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  • 1. SEBI (Venture Capital Funds)(Amendment) Regulations, 2000 and the SEBI (Foreign Venture Capital Investors)Regulations, 2000.1. Following are the salient features of SEBI (Venture Capital Funds)(Amendment) Regulations, 2000 : 1.1 Definition of Venture Capital Fund : The Venture Capital Fund is now defined as a fund established in the form of a Trust, a company including a body corporate and registered with SEBI which: A. has a dedicated pool of capital; B. raised in the manner specified under the Regulations; and C. to invest in Venture Capital Undertakings in accordance with the Regulations." 1.2 Definition of Venture Capital Undertaking: Venture Capital Undertaking means a domestic company :- a. Whose shares are not listed on a recognised stock exchange in India b. Which is engaged in business including providing services, production or manufacture of articles or things, or does not include such activities or sectors which are specified in the negative list by the Board with the approval of the Central Government by notification in the Official Gazette in this behalf. The negative list includes real estate, non-banking financial services, gold financing, activities not permitted under the Industrial Policy of the Government of India. 1.3 Minimum contribution and fund size : the minimum investment in a Venture Capital Fund from any investor will not be less than Rs. 5 lacs and the minimum corpus of the fund before the fund can start activities shall be atleast Rs. 5 crores. 1.4 Investment Criteria : The earlier investment criteria has been substituted by a new investment criteria which has the following requirements : o disclosure of investment strategy; o maximum investment in single venture capital undertaking not to exceed 25% of the corpus of the fund; o Investment in the associated companies not permitted; o atleast 75% of the investible funds to be invested in unlisted equity shares or equity linked instruments. o Not more than 25% of the investible funds may be invested by way of: a. subscription to initial public offer of a venture capital undertaking whose shares are proposed to be listed subject to lock-in period of one year; b. debt or debt instrument of a venture capital undertaking in which the venture capital fund has already made an investment by way of equity.It has also been provided that Venture Capital Fund seeking to avail benefit under the relevant provisions of the IncomeTax Act will be required to divest from the investment within a period of one year from the listing of the Venture CapitalUndertaking. 1.5 Disclosure and Information to Investors: In order to simplify and expedite the process of fund raising, the requirement of filing the Placement memorandum with SEBI is dispensed with and instead the fund will be required to submit a copy of Placement Memorandum/ copy of contribution agreement entered with the investors along with the details of the fund raised for information to SEBI. Further, the contents of the Placement Memorandum are strengthened to provide adequate disclosure and information to investors. SEBI will also prescribe suitable reporting requirement from the fund on their investment activity.2. QIB status for Venture Capital Funds : The venture capital funds will be eligible to participate in the IPO through bookbuilding route as Qualified Institutional Buyer subject to compliance with the SEBI (Venture Capital Fund) Regulations.3. Relaxation in Takeover Code: The acquisition of shares by the company or any of the promoters from the VentureCapital Fund under the terms of agreement shall be treated on the same footing as that of acquisition of shares bypromoters/companies from the state level financial institutions and shall be exempt from making an open offer to othershareholders.4. Investments by Mutual Funds in Venture Capital Funds: In order to increase the resources for domestic venture 1
  • 2. capital funds, mutual funds are permitted to invest upto 5% of its corpus in the case of open ended schemes and upto 10%of its corpus in the case of close ended schemes. Apart from raising the resources for Venture Capital Funds this wouldprovide an opportunity to small investors to participate in Venture Capital activities through mutual funds.5. Government of India Guidelines: The Government of India (MOF) Guidelines for Overseas Venture Capital Investmentin India dated September 20, 1995 will be repealed by the MOF on notification of SEBI Venture Capital Fund Regulations. 6. The following will be the salient features of SEBI (Foreign Venture Capital Investors) Regulations, 2000 : 6.1 Definition of Foreign Venture Capital Investor : any entity incorporated and established outside India and proposes to make investment in Venture Capital Fund or Venture Capital Undertaking and registered with SEBI. 6.2 Eligibility Criteria : entity incorporated and established outside India in the form of investment company, trust, partnership, pension fund, mutual fund, university fund, endowment fund, asset management company, investment manager, investment management company or other investment vehicle incorporated outside India would be eligible for seeking registration from SEBI. SEBI for the purpose of registration shall consider whether the applicant is regulated by an appropriate foreign regulatory authority; or is an income tax payer; or submits a certificate from its banker of its or its promoters track record where the applicant is neither a regulated entity nor an income tax payer. 6.3 Investment Criteria : o disclosure of investment strategy; o maximum investment in single venture capital undertaking not to exceed 25% of the funds committed for investment to India however it can invest its total fund committed in one venture capital fund; o atleast 75% of the investible funds to be invested in unlisted equity shares or equity linked instruments. o Not more than 25% of the investible funds may be invested by way of: a. subscription to initial public offer of a venture capital undertaking whose shares are proposed to be listed subject to lock-in period of one year; b. debt or debt instrument of a venture capital undertaking in which the venture capital fund has already made an investment by way of equity.7. Hassle Free Entry and Exit : The Foreign Venture Capital Investors proposing to make venture capital investmentunder the Regulations would be granted registration by SEBI. SEBI registered Foreign Venture Capital Investors shall bepermitted to make investment on an automatic route within the overall sectoral ceiling of foreign investment underAnnexure III of Statement of Industrial Policy without any approval from FIPB. Further, SEBI registered FVCIs shall begranted a general permission from the exchange control angle for inflow and outflow of funds and no prior approval of RBIwould be required for pricing, however, there would be ex-post reporting requirement for the amount transacted.8. Trading in unlisted equity : The Board also approved the proposal to permit OTCEI to develop a trading window forunlisted securities where Qualified Institutional Buyers(QIB) would be permitted to participate. Notifications & CircularsSEBI Guidelines for Overseas Investments by Venture Capital Funds Guidelines for Overseas Investments by Venture Capital Funds 2
  • 3. CIRCULAR NO. SEBI/VCF/CIR NO. 1/ 98645 /2007, DATED 9-8-2007 1. SEBI registered Venture Capital Fund (VCFs) are permitted to invest in securities of foreign companies in terms of regulation 12(ba) of the SEBI (Venture Capital Funds) Regulations 1996. Reserve Bank of India (RBI) vide its Circulars dated April 30, 2007 and May 04,2007, issued in this regard, has permitted these VCFs to invest in equity and equity linked instruments only of off-shore venture capital undertakings, subject to overall limit of USD 500 million and applicable SEBI regulations. 2. Accordingly, SEBI registered VCFs, desirous of making investments in offshore Venture Capital Undertakings may submit their proposal for investment (in the attached format) to SEBI for its prior approval. It is clarified that no separate permission from RBI is necessary in this regard. 3. For the purpose of such investment, it is clarified that - i. "Offshore Venture Capital Undertakings" means a foreign company whose shares are not listed on any of the recognized stock exchange in India or abroad. ii. Investments would be made only in those companies which have an Indian connection (i.e. company which has a front office overseas, while back office operations are in India) and such investments would be upto 10% of the investible funds of a VCF. iii. The allocation of investment limits would be done on first come- first serve basis, depending on the availability in the overall limit of USD 500 million. iv. It is clarified that in case a VCF who is allocated certain investment limit, wishes to apply for allocation of further investment limit, the fresh application shall be dealt with on the basis of the date of its receipt and no preference shall be granted to it in fresh allocation of investment limit. v. An applicant VCF shall have a time limit of 6 months for making allocated investments in offshore venture capital undertakings. In case the applicant does not utilize the limits allocated in the stipulated period of 6 months from the date of its approval, SEBI may allocate such unutilized limit to other VCFs/applicants whose applications are pending with it. 4. These investments would be subject to necessary amendments to Notification No. FEMA120/RB-2004 dated July 7, 2004 [Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004], and will also be governed by the related directions issued by the RBI from time to time.Roles within Venture Capital FirmsWithin the venture capital industry, the general partners and other investment professionals of the venture capitalfirm are often referred to as "venture capitalists" or "VCs". Typical career backgrounds vary, but broadly speakingventure capitalists come from either an operational or a finance background. Venture capitalists with anoperational background tend to be former founders or executives of companies similar to those which thepartnership finances or will have served as management consultants. Venture capitalists with finance backgroundstend to have investment banking or other corporate finance experience.Although the titles are not entirely uniform from firm to firm, other positions at venture capital firms include: Venture partners - Venture partners are expected to source potential investment opportunities ("bring in deals") and typically are compensated only for those deals with which they are involved. Entrepreneur-in-residence (EIR) - EIRs are experts in a particular domain and perform due diligence on potential deals. EIRs are engaged by venture capital firms temporarily (six to 18 months) and are expected to develop and pitch startup ideas to their host firm (although neither party is bound to work with each other). Some EIRs move on to executive positions within a portfolio company. 3
  • 4. Principal - This is a mid-level investment professional position, and often considered a "partner-track" position.Principals will have been promoted from a senior associate position or who have commensurate experience inanother field such as investment banking or management consulting. Associate - This is typically the most junior apprentice position within a venture capital firm. After a few successful years, an associate may move up to the "senior associate" position and potentially principal and beyond. Associates will often have worked for 1-2 years in another field such as investment banking or management consulting CHAPTER I PRELIMINARY Short title and commencement 1. (1) These regulations may be called the Securities and Exchange Board of India (Foreign Venture Capital Investor) Regulations, 2000. (2) They shall come into force on the date of their publication in the Official Gazette. Definitions 2 (1) In these regulations, unless the context otherwise requires, - (a) "Act" means the Securities and Exchange Board of India Act, 1992 (15 of 1992); (b) "certificate" means a certificate of registration granted by the Board under regulation 7. (c) "designated bank" means any bank in India which has been permitted by the Reserve Bank of India to act as banker to the Foreign Venture Capital Investor. (d) "domestic custodian" means a person registered under the Securities and Exchange Board of India (Custodian of Securities) Regulations, 1996. 1* [(e) "enquiry officer" means an enquiry officer appointed by the Board, under regulation 24]. 2* [(ee) "Inspection or Investigation Officer" means an officer appointed by the Board, under regulation 16]. (f) "equity linked instruments" includes instruments convertible into equity share or share warrants, preference shares, debentures compulsorily ; 3*[or optionally] convertible into equity. (g) ; 4*["foreign venture capital investor" means an investor incorporated and established outside India, is registered under these Regulations and proposes to make investment in accordance with these Regulations. (h) "form" means any of the forms set out in the First Schedule. (i) "investible funds" means the fund committed for investments in India net of expenditure for administration and management of the fund. (j) "negative list" means a list of items as specified in Third Schedule. (k) "Schedule" means a schedule annexed to these regulations; (l) "Venture Capital Fund" means a Fund established in the form of a Trust, a company including a body corporate and registered under Securities and Exchange Board of India (Venture Capital Fund) Regulations, 1996, which (i) has a dedicated pool of capital; (ii) raised in the manner specified under the Regulations; and (iii) invests ; 5*[*****] in accordance with the Regulations. (m) "venture capital undertaking" means a domestic company:- (i) whose shares are not listed in a recognised stock exchange in India; (ii) which is engaged in the business of providing services, production or manufacture of articles or things, but does not include such activities or sectors which are specified in the negative list by the Board, with approval of Central Government, by notification in the Official Gazette in this behalf." (2) Words and expressions used and not defined in these regulations but defined in the Act or Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996 shall have the same meaning as are respectively assigned to them in the Act or the said regulations. CHAPTER II REGISTRATION OF FOREIGN VENTURE CAPITAL INVESTORS Application for grant of certificate 3. For the purposes of seeking registration under these regulations, the applicant shall make an application to the Board in Form A along with the application fee as specified in Part A of the Second Schedule to be paid in the manner specified in Part B thereof. 4
  • 5. Eligibility Criteria4. (1) For the purpose of the grant of a certificate to an applicant as a Foreign Venture Capital Investor,the Board shall consider the following conditions for eligibility, namely: -(a) the applicants track record, professional competence, financial soundness, experience, generalreputation of fairness and integrity.(b) Whether the applicant has been granted necessary approval by the Reserve Bank of India for makinginvestments in India; 6*[**](c) whether the applicant is an investment company, investment trust, investment partnership, pensionfund, mutual fund, endowment fund, university fund, charitable institution or any other entity incorporatedoutside India; or(d) whether the applicant is an asset management company, investment manager or investmentmanagement company or any other investment vehicle incorporated outside India; 7*[**](e) whether the applicant is authorised to invest in venture capital fund or carry on activity as a 8*[foreignventure capital investors]; 9*[**](f) whether the applicant is regulated by an appropriate foreign regulatory authority or is an income taxpayer; or submits a certificate from its banker of its or its promoter’s track record where the applicant isneither a regulated entity nor an income tax payer.(g) the applicant has not been refused a certificate by the Board.(h) whether the applicant is a fit and proper person. 10* [ Applicability of Securities and Exchange Board of India (Criteria for Fit and proper Person)Regulations, 20044A. The provisions of the Securities and Exchange Board of India (Criteria for fit and proper person)Regulations, 2004 shall, as for as may be, apply to all applicants or the foreign venture capital investorsunder these regulations”]Furnishing of information, clarification5. The Board may require the applicant to furnish such further information as it may consider necessary.Consideration of application6. An application which is not complete in all respects shall be rejected by the Board:Provided that, before rejecting any such application, the applicant shall be given an opportunity toremove, within thirty days of the date of receipt of communication, the objections indicated by the Board.Provided further that the Board may, on being satisfied that it is necessary to extend the period specifiedabove may extend such period not beyond ninety days.Procedure for grant of certificate7. (1) If the Board is satisfied that the applicant is eligible for the grant of certificate, it shall send anintimation to the applicant.(2) On receipt of intimation, the applicant shall pay to the Board, the registration fee specified in Part A ofthe Second Schedule in the manner specified in Part B thereof.(3) The Board shall on receipt of the registration fee grant a certificate of registration in Form B.Conditions of certificate8. The certificate granted to the foreign venture capital 11*[investor] under regulation 7 shall be inter-alia,subject to the following conditions, namely:-(a) it shall abide by the provisions of the Act, and these regulations;(b) it shall appoint a domestic custodian for purpose of custody of securities;(c) it shall enter into arrangement with a designated bank for the purpose of operating a special non-resident rupee or foreign currency account.(d) it shall forthwith inform the Board in writing if any information or particulars previously submitted to theBoard are found to be false or misleading in any material particular or if there is any change in theinformation already submitted.Procedure where certificate is not granted9. (1) On considering an application made under regulation 3, if the Board is of the opinion that acertificate should not be granted, it may reject the application after giving the applicant a reasonableopportunity of being heard.(2) The decision of the Board to reject the application shall be communicated to the applicant. 5
  • 6. Effect of refusal to grant certificate10. Any applicant whose application has been rejected under regulation 9 shall not carry on any activityas a Foreign Venture Capital Investor. CHAPTER III INVESTMENT CONDITIONS AND RESTRICTIONSInvestment Criteria for a Foreign Venture Capital Investor11. All investments to be made by a foreign venture capital investors shall be subject to the followingconditions: -(a) it shall disclose to the Board its investment strategy.(b) 12*[**] it can invest its total funds committed in one venture capital fund 13*[***].(c) it shall make investments 14*[**] as enumerated below:(i) atleast 15*[66.67%] of the investible funds shall be invested in unlisted equity shares or equity linkedinstruments 16*[of Venture Capital Undertaking].(ii) not more than 17*[33.33%] of the investible funds may be invested by way of:(a) subscription to initial public offer of a venture capital undertaking whose shares are proposed to belisted 18*[**](b) debt or debt instrument of a venture capital undertaking in which the 19*[foreign venture capitalinvestor] has already made an investment by way of equity.(c) 20*[preferential allotment of equity shares of a listed company subject to lock in period of one year]. (d) 21*[ the equity shares or equity linked instruments of a financially weak company or a sick industrialcompany whose shares are listed].Explanation 1:- For the purpose of these regulations, a “financially weak company “ means a company,which has at the end of the previous financial year accumulated losses, which has resulted in erosion ormore than 50% but less than 100% of its net worth as at the beginning of the previous financial year.”(e) 22*[Special Purpose Vehicles which are created for the purpose of facilitating or promoting investmentin accordance with these Regulations].Explanation – the investment conditions and restrictions stipulated in clause (c) of regulation 11 shall beachieved by the Foreign Venture Capital Investor by the end of its life cycle”.(d) 23*[It shall disclose the duration of life cycle of the fund].22. Clause (e) in sub clause (ii) ) inserted by the SEBI (Foreign Venture Capital Investors) ( Amendment)Regulations, 2004 published in the Official Gazette of India dated 5.04.2004.23. Clause (d) in Regulation 11 inserted by the SEBI (Foreign Venture Capital Investors) ( Amendment)Regulations, 2004 published in the Official Gazette of India dated 5.04.2004 CHAPTER IV GENERAL OBLIGATIONS AND RESPONSIBILITIESMaintenance of books and records12. (1) Every Foreign Venture Capital Investor shall maintain for a period of eight years, books ofaccounts, records and documents which shall give a true and fair picture of the state of affairs of theForeign Venture Capital Investor.(2) Every Foreign Venture Capital Investor shall intimate to the Board, in writing, the place where thebooks, records and documents referred to in sub-regulation (1) are being maintained.Power to call for information13. (1) The Board may at any time call for any information from a Foreign Venture Capital Investor withrespect to any matter relating to its activity as a Foreign Venture Capital Investor.(2) Where any information is called for under sub-regulation (1) it shall be furnished within the timespecified by the Board. General Obligations and Responsibilities14 (1) Foreign Venture Capital Investor or a global custodian acting on behalf of the foreign venturecapital investor shall enter into an agreement with the domestic custodian to act as a custodian ofsecurities for Foreign Venture Capital Investor.(2) Foreign Venture Capital Investor shall ensure that domestic custodian takes steps for,-(a) monitoring of investment of Foreign Venture Capital Investors in India(b) furnishing of periodic reports to the Board 6
  • 7. (c) furnishing such information as may be called for by the Board.Appointment of designated bank15. Foreign Venture Capital Investor shall appoint a branch of a bank approved by Reserve Bank of Indiaas designated bank for opening of foreign currency denominated accounts or special non-resident rupeeaccount. CHAPTER V INSPECTION AND INVESTIGATIONSBoards right to inspect or investigate16. The Board may, suo-moto or upon receipt of information or complaint, cause an inspection orinvestigation to be made in respect of conduct and affairs of any foreign venture capital investor by anOfficer whom the Board considers fit for any of the following reasons namely: -(a) to ensure that the books of account, records and documents are being maintained by the foreignventure capital investor in the manner specified in these regulations.(b) to inspect or investigate into complaints received from investors, clients or any other person, on anymatter having a bearing on the activities of the foreign venture capital investor;(c) to ascertain whether the provisions of the Act and these regulations are being complied with by theforeign venture capital investor; and(d) to inspect or investigate suo-moto into the affairs of a foreign venture capital investor in the interest ofthe securities market or in the interest of investors.Obligation of Foreign Venture Capital Investor on investigation or inspection by Board17. (1) It shall be the duty of every Foreign Venture Capital Investor in respect of whom an inspection orinvestigation has been ordered under regulation 16 and any other person associated who is inpossession of relevant information pertaining to conduct and affairs of such Foreign Venture CapitalInvestor including asset management company or fund manager, to produce to the Inspecting orInvestigating Officer such books, accounts and other documents in his custody or control and furnish himwith such statements and information as the said Officer may require for the purposes of the inspection orinvestigation.(2) It shall be the duty of Foreign Venture Capital Investor and any other person associated who is inpossession of relevant information pertaining to conduct and affairs of the Foreign Venture CapitalInvestor to give to the Inspecting or Investigating Officer all such assistance and shall extend all such co-operation as may be required in connection with the inspections or investigations and shall furnish suchinformation sought by the Inspecting or Investigating Officer in connection with the inspections orinvestigations.(3) The Inspecting or Investigating Officer shall, for the purposes of inspection or investigation, havepower to examine on oath and record the statement of any person responsible for or connected withactivities of Foreign Venture Capital Investor or any other person associated having relevant informationpertaining to such Foreign Venture Capital Investor.(4) The Inspecting or Investigating Officer shall, for the purposes of inspection or investigation, havepower to get authenticated copies of documents, books, accounts of Foreign Venture Capital Investor,from any person having control or custody of such documents, books or accounts.Submission of the Report18. The Inspecting or Investigating Officer shall on completion of inspection or investigations, submit areport to the Board.Boards right to issue any direction to Foreign Venture Capital Investor19. The Board may after consideration of the inspection or investigation report and after giving areasonable opportunity of hearing to the Foreign Venture Capital Investor, require it to take such measureor issue such directions as it deems fit in the interest of capital market and investors, including directionsin the nature of: -(a) requiring the person concerned to dispose of the securities or disinvest in a manner as may bespecified in the directions;(b) requiring the person concerned not to further invest for a particular period;(c) prohibiting the person concerned from operating in the capital market in India for a specified period. 7
  • 8. CHAPTER VI PROCEDURE FOR ACTION IN CASE OF DEFAULTBoards right to suspend or cancel certificate of registration20. Without prejudice to the appropriate directions or measures under regulation 19, it may afterconsideration of the investigation report, initiate action for suspension or cancellation of the registration ofsuch Foreign Venture Capital Investor:Provided that no such certificate of registration shall be suspended or cancelled unless the procedurespecified in regulation 23 is complied with.Suspension of certificate21. The Board may suspend the certificate where the Foreign Venture Capital Investor:(a) contravenes any of the provisions of the Act or these regulations;(b) fails to furnish any information relating to its activity as a Foreign Venture Capital Investor as requiredby the Board;(c) furnishes to the Board information which is false or misleading in any material particular;(d) does not submit periodic returns or reports as required by the Board;(e) does not co-operate in any enquiry or inspection conducted by the Board;Cancellation of certificate22. The Board may cancel the certificate granted to a Foreign Venture Capital Investor: -(a) when the Foreign Venture Capital Investor is guilty of fraud or has been convicted of an offenceinvolving moral turpitude;Explanation: The expression "fraud" has the same meaning as is assigned to it in section 17 of the IndianContract Act, 1872. (9 of 1872)(b) the Foreign Venture Capital Investor has been guilty of repeated defaults of the nature mentioned inthe regulation 21; or(c) Foreign Venture Capital Investor does not continue to meet the eligibility criteria laid down in theseregulations;(d) contravenes any of the provisions of the Act or these regulations.Manner of making order of cancellation or suspension23. No order of penalty or cancellation of certificate shall be imposed on the Foreign Venture CapitalInvestor except after holding an enquiry in accordance with the procedure specified in the regulation 24.Manner of holding enquiry before suspension or cancellation24. (1) For the purpose of holding an enquiry under regulation 23, the Board may appoint one or moreenquiry officers.(2) The enquiry officer shall issue to the Foreign Venture Capital Investors, at its registered office or itsprincipal place of business or its agent or representative in India, a notice setting out the grounds onwhich action is proposed to be taken against it and calling upon it to show cause against such actionwithin a period of fourteen days from the date of receipt of the notice.(3) The Foreign Venture Capital Investor may, within fourteen days from the date of receipt of suchnotice, furnish to the enquiry officer a written reply, together with copies of documentary or other evidencerelied on by it or sought by the Board from the Foreign Venture Capital Investor.(4) The enquiry officer shall give a reasonable opportunity of hearing to the Foreign Venture CapitalInvestor to enable him to make submissions in support of its reply made under sub-regulation (3).(5) Before the enquiry officer, the Foreign Venture Capital Investor may appear through any person dulyauthorised by the Foreign Venture Capital Investor:Provided that no lawyer or advocate shall be permitted to represent the Foreign Venture Capital Investorsat the enquiry:Provided further that where a lawyer or an advocate has been appointed by the Board as a presentingofficer under sub-regulation (6), it shall be lawful for the Foreign Venture Capital Investor to present itscase through a lawyer or advocate.(6) The enquiry officer may, if he considers it necessary, ask the Board to appoint a presenting officer topresent its case(7) The enquiry officer shall, after taking into account all relevant facts and submissions made by theForeign Venture Capital Investor, submit a report to the Board and recommend the penal action, if any, tobe taken against the Foreign Venture Capital Investor as also the grounds on which the proposed actionis justified. 8
  • 9. Show-cause notice and order 25. (1) On receipt of the report from the enquiry officer, the Board shall consider the same and may issue to the Foreign Venture Capital Investor a show-cause notice as to why the penal action as proposed by the enquiry officer or such appropriate action should not be taken against it. (2) The Foreign Venture Capital Investor shall, within fourteen days of the date of the receipt of the show- cause notice, send a reply to the Board. (3) The Board, after considering the reply, if any, of the Foreign Venture Capital Investor, shall, as soon as possible pass such order as it deems fit. Effect of suspension and cancellation of certificate 26. (1) On and from the date of the suspension of the certificate, the Foreign Venture Capital Investor shall cease to carry on any activity as a Foreign Venture Capital Investor during the period of suspension, and shall be subject to such directions of the Board with regard to any records, documents or securities that may be in its custody or control, relating to its activities as Foreign Venture Capital Investor, as the Board may specify. (2) On and from the date of cancellation of the certificate, the Foreign Venture Capital Investor shall, with immediate effect, cease to carry on any activity as a Foreign Venture Capital Investor, and shall be subject to such directions of the Board with regard to the transfer of records, documents or securities that may be in its custody or control, relating to its activities as Foreign Venture Capital Investor, as the Board may specify. Publication of order of suspension or cancellation 27. The order of suspension or cancellation of certificate passed under regulation 25 may be published by the Board in two newspapers. Action against intermediary 28. The Board may initiate action for suspension or cancellation of registration of an intermediary holding a certificate of registration under section 12 of the Act who fails to exercise due diligence in the performance of its functions or fails to comply with its obligations under these regulations. Provided that no such certificate of registration shall be suspended or cancelled unless the procedure specified in the regulations applicable to such intermediary is complied with. 24* [Appeal to Securities Appellate Tribunal] Sebi board clears VCF norms sans tax sops ENS ECONOMIC BUREAUMUMBAI, SEP 14: The Securities and Exchange Board of India (SEBI) has finally approved the amendments envisagingrelaxation of regulations in venture capital (VC) norms, but without tax concessions. The one-year exit clause in theguidelines has upset fund managers and corporates.Domestic VC funds seeking to avail benefit under the relevant taxprovisions of the Income Tax Act are required to divest the investment within one years time from the listing of the companygot funding. However, SEBI, being a nodal agency for VC regulation, would continue to pursue the issue with the CentralBoard of Direct Taxes, which is the final authority in the case, Sebi chairman DR Mehta said.Federation of Indian Chambersof Commerce and Industry (FICCI) termed as "retrograde" the stipulation of a one-year time frame for venture capital funds tooff-load their stakes in portfolio companies. "Indian stock markets are illiquid and traded volumes in most listed stocks areinsignificant. Hence, the VCs who hold significant stakes in portfolio companies would not be in a position to dispose off theirentire holdings in a year," FICCI said.The Sebi board which met here today cleared the Sebi (Venture Capital Funds)(Amendment) Regulations, 2000 and the Sebi (Foreign Venture Capital Investors) Regulations, 2000. The government ofIndia guidelines (MoF) guidelines for overseas venture capital investment in India dated September 20, 1999 will be repealedon notification of Sebi guidelines.Mehta said the objective of the whole exercise was to create an environment for the healthygrowth of venture capital funds in the country. He said there was clear evidence that as an industry it was gaining momentumwith the number of Sebi-registered VCFs growing from 8 in April 1999 to 26 registered till date and the committed fundsduring the period rising from Rs 250 crore to around Rs 1700 crore. 9
  • 10. The regulations also take care of an important recommendation of the KB Chandrasekhar committee which called forproviding foreign venture capitalists the facility of registering with Sebi like FIIs which would enable them to makeinvestments in India automatically and within sectoral limits prescribed under the industrial policy statement of government ofIndia. In addition, the regulations ensure that foreign venture capitalists get "hassle free" exit without requiring pricingapproval from RBI based on the old CCI formula.Now Sebi registered foreign venture capital investors (FVCIs) will be permitted to make investment on an automatic routewithin the overall ceiling of foreign investment under Annexure II of Statement of Industrial Policy without any approval fromFIPB.Further, Sebi registered FVCIs will be granted a general permission from the exchange control angle for inflow andoutflow of funds and no prior approval of RBI would be required for pricing. However, there would be "ex-post" reportingrequirement for the amount transacted.Trading in unlisted stocks allowedMUMBAI: The SEBI board also approved a proposal to permit the Over-The-Counter Exchange of India to develop a tradingwindow for unlisted securities, where qualified institutional buyers would be permitted to participate.Initially trading, in theunlisted securities will be allowed only on OTCEI and Sebi may consider it on other exchanges after some time, Sebichairman D R Mehta said.Though the proposal was approved earlier, constraints in the form of too many regulations did notpermit OTCEI to launch such a product, he added. Though an entity incorporated or set up outside India in any of the variouspermitted forms were eligible for seeking SEBIs registration, the regulator would consider level of regulation in the country oforigin, tax assessment status, bankers certificate on the firms or its promoters track record, he said. SEBI clears internet equity trading, VCF norms ENS ECONOMIC BUREAUNEW DELHI, JAN 22: E-broking (electronic-broking or stock trading via the internet) has finally become a reality in India. TheSecurities and Exchange Board of India today approved the recommendations of the Birla committee on corporategovernance and allowed trading of shares through internet. The market regulator also approved, in-principal, venture capitalnorms receommended by the K B Chandrasekhar committee. On corporate governance, Sebi has drawn up a time-frame ofimplementation, which will be enforced through the listing agreement. On Internet-based securities trading, the marketwatchdog approved the order routing system in the absence of cyber laws. In its board meeting held in New Delhi, Sebi alsopermitted foreign corporates/individuals to invest in the Indian capital markets albeit with some restrictions. According to Sebi,both the mandatory and the non-mandatory recommendations of the Birla panel would be applicable to the corporatesthrough the listing agreement. For those seeking newlistings, these recommendations would be applicable with immediateeffect. However, companies which figure in BSEs specified list or in the Nifty, the Birla committee recommendations wouldbe applicable by fiscal 2000-2001. Companies which have a paid-up equity of Rs 10 crore and more (or a networth of Rs 25crore plus) would have to abide by these norms by fiscal 2001-2002. Companies with a paid-up capital of Rs 3-10 crorewould get an additional year as breather. Listed banks and financial institutions, which are incorporated under other statutes,would be exempt from these proposals.According to Sebi chairman D R Mehta, companies which do not adhere to the norms would be punished. However, thepunitive action would not be in the form of a delisting as "that would hurt small investors". The market regulator and stockexchanges concerned could consider initiating criminal proceedings against an errant company. Besides the `stick approach,Mehta said, even a `carrot in the form of better valuations forcompanies who follow the norms would go a long way inensuring compliance. ``Every companys annual report will now mandatorily have a disclosure on the level of corporategovernance achieved and that alone may ensure some compliance, Mehta added.For Internet-based trading, Mehta said, the regulatory framework was now in place. ``However, each stock exchange willhave to individually certify the specifications and we hope the process will be kicked off within a month, he added. While aclient will necessarily have to go through a broker, his transaction time will be cut drastically under the new system. Based onan agreement with the broker, a client can log in using a password and he will receive on-screen quotes. He punches hisbuy/sell order, which goes through the mainframe of a stock exchange through a filter of the broker. What this means is thatthe deal will be governed under the exposure/margin limit of the broker concerned.To promote venture capital activities, Sebi also approvedrecommendations of the Chandrasekhar committee. Few proposalslike one nodal agency for approval and an FII status would be decided by the government, Mehta said, as they were outsidethe purview of Sebi. But maters directly related to Sebi like relaxation of entry norms for IPOs were approved. According to 10
  • 11. the new norms, funding by a Sebi-registered venture capital fund would qualify a company to float an IPO (akin to a projectappraised and finance up to 10 per cent by a bank or FI). The three-year profitability criterion will not be applicable in thisregard. In order to lure more foreign inflows, Sebi also relaxed the entry norms for foreign corporate and individuals to investin the Indian capital markets. Earlier these had to be through a pool of 20 people; now they can invest via a registered FII.However, the total investment made by all these investors in this category cannot be more than 5 per cent of the total paid-upcapital of the company (and tat too, within the prescribed FII limit).According to Mehta, ``This should not be termed as hotmoney as experience shows that FIIs are more likely to withdraw from a country instead of individuals. Sebi has alsoallowed domestic asset management companies and Sebi registered domestic portfolio managers to manage foreigninvestments through the portfolio investment route. The market watchdog has also amended the regulation concerningdisclosure of mutual fund scheme portfolio. The present regulations provide that scheme-wise portfolio of investments is tobe disclosed by mutual funds in their annual reports and despatched to unit-holders within six months from date of closure ofrelevant accounting year. Mutual funds will now be required to send a complete statement of their scheme portfolios to allunit-holders within one month from the close of each half-year (March 31 and September 30). However, the requirement ofsuch disclosure shall be dispensed with if the statement of portfolio is published as an advertisement in twonewspapers.The latest sebi initiatives Internet stock trading through order routing system Foreign corporates and individuals permitted to invest in domestic capital markets through FII route Sebi-approved AMCs and domestic portfolio managers allowed to manage foreign investments through the portfolio route Birla panel report on corporate governance accepted in toto Approval for Chandrasekhar panel report on venture capitalists, allowing easier access to funds for first-time entrepreneurs MFs to disclose scheme-wise portfolios on half-yearly basis MFs will also be liable to pay interest to unitholders in case of delayed despatch of dividend warrants Half-yearly results of cos to be subjected to limited audit review Venture Capital in India - Chandrasekhar Committee on Venture Capital Analysis of Ground SituationWhy Venture CapitalThe venture capital industry in India is still at a nascent stage. With a view to promote innovation, enterprise andconversion of scientific technology and knowledge based ideas into commercial production, it is very important topromote venture capital activity in India. Indias recent success story in the area of information technology hasshown that there is a tremendous potential for growth of knowledge based industries. This potential is not onlyconfined to information technology but is equally relevant in several areas such as bio-technology,pharmaceuticals and drugs, agriculture, food processing, telecommunications, services, etc. Given the inherentstrength by way of its skilled and cost competitive manpower, technology, research and entrepreneurship, withproper environment and policy support, India can achieve rapid economic growth and competitive global strengthin a sustainable manner.A flourishing venture capital industry in India will fill the gap between the capitalrequirements of technology and knowledge based startup enterprises and funding available from traditionalinstitutional lenders such as banks. The gap exists because such startups are necessarily based on intangibleassets such as human capital and on a technology-enabled mission, often with the hope of changing the world.Very often, they use technology developed in university and government research laboratories that wouldotherwise not be converted to commercial use. However, from the viewpoint of a traditional banker, they haveneither physical assets nor a low-risk business plan. Not surprisingly, companies such as Apple, Exodus, Hotmailand Yahoo, to mention a few of the many successful multinational venture-capital funded companies, initiallyfailed to get capital as startups when they approached traditional lenders. However, they were able to obtainfinance from independently managed venture capital funds that focus on equity or equity-linked investments inprivately held, high-growth companies. Along with this finance came smart advice, hand-on management supportand other skills that helped the entrepreneurial vision to be converted to marketable products.Beginning with a consideration of the wide role of venture capital to encompass not just information technology,but all high-growth technology and knowledge-based enterprises, the endeavor of the Committee has been tomake recommendations that will facilitate the growth of a vibrant venture capital industry in India. 11
  • 12. The report examines- 1. the vision for venture capital 2. strategies for its growth and 3. how to bridge the gap between traditional means of finance and the capital needs of high growth startups. Critical Factors for Success of Venture Capital IndustryWhile making the recommendations the Committee felt that the following factors are critical for the success of theVC industry in India: A. The regulatory, tax and legal environment should play an enabling role. Internationally, venture funds have evolved in an atmosphere of structural flexibility, fiscal neutrality and operational adaptability. B. Resource raising, investment, management and exit should be as simple and flexible as needed and driven by global trends C. Venture capital should become an institutionalized industry that protects investors and investee firms, operating in an environment suitable for raising the large amounts of risk capital needed and for spurring innovation through startup firms in a wide range of high growth areas. D. In view of increasing global integration and mobility of capital it is important that Indian venture capital funds as well as venture finance enterprises are able to have global exposure and investment opportunities. E. Infrastructure in the form of incubators and R&D need to be promoted using Government support and private management as has successfully been done by countries such as the US, Israel and Taiwan. This is necessary for faster conversion of R & D and technological innovation into commercial products. RecommendationsMultiplicity of Regulations - Need for Harmonisation and Nodal RegulatorPresently there are three set of Regulations dealing with venture capital activity i.e. SEBI (Venture CapitalRegulations) 1996, Guidelines for Overseas Venture Capital Investments issued by Department of EconomicAffairs in the MOF in the year 1995 and CBDT Guidelines for Venture Capital Companies in 1995 which wasmodified in 1999. The need is to consolidate and substitute all these with one single regulation of SEBI to providefor uniformity, hassle free single window clearance. There is already a pattern available in this regard; the mutualfunds have only one set of regulations and once a mutual fund is registered with SEBI, the tax exemption byCBDT and inflow of funds from abroad is available automatically. Similarly, in the case of FIIs, tax benefits andforeign inflows/outflows are automatically available once these entities are registered with SEBI. Therefore, SEBIshould be the nodal regulator for VCFs to provide uniform, hassle free, single window regulatory framework. Onthe pattern of FIIs, Foreign Venture Capital Investors (FVCIs) also need to be registered with SEBI.Tax pass through for Venture Capital FundsVCFs are a dedicated pool of capital and therefore operates in fiscal neutrality and are treated as pass throughvehicles. In any case, the investors of VCFs are subjected to tax. Similarly, the investee companies pay taxes ontheir earnings. There is a well established successful precedent in the case of Mutual Funds which onceregistered with SEBI are automatically entitled to tax exemption at pool level. It is an established principle thattaxation should be only at one level and therefore taxation at the level of VCFs as well as investors amount todouble taxation. Since like mutual funds VCF is also a pool of capital of investors, it needs to be treated as a taxpass through. Once registered with SEBI, it should be entitled to automatic tax pass through at the pool levelwhile maintaining taxation at the investor level without any other requirement under Income Tax Act. Mobilisation of Global and Domestic resources A. Foreign Venture Capital Investors (FVCIs) 12
  • 13. Presently, FIIs registered with SEBI can freely invest and disinvest without taking FIPB/RBI approvals. This has brought positive investments of more than US $10 billion. At present, foreign venture capital investors can make direct investment in venture capital undertakings or through a domestic venture capital fund by taking FIPB / RBI approvals. This investment being long term and in the nature of risk finance for start-up enterprises, needs to be encouraged. Therefore, atleast on par with FIIs, FVCIs should be registered with SEBI and having once registered, they should have the same facility of hassle free investments and disinvestments without any requirement for approval from FIPB / RBI. This is in line with the present policy of automatic approvals followed by the Government. Further, generally foreign investors invest through the Mauritius-route and do not pay tax in India under a tax treaty. FVCIs therefore should be provided tax exemption. This provision will put all FVCIs, whether investing through the Mauritius route or not, on the same footing. This will help the development of a vibrant India-based venture capital industry with the advantage of best international practices, thus enabling a jump-starting of the process of innovation. The hassle free entry of such FVCIs on the pattern of FIIs is even more necessary because of the following factors: i. Venture capital is a high risk area. In out of 10 projects, 8 either fails or yield negligible returns. It is therefore in the interest of the country that FVCIs bear such a risk. ii. For venture capital activity, high capitalisation of venture capital companies is essential to withstand the losses in 80% of the projects. In India, we do not have such strong companies. iii. The FVCIs are also more experienced in providing the needed managerial expertise and other supports.B. Augmenting the Domestic Pool of Resources The present pool of funds available for venture capital is very limited and is predominantly contributed by foreign funds to the extent of 80 percent. The pool of domestic venture capital needs to be augmented by increasing the list of sophisticated institutional investors permitted to invest in venture capital funds. This should include banks, mutual funds and insurance companies upto prudential limits. Later, as expertise grows and the venture capital industry matures, other institutional investors, such as pension funds, should also be permitted. The venture capital funding is high-risk investment and should be restricted to sophisticated investors. However, investing in venture capital funds can be a valuable return-enhancing tool for such investors while the increase in risk at the portfolio level would be minimal. Internationally, over 50% of venture capital comes from pension funds, banks, mutual funds, insurance funds and charitable institutions. Venture Capital in India - Chandrasekhar Committee on Venture Capital - Recommendations Flexibility in Investment and ExitA. Allowing Multiple Flexible Structures: Eligibility for registration as venture capital funds should be neutral to firm structure. The government should consider creating new structures, such as limited partnerships, limited liability partnerships and limited liability corporations. At present, venture capital funds can be structured as trusts or companies in order to be eligible for registration with SEBI. Internationally, limited partnerships, Limited Liability Partnership and limited liability corporations have provided the necessary flexibility in risk-sharing, compensation arrangements amongst investors and tax pass through. Therefore, these structures are commonly used and widely accepted globally specially in USA. Hence, it is necessary to provide for alternative eligible structures.B. Flexibility in the Matter of Investment Ceiling and Sectoral Restrictions: 70% of a venture capital funds investible funds must be invested in unlisted equity or equity-linked instruments, while the rest may be invested in other instruments. Though sectoral restrictions for investment by VCFs are not consistent with the very concept of venture funding, certain restrictions could be put by specifying a negative list which could include areas such as finance companies, real estate, gold-finance, activities not legally permitted 13
  • 14. and any other sectors which could be notified by SEBI in consultation with the Government. Investments by VCFs in associated companies should also not be permitted. Further, not more than 25% of a funds corpus may be invested in a single firm. The investment ceiling has been recommended in order to increase focus on equity or equity-linked instruments of unlisted startup companies. As the venture capital industry matures, investors in venture capital funds will set their own prudential restrictions.C. Changes in Buy Back Requirements for Unlisted Securities : A venture capital fund incorporated as a company/ venture capital undertaking should be allowed to buyback upto 100% of its paid up capital out of the sale proceeds of investments and assets and not necessarily out of its free reserves and share premium account or proceeds of fresh issue. Such purchases will be exempt from the SEBI takeover code. A venture-financed undertaking will be allowed to make an issue of capital within 6 months of buying back its own shares instead of 24 months as at present. Further, negotiated deals may be permitted in Unlisted securities where one of the parties to the transaction is VCF.D. Relaxation in IPO Norms: The IPO norms of 3 year track record or the project being funded by the banks or financial institutions should be relaxed to include the companies funded by the registered VCFs also. The issuer company may float IPO without having three years track record if the project cost to the extent of 10% is funded by the registered VCF. Venture capital holding however shall be subject to lock in period of one year. Further, when shares are acquired by VCF in a preferential allotment after listing or as part of firm allotment in an IPO, the same shall be subject to lock in for a period of one year. Those companies which are funded by Venture capitalists and their securities are listed on the stock exchanges outside the country, these companies should be permitted to list their shares on the Indian stock exchanges.E. E. Relaxation in Takeover Code: The venture capital fund while exercising its call or put option as per the terms of agreement should be exempt from applicability of takeover code and 1969 circular under section 16 of SC(R)A issued by the Government of India.F. Issue of Shares with Differential Right with regard to voting and dividend: In order to facilitate investment by VCF in new enterprises, the Companies Act may be amended so as to permit issue of shares by unlisted public companies with a differential right in regard to voting and dividend. Such a flexibility already exists under the Indian Companies Act in the case of private companies which are not subsidiaries of public limited companies.G. QIB Market for Unlisted Securities: A market for trading in unlisted securities by QIBs be developed.H. NOC Requirement: In the case of transfer of securities by FVCI to any other person, the RBI requirement of obtaining NOC from joint venture partner or other shareholders should be dispensed with.I. RBI Pricing Norms: At present, investment/disinvestment by FVCI is subject to approval of pricing by RBI which curtails operational flexibility and needs to be dispensed with Global Integration and OpportunitiesA. Incentives for Employees: The limits for overseas investment by Indian Resident Employees under the Employee Stock Option Scheme in a foreign company should be raised from present ceilings of US$10,000 over 5 years, and US$50,000 over 5 years for employees of software companies in their ADRs/GDRs, to a common ceiling of US$100,000 over 5 years. Foreign employees of an Indian company may invest in the Indian company to a ceiling of US$100,000 over 5 years.B. Incentives for Shareholders: The shareholders of an Indian company that has venture capital funding and is desirous of swapping its shares with that of a foreign company should be permitted to do so. Similarly, if an Indian company having venture funding and is desirous of issuing an ADR/GDR, venture capital shareholders (holding saleable stock) of the domestic company and desirous of disinvesting their shares through the ADR/GDR should be permitted to do so. Internationally, 70% of successful startups are acquired through a stock-swap transaction rather than being purchased for cash or going public through an IPO. Such flexibility should be available for Indian startups as well. Similarly, shareholders can take advantage of the higher valuations in overseas markets while divesting their holdings.C. Global Investment Opportunity for Domestic Venture Capital Funds (DVCF): DVCFs should be permitted to invest higher of 25% of the funds corpus or US $10 million or to the extent of foreign contribution in the funds corpus in unlisted equity or equity-linked investments of a foreign company. Such investments will fall within the overall ceiling of 70% of the funds corpus. This will allow DVCFs to invest in synergistic startups offshore and also provide them with global management exposure. 14
  • 15. Infrastructure and R&DInfrastructure development needs to be prioritized using government support and private management of capitalthrough programmes similar to the Small Business Investment Companies in the United States, promotingincubators and increasing university and research laboratory linkages with venture-financed startup firms. Thiswould spur technological innovation and faster conversion of research into commercial products. Self Regulatory Organisation (SRO)A strong SRO should be encouraged for evolution of standard practices, code of conduct, creating awareness bydissemination of information about the industry.Implementation of these recommendations would lead to creation of an enabling regulatory and institutionalenvironment to facilitate faster growth of venture capital industry in the country. Apart from increasing thedomestic pool of venture capital, around US$ 10 billion are expected to be brought in by offshore investors over3/5 years on conservative estimates. This would in turn lead to increase in the value of products and servicesadding upto US$100 billion to GDP by 2005. Venture supported enterprises would convert into quality IPOsproviding over all benefit and protection to the investors.Additionally, judging from the global experience, this will result into substantial and sustainable employmentgeneration of around 3 million jobs in skilled sector alone over next five years. Spin off effect of such activitywould create other support services and further employment. This can put India on a path of rapid economicgrowth and a position of strength in global economy. Follow-up Action on the Report of Chandrasekhar Committee [source: Extract from SEBI Annual Report for 2000-01]SEBI had set up K B Chandrasekhar Committee to identify the impediments in the development of venture capitalindustry in India and to suggest suitable measures for its rapid growth. The report of the Committee wassubmitted to the SEBI Board in January 2000. The recommendations of the Committee were widely discussed.The recommendations were accepted in-principle by the Government also and pursuant to the same, the FinanceMinister in the Budget 2000 speech announced that SEBI would be the single point nodal agency for registrationand regulation of both domestic and overseas venture capital funds and the SEBI registered Venture CapitalFunds would be given total tax pass-through.In the light of the recommendations of the SEBI Committee on Venture Capital and the Budget announcements,the Board of SEBI in its meeting held on September 14, 2000 approved the SEBI (Venture Capital Funds)(Amendment) Regulations, 2000 and also the SEBI (Foreign Venture Capital Investors) Regulations, 2000.The SEBI (Substantial Acquisition of Shares and Takeover) Regulations were amended whereby the acquisitionof shares from venture capital funds/foreign venture capital investors either by company or by any promoter/s (onthe same footing as that of acquisition from the state level financial institutions) would be exempt from making anopen offer to other shareholders. The venture capital funds/foreign venture capital investors are eligible toparticipate in the IPO through book building route as Qualified Institutional Buyer subject to compliance with theSEBI (Venture Capital Fund) Regulations. Board also approved the amendment in the SEBI (Mutual Fund)Regulations permitting mutual funds to invest in venture capital funds. SEBI notified the Foreign Venture CapitalInvestors, Regulations, 2000 on September 15, 2000. The SEBI submitted a proposal to the Government toreconsider the condition of exit from investment within one year from the date of listing of shares of venture capitalundertaking to seek tax pass-through, Government agreed to remove such condition. Accordingly, the Board at itsmeeting held on December 22, 2000 amended the regulations removing the clause requiring mandatory exit.The SEBI advised all the registered venture capital funds vide circular no. Cir-1-2001 dated February 12, 2001 toreport every quarter about their resource mobilisation and investments. 15
  • 16. IntroductionThe venture capital investment helps for the growth of innovative entrepreneurships in India. Venture capitalhas developed as a result of the need to provide non-conventional, risky finance to new ventures based oninnovative entrepreneurship. Venture capital is an investment in the form of equity, quasi-equity andsometimes debt - straight or conditional, made in new or untried concepts, promoted by a technically orprofessionally qualified entrepreneur. Venture capital means risk capital. It refers to capital investment, bothequity and debt, which carries substantial risk and uncertainties. The risk envisaged may be very high maybe so high as to result in total loss or very less so as to result in high gainsThe concept of Venture CapitalVenture capital means many things to many people. It is in fact nearly impossible to come across one singledefinition of the concept. Jane Koloski Morris, editor of the well known industry publication, VentureEconomics, defines venture capital as providing seed, start-up and first stage financing and also funding theexpansion of companies that have already demonstrated their business potential but do not yet have accessto the public securities market or to credit oriented institutional funding sources. The European VentureCapital Association describes it as risk finance for entrepreneurial growth oriented companies. It isinvestment for the medium or long term return seeking to maximize medium or long term for both parties. Itis a partnership with the entrepreneur in which the investor can add value to the company because of hisknowledge, experience and contact base.The Origin of Venture CapitalIn the 1920s & 30s, the wealthy families of and individuals investors provided the start up money forcompanies that would later become famous. Eastern Airlines and Xerox are the more famous ventures theyfinanced. Among the early VC funds set up was the one by the Rockfeller Family which started a special fundcalled VENROCK in 1950, to finance new technology companies. General Doriot, a professor at HarvardBusiness School, in 1946 set up the American Research and Development Corporation (ARD), the first firm,as opposed to a private individuals, at MIT to finance the commercial promotion of advanced technologydeveloped in the US Universities. ARDs approach was a classic VC in the sense that it used only equity,invested for long term, and was prepared to live with losers. ARDs investment in Digital EquipmentCorporation (DEC) in 1957 was a watershed in the history of VC financing. While in its early years vc mayhave been associated with high technology, over the years the concept has undergone a change and as itstands today it implies pooled investment in unlisted companies.SEBI Venture Capital Funds (VCFs) Regulations, 1996A Venture Capital Fund means a fund established in the form of a trust/company; including a body corporate,and registered with SEBI which (i) has a dedicated pool of capital raised in a manner specified in theregulations and (ii) invests in venture capital undertakings (VCUs) in accordance with these regulations.A Venture Capital Undertaking means a domestic company (i) whose shares are not listed on a recognisedstock exchange in India and (ii) which is engaged in the business of providingservices/production/manufacture of articles/things but does not include such activities/sectors as arespecified in the negative list by SEBI with government approval-namely, real estate, non-banking financialcompanies (NBFCs), gold financing, activities not permitted under the industrial policy of the Governmentand any other activity which may be specified by SEBI in consultation with the Government from time totime. 16
  • 17. RegistrationAll VCFs must be registered with SEBI and pay Rs.25,000 as application fee and Rs. 5,00,000 as registrationfee for grant of certificate.Recommendations of SEBI (Chandrasekhar) Committee, 2000 SEBI appointed the Chandrasekhar Committeeto identify the impediments in the growth of venture capital industry in the country and suggest suitablemeasures for its rapid growth. Its report was submitted in January, 2000. The recommendations pertain to1. Harmonisation of multiplicity of regulations2. VCF structures3. Resource raising4. Investments5. Exit6. SEBI regulations7. Company law related issues and8. Other related issues.Types of Venture Capital FundsGenerally there are three types of organised or institutional venture capital funds: venture capital funds setup by angel investors, that is, high net worth individual investors; venture capital subsidiaries of corporationsand private venture capital firms/ funds. Venture capital subsidiaries are established by major corporations,commercial bank holding companies and other financial institutions. Venture funds in India can be classifiedon the basis of the type of promoters.1 . VCFs promoted by the Central govt. controlled development financial institutions such as TDICI, by ICICI,Risk capital and Technology Finance Corporation Limited (RCTFC) by the Industrial Finance Corporation ofIndia (IFCI) and Risk Capital Fund by IDBI.2. VCFs promoted by the state government-controlled development finance institutions such as AndhraPradesh Venture Capital Limited (APVCL) by Andhra Pradesh State Finance Corporation (APSFC) and GujaratVenture Finance Company Limited (GVCFL) by Gujarat Industrial Investment Corporation (GIIC)3. VCFs promoted by Public Sector banks such as Canfina by Canara Bank and SBI-Cap by State Bank ofIndia.4. VCFs promoted by the foreign banks or private sector companies and financial institutions such as IndusVenture Fund, Credit Capital Venture Fund and Grindlays India Development Fund.The Venture Capital Investment Process:The venture capital activity is a sequential process involving the following six steps.1. Deal origination2. Screening3. Due diligence Evaluation)4. Deal structuring5. Post-investment activity6. ExistVenture Capital Investment ProcessDeal origination: 17
  • 18. In generating a deal flow, the VC investor creates a pipeline of deals or investment opportunities that hewould consider for investing in. Deal may originate in various ways. referral system, active search system,and intermediaries. Referral system is an important source of deals. Deals may be referred to VCFs by theirparent organisaions, trade partners, industry associations, friends etc. Another deal flow is active searchthrough networks, trade fairs, conferences, seminars, foreign visits etc. Intermediaries is used by venturecapitalists in developed countries like USA, is certain intermediaries who match VCFs and the potentialentrepreneurs.Screening:VCFs, before going for an in-depth analysis, carry out initial screening of all projects on the basis of somebroad criteria. For example, the screening process may limit projects to areas in which the venture capitalistis familiar in terms of technology, or product, or market scope. The size of investment, geographical locationand stage of financing could also be used as the broad screening criteria.Due Diligence:Due diligence is the industry jargon for all the activities that are associated with evaluating an investmentproposal. The venture capitalists evaluate the quality of entrepreneur before appraising the characteristics ofthe product, market or technology. Most venture capitalists ask for a business plan to make an assessmentof the possible risk and return on the venture. Business plan contains detailed information about theproposed venture. The evaluation of ventures by VCFs in India includes;Preliminary evaluation: The applicant required to provide a brief profile of the proposed venture to establishprima facie eligibility.Detailed evaluation: Once the preliminary evaluation is over, the proposal is evaluated in greater detail. VCFsin India expect the entrepreneur to have:- Integrity, long-term vision, urge to grow, managerial skills,commercial orientation.VCFs in India also make the risk analysis of the proposed projects which includes: Product risk, Market risk,Technological risk and Entrepreneurial risk. The final decision is taken in terms of the expected risk-returntrade-off as shown in Figure.Deal Structuring:In this process, the venture capitalist and the venture company negotiate the terms of the deals, that is, theamount, form and price of the investment. This process is termed as deal structuring. The agreement alsoinclude the venture capitalists right to control the venture company and to change its management ifneeded, buyback arrangements, acquisition, making initial public offerings (IPOs), etc. Earned outarrangements specify the entrequreneurs equity share and the objectives to be achieved.Post Investment Activities:Once the deal has been structured and agreement finalised, the venture capitalist generally assumes the roleof a partner and collaborator. He also gets involved in shaping of the direction of the venture. The degree ofthe venture capitalists involvement depends on his policy. It may not, however, be desirable for a venturecapitalist to get involved in the day-to-day operation of the venture. If a financial or managerial crisis occurs,the venture capitalist may intervene, and even install a new management team. 18
  • 19. Exit:Venture capitalists generally want to cash-out their gains in five to ten years after the initial investment.They play a positive role in directing the company towards particular exit routes. A venture may exit in oneof the following ways:1. Initial Public Offerings (IPOs)2. Acquisition by another company3. Purchase of the venture capitalists shares by the promoter, or4. Purchase of the venture capitalists share by an outsider.Methods of Venture FinancingVenture capital is typically available in three forms in India, they are:Equity : All VCFs in India provide equity but generally their contribution does not exceed 49 percent of thetotal equity capital. Thus, the effective control and majority ownership of the firm remains with theentrepreneur. They buy shares of an enterprise with an intention to ultimately sell them off to make capitalgains.Conditional Loan: It is repayable in the form of a royalty after the venture is able to generate sales. Nointerest is paid on such loans. In India, VCFs charge royalty ranging between 2 to 15 percent; actual ratedepends on other factors of the venture such as gestation period, cost-flow patterns, riskiness and otherfactors of the enterprise.Income Note : It is a hybrid security which combines the features of both conventional loan and conditionalloan. The entrepreneur has to pay both interest and royalty on sales, but at substantially low rates.Other Financing Methods: A few venture capitalists, particularly in the private sector, have startedintroducing innovative financial securities like participating debentures, introduced by TCFC is an example. 19
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