venture capital in india & its major strategic player
TRANSCRIPT
A REPORT ON EMPIRICAL STUDY ON VENTURE CAPITAL IN INDIA &
ITS MAJOR STRATEGIC PLAYER
A PROJECT SUBMITTED TOWARDS THE PARTIAL FULFILLMENT OF
THE REQUIREMENT OF THE TWO YEAR FULL TIME POST GRADUATE
DIPLOMA IN MANAGEMENT.
SUBMITTED BY:-
HARSH VAIDWAN
ROLL NO. 34
PROGRAM: PGDM
SESSION : 2008-2010
AREA OF WINTER PROJECT: FINANCE
NEW DELHI INSTITUTE OF MANAGEMENT
60 & 50(B&C), Tuglakabad Institutional Area
New Delhi-110062
Phones: 29956566/67/68/69, 65695001, Fax: 29956570,
E-mail: [email protected] Website: www.ndimdelhi.org
1
PREFACE
A cloud does not know why it moves in just such a direction and at
such a speed ……
It feels an impulsion…. This is the place to go now. But the sky
knows the reasons and the patterns behind all clouds, and you will
know, too, when you lift yourself high enough to see beyond horizons.
. . . . Richard Bach
These words enlighten the spirits to see beyond the horizons and look
clearly into the mind of new entrepreneur. It is aimed at providing a
comprehensive introduction to the area of venture capital and its major
strategic player.
The principal concern of the report is to show how the sectors of
venture capital fund have changed from a completely descriptive
institutional body of literature to a highly formalized quantitative area
of study.
The past two decades have witnessed a dramatic transformation of the
Indian business and financial sector, thanks to deregulation,
liberalization, privatization, globalization and the ascendance of the
services sector. In wake of these development, investment and
financing avenues have expanded considerably; competition has
intensified in all sectors; institutional investor have become a major
force; financial prices have become more volatile; corporate have
grown in size and complexity ; and intangible assets have assumed
greater significance.
I hope that this collection of information will be useful to the future
investor in understanding the private equity and venture capital in India
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Acknowledgement
This report has been prepared to give a brief description of the “EMPIRICAL
STUDY ON VENTURE CAPITAL IN INDIA & ITS MAJOR STRATEGIC
PLAYER” which was taken for the Financial Analysis for the fulfillment of our
professional course.
I would like to express my gratitude towards my project guide Prof. who not only
gave me directions on how to work on the project but also taught the valuable skills of
getting my work done with the help of others. He was a constant source of inspiration.
I would like to thanks my all faculty member who helped me with valuable data and
reports.
Being on the same line, I am thankful to all my friends and well wishers whose moral
support has helped me directly or indirectly in completing this project.
(HARSH VAIDWAN)
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Contents
S. No. Particulars Page
No.
1 Cover Page I
2 Preface II
3 Acknowledgement III
4 Conceptual Framework V
5 Historical Background VI
6 Conceptual Understanding& Evolution VII
7 Stage Financing X
8 Forms of Finance XII
9 Conventional Sources Of Financing XIII
10 Review Of Different Studies XV
11 Research Methodology XIX
12 Objective &Scope Of The Study XX
13 Legal & Regulatory Framework XXII
14 Chandrasekhar Committee Report XXVIII
15 Analysis Of VCF In India XXXIV
16 Process Of Venture Capital XXXVI
17 Reason Of Growth XLII
18 Major Strategic Player XLVI
19 Present Scenario LVIII
20 Statistical Tools LXVIII
21 Conclusion & Suggestions LXXIV
22 Questionnaire LXXVII
23 Bibliography LXXVIII
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VENTURE CAPITAL FUND: CONCEPTUAL FRAME WORK
The concept of venture capital need to be understood in proper
perspective in order to analyses its working with specific reference to
India. With this objective, the present research is an attempt to define
the venture capital within Indian context. India is prime target for
venture capital and private equity today, owing to various factors such
as fast growing knowledge based industries, favorable investment
opportunities, cost competitive workforce, booming stock markets and
supportive regulatory environment among others. The sectors where the
country attracts venture capital are IT and ITES, software products,
banking, PSU disinvestments, entertainment and media, biotechnology,
pharmaceuticals, contract manufacturing and retail. An offshore
venture capital company may contribute unto 100 percent of the capital
of a domestic venture capital fund and may also set up a domestic asset
management company to manage the fund. Venture capital funds
(VCFs) and venture capital companies (VCC) are permitted up to 40
percent of the paid up corpus of the domestic unlisted companies. This
ceiling would be subject to relevant equity investment limit in force in
relation to areas reserved for SSI. Investment in a single company by a
VCF/VCC shall not exceed 5 percent of the paid up corpus of a
domestic VCF/VCC. The automatic route is not available.
The research is divided in to seven sections. Section 1: presents
historical background of venture capital in India. Section 2: explains
the definition of venture capital along with the salient features of
venture capital, Section 3: explains the stage financing features of
venture capital, Section 4: explain the different forms of venture
capital, section 5:Its major strategic player, Section 6: explains the
Stage of Financing in India and Section 7:recommendation and
conclusion.
5
HISTORICAL BACKGROUND OF VENTURE
CAPITAL IN INDIA
Capital is the one of the most important factor of production. No
economic entity can start functioning without required capital as this
help the entrepreneurs in acquiring machinery, equipment and the
productive facilities.
When the conventional means of funding are not available and it
is not possible in the routine course to procure funds to meet the
requirement of equity capital for the project, promoters turn to venture
capital financing. Venture capitalists not only provide funds but also
contribute to the project through proven expertise in the areas of
management, marketing, and technology which fill the gap by assuming
the role of partners in an enterprise. Venture capitalists take risks but
aspire for high return in the form of capital gain on investment.
Presently Venture Capital industry becomes an integral part of
the financial sector on par with the conventional financial institutions
in many of the countries because of its ability to promote
entropenetirial advancement and developing the economy in a manifold
way.
The impact of globalization around the world helped the venture
capital industry to move further ahead. The benefits of venture capital
financing can be seen in many advanced countries in the form of large
scale industrial development, increased employment opportunities,
higher turn over as well as revenue generation to the government.
In India the need for venture capital was first highlighted by the
Committee of Development of Small and Medium Enterprises under the
chairmanship of R.S. Bhatt in the year 1972. In 1975, the concept of
venture capital was introduced in India by Industrial Financial
Corporation of India (IFCI) with the inauguration of Risk Capital
Foundation (RCF) to supplement promoter’s equity with a view to
encouraging technologists and professionals to promote new industries.
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Venture Capital financing: Conceptual understanding and its Evolution
Despite being so much money at stake, there is no strict
regulatory definition of the Venture Capital industry. Generally venture
capital firms provide privately held "entrepreneurial" firms with
equity, debt or hybrid form of financing, often in conjunction with
managerial expertise. At theoretical level, basic hypothesis is that
informational asymmetries are the key to understand the venture capital
industry. There are two major forms of informational asymmetries. One
type, hidden information, occurs when one party to a transaction knows
relevant information that is not known to the other party for example,
an entrepreneur developing a new product may have much better idea
about whether the product will actually work than does the venture
capitalists that may finance the venture. The other type of
informational asymmetry is described as "hidden action." In this
situation one party to a transaction cannot observe relevant actions
taken by the other party (or at least can not legally verify these
actions). For example, an investor in an entrepreneurial firm might not
be able to observe whether the entrepreneur is working hard and
making sensible decisions or whether the entrepreneur is planning to
take the money run.
Informational asymmetries are costly to manage. The definition
indicates, that venture capitalist, in general consist of the following
features:
(I) Venture Capitalists have comparative advantage in selecting
and monitoring investment in the areas, where informational
concern are important;
(II) Still , given the choice, depending upon the market efficiency
and opportunities offered, venture capitalist would prefer less
risky projects;
(III) The ability of the venture capitalist to "exit" from the
invested firm, determine the reputation in an uniformed market.
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(IV) venture capital funds would have limited life span, so as to
enable the investor to keep a check on their performance;
(V) venture capitalist would finance the projects in stage (as a
device of strict monitoring) to avoid the problem of hidden
action (moral hazard, on the part of promoters); and
(VI) To mitigate the problem of hidden action, venture capitalist
would also work as partner in the business and generally serve a
board of the assisted company to influence major decisions.
FEATURES OF VENTURE CAPITAL:
Management of informational asymmetries requires venture
capitalists to incorporate distinctive and unique features in the venture
capital financing. A thorough analysis of these features is essential to
establish the real nature of venture capital. These are as follows:-
1. Investment in High-tech areas: - Venture capital is used only in
new high-tech emerging area specifically commercial
exploitation of lab research. It is used in high-tech areas but it is
not synonym to technology financing. In reality venture
capitalists
2. High Risk Proposition: - Financing innovation is a risky
business. A venture capitalist, while investing assumes four type
of risk viz.,
Product Risk: product technically sound yet may not be in
demand for one reason or the other;
Market Risk: unexpected competition, problems of marketing
problem related to channels of distribution etc. may be present;
3. Continuous Involvement: Management Support: - Success in
venture capital most often comes from a creative partnership in
which the investor's lengthy and painful experience in the
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company formation process is combined with the entrepreneur's
management skill and detailed knowledge of market or
technology. Venture capitalists usually have an active
involvement in the business of the invested after making an
investment.
4. Limited Life of Ventured Capital Firm : - Limited life period of
venture capital funds force the fund managers to show results to
the investors (suppliers of venture Capital). This phenomenon
also compels market. Therefore they try to avoid unethical take
over of the investor companies for personal purpose.
5. Equity Related Investment:- Investment made by the venture
capitalists into portfolio company are invariably in equity or
instruments which are convertible in to ordinary share capital at
some future date. In fact this type of financing help entrepreneur
and venture capitalists both to achieve their objectives. The
entrepreneur lacks funds and if the funds are provided in the
form of equity it can be used further to mobilizes more loans for
the company. At the same time, there is no outflow of payment
for the cash starved company in its initial stage of evolution.
6. Supporting Entrepreneurial Talent: - Venture Capitalist step
in, encourage and nurture entrepreneurs where the letter has
limited resources or in situations where entrepreneur is not than
the entrepreneur himself.
7. Long Term Investment: - In a venture capital financing package,
there involves long-term investment discipline, because major
share of ranging from three to eight years.
8. Supply of Reputation Capital: - Venture capitalist is repeat
players in the investment business. Consistently superior return
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in risky conditions is a prerequisite for their survival and growth.
This concern makes them highly choosy in selecting winning
projects. The obvious implication of selecting a project by
venture capitalist is that they land their reputation of judgment
about the future potential of the venture. In the terms of agency
theory, financial participation by venture capitalists confirms the
credibility of the projects future growth. The reputation effect
has May positive spill over effects for the venture. Bankers,
other creditors, suppliers, skilled managers, and distributors
come forward to join business once venture capitalist
9. Illiquid Investment: - Return on venture capital investments are
illiquid. Generally venture capital is invested into small and
newly established companies. Obviously most of the time, these
companies are not listed on stock exchange. It means that once
investment is made, it can be recovered only in the case when
company is successful and is sold at market price to other or
achieve a stock market listing. Returns however are completely
lost when company fails and goes into receivership or
liquidation.
STAGE FINANCING IN VENTURE CAPITAL
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Though staging of investment in venture capital financing is one
of the significant characteristics of venture capital, yet it has been
taken up in a separate section because it needs detail elaboration. In the
present study the discussion becomes more important in view of the
fact that in a country like India venture capital has a much wider role
to play in almost all the stages of investment. Generally, venture
capitalist concentrate investment in early stage companies and high
technology industries where informational asymmetries are significant
and monitoring is valuable. Asymmetric information associated with
start-up companies make project governance extremely important
during the screen.
In fact staging is a device to minimize financial exposure in the
project. The terms and conditions are determined to keep close check
on the opportunistic behavior of the entrepreneur, which at the same
time leave sufficient scope through incentives to work hard to
maximize the shareholders wealth.
The theoretical framework provides an insight in to the staging aspect
of venture financing. Venture capitalists would prefer a stage where
risk is relatively less given their appetite for return.
In which stage actually investment would be concentrated, depends
upon the market conditions and existing opportunities. In an efficient
market venture capital would have to focus on more risky start-up or
even seed stage, while less development market may offer profitable
possibilities, in less risky expansion stage. As far as turn-around stage
is concerned, interest by venture capitalist into this area will be
dependent upon the legal environment and prevailing market
conditions, conventions and practices.
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Venture financing consists of various stages during the life of a
company. A general purpose venture capitalist may provide finances to
all stages of a company’s development. Some venture capitalists can
specialize in one or more than one stage of financing. Each venture
capital fund has its own preferences, method of investigation and
selecting investments and its own type of legal investment agreement.
OUTLINE OF VENTURE CAPITAL SPECTRUM
S.
No.
Stage Time Scale of
Realization
(Years)
Risk
I Early Stage Investment
1 Seed Finance 7-10 Extreme
2 Start up Finance 5-10 Very High
3 First Stage 4-6 High
4 Second Stage / Follow on
Finance
3-6 High
II Later Stage Investment
5 Development/Expansion
Finance
1-3 Medium
6 Replacement/ Money out Deal 2-4 Medium
7 Turn around/ Recovery Finance 3-5 High/ Medium
8 Bridge Finance 1-3 Low
9 Mezzanine Finance 1-2 Low
10 Management/ Leverage Buy out 1-3 Low
11 Management Buy – in 1-3 High
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It is clear that seed finance involved largest duration of time for
investment to fructify result. The risk is also maximum in this stage.
Seed financing Successive stage involves less risk in relation to
previous stage. Relatively, least risky stage is bridge finance and
mezzanine finance. The role of venture capital in this stage arises
because of the fact that merchant bankers may not be interested in
comparatively small business units. The venture capitalist, instead of
charging fee simply participates in business, signaling to outside
investors the future viability of the venture. In this way venture
capitalist share future wealth of the business unit at the time of actual
realization. Expansion finance is the best option to the venture
capitalist. In case of expansion finance risk is relatively more than it is
in mezzanine, but much less than in start-up or seed stage. At the same
time, expansion finance offer sufficient profit potential to the venture
capitalist.
FORMS OF FINANCE
In India assistance of venture capital funds is available to the
business mainly in three different forms:
Equity Participation
The venture capital funds actually participate in the equity
through direct purchase of share but their stake does not exceed 49 per
cent. These share are retained by them till assisted projects start
making profit, when these are sold either (a) to the promoter at
negotiated price under buy back arrangement or (b) to the public in the
secondary market at a profit. The object is to make maximum capital
gain.
Conventional Loan
Under this scheme of finance, like other traditional loan, a lower
fixed rate of interest is charged till the assisted units become
commercially operational, after which the loan carries normal or higher
rate of interest. The loan has to be repaid according to pre-determined
schedule of repayment as per terms of loan agreement.
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Conditional Loan
In this type of project financing, an interest free loan is
provided, during the implementation period but it has to pay royalty on
sales and has to repay the coal according to a pre-determined schedule
as soon as the company is able to generate sales and income.
Income Notes
This type of financing is a blending of conventional and
conditional loans. The study once, both interest and royalty are payable
but at much lower rates than in case of conditional loans venture funds
being risk capital, should be available either in the form of equity or
quasi-equity. Quasi-equity finance in the form of conventional loan
would be unsuitable for a new risky venture due to the cash flow
problems initially. But this kind of assistance is needed during the
second stage of financing as soon as the venture has taken off.
VENTURE CAPITAL & CONVENTIONAL SOURCES OF
FINANCING: A COMPARATIVE VIEW
Venture capital differs from conventional development capital in
the sense that it is available in the situations when information is not
perfect and hence risk is beyond their acceptable level. Major
differences between venture capital financing and conventional
financing are summarized in the following Table:-
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DIFFERENCES BETWEEN VENTURE CAPITALIST AND
CONVENTIONAL FINANCIER
S.
No.
Parameter Venture Capitalist Conventional
Financier
1 Form of
Finance
Equity /quasi equity, bridge
finance
Term loan
(security backed)
2 Management
Approach
Act as partner, active
participation (make efforts in
the direction of maximization
of shareholders wealth)
Passive
participation
(make efforts to
keep its own
money safe and
secure)
3 Return
Expectation
Payments related to
performance/ capital
appreciation, royalty on sales.
Fixed obligation
(Interest rate)
4 Risk Taking
Behaviour
Risk taker, but not risk lover
willing to accept high risk only
for potential high return
Risk averser
5 Time Frame Long-term consideration
repayment schedule undefined
Short term to
long term, but
time of
engagements is
predetermined
and certain.
6 Projects Preference for small start-ups, Preference for
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innovative produces and
markets, new technology, high
growth sectors, generally
knowledge based and non-
tangible assets base
successful
business,
generally
tangible asset
based.
7 Exit routes Buy back by promoters, IPO,
sales to third party or any
other possible way (term and
conditions of exit route are not
pre-determined)
Fixed repayment
schedule
(determined well
in advance)
8 Financing
policy
Prefer stage-wise finance in
order to manage risk as well as
to monitor the performance
and opportunistic behaviour
(dishonesty of fraud) of the
promoters
One time
financing
9 Decision
Process
Multi stage, multi criteria,
multi purpose
Fixed norms
10 Services It specializes in management
services of which finance is a
part. It participates in the
whole scope of business from
team building through to
operations and even during
exit.
It specializes in
financial services
and generally has
nothing to do
with
management.
.
It is clear from the table that there is a fundamental difference
between a venture capitalist and a conventional financier. While
conventional financier is conservative, past looking, security oriented
and risk averse, the venture capitalist on the other hand in future
oriented and risk manager.
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REVIEW OF DIFFERENT STUDIES
Till now a number of studies have been conducted related to the
field of venture capital in India as well as abroad. The venture capital
is related to small-scale industries technocrats, first generation
entrepreneurs, and commercialization of technologies and financing of
high start-ups. Therefore, the endeavor is to review the research work
carried out in the areas of SSI, entrepreneurship development,
commercialization of untried R & D efforts and financing of high tech
start-ups and other relevant areas of venture capital activity abroad as
well as India.
Learner, J. (2004) “Venture Capital and the Decision to go
public” examines the timing of initial public offers and private
financing by venture capitalists. Using the sample of 350 privately held
venture capital backed biotechnology firms between 1978 and 1992, it
is established in the study that these companies go public when equity
valuations are high and employ private financing when values are
lower. Seasoned venture capitalist appears to be particularly proficient
at taking companies public near market peaks. The results are robust to
a variety of controls and alternative explanations. This establishes the
usefulness of venture capitalist as strategic adviser to the inverted
companies.
Black and Gilson (2007): “Venture capital and structure of
capital markets: Bank Versus Stock Market” examined one of the path-
dependent consequences of the difference between stock market centred
and bank centred capital market and the link between an active stock
market and a strong venture capital market. It is shown that ex-ante
exit strategy worked-out between venture capitalist and entrepreneur
has crucial bearing on finalizations of investment contract between the
two. Moreover the potential for exit through an IPO’s, possibly in a
stock-market – centered capital market allows the venture capitalist and
the entrepreneur to contract implicitly over control, in a manner that is
not easily duplicable in a bank-centered capital market. It is also
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suggested that the best strategy for overcoming path dependent barriers
to a venture capital market in bank cantered system is to piggyback on
infrastructure of stock-market cantered system of other countries. The
study demonstrates the importance of vibrant financial market in order
to enable the venture capitalist to exit from the invested company at
fair price.
Zider, B. (2003): presented an interesting and innovative analysis
of the venture capital Industry. One of his interesting observations is
that it is a myth that venture capitalists invert in good people and good
ideas. The reality is that they invest in good (fast growing) industries.
It is also highlighted that venture capitalists invest in adolescent phase
of a industry’s life cycle. In this period of accelerated growth,
financials of both the eventual winners and losers look strikingly
similar. The Study also provides a new insight into deal structuring and
management of portfolio companies. The paper provides useful clues
for selecting sectors for investment to the venture capital industry in
India. In India, numbers of fast growing sectors are neglected by
venture capital fund’s which is not a good investment strategy.
Which is high rigid and unresponsive to the specific needs and
requirement of the industry.
Gupta, N.S. (2009): “Venture Capital – Prospects and Problems”
reviews the success of venture capital in USA with the investment
break-up of venture capital industries. The Study also discussed the
success of venture capital in Japan, with a view to highlighted the
Sharma, N.K. (2005): In his article “Technology Development and
Technology Transfers in India” has stressed that venture capital can
play a very important role especially in financing the development of
technology and in financing the project based on such technology,
because the development cycle particularly in the high-tech areas is
sometimes very long. Regarding the success of venture capital, he
points out that it must be realized that at least fifty percent ventures
will fail . The venture company should set modest goals for success.
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The study has defined venture capital in a narrow sense i.e. funding the
development of technology and project based on such technology.
Ramesh, S. (2004): In “Venture Financing in India: suggestions
for its Growth” suggests certain measures to remove the existing
barriers in the growth of venture capital in India. The suggestions are
divided into two parts: disinvestments avenues, the study suggest
activation of overseas venture capital market and need for provision of
buyback of shares by the company. In the section 43A to retain private
ownership of assisted companies financed by financial institutions.
Saha, S.N. (2003); In the paper “Emerging Trends in Venture
capital market: A case study of Venture Capital” discusses the
distinctive features of venture capital financing and suggests the
establishment of a separate National Venture Financing Institution
(NVFI), The study describes specific provisions pertaining to royalties
on sales, conditional loans and equity funding by venture capital. The
studies also stress the need of a dynamic unlisted Securities Market
(USM) for the success of venture capital in India. The suggestion to
have a NVFI is at variance with the international experience in India.
The study finds that the coverage of risk situations involving the
development of enterprises, expansion of established technology and
growth of new management are the areas neglected by the venture
capitalists in India.
Pandey, I.M. (2009): In his scholarly work “Venture Capital:
The Indian Experience” focuses his attention on the strategic role of
venture capital in the development of technology, innovative
entrepreneurship and small enterprises in India; the development
process of venture capital by a systematic analysis of venture capital
practices and policies in India; and the policy initiatives necessary for
the success of venture capital in developing countries based on the
Indian experience.
The conclusion from the study emerge are that the guidelines
issued by the government related to venture capital in India,
specifically eligibility criteria with regard to the size of the
19
investment, technology and the background of the entrepreneurs are so
restrictive and indeed unrealistic in the sense that, they have come in
the way of growth of this business. The author seems to have confined
the role of venture capital in high-tech industries only that is certainly
unnecessary.
Aggarwal, V. (2004): In his write up “SEBI venture Capital
Guidelines: An Appraisal” evaluates the guidelines to regulates venture
capital, issued by SEBI in 1996. The study brings out certain
deficiencies and anomalies in the guideline. A number of suggestions
are mode to modify the guidelines to improve the functioning of VCF
in India. The suggestion are very useful and of critical importance for
the smooth functioning of the venture capital in India, particularly the
suggestions related to the fund management; conflict of interest
between different parties, appointment of custodian, investor
information and cancellation of registration etc.
Sethi, S. (2009); A practicing venture capitalist in his article
“Accessing Venture Capital Funds” lists the generic parameters that
VCFs look for before investing in start up companies. The Study also
mentions that during the last 12 to 18 months, there have been intense
activities amongst entrepreneurs seeking out venture capital. Factors
determining investing criteria by venture capitalist include professional
management team, an innovative business idea, scaleable market,
competitive entry barriers, and expected future value and exit routes
available to venture capitalist. Venture capitalists also keep in view the
political stability, rupee depreciation and portfolio balancing etc. at the
time of taking decision about investing in a project.
Sandhy, P. (2004); An opines that cause of halting growth in the
venture capital industry in India is the policy regime of the govt.
government that gives incentives to remain small, otherwise India has
no dearth of high caliber entrepreneurs and quality ideas. The scope is
really tremendous in high-tech, service industry and medicine. Besides,
absence of proper framework, for the entrepreneur who can, and have
the capability to go global from India, is inhibiting the growth of
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economy and venture capital in the country. The study has also
provided a coherent overview of venture capital and its objectives in
India. In the view of the author, venture capital has better prospects, if
it facilitates the growth of potential entrepreneurs in India.
Mishra A.K. (2009); explores and presents an integrated, factual
analysis related to the venture capital industry in India. The Study
observed that despite the declared policy of all India orientation by the
venture capitalists, there is a clear preference for the states like
Maharashtra, Gujarat, and Tamilnadu. It has been further found that out
of the many venture capital funding stage, three are being extensively
used, viz., start-up, expansion and turn around. Management buy-outs
are rare and form a negligible part in total assistance sanctioned to
different companies. The study has not tried to explain the reasons
behind the observed behaviour of venture capital funds in India.
The generalization of the studies is that the scope of venture
capital is really tremendous in high tech, services industry and
medicine. The venture capitalists invest only in fast growing industries.
Factors determining investment criteria by venture capitalist includes
professional management team, an innovative business idea, scaleable
market, competitive entry barriers, and expected future value and exit
routes available to venture capitalist. Venture Capital has better
prospects, if it facilitates the growth of potential entrepreneurs in India
21
RESEARCH METHODOLOGY
The venture capital funds seek to earn extraordinary return from
their investments. For this, generally they employ innovative methods
of fund management and at the same time they try to keep their
strategies a closely guarded secret. In India, an additional point to keep
in mind is the limited number of venture capital funds in operation of
venture capital funds in operation. The research methodology for the
present study has been adopted to reflect these realties and help reach
the logical conclusion in an objective and scientific manner.
The important component of research methodology such as
formulation of hypothesis, method of data collection, tools for
processing of the data and reporting format of the study, are
enumerated as follows:
IMPORTANCE OF THE STUDY
The concept of venture capital was introduced in India with the
objective of commercialization of the indigenously developed
technologies. It is an important objective in itself and there is nothing
wrong to pursue it vigorously. In the developed countries particularly
in the U.S.A., there has been a close linkage between venture capital
financing and commercial exploitation of new invariably high
technology related industries. The origin of the concept of venture
capital has been associated with the funding of untried technology in
the USDA in 1940's by American Research & Development Corporation
(ARDC) the first formal venture capital fund in the world. With the
success of ARDC experiment the concept of venture capital gained
popularity first in the U.S.A. and then gradually across the developed
world. The point missed in this connection is that the evolution of the
venture capital market has been country specific to repeat the
differences in conditions prevailing in different countries.
.
The rules announced by SEBI in 1996 to regulate the venture
capital funds (VCF's) in India have relaxed the eligibility criteria for
22
investment by venture capital funds. And the condition of financing for
untried technology by venture capital funds has been done away with.
Still in mindset in concerned quarters remain bounded to the same old
concept.
The relevant issues to explore in this context are – what
modifications are required in the policy regime? And what are the other
factors holding the progress of the industry? The answer to these
questions requires a through analysis of the role the venture capital can
play in an economy like India and specific issues related to the venture
fund in India, there in lies the importance of the study.
OBJECTIVES OF THE PRESENT STUDY
The present study has been undertaken with the following
objectives:-
(i) To analysis the conceptual issues pertaining to venture capital
with their implications for a developing country like India.
(ii) To examine the theoretical framework of venture capital fund
in India to provide clues for growth strategies of venture
capital industry in India.
(iii) To study the role of venture capital in the economic
development of the country, so as to bring out the biases and
inadequacy of the government policy related to the venture
capital in the country.
(iv) To study the legal and regulatory frame work of venture
capital in India;
(v) To study the working of venture capital industry in India in
terms of its practices, procedures and constraints within
which, it has been operating;
23
SCOPE OF THE STUDY
Venture Capital is related to such divers topic as corporate finance,
leverage buyouts, merchant banking financing of start-ups, small
business management, entrepreneurship development, business
incubators, technology transfers, and economic development. The
present study is confined to a specific aspect of venture capital i .e.
appraisal of working of venture capital in developing country like India
for proper perspective; the scope of the study has been widened to
include the practices and experiences of the developed and some
developing countries. The Venture Capital is relatively small and
emerging activity. The number of players in the industry is limited. It
also indicates that geographical coverage is at all India bases as
venture capital funds are spread in different parts of the country. As far
as the time period covered under the study is concerned, all possible
efforts are made to find out data from different authentic sources.
Data Collection
The present study contemplated an exploratory research.
Secondary data has been used which is collected through venture
activity reports, journals, magazines, newspapers reports prepared by
research scholars, universities and internet.
Analysis of Data
Analysis of data has been done with help of various statistical
tools. There are percents simple averages and time series analysis and
Trend fitting by least square method have been used to study the
pattern of venture fund investment over years.
Y = a + bx
LIMITATIONS OF THE STUDY
As far as limitations are concerned present research work has been
completed in the face of following major constraints.
24
1. The date used in my research study is secondary data.
2. Latest data and information about venture capital is very less.
The data is available till the year 2003 in most of the cases.
3. Limited analytical techniques have been used due to the nature
of data available on the subject.
LEGAL AND REGULATORY FRAMEWORK OF VENTURE
CAPITAL
In this section I will discusses the various legal and regulatory issues
related to working of fund venture capital in India. Section 1 of this
research will explains recent S.E.B.I. regulations regarding venture
capital fund in India. Sections 2 will discuss relevant Income tax
provisions and section 3 explains measure recommendations of the
venture capital committees.
There are a number of rules and regulation for venture capital
and these would come under either of the following heads: The Indian
Trust Act, 1882 or the Company Act, 1956 depending on whether the
fund is set up as a trust or a company. The Foreign Investment
Promotion Board (FIPB) and the Reserve Bank of India (RBI) in case
of an off shore fund. These funds have to secure the permission of the
FIPB while setting up in India and need a clearance form the RBI for
any repatriation of income. There are a number of arms of the
Government of India Ministry of Finance that may have to be
approached in certain situations. Also intervention allied agencies like
Department of Electronics, the National agencies like Department of
Electronics, the National Association of software and computers
(NASSCOM) and various task forces and standing committees is not
uncommon. The Securities and Exchange Board of India has come out
with a set guideline. The Central Board of Direct Taxation (CBDT)
governs the issues pertaining to income tax on the proceeds from
venture capital funding activity. The aspects discusses in detail are: -
25
Recent S.E.B.T. Regulations, Income Tax Production, Venture Capital
Committee Recommendations.
RECENT S.E.B.I. REGULATIONS REGARDING VENTURE
CAPITAL FUND IN INDIA
Meaning:
A venture capital fund means a fund established in the form of a
trust or a company including a body corporate and register under these
regulations which:
1. Has a dedicated pool of capital.
2. Raised in a manner specified in the regulations'
3. Invests in venture capital undertaking in accordance with
regulations.
Venture capital undertaking means a domestic company:
1. Whose shares are not listed on a recognized stock exchange in
India?
2. Which is engaged in the business for providing services,
production or manufacture of article or things or does not
include such activities or sectors which the approval of the
central Government by notification in the official Gazette in this
behalf?
Negative List:
1. Real Estate
2. Non-banking financial services
3. Gold financing
4. Activities not permitted under industrial policy of Government of
India.
5. Any other activity, which may be specified by the Board in
26
consultation with Government of India from time to time.
Associate in relation to venture capital fund means a person:
1. Who directly or indirectly, by himself or in combination with
relatives, exercises control over the venture capital fund or
2. In respect of whom the venture capital fund, directly or
indirectly, by itself, or in combination with other persons exercise
control or
3. Whose director is also a director of the venture capital fund?
Equity linked instruments: includes instruments convertible into
equity shares or share warrants, preference shares, debentures
compulsorily convertible into equity.
Ingestible funds:
It means corpus of the funds net of expenditure for
administration and management of the fund.
Unit:
It means beneficial interest of the investors in the scheme or
fund floated by trust or any other securities issued by a company
including a body corporate.
Application for grant of Certificate:
Any company or trust or body corporate proposing to carry on an
activity as a venture capital fund apply to SEBI for grant of a
certificate of carrying out venture capital activity in India. An
application for grant of certificate must be made in form A and must
accompanied by a non-refundable application fee of Rs. 25000/-
payable by the bank draft in favor of the securities and exchange Board
of India at Mumbai. Registration fee for grant of certificate is Rs.
500,000.
Eligibility criteria:
For the purpose of grant of certificate by SEBI, the following
conditions must be satisfied:
27
I. If the application is made by a company:
1. The main object of the company as per its memorandum of
association must be carrying on of the activity of venture capital
fund.
2. It is prohibited by its memorandum and Articles of Association
from making an invitation to the public subscribe to its
securities.
3. None of its directors or its principal officer or employee is
involved in any litigation concerned with the securities market
which may have an adverse bearing on the business of the
applicant. The directors or the principal officer or employee
must not have been at any time convicted for an offense
involving moral turpitude or any economic offense and is a fit
and proper person to act as director or principal officer or
employee of the company.
II. If the application is made by a trust:
1. The instrument of trust is in the form of a deed and has been
duly registered under the provisions of the Indian Registration
Act, 1908.
2. The main object of the trust is to carry on the activity of a
venture capital fund.
3. None of its trustees or directors of the trustee company. If any,
is involved in any litigation connected with the securities market
which may have an adverse bearing in the business of the
venture capital fund.
4. The directors of its trustee company or the trustee have not at
anytime being convicted of an offense involving moral turpitude
or any economic offense.
5. In both cases, the applicant must not have already applied for
certificate from SEBI or its certificate must not have been
suspended by SEBI or cancelled by SEBI and the applicant must
be a fit and proper person.
28
Maintenance of books and record:
Every venture capital fund must maintain for a period of 8 years
books of accounts, records and documents which must give a true and
fair picture of state of affairs of the venture capital fund.
Power to call for information:
SEBI may at anytime call for any information from the venture
capital fund in respect to any matter relating to its activity as a venture
capital fund. Such information must be submitted with in the time
specified by days to SEBI.
Submission of Reports to SEBI:
SEBI may at anytime call upon the venture capital fund to file
such report as it deems fit with regards to the activity carried out by
venture capital fund.
Winding up:
A scheme of venture capital fund setup as a trust shall be wound
up:
1. When the period of the scheme as mentioned in the placement
memorandum is over.
2. If in the opinion of the trustees or the trustee company, it is in
the interest of the investors that be wound up.
3. If 75% of the investors in the scheme pass a resolution at 9
meeting of unit holders of the scheme that the scheme be wound
up.
4. If SEBI, so directs, in the interest of investors.
The venture capital fund sets up as a company shall be wound up-
Act according to provision of the companies, 1956. records and documents
relating to the venture capital fund for any of the following reason:
1. To ensure that the books of accounts records and documents are
being maintained the venture capital fund in the manner
specified in these regulations.
29
2. To inspect or investigate into complaints received from
investors, clients or any other person on any matter having a
bearing on the activity of the venture capital fund.
3. To ascertain that the provision of the SEBI Act and these
regulations are being complied with by the venture capital fund.
4. To inspect or investigate sue motto into the affairs of the venture
capital fund in the interest of the securities market and the
interest of investors.
Submission of the report to SEBI:
The inspecting or investigating officer shall as soon as possible
on completion of the inspection submit his inspection or investigation
report to SEBI. The Study may also submit an interim report if so
required.
SEBI shall after consideration of inspection or investigation
report or the interim report communicate the funding of the inspecting
officer to the venture capital fund and give it an opportunity to make a
representation. On receipt of the reply, if any, from the venture capital
fund, SEBI may call upon the venture capital fund to take such
measures as the board may be fit in the interest of the- securities
market or for due compliance with the provisions of the SEBI Act.
The Board may after consideration of the investigation or
inspection report and after giving reasonable opportunity of hearing to
the venture capital fund or its trustees, directors issue such direction as
it deems fit in the interest of securities market or the investors
including directors in the nature of
a. Requiring a venture capital fund not to launch new schemes or
raise money from investors for a particular period;
b. Prohibiting the person concerned from disposing of any of the
properties of the fund or scheme acquired in violation of these
regulations;
c. Requiring the person connected to dispose of the assets of the fund
or scheme in a manner as may be specified in the directions.
30
d. Requiring the person concerned to refund any money or the assets
to the concerned investors along with the requisite interest or
other wise, collected under the scheme.
e. Prohibiting the person concerned from operating in the capital
market or from accessing the capital market for a specified period.
For the purpose of holding an enquiry, SEBI may appoint one or
more enquiry officers. The enquiry officer shall issue to venture capital
fund at its registered office or principal place of business a notice
stating the grounds on which the action is proposed to be taken and
show cause why such action need not be taken with in a period of 14
days from the date of receipt of notice.
The venture capital fund may with in 14 days from the date of
receipt of such notice furnish to the enquiry officer its reply and make
its representation before him. A venture capital fund may appear
through any person duly authorized by it . The enquiry officer shall
after taking into account all relevant facts and circumstances, submit a
report to SEBI and recommend penal action if any to be taken against
the venture capital fund and also the grounds on which such action is
justified.
On receipt of the report from the enquiry officer, SEBI shall
consider the same and may issue to the venture capital fund a show
cause notice as to why such penal action as proposed by the enquiry
officer or such appropriate action should not be taken against it . The
venture capital fund within 14, days from the date of receipt of such
show cause notice, sends a reply to after considering the reply, if any
of the venture capital fund, SEBI shall pass such an order as it deems
fit .
The order of suspension or cancellation of certificate may be
published by SEBI in at least two newspapers.
Action against intermediaries:
The board may initiate action for suspension or cancellation of
registration of an intermediary holding a certificate of registration who
31
fails to exercise due diligence in the performance of its functions or
fails to comply with its abdications under these regulations. However
no such certificate of registration shall be suspended or cancelled
unless the procedure specified in the regulation applicable to such
intermediary is complied with.
Appeal to the central Government:
Any person aggrieved by an order of the board under these
regulations may prefer an appeal to the securities Appellate Tribunal.
RELEVANT INCOME TAX PROVISION
I. Any income of a venture capital company or venture capital
fund set up to raise funds for investment in a venture capital
unit is totally except u/s 10 (23 FB) provided it is registered
under SEBI and has satisfied the conditions specified by
SEBI.
II. Chapter XII F: Special Provisions relating to tax on income
received by the primary investors from venture capital
companies or venture capital fund: (section 115 U):-
1. Such income shall be chargeable to Income tax in the
same manner as if it were the income received by such
person had he made investment directly in the venture
capital undertaking.
2. It is deemed to be of the same nature and the same
proportion in the hands of the person receiving such
income as if it had been received by or had been accrued
to the venture capital companies or the venture capital
fund as the case may be during the previous year.
A statement of distributed income, details of the nature of such
income (capital gain, dividend, interest etc.) In form 64 duly verified
by a Chartered Accountant shall be furnished to the investor and the
Income Tax Department by 30 t h of November of the Year following the
previous year.
32
MAJOR RECOMMENDATIONS OF THE CHANDRASEKHAR
COMMITTEE
A. 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 fund's 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 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 fund's 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.
33
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
34
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 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 Opportunities
A. 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
35
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 fund's corpus or US $10 million or to the extent of
foreign contribution in the fund's corpus in unlisted equity or
equity-linked investments of a foreign company. Such
investments will fall within the overall ceiling of 70% of the
fund's corpus. This will allow DVCFs to invest in synergistic
startups offshore and also provide them with global management
exposure.
Infrastructure and R&D
Infrastructure development needs to be prioritized using government
support and private management of capital through programmes similar
to the Small Business Investment Companies in the United States,
promoting incubators and increasing university and research laboratory
linkages with venture-financed startup firms. This would spur
technological innovation and faster conversion of research into
commercial products.
Self Regulatory Organization (SRO)
A strong SRO should be encouraged for evolution of standard
practices, code of conduct, creating awareness by dissemination of
information about the industry.
36
Implementation of these recommendations would lead to creation of an
enabling regulatory and institutional environment to facilitate faster
growth of venture capital industry in the country. Apart from
increasing the domestic pool of venture capital, around US$ 10 billion
are expected to be brought in by offshore investors over 3/5 years on
conservative estimates. This would in turn lead to increase in the value
of products and services adding up to US$100 billion to GDP by 2005.
Venture supported enterprises would convert into quality IPO’s
providing over all benefit and protection to the investors.
Additionally, judging from the global experience, this will result into
substantial and sustainable employment generation of around 3 million
jobs in skilled sector alone over next five years. Spin off effect of such
activity would create other support services and further employment.
This can put India on a path of rapid economic growth and a position of
strength in global economy.
FINAL CONCLUSION OF THE COMMITTEE
The committee came' to the conclusion that the 'venture capital
industry in India is still at a nascent stage. It also stated that with a
view to promote innovations – enterprise and conversion of scientific
technology and knowledge based ideas into commercial production, it
is very important to promote venture capital activity in India. The
report prepared a vision, identified strategies for growth and how to
bridge the gap between traditional means of finance and the capital
needs of the high growth start-ups.
The Committee (Chandrasekhar Committee) identified five critical
success factors for the growth of venture capital in India, namely:
The regulatory, tax and legal environment should pay an
enabling role as internationally venture funds have evolved in
and atmosphere of structural flexibility, fiscal neutrality and
operational adaptability.
37
Resource raising, investment, management and exit should be
as simple and flexible as needed and driven by global trends.
Venture capital should become an institutionalized industry that
protects investors and investee firms, operating in an
environment suitable of risk capital needed and for spurring
innovation through start up firms in a wide range of high growth
areas.
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.
Infrastructure in the form of incubators and RAD 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.
A set of major recommendations were suggested that can help in
the stimulation of the venture capital industry in India, some of these
are presented here:
There has been a multiplicity of regulations relating to venture
capital. There is a need for harmonization of regulations as there are
three sets of venture capital regulations, namely.
SEBI (venture capital Regulations) 1996, Guidelines for overseas
venture capital investments issued by Department of Economic Affaires
(1995), and CBDI Guidelines for Venture Capital Companies (1996).
To eliminate multiple regulations, the Committee proposed that SEBI
should become the nodal regulator for venture capital fund so or to
provide uniform hassle free, single window regulatory framework.
Venture capital funds tax pass:
Venture capital fund's are a dedicated pool of capital and therefore
operate in fiscal neutrality and are treated as pass through vehicles.
38
Once registered with SEBI, it should be entitled to automatic tax pass
through at the pool level while maintaining taxation at the investor
level without any other requirement under income tax Act.
Venture capital fund is defined as fund established in the form of
a trust, a company including a body corporate and registered with SEBI
which or a dedicated pool of capital raised in the manner specified
under the regulations to invest in venture capital undertakings in
accordance with the regulations. The minimum size of the fund from
any investor will not be less then INR 500,000 and the minimum corpus
of the fund at the start has to be at least INR 50 million. The new
regulations stipulated that the maximum investment in single venture
capital undertaking is to exceed 25% of the corpus of the fund. The
new regulations allowed venture capital fund to participate in a
company's initial public offering through the book building route as a
qualified institutional buyer.
The new regulations allowed foreign venture capital investor to
register with SEBI. Also, SEBI registered Foreign venture capital
investors will be permitted to make investment pursuant to the
automatic route with in the overall sectoral ceiling of foreign
investment without having to obtain the prior approval of the Foreign
investment promotion Board (FIPB), Along with this, with effect from
June 1, 2000 Foreign investment in Indian securities is controlled by
the provisions of the foreign exchange management Act 2000. This
required that an off shore venture capital fund investing in India will
need to consider the requirements under the Foreign Exchange &
Management Act (FEMA) which inter alias requires certain categories
of share. Foreign investors to seek the prior approval of the Foreign
Investment Promotion Board constituted by the Government on Indian
before they invest in India securities. The changes had a salutary effect
on venture capital industry and this is the third phase of venture capital
growth. though the dot. Com problem and global Economic slow down
affected venture capital funding the software exports continued to
39
surge. The growth of Information Technology exports over the year
show that Information Technology exports and venture capital growth
has a strong correlation. Unlike that in US Government of India did not
permit pension fund to flow into venture capital. One of the basic
differences between US SBIC and Indian pre venture entrepreneurship
has been that in that case of India there was no relationship between
entrepreneurship financing and venture capital financing.
ANALYSIS OF WORKING OF VENTURE
CAPITAL FUND IN INDIA
This chapter analyses the functioning of venture capital
fund/companies operating in India. For systematic reporting of the
matter, the chapter has divided into 3 sections. Sections 1 tell how
venture capital works. Section 2 investigates the process of venture
capital. Section 3 explains venture capital operations in India. Section
4 explains the venture Capitalists Are Looking For. Section 5 explains
Venture capital fund: Present scenario and section 6 explains Venture
capital scenario by 2010.
WORKING OF VENTURE CAPITAL
Venture capitalist is a financial intermediary, that raises funds
from several investors (called primary investors) and then invests its in
growth oriented new companies (called the venture capital undertakings
or investor companies).
A B C
40
Primary Investors Venture Invest Investor Co.
Investors Provide capitalist funds in venture Funds (VCC/VCF)
VCUcapital
Undertaking (VCU)
From the point of view of fund raising, funds are of the
following three types:
(a) Captive fund: This is an in-house private equity arm funded
by a company and/or its clients.
(b) Semi-captive Fund: This fund is similar to a captive fund but
a portion of the money is raised from third party sources.
(c) Independent Fund: This is a venture capital fund which raises
money wholly from outside investors.
(A) Primary Investors are the following
Financial Institutions (All India Level / State Level)
Commercial Banks
Insurance Companies
Corporate Sector
Mutual Funds
Multilateral Development Agencies such as World Bank
Foreign Institutional Investors
Non-Resident Indians
Public and Others
The primary investors have a large risk appetite as they
contribute to venture capital funds, which invest in companies that
have no major collateral security to offer as security. Since they
assume great risk, their return expectation from investment in venture
capital funds is also high.
(B) Structure of the Venture Capital Industry
41
There are broadly four categories of venture capital companies:
1 (Venture Capital Fund) Promoted by KSIIDC, KSFC
& SIDBI
2 Andhra Pradesh Venture Capital Limited Promoted
by PSFC.
3. Venture Capital Funds set up by Indian or foreign private sector
institutions.
4. Venture Capital funds sponsored by Public Sector banks or their
subsidiaries such as Canara bank Ventures and SBI Caps.
The bottom line is that if the deal succeeds a venture capital fund
gets a very high return on its investments. But if the financed venture
fails, the investment has to be written off. Some instances of such
doomed investment are:
(i) E-venture wrote off its $ 10 million investment in
chaitime.
(ii) Citibank private equity and Edelweiss capital shut down
Iclco, a portal for women and wrote off Rs. 1 crore.
(iii) Chryscapital wrote off $2 million invested in Avigna, $1
million each invested in Broadcast India and Cheecoo.
PROCESS OF VENTURE CAPITAL
Obtaining capital for a project through this route is very
difficult. It involves many steps which a prospective entrepreneur has
to adopt when he approaches investors. A strong business plan that
outlines the management team, project marketing plan, capital costs
and means of financing and profitability projection of the company.
The investment process is industry specific and may vary with time and
region. The typical stages in the investment cycle are given below:
42
As set out in Business Plan(Investment Proposal)
(a) Screening of the Proposal (Due Diligence)(b) Investment Valuation(c) Methods of Financing Providing Value added services
Typical Stages in an Investment Cycle:
IDEA
INVESTMENT
INCUBATION
(NURTURING)
DISINVESTMENT
MECHANISM
(EXIT STRATEGIES)
(I) Business Plan
The first step in procuring venture capital is the preparation of
business plan. A business plan should normally cover the following
points:
Full details of the project concentrating on the four basic elements –
people, product, market and competition.
Detailed Bio-data of the promoters and the key personnel.
Cost of the project and means of finance, duly supported by the
related plans, detailed estimates, Performa invoices, quotations etc.
Detail of marked studies, project demand and supply.
Projected financial statements for 5 years with assumptions
underlying the figures.
In case of an existing company audited financial statements relating
to the preceding 3 years and estimates for the current years.
Competitors in the field and competitive edge of the applicant-
company in terms of product features, pricing quality etc.
Schedule of implementation of the project.
43
(II) Screening of the Proposal
The venture capitalists do not finance all the ventures for which
proposals are received. They invest only in a small percentage of
business proposals, which they review. It is said that it is hard to
convince a venture capitalist that a business is sound as to get a first
novel published. Proposals are subjected to due diligence process. The
venture capitalist assesses whether the applicant has the passion,
commitment and ethical values to turn his idea in to a business.
Following point should be considered while selecting venture
capitalists.
Make sure that the venture capitalists approached has domain
knowledge of the space you hope to be in.
Find out if his existing portfolio of investment matches the type
of business you hope to build.
Match the stage of your project with the funding pattern of the
venture capitalist.
Choose between a domestic fund and an overseas fund based on
what your business demands – dollar or rupee input.
Track the venture capitalists network of contact 's and affiliations
and judge if they can add value to your business.
(III) Valuation Methods
After having decided to finance a project, the next question
addressed by a venture capitalist would be how much finance and how
to finance.
To determine the percentage of ownership to be acquired in a
venture capital undertaking, the venture capital investments normally
adopt the following valuation methods:
(a) Conventional venture capitalist valuation method.
(b) The first Chicago method.
(c) The Revenue multiplier method.
44
(a) Conventional Venture Capitalist Valuation Method
In this method only two points of time in the life of the venture
capital investment namely the starting time of investment and the exit
time when the investment would be liquidated through sale to public
third party and so on. The sequences of steps are:
(i) To compute the annual revenue at the time of liquidation of the
investments, the present annual revenue in the beginning is
compounded by an expected annual growth rate for the holding
period say seven years.
(ii) Compute the expected earnings level future earnings level
multiplied by after margin percentage at the time of liquidation.
(iii) Compute the future market valuation of the venture capital
undertaking = earning level multiplied by expected P/C ratio on
the date of liquidation.
(b) The First Chicago Method
This method considers the entire earnings stream between the
starting point and the exist point of the investment. The sequence of
steps in valuation and the determination of the percentage share
ownership of the VC are:
(i) Three alternative scenarios namely SUCCESS, SIDEWAYS,
SURVIVAL and FAILURE are considered. Each one of these
is assigned a probability rating.
(ii) Using a discount rate, the discount present value of the
venture capital unit is computed.
(iii) The discounted present value is multiplied by the respective
probabilities.
(iv) The expected present value of the venture capital undertaking
is equal to the total of these in the three alternative scenarios.
(v) Assumed if the expected present value of the venture capital
undertaking is Rs. 5 crore and the fund requirement from the
45
venture capitalists is 2.5 crore, the minimum ownership
required is 50%.
E.g. Daksh – c- services, taken over by IBM, was estimated to
have revenue of about USD 50 million and net profit of USD 10
Million for financial year 2004. The value of the deal estimated to be
between USD 130 to 170 million works out to 9 sales multiple of 3 and
earnings multiple of 15.
(c) Revenue Multiplier Method
This method can be used in the case of early stage / start up
venture capital investments when after tax profits may be low/negative.
Value is estimated by multiplying the revenue with a revenue
multiplier. A revenue multiplier is calculated as follows:
V (1+r) n x a x P
M = ----- = ------------------
R (1 + d) n
Where:
a = expected after tax profit margin percentage at the
t ime of exit.
p = expected price/earnings ratio at exit time.
r = expected annual rate of growth of revenue.
d = appropriate discount rate for a venture investment
at this stage, risk and other relevant factors.
R = annual revenue level.
V = present Value of the venture capital unit.
(IV) Value Addition and Nurturing
A private equity investor adds value to the investee company at
every stage. Suppose the promoters of a company raise at every stage.
Suppose the promoters of a company raise Rs. 10 lakh from savings and
personnel bank loans and invest in 10 lakh equity share of Rs. 1 each in
46
their company. Further suppose the entire amount was fully spent on
design and testing of the product. The balance sheet at this stage would
be as follows:
Balance Sheet
(Marked Value Rs. in Lakhs)
Original Equity held by
entrepreneurs
10 Intangible Assets 10
As there are no tangible fixed assets at this stage, a traditional
banker/lender would not touch the proposal even with a barge pole. But
suppose, the promoters are able to convince a venture capitalist that the
business is a good investment opportunity which has a potential to
generate capital appreciation and the venture capital investors 10 lakh
in the company for a 50% stake. By making such investment, the
venture capital has implicitly valued the company at Rs. 20 lakhs. The
balance sheet after this first stage financing would look like this:
First stage Balance sheet (Market Value in Rs. in Lakhs)
First Stage Balance Sheet
(Marked Value Rs. in Lakhs)
Original Equity held by
entrepreneurs
10 Intangible Assets 10
New Equity from Venture
capitalist
10 Cash 10
Total 20 Total 20
47
This cash is again fully utilized and the company asks for more
money from the venture capitalist for pilot Production and test
marketing of the product. After investment the Balance Sheet would
now look like this:
Second Stage Balance Sheet
(Marked Value Rs. in Lakhs)
New Equity 40 Cash 40
Original Equity held
by entrepreneurs
15 Intangible Assets as
revalued by the VC
30
First stage Venture
Capital Funding:
Funding
15
Total 70 Total 70
This value addition goes with every stage of investment. The
paper gains made by the venture capitalist and the promoters will turn
in to fungible wealth once the company goes public.
V) Exit Strategies
Exit is one of the most important issues from both the sides (Venture
capitalists and entrepreneur). The actual returns for the venture
capitalists come at the time of exit. Depending on the investment focus
and strategy of the venture firm, it will seek to exit the investment in
the portfolio company within three to five years of the initial
investment. While the initial public offering may be the most
glamorous and heralded type of exit for the venture capitalist and
owners of the company, most successful exits of venture investments
occur through a merger or acquisition of the company by either the
original founders or another company. Again, the expertise of the
48
venture firm in successfully exiting its investment will dictate the
success of the exit for themselves and the owner of the company .
The following are the disinvestments mechanisms open to venture
capitalists:-
1. IPO
The initial public offering is the most glamorous and visible type of
exit for a venture investment. In recent years technology IPO’s have
been in the limelight during the IPO boom of the last six years. At
public offering, the venture firm is considered an insider and will
receive stock in the company, but the firm is regulated and restricted in
how that stock can be sold or liquidated for several years. Once this
stock is freely tradable, usually after about two years, the venture fund
will distribute this stock or cash to its limited partner investor who
may then manage the public stock as a regular stock holding or may
liquidate it upon receipt. Over the last twenty-five years, almost 3000
companies financed by venture funds have gone public.
2 .Mergers and Acquisitions
Mergers and acquisitions represent the most common type of successful
exit for venture investments. In the case of a merger or acquisition, the
venture firm will receive stock or cash from the acquiring company and
the venture investor will distribute the proceeds from the sale to its
limited partners. Like a mutual fund, each venture fund has a net asset
value or the value of an investor’s holdings in that fund at any given
time. However, unlike a mutual fund, this value is not determined
through a public market transaction, but through a valuation of the
underlying portfolio. Remember, the investment is illiquid and at any
point, the partnership may have both private companies and the stock
49
of public companies in its portfolio. These public stocks are usually
subject to restrictions for a holding period and are thus subject to a
liquidity discount in the portfolio valuation.
3. Sales to other
Each company is valued at an agreed-upon value between the venture
firms when invested in by the venture fund or funds. In subsequent
quarters, the venture investor will usually keep this valuation intact
until a material event occurs to change the value. Venture investors try
to conservatively value their investments using guidelines or standard
industry practices and by terms outlined in the prospectus of the fund.
The venture investor is usually conservative in the valuation of
companies, but it is common to find that early stage funds may have an
even more conservative valuation of their companies due to the long
lives of their investments when compared to other funds with shorter
investment cycles.
VENTURE CAPITAL OPERATIONS IN INDIA: REASON OF
GROWTH
The venture capital industry was promoted by the government of
India as one of the supporting and enabling factor in commercialization
of technical inventions being developed in India. Accordingly, initially
the venture capital industry began in a narrow and restricted
environment. One of the outcomes of this approach was that, mostly
government controlled financial institutions in pursuance of the
government policy, sponsored venture capital outfits. One of the side
effects of this was that their efforts were not directed by the
commercial orientation; rather they were more of the nature of their
social obligations.
50
The experience gained through confronting practical
difficulties and problems made venture capital fund managers realize
the fact that technology financing is not rewarding enough to
compensate the inherent risk involved in the ventures. Therefore, they
pleaded with the government to relax the norms for investment by
venture capital funds. In the meantime, number of experts suggested
development of a commercially viable venture capital industry in the
country.
Acting on the feedback received from different
quarters, the government liberalized the regulatory norms for venture
capital funds substantially in the year 1995, 1996 and then in 2000.
This step helped accelerate the popularity of venture capital in India to
some extent.
Venture capital in India is classified as a sub-set of the
asset class ‘private equity’; other categories include growth/expansion
private equity, late stage private equity and pre-IPO and PIPE deals.
According to a number of sources, the total investments
in private equity and venture capital increased almost 600% between
2004 and 2006, from US$1.1 billion to US$7.46 billion. This incredible
growth has been fostered by a combination of country-specific factors
that distinguish India’s investment environment. These include:
Consistent economic Growth: the
Growth Performance of India has averaged 8.5% per year. Over the past
fiscal
Year, it was 6.9 in 2009 and is estimated to touch 8% in year 2010.And
overtake china. Market liberalization, the global ambitions of Indian
companies and an entrepreneurial culture point to the fact that the
dynamic growth will likely continue.
Public Equity market: India has deep and broad public securities
market which is a vital factor for private equity investors. The Bombay
Stock Exchange is the oldest stock exchange in Asia, and was
51
established in 1875. The Sensex, a basket of 30 stocks representing a
sample of large liquid and representative companies in India (oil/
power, realty, auto, banking, FMCG etc.) and considered to be the
pulse of the Indian stock market. In a 12 month period from 2008 to
2009, the BSE Bensex had a 47% increase, outperforming stock
markets in other emerging markets.
According to Reserve Bank of India indicators in 2009, Indian
companies have issued $42.6 billion in debt and equity worldwide up
from $32 billion in 2008. In 2003, the amount was $5.8 billion.
World class differential capabilities: India’s higher education system
has lead to the country is a dominant and lead position in a number of
growth sector, such as information technology, software development,
healthcare, pharmaceutical and automotive components. Both
Manufacturing and the services sector have witnessed increased
growth.
Rising Domestic Market: Although India’s GDP per capital at about
US$800 may appear low; the middle class defined as those with
incomes between US$4,400-US$22,000 has increased to 13 million
households or about 50 million people. As a result India is
experiencing surging demand for consumer durable goods such as
cellular mobile phones – the ownership of which as increased to 180 m
in August 2009. In the past year, ‘mobile’ India has been adding 7-8
million users per month.
In 2009 private equity and venture capital firms invested US14.2
billion in over 387 deals in India. This amount was almost twice the
amount invested in the previous year.
PE and VC Investments in India ($US million) – Amount invested and
Number of Deals.
In terms of number of deals done at 91 investments, Information
technology and IT-enabled services retailed its status as the favourite
among PE investors during 2009. However in terms of investment
amount it was the Banking, financial and services industry which
52
attracted the lion’s share of capital at about US$4 billion, followed by
telecom which captured US$2 billion. Media and entertainment, energy
and shipping & logistics gained the most over 2008 in terms of
investment activity. The healthcare & Life science industry was the
only sector to show a decline in activity in 2009.
Some of the highlights of 2009 include:
1. 31% of all investments fell into the US$10-25 million category
2. Venture capital investments accounted for 25% of the private
Equity deals (in volume terms). Late stage deals accounted for
35% of all deals
3. PE firms obtained exit routes in 65 companies, including 16 via
Initial public offering (IPO)
2009 Private equity and venture capital investments by industry –
Volume Amount and deals (in brackets)
Other key trends of the Indian private equity include:
1. While companies based in South India attracted a
higher number of investments, their peers in
western India attracted a far higher share of the pie in
53
value terms.
MAJOR STRATEGIC PLAYER IN INDIA
ICICI VENTURE FUND
ICICI Venture is a subsidiary of ICICI Bank, the largest private sector financial
services group in India. ICICI Venture is one of the largest and most successful
private equity firms in India with funds under management in excess of USD 2
billion.
ICICI Venture, over the years has built an enviable portfolio of companies across
sectors including pharmaceuticals, Information Technology, media, manufacturing,
logistics, textiles, real estate etc thereby building sustainable value.
It has several “firsts” to its credit in the Indian Private Equity industry. Amongst them
are India’s first leveraged buyout (Infomedia), the first real estate investment (Cyber
Gateway), the first mezzanine financing for a acquisition (Arch Pharmalabs) and the
first ‘royalty-based’ structured deal in Pharma Research & Development (Dr
Reddy’s).
INVESTMENT STRATEGY
Private Equity Practice: - The USD 810 million India Advantage Fund Series 2 from
which ICICI Venture is currently investing is a broad based Fund and intends to tap
the India growth story across various sectors.
Stage of Investments
The investments are primarily structured as growth capital or buyouts, though the
Fund may invest through the PIPE route and secondary transactions as well.
54
Buyouts
ICICI Venture has been a pioneer in buyout investing in India. Buyouts continue to
form a key focus area for the firm and its funds. ICICI Venture has developed the
requisite capability to manage these buyouts and has developed a rich storehouse of
knowledge and experience through its earlier buyout transactions.
While managing these buyouts, there is a strong involvement of the investment teams
in reorganizing, restructuring and re-strategizing the bought out companies, so that, by
the time of exit, these companies reach newer heights and generate handsome returns
for our investors as well as for themselves.
Growth Capital
The Funds managed by ICICI Venture endeavor to provide financial assistance to
well established/existing enterprises with robust business models and healthy balance
sheets through a variety of investment instruments.
The investment philosophy is to pursue transactions with established enterprises that
are leaders or potential leaders in their respective markets and where there is a clear
proposition for value creation.
Investment Theme
ICICI Venture, through its earlier Funds has invested in private equity across retail,
media, IT/ITES, consumer services, consumer goods, textiles, pharmaceuticals,
biotech, oil, non-consumer goods etc. The intention is to broad-base the investments
across certain focus sectors and pro actively create deals in these sectors.
For the current Fund (IAF Series 2), the investment themes are driven by four broad
macro drivers:
1. Indian domestic consumption growth
2. The India outsourcing advantage in both services and manufacturing
3. Infrastructural creation and allied services
4. Cross border - Assisting Indian corporate to expand overseas
55
Mezzanine Practice
The ICICI Venture Mezzanine practice provides mezzanine finance for buyout
opportunities by financial sponsors as well as leveraged acquisition by companies and
towards mid-market growth capital. It also looks at suitable turnaround opportunities,
real estate, recapitalization and ownership consolidations etc.
A characteristic mezzanine investment would be in a high growth, stable margins,
stable cash flows company that has favorable business outlook and strong promoter
background. However, the Fund is open to look at collateralized transactions of
shorter maturity and high upside potential. Typically, the investment period is
between 18 months to 5 years
Real Estate Practice
Credited with being the first institutional equity investor in the property space, ICICI
Venture Real Estate has built an enviable portfolio comprising premium housing,
integrated townships, commercial, retail hospitality and IT real estate, spread across
country.
ICICI Venture has a strategic long term joint venture with Tishman Speyer Properties,
one of the finest owners, developers, and operators of first class real estate in the
world, for investments and development of property in India. The JV Company, TSI
Ventures Limited, pursues ground-up development of commercial, office, residential
and retail properties throughout India.
ICICI Venture Real Estate also actively seeks to invest in and partner with leading
entrepreneurs and developers, for funding their growth aspirations in this space. The
focus of the Fund is to develop, acquire, lease, and sell quality real estate that is
attractive to quality consumers, tenants / users. The Fund is strongly diversified and
invests in projects in all growing Indian cities.
56
INVESTMENT APPROACH
Deal Sourcing
ICICI Venture's investment process starts with the sourcing of deals. Being the
premier private equity player in India, ICICI Venture's reputation and brand equity
has been attracting investment proposals and deals from entrepreneurs, management
teams, promoters and intermediaries. Deals are also directly sourced from industry
contacts of the management team. Besides, ICICI Venture also leverages its network
with investment banks, fund investors, and also draws upon its access to the ICICI
Bank Limited network with its large corporate clientele.
Deal Evaluation
ICICI Venture engages in a rigorous and disciplined decision-making process prior to
making an investment. When considering a potential transaction, ICICI Venture
conducts a timely and thorough due diligence investigation. The skills of the ICICI
Venture investment professionals are important to the due diligence process, as they
are able to determine the optimal structure and financing methods for a particular
transaction, as well as negotiate favorable acquisition terms. ICICI Venture has an in-
house risk, legal & compliance team which provides transactionary support to the
investment teams & greatly enhances the response time.
The investment proposal would move through various stages of preliminary analysis,
initial meeting, internal valuation discussion, valuation negotiation, term sheet
negotiation, management committee meeting, & due diligence appraisal meeting
before it is proposed in the Investor Committee meeting.
Investment Decision
The Investment Committee reviews a deal recommended for investment and either
approves or rejects the investment proposal. The Investment Committee may, if
considered necessary, ask for further analysis, additional due diligence or any other
57
clarifications. The final decision is based on a majority vote in the Investment
Committee.
Post-Investment Process
ICICI Venture endeavors to ensure that the Portfolio Companies are governed
effectively and that there is active involvement and timely intervention by the team
once the investment is made. The team creates value in the Portfolio Companies by
taking strategic, operational and financial initiatives aimed at strengthening their
competitive position vis-à-vis competitors and industry benchmarks.
The Investment team works with management teams to identify opportunities for
enhancing value through cost reduction and internal rationalization. They also work
together to implement growth strategies based on market definitions, customer
segmentation, price management, focused marketing and sales plans, strategic capital
investments and /or the introduction of proven technologies. The Investment teams
also help in further strengthening the management teams. ICICI Venture works
actively with management teams to identify and execute acquisitions.
Exit Strategy
ICICI Venture seeks to achieve a timely and appropriate exit to return cash and
profits for its Investors. Such exit strategies may include:
1. Selling off the stake to strategic investors
2. Initial Public Offering in India or overseas
3. Sale to any other private equity fund or venture capital fund
4. Secondary sale on stock markets
5. Merger with an existing listed company
6. Management / Company buy-backs.
The holding period of each investment is generally between 3 to 5 years. This
however depends upon the stage of investment and the performance of the sector and
the company
PORTFOLIO
58
BY FUND
IAF Series 1
PVR , Infomedia India, Cyber gateway ,Arch
Pharmalabs , I-Ven Realty (Glaxo) ,Welspun India
,Samtel Color , Subhiksha ,Deccan Aviation , VA
Tech
IAF Series 2
Geometric Software ,Arch Pharmalabs Perlecan
Kalpataru Power, Home Solutions ,Centurion Bank
of Punjab, Sainik Mining and Allied Services Limited
, Rubamin Limited , Tops Securities, Karvy Stock
Broking Ltd
Real estate Fund
I-Ven Township, Integrated Township at
Tellapur ,Jubilee Hills Landmark Projects, Tsi
business park, I-Ven Kolte Patil Projects , Corolla
Realty Entertainment World Developers ,Lodha
Elevation Buildcon Pvt. Ltd .
ICICI Emerging Sectors
Fund/Others
Shoppers' Stop ,TV Today (Aaj Tak) , Crossword ,
Pantaloon Retail Subhiksha Naukri.Com ,
Avesthagen Biocon , Medicorp , Intas Pharma
Mezzanine Fund
I-Ven Interactive Ltd.
BY SECTOR
Banking & Financial Services Centurion Bank of Punjab , Karvy
Stock Broking Ltd
Energy Reliance Petroleum , Kalpataru Power
59
Consumer Services PVR, Deccan Aviation, Tops Securities
Engineering Services Nagarjuna Construction VA Tech India
Action Construction Equipment
Life Sciences Arch Pharmalabs , Malladi Drugs
Bharat Biotech ,I-Ven Pharma (Dr
Reddy's Labs) ,Intas Pharma ,Swiss
Biosciences
IT/ITES Geometric Software, Infowavz, Rel Q,
Bill Junction/Techprocess
Manufacturing Samtel Color , Tebma Shipyards Ltd. ,
ACE Refractories , Electrotherm (India)
Limited
Media Infomedia India TV Today (Aaj Tak) ,
Miditech I-Ven Interactive Ltd.
Internet Naukri.com
Hospitality Mars restaurant
Logistics Gateway Distriparks
Metals Rubamin Limited
Real Estate Cyber gateway , I-Ven Realty (Glaxo) ,
Jubilee Hills Landmark Projects , TSI
Business Parks , I-Ven Kolte Patil
Projects , Corolla Realty
Retail Pantaloon Retail ,Subhiksha , Home
Solutions Shoppers' Stop ,Crossword ,
Trinethra
Textiles Welspun India , Sangam
60
SIDBI
Small Industries Development Bank of India ( SIDBI ) was established
in April 1990 as a wholly owned subsidiary of Industrial Development
Bank of India (IDBI ), under an Act of Indian Parliament to serve as the
principal financial institution for promotion, financing and
development of industry in the small scale sector and co-coordinating
the functions of other institutions engaged in similar activities. As a
result of an amendment to the SIDBI Act, SIDBI has since been made
as an independent financial institution to cater to the wider range of
SSI requirements.
SIDBI’s Assistance to the small scale sector is channelised
basically through 3 routes viz. :-
1. Indirect Assistance
2. Direct Assistance
3. Development and Support Services
SIDBI offers various schemes of assistance, designed to meet
every need of small scale industries, under one roof.
The unsecured bonds of SIDBI have been rated ‘AAA’ by leading
domestic rating agencies viz. The Credit Rating Information
Services of India Ltd. (CRISIL) and Credit Analysis and
Research Ltd. (CARE).
SIDBI is ranked 23rd in terms of Assets and 24th in terms of
Capital among the top 50 Development Banks in the World
(Source: The Banker, London, June 2000)
SIDBI is placing strong emphasis on technology development and
absorption both for modernization purposes and also for creating
new enterprises and strengthening existing enterprises in high
tech areas such as information technology.
SIDBI and Venture Capital Financing
SIDBI’s Venture Capital Fund constituted in October 1992. It is
utilized for direct investment in small scale units and
61
contribution to Venture Capital Funds for onward lending
to/investment in small scale units.
Promoted 15 State / All India Level Venture Funds. 10 Funds are
IT dedicated and the balance 5 is General Funds.
Promoted National level Fund NFSIT.
SIDBI has so far made an aggregate commitment of Rs.1.5
billion (US$ 33.33 million).
Further, SIDBI has also taken the initiative in setting up of two
Innovation and Incubation Centre in Indian Institute of
Technology, Kanpur and Birla Institute of Technology, Mesra.
National Venture Fund For Software and IT Industry (NFSIT) :-
NFSIT has been launched by the Hon'ble Prime Minister of India, Shri
Atal Behari Vajpayee on December10,1999.
At the national level a Rs. 1000 million (US$ 22.22 million) National
Venture Capital Fund for Software and IT industry (NFSIT) has been
set up by SIDBI and is being managed by SIDBI Venture Capital Ltd.
SIDBI has contributed Rs. 500 million (US$ 11.11 million).
Ministry of Information Technology, Government of India Rs.
300 million (US$ 6.67 million).
Rs. 200 million (US$ 4.44 million) by IDBI.
The basic idea of mooting this national fund is that:
The focus of the fund primarily be in small scale units in the
growing IT industry and related businesses such as networking,
multimedia, data communication and value added
telecommunication services.
A portion of the Fund could be earmarked for incubation projects
which are of high risk in nature and development of products,
evaluation of which would require high degree of expertise
including international linkages.
62
It will help in arranging strategic alliances with overseas IT units
including that setup by Non-Resident Indians (NRIs).
The Investment objective of the fund will be to meet the total
fund requirements of the IT units to enable them to achieve rapid
growth rates and maintain their competitive edge in the
international markets.
Investment may spread across the focus sector in the area of new
projects, expansion and diversification and product development
efforts.
SME Growth Fund (SGF)
The SME Growth Fund (SGF) has been set up by Small Industries
Development Bank of India (SIDBI) in association with other
leading commercial banks such as Punjab National Bank, State
Bank of India, Bank of Baroda, Bank of India, Central Bank of
India, Union Bank of India, Oriental Bank of Commerce and
Corporation Bank.
It is a close ended 8 year fund dedicated to SME sector with an
initial corpus of Rs. 5000 million/ US$ 111.10 million.
SME Growth Fund focuses at wide range of growth sectors, such
as life sciences, retailing, light engineering, food processing,
information technology, infrastructure related services,
healthcare, logistics and distribution, etc.
The main objective of the fund is to invest in companies at early
stage as well as in second round financing for those with a track
record of proven technology or business model and opportunities
for growth and earnings .
The fund would endeavor to develop international networking
and enable assisted units to attract co-investment from
international venture capitalists in subsequent rounds of
financing.
PORTFOLIO
63
NFSIT Portfolio
Axiom Consulting, Compulink Systems Limited,
IndiaIdeas.com Limited, E-Cube India Solutions
Limited, Indus Teqsite Private Limited, KarRox
Technologies Limited, KMG Infotech Pvt Ltd.
Manthan Software Services Private Limited ,
Mithi Software Technologies , Skelta Software
Private Limited , Winfoware Technologies
EXITS :- Benchmark Softech Limited, ECAD
Technologies , ICRA Online , Parsec
Technologies
SME Growth Fund Portfolio
Basil Communications , Carzonrent India ,
Digibee Microsystems , Direct Logistics,
Dynaspede Integrated Systems , Expressit
Logistics, Flash Electronics, Indo Shell Mould
Limited, Mudra Lifestyle Limited, Naturol
Bioenergy Limited, Prateek Apparels Limited,
V&S International Limited, Home Store India
Limited
64
Instruments of Finance
Venture capitalists are known for their innovation in using the
instruments of finance. Still in India their preferred method of
investment has been equity share. The contribution of equity share in
total financing has been consequently highest and well above 60% of
the total as shown in the table As far as the redeemable preference
share's contribution is concerned it was almost negligible but gained
importance in 1998 and after onwards. It was 27.54 in 2009. In
developed markets, the convertible preference share is the most
important instrument of finance in venture financing. The contribution
of convertible instrument and non-convertible debt is 16% and 24%
respectively.
INSTRUMENT OF FINANCE USED BY VCF'S IN INDIA
Sr.No. Instruments Rs. Million Per cent
1 Equity Share
2 Redeemable Preference Share
3 Convertible Instruments
4 Non-convertible Debt.
5 Other Instruments
6 Total 30167.46 100.00
65
CURRENT SCENARIO
Investment by Stage of Financing
Venture capitalists invest their funds in different stages of
development of an enterprise, depending upon their preferences,
expertise and opportunities. In certain cases they provide financing in
all the stages, in some cases they specialize in specific stages. In India
start-up stage has been the preferred stage of investment by venture
capital funds. The proportion of start-up has been consistently around
35% of total investment through out the observation period. The
importance of later stage is increasing. As table show from 1999-00 to
2006-07 it’s increasing rapidly. Seed stage is also showing an
increasing trend. It was 8.57% in 1999-00 and in 2008-09 it was
14.92%.
All over the world, the trend is shifting in favor of later stage
and drifting away from seed stage and start-up stage .
66
VENTURE CAPITAL IN INDIA BY STAGES (COMPARISON)
(Figure in Rs. Million)
Investment Amount
1999-00
%age Amount
2003-05
%age Amount
2008-09
%age
Start-up 6263 45.51 3813 38.36 9440 31.29
Later Stage 4194 30.47 3338 33.58 14652 48.56
Seed Stage 1180 8.57 963 9.69 4500 14.92
growth Stage 2124 15.45 1825 18.37 1575 5.23
Total 13761 100.00 9939 100.00 30167 100.00
PE Investments by Stage: 2008
Late stage and PIPE deals accounted for 70% of overall value of PE transactions
(PIPE: banking, pharma, auto components)
Investment by Stage (Number of Deals)
67
VENTURE CAPITAL INVESTMENT BY FINANCING STAGE IN
NUMBER OF PROJECTS: 2009 (FIRST HALF)
Total number of deals: 162 with total amount invested at ~ US$5.6B
Venture Capital Investment by Financing Stage - Average Investment
68
Investment Amount
in Rs.
MN
%age No. of
Projects
%age Average
Investment
in Rs. mn
Start-up 9440 31.29 59 22.18 160
Later Stage 14652 48.56 104 39.09 140
Seed Stage 4500 14.92 61 22.94 73.78
growth Stage 1575 5.23 42 15.79 37.5
Total 30167 100.00 266 100.00 411.28
As shown in table Average investment in start up stage is Rs.160
Million, in later stage Rs.140 Million and in seed stage it is Rs.73.78
Million.
Investment by Industry
Total investment in manufacturing sector in 2006 is 12.1% which
decrease in 2007 and become 7% and in 2009 it is 20.2% . The
significance of computer software has been decreasing consistently
69
over the period. In the year 2007, computer software accounted for
only 16% of the total investment by venture capitalists in India which
reached a respectable figure of 23.5% in 2006 and total allocation to
this department in 07-08 is 1500cr and in 08-09 it is 1680cr. This is a
clear indication that investment in the IT industry, as a whole is not
attracting greater attention as compared to other industries.
Engineering and Construction sector is attracting the huge amount of
venture capital. In 2006 the total investment was the 7.9% of the total
venture capital but in 2007 it reached a respectable figure of 14% and
in 2008 it is 16% and in 2009 it reached to 19% .In all other industry
groups, trend can be predict from the pie chart. Venture capital
investments in medical and healthcare related projects are decreasing.
VENTURE CAPITAL INVESTMENT BY INDUSTRY IN INDIA IN
2008 (US $ 7.5 BILLION)
(% AGE)
70
PE/VC Investments by Industry Total US$5.6B First Half of 2009
Investments by Sector (Number of Deals)
71
PE Investments by Sector: 2009
Top Cities attracting PE Investments 2008
Selected ES IT/ITES Investments 2008
72
VENTURE CAPITAL INVESTMENT IN INDIA-
PREFERRED EXIT OPTION
73
28%
12%
7%4%
28%
16%
5%
IPO
MERGER &ACQUISITION
MANAGEMENTBUYOUT
EXIT TOANOTHER FUND
BUYBACK BYPROMOTER
TRADE SALES
STOCK MARKET
Selected IT/ITES Exits 2008
Investment by Region
The explanation for regional variation in venture capital
investment can be found in the evolving social-economic environment
at regional level in the wake of new economic policy of liberalization
74
and globalization. The south including Tamilnadu, Karnataka and
Andhra Pradesh have been on the forefront of encouraging new sunrise
sectors. The inference is that atmosphere conducive to new business
development is more suitable in South in comparison to other part of
the country. The western part including Maharashtra and Gujarat are
also prominent emerging states. Eastern part of the country is
politically more left oriented and economically less developed. That is
reflected in less avenues and lower investment in eastern region.
0%
5%
10%
15%
20%
25%
30%
35%
south west east north
future
current
Investment by States
Among the individual states, in term of amount of investment the
highest investment was in Maharastra followed by TamilNadu, Andhra
Pradesh, Gujarat, Karnataka and west Bengal in that order. In term of
75
number of venture capital investments per state again, Maharashtra had
the highest number of venture capital projects, followed by TamilNadu,
Karnataka, Andhra Pradesh, and Gujarat in that order. While some of
the states are attracting higher amounts of investments per project.
Some attract higher number of venture capital projects. In the recent
years, state level venture capital funds have also been set up. This will
increase investment and venture activity in several states across the
country.
STATES AND INVESTMENT BY VCFS (2008-09)
Investment Amount
in (Rs.
Million)
%age No. of
Projects
%age Average
investment in
(Rs. Million)
West Bengal 312 3.10 22 3.20 14.20
Haryana 300 3.00 22 3.20 13.60
Delhi 294 2.90 21 3.00 14.00
U.P. 283 2.80 29 4.20 9.80
Goa 105 1.00 16 2.30 6.60
Orrisa 35 0.40 5 0.70 7.00
Total 9994 100.00 691 100.00 14.50
STATISTICAL TOOL-TREND FITTING INVESTMENT IN
VENTURE CAPITAL
76
Year
X
Venture Capital
Investment
(Rs Million)
Y.
Deviation
from
1999.5
Deviation
X 2 XY X2
1996 4646 -3.5 -7 -32522 49
1997 6948 -2.5 -5 -34740 25
1998 9876 -1.5 -3 -29628 9
1999 11258 -.5 -1 -11258 1
2000 13888 +.5 +1 +13888 1
2001 10848 +1.5 +3 +32544 9
2002 8920 +2.5 +5 +44600 25
2003 10000 +3.5 +7 +70000 49
N = 8 Y = 76384 X = 0 XY
= 52884
X2
= 168
Equation of the straight line trend is Y = a + bX
a =
b =
In 2007, X will be 15
So Y = 9548 + 314.78 × 15 = 14269.7
Thus estimated average venture capital investment for years 2007 is Rs.
14269.7 million
Statistical Tool-Trend Fitting Investment in Venture Capital According to number of
Projects
77
Year
X
No. of Project
funded by
Venture
Capital
Y
Deviation
from
1999.5
X
Deviation
X 2
XY
X2
1996 415 -3.5 -7 -2905 49
1997 491 -2.5 -5 -2455 25
1998 598 -1.5 -3 -1794 9
1999 685 -.5 -1 -685 1
2000 762 +.5 +1 +762 1
2001 678 +1.5 +3 +2034 9
2002 598 +2.5 +5 +2990 25
2003 691 +3.5 +7 +4837 49
N = 8 Y = 4918 X = 0 XY
= 2784
X2
= 168
Equation of the straight line trend is Y = a + bX
a =
b =
In 2007, X will be 15
So Y = 614.75 + 16.57 × 15 = 863.3
Thus estimated No. of Project funded by venture capital for year
2007 is Rs. 863.
THE VENTURE CAPITALISTS ARE LOOKING FOR
78
I. Target company characteristics:
Generally venture capitalist tells potential invitees that they
look for the following factors before investing.
(I) Strong Management team:
Industry experience drive and ambition and technical expertise
are all elements of a management team that venture capitalists will say
they are investing in depending up on the venture capitals however a
lock of depth in a particular area of management is not necessarily a
bar to investment. Certain venture capitalists particularly those who
invest in very early stage companies, will bring that talent to the
company from the venture capitalists itself, through the venture
capitalists network of talent or through recruiting efforts.
(ii) Market opportunity:
Overall size of the commercialization opportunities for the
company's product or service, barrier 's to entry, current competitive
and possible competitive landscape, profit margins and customer
excitement. The venture capitalists want to know that it is investing in
a company that, preferably, will be the dominant player in an emerging
area.
Shares will be entitled to a comparable dividend to the common shares
on an as converted basis.
(v) Voting rights:
The preferred shares will carry the same number of votes per
share as the common shares, in almost all cases, one vote per share.
The venture capitalists as a preferred shareholder will therefore be
entitled to all notices of meetings of shareholders and to attend and
vote on any matters on which common shareholders are entitled to
vote.
(vi) Liquidation preference:
The preferred shares will be senior to all other classes of shares
and the share rights contained in the amended constantan
documentation of the company will provide that no other class or series
79
of shares can be created without the approval of the holders of the
preferred shares. On dissolution, winding up merger or sale of the
company or sale of substantially all of the assets of the company, the
preferred shareholders are entitled to receive: - (I) the issue price of
the preferred shares (ii) some multiple of the issue price of the
preferred shares, plus all accrued and unpaid dividends..
(vii) Anti dilution:
Anti dilution mechanisms are always present, but the calculation
for formula varies. The effect of the anti-different provision is to
ensure that, upon the occurrence of certain events such as sub division,
consolidation or stock dividends, the merger or other corporate
arrangement resulting in the exchange of common shares, or any
financings which one completed at a price which is lower than the
issue price of the preferred shares, the holders of preferred shares will
maintain their relative positions in the company. The method of
calculation may vary, but typically, the provision will adjust the
preferred shares based upon a weighted average formula.
(viii) Retraction:
The preferred shares may have a retraction right. The right of
retraction will likely be exercisable often a certain period of time
following which, on 'notice by.
(ix) Redemption:
If a retraction right is included, the company might also include
the right, on notice to the preferred shareholders, to repurchase the
preferred shares. As with a retraction right; the right of redemption
will only be in effect after a period of time. The redemption price will
typically be the same as the retraction price.
B. Shareholder Agreement Rights:
80
(i) Board rights:-
As mentioned, venture capitalist rarely makes passive
investment. Almost always, venture capitalists will require a director
or the investee company. The venture capitalists might also wish to set
the number of
(ii) Matters which require preferred shareholder
approval:
The rights and restrictions attaching to the preferred shares will
generally be contained in the memorandum and articles or the articles.
These rights and restrictions will prescribe certain matters which
pertain to the preferred shares specifically such as dividend rights
redemption and retraction provisions and conversion features. In
additions, a shareholders agreement might also contain an expanded
list of matters which require shareholder and specifically, preferred
shareholder approval.
(iii) Rights of first offer:
A shareholders agreement in a private company will typically
have simple rights of first offer on all transfers of shares. Venture
capitalists will also require these provisions. Shareholder agreements
generally grant to either the company or the other shareholders the first
opportunity to purchase shares offered by a shareholder to a third party
on the same terms and conditions as are set out in the third party offer.
If the company or other shareholders do not exercise their rights, then
the other i .e. the shareholders or the company depending upon who had
first rights will have a second opportunity.
(iv) Preemptive Rights:
If the company governing corporate statue requires that all
shareholders have a right. This can not be generally waived, to exercise
a preemptive right on the issuance of treasury shares when shares are
issued. It is
(v) Conditions Precedent Including Due Diligence:
Almost always, the venture capitalists will require that the
81
closing of the investment is subject to satisfactory due diligence. If the
company is still at a relatively early stage without organized books of
account and financial statements, it may be a pre-requisite that the
company prepare and deliver to the venture
VENTURE CAPITAL FUND: PRESENT SCENARIO IN WORLD
The Indian venture capital segment, over the years, has
acquired its own distinct character. The industry has subsequently
witnessed in overseas activity with rise in the number as well as the
pool of funds for investment. India was the youth largest most active
market for venture capital funding as on December, 2009.
Investment breaks down by country from January 1 to December
31, 2009.
Country Amount
Invested
($ Million)
Number of
deals
Number
of
Investors
South Korea 4823.87 60 29
Japan 3067.24 84 84
Australia 3257.01 82 79
India 5400.18 203 106
Hong Kong 2650.00 106 86
China 8423.22 338 137
Singapore 1890.03 69 47
Thailand 101.45 72 72
Malaysia 41.18 21 20
There has been only a marginal decline in total amount of
venture funding during the year 2005-06. The total investment grew
82
from 1999 to 2008 and the next two years took a beating with the total
amount invested decreasing from Rs. 10,000 Crore in 1998 to Rs.
54000 Crore in 2007.
CONCLUSION AND SUGGESTIONS
This chapter is designed to recapitulate the nature, method and
analysis as being carried out in the preceding chapters and to
enumerate some of the major conclusions and suggestions to improve
the prospects of venture capital fund in the country. This chapter is
divided in two sections: Section 1 presents the conclusions and Section
2 explains the suggestions.
CONCLUSIONS
On the basis of the theoretical analysis and empirical findings
conclusions can be drawn that conceptual frame work related to the
venture capital industry focuses on two major forms of asymmetric
information, “hidden information” and “hidden action”. The central
presumption of the modern theoretical work on venture capital is that
the venture capitalists posses specialized abilities in selecting,
monitoring and nurturing the projects.
The SEBI (VCF) regulation 1996 lays down the overall,
regulatory framework for registration and operations of VCF’s in India.
Overseas Venture Capital investments of India are subjects to the
Government. For tax exemption purposes, venture capital funds also
need to comply with income tax rules under section 10 (23 FB) of the
Income Tax Act. The multiple set of guidelines and requirements create
inconsistencies and detract from the overall objectives of development
of venture capital industry in India.
As far as the sources of supply of venture capital are concerned
contribution of Foreign Financial Intuitions has been highest India.
Form the year 1997 its increasing, in 2003 it was 52.3% which is
indicating upwards trend in coming years. Since FII’s look for return
83
maximization on their investment, their increasing pressure has led
venture capitalist to adopt more business oriented strategy in their
operations.
In India, equity capital is the most popular instrument of
finance being in use by venture capitalist. Its contribution in total
financing has been consequently highest and above 60%. The point to
note in this connection is that the contribution of preference share was
almost negligible till 1993, but it gained importance in 1998 and after
onwards. This reflects the development of venture capital market in
India.
Stage-wise investment pattern demonstrates the proportion of
start-up has been well over and around 40 percent of the total
investment consistently during the observation period. Going by the
data for latter stage, its importance has been gone up from20.7 percent
to 33.4 percent which is showing that it will go higher in coming years.
As per investment by Industry the share of industrial products
and machinery has been highest in venture financing throughout the
observation period. The significance of computer software has been
growing consistently over the period; it was accounted 3.9% in 1997-
98 and reached a respectable figure of 18.3% in 2002-03 which reflect
a upward trend for up coming years. There is no clear preference
shown for investing any specific industry group by the venture capital
funds.
SUGGESTIONS
84
In the light of the conclusions reached related to the theoretical
analysis of present status and working of venture capital in India,
endeavor is made to offer some suggestions and recommendations to
make the venture capital more useful in the country. Some of the major
recommendations are as discussed below:-
There should be single regulatory agency, preferably SEBI to
regulate the operation of venture capital in India. As presently,
multiplicity of regularity policy regime related to different aspect of
venture capital such as: SEBI (VCF) Regulation 1996, Oversees
Guidelines for Venture Capital Investment 1995, Income tax Rules
Under Section 10 (23 FA) of the income Tax Act, and FIPB/ RBI
Approval in certain cases have been emanating contradictory signals
causing confusion to the various participants of the venture capital
market.
The Income Tax Act should be amended suitably to provide fiscal
neutrality to the venture capital investment. Following tax incentives
are suggested:-
The dividends paid to the investors of venture capital funds
should be exempt from tax.
Foreign venture capital investment should be encouraged by
providing additional tax exemptions.
The formation of limited partnership is not permitted to organize
their affairs in such a manner that their exposure to risk remain with in
tolerable limits.
Convertible preference share and other convertible instrument
are theoretically sound and empirically popular all over the world,
India should also take advantage of the same. Hence necessary enabling
provision should be made in the Company Law Act 1956.
As per investment by region the share of east is very law. A
recent development in spatial distribution of venture capital investment
is the emergence of out of the country investment by venture capitalist
operating from India.
85
Government needs to play a very active role for identifying and
increasing the domestic pool of funds for venture capital investment.
Currently 90% funds are foreign owned. Domestic flows of venture
capital in the form of insurance provident funds, pension funds, mutual
funds etc. need to be encouraged.
For the progress of venture capital industry in India, full support
is required from all corners and in all possible forms. The suggestions
discussed above are only indicative and not on exhaustive one.
86
QUESTIONNAIRE
1. Are you willing to give a venture capitalist an ownership position in your business?
(a) Yes (b) No
2. Are you willing to give a venture capitalist a seat on the board of directors?
(a) Yes (b) No
3. Are you prepared to treat a venture capitalist as a business partner?
(a) Yes (b) No
4. Have you prepared a comprehensive business plan?
(a) Yes (b) No
5. As part of courting a venture capitalist, will you develop a list of issues with
special significance to your business?
(a) Yes (b) No
6. Will you make whatever investigations are needed in order to address those
Special issues?
(a) Yes (b) No
7. Are you willing to spend time with a venture capitalist to discuss all aspects of
your business?
(a) Yes (b) No
87
8. Can you let go of some of your emotional involvement as the founder/owner of
your business?
(a) Yes (b) No
9. Are you willing to make future decisions only after discussions and negotiations
with others?
(a) Yes (b) No
88
BIBLIOGRAPHY
Books
1. Khan, M.Y., (2007) “Financial Services, “Tata McGraw Hill,
New Delhi.
2. Mishra, (2006) “Venture Capital Financing”, Shipra Publication,
New Delhi.
3. Pandey, I.M., (2006) “Venture Capital - The Indian Experience”,
Pub.: PHI, New Delhi,.
Research Articles & Journals
1. Aggarwal, Vipin. “SEBI Venture Capital Guidelines: An
Appraisal, Charted Secretary, March 2004, pp. 227-228.
2. Anandram, Sanjay, “Venture Capital: The Writing on the Wall,”
ICFAI Reader, Jan. 2008.
3. B. Ratna Ravishankar, “Risk Finance: Venture Capital and
Private Equity Finance,” The Chartered Accountant, Feb. 2008,
pp. 1022-1029.
.
4. Chary. T. Satyanrayana, “Working of Venture Capital Funds”,
Udyog Pragati, Jan-March 2009.
5. Gompers, P. and Lerner, J. “An Analysis of compensation in the
Venture Capital Partnership,” Journal of Financial Economics,
51, 2008.
6. Subhash, K.B. & Govindakutty Nair, T. “Globalization and
venture Capital System”, Udyog Pragati, July-Sept. 2004. Pp.1-2.
7. Lerner, J. “Venture Capitalists and the Decision to go Public”,
Journal of Financial Economics, 35, pp. 294-316.
Internet
1. www.nvca.com
2. www.ivca.com
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3. www.indiainfoline.com
4. www.sebi.com
5. www.vcline.com
6. www.financemedia.com
90