vc financing

3. Venture capital
 It is defined as equity investment in a growth oriented
small/medium business to enable investees to
accomplish corporate objectives, in return for minority
shareholding in the business or the irrevocable right to
acquire it.
 Venture capital institution/fund- Intermediary
between investors looking for returns and
entrepreneurs who need institutional capital as they
are yet not ready to go to the public.

4. Venture capital
 Features
- Primarily equity finance
- Long term investment
- Substantial degree of active involvement
- High risk return spectrum
- Not only technology finance

5. Selection of investment
 Business plan feasability study track record of
owner etc
Stages of financing
1. Early stage – Seed capital , Start up , Second round
financing
2. Later stage – Mezzanine capital, Bridge/Expansion,
Buyouts, Turnaround

6. Selection of investment(stages)
1. Early stage
 Seed capital /pre start up
- Applied research phase
- Entrepreneurial skills match with the market
opportunity
- High risk
- Marketing related risk

7. Selection of investment(stages)
 Start up
- Includes new projects based on technology, knowledge
new projects by established companies or a new
company
- Indication about potential market
- High risk
 Second round financing
- Product launched but not profitable
- large funds
- Debt and some income

8. Selection of investment(stages)
2. Later stage financing
 Mezzanine /development capital
- Require additional finance but cannot resort to public
issue
- Expansion , penetration ,new management etc
 Bridge/expansion
- Low risk
- Acquisition of other firms

9. Selection of investment(stages)
 Buyout
- Management buyout
- Management buyins
 Turnaround
- Buying the control of sick company

10. Selection of investment (FA)
Financial analysis
 Various methods include
I Conventional Venture Capitalist Valuation Method
II The First Chicago Method
III The Revenue Multiplier Method

11. Selection of investment (FA)
I Conventional Venture Capitalist Valuation Method
- Two points of time- starting time and exit time
- Steps
Compute the annual revenue at the time of liquidation
Compute the expected earnings level
Compute the future market valuation of VCU
Obtain the PV of VCU
 PV= Rs 50 lakhs , Fund= Rs 20 lakhs, Ownership=
40%

12. Selection of investment (FA)
II The First Chicago Method
- Considers the entire earning stream
- Steps
Scenarios- Success , Sideway survival, Failure and their
probability
Find discounted present value under three scenarios
 PV * Prob
Assume PV= Rs 5 cr, Fund= Rs 2.5 cr, Ownership=50%

13. Selection of investment (FA)
III The Revenue Multiplier Method
- Mt = (1 +r)n ap
(1+d)n
V= PV
R = annual revenue
r= expected growth rate
n=expected no of years
a= expected profit margin at the time of exit
p= expected P/E ratio
d= discount rate

14. Selection of investment ( Structuring)
Structuring the deal / Financial Instruments
 Refers to financial instruments through which investment is made.
 Types
1. Equity
- Ordinary
- Non voting
- Deferred
- Preferred
- Equity warrants
- Preference shares
- Cumulative convertible pref shares
- Participating pref shares
- Cumulative convertible participatory preferred ordinary
- Convertible cumulative redeemable preference shares

15. Selection of investment ( Structuring)
2. Debt
- Conditional loan
- Conventional loan
- Income notes
- Non convertible debentures
- Partly convertible debentures
- Zero interest bonds
- Secured Premium notes
- Deep discount bonds

16. Selection of investment (Aftercare)
Investment Nurturing/Aftercare
 The enduring relationship between VCI and VCU and
the active relationship played by the former in the
management of latter.
 Styles
1. Hands on
2. Hands off
3. Hand holding

17. Selection of investment (Aftercare)
1. Hands on
- Continuous and constant involvement
- Representation on the board
- Generally in early stage financing
- Need experts
2. Hands off
- Passive role
- Rarely have nominee directors
- Business running smoothly

18. Selection of investment (Aftercare)
3. Hands holding
- Reactive approach
- Right to nominate
- Actively participates
 Objectives
- Proper utilisation of assistance
- Implement the project
- Finding additional finance

19. Selection of investment (Aftercare)
- Provide strategic inputs
- Anticipates problem
- No default
- Evaluate the perfomance
- Use the feedback

20. Selection of investment (Aftercare)
 Techniques
- Personal discussion
- Plant visits
- Feedback through nominee directors
- Periodic reports
- Commissioned studies

21. Valuation of Portfolio
 Two instruments
1. Equity
2. Debt
1. Equity investments
I. Cost method
II. Market value based method

22. Valuation of Portfolio
I. Cost method
• At the historical cost
• Simple and objective
• Two values at different times
II. Market value based method
• Quoted MV method
- based on market quotations
- large holdings

23. Valuation of Portfolio
• Fair market value method
– assets are worth what they can earn
- based on risk and future earnings
 Stages of investment
1. Unquoted venture investments
- immature companies
- at cost

24. Valuation of Portfolio
-written up : third party, better operating results
- written down : long term problems , need finance
2. Unquoted development investments
- mature companies
- based on P/E ratio and dis rate
3. Quoted investments
- companies with IPO
- restriction on sale of shares

25. Valuation of Portfolio
2. Debt instruments
i. Convertible debt
 Market value method
- moving averages/weighted average is a better
approach
- MV + fluctuations
- Underestimation

26. Valuation of Portfolio
 Fair value method
- Price in open market
- Biased
ii. Non convertible debt
 Fixed interest non convertible debt
- Relate nominal yield to current yield
- Maturity date, date of valuation ,safety etc

27. Valuation of Portfolio
 Non interest non convertible debt
- Discount rate acc to solvency
Highly leveraged investments
- At cost

28. Structural aspects
 Objectives
- Limited liability
- Simple operation
- Tax transparency
- Tax exemption for managers
- Tax benefits for investors

29. Structural aspects
 Alternative forms
1. Limited partnership
2. Investment company
3. Investment trust
4. Off shore funds
5. Small business investment company

30. Structural aspects
1. Limited partnership
- Evolved in USA
- General and limited partners
- General partners : business identification
investment appraisal
Negotiation
Investment monitoring
Exit deals
Others

31. Structural aspects
- Mode of Compensation: annual mgt fee and carried
interest
- Advantages
taxed for partners only
carried interest
- Disadvantage: unlimited liability

32. Structural aspects
2 Investment company
- Limited liability
- Double taxation
3. Investment trust
-no tax on dividend
- conditions
Income from investment in shares / security
Not more than 15%
Shares are listed
Distribute income

33. Structural aspects
4. Offshore investment company
5. Offshore unit trust
6. Small business investment company
- not more than 20% of capital n reserves
- No controlling interest
- loans for five yrs or so

34. Exit /Disinvestment
 Depends on number of factors
 Equity / quasi equity investments
1. Going public
2. Sale to entrepreneurs
3. Trade sale
4. Selling to new investor
5. Liquidation

35. Exit /Disinvestment
1. Going public
- Advantage : liquidity , higher price, better image
- Limitations: reporting requirements, disclosures ,
cost , stock exchange regulations
- OTCEI route could be opted

36. Exit /Disinvestment
2. Sale to entrepreneur
- Directly or through employees
- Exit by put or call option
BV method
P/E ratio
% of Sales method
Multiple cash flow method
Independent valuation
Agreed price

37. Exit /Disinvestment
3. Trade sales
- Management buyins/ buyout
- alternatives : cash sales of equity shares
issue of notes secured by assets
in consideration
4. Sales to new investor
5. Liquidation

38. Exit /Disinvestment
 Debt instruments
- Normal loan
- Conditional loan

39. Disadvantages of VC financing
 Forced management changes
 Loss of equity stake
 Decision making ability
 Delays in funding
 Entrepreneur will be the last to be paid

40. Venture capital Vs Debt finance
Basis Venture Capital Debt Financing
Objective Realise 'market'
investment returns
Regular interest
& principal payments
Holding Period Long term Short/medium term
Instruments Common &
preference shares,
convertible warrants,
options
Loans, factoring,
installment plans
Collateral No Yes

41. Venture capital Vs Debt finance
Basis Venture Capital Debt Financing
Pricing Earnings multiple Interest spread
Impact on Balance
Sheet
Reduce leverage Increase leverage
Impact on Cash-
Flow
Cash sourced from
the market
Cash sourced from
the borrower
Exit Mechanism Listing, buy-back,
sale to 3rd parties
Loan repayments

42. Angel Investors, VCs and PE Firms
 Three forms of funding available
 Angel Investor
Retired entrepreneurs
Motivated beyond pure money
Make bigger and better investment
Software ,media, healthcare etc
Seed stage

43. Angel Investors, VCs and PE Firms
 Venture Capitalists
Comes after seed funding
Highly risk ventures
Diverse mix of enterprises and small businesses
Capable of turning into $100million company
1-3-6 out of 10
Interest in high tech co.s

44. Angel Investors, VCs and PE Firms
 PE Firms
Raise funds from HNI and institutional investors
Few investments but larger in value
Support companies for expansion
Big firms engage in leveraged buyouts

45. Indian scenario
Initiative
• More than 150 yrs ago – Managing agency houses acted
as VC
• Tata Iron and Steels and Empress Mills were created
• Investment Corporation of India was formed
• Abolished managing agency system and Public sector
term lending institutions came in

46. Indian scenario
• 1973- R.S. Bhatt Committee
1986- Research and Development Act
1987- UNDP examined the possibility of developing
VC
1988- CCI issued guidelines

47. Indian scenario
Guidelines
 Public Sector FI, SBI and banks to set up VC with min
fund of Rs 10 crore :
Promoters- Min 40%
Foreign equity- upto 25%
NRI – upto 74% , 25-40%
 VCC/ VCF can be set up as a joint venture
 Managed by professionals
 Cannot do trading, broking etc

48. Indian scenario
 Listing according to prescribed conditions
 A person acting as President, VP etc cannot hold same
position
 VC assistance – Upto 10 crore, new technology ,new
promoters ,employing professionals
 Share pricing at the time of disinvestment

49. Indian scenario
Methods of venture financing
1. Equity
2. Conventional loan
3. Conditional loan
4. Income notes
At present several VCC are incorporated and they are
promoted by All India level institutions or state level
financial institutions

50. Indian scenario
 All India FIs
1. VC division of IDBI
2. Risk Capital and Technology Finance Corporation
(RCTC) (Subs of IFCI)
 State FI
1. Gujarat Venture Finance Ltd. (Promoted by GUC)
2. AP Industrial Development Corporation Venture
Capital Ltd

51. Indian scenario
 Banks
1. Canbank Venture Capital Fund (Canfina and Canara
Bank)
2. SBI Venture Capital Fund
3. Indian Investment Fund (Grindlays Bank)
 Private Sector
1. Indus Venture Capital Fund (Mafatlals and HUL)
2. Credit Capital VF (India) Ltd

52. Indian scenario
Present Position
 1993-94: 20 VCCs ,350 projects , Rs 250 crore
 1996
Set up 17 funds
61% equity investment , 21% convertible instruments
and 6% debt
 Industrial products and machinery > Consumer
products > Food processing > Software and aservice
sector

53. Indian scenario
 Year 2000- 13 more VCF
 Year 2009 – $117 million in six months
Year No of VC funds
2002 78
2003 81
2004 86
2005 105
2006 146
2008 160
2011 184