final venture capital

8/7/2019 Final Venture Capital

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REPORT ON Venture

Capital

Submitted By

VISHAWAS WADE

ROLL NO:

SPECIALIZATION: MARKETING

WELINGKAR INSTITUTE OF MANAGEMENT STUDIES,

2010

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DECLARATION

I hereby declare that the project work entitled VENTURE CAPITAL submitted to

the [UNIVERSITY NAME], is a record of an original work done by me under the

guidance of [RESPECTIVE NAME], Faculty Member, [RESPECTIVE COLLEGE

OR UNIVERSITY NAME AND PLACE FROM WHERE THE FACULTY

MEMBER IS FROM ], and this project work has not performed the basis for the

award of any Degree or diploma/ associate ship/fellowship and similar project if any.

Date:

Place:

VISHAWAS WADE

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Acknowledgement

No Learning is proper and effective without

Proper Guidance

Every study is incomplete without having a well plan and concrete exposure to the

student. Management studies are not exception. Scope of the project at this level is

very wide ranging. On the other hand it provide sound basis to adopt the theoretical

knowledge and on the other hand it gives an opportunities for exposure to real time

situation.

This study is an internal part of our MBA program and to do this project in a short

period was a heavy task.

Intention, dedication, concentration and hard work are very much essential to

complete any task. But still it needs a lot of support, guidance, assistance, co-

operation of people to make it successful.

I bear to imprint of my people who have given me, their precious ideas and times to

enable me to complete the research and the project report. I want to thanks them for

their continuous support in my research and writing efforts.

I wish to record my thanks and indebtedness to Mr Vivek Bhatia - Faculty

International Business, ITM Gurgaon, whose inspiration, dedication and helping

nature provided me the kind of guidance necessary to complete this project.

I am extremely grateful to management of Institute of Technology &

Management, Gurgaon for granting me permission to be part of this college.

I would also like to acknowledge my batch mates for their guidance and blessings

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Index

4

Sr. No. Content Page No.

1 Introduction 5

2 Venture Capital 6

3 A Brief History 12

4 Venture Capital in India 15

5 Investment Philosophy 16

6 Stages of Venture Capital Funding 19

7 Methods of Venture Financing 208 Venture Capital Fund Operation 21

9 Significance of study 23

10 Objective of Study 24

11 Assessing Venture Capital 32

4 Research Methodology 35

5 Literature Review 37

6 Conceptual Framework 42

8 Findings 52

9 Limitation 53

11 Suggestion 54

12 Bibliographies 55

13 Annexure Venture Capital Firms Outside India 56

14 Annexure Venture Capital Firms in India 57

15 Conclusion 58


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Introduction

Anumberof technocratsare seeking to setup shopon theirownandcapitalizeon

opportunities.Inthehighlydynamiceconomicclimatethatsurroundsus today, few

traditional business models may survive. Countries across the globe are realizing

that it is not the conglomerates and the gigantic corporations that fuel economic

growth any more. The essence of any economy today is the small and medium

enterprises. For example, in the US, 50% of the exports are created by companies

withlessthan20employeesandonly7%arecreatedbycompanieswith500ormore

employees.Thisgrowing trendcanbeattributedtorapidadvancesintechnology in

the last decade. Knowledge driven industries like InfoTech, health-care,

entertainmentandserviceshavebecomethecynosureofboursesworldwide.Inthese

sectors,itisinnovationandtechnicalcapabilitythatarebigbusiness-drivers.Thisisa

paradigmshiftfromtheearlierphysicalproductionandeconomiesofscalemodel.

However,startinganenterpriseisnevereasy.Thereareanumberofparametersthat

contribute to its success or downfall. Experience, integrity, prudence and a clear

understanding of the market are among the sought after qualities of a promoter.

However, there are other factors, which lie beyond the control of the entrepreneur.

Prominent among these is the timely infusion of funds. This is where the venture

capitalistcomesin,withmoney,businesssenseandalotmore.

What is Venture Capital???

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Theventurecapital investmenthelps forthegrowthof innovativeentrepreneurships

in India. Venture capital has developed as a result of the need to provide non-

conventional, risky finance to new ventures based on innovative entrepreneurship.

Venturecapital is an investment in the formof equity, quasi-equityand sometimes

debt - straight or conditional, made in new or untried concepts, promoted by a

technically or professionally qualified entrepreneur. Venture capital means risk

capital.Itreferstocapitalinvestment,bothequityanddebt,whichcarriessubstantial

risk and uncertainties. The risk envisaged may be very high may be so high as to

resultintotallossorverylesssoastoresultinhighgains

TheconceptofVentureCapital

Venturecapitalmeansmanythingstomanypeople.Itisinfactnearlyimpossibleto

comeacrossonesingledefinitionoftheconcept.

Jane Koloski Morris, editor of the well known industry publication, Venture

Economics, defines venture capital as 'providing seed, start-up and first stage

financing' and also 'funding the expansion of companies that have already

demonstrated their business potential but do not yet have access to the public

securitiesmarketortocreditorientedinstitutionalfundingsources.

The European Venture Capital Association describes it as risk finance for

entrepreneurialgrowthorientedcompanies. It is investment for themediumor long

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term return seeking to maximize medium or long term for both parties. It is a

partnershipwiththeentrepreneurinwhichtheinvestorcanaddvaluetothecompany

becauseofhisknowledge,experienceandcontactbase.

Meaningofventurecapital:

Venture capital is money provided by professionals who invest alongside

managementinyoung,rapidlygrowingcompaniesthathavethepotentialtodevelop

into significant economic contributors. Venture capital is an important source of

equityforstart-upcompanies.

Professionally managed venture capital firms generally are private partnerships orclosely-held corporations funded by private and public pension funds, endowment

funds, foundations, corporations, wealthy individuals, foreign investors, and the

venturecapitaliststhemselves.

Venturecapitalistsgenerally:

Financenewandrapidlygrowingcompanies

Purchaseequitysecurities

Assistinthedevelopmentofnewproductsorservices

Addvaluetothecompanythroughactiveparticipation

Takehigherriskswiththeexpectationofhigherrewards

Havealong-termorientation

When considering an investment, venture capitalists carefully screen the technicaland business merits of the proposed company. Venture capitalists only invest in a

small percentage of the businesses they review and have a long-term perspective.

They also actively work with the company's management, especially with contacts

andstrategyformulation.

Venturecapitalistsmitigate the riskof investingbydevelopingaportfolioofyoung

companies in a single venture fund. Many times they co-invest with other

professional venture capital firms. In addition, many venture partnerships manage

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multiple funds simultaneously. For decades, venture capitalists have nurtured the

growth of America's high technology and entrepreneurial communities resulting in

significant job creation, economic growth and international competitiveness.

CompaniessuchasDigitalEquipmentCorporation,Apple,FederalExpress,Compaq,

SunMicrosystems,Intel,MicrosoftandGenetecharefamousexamplesofcompanies

thatreceivedventurecapitalearlyintheirdevelopment.

(Source:NationalVentureCapitalAssociation1999Yearbook)

PrivateEquityInvesting

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Venturecapital investinghasgrownfromasmall investmentpool in the1960sand

early 1970s to a mainstream asset class that is a viable and significant part of the

institutionalandcorporate investmentportfolio.Recently,someinvestorshavebeen

referringtoventureinvestingandbuyoutinvestingas"privateequityinvesting."This

termcanbeconfusingbecausesomeintheinvestmentindustryusetheterm"private

equity" to referonly tobuyout fund investing. Inanycase,an institutional investor

will allocate 2% to 3% of their institutional portfolio for investment in alternative

assetssuchasprivateequityorventurecapitalaspartoftheiroverallassetallocation.

Currently, over 50% of investments in venture capital/private equity comes from

institutional public and private pension funds, with the balance coming from

endowments,foundations,insurancecompanies,banks,individualsandotherentities

whoseektodiversifytheirportfoliowiththisinvestmentclass.

WhatisaVentureCapitalist?

Thetypicalperson-on-the-streetdepictionofaventurecapitalististhatofawealthy

financierwhowantstofundstart-upcompanies.Theperceptionisthatapersonwho

developsabrandnewchange-the-worldinventionneedscapital;thus,iftheycantget

capital from a bank or from their own pockets, they enlist the help of a venture

capitalist.

In truth, venture capital and private equity firms are pools of capital, typically

organized as a limited partnership that invests in companies that represent the

opportunityforahighrateofreturnwithinfivetosevenyears.Theventurecapitalist

maylookatseveralhundredinvestmentopportunitiesbeforeinvestinginonlyafew

selectedcompanieswith favorable investmentopportunities.Far frombeing simply

passive financiers, venture capitalists foster growth in companies through their

involvement in themanagement, strategic marketing and planningof their investee

companies.Theyareentrepreneursfirstandfinancierssecond.

Even individuals may be venture capitalists. In the early days of venture capital

investment,inthe1950sand1960s,individualinvestorswerethearchetypalventure

investor. While this type of individual investment did not totally disappear, the

modernventurefirmemergedasthedominantventureinvestmentvehicle.However,

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inthelastfewyears,individualshaveagainbecomeapotentandincreasinglylarger

partoftheearlystagestart-upventurelifecycle.These"angelinvestors"willmentor

a company and provide needed capital and expertise to help develop companies.

Angel investorsmayeitherbewealthypeoplewithmanagementexpertiseorretired

business men and women who seek the opportunity for first-hand business

development.

Difference between Venture Capital and Private

equity:

Private equity refers to equity or quasi-equity investments in high-growth companies

and includes buyouts, mezzanine financing, privatization and public as well as private

deals. The private equity asset class includes venture capital, buyouts, and mezzanine

investment activity. While venture capital focuses on investing in private, young, fast

growing companies, private equity players largely provide mezzanine or bridge

funding.

Factorto be consideredby venture capitalistin

selection ofinvestment proposal

Therearebasically fourkeyelements in financingofventureswhicharestudied in

depthbytheventurecapitalists.Theseare:

1.Management : Thestrength,expertise&unityofthekeypeopleontheboardbringsignificant 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 : Anaboveaveragerateofreturnofabout30-40%is

requiredbyventurecapitalists.Therateofreturnalsodependsuponthestageofthe

businesscyclewhere fundsarebeingdeployed.Earlier the stage, higher is the risk

andhencethereturn.

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3.Realistic Financial Requirement and Projections: Theventurecapitalistrequires

a realistic view about the present health of the organization as well as future

projectionsregardingscope,natureandperformanceofthecompanyintermsofscale

of operations, operating profit and further costs related to product development

throughResearch&Development.

4. Owner's Financial Stake: The financial resources owned & committed by the

entrepreneur/ owner in thebusiness including the funds investedby family, friends

andrelativesplayaveryimportantroleinincreasingtheviabilityofthebusiness.Itis

animportantavenuewheretheventurecapitalistkeepsanopeneye.

A Brief History

Theconceptofventurecapitalisnotnew.Venturecapitalistsoftenrelatethestoryof

ChristopherColumbus.Inthefifteenthcentury,hesoughttotravelwestwardsinstead

ofeastwardsfromEuropeandsoplannedtoreachIndia.Hisfar-fetchedideadidnot

find favor with the King of Portugal, who refused to finance him. Finally, Queen

IsabellaofSpaindecidedtofundhimandthevoyagesofChristopherColumbusare

nowempanelledinhistory.

ThemodernventurecapitalindustrybegantakingshapeinthepostWorldWarII

years. It is often said that people decide tobecome entrepreneurs because they see

role models in other people who have become successful entrepreneurs. Much the

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same thing can be said about venture capitalists. The earliest members of the

organizedventurecapitalindustryhadseveralrolemodels,includingthesethree:

American Research and Development Corporation, formed in 1946, whose

biggest successwasDigitalEquipment.ThefounderofARDwasGeneralGeorges

Doroit, a French-born military man who is considered "the father of venture

capital."Inthe1950s,hetaughtattheHarvardBusinessSchool.Hislecturesonthe

importance of risk capital were considered quirky by the rest of the faculty, who

concentratedonconventionalcorporatemanagement.

J.H.Whitney&Coalsoformedin1946,oneofwhoseearlyhitswasMinuteMaid

juice.JockWhitneyisconsideredoneoftheindustrysfounders.

TheRockefellerFamily, and in particular,L S Rockefeller, one of whose earliest

investmentswasinEasternAirlines,whichisnowdefunctbutwasoneoftheearliest

commercialairlines.

The Second World War produced an abundance of technological innovation,

primarilywithmilitaryapplications.Theyinclude,forexample,someoftheearliest

work on micro circuitry. Indeed, J.H. Whitneys investment in Minute Maid was

intended to commercialize an orange juice concentrate that had been developed to

providenourishmentfortroopsinthefield.

In themid-1950s, theU.S. federalgovernmentwantedtospeed thedevelopmentof

advancedtechnologies.In1957, theFederalReserveSystemconductedastudythat

concluded that a shortage of entrepreneurial financing was a chief obstacle to the

development of what it called "entrepreneurial businesses."As a response this a

number of Small Business Investment Companies (SBIC) were established to

"leverage"theirprivatecapitalbyborrowingfromthefederalgovernmentatbelow-

marketinterestrates.SooncommercialbankswereallowedtoformSBICsandwithin

fouryears,nearly600SBICswereinoperation.

Atthesametimeanumberofventurecapitalfirmswereformingprivatepartnerships

outsidetheSBICformat.Thesepartnershipsaddedtotheventurecapitaliststoolkit,

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byofferingadegreeofflexibilitythatSBICslack.Withinadecade,privateventure

capitalpartnershipspassedSBICsintotalcapitalundermanagement.

The1960s sawa tremendousbull IPOmarket thatallowedventurecapital firms to

demonstrate their ability to create companies andproducehuge investment returns.

For example, when Digital Equipment went public in 1968 it provided ARD with

101% annualized Return on Investment (ROI). The US$70,000 Digital invested to

start the company in 1959 had a market value of US$37mn. As a result, venture

capital became a hot market, particularly for wealthy individuals and families.

However,itwasstillconsideredtooriskyforinstitutionalinvestors.

Inthe1970s,though,venturecapitalsufferedadouble-whammy.First,ared-hotIPOmarketbroughtover1,000venture-backedcompanies tomarket in1968, thepublic

marketswentintoaseven-yearslump.Therewerealotofdisappointedstockmarket

investorsandalotofdisappointedventurecapitalinvestorstoo.Thenin1974,after

Congress legislation against the abuse of pension fund money, all high-risk

investment of these funds was halted. As a result of poor public market and the

pensionfundlegislation,venturecapitalfundraisinghitrockbottomin1975.

Well, things could only get better from there. Beginning in 1978, a series of

legislative and regulatory changes gradually improved the climate for venture

investing.FirstCongressslashedthecapitalgainstaxrateto28%from49.5%.Then

theLaborDepartment issuedaclarificationthateliminatedthepensionfundsactas

an obstacle to venture investing. At around the same time, there was a number of

high-profile IPOsbyventure-backedcompanies.These includedFederalExpress in

1978, and Apple Computer and Genetech Inc in 1981. This rekindled interest in

venturecapitalonthepartofwealthyfamiliesandinstitutional investors.Indeed, in

the1980s, theventurecapital industrybegan itsgreatestperiodofgrowth.In1980,

venture firms raisedand invested less thanUS$600million.Thatnumbersoared to

nearly US$4bn by 1987. The decade also marked the explosion in the buy-out

business.

The late1980smarked thetransitionof theprimarysourceofventurecapital funds

fromwealthyindividualsandfamiliestoendowment,pensionandotherinstitutional

funds.The surgeincapital in the1980shadpredictable results.Returnsonventure

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capitalinvestmentsplunged.Manyinvestorswentintothefundsanticipatingreturns

of 30% or higher.That wasprobably an unrealistic expectation to begin with. The

consensustodayisthatprivateequityinvestmentsgenerallyshouldgivetheinvestor

aninternalrateofreturnsomethingtotheorderof15%to25%,dependinguponthe

degreeofriskthefirmistaking.

However,by1990, theaveragelong-termreturnonventurecapitalfundsfellbelow

8%, leading toyet anotherdownturn inventure funding.Disappointed familiesand

institutionswithdrew fromventure investing indroves in the1989-91periods. The

economic recovery and the IPO boom of 1991-94 have gone a long way towards

reversing the trend in both private equity investment performance and partnership

commitments.

In 1998, the venture capital industry in the United States continued its seventh

straightyear ofgrowth. It raisedUS$25bn in committed capital for investments by

venturefirms,whoinvestedoverUS$16bnintodomesticgrowthcompaniesUSfirms

havetraditionallybeenthebiggestparticipantsinventuredeals,butnon-USventure

investment is growing. In India, venture funding more than doubled from $420

millionin2002toalmost$1billionin2003.Forthefirsthalfof2004,venturecapital

investmentrose32%from2003.

Venture Capital in INDIA

Venture capital was introduced in India in mid eighties by All India Financial

Institutions with the inauguration of Risk Capital Foundation (RCF) sponsored by

IFCIwithaviewtoencouragethetechnologistsandtheprofessionaltopromotenew

industries.ConsequentlythegovernmentofIndiapromotedtheventurecapitalduring

1986-87bycreatingaventurecapital fund in thecontextof structuraldevelopment

and growth of small-scale business enterprises. Since then several venture capital

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firms/funds (VCFs) are incorporated by Financial Institutions (FIs), Public Sector

Banks(PSBs),and PrivateBanksandPrivateFinancialcompanies.

The Indian Venture Capital Industry (IVCI) is just about a decade old industry as

compared to that inEurope andUS. In this short span it hasnurtured close toone

thousand ventures, mostly in SME segment and has supported building

technocrat/professionalsallthrough.TheVCindustry,throughitsinvestmentinhigh

growthcompaniesaswellascompaniesadoptingnewertechnologiesbackedbyfirst

generationentrepreneurs,hasmadea substantial contribution to economy. In India,

however,thepotentialofventurecapitalinvestmentsisyettobefullyrealized.There

arearound thirtyventure capital funds,whichhavegarneredoverRs. 5000Crores.

TheventurecapitalinvestmentsinIndiaatRs.1000.05croreasin1997,representing

0.1percentofGDP,ascomparedto5.5percentincountriessuchasHongKong.

InvestmentPhilosophy

Venturecapitalistscanbegeneralists,investinginvariousindustrysectors,orvarious

geographiclocations,orvariousstagesofacompanyslife.Alternatively, theymay

bespecialistsinoneortwoindustrysectors,ormayseektoinvestinonlyalocalizedgeographicarea.

Not all venture capitalists invest in "start-ups." While venture firms will invest in

companiesthatareintheirinitialstart-upmodes,venturecapitalistswillalsoinvestin

companiesatvariousstagesofthebusinesslifecycle.Aventurecapitalistmayinvest

before there isa realproductorcompanyorganized(socalled"seed investing"),or

mayprovidecapitaltostartupacompanyinitsfirstorsecondstagesofdevelopment

known as "early stage investing." Also, the venture capitalist may provide needed

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financingtohelpacompanygrowbeyondacriticalmasstobecomemoresuccessful

("expansionstagefinancing").

Theventurecapitalistmayinvestinacompanythroughoutthecompanyslifecycle

andthereforesomefundsfocusonlaterstageinvestingbyprovidingfinancingtohelp

the company grow to a critical mass to attract public financing through a stock

offering.Alternatively,theventurecapitalistmayhelpthecompanyattractamerger

or acquisition with another company by providing liquidity and exit for the

companysfounders.

At theother endof the spectrum, someventure funds specialize in the acquisition,

turnaround or recapitalization of public and private companies that representfavorableinvestmentopportunities.

Thereareventurefundsthatwillbebroadlydiversifiedandwillinvestincompanies

in various industry sectors as diverse as semiconductors, software, retailing and

restaurantsandothersthatmaybespecialistsinonlyonetechnology.

While high technology investment makes up most of the venture investing in the

U.S., and the venture industry gets a lot of attention for its high technology

investments, venture capitalists also invest in companies such as construction,

industrial products, business services, etc. There are several firms that have

specialized in retail company investment and others that have a focus in investing

onlyin"sociallyresponsible"start-upendeavors.

Thebasicprincipalunderlyingventurecapitalinvestinhigh-riskprojectswiththe

anticipation of high returns. These funds are then invested in several fledging

enterprises, which require funding, but are unable to access it through the

conventional sources such as banks and financial institutions. Typically first

generation entrepreneurs start such enterprises. Such enterprises generally do not

haveanymajorcollateraltoofferassecurity,hencebanksandfinancial institutions

areaversetofundingthem.Venturecapitalfundingmaybebywayofinvestmentin

theequityofthenewenterpriseoracombinationofdebtandequity,thoughequityis

themostpreferredroute.

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Sincemostof theventuresfinanced through this routeare innewareas(worldwide

venturecapitalfollows"hotindustries"likeInfoTech,electronicsandbiotechnology),

theprobabilityofsuccessisverylow.Allprojectsfinanceddonotgiveahighreturn.

Some projects fail and some give moderate returns. The investment, however, is a

long-term risk capital as such projects normally take 3 to 7 years to generate

substantial returns.Venture capitalists offer "more than money" to the venture and

seektoaddvaluetotheinvesteeunitbyactiveparticipationinitsmanagement.They

monitorandevaluatetheprojectonacontinuousbasis.

Theventurecapitalist ishowevernotworriedaboutfailureofaninvesteecompany,

because thedealwhichsucceeds,netsaveryhighreturnonhis investmentshigh

enough to make up for the losses sustained in unsuccessful projects. The returns

generally come in the form of selling the stocks when they get listed on the stock

exchangeorbyatimelysaleofhisstakeinthecompanytoastrategicbuyer.Theidea

is tocash inonan increasedappreciationof the sharevalueof thecompanyat the

timeofdisinvestment intheinvesteecompany.If theventurefails(moreoftenthan

not), the entire amount gets written off. Probably, that is one reason why venture

capitalistsassessseveralprojectsandinvestonlyinahandfulaftercarefulscrutinyof

themanagementandmarketabilityoftheproject.

Toconclude,aventurefinancierisonewhofundsastartupcompany,inmostcases

promotedbyafirstgenerationtechnocratpromoterwithequity.Aventurecapitalistis

notalender,butanequitypartner.Hecannotsurviveonminimalism.Heisdrivenby

maximization:wealthmaximization.Venturecapitalists are sourcesof expertise for

the companies they finance. Exit is preferably through listing on stock exchanges.

This method has been extremely successful in USA, and venture funds have been

credited with the success of technology companies in Silicon Valley. The entire

technologyindustrythrivesonit

Length ofinvestment :

Venture capitalists will help companies grow, but they eventually seek to exit the

investmentinthreetosevenyears.Anearlystageinvestmentmaketakeseventoten

years tomature,while a later stage investmentmanyonly take a few years, so the

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appetitefortheinvestmentlifecyclemustbecongruentwiththelimitedpartnerships

appetite for liquidity. The venture investment is neither a short term nor a liquid

investment,butaninvestmentthatmustbemadewithcarefuldiligenceandexpertise.

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Stages of Venture Capital Funding

TheVentureCapital fundingvaries across thedifferent stagesof growthof a firm.

Thevariousstagesare:

:

1. Pre seed Stage : Here, a relatively small amount of capital is provided to an

entrepreneur to conceive andmarket a potential ideahavinggood futureprospects.

Thefundedworkalsoinvolvesproductdevelopmenttosomeextent.

2. Seed Stage : Financing is provided to complete product development and

commenceinitialmarketingformalities.

3. Early Stage / First Stage : Finance is provided to companies to initiate

commercialmanufacturingandsales.

4.Second Stage : IntheSecondStageofFinancingworkingcapitalisprovidedfor

theexpansionofthecompanyintermsofgrowingaccountsreceivableandinventory.

5. Third Stage : Funds provided for major expansion of a company having

increasingsalesvolume.Thisstageismetwhenthefirmcrossesthebreakevenpoint.

6. Bridge / Mezzanine Financing or Later Stage Financing : Bridge /

MezzanineFinancingorLaterStageFinancingisfinancingacompanyjustbeforeits

IPO(InitialPublicOffer).Often,bridgefinanceisstructuredsothatitcanberepaid,

fromtheproceedsofapublicoffering.

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Methods of Venture Financing

VenturecapitalistypicallyavailableinthreeformsinIndia,theyare:

Equity: AllVCFsinIndiaprovideequitybutgenerallytheircontributiondoesnot

exceed49percentofthetotalequitycapital. Thus,theeffectivecontrolandmajority

ownershipofthefirmremainswiththeentrepreneur. Theybuysharesofanenterprise

withanintentiontoultimatelysellthemofftomakecapitalgains.

Conditional Loan :Itisrepayableintheformofaroyaltyaftertheventureisable

togeneratesales.Nointerestispaidonsuchloans.InIndia,VCFschargeroyalty

rangingbetween2to15percent;actualratedependsonotherfactorsoftheventure

suchasgestationperiod,cost-flowpatterns,riskinessandotherfactorsofthe

enterprise.

Income Note : It is a hybrid security which combines the features of both

conventionalloanandconditionalloan.Theentrepreneurhastopaybothinterestand

royaltyonsales,butatsubstantiallylowrates.

Other Financing Methods : A few venture capitalists, particularly in the

private sector, have started introducing innovative financial securities like

participatingdebentures,introducedbyTCFCisanexample.

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Venture Capital Fund Operation

Venturecapitalistsareveryselectiveindecidingwhattoinvestin.Acommonfigure

isthattheyinvestonlyinaboutoneinfourhundredventurespresentedtothem.

Theyareonly interestedinventureswithhighgrowthpotential.Onlyventureswith

high growth potential are capable of providing the return that venture capitalists

expect, and structure their businesses to expect. Because many businesses cannot

create the growth required having an exit event within the required timeframe,

venturecapitalisnotsuitableforeveryone.

Venturecapitalistsusuallyexpecttobeabletoassignpersonneltokeymanagement

positionsandalso toobtainoneormore seatson the company's board of directors.

This is to put people in place, a phrase that has sometimes quite unfortunate

implications as it was used in many accounting scandals to refer to a strategy of

placing incompetent or easily bypassed individuals in positions of due diligence and

formal legal responsibility, enabling others to rob stockholders blind. Only a tiny

portion of venture capitalists, however, have been found liable in the large scale

frauds that rocked American (mostly) finance in 2000 and 2001.

Venture capitalists expect to be able to sell their stock, warrants, options,

convertibles, or other forms of equity in three to ten years: this is referred to as

harvesting. Venture capitalists know that not all their investments will pay-off. The

failure rate of investments can be high; anywhere from 20% to 90% of the enterprises

funded fail to return the invested capital.

Many venture capitalists try to mitigate this problem through diversification. They

invest in companies in different industries and different countries so that the

systematic risk of their total portfolio is reduced. Others concentrate their investments

in the industry that they are familiar with. In either case, they work on the assumption

that for every ten investments they make, two will be failures, two will be successful,

and six will be marginally successful. They expect that the two successes will pay for

the time given to, and risk exposure of the other eight. In good times, the funds that

do succeed may offer returns of 300 to 1000% to investors.

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Venture capital partners (also known as "venture capitalists" or "VCs") may be

former chief executives at firms similar to those which the partnership funds.

Investors in venture capital funds are typically large institutions with large amounts of

available capital, such as state and private pension funds, university endowments,

insurance companies and pooled investment vehicles.

Most venture capital funds have a fixed life of ten yearsthis model was pioneered

by some of the most successful funds in Silicon Valley through the 1980s to invest in

technological trends broadly but only during their period of ascendance, to cut

exposure to management and marketing risks of any individual firm or its product.

In such a fund, the investors have a fixed commitment to the fund that is "calleddown" by the VCs over time as the fund makes its investments. In a typical venture

capital fund, the VCs receive an annual "management fee" equal to 2% of the

committed capital to the fund and 20% of the net profits of the fund. Because a fund

may run out of capital prior to the end of its life, larger VCs usually have several

overlapping funds at the same timethis lets the larger firm keep specialists in all

stage of the development of firms almost constantly engaged. Smaller firms tend to

thrive or fail with their initial industry contactsby the time the fund cashes out, an

entirely new generation of technologies and people is ascending, whom they do not

know well, and so it is prudent to re-assess and shift industries or personnel rather

than attempt to simply invest more in the industry or people it already knows

22
http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Chief+executive+officer&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Pension&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Endowment&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Insurance&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Pooling&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Silicon+Valley&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=1980s&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Chief+executive+officer&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Pension&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Endowment&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Insurance&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Pooling&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Silicon+Valley&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=1980s&gwp=8&curtab=2222_1


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Significance of Study

Venture capitalists not only support high technology projects they also fianc any

risky idea, they provide funds (a) if one needs additional capital to expand his

existingbusinessoronehasanew&promisingproject toexploit(b) ifonecannot

obtain aconventional loan the requirement termswould create a burdenduring the

periodthefirmisstrugglingtogrown.

ItistheambitionofmanytalentedpeopleinIndiatosetuptheirownventureifthey

couldgetadequate&reliablesupport.Financialinvestmentprovidesloans&equity.Buttheydonotprovidemanagementsupport,whichisoftenneededby

entrepreneurs.Buttheventurecapitalindustriesprovidesuchsupportalongwith

capitalalso.Venturecapitalist actsapartnernotafinancier.

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Objective of the Study

Whenwearegoingtostudysomethingthereisspecificpurposeforourstudy.Itmay

beforourcourse,ashobby,forpassingourtime,tofindoutgenuinesolutionforany

problemortodrawoutcertaininferencesoutoftheavailabledata.Theobjectivesof

mystudyare:

TofindouttheventurecapitalinvestmentvolumeinIndia.

TostudytheproblemfacedbyventurecapitalistinIndia.

Tostudythefutureprospectsofventurecapitalfinancing

Objective No. 1

To Findoutthe venture capitalinvestment

volume in India

MethodsofFinancing

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Instruments Rsmillion Percent

EquityShares 6,318.12 63.18

RedeemablePreferenceShares 2,154.46 21.54

NonConvertibleDebt 873.01 8.73

ConvertibleInstruments 580.02 5.8

OtherInstruments 75.85 0.75

Total 10,000.46 100

Rs million

6,318.12

2,154.46

873.01 580.0275.85

0.00

1,000.00

2,000.00

3,000.00

4,000.005,000.00

6,000.00

7,000.00

Equity

Shares

Redeemable

Preference

Shares

Non

Convertible

Debt

Convertible

Instruments

Other

Instruments

Interpretation:Thisdiagramshowstheventurecapitalfinancinginequityshare

andsecondlytheyinvestinredeemablepreferencesharestogethigherreturns.

ContributorsofFunds

Contributors Rs.mn Percent

ForeignInstitutionalInvestors 13,426.47 52.46%

AllIndiaFinancialInstitutions 6,252.90 24.43%

MultilateralDevelopmentAgencies 2,133.64 8.34%

OtherBanks 1,541.00 6.02%

ForeignInvestors 570 2.23%

PrivateSector 412.53 1.61%

PublicSector 324.44 1.27%

NationalizedBanks 278.67 1.09%

NonResidentIndians 235.5 0.92%StateFinancialInstitutions 215 0.84%

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OtherPublic 115.52 0.45%

InsuranceCompanies 85 0.33%

MutualFunds 4.5 0.02%

Total 25,595.17 100.00%

Interpretation:ThistableshowsthehighestcontributionoffundFIIandsecondly

AIFItodeveloptheIndustry.

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FinancingByInvestmentStage

InvestmentStages Rsmillion Number

Start-up 3,813.00 297

Laterstage 3,338.99 154

Otherearlystage 1,825.77 124

Seedstage 963.2 107

Turnaroundfinancing 59.5 9

Total 10,000.46 691

Rs million

3,813.003,338.99

1,825.77

963.2

59.50.00

500.001,000.00

1,500.002,000.002,500.003,000.003,500.004,000.004,500.00

Start-up Later stage Other early

stage

Seed stage Turnaround

financing

Interpretation:Thisdiagramshowsthehighestfinanceisreceivedbytheventure

instartupstageofanyventure.

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FinancingByIndustry

Industry Rsmillion

Industrialproducts,machinery 2,599.32

ComputerSoftware 1,832

ConsumerRelated 1,412.74

Medical 623.8

Food,foodprocessing 500.06

Otherelectronics 436.54

Tel&DataCommunications 385.09

Biotechnology 376.46

Energyrelated 249.56

ComputerHardware 203.36

Miscellaneous 1,380.85

Total 10,000.46

Rs million

2,599.32

1,832

1,412.74

623.8500.06 436.54 385.09 376.46

249.56 203.36

1,380.85

0.00

500.00

1,000.00

1,500.00

2,000.00

2,500.00

3,000.00

Industrial

products,

Computer

Software

Consumer

Related

Medical

Food,food

processing

Other

electronics

Tel&Data

Communications

Biotechnology

Energyrelated

Computer

Hardware

Miscellaneous

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Interpretation:Inthisdiagramhighestfinancereceivedbyindustrialproductsand

machineryandsecondlyfinancereceivedbycomputersoftware.

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FinancingByStates

Investment Rsmillion

Maharashtra 2,566

TamilNadu 1531

AndhraPradesh 1372

Gujarat 1102

Karnataka 1046

WestBengal 312

Haryana 300

Delhi 294

UttarPradesh 283

MadhyaPradesh 231

Kerala 135

Goa 105

Rajasthan 87

Punjab 84

Orissa 35

Dadra&NagarHaveli 32HimachalPradesh 28

Pondicherry 22

Bihar 16

Overseas 413

Total 9994

SourceIVCA(2005-06)

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Rs million

2,566

15311372

1102 1046

312 300 294

0

500

1,000

1,500

2,000

2,500

3,000

Maharas

htra

Tam

ilNadu

AndhraP

radesh

Gujarat

Karna

taka

WestBe

ngal

Hary

ana

Delhi

Interpretation: In this diagramhighest finance givenby theMaharashtra to the

venturestopromotethestateeconomygrowth.

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Assessing Venture Capital

Venturefunds,bothdomesticandoffshore,havebeenaroundinIndiaforsomeyears

now. However it is only in the past 12 to 18 months, they have come into the

limelight.Therejectionratioisveryhigh,about10in100getbeyondpreevaluation

stage,and1getsfunded.

Venturecapitalfundsarebroadlyoftwokinds-generalistsorspecialists.Itiscritical

forthecompanytoaccesstherighttypeoffund,iewhocanaddvalue.Thisbacking

isinvaluableasfocused/specializedfundsopendoors,assistinfutureroundsandhelpinstrategy.Hence,itisimportanttochoosetherightventurecapitalist.

The standard parameters used by venture capitalists are very similar to any

investmentdecision.Theonlydifferencebeingexit.Ifonebuysalistedsecurity,one

can exit at a price but with an unlisted security, exit becomes difficult. The key

factorswhichtheylookforin

TheManagement

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,gettingthefundinginplaceisamongstothers,somekeyaspectsoftherole

oftheentrepreneur.Venturecapitalistswillinsistonaprofessionalteamcomingin,

including a CEO to execute the idea. One-man armies are passe. Integrity andcommitmentareattributessoughtfor.Theventurecapitalistcanprovidethestrategic

vision,buttheteamexecutesit.AsafamousSiliconValleysayinggoes"Successis

execution,strategyisadream".

TheIdea

Theideaanditspotentialforcommercializationarecritical.Venturefundslookfora

scalablemodel,atacountryoraregionallevel.Otherwisetheentiregamewouldbe

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reduced to amanpower ormachinemultiplication exercise.For example, it is very

easyforHindustanLevertodoublesalesofLiril-asoapwithoutincrementalcapex,

whileGujaratAmbujaneeds tospendat leastRs4bnbeforeitcan increasesalesby

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.

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

expectationmismatch. In India,whilecalculatingreturns,venturecapital fundswill

takeintoaccountissueslikerupeedepreciation,politicalinstability,whichaddstothe

riskpremia, thussuppressingvaluations.Linkedtovaluationis thestake,whichthe

fund takes. In India, entrepreneurs are still uncomfortable with the venture capital

"takingcontrol"inaseedstageproject.

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

optionsbefore closing a deal. Sometimes, the fund insists on a buy back clause to

ensureanexit.

PortfolioBalancing

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

stageprojectsforfutureinvestmentstobalancetheinvestmentportfolio.Thiswould

enable themtohaveaphasedexit. In summary,venturecapital fundsgo througha

certainduediligencetofinalizethedeal.Thisincludesevaluationofthemanagement

team,strategy,executionandcommercializationplans.Thisissupplementedbylegal

andaccountingduediligence, typically carriedoutbyanexternal agency. In India,

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the entire process takes about 6 months. Entrepreneurs are advised to keep that in

mindbeforelookingtoraisefunds.Theactualcashinflowmightgetdelayedbecause

ofregulatoryissues.ItisinterestingtonotethatinUSA,attimesangelswritechecks

acrossthetable.

Financing Options in General

ThepossibilityofraisingasubstantialpartofprojectfinancesinIndiathroughboth

equityanddebtinstrumentsareamongthekeyadvantagesofinvestinginIndia.

TheIndianbankingsystemhasshownremarkablegrowthoverthelasttwodecades.Therapidgrowthandincreasingcomplexityof the financialmarkets,especially the

capital market have brought about measures for further development and

improvement in the working of these markets. Banks and development financial

institutions led by ICICI, IDBI and IFCI were providers of term loans for funding

projects. The options were limited to conventional businesses, i.e. manufacturing

centric.Servicessectorwasignoredbecauseofthe"collateral"issue.

EquitywasraisedfromthecapitalmarketsusingtheIPOroute.Thebullmarketsof

the90s,fuelledbyHarshadMehtaandtheFIIs,ensuredthat(ad) venturecapitalwas

easilyavailable.Manufacturingcompaniesexploitedthistothefull.

Theservicessectorwasignored,likesoftware,media,etc.Lackofunderstandingof

thesesectorswasalsoresponsibleforthesame.Ifwelookbackto1991oreven1992,

thesituationas regards financialoutlayavailable to Indiansoftwarecompanieswas

poor. Most software companies found it extremely difficult to source seed capital,workingcapitalorevenventurecapital.

Most software companies started off undercapitalized, and had to rely on

loansoroverdraftfacilitiestoprovideworkingcapital.Thisapproachforcedthemto

generaterevenueintheshortterm,ratherthaninvestinginproductdevelopment.The

situationfortunatelyhaschanged.

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Research MethodologyREDMEN&MORYdefines,Researchasasystematizedefforttogainnow

knowledge.

Itisacarefulinvestigationforsearchofnewfactsinanybranchofknowledge.The

purposeofresearchmethodologysectionistodescribetheprocedureforconduction

the study. It includes researchdesign, sample size,datacollectionandprocedureof

analysisofresearchinstrument.

Research always starts with a question or a problem. Its purpose is to find answers to

questions through the application of the scientific method. It is a systematic and

intensive study directed towards a more complete knowledge of the subject studied.

RESEARCH DESIGN :

Acc. to Kerlinger, Research design is the plan structure & strategy of

investigation conceived so as to obtain answers to research questions and to control

variance.

Acc. to Green and Tull, A research design is the specification of methods

and procedures for acquiring the information needed. It is the overall operational

pattern or framework of the project that stipulates what information is to be collected

from which sources by what procedures.

Its found that research design is purely and simply the framework for a study that

guidesthecollectionandanalysisofrequireddata.

Researchdesignisbroadlyclassifiedinto

Exploratoryresearchdesign

Descriptiveresearchdesign

Casualresearchdesign

This research is a Exploratory research . The major purpose of this research is

descriptionofstateofaffairsasitexistsatpresent.

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DATA COLLECTION

Secondarydata

Secondarydata is thedatawhich is alreadycollectedbysomeoneandcomplied for

different purposes which are used in research for this study. It includes:-

Internet

Magazine

Journal

Newspaper

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Literature Review

AccordingtoSubashandNair,(May2005)

According to theses persons though the modern concept of venture capital stated

during 1946 and now practiced by almost all economies around the world, there

seemstobeaslowdownofventurecapitalactivitiesafter2000.Theremaybealong

listofreasonsforthissituation,wherepeoplefeelmoreriskytoputtheirmoneyin

new and emerging ventures. Hardly 5% of the total venture capital investment

globallyisgiventoreallystageventures.Inalltheyearspeoplearoundtheworldhas

seenthepotentialityofventurecapitalinpromotingdifferenteconomiesoftheworld

by improving the standardof livingof thepeopleby expandingbusiness activities,

increasingemploymentandalsogeneratingmorerevenuetothegovernment

AccordingToKumar,(June2003)

This study focus on the industry should concentrate more on early stage business

opportunitiesinsteadof laterstage.Itis theexperienceworldoverandespeciallyin

the United States of America that the early stage opportunities have generated

exceptionalreturnsfortheindustry.Healsosuggeststhatindividualcapitalistsshould

follow a focused investment strategy. The specialization should be in a board

technologysegment.

AccordingtoKumarandKaura,(March2006)

The present study reports four factors which are used by the venture capitalist to

screen new venture proposals. Using Kendalls tau-c analysis, the study brings out

strongassociationbetweenseveralvariablepair.Broadly,theanalysisfindsthat:

Successfulventureteamsputinsustainedeffortsoidentifiedtargetmarkets.

Theyarehighlymeticulouswhileattendingtothedetails.

Theseteamsareadeptatdealingwith riskbecauseof their impeccablepast

experience.

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Indianventure capitalists do not seem to be much enamoredof technology

venturing; at least some of the successful funded by them do not seem to

showsignsofbeinghi-tech.

Thestudybringsoutfourimportantvariableswhicharehighlyuniquetosuccessful

ventureinIndia.Theyare:

Abilityto evaluateandreacttorisk

Attentiontodetails

Marketshare

Profits.

Evaluatingriskseemstobeanareawhereunsuccessfulventurefail.Sincesuccessful

teams focus on established markets and meticulously pursue these markets to gain

marketshare,theyachievedesiredprofits.

AccordingtoKumar,(May2004)

The Indian Venture Capital Industry has followed the classical model of venture

capitalfinance.Theearlystagefinancingwhichincludesseeds,startup&earlystage

investment was always the major part of the total investment. Whenever venture

capitalistsinvestinventurecertainbasicpreferenceplayacrucialroleininvestment

decision. Two such considerations are location preferences and ownership

preferences.Seedstagefinanceisprovidedtonewcompaniesfortheuseinproduct

development & initial marketing company may be in the process of setting up the

businessormaybe in thebusiness for shortperiodbuthavenot reach the stageofcommercialization.

AccordingtoKumar,(March, 2004)

Theindustryshouldconcentratemoreanearlystagebusinessopportunitiesinsteadof

later stage. It is the experience world over and especially in the United states of

America that the early stage opportunities have generated exceptional for the

industry. It is recommended that the venture capitalists should retain their basic

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feature that taking retain their basic feature that is taking high risk. The present

situationmay compel venture capitalists to opt for less riskyopportunities but it is

againstthespritofventurecapitalism.Theestablishedfactisbiggainsarepossiblein

highriskprojects.

AccordingtoChary,(September2005)

Therehasbeenaplethoraofliteratureonventurecapitalfinance,whichishelpingthe

practitioners viz., venture capital finance companies and fund manage for better

understandingtheroleofventurecapitalineconomicdevelopment.Therearenumber

of studies on the venture capital and activities of venture capitalists in developedcountries.

AccordingtoVijayalakshman&Dalvi, ((Jan., 2006)

WheneverIndianpolicymakershavetoencourageanyindustry.Theusualpracticeis

to grant that the industry tax breaks for a limited period. This definitely acts as a

positive incentive for that industry. However, what is required is a through

understandingoftheindustryrequirementframingandimplementationofaggregative

strategyforitsdevelopment.VCfundsarenotevenregisteredwithSEBIin spiteof

all thebenefit available.VC industry is one, whichwill today prepare abase for a

strong tomorrow.What isneed for thedevelopmentofVC industry isnotonly tax

breaksbut simpler procedures legislation for simplified exit form investment,more

transparencyandlegalbackingtoparticipateinbusinessamongstotherthings.

AccordingtoKumar,(July, 2005)

Oneoftheintegralaspectsofventurefundingisventurecapitalist'sinvolvementwith

theentrepreneurialteam.Therelationshipthroughbroadinteractionwasexploredby

Rosenstein (1988). A comparison was drawn between small and large firms with

regardtoboardinteraction.Whileitisimportantinlargefirmstherelativepowerof

smallconventionalfirms,boardinteractiongenerallyisundermined.Rosensteinet.a.

(1993) studied the finer aspects of boards in the venture funded companies in the

USA.From98candidatesinthesample,thestudyattemptedtobringoutthechanges

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intheboardsize,boardcompositionandcontrolandtheirrelationtovalueaddedto

thefundedunit.Theempiricalanalysisyieldedresultswhereinthesizeoftheboard

increasedafterventurefunding,indicatingmoretransparencyinboardoperations.

Through a case based approach Lloyd et. al. (1995) explored the aspect of

deal structuring and post investment staging of venture capitalists through venture

capitalists'co-investingstrategy.Thestudyfindsthateventhroughventurecapitalists

fixtightmilestonesandtimelinestheythemselvescontributetomanyof thedelays

thatareexperiencedbyatypicalstartupfirm.Thisisbecauseofthehierarchicalco-

investing partners and the lack of understanding within the venture capitalist co-

investorsastowhatroletheyindividuallyplayinthedevelopmentoftheirportfolio

company.

AccordingtoRobbie,(1997)

Robbies,et.al.(1997)highlightsthemonitoringpoliciesoffundedunitsbyventure

capitalists and studies the performance targets, monitoring information, and

monitoring actions through a questionnaire-based survey. The survey was

administered to 108 British Venture Capital Association members and total of 77

responsesweregatheredinthestudy.Thefindingsrelatedtoperformancetargetsand

othermonitoringissueswereconsiderableadditiontotheliteratureinthesubject.

The issues concerning board of directors' role in venture backed companies

arewidelydebatedtopicsinacademicresearch.ThefindingsofthestudybyFriedet.

al. (1998)emphasizethat theboardofdirectorsareamoreinvolvedintheventure-

backedfirmsthanboardswheremembersdonothavelargeownershipatstake.The

study provides an empirical evidence of variation in the boards' involvement and

showsitsrelevanceinperformancemanagementoffundedunits.

AccordingtoMishra,(July2004)

Thereisabundantempiricalresearchconductedindevelopedcountrieswhichaddress

therelativeinvestmentevaluationcriteriatakenintoaccountinthescreeningprocess

fornewventureinvestmentproposals.Zopunidis(1994)providesausefulsummary

ofthepreviousresearchinthisfield.Theidentificationofselectioncriteriahasbeen

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researchedusingdifferentmethodologiessuchassimpleratingofcriteria(perpetual

anddealspecificresponses)Knight,1986;Dixon,1991;HallandHofer,1993;Rah,

Jung andLee,1994), construct analysis (Fried andHisrich, 1994),verbal protocols

(Zhacharakis and Meyer, 1998), and quantitative compensatory models (Muzyka,

Birley and Leleux, 1996; Shepherd, 1999). Multi methods (case analysis, study of

administrative records,published interviews,questionnaireandpersonal interviews)

approach has also been used (Riquelme, 1994) to enhance understanding of

investmentcriteriaandalsoextendittootheraspectsofinvestmentprocesslikedeal

structuringanddivestment.

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ConceptualFrame Work

The Venture CapitalProcess

TheVentureCapitalInvestmentProcess:

Theventurecapitalactivityisasequentialprocessinvolvingthefollowingsixsteps.

1.Dealorigination

2.Screening

3.DuediligenceEvaluation

4.Dealstructuring

5.Post-investmentactivity

6.Exit

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VentureCapitalInvestmentProcess

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Deal origination:

Ingeneratingadeal flow,theVCinvestorcreatesapipelineofdealsor investment

opportunities thathewouldconsiderfor investing in.Dealmayoriginate invarious

ways.referralsystem,activesearchsystem,andintermediaries.Referralsystemisan

important source of deals. Deals may be referred to VCFs by their parent

organizations, tradepartners,industryassociations, friendsetc.Anotherdealflowis

activesearchthroughnetworks,tradefairs,conferences,seminars,foreignvisitsetc.

Intermediaries is used by venture capitalists in developed countries like USA, is

certainintermediarieswhomatchVCFsandthepotentialentrepreneurs.

Screening:

VCFs,beforegoingforanin-depthanalysis,carryoutinitialscreeningofallprojects

on the basis of some broad criteria. For example, the screening process may limit

projectstoareasinwhichtheventurecapitalistisfamiliarintermsoftechnology,or

product,ormarketscope.Thesizeofinvestment,geographicallocationandstageof

financingcouldalsobeusedasthebroadscreeningcriteria.

Due Diligence:

Due diligence is the industry jargon for all the activities that are associated with

evaluating an investment proposal. The venture capitalists evaluate the quality of

entrepreneur before appraising the characteristics of the product, market or

technology.Mostventurecapitalistsaskforabusinessplantomakeanassessmentof

the possible risk and return on the venture. Business plan contains detailed

informationabouttheproposedventure.TheevaluationofventuresbyVCFsinIndia

includes;

Preliminary evaluation: The applicant required to provide a brief profile of the

proposedventuretoestablishprimafacieeligibility.

Detailed evaluation: Once the preliminary evaluation is over, the proposal is

evaluatedingreaterdetail.VCFsinIndiaexpecttheentrepreneurtohave:- Integrity,

long-termvision,urgetogrow,managerialskills,commercialorientation.

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VCFs in Indiaalsomake the riskanalysisof theproposedprojectswhich includes:

Product risk, Market risk, Technological risk and Entrepreneurial risk. The final

decisionistakenintermsoftheexpectedrisk-returntrade-offasshowninFigure.

DealStructuring: Structuring refers to putting together the financial aspects of the

dealandnegotiatingwiththeentrepreneurstoacceptaventurecapitalsproposaland

finally closing the deal. To do a good job in structuring, one needs to be

knowledgeableinareasofaccounting,cashflow,finance,legalandtaxation.Alsothe

structure should take into consideration the various commercial issues (ie what the

entrepreneur wants and what the venture capital would require protecting the

investment).Documentationreferstothelegalaspectsofthepaperworkinputtingthe

deal together.The instruments tobeused in structuringdealsaremanyandvaried.Theobjectiveinselectingtheinstrumentwouldbetomaximize(oroptimize)venture

capitals returns/protection and yet satisfies the entrepreneurs requirements. The

instrumentscouldbeasfollows:

Instrument Issues

Loan Cleanvssecured

Interestbearingvsnoninterestbearing

convertiblevsonewithfeatures(warrants)

1stCharge,2ndCharge,loanvsloanstock

Maturity

Preferenceshares redeemable(conditionsunderCompanyAct)

Participating

parvalue

nominalshares

Warrants exerciseprice,expiryperiod

Commonshares neworvendorshares

parvaluepartially-paidshares

InIndia,straightequityandconvertiblesarepopularandcommonlyused.Nowadays,

warrantsareissuedasatooltobringdownpricing.

Avariation thatwas firstusedbyPACTandTDICIwas"royaltyon sales".Under

this, the company was given a conditional loan. If the project was successful, the

companyhadtopaya%ageofsalesasroyaltyandifitfailedthentheamountwaswritten off. In structuring a deal, it is important to listen to what the entrepreneur

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wants,buttheventurecapitalcomesupwithhisownsolution.Evenfortheproposed

investmentamount,theventurecapitaldecideswhetherornottheamountrequested,

isappropriateandconsistentwiththeriskleveloftheinvestment.Therisksshouldbe

analyzed, taking into consideration the stage at which the company is in and other

factorsrelatingtotheproject.(egexitproblems,etc).

Post Investment Activities :

Once the deal has been structured and agreement finalized, the venture capitalist

generally assumes the role of a partner and collaborator. He also gets involved in

shaping of the direction of the venture. The degree of the venture capitalist's

involvementdependsonhispolicy. Itmaynot,however,bedesirable for aventurecapitalisttogetinvolvedintheday-to-dayoperationoftheventure.Ifafinancialor

managerialcrisisoccurs,theventurecapitalistmayintervene,andeveninstallanew

managementteam.

Exit:

Venturecapitalistsgenerallywanttocash-outtheirgainsinfivetotenyearsafterthe

initialinvestment.Theyplayapositiveroleindirectingthecompanytowards

particularexitroutes.Aventuremayexitinoneofthefollowingways:

1.InitialPublicOfferings(IPOs)

2.Acquisitionbyanothercompany

3.Purchaseoftheventurecapitalist'ssharesbythepromoter,

4.Purchaseoftheventurecapitalist'ssharebyanoutsider

Objective No.2

To study the problems facedby venture

capitalistin India.

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ProblemsofVenture Capital in Indian Context

One can ask why venture funding is so successful in USA and faced a number of

problems in India. The biggest problem was a mindset change from "collateralfunding"tohighriskhighreturnfunding.Mostofthepioneersin theindustrywere

peoplewithcreditbackgroundandexposuretomanufacturingindustries.Exposureto

fast growing intellectual property business and services sector was almost zero.

Moreover VCF is in its nascent stages in India. The emerging scenario of global

competitivenesshasputanimmensepressureontheindustrialsectortoimprovethe

quality level with minimization of cost of products by making use of latest

technological skills.The implication is to obtain adequate financing alongwith the

necessary hi-tech equipments to produce an innovative product which can succeed

andgrowinthepresentmarketcondition.Unfortunately,ourcountry lacksonboth

fronts. The necessary capital can be obtained from the venture capital firms who

expectanaboveaveragerateofreturnontheinvestment.Thefinancingfirmsexpect

a sound, experienced,matureand capablemanagement teamof the companybeing

financed.Sincetheinnovativeprojectinvolvesahigherrisk,thereisanexpectation

ofhigherreturnsfromtheproject.Thepaybackperiodisalsogenerallyhigh(5 -7

years).Theotherissuesthatledtosuchasituationinclude:

LicenseRajandTheIPOBoom

Till early 90s, under the license raj regime, only commodity centric businesses

thrived inadeficit situation.Tofundacementplant,venturecapital isnotneeded.

Whatwasneededwasabilitytogetalicenseandthengettheprojectfundedbythe

banksandDFIs.Inmostcases,thepromoterswerewell-establishedindustrialhouses,

withnoapparentneedforfunds.Mostoftheseentitieswerecapableofraisingfunds

fromconventionalsources,includingtermloansfrominstitutionsandequitymarkets.

Scalability

The Indian software segment has recorded an impressive growth over the last few

yearsandearns large revenues fromitsexport earnings,yetour share in theglobal

market is less than1percent.Within thesoftware industry, thevaluechain ranges

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from body shopping at the bottom to strategic consulting at the top. Higher value

addition and profitability as well as significant market presence take place at the

higherendofthevaluechain.Iftheindustryhastogrowfurtherandsurvivetheflux

itwouldonlybethroughinnovation.Foranyventureideatosucceedthereshouldbe

aproductthathasagrowingmarketwithascalablebusinessmodel.TheITindustry

(which ismostsuitedforventurefundingbecauseof its"ideas"nature) inIndiatill

recentlyhadaservicecentricbusinessmodel.ProductsdevelopedforIndianmarkets

lackscale.

Mindsets

Venturecapitalasanactivitywasvirtuallynon-existentinIndia.Mostventurecapital

companieswanttoprovidecapitalonasecureddebtbasis,toestablishedbusinesses

withprofitableoperatinghistories.Mostoftheventurecapitalunitswereoffshootsof

financial institutions and banks and the lending mindset continued. True venture

capitaliscapitalthatisusedtohelplaunchproductsandideasoftomorrow.Abroad,

thisproblemissolvedbythepresenceof`angelinvestors.Theyaretypicallywealthy

individualswhonotonlyprovideventurefinancebutalsohelpentrepreneurstoshape

theirbusinessandmaketheirventuresuccessful.

Returns,TaxesandRegulations

ThereisamultiplicityofregulatorslikeSEBIandRBI.Domesticventurefundsare

set upunder the Indian TrustsAct of 1882 as per SEBI guidelines, while offshore

fundsroutedthroughMauritiusfollowRBIguidelines.Abroad,suchfundsaremade

undertheLimitedPartnershipAct,whichbringsadvantagesintermsoftaxation.The

governmentmustallowpensionfundsandinsurancecompanies toinvestinventure

capitalsasinUSAwherecorporatecontributionstoventurefundsarelarge.

Exit

The exit routesavailable to theventurecapitalistswere restricted to the IPO route.

Before deregulation, pricing was dependent on the erstwhile CCI regulations. In

general,allissueswereunderpriced.EvennowSEBIguidelinesmakeitdifficultfor

pricing issues for an easy exit. Given the failure of the OTCEI and the revised

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guidelines, small companiescouldnothope for aBSE/NSElisting.Given thedull

marketformergersandacquisitions,strategicsalewasalsonotavailable.

Valuation

Therecentphenomenonisvaluationmismatches.Thankstothesoftwareboom,most

promotershaveskyhighvaluationexpectations.Giventhis,itisdifficultfordealsto

reachfinancialclosureaspromotersdonotagreetoavaluation.Thiscoupledwith

thefancyforsoftwarestocksintheboursesmeansthatmostcompaniesarepreponing

theirIPOs.Consequently,thenumberandqualityofdealsavailabletotheventure

fundsgetsreduced

SomeothermajorproblemsfacingbyventurecapitalistinIndiaare:

a. Requirementofanexperiencedmanagementteam.

b. Requirement of an above average rate of return on investment.

Longerpaybackperiod.

c. Uncertaintyregardingthesuccessoftheproductinthemarket.

d. Questionsregardingtheinfrastructuredetailsofproductionlikeplantlocation,

accessibility, relationship with the suppliers and creditors, transportation

facilities,labouravailabilityetc.

e. The category of potential customers and hence the packaging and pricing

detailsoftheproduct.

f. Thesizeofthemarket.

g. Majorcompetitorsandtheirmarketshare.

h. SkillsandTrainingrequiredandthecostoftraining.

i. Financialconsiderationslikereturnoncapitalemployed(ROCE),costofthe

project,theInternalRateofReturn(IRR)oftheproject,totalamountoffunds

required, ratio of owners investment (personnel funds of the entrepreneur),

borrowedcapital,mortgageloansetc.inthecapitalemployed.

[SourcePandey,I.M.,VentureCapitalTheIndianExpressVIthEdition(2006)]]

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ObjectiveNo. 3

To study the future prospectofVenture

CapitalFinancing .

ProspectsofVenture Capital Financing

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With theadventof liberalization, Indiahasbeenshowingremarkablegrowth in the

economyinthepast10-12years.Thegovernmentispromotinggrowthincapacity

utilization of available and acquired resources and hence entrepreneurship

development, by liberalizing norms regarding venture capital. While only eight

domesticventurecapitalfundswereregisteredwithSEBIduring1996-1998,14funds

have already been registered in 1999-2000. Institutional interest is growing and

foreignventure investmentsarealsoonthe rise.Manystategovernmentshavealso

set up venture capital funds for the IT sector in partnership with the local state

financial institutionsandSIDBI.These includeAndhraParadesh,Karnataka,Delhi,

KeralaandTamilNadu.Theotherstatesaretofollowsoon.

In theyear2000, the financeministryannounced the liberalizationof tax treatment

forventurecapitalfundstopromotethem&toincreasejobcreation.Thisisexpected

togivea strongboost to thenonresident Indians located in theSiliconValleyand

elsewheretoinvestsomeoftheircapital,knowledgeandenterpriseintheseventures.

A Bangalore based media company, Gray cell Ltd., has recently obtained VC

investment totalingabout$1.7mn.Thecompanywouldbecreatingandmarketing

brandedwebbasedconsumerproductsinthenearfuture.

ThefollowingpointscanbeconsideredastheharbingersofVCfinancinginIndia:-

a. Existenceofagloballycompetitivehightechnology.

b. Globallycompetitivehumanresourcecapital.

c. Second Largest English speaking, scientific & technical manpower in the

world.

d. Vastpoolofexistingandongoingscientificandtechnicalresearchcarriedby

largenumberofresearchlaboratories.

e. Initiatives taken by the Government in formulating policies to encourage

investorsandentrepreneurs.

f. Initiativesof theSEBI todevelopastrongandvibrantcapitalmarketgiving

theadequateliquidityandflexibilityforinvestorsforentryandexit.

InarecentsurveyithasbeenshownthattheVCinvestmentsinIndia'sI.T.-Software

andservicessector(includingdotcomcompanies)-havegrownfromUS$150million

in1998 tooverUS$1200million in2008.Thecredit canbegiven to settingupof a

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NationalVentureCapitalFundfortheSoftwareandI.T.Industry(NFSIT)inassociation

withvarious financial institutionsofSmall IndustriesandDevelopmentBankof India

(SIDBI). The facts reveal that VC disbursements as on September 30, 2002 made by

NFSITtotaledRs254.36mn.

Sourcewww.evaluesevrve.com

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Findings

During the preparation of my report I have analyzed many things which are

following:-

A number of people in India feel that financial institution are not only

conservativesbuttheyalsohaveabiasforforeigntechnology&theydonottrust

ontheabilitiesofentrepreneurs.

Someventure failsdue to fewexitoptions.Teams are ignorant of international

standards. The team usually a two or three man team. It does not possess therequired depth In top management. The team is often found to have technical

skills but doesnotpossess theoverall organizationbuilding skills team is often

shortsited.

VenturecapitalistsinIndiaconsidertheentrepreneursintegrity&urgetogrowas

themostcriticalaspectorventureevaluation.

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Limitations of Study

1. Thebiggestlimitationwastimebecausethetimewasnotsufficientastherewaslot

ofinformationtobegot&tohaveitinterpretation

2. Thedatarequiredwassecondary&thatwasnoteasilyavailable.

3. Studybyitsnatureissuggestive&notconclusive

4. Expenseswerehighincollecting&searchingthedata.

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Suggestions

1. Theinvestmentshouldbeinturnaroundstage.Sincetherearemanysickindustries

in India and the number is growing each year, the venture capitalists that have

specialized knowledge in management can help sick industries. It would also be

highlyprofitableiftheventurecapitalistreplacemanagementeithergoodonesinthe

sickindustries.

2. Itisrecommendedthattheventurecapitalistsshouldretaintheirbasicfeaturethat

is taskinghigh risk.Thepresent situationmaycompelventurecapitalists toopt for

lessriskyopportunitiesbutisagainstthespiritofventurecapitalism.Theestablished

factisbiggainsarepossibleinhighriskprojects.

3. There should be a greater role for the venture capitalists in the promotion of

entrepreneurship.TheVenturecapitalistsshouldpromoteentrepreneurforums,clubs

andinstitutionsoflearningtoenhancethequalityofentrepreneurship.

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Bibliography

1. JOURNALS

APPLIED FINANCE VENTURE STAGE INVESTMENT

PREFERENCEININDIA,VINAYKUMAR,MAY, 2004.

ICFAIJOURNALOFAPPLIEDFINANCEMAY-JUNE

VIKALPAVOLULMLE28,APRIL-JUNE2003

ICFAIJOURNALOFAPPLIEDFINANCE,JULY-AUG.

2. BOOKS

I.M.Panday-venturecapitaldevelopmentprocessinIndia

I.M.Panday-venturecapitaltheIndianexperience,

3. VARIOUSNEWSPAPERS

4. INTERNET

www.indiainfoline.com

www.vcapital.com

www.investopedia.com

www.vcinstitute.com

ANNEXURE I56
http://www.indiainfoline.com/http://www.vcapital.com/http://www.investopedia.com/http://www.vcinstitute.com/http://www.indiainfoline.com/http://www.vcapital.com/http://www.investopedia.com/http://www.vcinstitute.com/


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Venturecapitalfirms

Examplesofventurecapitalfirmsinclude:

AccedePartners

AustinVentures

AtlasVenture

BatteryVentures

BenchmarkCapital

CharlesRiverVentures

DoughtyHansonTechnologyVentures

FidelityVentures

Health Cap

HummerWimbled

InsightVenturePartners

MobiusVentureCapital

MohrDavidowVentures

SevinRosenFunds

SequoiaCapital

Trelys

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http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Atlas+Venture&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Atlas+Venture&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Atlas+Venture&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Benchmark+Capital&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Benchmark+Capital&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Benchmark+Capital&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Fidelity+Ventures&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Fidelity+Ventures&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Fidelity+Ventures&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Fidelity+Ventures&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Insight+Venture+Partners&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Insight+Venture+Partners&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Insight+Venture+Partners&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Insight+Venture+Partners&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Insight+Venture+Partners&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Sequoia+Capital&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Sequoia+Capital&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Sequoia+Capital&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Trelys&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Trelys&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Atlas+Venture&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Benchmark+Capital&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Fidelity+Ventures&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Insight+Venture+Partners&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Sequoia+Capital&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Trelys&gwp=8&curtab=2222_1


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ANNEXUREII

SomeimportantVentureCapitalFundsinIndia

1.APIDCVentureCapitalLimited, ,BabukhanEstate,Hyderabad500001

2.CanbankVentureCapitalFundLimited,IIndFloor,KareemTowers,Bangalore.

3.GujaratVentureCapitalFund1997,AshramRoad,Ahmedabad380009

4.IndustrialVentureCapitalLimited,ThyagarayaRoad,Chennai 600017

5.GujaratVentureCapitalFund1995AshramRoadAhmedabad380009

6.KarnatakaInformationTechnologyVentureCapitalFundCunninghamRdBangalore

7.IndiaAutoAncillaryFundNarimanPoint,Mumbai400021

8.InformationTechnologyFund,NarimanPoint,Mumbai400021

9.TamilnaduInfoTechFund NarimanPoint,Mumbai400021

10.OrissaVentureCapitalFundNarimanPointMumbai400021

11.UttarPradeshVentureCapitalFundNarimanPoint,Mumbai400021

12.SICOMVentureCapitalFundNarimanPointMumbai400021

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Conclusion

Venture capital can play a more innovation and development role in a developing

country like India. It could help the rehabilitation of sick unit through people with

ideasandturnaroundmanagementskill.AlargenumberofsmallenterprisesinIndia

because sick unit even before the commencement of production of production.

Venture capitalist couldalsobe in linewith thedevelopments takingplace in their

parentcompanies.

Yet another area where can play a significant role in developing countries is the

servicesector including tourism,publishing,healthcareetc. theycouldalsoprovide

financialassistancetopeoplecomingoutof theuniversities,technical institutesetc.

whowishtostarttheirownventurewithorwithouthigh-techcontent, butinvolving

high risk. This would encourage the entrepreneurial spirit. It is not only initial

fundingwhichisneedfromtheventurecapitalists,buttheshouldalsosimultaneously

provide management and marketing expertise-a real critical aspect of venture

capitalists, but they also simultaneously provide management and marketingexpertise-arealcriticalaspectofventurecapitalindevelopingcountries. Whichcan

improve their effectiveness by setting up venture capital cell in R&D and other

scientific generation, providing syndicated or consortium financing and acing as

businessincubators.

final venture capital

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