INTRODUCTION
Evolution of venture capital:
The word VENTURE has several meanings, depending upon the context in which it is used. Venture means chance, hinting at speculation to try one’s luck good or bad, involving risk or hazard or exposure to insecurity or danger. Venture also means trial i.e. an attempt or endeavor hinting again at trying ones luck. In the highly dynamic business environment that surrounds us today, a venture includes a firm that deals in unproven technology or products that require a market segment to be created for it The earliest origins of venture capital can be traced back to the medieval Islamic mudaraba partnership. In terms of protecting the entrepreneur, sharing the risks, losses and profits the two systems of finance are remarkably similar. General Georges Doriot is considered to be the father of the modern venture capital industry. In 1946, Doriot co-founded American Research and Development Corporation (AR&DC) with Ralph Flanders, Karl Compton It is commonly accepted that the first venture-backed startup is Fairchild Semiconductor, funded in 1959 by Venrock Associates. Venture capital investments, beforeWorld War II, were primarily the sphere of influence of wealthy individuals and families. One of the first steps toward a professionally-managed venture capital industry was the passage of the Small Business Investment Act of 1958. Slow Growth in 1960s & early 1970s, and the First Boom Year in 1978 During the 1960s and 1970s, venture capital firms focused their investment activity primarily on starting and expanding companies. More often than not, these companies were exploiting breakthroughs in electronic, medical or data-processing technology. As a result, venture capital came to be almost synonymous with technology finance. Venture capital firms suffered a temporary downturn in 1974, when the stock market crashed and
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investors were naturally wary of this new kind of investment fund. 1978 was the first big year for venture capital. The industry raised approximately $750,000 in 1978. Highs & Lows of the 1980s In 1978, the US Labor Department reinterpreted ERISA legislation and thus enabled this major pool of pension fund money to invest in alternative assets classes such as venture capital firms.Venture capital financing took off. 1983 was the boom year - the stock market went through the roof and there were over 100 initial public offerings for the first time in U.S. history. Due to the excess of IPOs and the inexperience of many venture capital fund managers, VC returns were very low through the 1980s. VC firms retrenched, working hard to make their portfolio companies successful. The work paid off and returns began climbing back up. Stages in the Evolution of Venture Capital Financing The different stages are depicted in the table below: S. No 1 Stages Persoal borrowing Commercial borrowing (working Capital) Term Loan Developmental Borrowing Development Credit allowed purely on the strength of the security offered. No other questions asked. Liquidity(current ratio) and solvency (debtequity ratio) are considered. Turn-over of the business & Profitability verified. Loan given after obtaining collateral. Technical Feasibility & Financial Viability of the activity to be financed looked into through detailed project appraisal. Loan given obtaining collaterial & with a host of terms & conditions.
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3
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VC Financier looks at the projet as a intending Venture Capital partner will examine a proposition that is highFinance (Technology risk oriented, but with potential for large reward Development and accepts to participate in the venture and in its Purpose) financing if satisfied.
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Concept of venture capital:
What is venture capital? Venture capital is a type of private equity capital typically provided by professional, outside investors to new, growth businesses. Venture capital investments are generally made as cash in exchange for shares in the invested company. A venture capitalist (VC) is a person who makes such investments. A venture capital fund is a pooled investment vehicle (often a limited partnership) that primarily invests the financial capital of thirdparty investors in enterprises that are too risky for the standard capital markets or bank loans. Venture capital can also include managerial and technical expertise. Most venture capital comes from a group of wealthy investors, investment banks and other financial institutions that pool such investments or partnerships. Professionally managed venture
capital firms generally are private partnerships or closely-held corporations funded by private and public pension funds, endowment funds, foundations, corporations, foreign investors, and the venture capitalists themselves. Venture capitalists generally: Finance new and rapidly growing companies Purchase equity securities Assist in the development of new products or services Add value to the company through active participation Take higher risks with the expectation of higher rewards Have a long-term orientation When considering an investment, venture capitalists carefully screen the technical and business merits of the proposed company. Venture capitalists only invest in a small percentage of the businesses they review and have a long-term perspective. They also actively work with the company's management, especially with contacts and strategy formulation. Venture capitalists mitigate the risk of investing by developing a portfolio of young companies in a single venture fund. Many times they co-invest with other professional venture capital firms. In addition, many venture partnerships manage multiple funds simultaneously. For decades, venture capitalists have nurtured the growth of America's high technology and
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entrepreneurial communities resulting in significant job creation, economic growth and international competitiveness. Companies such as Digital Equipment Corporation, Apple, Federal Express, Compaq, Sun Microsystems, Intel,Microsoft and Genentech are famous examples of companies that received venture capital early in their development. (Source: National Venture Capital Association 1999 Yearbook).
Features of venture Capital: The main attributes of venture capital are as follows: 1. Equity participation: Actual or potential equity participation through direct of shares, option or convertible securities. The objective is to make capital gains by selling off the enterprise becomes profitable. 2. Long term investment: venture financing is a long term illiquid investment it is not repayable on demand. It requires long term investment attitude that requires the venture capital firms to wait for a long period, say 5-10 years to make profits. 3. Investment in high-risk, high-returns ventures: As VCs invest in untested, innovative ideas the investments entail high risks. In return, they expect a much higher return than usual. (Internal Rate of return expected is generally in the range of 25 per cent to 40 per cent). 4. Expertise in managing funds: VCs generally invest in particular type of industries or some of them invest in particular type of businesses and hence have a prior experience and contacts in the specific industry which gives them an expertise in better management of the funds deployed. 5. Raises funds from several sources: A misconception among people is that venture capitalists are rich individuals who come together in a partnership. In fact, VCs are not necessarily rich and almost always deal with funds raised mainly from others. The various sources of funds are rich individuals, other investment funds, pension funds, endowment funds, et cetera, in addition to their own funds, if any. 6. Diversification of the portfolio: VCs reduce the risk of venture investing by developing a portfolio of companies and the norm followed by them is same as the portfolio managers, that is, not to put all the eggs in the same basket.
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7. 8.
Exit after specified time: VCs are generally interested in exiting from a Participation in management: The hands on approach of continuing
business after a pre-specified period. This period may usually range from 3 to 7 years. participation of the venture capitalist in the management of the entrepreneurs business helps him to protect and enhance his investment by actively involving and supporting the entrepreneur. More than finance the venture capitalist gives his marketing, planning and management skills and technology to new firm. Venture capital also differs from development finance .A development bank safeguards its interest through collateral and substantial stake in ownership and control through a nominee director. It does not play an active role in the management of the company. A company obtaining funds from its holding or parent company will be fully owned or managed by the holding company. Venture capital and Alternative Financing Compared Venture capital High Management Information Low Commercial Loan Parent company finance Development finance
Low Ownership
High
The venture capitalist is also not exactly is not like the stock market investor who merely trades in the shares of a company without any relations with or knowledge of its management. In fact a venture capitalist combines the qualities of banker, stock market investor and entrepreneur.
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Venture capital has a number of advantages over other forms of finance, such as: 1. 2. 3. It injects long term equity finance which provides a solid capital base for The venture capitalist is a business partner, sharing both the risks and The venture capitalist is able to provide practical advice and assistance to
future growth. rewards. Venture capitalists are rewarded by business success and the capital gain. the company based on past experience with other companies which were in similar situations. 4. The venture capitalist also has a network of contacts in many areas that can add value to the company, such as in recruiting key personnel, providing contacts in international markets, introductions to strategic partners, and if needed co-investments with other venture capital firms when additional rounds of financing are required.
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VENTURE CAPITAL IN INDIA
Venture capital Scenario in India:
In the earlier years, individual investors and development financial institutions played the role of venture capitalists in India and entrepreneurs largely depended upon private placements, public offerings and the finance lend by financial institutions. In early seventies, the need to foster venture capital as a source of funding new entrepreneurs and technology was highlighted by the Committee on Development of Small and Medium Enterprises. In spite of some public sector funds being set up, the venture capital activity did not gather momentum. In 1988, the Government of India, based on a study undertaken by the World Bank, announced guidelines for setting up venture capital funds (VCFs). These guidelines were restricted to setting up of VCFs by banks or financial institutions only. Internationally, however, entrepreneurs who are willing to take higher risk, in anticipation of higher returns, usually set up venture capital funds. This is in contrast to banks and financial institutions, which are more averse to risk. In September 1995, Government of India issued guidelines for overseas venture capital investment in India whereas the Central Board of Direct Taxes (CBDT) issued guidelines for tax exemption purposes. As a part of its mandate to regulate and to develop the Indian capital markets, Securities and Exchange Board of India (SEBI) framed the SEBI (Venture Capital Funds) Regulations, 1996. Pursuant to the regulatory framework, some domestic VCFs were registered with SEBI. Some overseas investments also came through the Mauritius route. However, the venture capital industry, understood globally as independently managed, dedicated pools of capital that focus on equity or equity linked investments in privately held, high growth companies is still relatively in a nascent stage in India. Figures from the Indian Venture Capital Association (IVCA) reveal that, till 2000, around Rs. 2,200 crore (US$ 500 million) had been committed by the domestic VCFs and offshore funds which are members of IVCA. Figures available from private sources indicate that overall funds committed are around US$ 1.3 billion. Also due to economic liberalisation and increasing global outlook in India, an increased awareness and interest of domestic as well as foreign investors in venture capital was
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observed. While only 8 domestic VCFs were registered with SEBI during 1996-98, more than 30 additional funds have already been registered in 2000-01. Institutional interest is growing and foreign venture investments are also on the increase. Given the proper environment and policy support, there is a tremendous potential for venture capital activity in India. The Finance Minister, in the Budget 2000 speech announced, "For boosting high tech sectors and supporting first generation entrepreneurs, there is an acute need for higher investments in venture capital activities." He also said that the guidelines for the registration of venture capital activity with the Central Board of Direct Taxes would be harmonised with those for registration with the Securities and Exchange Board of India. SEBI decided to set up a committee on venture capital to identify the impediments and suggest suitable measures to facilitate the growth of venture capital activity in India. Keeping in view the need for global perspective, it was decided to associate Indian entrepreneur from Silicon Valley in the committee. The setting up of this committee was primarily motivated by the need to play a facilitating role in tune with the mandate of SEBI, to regulate as well as develop the market. The committee headed by K. B. Chandrasekhar, Chairman, Exodus Communications Inc., submitted its report on 8 January 2000. In his Budget Proposals 2000-01, the Finance Minister announced new regime for venture capital funds. And proclaimed SEBI as the single point nodal agency for registration and regulation of both domestic and overseas venture capital funds. The new regime stipulated that no approval of venture capital funds by tax authorities would be required and that the principle of "pass through" would be applied in tax treatment of venture capital funds. Recently, the Government of India has also announced the"exit policy" for venture capitalists. India has the second largest English speaking scientific and technical manpower in the world. Given this quality and magnitude of human capital India's potential to create enterprises is unlimited. Given the vast potential, which is, not only confined to IT and software but also in other sectors like biotechnology, telecommunications, media and entertainment, medical and health etc., venture capital industry is playing and shall continue to play a catalyst's role in industrial development. In the early 1980s, the idea that venture capital might be established in India would have seemed utopian. India's highly bureaucratized economy, avowed pursuit of socialism, still
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quite conservative social and business worlds, and a risk-averse financial system provided little institutional space for the development of venture capital. With the high level of government involvement, it is not surprising that the first formal venture capital organizations began in the public sector. From its inception the Indian venture capital was linked with exogenous actors, public and private. In India, one of the most autarchic economies in the world, both the development of venture capital and the information technology industry have been intimately linked with the international economy. The earliest discussion of venture capital in India came in 1973, when the government appointed a commission to examine strategies for fostering small and medium-sized enterprises the Indian financial systems' operation made it difficult to raise "risk capital" for new ventures and proposed various measures to liberalize and deregulate the financial market. The First Stage, 1986–1995 Indian policy toward venture capital has to be seen in the larger picture of the government's interest in encouraging economic growth. The 1980s were marked by an increasing disillusionment with the trajectory of the economic system and a belief that liberalization was needed. Prior to 1988, the Indian government had no policy toward venture capital; in fact, there was no formal venture capital. In 1988, the Indian government issued its first guidelines to legalize venture capital operations. These regulations really were aimed at allowing state controlled banks to establish venture capital subsidiaries, though it was also possible for other investors to create a venture capital firm. However, there was only minimal interest in the private sector in establishing a venture capital firm. The government's awakening to the potential of venture capital occurred in conjunction with the World Bank's interest in encouraging economic liberalization in India. So, in November 1988, the Indian government announced an institutional structure for venture capital. Making the case for supporting the new venture capital guidelines with investments into Indian venture capital funds, the World Bank calculated that demand over the next 2–3 years would be around $67–133 million per annum, and it proposed providing $45 million to four public sector financial institutions for the purpose of
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permitting them to establish venture capital operations under the November 1988 guidelines issued by the Government of India. The funds were restricted to investing in small amounts per firm (less than 100 million rupees); the recipient firms had to be involved in technology that was “new, relatively untried, very closely held or being taken from pilot to commercial stage, or which incorporated some significant improvement over the existing ones in India.” The government also specified that the recipient firm’s founders should be “relatively new, professionally or technically qualified, and with inadequate resources or backing to finance the project.” There were also other bureaucratic fetters. There was even a list of approved investment areas. Two government-sponsored development banks, ICICI and IDBI, were required to clear every portfolio firm’s application to a venture capital firm to ensure that it fulfilled the right purposes. Also, the Controller of Capital Issues of the Ministry of Finance had to approve every line of business in which a venture capital firm wished to invest. In other words, the venture capitalists were to be kept on a very short leash. Despite these constraints, the World Bank supported the venture capital project, noting that the Guidelines reflect a cautious approach designed to maximize the likelihood of venture capital financing for technology-innovation ventures during the initial period of experimentation and thereby demonstrate the viability of venture capital in India. The Second Stage, 1995–1999 The success of Indian entrepreneurs in Silicon Valley that began in the 1980s became far more visible in the 1990s. This attracted attention and encouraged the notion in the U.S. that India might have more possible entrepreneurs. Very often, NRIs were important investors in these funds. In quantitative terms, it is possible to see a dramatic change in the role of foreign investors. Notice also the comparative decrease in the role of the multilateral development agencies and the Indian government’s financial institutions. The overseas private sector investors became a dominant force in the Indian venture capital industry.
Indian Scenario - A Statistical Snapshot
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Contributors of Funds Contributors Foreign Institutional Investors All India Financial Institutions Multilateral Development Agencies Other Banks Foreign Investors Private Sector Public Sector Nationalized Banks Non Resident Indians State Financial Institutions Other Public Insurance Companies Mutual Funds Total Rs mn 13,426.47 6,252.90 2,133.64 1,541.00 570 412.53 324.44 278.67 235.5 215 115.52 85 4.5 25,595.17 Per cent 52.46% 24.43% 8.34% 6.02% 2.23% 1.61% 1.27% 1.09% 0.92% 0.84% 0.45% 0.33% 0.02% 100.00%
Foreign Institutional Investors All India Financial Institutions Multilateral Development Agencies Other Banks
Foreign Investors
Private Sector
Public Sector
Financing By Industry Industry Industrial products, machinery Computer Software Consumer Related Medical Rs million 2,599.32 1,832 1,412.74 623.8 percent 27 18 14 6
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Food, food processing Other electronics Tel & Data Communications Biotechnology Energy related Computer Hardware Miscellaneous Total
500.06 436.54 385.09 376.46 249.56 203.36 1,380.85 10,000.46
5 4 4 4 2 2 14 100
1,380.85, 14% 203.36, 2% 249.56, 2% 376.46, 4% 385.09, 4% 436.54, 4% 500.06, 5% 623.8, 6% 1,412.74, 14% 1,832, 18% 2,599.32, 27%
Industrial products, m achinery C puter Softw om are C onsumer R elated M edical Food, food processing O ther electronics T &D el ata C munications om Biotechnology Energy related
Financing By States Investment Maharashtra Tamil Nadu Andhra Pradesh Gujarat Rs million 2,566 1531 1372 1102 12
Karnataka West Bengal Haryana Delhi Uttar Pradesh Madhya Pradesh Kerala Goa Rajasthan Punjab Orissa Dadra & Nagar Haveli Himachal Pradesh Pondicherry Bihar Overseas Total
1046 312 300 294 283 231 135 105 87 84 35 32 28 22 16 413 9994
Ma sta a r h ha r T iNu al a m d Adr Pds nh r eh a a G rt u a j a K nt k aa a r a WtB gl e e a s n Hyn a aa r Di e l h U rPds ta r eh t a Mha r ds a y P eh d a
VENTURE CAPITAL OPERATIONS IN INDIA
The venture capital industry has grown in a narrow and restricted environment where the growth and development has been limited due to the conservative government
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policy. Although its presence on the platform of industrial finance has created new hopes for industrial development and growth. Also why the venture capital industry has not grown can be argued with reference to the following reasons
• Most of the venture capitalist funds are managed by the financial institutions and
banks where the venture capital fund is distinct from the management company. It is the latter that screens, makes and manages individual investments. Except for IDBI and SIDBI who have their own equity funds earmarked for venture capital financing and as such are an exception.
• Venture capital financing is only on the strengths of the business plan of the
venture and the chances of the success depends on various qualified considerations like the fund managers skill and experience in understanding the business plan, the skills of the entrepreneurs promoting the venture etc. Thus unlike a traditional pattern of lending followed by banks and financial institutions where the stress for financing is on the cash flows or collaterals, the venture capitalists don’t have any collateral or existing assets.
• The long term nature of venture capital investments carries a high and
differentiated risk in each stage of enterprise. Investments focus on high returns in the forms of long term capital gains, therefore only serious business proposals with fair amount of probability of success are selected by fund managers, also the procedures for making a investment decisions followed by the fund managers are still a gaurded secret, but generally private placements are made on high growth and high return basis.
Venture capital firms typically source the majority of their funding from large investment institutions such as fund of funds, financial institutions, endowments, pension funds and banks. These institutions typically invest in a venture capital fund for a period of up to ten years.
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To compensate for the long term commitment and lack of both security and liquidity, investment institutions expect to receive very high returns on their investment. Therefore venture capitalists invest in either companies with high growth potential where they are able to exit through either an IPO or a merger/acquisition. Although the venture capitalist may receive some return through dividends, their primary return on investment comes from capital gains when they eventually sell their shares in the company, typically between three to five years after the investment. Venture capitalists are therefore in the business of promoting growth in the companies they invest in and managing the associated risk to protect and enhance their investors' capital.
Stage – wise Investments
VC’s invest funds in either the early stage or later stage development of the enterprise, in certain cases they may provide finance in both the stages. Depending on the uniform practice followed by VCs in India the investment stages has been defined by IVCA as under :
• Seed Stage – Financing is provided to new companies for use in product
development and initial marketing. Companies may be in the process of being set up, or may have been in the nusiness for a short time.
• Start-up – Financing is provided to new companies for manufacturing and
commercializing the product developed. Finance is given for creation of new infrastructure and meeting the working capital requirements.
• Other Early stage – Financing is provided to companies that have completed
commercial-scale implementation and require further funds to meet initial cash loss and further working capital. They may not be generating profits.
• Later Stage – Capital is provided for the growth and expansion of the established company. Funds may be used to finance increase in production capacity, for market or product development etc. Capital provided for managing turnaround situations is also included in this category
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An analysis of financing by investment stages indicates the following figures:
Difference:
With respect to conventional financing, a VC financing differs in the following ways:
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1. Venture Capitalists are risk takers like entrepreneurs. A conventional financier is a risk avoider as protection of funds is a prime responsibility of the financier. 2. Venture Capitalists acquires equity, a share of ownership and with it a share of risk. He does not eliminate risk but manages it through in-depth monitoring, assisting and directing his the company he has invested in through portfolio diversification. He considers himself a partner of the entrepreneur while conventional financier objective is to eliminate risk by loaning money against collateral and ensuring debt repayment capacity. 3. A Venture Capitalist specializes in management services of which finance is a part. It understands the whole scope of business to operations. Conventional specializes in financial services and has nothing to do with management or marketing to clients. 4. A Venture Capitalist has extensive operating experience and provides entrepreneurs full hands on support. Such experience is not required at all in conventional financing. 5. A Venture Capitalist injects an element of vitality and innovation into business community. The conventional financier is not equipped to provide support which new enterprises demand along side investments. A Venture Capitalist encourages entrepreneurial initiatives and innovations, which accelerate business development and the pace of national economic growth. Thus VC tries to fill the gap that exists between traditional financiers and entrepreneurs needs.
Objectives and Activities of Venture capital funds in India:
VCF Objectives Target activities Target enterprises/
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IDBI Venture capital Fund(M arch 1987)
To provide financial assistance for attaining commercial application of indigenous technology or adapting imported technology for wider domestic application.
IFCIs RCTC (January 1988)
To provide risk capital to first generation entrepreneurs for setting up industrial projects. To provide finance for technological development for advancement, promotion, commercialization of technology. To develop and financing of indigenous technology.
To setup pilot plant based on processes developed in laboratories in the country To introduce technological innovation leading to substantial quality upgradation, reduced material consumption, reduced energy consumption, cost reduction. To adapt or modify processes and products to suit Indian conditions. Setting up pilot plants, demonstration scale plants and studies, R&D activities, specialized training, providing quality and market acceptability etc. Sponsoring commercial R&D programmes. Prototype or pilot plant commercialization, funding of grassroots R & D efforts for prototype and product/process development on very selective basis. Activities that involve development through R&D of an innovative product or process which promises tangible benefit to Indian economy. Activities that have significant commercial potential.
entrepreneurs Existing and new units.
TDICI(J anuary1 988)
Applicants with proven track records of innovation and having the requisite technological and managerial strengths. New or established entrepreneurs.
PACT
To accelerate the pace and quality of technological innovations for products having application in industry,agriculture,health,ener gy & other areas beneficial to development process in India.
Canbank venture capital fund(Au gust 1989 ) Gujarat venture
Financial participation in ventures with technological innovations and high-tech content promoting high return to the fund.
Venture financing.
Commercial exploitation of lab proven technologies. Evolution of new process or products. Adaption of imported technology to suit Indian conditions. Technological upgradation. Commercialization of new technologies resulting in
A team of companies one from India and one from US, having access to R&D and manufacturing facilities and demonstrated capability in selling its product. Relatively new ,but not affluent, professionally and technically qualified entrepreneurs. Both new & existing
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finance limited(J uly 1990) Credit Capital Venture Fund(Ja nuary 1990) Indus Venture Capital Fund(19 91) To take advantage of investment opportunities in the area of venture finance & investment in primary markets. To invest in the equity of venture as defined in the government of India’s venture capital guidelines.
lower cost of production. Skill intensive industries utilizing local talent. New product or process based on indigenous or imported technology etc. Thrust areas for investment: ancillary units& small export oriented units.
companies.
All enterprises with good investment potential. Individuals with combination of professional skills, entrepreneurial spirit and integrity in dealings.
Specialty chemicals, healthcare products, electronics and computers and consumer products.
STAGES IN VENTURE FINANCING
Historically VC evolved as a method of early-stage financing, but the notion of VC recognizes different stages of financing. It also includes development, expansion and 19
buyouts financing for those enterprises that are unable to raise funds from the normal financing channels. VC financing also provides turnaround finances to revitalize and revive sick enterprises The different stages of venture financing is as shown below Sr. No. 1. Stage Early stage financing Description • Seed financing for supporting a concept or idea • • • 2. Expansion financing • • • • • R&D financing for product development Start-up capital for initial production and marketing First stage financing for full-scale production and marketing Second stage financing for working capital and initial expansion Development financing for facilitation public issues 3. Acquisition/buyout financing Bridge financing for facilitating public issues Acquisition financing for acquiring another firm for further growth Management buyout financing for enabling operating group to acquire or part of its business • Turnaround financing for turning around a sick unit
Consideration for early stage investments: In the early stage of financing the exposure to risk is greater. The venture capitalist is more careful about ascertaining the credibility of the business plan and looks into the future prospects in terms of risks and rewards. The probability of success or failures is
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50:50 in the early stage. The following points are looked into before venture financing in the early stages: 1. Commercial viability if the project and product life cycle 2. Technical feasibility of the manufacturing process of the product or service, chances of obsolescence of technology 3. Marketability of the product or service, competition at home and overseas 4. Long term potential of the product to stay in the market 5. Management experience, skills and resources Consideration for later stage investments: The later stages of project or enterprise investments involve mezzanine financing, expansion financing, turnaround financing or buy-out financing. All aspects of an enterprise with reference to early stages of financing are scrutinized with an eye on performance and achievements in the early stage of project implementations. There is now enough evidence to judge the quality of management, standard of financial performance, usefulness of technical process marketability of the product and likely competition. The investment strategy for later stage financing is different on account of more safety in investments. There is a shift in the expectation profile of the venture capitalists, from huge capital gains of the early stage to solid income yield in secured investments in the later stage. There must be good generation of funds depicting successful completion of the project to meet its own working capital requirements. These aspects are important considerations in later stage financing.
Categorization of VC Investors:
1. Incubators 2. Angel Investors 3. Venture Capitalists (VCs)
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4. Private Equity Player Incubators: An incubator is a hardcore technocrat who works with an entrepreneur to develop a business idea, and prepares a Company for subsequent rounds of growth & funding. Ventures, Infinity are examples of incubators in India. Angel Investors: An angel is an experienced industry-bred individual with high net worth. Typically, an angel investor would:
• • • • • •
invest only his chosen field of technology take active participation in day-to-day running of the Company invest small sums in the range of USD 1 - 3 million not insist on detailed business plans sanction the investment in up to a month help company for "second round" of funding
Venture Capitalists (VCs): VCs are organizations raising funds from numerous investors & hiring experienced professional mangers to deploy the same. They typically:
• • • • • • •
invest at "second" stage invest over a spectrum over industry have hand-holding "mentor" approach insist on detailed business plans invest into proven ideas/businesses provide "brand" value to investee invest between USD 2 - 5 million
Private Equity Players: They are established investment bankers. Typically:
• • •
invest into proven/established businesses have "financial partners" approach invest between USD 5 -100 million 22
Methods of financing:
The following forms of financing are used by venture capitalists in India: 1. Equity
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The venture capitalist provides capital in the form of equity for the project and acts as coowner with the promoter, sharing profits and losses in the venture. The equity contribution is less than the promoter’s contribution (generally not exceeding 49% of the total capital) so that the promoter can retain effective control and majority ownership of the enterprise. 2. Conventional loans Some venture capitalists provide conventional loans to promoters for a longer period of 10-12 years. The loans are offered at concessional rates of 6% per annum during the initial development period, and then raised to as much as 14% once the project is demonstrated to be commercially viable and successful. In some cases the venture fund may decide to charge a royalty after the project is commercialized. 3. Conditional loans A conditional loan is not repayable like a conventional loan and does not carry interest. The repayment of a conditional loan is linked to the sales or turnover of the company in the form of royalty. The rate of royalty and the schedule payments are decided keeping in view the gestation period and the repayment capacity of the project. In cases of projects which the promoter anticipates a high turnover, he readily opts to pay a high rate of interest (as high as 20% per annum) once the project becomes viable, instead of paying royalty on sales. 4. Income notes It is a hybrid security combining the features of both conventional loans and conditional loans. The promoter has to pay both interest and royalty on sales, but at substantially low rates. IDBI VC fund provides funding equal to 80 – 87.5% of a project’s cost for commercial application of indigenous technology or adapting imported technology to wider domestic application. Funds are made available in the form of unsecured loans at a lower rate of interest during development phase and at a higher rate after development stage. In addition to interest charges, royalty on sales could also be charge. 5. Other instruments A few venture capitalists, particularly in the private sector, have started introducing innovative financial securities. The ‘Participating debenture’ introduced by Twentieth Century Finance Corporation is an example. Such securities carries charges spread over
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three phases. In the start-up phase, before the venture attains operations on a minimum level, no interest is charged. After this, a low rate of interest is charged up to a particular level of operation. Once the venture starts operating on full commercial basis, a high rate of interest is required to be paid. A variation could be in terms of paying a certain share of the post-tax profits instead of royalty.
VENTURE CAPITAL INVESTMENT PROCESS
The venture capital investment activity is a sequential process involving six steps
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1. Setting up a deal 2. Screening 3. Evaluation or due diligence 4. Deal structuring 5. Post-investment activities and 6. Exit plan 1. Setting up a deal A VC business requires a continuous flow of ventures for it to flourish. This steady stream of deals can be obtained from a. Referral schemes: deals referred to by parent organizations, trade partners, industry organizations, friends, etc. b. Active search: Searching through networks, trade fairs, conferences, seminars, foreign visits, etc. c. Intermediaries: Organizations acting as middle-men who match VC firms and potential entrepreneurs. 2. Screening
Venture capital is a service industry, and VCFs generally operate with a small staff. In order to save on time and to select the best ventures, before going for an in-depth analysis, VCFs carry out initial screening of all projects on the basis of some broad criteria. For example, the screening process may limit projects to areas in which the venture capitalist is familiar in terms of technology, or product, or market scope. The size of investment, geographical location and stage of financing could also be used as the broad screening criteria.
3. Evaluation or Due Diligence Once a proposal has passed through initial screening, it is subjected to a detailed evaluation or due diligence process. Most ventures are new and the entrepreneurs may lack operating experience. Hence, a sophisticated, formal evaluation is neither possible nor desirable. The venture capitalists, thus, rely on a subjective, but comprehensive, evaluation. VCFs evaluate the quality of the entrepreneur before appraising the
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characteristics of the product, market or technology. Most venture capitalists ask for a business plan* to make an assessment of the possible risk of and return on the venture. 4. Deal Structuring Once the venture has been evaluated as viable, the venture capitalist and the investee company negotiate the terms of the deal, viz., the amount, form and price of the investment. This process is termed as deal structuring. The agreement also includes the protective covenants and earn-out arrangements. Covenants include the venture capitalist's right to control the investee company and to change its management if needed, buyback arrangements, acquisition, making initial public offerings (IPOs), etc. Venture capitalists generally negotiate deals to ensure protection of their interests. They would like a deal to provide for • • • A return commensurate with the risk Influence over the firm through board membership Minimizing taxes
•Assuring investment liquidity •The right to replace management in case of consistent poor managerial performance, The investee companies would like the deal to be structured in such a way that their interests are protected. They would like to earn reasonable return, minimise taxes, have enough liquidity to operate their business and remain in commanding position of their business. 5. Post-investment Activities Once the deal has been structured and agreement finalized, the venture capitalist generally assumes the role of a partner and collaborator. He also gets involved in shaping of the direction of the venture. This may be done via a formal representation on the board of directors, or informal influence in improving the quality of marketing, finance and other
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managerial functions. If a financial or managerial crisis occurs, the venture capitalist may intervene, and even, install a new management team. 6 Exit A venture capitalist partly owns the company because of his equity investment but is not interested in retaining his ownership. He is interested in converting his ownership into cash at the earliest possible opportunity when he receives a higher return on his investments. Such realization is called as exit. The schedule of time and the route for exit is known as ‘exit strategy’. The objective of the VC investment is to help the promoter establish his company after which it is not necessary for the VC money to remain invested there. The holding is therefore liquidated so that it can be reinvested in other profit bearing opportunities. The price that the investment can fetch will depend on the value of the company, which in turn depends on the stage of development of the company. In order to get a good price a venture capitalist will refrain from selling his stake in a short time frame if he foresees that the worth of the enterprise is likely to increase. The exit methods that are commonly used are: a. Initial Public Offering [IPO] b. Buy back by promoters c. Sale of the enterprise to another company d. Sale to new investors e. Self liquidating process f. Liquidation of the company
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SELECTING THE VC INVESTOR
The members of the Indian Venture Capital Association comprise a number of venture capital firms in India. The IVCA Directory of Members provides basic information about each member's investment preferences and is available from the Association. Prior to selecting a venture capitalist, the entrepreneur should study the particular investment preferences set down by the venture capital firm. Often venture capitalists have preferences for particular stages of investment, amount of investment, industry sectors, and geographical location. An investment in an private, unlisted company has a long-term horizon, typically 4-6 years. It is important to select venture capitalists with whom it is possible to have a good working relationship. Often businesses do not meet their cash-flow forecasts and require additional funds, so an investor's ability to invest in additional financing rounds if required is also important. Finally, when choosing a venture capitalist, the entrepreneur should consider not just the amount and terms of investments, but also the additional value that the venture capitalist can bring to the company. These skills may include industry knowledge, fund raising, financial and strategic planning, recruitment of key personnel, mergers and acquisitions, and access to international markets and technology. Entrepreneurs should not hesitate to ask for references from investors. What do venture capital look for? Venture capitalists are higher risk investors and, in accepting these risks, they desire a higher return on their investment. The venture capitalist manages the risk/reward ratio by only investing in businesses which fit their investment criteria and after having completed extensive due diligence.
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Venture capitalists have differing operating approaches. These differences may relate to location of the business, the size of the investment, the stage of the company, industry specialization, structure of the investment and involvement of the venture capitalists in the companies activities. The entrepreneur should not be discouraged if one venture capitalist does not wish to proceed with an investment in the company. The rejection may not be a reflection of the quality of the business, but rather a matter of the business not fitting with the venture capitalist's particular investment criteria. Often entrepreneurs may want to ask the venture capitalist for other firms that might be interested in the investment opportunity. Venture capital is not suitable for all businesses, as a venture capitalist typically seeks: Superior Businesses Venture capitalists look for companies with superior products or services targeted at large, fast growing or untapped markets with a defensible strategic position such as intellectual property or patents. Quality and Depth of Management Venture capitalists must be confident that the firm has the quality and depth in the management team to achieve its aspirations. Venture capitalists seldom seek managerial control, rather they want to add value to the investment where they have particular skills including fund raising, mergers and acquisitions, international marketing, product development, and networks. Appropriate Investment Structure As well as the requirement of being an attractive business opportunity, the venture capitalist will also seek to structure a deal to produce the anticipated financial returns to investors. This includes making an investment at a reasonable price per share (valuation).
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Exit Opportunity Lastly, venture capitalists look for the clear exit opportunity for their investment such as public listing or a third party acquisition of the investee company.
Once a short list of appropriate venture capitalists has been selected, the entrepreneur can proceed to identify which investors match their funding requirements. At this point, the entrepreneur should contact the venture capital firm and identify an investment manager as an initial contact point. The venture capital firm will ask prospective investee companies for information concerning the product or service, the market analysis, how the company operates, the investment required and how it is to be used, financial projections, and importantly questions about the management team.
In reality, all of the above questions should be answered in the Business Plan. Assuming the venture capitalist expresses interest in the investment opportunity, a good business plan is a pre-requisite. The Business plan: Venture capitalists view hundreds of business plans every year. The business plan must therefore convince the venture capitalist that the company and the management team have the ability to achieve the goals of the company within the specified time. The business plan should explain the nature of the company’s business, what it wants to achieve and how it is going to do it. The company’s management should prepare the plan and they should set challenging but achievable goals.
The length of the business plan depends on the particular circumstances but, as a general rule, it should be no longer than 25-30 pages. It is important to use plain English, especially if you are explaining technical details. Aim the business plan at nonspecialists, emphasising its financial viability. Avoid jargon and general position statements.
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Essential areas to cover in your business plan: Executive Summary This is the most important section and is often best written last. It summarizes your business plan and is placed at the front of the document. It is vital to give this summary significant thought and time, as it may well determine the amount of consideration the venture capital investor will give to your detailed proposal. It should be clearly written and powerfully persuasive, yet balance "sales talk" with realism in order to be convincing. It should be limited to no more than two pages and include the key elements of the business plan. 1. Background on the company Provide a summary of the fundamental nature of the company and its activities, a brief history of the company and an outline of the company’s objectives. 2. The product or service Explain the company's product or service. This is especially important if the product or service is technically orientated. A non-specialist must be able to understand the plan. • • Emphasise the product or service's competitive edge or unique selling point. Describe the stage of development of the product or service (seed, early stage,
expansion). Is there an opportunity to develop a second-generation product in due course? Is the product or service vulnerable to technological redundancy? • If relevant, explain what legal protection you have on the product, such as patents attained, pending or required. Assess the impact of legal protection on the marketability of the product.
3. Market analysis The entrepreneur needs to convince the venture capital firm that there is a real commercial opportunity for the business and its products and services.
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•
Define your market and explain in what industry sector your company operates. What is the size of the whole market? What are the prospects for this market? How developed is the market as a whole, i.e. developing, growing, mature, declining?
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How does your company fit within this market? Who are your competitors? For what proportion of the market do they account? What is their strategic positioning? What are their strengths and weaknesses? What are the barriers to new entrants?
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Describe the distribution channels. Who are your customers? How many are there? What is their value to the company now? Comment on the price sensitivity of the market.
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Explain the historic problems faced by the business and its products or services in the market. Have these problems been overcome, and if so, how? Address the current issues, concerns and risks affecting your business and the industry in which it operates. What are your projections for the company and the market? Assess future potential problems and how they will be tackled, minimised or avoided.
4. Marketing Having defined the relevant market and its opportunities, it is necessary to address how the prospective business will exploit these opportunities.
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Outline your sales and distribution strategy. What is your planned sales force?
What are your strategies for different markets? What distribution channels are you planning to use and how do these compare with your competitors? Identify overseas market access issues and how these will be resolved.
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What is your pricing strategy? How does this compare with your competitors? What are your advertising, public relations and promotion plans?
•
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5. The management team Demonstrate that the company has the quality of management to be able to turn the business plan into reality.
•
The senior management team ideally should be experienced in complementary areas, such as management strategy, finance and marketing, and their roles should be specified. The special abilities each member brings to the venture should be explained. A concise curriculum vitae should be included for each team member, highlighting the individual’s previous track record in running, or being involved with, successful businesses.
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Identify the current and potential skills gaps and explain how you aim to fill them. Venture capital firms will sometimes assist in locating experienced managers where an important post is unfilled - provided they are convinced about the other aspects of your plan.
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List your advisors and board members. Include an organization chart.
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6. Financial projections The following should be considered in the financial aspect to your business plan: 1. Realistically assess sales, costs (both fixed and variable), cash flow and working capital. Produce a profit and loss statement and balance sheet. Ensure these are easy to update and adjust. 2. 3. 4. Explain the research undertaken to support these assumptions. What are your budgets for each area of your company's activities Keep the plan feasible. Avoid being overly optimistic. Highlight challenges and show how they will be met.
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Relevant historical financial performance should also be presented. The company’s historical projections. 7. Amount and use of finance required and exit opportunities State how much finance is required by your business and from what sources and explain the purpose for which it will be applied. Consider how the venture capital investors will exit the investment and make a return. Possible exit strategies for the investors may include floating the company on a stock exchange or selling the company to a trade buyer. achievements can help give meaning, context and credibility to future
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LEGAL & REGULATORY ISSUES IN INDIA
The legal framework within which venture capital companies operate comprises the erstwhile government guidelines 1988, repealed in 1995 to give way to SEBI regulations which have since been enforced.At present the regulatory framework comprises the following: Central government guidelines, SEBI regulations, Self regulatory body of venture capital companies and funds better known as Indian Venture Capital Association (IVCA). However to regulate business transactions of VCs the provisions of Indian Contract Act 1872, Companies Act 1956, SEBI Act 1992, Securities Contract Act 1956 etc are applicable just like any other Investment company. SEBI Regulations The SEBI is empowered to register and regulate the working of venture capital funds. This powers where given very recently in 1995 under the Securities Law Amendment Act. Since then SEBI has formulated regulations known as Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996. A venture capital fund means a fund established in the form of a trust or a company including a body corporate and registered under these regulations which• • • Has a dedicated pool of capital, Raised in a manner specified in the regulations, and Invests in venture capital undertaking in accordance with the regulations.
Venture capital undertaking means a domestic company :– • • Whose shares are not listed on a recognized stock exchange in India; 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
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are specified in the negative list by the Board with the approval of the central Government by notification in the Official Gazette in this behalf. 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 consultation with Government of India from time to time."
Application for grant of certificate
Any company or trust or body corporate proposing to carry on any activity as a venture capital fund must 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 be accompanied by a non-refundable application fee of Rs 25,000/payable by 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 :A.If the application is made by a company 1. The main object of the company as per its Memorandum of Association must be the 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 anytime convicted for an offense involving moral turpitude or any 37
economic offense and is a fit and proper person to act as director or principal officer or employee of the company. B. If the application is made by a trust 1. The instrument of trust (Trust Deed) 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 trustees have not at anytime being convicted of an offense involving moral turpitude or any economic offense 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.
Furnishing of information and clarification at the time of application
SEBI may require the applicant to furnish such further information as it considers necessary for processing the application. An application, which is not complete in all respects, shall be rejected by SEBI. However, before rejecting any application, the applicant will be given an opportunity to make representation before SEBI and to remove any defect in the application within 30 days of the date of receipt of communication from SEBI regarding the defect. SEBI may extend the period of 30 days for upto another 90 days on being satisfied that it is necessary and is equitable to do so. Procedure for grant of certificate If SEBI is satisfied that the applicant is eligible for grant of certificate, it shall send intimation to the applicant of its eligibility. On receipt of intimation, the applicant must pay to SEBI, registration fee of Rs 500,000 and on the receipt of such fees, SEBI will grant a certificate of registration. 38
Conditions of certificate The certificate granted shall be subject to the following conditions 1. The venture capital fund shall abide by the provisions of the SEBI Act and these regulations. 2. The venture capital fund shall not carry on any other activity other than that of a venture capital fund. 3. The venture capital fund shall inform SEBI in writing of any information or details previously submitted to SEBI which have changed after grant of the certificate. 4. If the information or details submitted are found to be false or are misleading in any particular manner, suitable action can be taken. All investment made or to be made by a venture capital fund shall be subject to the following conditions, namely:a. Venture capital fund shall disclose the investment strategy at the time of application for registration; b.Venture capital fund shall not invest more than 25% corpus of the fund in one venture capital undertaking; c.Shall not invest in the associated companies; and d.Venture capital fund shall make investment in the venture capital undertaking as enumerated below: I. At least 75% of the investible funds shall be invested in unlisted equity shares or equity linked instruments. However, if the venture capital fund seeks to avail benefits under the relevant provisions of the Income Tax Act applicable to a venture capital fund, it shall be required to disinvest from such investments within a period of one year from the date on which the shares of the venture capital undertaking are listed in a recognized Stock Exchange. II. Not more than 25% of the investible funds may be invested by way of: a. Subscription to initial public offer of a venture capital undertaking whose shares are proposed to be listed subject to lock-in period of one year; b.Debt or debt instrument of a venture capital undertaking in which the venture capital fund has already made an investment by way of equity.
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General obligations and responsibilities No venture capital fund shall issue any documents or advertisement inviting offers from the public for the subscription of the purchase of any of its securities or units. Maintenance of books and records 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 within the time specified by days to SEBI. Inspection and Investigation SEBI may appoint one or more person, upon receipt of information or complaint, as inspecting or investigating officer for inspection or investigation of the books of accounts, 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 by the venture capital fund in the manner specified in these regulations. 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 the affairs of the venture capital fund in the interest of the securities market and the interest of investors.
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LIMITATIONS OF VENTURE CAPITAL IN INDIA
1. Lack of prioritization of thrust areas: VCFs in India have not prioritized high tech thrust areas for venture financing. The prioritization of thrust areas may facilitate development of technological Specialiality and expertise by VCFs. 2. Lack of regional focus: VCFs even the state level institution lack regional focus. A regional focus could lead to concentrated efforts and specialization and could in the taking of full advantages of the regional benefits. 3. Lack of full rage financing: All funds offer funding for early stage activities viz. seed capital and start up financing. However all start up companies do not get venture capital because of the perceived high risk. Similarly financing for expansion and rehabilitation of sick units is lacking in spite of the concessions available under the government guidelines. 4. Lack of focus on entrepreneurial development: The focus of VCFs in India is on technology financing and rightly so, for making Indian industry globally competitive. But given the needs of India in terms of high production and productivity and employment, VCFs should adopt a broader approach on financing and supporting novel ideas of entrepreneurs, which may not necessarily be high-tech in nature. 5. Limitations on structuring of VC funds: VCFs in India are structured in the form of a company or trust fund and are required to follow a three tier mechanisminvestors, trustee company and Asset Management Company [AMC]. A proper tax efficient vehicle in the form of limited liability partnership act, which is popular in USA, is not made applicable for structuring of VCFs in India. In this form of structuring, investors’ liability towards the fund is limited to the extent of his contribution in the fund and also formalities in structuring of fund are simpler.
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Limitations on industry segments: In sharp contrast to other countries where telecom, services and software bag the largest share of VC investments, in India other conventional sectors dominate venture finance. Opening up of restrictions, in recent time, on investing in the services sectors such as telecommunication and related services, project consultancy, design and testing services, tourism etc. would increase the domain and growth possibilities of VC. Anomaly between SEBI regulations and CBDT rules: CBDT tax rules recognize investment in financially week companies only in case of unlisted companies as venture investment whereas SEBI regulations recognize investment in financially week companies as venture investment irrespective of their listing status. If investment in financially weak companies offers an attractive opportunity to VCFs the same may be allowed by CBDT for availing of tax exemptions on capital gains at a later stage. Also SEBI regulations do not restrict size of an investment in a company. However, as per income tax rules, maximum investment in a company is restricted to less than 20% of the raised corpus of VCF and paid up share capital in case of VC Company. Further, investment in company is also restricted upto 40% of equity of Investee Company. 8. Returns, Taxes and Regulations: There is a multiplicity of regulators like SEBI and RBI. Domestic venture funds are set up under the Indian Trusts Act of 1882 as per SEBI guidelines, while offshore funds routed through Mauritius follow RBI guidelines. Abroad, such funds are made under the Limited Partnership Act, which brings advantages in terms of taxation. The government must allow pension funds and insurance companies to invest in venture capitals as in USA where corporate contributions to venture funds are large.
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PROJECT EVALUATION: A CASE STUDY
How do venture capitalists evaluate a project in practice? This is the case of Electro vision Limited to illustrate the process of venture evaluation by VCFs in India.
CASE HISTORY The venture, Electrovision Ltd., was in the joint sector and the product, microwave ovens, was, at that point of time, neither manufactured nor marketed in India. The venture was to be jointly promoted by the Himalaya Rashtra State Electronics Development Corporation (HRSEDC) and Mr G. Of the total equity of Rs 8.8 million, the promoters had approached Delta Venture Capital Ltd., for equity assistance of Rs 3.2 million (i.e. 35.68%). Electrovision Ltd. had been incorporated in April 1988, and it was granted venture capital funding by Delta a year later, i.e. in April 1989. The project was located in a category "C" district of Himalaya Rashtra.The Board of Directors of Delta Venture Capital Ltd., prior to their final approval of the project, considered the following points. Promoters' Background With regard to HRSEDC, the joint promoter, the following factors were examined:
•
•
Their previous experience in the field of electronic appliances, consumer durables and high-tech
products in general. Their experience with joint ventures and collaborations. HRSEDC had been manufacturing and marketing a range of black and white TV sets since November 1986. They had set up a joint venture for the manufacture of heavy duty electronic printers, photo facsimile equipment, and minicomputer modules etc. They had also formed a
joint venture for manufacturing aluminium electrolytic capacitors, and had collaboration with Fujitsu Ltd. and Fukazawa Electronic Co. Ltd. for manufacture of fibre optic communication systems.
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With regard to Mr G, his age, educational and business background, his experience in the field of kitchen appliances, and details of firms in which he had Interests, were examined. Mr G was 35 years old and had degrees in engineering and management to his credit. He had 12 years of business experience and had been associated with a well-known brand of kitchen equipment firm for eight years. Electrovision Ltd. had a seven-member board of directors. The chairman and two directors represented HRSEDC; Mr G was the managing director while two of the other three directors were professors at I IT’S Technology of the Product Microwave ovens were introduced in developed countries in the 1960s and their technology was well established. Electrovision wanted to pioneer this product in India. The critical element of such an oven is a magnetron that emits microwaves having a frequency of 2450 MHz, and Electrovision planned to import it from Toshiba, Japan. An expert group constituted by the Department of Science and Technology (DST), Government of India, had concluded that with regard to the other components the technology had been developed indigenously utilizing resources and expertise available in Electrovision and that it was suitable for commercial production. The technical advisor to Delta had opined that the project had a good chance of success contingent on achieving reliable quality and efficient after-sales service and, being the first to introduce the product in the Indian market. He also drew special attention to the need for controlling the microwave leakage which could be hazardous to human health. The Government of India Committee, however, had tested a prototype of the Electrovision oven and had found the emissions to be within the permissible limits. Project Cost The total cost of the project was estimated at Rs 28.3 million, of which imported plant and machinery accounted for a little over Rs 2.4 million. MarketProjections In 1988, Electrovision had commissioned a well-known research organisation to conduct an exploratory study on the demand for microwave ovens in the country.
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The findings were purely qualitative in nature. Subsequently in December 1988, they engaged yet another marketing research organisation to do a sample study of 300 housewives each, in Bombay and Bangalore. The study arrived at a figure of 31,500 pieces as the annual potential demand in the top 12 cities/towns of India. Three of these (Bombay, Delhi and Bangalore) were classified as "A" class markets and the other nine as "B" class. The assumption was that in the "A" class of markets 5 per cent of those households with a monthly income exceeding Rs 3,000 would be potential buyers of microwave ovens. The corresponding adoption rate for market "B" class markets was would taken as 3 per cent. expand. Electrovision also hoped that with the entry of competitors in due course the potential They had also contacted the Indian Railways to seek potential orders for microwave ovens for their catering service and hoped to make an entry into other institutional markets apart from the household sector assessed above.
ProfitabilityEstimates Based on sales estimates of 8,000, 15,000, 19,500 and 24,000 pieces respectively in the first four years, Electrovision had made projections of their financial performance. Year Cash profit (Rs 000) Net worth* (R.s 000) EPS (Rs) Book value per share (R,s) Exit Routes Delta Venture Capital Ltd. considered two routes of disinvestment. The first was sale in the proposed OTC market. Using the existing CCI guidelines for pricing a new issue (viz. average of cumulative average of the EPS, till the date of proposed issue capitalized at 12 per cent and book value per share on the date of proposed Some relevant I II indicators III IV are provided below:
13.71 59.83 68.77 69.99 95.10 133.32 176.08 206.66 0.00 4.34 5.36 4.48 10.81 15.35 20.01 23.48
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issue), the exit price at the end of each of the first 4 years would be Rs 5.40, Rs 16.62, Rs 23.48 and Rs 31.43 respectively. It was granted that the OTC market could initially be characterized by lower P/E ratios than the stock exchanges. Delta Venture Capital Ltd. considered, in particular, disinvestment at the end of the third year. Under Five different scenarios (comprising five different disinvestment prices each less than the book value Rs ' (23.48 obtained above), the annualized yields were Computed as given below: Disinvestment Price (Rs) 16 17 18 19 20 Net yield per annum (%) 18.97 21.40 23.74 25.99 28.16
In the event of an exit price of Rs 23.48 (calculated as per the CCI guidelines), the annual yield would be 32.91 per cent. The second exit route was buy-back by the private sector promoter. Delta Venture Capital Ltd. considered executing an agreement jointly with Mr G, his uncle, father and mother, whereby they would repurchase the equity holdings in three convenient lots at the end of the third, fourth and fifth years. They called for details to be furnished regarding the net worth of the latter at the time of the appraisal. Viability of the Project Delta Venture Capital Ltd. felt that the project would qualify for venture capital assistance because the technology had been developed indigenously for the first time in India, and the project was an appropriate case of R&D work being commercialized. Thus, Delta Venture Capital Ltd. approved financing in the form of direct subscription to 314,000 equity shares of Rs 10 each. ANALYSIS OF THE CASE
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Venture capital assistance essentially involves investment in ventures which are considered too risky to be eligible for conventional sources of finance. This high risk may arise from market, product, technology, or entrepreneurial reasons. Market Potential and Risk Market risk is derived as a consequence of several factors, significant among which are indifferent response from buyers in terms of poor acceptance (which may result from incorrect assessment of the need for the product), unexpected competition (which may step in if the idea appeals to many entrepreneurs as being commercially lucrative), inadequate support from the trade channels or intermediaries (who may not be equally enthusiastic about the idea) and so on. Imported microwave ovens were already in use in India. Electrovision had commissioned two market research surveys and the second survey had arrived at a reasonable demand estimate of 31,500 per year from the household sector alone even prior to advertising and sales promotion or market development efforts. Electrovision hoped to make a dent in the institutional market as well by being the first to introduce this product and by capitalizing on the Government customers using the HRSEDC contacts. The prior experience of Mr G and HRSEDC in the field of kitchen appliances and other consumer durables that they would be somewhat familiar with the network of dealers through whom the oven would be marketed.Further, a favourable outcome could be expected from the entry of competitors: they would be sharing the costs of initial market development and creating awareness about the suitability of microwave ovens to the Indian style of cooking. Thus this component of risk was not excessively overwhelming. Product Quality and Risk: Product risk is generally inherent in products/processes when they are based on untried new ideas. Ventures based on entirely new ideas or concepts can fail when they go into production on a commercial scale although the product development at the R&D stage may have been proper. In case of Electrovision, the prototype, apart from the magnetron, was developed by HRSEDC and Mr G with technical assistance of the IITs. They had also developed the "manufacturing technology" for assembling the ovens on a commercial scale. They planned to phase their production-over the first
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four years gradually increasing the utilization of capacity (8,000 pieces in the first year and 15,000, 19,500 and 24,000 pieces thereafter). The microwave leak had been tested and other safety features incorporated into the design of the ovens. All this had already been done by Electrovision to take care of the product risk.
Technological Capability and Risk: Technological risk may arise when the technology is perhaps too complex to fructify. The technology involved may be entirely new at least to the country in question and hence may not be attuned to the specific requirements of the local environment. The technology for microwave ovens was well established in the West where they had been in the market for nearly three decades. The most critical element, i.e. the magnetron, was perhaps the only one where technical capability of Electrovision was wanting but here again there was no real risk since the company proposed to import it from one of the most reputed Japanese manufacturers. The Board of Directors of Electrovision included technologists from IITs and HRSEDC. The technology for the components other than the magnetron developed indigenously by Electrovision had already been endorsed by an expert group of the DST. Entrepreneurial Skills and Risk : Entrepreneurial risk arises because ventures are usually small or medium-sized and their promoters are not likely to have adequate personal financial resources or any demonstrated managerial experience or calibre. In many cases, the aspirants are first generation entrepreneurs who have an innovative technical idea but no prior business expertise. The credentials of HRSEDC in the field of consumer durables and hi-tech products as well as their experience with joint ventures and collaborations was established. Mr G's educational and business background and his experience in the field of kitchen appliances were also adequate. Thus this risk also was low. The analysis indicates that the project was a medium- to high-risk category venture. Since it was not a conventionally used and traditionally familiar product in India, it was considered to be fit for venture financing and not for conventional financing.
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CASE STUDY
VENTURE CAPITAL DEVELOPMENT AT CANFINA-VCF As already explained, venture capital in India was started in 1985-86. Financial institutions like IDBI, ICICI, and IFCI were the first to enter the venture capital business. They were followed by the nationalized banks such as the State Bank of India. Canara Bank entered the venture capital business in 1989, through its subsidiary— Can Financial Services Ltd. Canfina-VCF is a relatively smaller player in the venture capital industry as compared to TDICI or IDBI-VCF. Initial Efforts and Context In 1985, the Chairman of Canara Bank initiated the idea of venture capital. The Bank has been quite active in financing small- and medium-size firms, and it had quite a few technical entrepreneurs in its portfolio. Thus, there existed a context for trying out venture capital and culturally, the bank was geared to take up this activity. Mr Venkatdas was made responsible, as chief executive, for Canara Bank's venture capital business. He is a mechanical engineer and joined the bank with 5-6 years experience as a technical field officer. He has been associated with the credit administration of small- and medium-size business in the bank (SSIs). He was instrumental in bringing the World Bank's industrial export-credit project to Canara Bank. He presented the scheme on behalf of the Bank to the World Bank. Thus, Can Bank established good rapport with the World Bank. It was at this time that Can Bank came to know about the World Bank's Technological Development Fund. In 1988-89, when the World Bank was appraising Can Bank's industrial export-credit project, that the earlier idea of venture financing started taking shape. Canara Bank at the same time floated a subsidiary company, Can Financial Services Ltd. (Canfina), to further the growth and 49
profitability of the bank. The Bank was interacting with the World Bank for a line of credit under their industry-technology development policy (ITP). Canara Bank was able to negotiate a US$ 5.25 million line of credit with them.
The venture capital concept of Canara Bank shaped up according to the World Bank's thinking. Since Canara Bank had Canfina, it was thought that it could manage the Fund. It created a trust, and made Canfina the trustee and manager of the Fund under the Indian Trust Act. In October 1989, the Canfina venture capital (Canfina-VCF) was born. It was started with an initial corpus of Rs 30 million given by Canara Bank plus Rs 1 million given by Canfina—the managers of the Fund. Then Canara Bank deputed executives from Canfina to the venture fund. The venture capital activities slowly got started. Meanwhile, Canara Bank also got US$ 5.25 million from the World Bank to be invested in venture capital activity. In fact, the fund was to flow from the World Bank to the Government to IDBI to Canara Bank, and finally to Canfina-VCF. Early Phase The first six ventures were to be evaluated and approved by the World Bank. It started progressing slowly but steadily. Canfina-VCF formulated operating guidelines for the Fund as well as for the managers, which then became the investment policy aligned to the government guidelines. Canfina-VCF was required to get permission from the RBI, the Ministry of Finance, the CCI, and the Department of Economic Affairs to enable the fund listed as a venture capital fund. Canfina-VCF's investment policy is directed by the guidelines. Presently, it is investing 25 per cent of funds in non-ventures. Canf'ina-VCF now receives ten to fifteen deals each month. Most deals come on their own. When Canfina VCF was learning the game, its rejection rate was about 60 per cent. Today, the rejection rate has gone up to around 90 per cent. Canfina VCF has now learnt which project to accept and which to reject. It has become wiser through experience. In the initial phase there was a tendency to look at the project per se, rather than the project's growth path and the management capability and competence of the managing team. Today, Canfina VCF is dealing with "company" and not the "project". But it does look into the project cost and equity requirement. 50
Canfina-VCF does not want to invest 49 per cent in equity alone. Some companies' equity requirements may be more than 49 per cent because promoters are- unable to bring insufficient equity. Canfina-VCF also lends in a "package" but when there are other people ready to lend to the enterprise, it generally takes only the equity position. It has both conditional loans and income notes (IN) as the venture capital finance instruments. INs are meant typically for second-stage.For example, an entrepreneur might have started by using his own capital and may not have a problem in terms of cash flow but he needs to grow faster using some technological upgradation. He would obviously need money. He may have diversification plans as well, but basically through value addition using technological development. Canfina-VCF would give him a loan with an initial low interest rate—may be no interest at all during the first year and 10 per cent p.a. afterwards. He also needs to pay a percentage royalty on sales. Royalty is like a reward for equity. What Canfina-VCF is looking for is a total IRR. This Instrument is also helpful in financing an entrepreneur's working capital requirement as he may not be able to obtain funds from a bank. Thus, in the case of Canfina-VCF, it can be concluded that in financing entrepreneurs’’ it looks at equity or equity-leading routes of financing. Performance Experience By and large, Canfina-VCF has had mixed experience in its venture capital business so far. Of course it is too early to say whether or not it has succeeded. It is still in an investment mode. Although it started in 1989, it considers 1990-91 as the first active year for this new business. Some assisted projects have posed problems which made canfina-VCF more conscious, especially during 1992-93. Canfina-VCF's minimum level of investment has been Rs 1 million; but nowadays, it is looking for a minimum investment of Rs 3-4 million. Processing charges are still unchanged. It has invested in a number of technology-based enterprises. It considers technology as the leading factor for its investment decision.
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Canfina-VCF's most successful case is that of a blue chip company where it invested Rs 0.15 million and provided conditional loan of Rs 2.5 million. After two bonuses, CanfinaVCF's equity investment has become Rs 0.75 million in two years. The company will go public shortly, may be with Rs 80 share value. Canfina-VCF's investment has increased 56 times in three years. It was bargaining for an initial equity of Rs 0.75 million, but the investee company did not give in since the promoters knew that it will perform well. Mr Venkatdas feels that the entrepreneurs know they are going to succeed, and hence do not want to part with the equity and want to hold on. Tax is a bothersome thing for CanfinaVCF. For example, TDICI does not pay any tax. In fact, Canfina-VCF's chief thinks that in venture capital there is no tax exemption at all. All those funds coming from the Unit Trust of India (UTI) can get tax exemptions but not those which do not have access to UTI funds. Regional Focus and Co-financing All companies asking to be financed by Canfina-VCF have to have technology. CanfinaVCF would like to concentrate on South India. All its investments are in Bangalore, Hyderabad and Madras. It has started an experiment in co-financing with Gujarat Venture Capital Co. Canfina-VCF as the lead financier, has co-financed one unit in Gujarat. Cofinancing needs perfect understanding of each others' culture, thinking, etc. by the two or more parties. Unfortunately, there are differences in the venture capital focus and this stands in the way of co-financing. The focus must be on technology. Once there is an agreement on the venture capital focus, there can be many possibilities of co-financing. Customerisation There are certain areas where the technology is imported which Canfina-VCF supports, provided there is good potential of customerisation of the product within India. Basically, it supports the financial effort needed to bring the product to the Indian market, adapting it to make it suitable to the Indian context, through the knowledge of the entrepreneurs. Canfina-VCF also assists in creating markets abroad. For example, Electrosonic Instruments a firm assisted by Canfina-VCF, Caters to the domestic market. It is newly developed in the country and has established itself domestically, Canfina-VCF
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saw its potential in the international market, and gave the company money to go abroad. The firm has tremendous market potential.
Evaluating Entrepreneurs Canfina-VCF gathers information about the entrepreneurs from various sources. It tries to ascertain the commitment of the entrepreneur through interaction with people known to him. It insists on an effective team. Canfina-VCF avoids one-man show as well as adamant, rigid, inflexible entrepreneurs. It also avoids those people who show great enthusiasm to go public immediately after venture financing. They may be intending to make quick money from the investors. It checks out long-term commitment of the entrepreneur and his contribution in terms of critical areas of management. Also, it tries to know how the entrepreneurs are going to divide their authority and responsibility later on. They have to identify one of them as the leader.
Technical skills are good, but promoters must have appreciation for management requirements and skills. According to Mr. Venkatdas, if a man is endowed with both Lakshmi (money) and Saraswati (knowledge), he would be Successful. He feels that an entrepreneur should be accommodating and have commercial orientation. If he is simply obsessed with technology, without concern for the commercial aspect of his enterprise, he may not succeed. He should be capable of looking at commercial options. He must be a strategist as well. A number of entrepreneurs do not know the kind (and extent) of risk they are taking. During appraisal, Canfina-VCF executives know they are able to ascertain what risks the entrepreneurs are taking. Some of the entrepreneurs do know the extent of these risks. They know all the situations that may arise but are not able to develop a good business plan. For example, a mechanical engineer approached Canfina-VCF with the concept of an auto-rikshaw. His design was good and Comfortable from the user's point of view but he was not aware of the risk he was taking. He did not know anything about marketing, 53
operating conditions, production, etc. He did not know anything about the environment. His product was good but Canfina-VCF could not finance him because he did not know his market and the business. Canfina-VCF likes entrepreneurs to be ambitious, but they should also be pragmatic. An ambitious person knows his target but Canfina-VCF makes its own analysis. Canfina-VCF acts quite fast once a proposal is received and if the proposal is to be rejected, the promoter is informed within 15 days. If it has initial interest in the venture, it conducts a detailed analysis. It wants a simple plan but people do come to Canfina-VCF with ideas but without plans. Canfina-VCF executives discuss their Ideas with them, and indicate whether they would be interested. They have teamed by experience. Today their executives can pick, and choose ventures. Canfina VCF avoids those ventures which may not have growth potential or are expected to face problem s. Participation in Management Canfina VCF participates in the management of companies. Its executives attend business committee meetings; they always conduct these meetings as a marketing audit, not merely for finance. The business environment is quite dynamic and so are the strategies; therefore, one cannot procrastinate for 10 years and still continue working. Canfina-VCFs scan the environment continuously. In the meetings, Canfina-VCF executives discuss product-mix options. They also participate in board meetings. In some companies, they are on the board of directors while in others they are just observers. After some time, the executives are able to know which companies in the portfolio will be able to produce good results. The executives optimize their time and efforts in those companies which are expected to grow fast. They have their usual follow-up and monitoring, and they talk to the entrepreneurs. They act as entrepreneurs themselves. They keep themselves informed of the environmental changes and advise the clients accordingly. The entrepreneurs are not always able to know the rapid changes in the environment. Thus, one of the tasks of Canfina-VCF executives is to keep the entrepreneurs abreast of the environmental changes and discuss the financial implications. They have to condition themselves to ultimately go to the OTC market. Canfina-VCF has been educating the company, how it will not lose control even if it goes public. To exit is a real problem in India. If a company has a good book value, the problem is to convert it into market value and still exit. Another problem is 54
the locking period for the venture capital companies. For example, if a VCF has stayed with the company for 3-4 years, nurtured it and brought it to a profitable level, why should it be required to hold on to the investment in the company? In the USA, all bio-tech companies go the venture capital route when the technology is developed, and when it takes some shape, they go the IPO route and venture capital firms exit. They do not carry on; they recycle their funds.
Venture capital companies today need to have a different breed of people, feels the chief of Canfina-VCF. According to him, they should be entrepreneurs; they should be given salaries and incentives and groomed properly and should be seen as partners. In the USA, they direct their best efforts to make the enterprises successful. They get management fees and share in the profit. Interest and commitment to the project have to be generated through incentives but since stock options are not allowed in India, employees in VCFs should be given share in the profit. The investment needs nurturing and development over a period of time.
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IMPACT OF BUDGET ON VENTURE CAPITAL
Budget Proposal Four services brought under service tax net namely, asset management service provided under ULIP, services provided by stock/commodity exchanges and clearing houses; right to use goods, in cases where VAT is not payable; and customized software, to bring it on par with packaged software and other IT services. Impact Above four services, being brought in the service tax net, will become expensive and may affect the returns on investment made by VC in above sectors. Budget Proposal Income Tax Act to be amended to provide that reverse mortgage would not amount to "transfer"; and the stream of revenue received by the senior citizen would not be "income". Impact Reverse mortgage is new thing to India and is expected to catch up very fast. With the above proposal, financial sector may see boom in reverse mortgage business. VC may look positively at this sector for investments. Budget Proposal Parent company allowed to set off the dividend received from its subsidiary company against dividend distributed by the parent company; provided that the dividend received has suffered DDT and the parent company is not a subsidiary of another company. Impact Relief in Dividend Distribution Tax (DDT) may increase the returns on investment of VC who have invested in companies as mentioned above.
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Budget Proposal Insert a new sub-section (11C) in Section 80-IB to grant a five year tax holiday to hospitals located in any place outside the urban agglomerations especially in tier2 and tier-3 towns; this window will be open for the period April 1, 2008 to March31, 2013. Impact VC may look at investment opportunities in above specified hospitals and expect good returns on their investments. They can plan their entry and exits accordingly. Budget Proposal Five year holiday from income tax being granted to two, three or four star hotels established in specified districts having UNESCO-declared 'World Heritage Sites'; the hotel should be constructed and start functioning during the period April 1, 2008 to March 31, 2013. Impact VC may look at investment opportunities in above specified hotels and expect good returns on their investments. They can plan their entry and exits accordingly. Budget Proposal Rate of tax on short term capital gains under Section 111A & Section 115AD increased to 15 per cent. Impact Though generally VC does not look at Short Term Capital Gains, However, if some VC holding listed securities, want to exit in short term (may be because share market is not doing well) then they have to pay 15% Short Term Capital Gain Tax instead of 10% earlier. In any case funds from Mauritius or like tax heavens will not be affected due to DTAA. Budget Proposal Anti AIDS drug, Atazanavir, as well as bulk drugs for its manufacture are to be exempted from excise duty. Impact
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VC may look at investment opportunities in Pharma Sector, specifically in area as mentioned above. If VC who have already invested in above area may expect better returns on their investments and accordingly they may plan their entry and exits. Budget Proposal Excise duty being exempted on end-use basis, on refrigeration equipment (consisting of compressor, condenser units, evaporator, etc) above 2 TR (tonne refrigeration) utilising power of 50 KW and above. Impact VC who have invested in above can expect better returns on their investments and accordingly they may plan their exits.
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FINDINGS
VCF is in its nascent stages in India. The emerging scenario of global competitiveness has put an immense pressure on the industrial sector to improve the quality level with minimization of cost of products by making use of latest technological skills. The implication is to obtain adequate financing along with the necessary hi-tech equipments to produce an innovative product which can succeed and grow in the present market condition. Unfortunately, our country lacks on both fronts. The financing firms expect a sound, experienced, mature and capable management team of the company being financed. The payback period is also generally high (5 - 7 years). The various queries can be outlined as follows: 1. 2. 3. 4. 5. Requirement of an experienced management team. Requirement of an average rate of return on investment. Longer payback period Uncertainty regarding the success of the product in the market. Questions regarding the infrastructure details of production like plant location, accessibility, relationship with the suppliers and creditors, transportation facilities, labour availability etc. 6. 7. 8. 9. 10. 11. The category of potential customers and hence the packaging and pricing details of the product. Less knowledge of the market size . Lack of information regarding Major competitors and their market share. Skills and Training required and the cost of training. Problems in raising of funds It is not known from whom the permission should be sought to start a venture capital activity (it is not clearly spelt out). CCI was to give permission but has been wound up now.
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12. 13.
UTI-assisted funds are tax-exempt, not others. Thus, other venture capital funds are at a disadvantage. Eligibility certificate is needed for capital gains tax exemption. Canfina VCF needs to get permission from ICICI, IDBI—its competitors. They may not know anything about the project. Canfina-VCF has to provide them all the data.
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Lack of broad knowledge base.
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SUGGESTIONS
The following things are essential for the success of venture capital in any country: 1. In order to establish a thriving venture capital industry, all economic players must participate. 2. Participate in those acquisitions that transfer technology to India.
3. VC funds should be managed by professionals with proper check & balance. 4. Documents. Prepare three documents: (i) a thoughtfully reasoned full business plan; (ii) a one to two page executive summary of the business plan; and (iii) a PowerPoint presentation. A full business plan should include a business model, financial projections and assumptions. 5. Life cycle. Know with certainty where your company is in the life cycle and target investors accordingly. Is your company in the hangar, on the runway, taking off or at cruising altitude? 6. Deregulated economic environment: A less regulated and controlled business and economic environment where attractive customer opportunities exist or could be created for high-tech and quality products. 7. Disinvestment mechanism: Existence of disinvestment mechanisms, particularly an over-the counter stock exchange catering to the needs of SMEs. 8. Broad knowledge base: A more general, business and entrepreneurship oriented education system where scientists and engineers have knowledge of accounting, finance and economics. 61
9. Management training: An effective management education and training programme for developing professionally competent and committed venture capital managers trained to evaluate and manage high-tech, high risk ventures is necessary. 10. Technological competitiveness: Encouraging and funding of R&D by private and public sector companies and the government, for ensuring technological competitiveness. 11. Marketing thrust: A vigorous marketing thrust, promotional efforts and development strategy, business incubators etc. for the growth of venture capital. 12. Due Diligence: Review a sample due diligence request. Prepare a due diligence binder. This facilitates the fund raising process and gives the positive impression of being highly organized.
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CONCLUSION
Venture Capital can play a more innovative and developmental role in a developing country like India. It could help the rehabilitation of sick units through people with ideas and turnaround management skills. The world is becoming increasingly competitive. Companies are required to be super efficient with respect to cost, productivity, and labour efficiency, technical back up, flexibility to consumer demand, adaptability and foresightedness. There is an impending demand for highly cost effective, quality products and hence the need for right access to valuable human expertise to guide and monitor along with the necessary funds for financing the new projects. The Government of India in an attempt to bring the nation at par and above the developed nations has been promoting venture capital financing to new, innovative concepts & ideas, liberalizing taxation norms providing tax incentives to venture firms, giving a Philip to the creation of local pools of capital and holding training sessions for the emerging VC investors. There are large sectors of the economy that are ripe for VC investors, like,. I.T., Pharma, Manufacturing. Telecom, Retail franchises, food processing and many more. By combining risk financing with management and marketing assistance , venture capital thus could become an effective instrument in fostering the development of entrepreneurship and transfer of technology on developing countries.
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doc_328931750.doc
Evolution of venture capital:
The word VENTURE has several meanings, depending upon the context in which it is used. Venture means chance, hinting at speculation to try one’s luck good or bad, involving risk or hazard or exposure to insecurity or danger. Venture also means trial i.e. an attempt or endeavor hinting again at trying ones luck. In the highly dynamic business environment that surrounds us today, a venture includes a firm that deals in unproven technology or products that require a market segment to be created for it The earliest origins of venture capital can be traced back to the medieval Islamic mudaraba partnership. In terms of protecting the entrepreneur, sharing the risks, losses and profits the two systems of finance are remarkably similar. General Georges Doriot is considered to be the father of the modern venture capital industry. In 1946, Doriot co-founded American Research and Development Corporation (AR&DC) with Ralph Flanders, Karl Compton It is commonly accepted that the first venture-backed startup is Fairchild Semiconductor, funded in 1959 by Venrock Associates. Venture capital investments, beforeWorld War II, were primarily the sphere of influence of wealthy individuals and families. One of the first steps toward a professionally-managed venture capital industry was the passage of the Small Business Investment Act of 1958. Slow Growth in 1960s & early 1970s, and the First Boom Year in 1978 During the 1960s and 1970s, venture capital firms focused their investment activity primarily on starting and expanding companies. More often than not, these companies were exploiting breakthroughs in electronic, medical or data-processing technology. As a result, venture capital came to be almost synonymous with technology finance. Venture capital firms suffered a temporary downturn in 1974, when the stock market crashed and
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investors were naturally wary of this new kind of investment fund. 1978 was the first big year for venture capital. The industry raised approximately $750,000 in 1978. Highs & Lows of the 1980s In 1978, the US Labor Department reinterpreted ERISA legislation and thus enabled this major pool of pension fund money to invest in alternative assets classes such as venture capital firms.Venture capital financing took off. 1983 was the boom year - the stock market went through the roof and there were over 100 initial public offerings for the first time in U.S. history. Due to the excess of IPOs and the inexperience of many venture capital fund managers, VC returns were very low through the 1980s. VC firms retrenched, working hard to make their portfolio companies successful. The work paid off and returns began climbing back up. Stages in the Evolution of Venture Capital Financing The different stages are depicted in the table below: S. No 1 Stages Persoal borrowing Commercial borrowing (working Capital) Term Loan Developmental Borrowing Development Credit allowed purely on the strength of the security offered. No other questions asked. Liquidity(current ratio) and solvency (debtequity ratio) are considered. Turn-over of the business & Profitability verified. Loan given after obtaining collateral. Technical Feasibility & Financial Viability of the activity to be financed looked into through detailed project appraisal. Loan given obtaining collaterial & with a host of terms & conditions.
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VC Financier looks at the projet as a intending Venture Capital partner will examine a proposition that is highFinance (Technology risk oriented, but with potential for large reward Development and accepts to participate in the venture and in its Purpose) financing if satisfied.
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Concept of venture capital:
What is venture capital? Venture capital is a type of private equity capital typically provided by professional, outside investors to new, growth businesses. Venture capital investments are generally made as cash in exchange for shares in the invested company. A venture capitalist (VC) is a person who makes such investments. A venture capital fund is a pooled investment vehicle (often a limited partnership) that primarily invests the financial capital of thirdparty investors in enterprises that are too risky for the standard capital markets or bank loans. Venture capital can also include managerial and technical expertise. Most venture capital comes from a group of wealthy investors, investment banks and other financial institutions that pool such investments or partnerships. Professionally managed venture
capital firms generally are private partnerships or closely-held corporations funded by private and public pension funds, endowment funds, foundations, corporations, foreign investors, and the venture capitalists themselves. Venture capitalists generally: Finance new and rapidly growing companies Purchase equity securities Assist in the development of new products or services Add value to the company through active participation Take higher risks with the expectation of higher rewards Have a long-term orientation When considering an investment, venture capitalists carefully screen the technical and business merits of the proposed company. Venture capitalists only invest in a small percentage of the businesses they review and have a long-term perspective. They also actively work with the company's management, especially with contacts and strategy formulation. Venture capitalists mitigate the risk of investing by developing a portfolio of young companies in a single venture fund. Many times they co-invest with other professional venture capital firms. In addition, many venture partnerships manage multiple funds simultaneously. For decades, venture capitalists have nurtured the growth of America's high technology and
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entrepreneurial communities resulting in significant job creation, economic growth and international competitiveness. Companies such as Digital Equipment Corporation, Apple, Federal Express, Compaq, Sun Microsystems, Intel,Microsoft and Genentech are famous examples of companies that received venture capital early in their development. (Source: National Venture Capital Association 1999 Yearbook).
Features of venture Capital: The main attributes of venture capital are as follows: 1. Equity participation: Actual or potential equity participation through direct of shares, option or convertible securities. The objective is to make capital gains by selling off the enterprise becomes profitable. 2. Long term investment: venture financing is a long term illiquid investment it is not repayable on demand. It requires long term investment attitude that requires the venture capital firms to wait for a long period, say 5-10 years to make profits. 3. Investment in high-risk, high-returns ventures: As VCs invest in untested, innovative ideas the investments entail high risks. In return, they expect a much higher return than usual. (Internal Rate of return expected is generally in the range of 25 per cent to 40 per cent). 4. Expertise in managing funds: VCs generally invest in particular type of industries or some of them invest in particular type of businesses and hence have a prior experience and contacts in the specific industry which gives them an expertise in better management of the funds deployed. 5. Raises funds from several sources: A misconception among people is that venture capitalists are rich individuals who come together in a partnership. In fact, VCs are not necessarily rich and almost always deal with funds raised mainly from others. The various sources of funds are rich individuals, other investment funds, pension funds, endowment funds, et cetera, in addition to their own funds, if any. 6. Diversification of the portfolio: VCs reduce the risk of venture investing by developing a portfolio of companies and the norm followed by them is same as the portfolio managers, that is, not to put all the eggs in the same basket.
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7. 8.
Exit after specified time: VCs are generally interested in exiting from a Participation in management: The hands on approach of continuing
business after a pre-specified period. This period may usually range from 3 to 7 years. participation of the venture capitalist in the management of the entrepreneurs business helps him to protect and enhance his investment by actively involving and supporting the entrepreneur. More than finance the venture capitalist gives his marketing, planning and management skills and technology to new firm. Venture capital also differs from development finance .A development bank safeguards its interest through collateral and substantial stake in ownership and control through a nominee director. It does not play an active role in the management of the company. A company obtaining funds from its holding or parent company will be fully owned or managed by the holding company. Venture capital and Alternative Financing Compared Venture capital High Management Information Low Commercial Loan Parent company finance Development finance
Low Ownership
High
The venture capitalist is also not exactly is not like the stock market investor who merely trades in the shares of a company without any relations with or knowledge of its management. In fact a venture capitalist combines the qualities of banker, stock market investor and entrepreneur.
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Venture capital has a number of advantages over other forms of finance, such as: 1. 2. 3. It injects long term equity finance which provides a solid capital base for The venture capitalist is a business partner, sharing both the risks and The venture capitalist is able to provide practical advice and assistance to
future growth. rewards. Venture capitalists are rewarded by business success and the capital gain. the company based on past experience with other companies which were in similar situations. 4. The venture capitalist also has a network of contacts in many areas that can add value to the company, such as in recruiting key personnel, providing contacts in international markets, introductions to strategic partners, and if needed co-investments with other venture capital firms when additional rounds of financing are required.
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VENTURE CAPITAL IN INDIA
Venture capital Scenario in India:
In the earlier years, individual investors and development financial institutions played the role of venture capitalists in India and entrepreneurs largely depended upon private placements, public offerings and the finance lend by financial institutions. In early seventies, the need to foster venture capital as a source of funding new entrepreneurs and technology was highlighted by the Committee on Development of Small and Medium Enterprises. In spite of some public sector funds being set up, the venture capital activity did not gather momentum. In 1988, the Government of India, based on a study undertaken by the World Bank, announced guidelines for setting up venture capital funds (VCFs). These guidelines were restricted to setting up of VCFs by banks or financial institutions only. Internationally, however, entrepreneurs who are willing to take higher risk, in anticipation of higher returns, usually set up venture capital funds. This is in contrast to banks and financial institutions, which are more averse to risk. In September 1995, Government of India issued guidelines for overseas venture capital investment in India whereas the Central Board of Direct Taxes (CBDT) issued guidelines for tax exemption purposes. As a part of its mandate to regulate and to develop the Indian capital markets, Securities and Exchange Board of India (SEBI) framed the SEBI (Venture Capital Funds) Regulations, 1996. Pursuant to the regulatory framework, some domestic VCFs were registered with SEBI. Some overseas investments also came through the Mauritius route. However, the venture capital industry, understood globally as independently managed, dedicated pools of capital that focus on equity or equity linked investments in privately held, high growth companies is still relatively in a nascent stage in India. Figures from the Indian Venture Capital Association (IVCA) reveal that, till 2000, around Rs. 2,200 crore (US$ 500 million) had been committed by the domestic VCFs and offshore funds which are members of IVCA. Figures available from private sources indicate that overall funds committed are around US$ 1.3 billion. Also due to economic liberalisation and increasing global outlook in India, an increased awareness and interest of domestic as well as foreign investors in venture capital was
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observed. While only 8 domestic VCFs were registered with SEBI during 1996-98, more than 30 additional funds have already been registered in 2000-01. Institutional interest is growing and foreign venture investments are also on the increase. Given the proper environment and policy support, there is a tremendous potential for venture capital activity in India. The Finance Minister, in the Budget 2000 speech announced, "For boosting high tech sectors and supporting first generation entrepreneurs, there is an acute need for higher investments in venture capital activities." He also said that the guidelines for the registration of venture capital activity with the Central Board of Direct Taxes would be harmonised with those for registration with the Securities and Exchange Board of India. SEBI decided to set up a committee on venture capital to identify the impediments and suggest suitable measures to facilitate the growth of venture capital activity in India. Keeping in view the need for global perspective, it was decided to associate Indian entrepreneur from Silicon Valley in the committee. The setting up of this committee was primarily motivated by the need to play a facilitating role in tune with the mandate of SEBI, to regulate as well as develop the market. The committee headed by K. B. Chandrasekhar, Chairman, Exodus Communications Inc., submitted its report on 8 January 2000. In his Budget Proposals 2000-01, the Finance Minister announced new regime for venture capital funds. And proclaimed SEBI as the single point nodal agency for registration and regulation of both domestic and overseas venture capital funds. The new regime stipulated that no approval of venture capital funds by tax authorities would be required and that the principle of "pass through" would be applied in tax treatment of venture capital funds. Recently, the Government of India has also announced the"exit policy" for venture capitalists. India has the second largest English speaking scientific and technical manpower in the world. Given this quality and magnitude of human capital India's potential to create enterprises is unlimited. Given the vast potential, which is, not only confined to IT and software but also in other sectors like biotechnology, telecommunications, media and entertainment, medical and health etc., venture capital industry is playing and shall continue to play a catalyst's role in industrial development. In the early 1980s, the idea that venture capital might be established in India would have seemed utopian. India's highly bureaucratized economy, avowed pursuit of socialism, still
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quite conservative social and business worlds, and a risk-averse financial system provided little institutional space for the development of venture capital. With the high level of government involvement, it is not surprising that the first formal venture capital organizations began in the public sector. From its inception the Indian venture capital was linked with exogenous actors, public and private. In India, one of the most autarchic economies in the world, both the development of venture capital and the information technology industry have been intimately linked with the international economy. The earliest discussion of venture capital in India came in 1973, when the government appointed a commission to examine strategies for fostering small and medium-sized enterprises the Indian financial systems' operation made it difficult to raise "risk capital" for new ventures and proposed various measures to liberalize and deregulate the financial market. The First Stage, 1986–1995 Indian policy toward venture capital has to be seen in the larger picture of the government's interest in encouraging economic growth. The 1980s were marked by an increasing disillusionment with the trajectory of the economic system and a belief that liberalization was needed. Prior to 1988, the Indian government had no policy toward venture capital; in fact, there was no formal venture capital. In 1988, the Indian government issued its first guidelines to legalize venture capital operations. These regulations really were aimed at allowing state controlled banks to establish venture capital subsidiaries, though it was also possible for other investors to create a venture capital firm. However, there was only minimal interest in the private sector in establishing a venture capital firm. The government's awakening to the potential of venture capital occurred in conjunction with the World Bank's interest in encouraging economic liberalization in India. So, in November 1988, the Indian government announced an institutional structure for venture capital. Making the case for supporting the new venture capital guidelines with investments into Indian venture capital funds, the World Bank calculated that demand over the next 2–3 years would be around $67–133 million per annum, and it proposed providing $45 million to four public sector financial institutions for the purpose of
9
permitting them to establish venture capital operations under the November 1988 guidelines issued by the Government of India. The funds were restricted to investing in small amounts per firm (less than 100 million rupees); the recipient firms had to be involved in technology that was “new, relatively untried, very closely held or being taken from pilot to commercial stage, or which incorporated some significant improvement over the existing ones in India.” The government also specified that the recipient firm’s founders should be “relatively new, professionally or technically qualified, and with inadequate resources or backing to finance the project.” There were also other bureaucratic fetters. There was even a list of approved investment areas. Two government-sponsored development banks, ICICI and IDBI, were required to clear every portfolio firm’s application to a venture capital firm to ensure that it fulfilled the right purposes. Also, the Controller of Capital Issues of the Ministry of Finance had to approve every line of business in which a venture capital firm wished to invest. In other words, the venture capitalists were to be kept on a very short leash. Despite these constraints, the World Bank supported the venture capital project, noting that the Guidelines reflect a cautious approach designed to maximize the likelihood of venture capital financing for technology-innovation ventures during the initial period of experimentation and thereby demonstrate the viability of venture capital in India. The Second Stage, 1995–1999 The success of Indian entrepreneurs in Silicon Valley that began in the 1980s became far more visible in the 1990s. This attracted attention and encouraged the notion in the U.S. that India might have more possible entrepreneurs. Very often, NRIs were important investors in these funds. In quantitative terms, it is possible to see a dramatic change in the role of foreign investors. Notice also the comparative decrease in the role of the multilateral development agencies and the Indian government’s financial institutions. The overseas private sector investors became a dominant force in the Indian venture capital industry.
Indian Scenario - A Statistical Snapshot
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Contributors of Funds Contributors Foreign Institutional Investors All India Financial Institutions Multilateral Development Agencies Other Banks Foreign Investors Private Sector Public Sector Nationalized Banks Non Resident Indians State Financial Institutions Other Public Insurance Companies Mutual Funds Total Rs mn 13,426.47 6,252.90 2,133.64 1,541.00 570 412.53 324.44 278.67 235.5 215 115.52 85 4.5 25,595.17 Per cent 52.46% 24.43% 8.34% 6.02% 2.23% 1.61% 1.27% 1.09% 0.92% 0.84% 0.45% 0.33% 0.02% 100.00%
Foreign Institutional Investors All India Financial Institutions Multilateral Development Agencies Other Banks
Foreign Investors
Private Sector
Public Sector
Financing By Industry Industry Industrial products, machinery Computer Software Consumer Related Medical Rs million 2,599.32 1,832 1,412.74 623.8 percent 27 18 14 6
11
Food, food processing Other electronics Tel & Data Communications Biotechnology Energy related Computer Hardware Miscellaneous Total
500.06 436.54 385.09 376.46 249.56 203.36 1,380.85 10,000.46
5 4 4 4 2 2 14 100
1,380.85, 14% 203.36, 2% 249.56, 2% 376.46, 4% 385.09, 4% 436.54, 4% 500.06, 5% 623.8, 6% 1,412.74, 14% 1,832, 18% 2,599.32, 27%
Industrial products, m achinery C puter Softw om are C onsumer R elated M edical Food, food processing O ther electronics T &D el ata C munications om Biotechnology Energy related
Financing By States Investment Maharashtra Tamil Nadu Andhra Pradesh Gujarat Rs million 2,566 1531 1372 1102 12
Karnataka West Bengal Haryana Delhi Uttar Pradesh Madhya Pradesh Kerala Goa Rajasthan Punjab Orissa Dadra & Nagar Haveli Himachal Pradesh Pondicherry Bihar Overseas Total
1046 312 300 294 283 231 135 105 87 84 35 32 28 22 16 413 9994
Ma sta a r h ha r T iNu al a m d Adr Pds nh r eh a a G rt u a j a K nt k aa a r a WtB gl e e a s n Hyn a aa r Di e l h U rPds ta r eh t a Mha r ds a y P eh d a
VENTURE CAPITAL OPERATIONS IN INDIA
The venture capital industry has grown in a narrow and restricted environment where the growth and development has been limited due to the conservative government
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policy. Although its presence on the platform of industrial finance has created new hopes for industrial development and growth. Also why the venture capital industry has not grown can be argued with reference to the following reasons
• Most of the venture capitalist funds are managed by the financial institutions and
banks where the venture capital fund is distinct from the management company. It is the latter that screens, makes and manages individual investments. Except for IDBI and SIDBI who have their own equity funds earmarked for venture capital financing and as such are an exception.
• Venture capital financing is only on the strengths of the business plan of the
venture and the chances of the success depends on various qualified considerations like the fund managers skill and experience in understanding the business plan, the skills of the entrepreneurs promoting the venture etc. Thus unlike a traditional pattern of lending followed by banks and financial institutions where the stress for financing is on the cash flows or collaterals, the venture capitalists don’t have any collateral or existing assets.
• The long term nature of venture capital investments carries a high and
differentiated risk in each stage of enterprise. Investments focus on high returns in the forms of long term capital gains, therefore only serious business proposals with fair amount of probability of success are selected by fund managers, also the procedures for making a investment decisions followed by the fund managers are still a gaurded secret, but generally private placements are made on high growth and high return basis.
Venture capital firms typically source the majority of their funding from large investment institutions such as fund of funds, financial institutions, endowments, pension funds and banks. These institutions typically invest in a venture capital fund for a period of up to ten years.
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To compensate for the long term commitment and lack of both security and liquidity, investment institutions expect to receive very high returns on their investment. Therefore venture capitalists invest in either companies with high growth potential where they are able to exit through either an IPO or a merger/acquisition. Although the venture capitalist may receive some return through dividends, their primary return on investment comes from capital gains when they eventually sell their shares in the company, typically between three to five years after the investment. Venture capitalists are therefore in the business of promoting growth in the companies they invest in and managing the associated risk to protect and enhance their investors' capital.
Stage – wise Investments
VC’s invest funds in either the early stage or later stage development of the enterprise, in certain cases they may provide finance in both the stages. Depending on the uniform practice followed by VCs in India the investment stages has been defined by IVCA as under :
• Seed Stage – Financing is provided to new companies for use in product
development and initial marketing. Companies may be in the process of being set up, or may have been in the nusiness for a short time.
• Start-up – Financing is provided to new companies for manufacturing and
commercializing the product developed. Finance is given for creation of new infrastructure and meeting the working capital requirements.
• Other Early stage – Financing is provided to companies that have completed
commercial-scale implementation and require further funds to meet initial cash loss and further working capital. They may not be generating profits.
• Later Stage – Capital is provided for the growth and expansion of the established company. Funds may be used to finance increase in production capacity, for market or product development etc. Capital provided for managing turnaround situations is also included in this category
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An analysis of financing by investment stages indicates the following figures:
Difference:
With respect to conventional financing, a VC financing differs in the following ways:
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1. Venture Capitalists are risk takers like entrepreneurs. A conventional financier is a risk avoider as protection of funds is a prime responsibility of the financier. 2. Venture Capitalists acquires equity, a share of ownership and with it a share of risk. He does not eliminate risk but manages it through in-depth monitoring, assisting and directing his the company he has invested in through portfolio diversification. He considers himself a partner of the entrepreneur while conventional financier objective is to eliminate risk by loaning money against collateral and ensuring debt repayment capacity. 3. A Venture Capitalist specializes in management services of which finance is a part. It understands the whole scope of business to operations. Conventional specializes in financial services and has nothing to do with management or marketing to clients. 4. A Venture Capitalist has extensive operating experience and provides entrepreneurs full hands on support. Such experience is not required at all in conventional financing. 5. A Venture Capitalist injects an element of vitality and innovation into business community. The conventional financier is not equipped to provide support which new enterprises demand along side investments. A Venture Capitalist encourages entrepreneurial initiatives and innovations, which accelerate business development and the pace of national economic growth. Thus VC tries to fill the gap that exists between traditional financiers and entrepreneurs needs.
Objectives and Activities of Venture capital funds in India:
VCF Objectives Target activities Target enterprises/
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IDBI Venture capital Fund(M arch 1987)
To provide financial assistance for attaining commercial application of indigenous technology or adapting imported technology for wider domestic application.
IFCIs RCTC (January 1988)
To provide risk capital to first generation entrepreneurs for setting up industrial projects. To provide finance for technological development for advancement, promotion, commercialization of technology. To develop and financing of indigenous technology.
To setup pilot plant based on processes developed in laboratories in the country To introduce technological innovation leading to substantial quality upgradation, reduced material consumption, reduced energy consumption, cost reduction. To adapt or modify processes and products to suit Indian conditions. Setting up pilot plants, demonstration scale plants and studies, R&D activities, specialized training, providing quality and market acceptability etc. Sponsoring commercial R&D programmes. Prototype or pilot plant commercialization, funding of grassroots R & D efforts for prototype and product/process development on very selective basis. Activities that involve development through R&D of an innovative product or process which promises tangible benefit to Indian economy. Activities that have significant commercial potential.
entrepreneurs Existing and new units.
TDICI(J anuary1 988)
Applicants with proven track records of innovation and having the requisite technological and managerial strengths. New or established entrepreneurs.
PACT
To accelerate the pace and quality of technological innovations for products having application in industry,agriculture,health,ener gy & other areas beneficial to development process in India.
Canbank venture capital fund(Au gust 1989 ) Gujarat venture
Financial participation in ventures with technological innovations and high-tech content promoting high return to the fund.
Venture financing.
Commercial exploitation of lab proven technologies. Evolution of new process or products. Adaption of imported technology to suit Indian conditions. Technological upgradation. Commercialization of new technologies resulting in
A team of companies one from India and one from US, having access to R&D and manufacturing facilities and demonstrated capability in selling its product. Relatively new ,but not affluent, professionally and technically qualified entrepreneurs. Both new & existing
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finance limited(J uly 1990) Credit Capital Venture Fund(Ja nuary 1990) Indus Venture Capital Fund(19 91) To take advantage of investment opportunities in the area of venture finance & investment in primary markets. To invest in the equity of venture as defined in the government of India’s venture capital guidelines.
lower cost of production. Skill intensive industries utilizing local talent. New product or process based on indigenous or imported technology etc. Thrust areas for investment: ancillary units& small export oriented units.
companies.
All enterprises with good investment potential. Individuals with combination of professional skills, entrepreneurial spirit and integrity in dealings.
Specialty chemicals, healthcare products, electronics and computers and consumer products.
STAGES IN VENTURE FINANCING
Historically VC evolved as a method of early-stage financing, but the notion of VC recognizes different stages of financing. It also includes development, expansion and 19
buyouts financing for those enterprises that are unable to raise funds from the normal financing channels. VC financing also provides turnaround finances to revitalize and revive sick enterprises The different stages of venture financing is as shown below Sr. No. 1. Stage Early stage financing Description • Seed financing for supporting a concept or idea • • • 2. Expansion financing • • • • • R&D financing for product development Start-up capital for initial production and marketing First stage financing for full-scale production and marketing Second stage financing for working capital and initial expansion Development financing for facilitation public issues 3. Acquisition/buyout financing Bridge financing for facilitating public issues Acquisition financing for acquiring another firm for further growth Management buyout financing for enabling operating group to acquire or part of its business • Turnaround financing for turning around a sick unit
Consideration for early stage investments: In the early stage of financing the exposure to risk is greater. The venture capitalist is more careful about ascertaining the credibility of the business plan and looks into the future prospects in terms of risks and rewards. The probability of success or failures is
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50:50 in the early stage. The following points are looked into before venture financing in the early stages: 1. Commercial viability if the project and product life cycle 2. Technical feasibility of the manufacturing process of the product or service, chances of obsolescence of technology 3. Marketability of the product or service, competition at home and overseas 4. Long term potential of the product to stay in the market 5. Management experience, skills and resources Consideration for later stage investments: The later stages of project or enterprise investments involve mezzanine financing, expansion financing, turnaround financing or buy-out financing. All aspects of an enterprise with reference to early stages of financing are scrutinized with an eye on performance and achievements in the early stage of project implementations. There is now enough evidence to judge the quality of management, standard of financial performance, usefulness of technical process marketability of the product and likely competition. The investment strategy for later stage financing is different on account of more safety in investments. There is a shift in the expectation profile of the venture capitalists, from huge capital gains of the early stage to solid income yield in secured investments in the later stage. There must be good generation of funds depicting successful completion of the project to meet its own working capital requirements. These aspects are important considerations in later stage financing.
Categorization of VC Investors:
1. Incubators 2. Angel Investors 3. Venture Capitalists (VCs)
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4. Private Equity Player Incubators: An incubator is a hardcore technocrat who works with an entrepreneur to develop a business idea, and prepares a Company for subsequent rounds of growth & funding. Ventures, Infinity are examples of incubators in India. Angel Investors: An angel is an experienced industry-bred individual with high net worth. Typically, an angel investor would:
• • • • • •
invest only his chosen field of technology take active participation in day-to-day running of the Company invest small sums in the range of USD 1 - 3 million not insist on detailed business plans sanction the investment in up to a month help company for "second round" of funding
Venture Capitalists (VCs): VCs are organizations raising funds from numerous investors & hiring experienced professional mangers to deploy the same. They typically:
• • • • • • •
invest at "second" stage invest over a spectrum over industry have hand-holding "mentor" approach insist on detailed business plans invest into proven ideas/businesses provide "brand" value to investee invest between USD 2 - 5 million
Private Equity Players: They are established investment bankers. Typically:
• • •
invest into proven/established businesses have "financial partners" approach invest between USD 5 -100 million 22
Methods of financing:
The following forms of financing are used by venture capitalists in India: 1. Equity
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The venture capitalist provides capital in the form of equity for the project and acts as coowner with the promoter, sharing profits and losses in the venture. The equity contribution is less than the promoter’s contribution (generally not exceeding 49% of the total capital) so that the promoter can retain effective control and majority ownership of the enterprise. 2. Conventional loans Some venture capitalists provide conventional loans to promoters for a longer period of 10-12 years. The loans are offered at concessional rates of 6% per annum during the initial development period, and then raised to as much as 14% once the project is demonstrated to be commercially viable and successful. In some cases the venture fund may decide to charge a royalty after the project is commercialized. 3. Conditional loans A conditional loan is not repayable like a conventional loan and does not carry interest. The repayment of a conditional loan is linked to the sales or turnover of the company in the form of royalty. The rate of royalty and the schedule payments are decided keeping in view the gestation period and the repayment capacity of the project. In cases of projects which the promoter anticipates a high turnover, he readily opts to pay a high rate of interest (as high as 20% per annum) once the project becomes viable, instead of paying royalty on sales. 4. Income notes It is a hybrid security combining the features of both conventional loans and conditional loans. The promoter has to pay both interest and royalty on sales, but at substantially low rates. IDBI VC fund provides funding equal to 80 – 87.5% of a project’s cost for commercial application of indigenous technology or adapting imported technology to wider domestic application. Funds are made available in the form of unsecured loans at a lower rate of interest during development phase and at a higher rate after development stage. In addition to interest charges, royalty on sales could also be charge. 5. Other instruments A few venture capitalists, particularly in the private sector, have started introducing innovative financial securities. The ‘Participating debenture’ introduced by Twentieth Century Finance Corporation is an example. Such securities carries charges spread over
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three phases. In the start-up phase, before the venture attains operations on a minimum level, no interest is charged. After this, a low rate of interest is charged up to a particular level of operation. Once the venture starts operating on full commercial basis, a high rate of interest is required to be paid. A variation could be in terms of paying a certain share of the post-tax profits instead of royalty.
VENTURE CAPITAL INVESTMENT PROCESS
The venture capital investment activity is a sequential process involving six steps
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1. Setting up a deal 2. Screening 3. Evaluation or due diligence 4. Deal structuring 5. Post-investment activities and 6. Exit plan 1. Setting up a deal A VC business requires a continuous flow of ventures for it to flourish. This steady stream of deals can be obtained from a. Referral schemes: deals referred to by parent organizations, trade partners, industry organizations, friends, etc. b. Active search: Searching through networks, trade fairs, conferences, seminars, foreign visits, etc. c. Intermediaries: Organizations acting as middle-men who match VC firms and potential entrepreneurs. 2. Screening
Venture capital is a service industry, and VCFs generally operate with a small staff. In order to save on time and to select the best ventures, before going for an in-depth analysis, VCFs carry out initial screening of all projects on the basis of some broad criteria. For example, the screening process may limit projects to areas in which the venture capitalist is familiar in terms of technology, or product, or market scope. The size of investment, geographical location and stage of financing could also be used as the broad screening criteria.
3. Evaluation or Due Diligence Once a proposal has passed through initial screening, it is subjected to a detailed evaluation or due diligence process. Most ventures are new and the entrepreneurs may lack operating experience. Hence, a sophisticated, formal evaluation is neither possible nor desirable. The venture capitalists, thus, rely on a subjective, but comprehensive, evaluation. VCFs evaluate the quality of the entrepreneur before appraising the
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characteristics of the product, market or technology. Most venture capitalists ask for a business plan* to make an assessment of the possible risk of and return on the venture. 4. Deal Structuring Once the venture has been evaluated as viable, the venture capitalist and the investee company negotiate the terms of the deal, viz., the amount, form and price of the investment. This process is termed as deal structuring. The agreement also includes the protective covenants and earn-out arrangements. Covenants include the venture capitalist's right to control the investee company and to change its management if needed, buyback arrangements, acquisition, making initial public offerings (IPOs), etc. Venture capitalists generally negotiate deals to ensure protection of their interests. They would like a deal to provide for • • • A return commensurate with the risk Influence over the firm through board membership Minimizing taxes
•Assuring investment liquidity •The right to replace management in case of consistent poor managerial performance, The investee companies would like the deal to be structured in such a way that their interests are protected. They would like to earn reasonable return, minimise taxes, have enough liquidity to operate their business and remain in commanding position of their business. 5. Post-investment Activities Once the deal has been structured and agreement finalized, the venture capitalist generally assumes the role of a partner and collaborator. He also gets involved in shaping of the direction of the venture. This may be done via a formal representation on the board of directors, or informal influence in improving the quality of marketing, finance and other
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managerial functions. If a financial or managerial crisis occurs, the venture capitalist may intervene, and even, install a new management team. 6 Exit A venture capitalist partly owns the company because of his equity investment but is not interested in retaining his ownership. He is interested in converting his ownership into cash at the earliest possible opportunity when he receives a higher return on his investments. Such realization is called as exit. The schedule of time and the route for exit is known as ‘exit strategy’. The objective of the VC investment is to help the promoter establish his company after which it is not necessary for the VC money to remain invested there. The holding is therefore liquidated so that it can be reinvested in other profit bearing opportunities. The price that the investment can fetch will depend on the value of the company, which in turn depends on the stage of development of the company. In order to get a good price a venture capitalist will refrain from selling his stake in a short time frame if he foresees that the worth of the enterprise is likely to increase. The exit methods that are commonly used are: a. Initial Public Offering [IPO] b. Buy back by promoters c. Sale of the enterprise to another company d. Sale to new investors e. Self liquidating process f. Liquidation of the company
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SELECTING THE VC INVESTOR
The members of the Indian Venture Capital Association comprise a number of venture capital firms in India. The IVCA Directory of Members provides basic information about each member's investment preferences and is available from the Association. Prior to selecting a venture capitalist, the entrepreneur should study the particular investment preferences set down by the venture capital firm. Often venture capitalists have preferences for particular stages of investment, amount of investment, industry sectors, and geographical location. An investment in an private, unlisted company has a long-term horizon, typically 4-6 years. It is important to select venture capitalists with whom it is possible to have a good working relationship. Often businesses do not meet their cash-flow forecasts and require additional funds, so an investor's ability to invest in additional financing rounds if required is also important. Finally, when choosing a venture capitalist, the entrepreneur should consider not just the amount and terms of investments, but also the additional value that the venture capitalist can bring to the company. These skills may include industry knowledge, fund raising, financial and strategic planning, recruitment of key personnel, mergers and acquisitions, and access to international markets and technology. Entrepreneurs should not hesitate to ask for references from investors. What do venture capital look for? Venture capitalists are higher risk investors and, in accepting these risks, they desire a higher return on their investment. The venture capitalist manages the risk/reward ratio by only investing in businesses which fit their investment criteria and after having completed extensive due diligence.
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Venture capitalists have differing operating approaches. These differences may relate to location of the business, the size of the investment, the stage of the company, industry specialization, structure of the investment and involvement of the venture capitalists in the companies activities. The entrepreneur should not be discouraged if one venture capitalist does not wish to proceed with an investment in the company. The rejection may not be a reflection of the quality of the business, but rather a matter of the business not fitting with the venture capitalist's particular investment criteria. Often entrepreneurs may want to ask the venture capitalist for other firms that might be interested in the investment opportunity. Venture capital is not suitable for all businesses, as a venture capitalist typically seeks: Superior Businesses Venture capitalists look for companies with superior products or services targeted at large, fast growing or untapped markets with a defensible strategic position such as intellectual property or patents. Quality and Depth of Management Venture capitalists must be confident that the firm has the quality and depth in the management team to achieve its aspirations. Venture capitalists seldom seek managerial control, rather they want to add value to the investment where they have particular skills including fund raising, mergers and acquisitions, international marketing, product development, and networks. Appropriate Investment Structure As well as the requirement of being an attractive business opportunity, the venture capitalist will also seek to structure a deal to produce the anticipated financial returns to investors. This includes making an investment at a reasonable price per share (valuation).
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Exit Opportunity Lastly, venture capitalists look for the clear exit opportunity for their investment such as public listing or a third party acquisition of the investee company.
Once a short list of appropriate venture capitalists has been selected, the entrepreneur can proceed to identify which investors match their funding requirements. At this point, the entrepreneur should contact the venture capital firm and identify an investment manager as an initial contact point. The venture capital firm will ask prospective investee companies for information concerning the product or service, the market analysis, how the company operates, the investment required and how it is to be used, financial projections, and importantly questions about the management team.
In reality, all of the above questions should be answered in the Business Plan. Assuming the venture capitalist expresses interest in the investment opportunity, a good business plan is a pre-requisite. The Business plan: Venture capitalists view hundreds of business plans every year. The business plan must therefore convince the venture capitalist that the company and the management team have the ability to achieve the goals of the company within the specified time. The business plan should explain the nature of the company’s business, what it wants to achieve and how it is going to do it. The company’s management should prepare the plan and they should set challenging but achievable goals.
The length of the business plan depends on the particular circumstances but, as a general rule, it should be no longer than 25-30 pages. It is important to use plain English, especially if you are explaining technical details. Aim the business plan at nonspecialists, emphasising its financial viability. Avoid jargon and general position statements.
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Essential areas to cover in your business plan: Executive Summary This is the most important section and is often best written last. It summarizes your business plan and is placed at the front of the document. It is vital to give this summary significant thought and time, as it may well determine the amount of consideration the venture capital investor will give to your detailed proposal. It should be clearly written and powerfully persuasive, yet balance "sales talk" with realism in order to be convincing. It should be limited to no more than two pages and include the key elements of the business plan. 1. Background on the company Provide a summary of the fundamental nature of the company and its activities, a brief history of the company and an outline of the company’s objectives. 2. The product or service Explain the company's product or service. This is especially important if the product or service is technically orientated. A non-specialist must be able to understand the plan. • • Emphasise the product or service's competitive edge or unique selling point. Describe the stage of development of the product or service (seed, early stage,
expansion). Is there an opportunity to develop a second-generation product in due course? Is the product or service vulnerable to technological redundancy? • If relevant, explain what legal protection you have on the product, such as patents attained, pending or required. Assess the impact of legal protection on the marketability of the product.
3. Market analysis The entrepreneur needs to convince the venture capital firm that there is a real commercial opportunity for the business and its products and services.
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•
Define your market and explain in what industry sector your company operates. What is the size of the whole market? What are the prospects for this market? How developed is the market as a whole, i.e. developing, growing, mature, declining?
•
How does your company fit within this market? Who are your competitors? For what proportion of the market do they account? What is their strategic positioning? What are their strengths and weaknesses? What are the barriers to new entrants?
•
Describe the distribution channels. Who are your customers? How many are there? What is their value to the company now? Comment on the price sensitivity of the market.
•
Explain the historic problems faced by the business and its products or services in the market. Have these problems been overcome, and if so, how? Address the current issues, concerns and risks affecting your business and the industry in which it operates. What are your projections for the company and the market? Assess future potential problems and how they will be tackled, minimised or avoided.
4. Marketing Having defined the relevant market and its opportunities, it is necessary to address how the prospective business will exploit these opportunities.
•
Outline your sales and distribution strategy. What is your planned sales force?
What are your strategies for different markets? What distribution channels are you planning to use and how do these compare with your competitors? Identify overseas market access issues and how these will be resolved.
•
What is your pricing strategy? How does this compare with your competitors? What are your advertising, public relations and promotion plans?
•
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5. The management team Demonstrate that the company has the quality of management to be able to turn the business plan into reality.
•
The senior management team ideally should be experienced in complementary areas, such as management strategy, finance and marketing, and their roles should be specified. The special abilities each member brings to the venture should be explained. A concise curriculum vitae should be included for each team member, highlighting the individual’s previous track record in running, or being involved with, successful businesses.
•
Identify the current and potential skills gaps and explain how you aim to fill them. Venture capital firms will sometimes assist in locating experienced managers where an important post is unfilled - provided they are convinced about the other aspects of your plan.
•
List your advisors and board members. Include an organization chart.
•
6. Financial projections The following should be considered in the financial aspect to your business plan: 1. Realistically assess sales, costs (both fixed and variable), cash flow and working capital. Produce a profit and loss statement and balance sheet. Ensure these are easy to update and adjust. 2. 3. 4. Explain the research undertaken to support these assumptions. What are your budgets for each area of your company's activities Keep the plan feasible. Avoid being overly optimistic. Highlight challenges and show how they will be met.
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Relevant historical financial performance should also be presented. The company’s historical projections. 7. Amount and use of finance required and exit opportunities State how much finance is required by your business and from what sources and explain the purpose for which it will be applied. Consider how the venture capital investors will exit the investment and make a return. Possible exit strategies for the investors may include floating the company on a stock exchange or selling the company to a trade buyer. achievements can help give meaning, context and credibility to future
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LEGAL & REGULATORY ISSUES IN INDIA
The legal framework within which venture capital companies operate comprises the erstwhile government guidelines 1988, repealed in 1995 to give way to SEBI regulations which have since been enforced.At present the regulatory framework comprises the following: Central government guidelines, SEBI regulations, Self regulatory body of venture capital companies and funds better known as Indian Venture Capital Association (IVCA). However to regulate business transactions of VCs the provisions of Indian Contract Act 1872, Companies Act 1956, SEBI Act 1992, Securities Contract Act 1956 etc are applicable just like any other Investment company. SEBI Regulations The SEBI is empowered to register and regulate the working of venture capital funds. This powers where given very recently in 1995 under the Securities Law Amendment Act. Since then SEBI has formulated regulations known as Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996. A venture capital fund means a fund established in the form of a trust or a company including a body corporate and registered under these regulations which• • • Has a dedicated pool of capital, Raised in a manner specified in the regulations, and Invests in venture capital undertaking in accordance with the regulations.
Venture capital undertaking means a domestic company :– • • Whose shares are not listed on a recognized stock exchange in India; 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
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are specified in the negative list by the Board with the approval of the central Government by notification in the Official Gazette in this behalf. 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 consultation with Government of India from time to time."
Application for grant of certificate
Any company or trust or body corporate proposing to carry on any activity as a venture capital fund must 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 be accompanied by a non-refundable application fee of Rs 25,000/payable by 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 :A.If the application is made by a company 1. The main object of the company as per its Memorandum of Association must be the 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 anytime convicted for an offense involving moral turpitude or any 37
economic offense and is a fit and proper person to act as director or principal officer or employee of the company. B. If the application is made by a trust 1. The instrument of trust (Trust Deed) 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 trustees have not at anytime being convicted of an offense involving moral turpitude or any economic offense 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.
Furnishing of information and clarification at the time of application
SEBI may require the applicant to furnish such further information as it considers necessary for processing the application. An application, which is not complete in all respects, shall be rejected by SEBI. However, before rejecting any application, the applicant will be given an opportunity to make representation before SEBI and to remove any defect in the application within 30 days of the date of receipt of communication from SEBI regarding the defect. SEBI may extend the period of 30 days for upto another 90 days on being satisfied that it is necessary and is equitable to do so. Procedure for grant of certificate If SEBI is satisfied that the applicant is eligible for grant of certificate, it shall send intimation to the applicant of its eligibility. On receipt of intimation, the applicant must pay to SEBI, registration fee of Rs 500,000 and on the receipt of such fees, SEBI will grant a certificate of registration. 38
Conditions of certificate The certificate granted shall be subject to the following conditions 1. The venture capital fund shall abide by the provisions of the SEBI Act and these regulations. 2. The venture capital fund shall not carry on any other activity other than that of a venture capital fund. 3. The venture capital fund shall inform SEBI in writing of any information or details previously submitted to SEBI which have changed after grant of the certificate. 4. If the information or details submitted are found to be false or are misleading in any particular manner, suitable action can be taken. All investment made or to be made by a venture capital fund shall be subject to the following conditions, namely:a. Venture capital fund shall disclose the investment strategy at the time of application for registration; b.Venture capital fund shall not invest more than 25% corpus of the fund in one venture capital undertaking; c.Shall not invest in the associated companies; and d.Venture capital fund shall make investment in the venture capital undertaking as enumerated below: I. At least 75% of the investible funds shall be invested in unlisted equity shares or equity linked instruments. However, if the venture capital fund seeks to avail benefits under the relevant provisions of the Income Tax Act applicable to a venture capital fund, it shall be required to disinvest from such investments within a period of one year from the date on which the shares of the venture capital undertaking are listed in a recognized Stock Exchange. II. Not more than 25% of the investible funds may be invested by way of: a. Subscription to initial public offer of a venture capital undertaking whose shares are proposed to be listed subject to lock-in period of one year; b.Debt or debt instrument of a venture capital undertaking in which the venture capital fund has already made an investment by way of equity.
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General obligations and responsibilities No venture capital fund shall issue any documents or advertisement inviting offers from the public for the subscription of the purchase of any of its securities or units. Maintenance of books and records 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 within the time specified by days to SEBI. Inspection and Investigation SEBI may appoint one or more person, upon receipt of information or complaint, as inspecting or investigating officer for inspection or investigation of the books of accounts, 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 by the venture capital fund in the manner specified in these regulations. 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 the affairs of the venture capital fund in the interest of the securities market and the interest of investors.
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LIMITATIONS OF VENTURE CAPITAL IN INDIA
1. Lack of prioritization of thrust areas: VCFs in India have not prioritized high tech thrust areas for venture financing. The prioritization of thrust areas may facilitate development of technological Specialiality and expertise by VCFs. 2. Lack of regional focus: VCFs even the state level institution lack regional focus. A regional focus could lead to concentrated efforts and specialization and could in the taking of full advantages of the regional benefits. 3. Lack of full rage financing: All funds offer funding for early stage activities viz. seed capital and start up financing. However all start up companies do not get venture capital because of the perceived high risk. Similarly financing for expansion and rehabilitation of sick units is lacking in spite of the concessions available under the government guidelines. 4. Lack of focus on entrepreneurial development: The focus of VCFs in India is on technology financing and rightly so, for making Indian industry globally competitive. But given the needs of India in terms of high production and productivity and employment, VCFs should adopt a broader approach on financing and supporting novel ideas of entrepreneurs, which may not necessarily be high-tech in nature. 5. Limitations on structuring of VC funds: VCFs in India are structured in the form of a company or trust fund and are required to follow a three tier mechanisminvestors, trustee company and Asset Management Company [AMC]. A proper tax efficient vehicle in the form of limited liability partnership act, which is popular in USA, is not made applicable for structuring of VCFs in India. In this form of structuring, investors’ liability towards the fund is limited to the extent of his contribution in the fund and also formalities in structuring of fund are simpler.
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Limitations on industry segments: In sharp contrast to other countries where telecom, services and software bag the largest share of VC investments, in India other conventional sectors dominate venture finance. Opening up of restrictions, in recent time, on investing in the services sectors such as telecommunication and related services, project consultancy, design and testing services, tourism etc. would increase the domain and growth possibilities of VC. Anomaly between SEBI regulations and CBDT rules: CBDT tax rules recognize investment in financially week companies only in case of unlisted companies as venture investment whereas SEBI regulations recognize investment in financially week companies as venture investment irrespective of their listing status. If investment in financially weak companies offers an attractive opportunity to VCFs the same may be allowed by CBDT for availing of tax exemptions on capital gains at a later stage. Also SEBI regulations do not restrict size of an investment in a company. However, as per income tax rules, maximum investment in a company is restricted to less than 20% of the raised corpus of VCF and paid up share capital in case of VC Company. Further, investment in company is also restricted upto 40% of equity of Investee Company. 8. Returns, Taxes and Regulations: There is a multiplicity of regulators like SEBI and RBI. Domestic venture funds are set up under the Indian Trusts Act of 1882 as per SEBI guidelines, while offshore funds routed through Mauritius follow RBI guidelines. Abroad, such funds are made under the Limited Partnership Act, which brings advantages in terms of taxation. The government must allow pension funds and insurance companies to invest in venture capitals as in USA where corporate contributions to venture funds are large.
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PROJECT EVALUATION: A CASE STUDY
How do venture capitalists evaluate a project in practice? This is the case of Electro vision Limited to illustrate the process of venture evaluation by VCFs in India.
CASE HISTORY The venture, Electrovision Ltd., was in the joint sector and the product, microwave ovens, was, at that point of time, neither manufactured nor marketed in India. The venture was to be jointly promoted by the Himalaya Rashtra State Electronics Development Corporation (HRSEDC) and Mr G. Of the total equity of Rs 8.8 million, the promoters had approached Delta Venture Capital Ltd., for equity assistance of Rs 3.2 million (i.e. 35.68%). Electrovision Ltd. had been incorporated in April 1988, and it was granted venture capital funding by Delta a year later, i.e. in April 1989. The project was located in a category "C" district of Himalaya Rashtra.The Board of Directors of Delta Venture Capital Ltd., prior to their final approval of the project, considered the following points. Promoters' Background With regard to HRSEDC, the joint promoter, the following factors were examined:
•
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Their previous experience in the field of electronic appliances, consumer durables and high-tech
products in general. Their experience with joint ventures and collaborations. HRSEDC had been manufacturing and marketing a range of black and white TV sets since November 1986. They had set up a joint venture for the manufacture of heavy duty electronic printers, photo facsimile equipment, and minicomputer modules etc. They had also formed a
joint venture for manufacturing aluminium electrolytic capacitors, and had collaboration with Fujitsu Ltd. and Fukazawa Electronic Co. Ltd. for manufacture of fibre optic communication systems.
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With regard to Mr G, his age, educational and business background, his experience in the field of kitchen appliances, and details of firms in which he had Interests, were examined. Mr G was 35 years old and had degrees in engineering and management to his credit. He had 12 years of business experience and had been associated with a well-known brand of kitchen equipment firm for eight years. Electrovision Ltd. had a seven-member board of directors. The chairman and two directors represented HRSEDC; Mr G was the managing director while two of the other three directors were professors at I IT’S Technology of the Product Microwave ovens were introduced in developed countries in the 1960s and their technology was well established. Electrovision wanted to pioneer this product in India. The critical element of such an oven is a magnetron that emits microwaves having a frequency of 2450 MHz, and Electrovision planned to import it from Toshiba, Japan. An expert group constituted by the Department of Science and Technology (DST), Government of India, had concluded that with regard to the other components the technology had been developed indigenously utilizing resources and expertise available in Electrovision and that it was suitable for commercial production. The technical advisor to Delta had opined that the project had a good chance of success contingent on achieving reliable quality and efficient after-sales service and, being the first to introduce the product in the Indian market. He also drew special attention to the need for controlling the microwave leakage which could be hazardous to human health. The Government of India Committee, however, had tested a prototype of the Electrovision oven and had found the emissions to be within the permissible limits. Project Cost The total cost of the project was estimated at Rs 28.3 million, of which imported plant and machinery accounted for a little over Rs 2.4 million. MarketProjections In 1988, Electrovision had commissioned a well-known research organisation to conduct an exploratory study on the demand for microwave ovens in the country.
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The findings were purely qualitative in nature. Subsequently in December 1988, they engaged yet another marketing research organisation to do a sample study of 300 housewives each, in Bombay and Bangalore. The study arrived at a figure of 31,500 pieces as the annual potential demand in the top 12 cities/towns of India. Three of these (Bombay, Delhi and Bangalore) were classified as "A" class markets and the other nine as "B" class. The assumption was that in the "A" class of markets 5 per cent of those households with a monthly income exceeding Rs 3,000 would be potential buyers of microwave ovens. The corresponding adoption rate for market "B" class markets was would taken as 3 per cent. expand. Electrovision also hoped that with the entry of competitors in due course the potential They had also contacted the Indian Railways to seek potential orders for microwave ovens for their catering service and hoped to make an entry into other institutional markets apart from the household sector assessed above.
ProfitabilityEstimates Based on sales estimates of 8,000, 15,000, 19,500 and 24,000 pieces respectively in the first four years, Electrovision had made projections of their financial performance. Year Cash profit (Rs 000) Net worth* (R.s 000) EPS (Rs) Book value per share (R,s) Exit Routes Delta Venture Capital Ltd. considered two routes of disinvestment. The first was sale in the proposed OTC market. Using the existing CCI guidelines for pricing a new issue (viz. average of cumulative average of the EPS, till the date of proposed issue capitalized at 12 per cent and book value per share on the date of proposed Some relevant I II indicators III IV are provided below:
13.71 59.83 68.77 69.99 95.10 133.32 176.08 206.66 0.00 4.34 5.36 4.48 10.81 15.35 20.01 23.48
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issue), the exit price at the end of each of the first 4 years would be Rs 5.40, Rs 16.62, Rs 23.48 and Rs 31.43 respectively. It was granted that the OTC market could initially be characterized by lower P/E ratios than the stock exchanges. Delta Venture Capital Ltd. considered, in particular, disinvestment at the end of the third year. Under Five different scenarios (comprising five different disinvestment prices each less than the book value Rs ' (23.48 obtained above), the annualized yields were Computed as given below: Disinvestment Price (Rs) 16 17 18 19 20 Net yield per annum (%) 18.97 21.40 23.74 25.99 28.16
In the event of an exit price of Rs 23.48 (calculated as per the CCI guidelines), the annual yield would be 32.91 per cent. The second exit route was buy-back by the private sector promoter. Delta Venture Capital Ltd. considered executing an agreement jointly with Mr G, his uncle, father and mother, whereby they would repurchase the equity holdings in three convenient lots at the end of the third, fourth and fifth years. They called for details to be furnished regarding the net worth of the latter at the time of the appraisal. Viability of the Project Delta Venture Capital Ltd. felt that the project would qualify for venture capital assistance because the technology had been developed indigenously for the first time in India, and the project was an appropriate case of R&D work being commercialized. Thus, Delta Venture Capital Ltd. approved financing in the form of direct subscription to 314,000 equity shares of Rs 10 each. ANALYSIS OF THE CASE
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Venture capital assistance essentially involves investment in ventures which are considered too risky to be eligible for conventional sources of finance. This high risk may arise from market, product, technology, or entrepreneurial reasons. Market Potential and Risk Market risk is derived as a consequence of several factors, significant among which are indifferent response from buyers in terms of poor acceptance (which may result from incorrect assessment of the need for the product), unexpected competition (which may step in if the idea appeals to many entrepreneurs as being commercially lucrative), inadequate support from the trade channels or intermediaries (who may not be equally enthusiastic about the idea) and so on. Imported microwave ovens were already in use in India. Electrovision had commissioned two market research surveys and the second survey had arrived at a reasonable demand estimate of 31,500 per year from the household sector alone even prior to advertising and sales promotion or market development efforts. Electrovision hoped to make a dent in the institutional market as well by being the first to introduce this product and by capitalizing on the Government customers using the HRSEDC contacts. The prior experience of Mr G and HRSEDC in the field of kitchen appliances and other consumer durables that they would be somewhat familiar with the network of dealers through whom the oven would be marketed.Further, a favourable outcome could be expected from the entry of competitors: they would be sharing the costs of initial market development and creating awareness about the suitability of microwave ovens to the Indian style of cooking. Thus this component of risk was not excessively overwhelming. Product Quality and Risk: Product risk is generally inherent in products/processes when they are based on untried new ideas. Ventures based on entirely new ideas or concepts can fail when they go into production on a commercial scale although the product development at the R&D stage may have been proper. In case of Electrovision, the prototype, apart from the magnetron, was developed by HRSEDC and Mr G with technical assistance of the IITs. They had also developed the "manufacturing technology" for assembling the ovens on a commercial scale. They planned to phase their production-over the first
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four years gradually increasing the utilization of capacity (8,000 pieces in the first year and 15,000, 19,500 and 24,000 pieces thereafter). The microwave leak had been tested and other safety features incorporated into the design of the ovens. All this had already been done by Electrovision to take care of the product risk.
Technological Capability and Risk: Technological risk may arise when the technology is perhaps too complex to fructify. The technology involved may be entirely new at least to the country in question and hence may not be attuned to the specific requirements of the local environment. The technology for microwave ovens was well established in the West where they had been in the market for nearly three decades. The most critical element, i.e. the magnetron, was perhaps the only one where technical capability of Electrovision was wanting but here again there was no real risk since the company proposed to import it from one of the most reputed Japanese manufacturers. The Board of Directors of Electrovision included technologists from IITs and HRSEDC. The technology for the components other than the magnetron developed indigenously by Electrovision had already been endorsed by an expert group of the DST. Entrepreneurial Skills and Risk : Entrepreneurial risk arises because ventures are usually small or medium-sized and their promoters are not likely to have adequate personal financial resources or any demonstrated managerial experience or calibre. In many cases, the aspirants are first generation entrepreneurs who have an innovative technical idea but no prior business expertise. The credentials of HRSEDC in the field of consumer durables and hi-tech products as well as their experience with joint ventures and collaborations was established. Mr G's educational and business background and his experience in the field of kitchen appliances were also adequate. Thus this risk also was low. The analysis indicates that the project was a medium- to high-risk category venture. Since it was not a conventionally used and traditionally familiar product in India, it was considered to be fit for venture financing and not for conventional financing.
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CASE STUDY
VENTURE CAPITAL DEVELOPMENT AT CANFINA-VCF As already explained, venture capital in India was started in 1985-86. Financial institutions like IDBI, ICICI, and IFCI were the first to enter the venture capital business. They were followed by the nationalized banks such as the State Bank of India. Canara Bank entered the venture capital business in 1989, through its subsidiary— Can Financial Services Ltd. Canfina-VCF is a relatively smaller player in the venture capital industry as compared to TDICI or IDBI-VCF. Initial Efforts and Context In 1985, the Chairman of Canara Bank initiated the idea of venture capital. The Bank has been quite active in financing small- and medium-size firms, and it had quite a few technical entrepreneurs in its portfolio. Thus, there existed a context for trying out venture capital and culturally, the bank was geared to take up this activity. Mr Venkatdas was made responsible, as chief executive, for Canara Bank's venture capital business. He is a mechanical engineer and joined the bank with 5-6 years experience as a technical field officer. He has been associated with the credit administration of small- and medium-size business in the bank (SSIs). He was instrumental in bringing the World Bank's industrial export-credit project to Canara Bank. He presented the scheme on behalf of the Bank to the World Bank. Thus, Can Bank established good rapport with the World Bank. It was at this time that Can Bank came to know about the World Bank's Technological Development Fund. In 1988-89, when the World Bank was appraising Can Bank's industrial export-credit project, that the earlier idea of venture financing started taking shape. Canara Bank at the same time floated a subsidiary company, Can Financial Services Ltd. (Canfina), to further the growth and 49
profitability of the bank. The Bank was interacting with the World Bank for a line of credit under their industry-technology development policy (ITP). Canara Bank was able to negotiate a US$ 5.25 million line of credit with them.
The venture capital concept of Canara Bank shaped up according to the World Bank's thinking. Since Canara Bank had Canfina, it was thought that it could manage the Fund. It created a trust, and made Canfina the trustee and manager of the Fund under the Indian Trust Act. In October 1989, the Canfina venture capital (Canfina-VCF) was born. It was started with an initial corpus of Rs 30 million given by Canara Bank plus Rs 1 million given by Canfina—the managers of the Fund. Then Canara Bank deputed executives from Canfina to the venture fund. The venture capital activities slowly got started. Meanwhile, Canara Bank also got US$ 5.25 million from the World Bank to be invested in venture capital activity. In fact, the fund was to flow from the World Bank to the Government to IDBI to Canara Bank, and finally to Canfina-VCF. Early Phase The first six ventures were to be evaluated and approved by the World Bank. It started progressing slowly but steadily. Canfina-VCF formulated operating guidelines for the Fund as well as for the managers, which then became the investment policy aligned to the government guidelines. Canfina-VCF was required to get permission from the RBI, the Ministry of Finance, the CCI, and the Department of Economic Affairs to enable the fund listed as a venture capital fund. Canfina-VCF's investment policy is directed by the guidelines. Presently, it is investing 25 per cent of funds in non-ventures. Canf'ina-VCF now receives ten to fifteen deals each month. Most deals come on their own. When Canfina VCF was learning the game, its rejection rate was about 60 per cent. Today, the rejection rate has gone up to around 90 per cent. Canfina VCF has now learnt which project to accept and which to reject. It has become wiser through experience. In the initial phase there was a tendency to look at the project per se, rather than the project's growth path and the management capability and competence of the managing team. Today, Canfina VCF is dealing with "company" and not the "project". But it does look into the project cost and equity requirement. 50
Canfina-VCF does not want to invest 49 per cent in equity alone. Some companies' equity requirements may be more than 49 per cent because promoters are- unable to bring insufficient equity. Canfina-VCF also lends in a "package" but when there are other people ready to lend to the enterprise, it generally takes only the equity position. It has both conditional loans and income notes (IN) as the venture capital finance instruments. INs are meant typically for second-stage.For example, an entrepreneur might have started by using his own capital and may not have a problem in terms of cash flow but he needs to grow faster using some technological upgradation. He would obviously need money. He may have diversification plans as well, but basically through value addition using technological development. Canfina-VCF would give him a loan with an initial low interest rate—may be no interest at all during the first year and 10 per cent p.a. afterwards. He also needs to pay a percentage royalty on sales. Royalty is like a reward for equity. What Canfina-VCF is looking for is a total IRR. This Instrument is also helpful in financing an entrepreneur's working capital requirement as he may not be able to obtain funds from a bank. Thus, in the case of Canfina-VCF, it can be concluded that in financing entrepreneurs’’ it looks at equity or equity-leading routes of financing. Performance Experience By and large, Canfina-VCF has had mixed experience in its venture capital business so far. Of course it is too early to say whether or not it has succeeded. It is still in an investment mode. Although it started in 1989, it considers 1990-91 as the first active year for this new business. Some assisted projects have posed problems which made canfina-VCF more conscious, especially during 1992-93. Canfina-VCF's minimum level of investment has been Rs 1 million; but nowadays, it is looking for a minimum investment of Rs 3-4 million. Processing charges are still unchanged. It has invested in a number of technology-based enterprises. It considers technology as the leading factor for its investment decision.
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Canfina-VCF's most successful case is that of a blue chip company where it invested Rs 0.15 million and provided conditional loan of Rs 2.5 million. After two bonuses, CanfinaVCF's equity investment has become Rs 0.75 million in two years. The company will go public shortly, may be with Rs 80 share value. Canfina-VCF's investment has increased 56 times in three years. It was bargaining for an initial equity of Rs 0.75 million, but the investee company did not give in since the promoters knew that it will perform well. Mr Venkatdas feels that the entrepreneurs know they are going to succeed, and hence do not want to part with the equity and want to hold on. Tax is a bothersome thing for CanfinaVCF. For example, TDICI does not pay any tax. In fact, Canfina-VCF's chief thinks that in venture capital there is no tax exemption at all. All those funds coming from the Unit Trust of India (UTI) can get tax exemptions but not those which do not have access to UTI funds. Regional Focus and Co-financing All companies asking to be financed by Canfina-VCF have to have technology. CanfinaVCF would like to concentrate on South India. All its investments are in Bangalore, Hyderabad and Madras. It has started an experiment in co-financing with Gujarat Venture Capital Co. Canfina-VCF as the lead financier, has co-financed one unit in Gujarat. Cofinancing needs perfect understanding of each others' culture, thinking, etc. by the two or more parties. Unfortunately, there are differences in the venture capital focus and this stands in the way of co-financing. The focus must be on technology. Once there is an agreement on the venture capital focus, there can be many possibilities of co-financing. Customerisation There are certain areas where the technology is imported which Canfina-VCF supports, provided there is good potential of customerisation of the product within India. Basically, it supports the financial effort needed to bring the product to the Indian market, adapting it to make it suitable to the Indian context, through the knowledge of the entrepreneurs. Canfina-VCF also assists in creating markets abroad. For example, Electrosonic Instruments a firm assisted by Canfina-VCF, Caters to the domestic market. It is newly developed in the country and has established itself domestically, Canfina-VCF
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saw its potential in the international market, and gave the company money to go abroad. The firm has tremendous market potential.
Evaluating Entrepreneurs Canfina-VCF gathers information about the entrepreneurs from various sources. It tries to ascertain the commitment of the entrepreneur through interaction with people known to him. It insists on an effective team. Canfina-VCF avoids one-man show as well as adamant, rigid, inflexible entrepreneurs. It also avoids those people who show great enthusiasm to go public immediately after venture financing. They may be intending to make quick money from the investors. It checks out long-term commitment of the entrepreneur and his contribution in terms of critical areas of management. Also, it tries to know how the entrepreneurs are going to divide their authority and responsibility later on. They have to identify one of them as the leader.
Technical skills are good, but promoters must have appreciation for management requirements and skills. According to Mr. Venkatdas, if a man is endowed with both Lakshmi (money) and Saraswati (knowledge), he would be Successful. He feels that an entrepreneur should be accommodating and have commercial orientation. If he is simply obsessed with technology, without concern for the commercial aspect of his enterprise, he may not succeed. He should be capable of looking at commercial options. He must be a strategist as well. A number of entrepreneurs do not know the kind (and extent) of risk they are taking. During appraisal, Canfina-VCF executives know they are able to ascertain what risks the entrepreneurs are taking. Some of the entrepreneurs do know the extent of these risks. They know all the situations that may arise but are not able to develop a good business plan. For example, a mechanical engineer approached Canfina-VCF with the concept of an auto-rikshaw. His design was good and Comfortable from the user's point of view but he was not aware of the risk he was taking. He did not know anything about marketing, 53
operating conditions, production, etc. He did not know anything about the environment. His product was good but Canfina-VCF could not finance him because he did not know his market and the business. Canfina-VCF likes entrepreneurs to be ambitious, but they should also be pragmatic. An ambitious person knows his target but Canfina-VCF makes its own analysis. Canfina-VCF acts quite fast once a proposal is received and if the proposal is to be rejected, the promoter is informed within 15 days. If it has initial interest in the venture, it conducts a detailed analysis. It wants a simple plan but people do come to Canfina-VCF with ideas but without plans. Canfina-VCF executives discuss their Ideas with them, and indicate whether they would be interested. They have teamed by experience. Today their executives can pick, and choose ventures. Canfina VCF avoids those ventures which may not have growth potential or are expected to face problem s. Participation in Management Canfina VCF participates in the management of companies. Its executives attend business committee meetings; they always conduct these meetings as a marketing audit, not merely for finance. The business environment is quite dynamic and so are the strategies; therefore, one cannot procrastinate for 10 years and still continue working. Canfina-VCFs scan the environment continuously. In the meetings, Canfina-VCF executives discuss product-mix options. They also participate in board meetings. In some companies, they are on the board of directors while in others they are just observers. After some time, the executives are able to know which companies in the portfolio will be able to produce good results. The executives optimize their time and efforts in those companies which are expected to grow fast. They have their usual follow-up and monitoring, and they talk to the entrepreneurs. They act as entrepreneurs themselves. They keep themselves informed of the environmental changes and advise the clients accordingly. The entrepreneurs are not always able to know the rapid changes in the environment. Thus, one of the tasks of Canfina-VCF executives is to keep the entrepreneurs abreast of the environmental changes and discuss the financial implications. They have to condition themselves to ultimately go to the OTC market. Canfina-VCF has been educating the company, how it will not lose control even if it goes public. To exit is a real problem in India. If a company has a good book value, the problem is to convert it into market value and still exit. Another problem is 54
the locking period for the venture capital companies. For example, if a VCF has stayed with the company for 3-4 years, nurtured it and brought it to a profitable level, why should it be required to hold on to the investment in the company? In the USA, all bio-tech companies go the venture capital route when the technology is developed, and when it takes some shape, they go the IPO route and venture capital firms exit. They do not carry on; they recycle their funds.
Venture capital companies today need to have a different breed of people, feels the chief of Canfina-VCF. According to him, they should be entrepreneurs; they should be given salaries and incentives and groomed properly and should be seen as partners. In the USA, they direct their best efforts to make the enterprises successful. They get management fees and share in the profit. Interest and commitment to the project have to be generated through incentives but since stock options are not allowed in India, employees in VCFs should be given share in the profit. The investment needs nurturing and development over a period of time.
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IMPACT OF BUDGET ON VENTURE CAPITAL
Budget Proposal Four services brought under service tax net namely, asset management service provided under ULIP, services provided by stock/commodity exchanges and clearing houses; right to use goods, in cases where VAT is not payable; and customized software, to bring it on par with packaged software and other IT services. Impact Above four services, being brought in the service tax net, will become expensive and may affect the returns on investment made by VC in above sectors. Budget Proposal Income Tax Act to be amended to provide that reverse mortgage would not amount to "transfer"; and the stream of revenue received by the senior citizen would not be "income". Impact Reverse mortgage is new thing to India and is expected to catch up very fast. With the above proposal, financial sector may see boom in reverse mortgage business. VC may look positively at this sector for investments. Budget Proposal Parent company allowed to set off the dividend received from its subsidiary company against dividend distributed by the parent company; provided that the dividend received has suffered DDT and the parent company is not a subsidiary of another company. Impact Relief in Dividend Distribution Tax (DDT) may increase the returns on investment of VC who have invested in companies as mentioned above.
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Budget Proposal Insert a new sub-section (11C) in Section 80-IB to grant a five year tax holiday to hospitals located in any place outside the urban agglomerations especially in tier2 and tier-3 towns; this window will be open for the period April 1, 2008 to March31, 2013. Impact VC may look at investment opportunities in above specified hospitals and expect good returns on their investments. They can plan their entry and exits accordingly. Budget Proposal Five year holiday from income tax being granted to two, three or four star hotels established in specified districts having UNESCO-declared 'World Heritage Sites'; the hotel should be constructed and start functioning during the period April 1, 2008 to March 31, 2013. Impact VC may look at investment opportunities in above specified hotels and expect good returns on their investments. They can plan their entry and exits accordingly. Budget Proposal Rate of tax on short term capital gains under Section 111A & Section 115AD increased to 15 per cent. Impact Though generally VC does not look at Short Term Capital Gains, However, if some VC holding listed securities, want to exit in short term (may be because share market is not doing well) then they have to pay 15% Short Term Capital Gain Tax instead of 10% earlier. In any case funds from Mauritius or like tax heavens will not be affected due to DTAA. Budget Proposal Anti AIDS drug, Atazanavir, as well as bulk drugs for its manufacture are to be exempted from excise duty. Impact
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VC may look at investment opportunities in Pharma Sector, specifically in area as mentioned above. If VC who have already invested in above area may expect better returns on their investments and accordingly they may plan their entry and exits. Budget Proposal Excise duty being exempted on end-use basis, on refrigeration equipment (consisting of compressor, condenser units, evaporator, etc) above 2 TR (tonne refrigeration) utilising power of 50 KW and above. Impact VC who have invested in above can expect better returns on their investments and accordingly they may plan their exits.
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FINDINGS
VCF is in its nascent stages in India. The emerging scenario of global competitiveness has put an immense pressure on the industrial sector to improve the quality level with minimization of cost of products by making use of latest technological skills. The implication is to obtain adequate financing along with the necessary hi-tech equipments to produce an innovative product which can succeed and grow in the present market condition. Unfortunately, our country lacks on both fronts. The financing firms expect a sound, experienced, mature and capable management team of the company being financed. The payback period is also generally high (5 - 7 years). The various queries can be outlined as follows: 1. 2. 3. 4. 5. Requirement of an experienced management team. Requirement of an average rate of return on investment. Longer payback period Uncertainty regarding the success of the product in the market. Questions regarding the infrastructure details of production like plant location, accessibility, relationship with the suppliers and creditors, transportation facilities, labour availability etc. 6. 7. 8. 9. 10. 11. The category of potential customers and hence the packaging and pricing details of the product. Less knowledge of the market size . Lack of information regarding Major competitors and their market share. Skills and Training required and the cost of training. Problems in raising of funds It is not known from whom the permission should be sought to start a venture capital activity (it is not clearly spelt out). CCI was to give permission but has been wound up now.
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12. 13.
UTI-assisted funds are tax-exempt, not others. Thus, other venture capital funds are at a disadvantage. Eligibility certificate is needed for capital gains tax exemption. Canfina VCF needs to get permission from ICICI, IDBI—its competitors. They may not know anything about the project. Canfina-VCF has to provide them all the data.
14.
Lack of broad knowledge base.
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SUGGESTIONS
The following things are essential for the success of venture capital in any country: 1. In order to establish a thriving venture capital industry, all economic players must participate. 2. Participate in those acquisitions that transfer technology to India.
3. VC funds should be managed by professionals with proper check & balance. 4. Documents. Prepare three documents: (i) a thoughtfully reasoned full business plan; (ii) a one to two page executive summary of the business plan; and (iii) a PowerPoint presentation. A full business plan should include a business model, financial projections and assumptions. 5. Life cycle. Know with certainty where your company is in the life cycle and target investors accordingly. Is your company in the hangar, on the runway, taking off or at cruising altitude? 6. Deregulated economic environment: A less regulated and controlled business and economic environment where attractive customer opportunities exist or could be created for high-tech and quality products. 7. Disinvestment mechanism: Existence of disinvestment mechanisms, particularly an over-the counter stock exchange catering to the needs of SMEs. 8. Broad knowledge base: A more general, business and entrepreneurship oriented education system where scientists and engineers have knowledge of accounting, finance and economics. 61
9. Management training: An effective management education and training programme for developing professionally competent and committed venture capital managers trained to evaluate and manage high-tech, high risk ventures is necessary. 10. Technological competitiveness: Encouraging and funding of R&D by private and public sector companies and the government, for ensuring technological competitiveness. 11. Marketing thrust: A vigorous marketing thrust, promotional efforts and development strategy, business incubators etc. for the growth of venture capital. 12. Due Diligence: Review a sample due diligence request. Prepare a due diligence binder. This facilitates the fund raising process and gives the positive impression of being highly organized.
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CONCLUSION
Venture Capital can play a more innovative and developmental role in a developing country like India. It could help the rehabilitation of sick units through people with ideas and turnaround management skills. The world is becoming increasingly competitive. Companies are required to be super efficient with respect to cost, productivity, and labour efficiency, technical back up, flexibility to consumer demand, adaptability and foresightedness. There is an impending demand for highly cost effective, quality products and hence the need for right access to valuable human expertise to guide and monitor along with the necessary funds for financing the new projects. The Government of India in an attempt to bring the nation at par and above the developed nations has been promoting venture capital financing to new, innovative concepts & ideas, liberalizing taxation norms providing tax incentives to venture firms, giving a Philip to the creation of local pools of capital and holding training sessions for the emerging VC investors. There are large sectors of the economy that are ripe for VC investors, like,. I.T., Pharma, Manufacturing. Telecom, Retail franchises, food processing and many more. By combining risk financing with management and marketing assistance , venture capital thus could become an effective instrument in fostering the development of entrepreneurship and transfer of technology on developing countries.
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