create an advisory board that makes investment and divestment decisions. The funds are routed through Mauritius for investment in Indian companies. This is primarily done to save taxes under a double tax treaty between India and Mauritius. The Mauritius based companies are totally exempted from paying capital gains tax. Such investments are also subject to Foreign Investment Promotion Board (FIPB) approval.
  18. 18. K.E.S. SHROFF COLLEGE Page 18 CHAPTER-8 CORPORATE VENTURING (INVESTMENT PROCESS) Even though investor and the entire process that goes into the wooing the venture capital with your plan. First, you need to work out a business plan. The business plan is a document that outlines the management team, product, marketing plan, capital costs and means of financing and profitability statements. The venture capital investment process has variances/features that are context specific and vary from industry, timing and region. However, activities in a venture capital fund follow a typical sequence. The typical stages in an investment cycle are as below:  Generating a deal flow  Due diligence  Investment valuation  Pricing and structuring the deal  Value Addition and monitoring  Exit I] Generating A Deal Flow In generating a deal flow, the venture capital investor creates a pipeline of „deals‟ or investment opportunities that he would consider for investing in. This is achieved primarily through plugging into an appropriate network. The most popular network obviously is the network of venture capital funds/investors. It is also common for venture capitals to develop working relationships with R&D institutions, academia, etc, which could potentially lead to business opportunities. Understandably the composition of the network would depend on the investment focus of the venture capital funds/company. Thus venture capital funds focussing on early stage technology based deals would develop a network of R&D centers working in those areas. The network is crucial to the success of the venture capital investor. It is almost imperative for the venture capital investor to receive a large number of investment proposals from which he can select a few good investment candidates finally. Successful venture capital investors in the USA examine hundreds of business plans in order to make three or four investments in a year.-It is important to note the difference between the profile of the investment opportunities that a venture capital would examine and those pursued by a conventional credit oriented agency or an investment institution. By definition, the venture capital investor focuses on opportunities with a high degree of innovation.
  19. 19. K.E.S. SHROFF COLLEGE Page 19 The deal flow composition and the technique of generating a deal flow can vary from country to country. In India, different venture capital funds/companies have their own methods varying from promotional seminars with R&D institutions and industry associations to direct advertising campaigns targeted at various segments. A clear pattern between the investment focus of a fund and the constitution of the deal generation network is discernible even in the Indian context. II] Due Diligence Due diligence is the industry jargon for all the activities that are associated with evaluating an investment proposal. It includes carrying out reference checks on the proposal related aspects such as management team, products, technology and market. The important feature to note is that venture capital due diligence focuses on the qualitative aspects of an investment opportunity. It is also not unusual for venture capital fund/companies to set up an „investment screen‟. The screen is a set of qualitative (sometimes quantitative criteria such as revenue are also used) criteria that help venture capital funds/companies to quickly decide on whether an investment opportunity warrants further diligence. Screens can be sometimes elaborate and rigorous and sometimes specific and brief. The nature of screen criteria is also a function of investment focus of the firm at that point. Venture capital investors rely extensively on reference checks with „leading lights‟ in the specific areas of concern being addressed in the due diligence. A venture capitalist tries to maximize the upside potential of any project. He tries to structure his investment in such a manner that he can get the benefit of the upside potential ie he would like to exit at a time when he can get maximum return on his investment in the project. Hence his due diligence appraisal has to keep this fact in mind. New Financing Sometimes, companies may have experienced operational problems during their early stages of growth or due to bad management. These could result in losses or cash flow drains on the company. Sometimes financing from venture capital may end up being used to finance these losses. They avoid this through due diligence and scrutiny of the business plan. Inter-Company Transactions When investments are made in a company that is part of a group, inter-company transactions must be analyzed.
  20. 20. K.E.S. SHROFF COLLEGE Page 20 III] Investment Valuation The investment valuation process is an exercise aimed at arriving at ‘an acceptable price’ for the deal. Typically in countries where free pricing regimes exist, the valuation process goes through the following steps:  Evaluate future revenue and profitability  Forecast likely future value of the firm based on experienced market capitalization or expected acquisition proceeds depending upon the anticipated exit from the investment.  Target an ownership position in the investee firm so as to achieve desired appreciation on the proposed investment. The appreciation desired should yield a hurdle rate of return on a Discounted Cash Flow basis.  Symbolically the valuation exercise may be represented as follows:  NPV = [(Cash)/(Post)] x [(PAT x PER)] x k, where  NPV = Net Present Value of the cash flows relating to the investment comprising outflow by way of investment and inflows by way of interest/dividends (if any) and realization on exit. The rate of return used for discounting is the hurdle rate of return set by the venture capital investor.  Post = Pre + Cash  Cash represents the amount of cash being brought into the particular round of financing by the venture capital investor.  ‘Pre’ is the pre-money valuation of the firm estimated by the investor. While technically it is measured by the intrinsic value of the firm at the time of raising capital. It is more often a matter of negotiation driven by the ownership of the company that the venture capital investor desires and the ownership that founders/management team is prepared to give away for the required amount of capital  PAT is the forecast Profit after tax in a year and often agreed upon by the founders and the investors (as opposed to being „arrived at‟ unilaterally). It would also be the net of preferred dividends, if any.  PER is the Price-Earning multiple that could be expected of a comparable firm in the industry. It is not always possible to find such a „comparable fit‟ in venture capital situations. That necessitates, therefore, a significant degree of judgement on the part of the venture capital to arrive at alternate PER scenarios.
  21. 21. K.E.S. SHROFF COLLEGE Page 21  „k‟ is the present value interest factor (corresponding to a discount rate „r‟) for the investment horizon. It is quite apparent that PER time PAT represents the value of the firm at that time and the complete expression really represents the investor‟s share of the value of the investee firm. The following example illustrates this framework: Example: Best Mousetrap Limited (BML) has developed a prototype that needs to be commercialized. BML needs cash of Rs2mn to establish production facilities and set up a marketing program. BML expects the company will go public in the third year and have revenues of Rs70mn and a PAT margin of 10% on sales. Assume, for the sake of convenience that there would be no further addition to the equity capital of the company. Prudent Fund Managers (PFM) propose to lead a syndicate of like minded investors with a hurdle rate of return of 75% (discounted) over a five year period based on BML‟s sales and profitability expectations. Firms with comparable sales and profitability and risk profiles trade at 12 times earnings on the stock exchange. The following would be the sequence of computations: In order to get a 75% return p.a. the initial investment of Rs2 million must yield an accumulation of 2 x (1.75)5 = Rs32.8mn on disinvestment in year 5. BML‟s market capitalization in five years is likely to be Rs (70 x 0.1 x 12) million = Rs84mn. Percentage ownership in BML that is required to yield the desired accumulation will be (32.8/84) x 100 = 39% Therefore the post money valuation of BML At the time of raising capital will be equal to Rs(2/0.39) million = Rs5.1 million which implies that a pre-money valuation of Rs3.1 million for BML Another popular variant of the above method is the First Chicago Method (FCM) developed by Stanley Golder, a leading professional venture capital manager. FCM assumes three possible scenarios – „success‟, „sideways survival‟ and „failure‟. Outcomes under these three scenarios are probability weighted to arrive at an expected rate of return:In reality the valuation of the firm is driven by a number of factors. The more significant among these are: Overall economic conditions: A buoyant economy produces an optimistic long- term outlook for new products/services and therefore results in more liberal pre-money valuations.  Demand and supply of capital: when there is a surplus of venture capital of venture capital chasing a relatively limited number of venture capital deals, valuations go up. This can result in unhealthy levels of low returns for venture capital investors.  Specific rates of deals: such as the founder‟s/management team‟s track record, innovation/ unique selling propositions (USPs), the product/service size of the potential market, etc affects valuations in an obvious manner.
  22. 22. K.E.S. SHROFF COLLEGE Page 22  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 venture capital Well established venture capitals who are sought after by entrepreneurs for a number of reasons could get away with tighter valuations than their less known counterparts.  Investor‟s considerations could vary significantly. A study by an American venture capital, „VentureOne‟, revealed the following trend. Large corporations who invest for strategic advantages such as access to technologies, products or markets pay twice as much as a professional venture capital investor, for a given ownership position in a company but only half as much as investors in a public offering.  Valuation offered on comparable deals around the time of investing in the deal. Quite obviously, valuation is one of the most critical activities in the investment process. It would not be improper to say that the success for a fund will be determined by its ability to value/price the investments correctly. Sometimes the valuation process is broadly based on thumb rule metrics such as multiple of revenue. Though such methods would appear rough and ready, they are often based on fairly well established industry averages of operating profitability and assets/capital turnover ratios Such valuation as outlined above is possible only where complete freedom of pricing is available. In the Indian context, where until recently, the pricing of equity issues was heavily regulated, unfortunately valuation was heavily constrained.
  23. 23. K.E.S. SHROFF COLLEGE Page 23 IV] Structuring A Deal Structuring refers to putting together the financial aspects of the deal and negotiating with the entrepreneurs to accept a venture capital‟s proposal and finally closing the deal. To do a good job in structuring, one needs to be knowledgeable in areas of accounting, cash flow, finance, legal and taxation. Also the structure should take into consideration the various commercial issues (ie what the entrepreneur wants and what the venture capital would require to protect the investment). Documentation refers to the legal aspects of the paperwork in putting the deal together. The instruments to be used in structuring deals are many and varied. The objective in selecting the instrument would be to maximize (or optimize) venture capital‟s returns/protection and yet satisfy the entrepreneur‟s requirements. The instruments could be as follows: Instrument Issues Loan clean vs secured Interest bearing vs non interest bearing convertible vs one with features (warrants) 1st Charge, 2nd Charge, Stock maturity Preference shares redeemable (conditions under Company Act) participating Par value nominal shares Warrants exercise price, expiry period Common shares New or vendor shares Par value partially-paid shares Options exercise price, expiry period, call, put In India, straight equity and convertibles are popular and commonly used. Nowadays, 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 % age of sales as royalty and if it failed then the amount was written off.
  24. 24. K.E.S. SHROFF COLLEGE Page 24 In structuring a deal, it is important to listen to what the entrepreneur wants, but the venture capital comes up with his own solution. Even for the proposed investment amount, the venture capital decides whether or not the amount requested, is appropriate and consistent with the risk level of the investment. The risks should be analyzed, taking into consideration the stage at which the company is in and other factors relating to the project. (eg exit problems, etc). Promoter Shares As venture capital is to finance growth, venture capital investment should ideally be used for financing expansion projects (eg new plant, capital equipment, additional working capital). On the other hand, entrepreneurs may want to sell away part of their interests in order to lock-in a profit for their work in building up the company. In such a case, the structuring may include some vendor shares, with the bulk of financing going into buying new shares to finance growth. Handling Director’s And Shareholder’s Loans Frequently, a company has existing director‟s and shareholder‟s loans prior to inviting venture capitalists to invest. As the money from venture capital is put into the company to finance growth, it is preferable to structure the deal to require these loans to be repaid back to the shareholders/directors only upon IPOs/exits and at some mutually agreed period (eg 1 or 2 years after investment). This will increase the financial commitment of the entrepreneur and the shareholders of the project. A typical proposal may include a combination of several different instruments listed above. Under normal circumstances, entrepreneurs would prefer venture capitals to invest in equity as this would be the lowest risk option for the company. However from the venture capitals point of view, the safest instrument, but with the least return, would be a secured loan. Hence, ultimately, what you end up with would be some instruments in between which are sold to the entrepreneur. V] Monitoring and Follow Up The role of the venture capitalist does not stop after the investment is made in the project. The skills of the venture capitalist are most required once the investment is made. The venture capitalist gives ongoing advice to the promoters and monitors the project continuously. It is to be understood that the providers of venture capital are not just financiers or subscribers to the equity of the project they fund. They function as a dual capacity, as a financial partner and strategic advisor. Venture capitalists monitor and evaluate projects regularly. They keep a hand on the pulse of the project. They are actively involved in the management of the of the investee unit and provide expert business counsel, to ensure its survival and growth. Deviations or causes of worry may alert them to potential problems and they can suggest remedial actions or measures to avoid these problems. As professional in this unique method of financing, they may have innovative solutions to maximize the chances of success of the project. After all, the ultimate aim of the venture capitalist is the same as that of the promoters – the long term profitability and viability of the investee company.
  25. 25. K.E.S. SHROFF COLLEGE Page 25 VI] Exit One of the most crucial issues is the exit from the investment. After all, the return to the venture capitalist can be realized only at the time of exit. Exit from the investment varies from the investment to investment and from venture capital to venture capital. There are several exit routes, buy-buck by the promoters, sale to another venture capitalist or sale at the time of Initial Public Offering, to name a few. In all cases specialists will work out the method of exit and decide on what is most profitable and suitable to both the venture capitalist and the investee unit and the promoters of the project. At present many investments of venture capitalists in India remain on paper as they do not have any means of exit. Appropriate changes have to be made to the existing systems in order that venture capitalists find it easier to realize their investments after holding on to them for a certain period of time. This factor is even more critical to smaller and mid sized companies, which are unable to get listed on any stock exchange, as they do not meet the minimum requirements for such listings. Stock exchanges could consider how they could assist in this matter for listing of companies keeping in mind the requirement of the venture capital industry
  26. 26. K.E.S. SHROFF COLLEGE Page 26 CHAPTER-9 ACCESSING VENTURE CAPITAL UNDERTAKING Venture funds, both domestic and offshore, have been around in India for some years now. However it is only in the past 12 to 18 months, they have come into the limelight. The rejection ratio is very high, about 10 in 100 get beyond pre evaluation stage, and I get funded. Venture capital funds are broadly of two kinds – generalists or specialists. It is critical for the company to access the right type of fund, i.e. who can add value. This backing is invaluable as focused / specialized funds open doors,assist in future rounds and help in strategy. Hence, it is important to choose the right venture capitalist. The standard parameters used by venture capitalists are very similar to any investment decision. The only difference being exit. If one buys a listed security, one can exit at a price but with an unlisted security, exit becomes difficult. The key factors which they look for in The Management Most businesses are people driven, with success or failure depending on the performance of the team. It is important to distinguish the entrepreneur from the professional management team. The value of the idea, the vision, putting the team together, getting the funding in place are amongst others, some key aspects of the role of the entrepreneur. Venture capitalists will insist on a professional team coming in, including a CEO to execute the idea. One-man armies are passe. Integrity and commitment are attributes sought for. The venture capitalist can provide the strategic vision, but the team executes it. As a famous Silicon Valley saying goes "Success is execution, strategy is a dream". The Idea The idea and its potential for commercialization are critical. Venture funds look for a scalable model, at a country or a regional level. Otherwise the entire game would be reduced to a manpower or machine multiplication exercise. For example, it is very easy for Hindustan Lever to double sales of Liril - a soap without incremental capex, while Gujarat Ambuja needs to spend at least Rs4bn before it can increase sales by 1mn ton. Distinctive competitive advantages must exist in the form of scale, technology, brands, distribution, etc which will make it difficult for competition to enter.
  27. 27. K.E.S. SHROFF COLLEGE Page 27 Valuation All investment decisions are sensitive to this. An old stock market saying "Every stock is a buy at a price and vice versa". Most deals fail because of valuation expectation mismatch. In India, while calculating returns, venture capital funds will take into account issues like rupee depreciation, political instability, which adds to the risk premia, thus suppressing valuations. Linked to valuation is the stake, which the fund takes. In India, entrepreneurs are still uncomfortable with the venture capital "taking control" in a seed stage project. Exit Without exit, gains cannot be booked. Exit may be in the form of a strategic sale or/and IPO. Taxation issues come up at the time. Any fund would discuss all exit options before closing a deal. Sometimes, the fund insists on a buy back clause to ensure an exit. Portfolio Balancing Most venture funds try and achieve portfolio balancing as they invest in different stages of the company life cycle. For example, a venture capital has invested in a portfolio of companies predominantly at seed stage, they will focus on expansion stage projects for future investments to balance the investment portfolio. This would enable them to have a phased exit. In summary, venture capital funds go through a certain due diligence to finalize the deal. This includes evaluation of the management team, strategy, execution and commercialization plans. This is supplemented by legal and accounting due diligence, typically carried out by an external agency.
  28. 28. K.E.S. SHROFF COLLEGE Page 28 CHAPTER-10 ACCESSING VENTURE CAPITAL FUND The Business Plan The first step towards accessing venture capital funding is the preparation of the business plan. The business plan should be able to provide information regarding the promoters, amount of funding needed and the time period for which it is needed and how this funding is going to be paid back to the VC. To answer the above fundamental queries of a venture capital firm the business plan is to be structured with the necessary information. Business Plan Coverage Executive summary A brief description of the company and the type of business A summary of the business nature A description of the experience and expertise of the management team A summary of the product/service and competition A summary of financial history and projections Funds required and equity offered to the investors A description of use of proceeds The timing of returns on investment and exit routes offered to the investor Business background A brief history and nature of the business The industry details of the business involved in A summary of the future of the business Product / Service A description of the product or service The uniqueness of the product The present status of the product, that is a concept, prototype or product ready for market Market analysis The size of the potential market and market niche being pursued A projection of the trends and future size of the market place The estimated market share A description of the competition The marketing channel
  29. 29. K.E.S. SHROFF COLLEGE Page 29 A summary of the potential customers The possibility of related or new markets that can be developed Sales and marketing strategy The specific marketing techniques planned to be used The pricing plans and comparisons with pricing adopted by competitors The planned sales force and selling strategies for various accounts and markets The specific approaches for capitalizing on each marketing channel and comparison with other practices within the industry Details of advertising and promotional plans A description of customer service- which markets will be covered by direct sales force, which by distributors, representative or resellers Production operations A description of the production process Details of the production costs, including labour force, equipment, technology involved, extent of subcontract or outsourcing, supplier Management An organization chart showing the corporate structure A summary of the board of directors and key employees and details of their skills and experience .A list of the remuneration for all levels of staff A proposed plan of how to retain key staff Risk factors A description of the major problems and risks relating to the industry, the company and the products market Funds requested A description of the type of financing, such as equity only or a combination of equity and loan, and stock options to the investor The capital structure and ownership before and after the financing Return on investment and exit Details of the timing and expected return of the investment A summary of the exit strategies, such as initial public offering, sale to a third party or management buyout
  30. 30. K.E.S. SHROFF COLLEGE Page 30 Use of proceeds Specify how the capital will be spent, i.e.; what amount of capital will go to which items. Financial summaries A summary of the company‟s financial history and projections of three to five year period Details of the principal accounting policies of the company and the major assumptions made about the projections Appendices Resumes of key management and employees Detailed financial forecast and assumptions Market research report Company literature and brochures and pictures of the product A good business plan shows investors the quality and depth of a company‟s corporate leadership and indicates management‟s ability to reach stated goals. These factors lie at the heart of the decision of a venture capitalist to invest in the company‟s future. Selection of Venture capital fund After the business plan is completed, the next step is to select the venture capital fund, which is suitable to your proposal. The entrepreneur should first ascertain as to the investment strategy of the VC with regards to the sector in which the VC is interested as well as the stage at which he chooses to fund the project. Based on this information the entrepreneur should shortlist the suitable VCs who match his requirement and then approach them Financing from venture capital funds is available at various stages and different VCs provide funding in some or all of the stages.
  31. 31. K.E.S. SHROFF COLLEGE Page 31 CHAPTER-11 EXIT ROUTES After the unit has settled down to a profitable working and the enterprise is in a position to raise funds through conventional resources like capital market, financial institution or commercial banks, the venture capitalist liquidate their investment and make an exit from the investee company. The ultimate objective of a Venture Capitalist is to realize from his investment by selling off the same at a substantial capital gain. Infect at the time of making their investment, the venture capitalist plan their potential exit. The investee company has to prepare and make suitable adjustments in its capital structure at the time of realization by the venture capitalist. The convertible preference shares and convertible loans must be converted to ordinary equity before the exit by the venture capitalist. In case of non- convertible preference shares and loans by the venture capitalist these are to be redeemed. At exit the special rights granted to the venture capitalist cease to operate and venture capital firms normally withdraw their nominees from the board of the investee company. The venture capitalist firms have a motto „exit at the maximum possible profit or at a minimum possible loss’ – in case of a failed investment. The exit can be voluntary or involuntary. Liquidation or receivership of a failed venture is a case of involuntary exit. The voluntary exit can have four altenative routes for disinvestment: Buy back of shares by promoters or company. Sale of stock (shares) Selling to a new investor Strategic/ Trade sale BUY BACK / SHARES REPURCHASE Buy back or shares repurchase has the following forms: The investee company has to buyback its own shares for cash from its venture capitalist using its internal accruals The promoters and their group buys back the equity stake of venture capitalist. The employees‟ stock trusts are formed which, in turn, buy the share holding of the venture capitalist in the company. The route is suited to the Indian conditions because it keeps the ownership and control of the promoters intact. Indian entrepreneurs are often very touchy about ownership and control of their business. Hence in India, first a buy back option is normally given to the promoters or to the company and only on their refusal the other disinvestments routes are looked into. The exact price is mutually negotiated between the entrepreneur and the venture capitalist. The price is determined considering the book value of shares, future earning potential of the venture, Price/Earning ratio of similar listed companies.
  32. 32. K.E.S. SHROFF COLLEGE Page 32 The companies were not allowed to buy back their shares in India; however, with effect from the amendment in the companies act (1999) the companies can do so now. SALE OF SHARES ON THE STOCK EXCHANGE The venture capitalist can exit by getting the company listed on the stock exchange and selling his equity in the primary or secondary market using any of the following three methods: Sale of shares on stock exchange after listing shares. Venture capitalists generally invest at the start up stage and propose to disinvest their holding after the company brings out an IPO for raising funds for expansion. This listing on stock exchange provides an exit route from investment. Initial Public Offer (IPO)/ Offer for sale When the existing entrepreneurs opt out of buy back, the venture capitalists opt for disinvesting their stocks through public offering. Disinvestments on OTC An active capital market supports the venture capital activities. It enables the venture capitalists to get a suitable valuation for their investment. Besides the regular stock exchange a well developed OTC market where dealers can trade in shares. The OTC market enables the new and smaller companies not eligible for listing on a regular stock exchange to be listed at an OTC exchange and thus provide liquidity to the investors. As per the recommendations of a number of committees, an OTC exchange was required in India. As a result „Over The Counter Exchange of India (OTCEI)‟ was set up. SELLING TO AN INVESTOR Many a times for their exit venture capitalist and /or the promoters locate a new investor, a corporate body or another venture capital firm. The new investors are normally those who find some sort of synergy between the investee company and their existing operations such that the relationship is useful to both the companies. This route is also used when the promoters want to get rid of the venture capitalist. Some venture capitalists, as a policy concentrate their activities to startups and early stage investments. Such venture capital funds exit paving way for the venture capital fund specializing in the later stage investment or buy out deals. Often a growing venture needs second stage financing, if the existing venture capitalist as a policy does not commit funds for the second stage it normally locates another venture capitalist that finds the investment attractive enough to enter.
  33. 33. K.E.S. SHROFF COLLEGE Page 33 CORPORATE / TRADE SALE The venture capital firm and the entrepreneur together sell the enterprise to a third party mostly a corporate entity. Herein the promoters also exit from the venture along with the venture capitalist.This is called a corporate, strategic or trade sale. The reasons for this sale can be varied, difficulty in running the business profitability or a perceived competition from more established big business houses having huge resources and business synergy. On the other hand, where operations of an existing venture are modest, a higher exit valuation may be achieved in the market rather than by a trade sale, as the market investors are usually swayed by the appeal of the sector in which the venture operates rather than the quality of its specific business operations. Modalities The modalities of the trade sale differ from case to case depending upon the nature of operations, its size, the requirements of the buyer, etc. The sale can be in cash, against the shares of the acquiring company or the combination of the two. The equity owners get the shares of the buyer company in lieu of the shares bein sold by them. Such sales have the advantage that the seller does not have to pay any tax as the transaction involves only exchange of shares. At times, it is through a management buy- out or buy-in, which in turn may be financed partially by another venture capital fund. It is important to note that in India if the investee company is a listed company at the time of trade sale, then the provisions of listing agreement are attracted besides the provisions of the SEBI regulations of merger and acquisitions are also applicable. Management Buy-Outs Venture capital buy-outs are both a successful investment strategy for venture capital investment as well as an efficient exit route. Buy-out financed by another venture capitalist primarily by providing debt is known as leveraged buy-out. Buy-out without participation by another investor is called management buy-out. Here in the current management group purchases the stake of the venture capitalist. The stock options and sweat equity have made management buy-out possible in India. Management buy-outs are important in venture capital market for various reasons: MBO‟s provide an opportunity to managers to become entrepreneurs. Venture capital investment in buy-out has a lower investment risk than early stage investment. MBO‟s help smaller enterprises to adapt to technological changes.
  34. 34. K.E.S. SHROFF COLLEGE Page 34 Buy-in is similar to buy-out but involves new management from outside and improvement in the operations of the venture. Incoming new management is often unfamiliar with the operations of the venture hence the acquiring company may feel that the continuity of the existing entrepreneur will be beneficial for the business; the services of the original entrepreneur are retained. This helps in implementing the remaining parts of the original ideas and also provides continuity to the venture. PRE-REQUISITE FOR THE EFFICIENT EXIT MECHANISM Legal framework Smooth procedures for sale / transfer of enterprises Efficient stock market Mechanism for listing and trading of equity of smaller companies.
  35. 35. K.E.S. SHROFF COLLEGE Page 35 CHAPTER-12 RISK OF VENTURE CAPITAL The primary risk of venture capital investing is that the companies into which the capital is invested will fail, and the money will be lost. The risk of investing money as a Limited Partner into a venture capital fund is that the managers of the fund (the General Partners, or 'venture capitalists') will pick more losing companies to invest in than winning companies, and that over time the total return from the fund will be less than might have been received from alternative investments. Is the venture capital a risky capital? It depends on the source, what their terms are, do they have the financial resources to back you when you really need to grow, is it going to be a short term investment or are they in for the long haul? These are just a few things you must have in writing before accepting any offer of capital. Also you will want to be in control of your own business not the venture capitalist. Alot will depend on what you are offering and how risky it is, your experience etc for them to even consider your needs. Types of Risks 1. Completion Risk: Design and Construction phase involves Completion risk. Completion risk involves the risk of not completing a project on schedule due to time, budget, or technological constraints. Such events lead to delay in loan repayment and debt accumulation. To minimize risk before lending…….. a. Obtain completion guarantees from sponsors, requiring them to pay all debts if completion is not on schedule. b. Ensure significant financial interest of sponsors in the project to maintain their commitment. c. Ensure that the project is developed under the terms of fixed price and time, under the supervision of reputed developers. 2. Resource Risk: Operation Phase involves Resource risk- Risk of shortage of inputs to generate adequate returns. To minimize this kind of risk: a. Experts reports must certify the existence of inputs. b. Ensure long-term supply contracts for inputs as a protection against shortages or price fluctuations. c. Obtain guarantees for minimum input levels. 3. Operating Risks: Operating risks are risks affecting cash flows and generation capacity of projects, such as inefficiencies in operations, shortage of skilled labour etc.
  36. 36. K.E.S. SHROFF COLLEGE Page 36 Prior to lending, the risks can be minimized by ensuring that a reputed and financially sound operator is in charge of the project. During the loan period, detailed operations showing the utilization of acquired funds should be prepared. This helps ensure that the funds are being utilized for permitted operating costs only.s 4. Market/Off Take Risks: Market/Off Take Risk is a type of risk of not finding a buyer at the fixed price to generate adequate cash flows. This kind of risk is minimized by entering into a forward sales contract with a financially sound company. 5. Credit Risks: Credit risk involves the repayment capacity of the borrower. This kind of risk could be minimized if the financier obtains a certificate of satisfaction with regard to experience, personnel, and financial soundness. 6. Technical Risks: Technical risk involves the risk of technical difficulties in construction and operation of the projects plant. It can be minimized by mostly adopting new proven technologies. 7. Currency Risks: Currency Risks involves depreciation in loan and revenue currencies causing an increase in costs and decrease in cash flows. This risk can be minimized by entering into suitable hedging contracts, matching the currencies of supply contracts. RISK MINIMIZATION Risk minimization lies at the heart of Project Finance. Project Finance is providing finance for particular projects, which are later repaid from cash flows generated by those specific projects. Risk Management Risk Management is the process of Identification, Measurement, Monitoring and Control and Mitigation of risks. Risk Management aims at Risk Minimization and not Risk Elimination. Risk Risk is defined as a possibility of adverse impact on earnings and capital on account of expected or unanticipated event. Risk and Time are opposite sides of same coin, for if there were no tomorrow there would be any risk. Time transforms risk and the nature of risk is shaped by time horizon.
  37. 37. K.E.S. SHROFF COLLEGE Page 37 Risk Minimization Process Risk arises due to projects if not being completed on time or within the specified budget, not operating to their full potential, or failing to generate sufficient revenues to repay loans, or else getting terminated prematurely. To prevent the above events from occurring and adversely affecting the project, a three step risk minimization process can be implemented. Risks for the Venture Capitalist Few venture capital firms invest in seed-stage or pre-revenue companies because those companies present the greatest risk as well as the longest time before a return can be realized. Venture firms seek to lessen their investment risk by investing in companies that are already producing revenues and have proven management. Market Risk Venture capitalists invest in start-up or young companies that have new ideas. The biggest question the venture investor must answer is whether there is actually a market for what the company proposes to do. To complicate matters, there is rarely a current market for a new idea so the venture investor must project the future likelihood of a market and whether it will be robust enough to support a successful venture. More importantly, will the market develop in time? Technical Risk When a venture investment is made there is no guarantee that another company won't produce a product that advances the technology in such a way as to make the portfolio company obsolete. The venture investor must strive to learn as much as possible about the progressive state of the art technology and monitor the progress of the portfolio company to make sure it updates its business idea in keeping with developments in the technology of its industry. Operational Risk Poor management can ruin the best company. Founders tend to be creative idea people and not particularly good managers because launching and building a company takes long hard careful hours of methodical work and patient attention. That is why most venture investors bring in managers to run the portfolio companies while the founders continue to innovate. Financial Risk Running out of money is a common but terminal problem. Inflation, errors in judgment, necessary redesigns, and other unforeseeable causes of cost overruns can increase the burn rate of a company beyond what even careful analysis can project. Even without surprise costs, there is no guarantee that planned additional rounds of funding will be raised. Venture investors must be prepared to lose all or most of their investment if the company does not succeed.
  38. 38. K.E.S. SHROFF COLLEGE Page 38 CHAPTER-13 ISSUED FACED BY VENTURE CAPITAL IN INDIA The Indian venture capital industry, at the present, is at crossroads. Following are the major issues faced by this industry. 1. Limitation on structuring of Venture Capital Funds (VCFs): VCFs in India are structured in the form of a company or trust fund and are required to follow a three-tier mechanism-investors, trustee company and AMC. A proper tax-efficient vehicle in the form of „Limited Liability Partnership Act‟, which is popular in USA, is not made applicable for structuring of VCFs in India. In this form of structuring, investors‟ liability towards the fund is limited to the extent of his contribution in the fund and also formalities in structuring of fund are simpler. 2. Problem in raising of funds: In USA primary sources of funds are insurance companies, pensions funds, corporate bodies etc; while in Indian domestic financial institutions, multilateral agencies and state government undertakings are the main sources of funds for VCFs. Allowing Pension funds, Insurance companies to invest in the VCFs would enlarge the possibility of setting up of domestic VCFs. Further, if Mutual Funds are allowed to invest upto 5 percent of their corpus in VCFs by SEBI, it may lead to increased availability of fund for VCFs. 3. Lack of Inventive to Investors: Presently, high net worth individuals and corporate are not provided with any investments in VCFs. The problem of raising funds from these sources further gets aggravated with the differential tax treatment applicable to VCFs and mutual funds. While the income of the Mutual funds is totally tax exempted under Section 10(23D) of the Income Tax Act income of domestic VCFs, which provide assistance to small, and medium enterprise is not totally exempted from tax. In absence of any inventive, it is extremely difficult for domestic VCFs to raise money from this investor group that has a good potential. 4. Absence of ‘angel investors: In Silicon Valley, which is a nurturing ground for venture funds financed IT companies; initial/ seed stage financing is provided by the angel investors till the company becomes eligible for venture funding . There after Venture Capitalist through financial support and value-added inputs enables the company to achieve better growth rate and facilitate its listng on stock exchanges.
  39. 39. K.E.S. SHROFF COLLEGE Page 39 Private equity investors typically invest at expansion/ later stages of growth of the company with large investments. In contrast to this phenomenon, Indian industry is marked by an absence of angel investors. 5. Limitations of investment instruments: As per the section 10(23FA) of the Income Tax Act, income from investments only in equity instruments of venture capital undertakings is eligible for tax exemption; whereas SEBI regulations allow investments in the form of equity shares or equity related securities issued by company whose shares are not listed on stock exchange. As VCFs normally structure the investments in venture capital undertakings by way of equity and convertible instruments such as Optionally/ Fully Convertible Debentures, Redeemable Preference shares etc., they need tax breaks on the income from equity linked instruments. 6. Domestic VCFs vis-à-vis Offshore Funds: The domestic VCFs operations in the country are governed by the regulations as prescribed by SEBI and investment restrictions as placed by CBDT for availing of the tax benefits. They pay maximum marginal tax 35 percent in respect of non-exempt income such as interest through Debentures etc., while off- shore funds which are structured in tax havens such as Mauritius are able to overcome the investment restriction of SEBI and also get exemption from Income Tax under Tax Avoidance Treaties. This denies a level playing field for the domestic investors for carrying out the similar activity in the country. 7. Limitation on industry segments: In sharp contrast to other countries where telecom, services and software bag the largest share of venture capital investments, in India other conventional sectors dominate venture finance. Opening up of restrictions, in recent time, on investing in the services sectors such as telecommunication and related services, project consultancy, design and testing services, tourism etc, would increase the domain and growth possibilities of venture capital. 8. Anomaly between SEBI regulations and CBDT rules: CBDT tax rules recognize investment in financially weak companies only in case of unlisted companies as venture investment whereas SEBI regulations recognize investment in financially weak companies, which offers an attractive opportunity to VCFs. The same may be allowed by CBDT for availing of tax exemption on capital gains at a later stage. Also SEBI regulations do not restrict size of an investment in a company. However, as per Income tax rules, maximum investment in a company is restricted to less than 20 per cent of the raised corpus of VCF and paid up share capital in case of Venture Capital Company. Further, investment in company is also restricted upto 40 per cent of equity of Investee Company. VCFs may place the investment restriction for VCFs by way of maximum equity stake in the company, which could be upto 49 per cent of equity of the Investee Company.
  40. 40. K.E.S. SHROFF COLLEGE Page 40 9. Limitations on Exit Mechanism: The VCFs , which have invested in various ventures, have not been able to exit from their investments due to limited exit routes and also due to unsatisfactory performance of OTCEI . The threshold limit placed by various stock exchanges acts as deterrent for listing of companies with smaller equity base. SEBI can consider lowering of threshold limit for public/listing for companies backed by VCFs. Buy-back of equity shares by the company has been permitted for unlisted companies, which would provide exit route to investment of venture capitalists. 10. Legal Framework: Lack of requisite legal framework resulting in adequate penalties in case of suppression of facts by the promoters-results in low returns even from performing companies. This has bearing on equity investments particularly in unlisted companies.
  41. 41. K.E.S. SHROFF COLLEGE Page 41 CHAPTER-14 FUTURE OF VENTURE CAPITAL IN INDIA Rapidly changing economic environment accelerated by the high technology explosion, emerging needs of new generation of entrepreneurs in the process and inadequacy of the existing venture capital funds/schemes are indicative 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 in laboratories are not commercialized because of unwillingness of people to take entrepreneurial risks, i.e. risk their 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 for entrepreneurs to develop products involving newer technologies and commercialize them. This will give a fillip 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. In addition, venture capital will be needed urgently to solve the serious problems of sickness which has plagued many Indian Industries. There are large number of sick companies which offer opportunities for turn-around, either through a change in the product line or use of existing facilities in a different way or in any other manner. What is needed is the supply of equity to persons who have fertile ideas, necessary expertise and competence and who can bring about improvements in some units. 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 to a certain percentage. For the personal reasons or because of 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. A large number of smaller units serving as ancillaries to major industrial groups need capital, expertise and contacts of venture capitalist for upgradation of their technology in tune with the demands from the major industrial units. It is generally found that small suppliers are faced with a choice of going out of business, losing their major client, being acquired by the client or obtaining at an exorbitant rate from a source outside the industry. Venture capitalist can help these units and save them from the crisis.
  42. 42. K.E.S. SHROFF COLLEGE Page 42 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 capitalists can provide capital and expertise to organizations selling antique, 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, developmental an exploitation phases in the process of commercialization of the technological innovation and (ii) as may of the risk stages-development, manufacturing, marketing, management and growth as possible under Indian Conditions. The fund should offer 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, 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.
  43. 43. K.E.S. SHROFF COLLEGE Page 43 CHAPTER-15 SWOT ANALYSIS OF INDIAN VENTURE CAPITAL STRENGHTS WEAKNESS An effort initiated from within – Home grown Increased awareness of venture capital More capital under management by VCFs Industry crossed learning curve. More experienced Venture Capitalists, Intermediaries, and Entrepreneurs. Growing number of foreign trained professionals. Global competition growing. Moving towards international standards Offshore funds bring strong foreign ties Matured towards market system Electronic trading – through NSE & BSE. Valuation addition Irreversible reform Faddish Limited exit option Uncertainties Policy repatriation, taxation Bureaucratic meddling and rigid official attitude Industry fragmented and polarized- Mixed V.C culture Smaller funds with illiquid investments Domestic fund raising difficult Lack of transparency & corporate governance Accounting standards Poor legal administration Difficult due diligence Inadequate management depth Valuation expectations unrealistic
  44. 44. K.E.S. SHROFF COLLEGE Page 44 Regulatory framework evolving Technical and Market evaluation difficult Negligible minority protection rights Inadequate corporate laws
  45. 45. K.E.S. SHROFF COLLEGE Page 45 OPPORTUNITIES THREATS Growth capital for strong companies and Buyouts of weak companies due to growing global competition Financial restructuring have over leveraged companies taking place. Acquisition of quoted small/ medium cap companies. Pre money valuations low Vast potential exists in turn around, MBO, MBI. Change in government policies with respect to – 1. Structuring 2. Taxation Threats from within Explosive expansion and over Exuberance of investors Greed fro very high returns.
  46. 46. K.E.S. SHROFF COLLEGE Page 46 CHAPTER-16 SURVEY REPORT 1) Are you aware about venture capital? 8 people Say– Yes 2 people Say – No 2) Which company of venture capital would you prefer? 9 people Say– Indian 1 people Say – Foriegn
  47. 47. K.E.S. SHROFF COLLEGE Page 47 3) Have you ever invested in any venture capital company? 1 people Say– Yes 9 people Say – No 4) According to you, venture capital is profitable or not? 7 people Say– Yes 3 people Say – No
  48. 48. K.E.S. SHROFF COLLEGE Page 48 5) Do you think the procedure of venture capital is? 6 people Say– Convenoent 4 people Say – Lengthy 6) Do you think after the establishment of venture capital in India, there is growth in entrepreneurship? 9 people Say– Yes 1 people Say – No Yes No
  49. 49. K.E.S. SHROFF COLLEGE Page 49 CHAPTER-17 CONCLUSION Venture Financing in India is still in its infancy. There is no reliable estimates of VC funding because what all is repo rted is not real as rules allow many VC transactions to fall outside official statistics by making them indistinguishable from routine foreign investment. VC financing increased in the beginning with liberalization but started falling thereafter. VC in India invest in profitable companies rather than start-ups. VC in India invest in profitable companies rather than start-ups. Information technology, software development, BPO, biotechnology, food and agro-processing industries, pharmaceuticals, service enterprises, media, entertainment and healthcare have emerged as the new stars. Indian VC investment is essentially small, far less than China and Japan. Venture fund, generally, flows to the entrepreneur when the investor is personally familiar with him. For entrepreneurs seeking informal investments from outside their circle of social networks, this means that they must be prepared to provide sufficient information for the potential investor to make informed risk evaluation. They should also seek out, where possible, potential investors with experience in the area of their proposed new business. There is a need to professionalize the venture fund investment for which greater transparency and trust is needed between the entrepreneur and the investor. With greater encouragement given to professional entrepreneurship, adoption of innovative technologies and an integration of Indian business with the global market; industry and service sector in particular offer bright prospects for venture capital industry in th e country.
  50. 50. K.E.S. SHROFF COLLEGE Page 50 CHAPTER-18 BIBLIOGRAPHY Reference Books & Magazines  Venture Capital, The Indian Experience by I M T Tandey  Issues Facing Indian Venture Capital Industry by H Rajurkar  Business World  India Today Newspapers  The Times of India  Economics Times Websites  www.indiainfoline.com  www.icfaipress.org  www.webcrawler.com  www.namasthenri.com