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Venture Capital
Venture Capital:
Meaning:
• VC plays a strategic role as a source of finance especially in case of small scale,
high technology drivers and risky ventures
• VC refers to the capital provided by venture capital companies to new industrial
entrepreneurs for financing industrial projects which are new and innovative,
and are essential for the economic development of a country but are highly risky
• A b/s organization involving in new, innovative and risky business/projects may
not be able to get its financial requirement fulfilled from any traditional sources.
• Therefore they approach a specialized agency specially meat for financing such
projects. Such agencies are known as venture capitalists or venture capital firms
Concept:
In a narrow sense: Investment in new and tried enterprises that lack
stable growth
In a broad sense: Commitment of capital as shareholding , for the
formulation and setting up of small firms specializing in new ideas or
new technologies
Definition of Venture capital:
“Venture capital is an equity or equity featured capital seeking
investment in new ideas, new companies, new production, new process
or new services that offer the potential of high returns on investment”
International Finance Corporation(IFC)
Features of VC
1. VC is usually in the form of an equity participation
2. It may also take the form of convertible debt or long term loans
3. Investment is made only in high risk but also high growth potential
projects.
4. VC is available only for commercialization of new ideas or new
technologies
5. VC joins the entrepreneur as a co promoter in projects and share the
risk and rewards of the enterprise.
6. There is a continuous involvement in business after making an
investment to the investor
7. Investment is usually made in small and medium scale enterprises
Importance of VC:
1. Advantages to the investing public’:
If the public invests in the venture fund who in turn will invest in
equity of new business, this will reduce the risk of the public and
malpractice by the management can also be reduced
The venture fund equipped with necessary skills will be ale to analyze
the prospects of the business
The investors do not have any means to ensure that the affairs of the
business are conducted prudently. The venture fund having
representatives on the board of directors of the company would
overcome it.
Importance of VC:
2. To the promoter:
The entrepreneur for the success of public issue is required to convince
underwriters, brokers, and thousands of investors but obtain venture
capital assistance , he will be required to sell his idea to justify the
official of the venture fund.
The expenses of the public issue of the equity share will be less if it is
through venture fund capitalists.
3. General:
The public issue through the developed venture capital institution is
fast.
The venture capitalist will assist in the smooth functioning of the
business
A venture capital firm serves as an intermediary between investors
looking for high returns for their money and entrepreneurs in search of
need capital for their start ups
New Product or project Development Process:
 Idea Generation
 Idea screening
 Concept Development Testing
 Marketing strategy Development
 Business analysis
 Product development
 Test Marketing
 Commercialisation
Stages of Venture Capital-Financing
Every company is different – that is why the different investment-stages vary in
each start up and can only be roughly divided.
two general stages: The Early Stage and the Expansion Stage.
Early stage: Seed Stage
General description –
 This stage starts with an idea for a product, technology or service.
 The most important targets now are the development of a
prototype, the definition of relevant markets and the formulation of
a corporate concept.
 The primary task of the Seed-Stage is to estimate the chances of
success for the new enterprise.
Seed-Financing
In this early stage of the company, the company needs a comparatively
low capital expenditure.
As there is no marketable product or a thorough market analysis yet, an
investment in this stage involves great risks.
Business Angels and VC-networks are preferred contact points for
entrepreneurs, because they have the needed know-how and typically
invest smaller amounts than venture capital firms.
Start Up-Stage
First ,market analyses have been accomplished and the product is on its way from
the development stage to the market launch. (Product development and Test
marketing)
This type of financing is provides fund to those companies that have been in
business for a short time but have not yet sold their products in the market – they
are prepared with b/s plan and market studies
Start Up Financing – Because of the many requirements in the Start Up-stage,
capital requirements increase, too.
In addition to Business Angels, networks, friends and family, venture capital firms
can now start to invest higher expenditure and engage in the long-term development
of the company.
First Stage
General description –
Once the product is thoroughly tested and ready for market, the FirstStage-financing starts with the market launch.
First-Stage-Financing – Now the invested capital is needed for the
further development of the company, especially in sales, marketing and
production facilities.
Therefore, the First-Stage has higher capital requirements, but also, the
loss-making Early-Stage comes to an end. Venture capital firms are
typical investors in this stage.
Expansion: Second Stage
General description –
The Second Stage is about market expansion, additional production
capacities and product diversification to stand out from competition
and to balance product-specific fluctuations through a broad range of
services.
Second Stage–Financing
The enterprise is usually growing exponentially in this stage, so the
generated gains often cannot provide for further expansion. This is why
the company typically still resorts to venture capital firms and
subsidies.
Bridge Stage
General description –
If the company has successfully run through the first expansion stages ,
the next step might be an acquisition of another company or a joint
venture, which will need further financing.
Bridge-Financing – Now that the enterprise has reached maturity,
flotation or corporate succession.
It is a method of financing used by companies before their IPO, to
obtain necessary cash for the maintenance of operations. Bridge
financing is designed to cover expenses associated with the IPO and is
typically short-term in nature. Once the IPO is complete, the cash raised
from the offering will immediately payoff the loan liability.
Buyout Financing:
• Acquisition financing
• Leveraged Buyout – Management buyout
The purchase of a company's shares in which the acquiring party gains controlling
interest of the targeted firm
The acquisition of another company using a significant amount of borrowed money
(bonds or loans) to meet the cost of acquisition.
Often, the assets of the company being acquired are used as collateral for the loans
in addition to the assets of the acquiring company.
The purpose of leveraged buyouts is to allow companies to make large acquisitions
without having to commit a lot of capital.
Venture Financing Methods:
Three forms: equity, conditional loans and income notes.
1.Equity
All VCFs in India provide equity. Generally, their contribution may not
exceed 49 per cent of the total equity capital. Thus, the effective control
and majority ownership of the firm may remain with the entrepreneur.
When a venture capitalist contributes equity capital, he acquires the
status of an owner, and becomes entitled to a share in the firm’s profits
as much as he is liable for losses.
VCFs buy shares of an enterprise with an intention to ultimately sell
them off to make capital gains.
The advantage to the VCF is that it can share in the high value of the
venture and makes capital gains if the venture succeeds.
But the flip side is that the VCF will lose if the venture is
unsuccessful. Venture financing is a risky business.
2. Conditional loan
For the venture capitalist – equity participation is less preferable as it
is an unsecured method of financing.
A conditional loan is repayable in the form of a royalty after the
venture is able to generate sales.
No interest is paid on such loans in India, VCFs charged royalty
ranging between 2 and 15 per cent gestation period, cost-flow patterns,
risk and other factors of the enterprise.
Some VCFs gave a choice to the enterprise of paying a high rate of
interest (which could be well above 20 per cent) instead of royalty on
sales once it becomes commercially sound.
Some funds recovered only half of the loan if the venture failed.
3.Conventional loan:
A straight or conventional loan, involving fixed payments, would be
unsuitable form of providing assistance to a new, risky venture.
New ventures have the problem of cash flows in the initial years of
their development; hence they are not able to service debt.
4.Income note
A unique way of venture financing in India was income note.
It was a hybrid security which combined the features of both
conventional loan and conditional loan.
The entrepreneur had to pay both interest and royalty on sales, but at
substantially low rates.
Funds were made available in the form of unsecured loans at a lower
rate of interest during development phase and at a higher rate after
development.
In addition to interest charges, royalty on sales could also be charged.
Other financing methods
A few venture capitalists, particularly in the private sector introduced
innovative financial securities.
The participating debenture; is an example of innovative venture
financial.
Such security carries charges in three phases:
1. In the start-up phase, before the venture attains operations to a
minimum level, no interest is charged.
2. After this, a low rate of interest is charged up to a particular level of
operation.
3. Once the venture starts operating on full commercial basis, a high
rate of interest is required to be paid.
VCFs in India provide venture finance through partially or fully
convertible debentures and cumulative convertible preference share
(CPP)
Venture Leasing:
Venture capital backed start ups rely on the continued funding from
outside investors to support them until their business models are proven
or profitability is achieved.
The term venture leasing describes the leasing of equipment to preprofit, early stage companies funded by venture capital investors.
These companies, like most growing businesses, need computers,
networking equipment, furniture, telephone equipment, and equipment
for production and R&D.
Venture leasing companies provide the capital to lease equipment and
software in exchange for equity or stock options and warrants for
future equity.
Leasing provides maximum flexibility for the lessee as equipment leases
are generally without loan covenants.
The lessor and lessee can match the term of the lease to the equipment
asset life and usage needs, thus reducing equipment obsolescence
factors.
Venture Leasing in the Financing Risk Chain
If a start up does poorly, the venture lessor will probably be able to
cover costs through lease payments and/or equipment seizure
A venture lessor takes on less risk backing a company who has passed
the scrutiny of a reliable venture capital firm
This is the reason why most Venture Leasing companies prefer business
with companies that have VC backing.
The Process:
•
Venture leasing companies work the same as regular leasing
companies, except they are willing to take greater risks.
• Venture leasing companies are interested in reviewing the same
business plan and financial statements as banks, venture capitalists
and investment bankers.
A startup company will normally qualify for a venture lease under the
following conditions:
• The company is receiving funding from a respected VC Company or
Angel Investor.
• In most circumstances the LLOC (Lease Line of Credit) is granted
in conjunction with a VC investment.
Legal Aspect:
Venture Capital in India is governed by the
• SEBI Act, 1992 and
• SEBI (Venture Capital Fund) Regulations, 1996.
Venture Capital funds and Foreign Venture Capital Investors are also covered by
• Securities Contract (Regulation) Act, 1956,
• SEBI (Substantial Acquisition of Shares & Takeover) Regulations, 1997,
• SEBI (Disclosure of Investor Protection) Guidelines, 2000.
According to which, any company or trust proposing to carry on activity of a
Venture Capital Fund shall get a grant of certificate from SEBI[10].
However, registration of Foreign Venture Capital Investors (FVCI) is not
obligatory under the FVCI regulations.
Venture Capital Fund: means a fund established in the form of a trust or a
company and registered under these regulations which
1) Has a dedicated pool of capital;
2) Raised in a manner specified in the regulations and
3) Invest in accordance with the regulation
Constitution of Venture Capital Funds
There are three layers of structured or institutional venture capital funds i.e.
1. Venture capital funds set up by high net worth individual investors,
2. Venture capital subsidiaries of corporations and
3. Private venture capital firms/ funds.
Venture funds in India can be divided on the basis of the type of promoters.
1. Venture Capital Funds promoted by the Central government controlled by
development financial institutions such as
• Technology Development and Information Company of India (TDICI), by
ICICI,
• Risk capital and Technology Finance Corporation Limited (RCTFC) by the
Industrial Finance Corporation of India (IFCI) and
• Risk Capital Fund by IDBI.
2. It is promoted by the state government-controlled development finance
institutions such as
• Andhra Pradesh Venture Capital Limited (APVCL) by Andhra Pradesh State
Finance Corporation (APSFC) and
• Gujarat Venture Finance Company Limited (GVCFL) by Gujarat Industrial
Investment Corporation (GIIC)
3. Also, promoted by Public Sector banks
4. Venture Capital Funds promoted by the foreign banks or private sector
companies and financial institutions such as
Eg:Indus Venture Fund and Grindlay's India Development Fund.
SEBI (Venture Capital Funds) Regulation 1996 and SEBI
(FVCI)Regulation 2000
Who can apply for VCF? : Company/Trust/Body corporate
Eligibility Criteria for VCF:
• MoA or Trust Deed must have main objective to carry on action of
Venture Capital Fund
• Prohibition by Memorandum of Association & Article of Association for
making an invitation to the public to subscribe to its securities.
• Director or Principal Officer or Employee or Trustee is not involved in
any litigation connected with the securities market
• Director or Principal Officer or Employee or Trustee has not at any time
been convicted of any offence involving moral turpitude or any economic
offence.
•
Also, in case of, body corporate, it must have been set up under Central
or State legislations and applicant has not been refused certificate by
SEBI.
•
A Venture Capital Funds may generate investment from any investor
(Indian, Foreign or Non-resident Indian) by means of issue of units and
no Venture Capital Fund shall admit any investment from any investor
which is less than five Lakhs.
• It is also mandatory that VCF shall have firm commitment of at
least five Crores from the Investors before the start of functions by
the VCF.
• Disclosure of investment strategy to SEBI before registration
It shall not invest more than twenty five percent of the funds in one
Venture Capital Undertaking.
Also, minimum 66.67% of the investible funds shall be utilized in
unlisted equity shares or equity linked instruments of Venture Capital
Undertaking.
Investment Conditions and restrictions:
It is also mandatory that not more than 33.33% of the investible funds
may be invested by way of following as stated below:1. Subscription to IPO of a Venture Capital Undertaking (VCU)
2. Debt or debt instrument of a VCU in which VCF has already made
an investment by way of equity
3. Preferential allotment of equity shares of a listed company subject to
lock in period of one year
4. The equity shares or equity linked instruments of a monetarily weak
company or a sick industrial company whose shares are listed.
5. SPV (special purpose vehicles) which are created by VCF for the
purpose of making possible investment.
Exit Route:
Initial Public Offering (IPO) :
• IPO is about offering company shares in the market for public to
buy or sell.
• IPO constitutes the most preferred route for VC exit as it offers
flexibility to investors in terms of time, price and quantity.
• Through this route, investors can decide when to sell, at what price
to sell and in what quantity to sell depending upon the market
scenario.
• IPO gives a perfect opportunity to reap benefits for their
investment.
Mergers & Acquisition:
• M&A offers an opportunity to investors to sell company shares
(partially /fully) to another company.
• In this case, investors doesn’t have enough flexibility since pricing,
timing and quantity are decided simultaneously during the process
and thereby investors don’t have control over the exit.
Shares buyback:
• Company promoters or entrepreneur can buy back the company’s
shares from Investors on a fixed price after negotiation.
• However, investors would like to go for this VC exit option only
when IPO & M&A route is not available to them and company is
not doing well in terms of meeting expectations of investors.
Sale to Other Strategic Investor/Venture Capital Fund: It is quite
possible that VC prefer to offload their shares to other strategic
investors which could be either bigger angel investors or venture capital
funds who are ready to put more money into the business.
NEED FOR A VIBRANT VENTURE
CAPITAL INDUSTRY IN INDIA
• Venture Capital Fund can provide the following
urgently needed support for a robust growth of industry
in India:
 Finance new and rapidly growing companies
 Typically knowledge-based, sustainable, up scalable
companies
 Purchase equity / quasi-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
How Venture Capital was promoted in India:
•
Given the virtual monopoly of public sector financial institutions and
in particular Development Financial Institutions in the financial
intermediation until the reform period of 1990s, the initiatives for
venture capital also were taken by them.
•
In 1975, venture capital financing was introduced by the all-India
financial institutions with the inauguration of the Risk Capital
Foundation (RCF) sponsored by Industrial Finance Corporation of
India (IFCI) to supplement promoters' equity as means of encouraging
technologists and professionals to promote new industries.
•
In 1976, the seed capital scheme was introduced by Industrial
Development Bank of India (IDBI).
• Until 1984, venture capital took the form of risk capital and seed
capital.
• 1984 – ICICI allocates funds for high risk enterprises.
• 1985 - The government announced the creation of a Venture Capital
Fund (VCF) in December
• 1986 - The Fund became operational. Administered by IDBI
• 1988 – First comprehensive guidelines governing venture capital
funds were framed.
IFCI sponsored RCF was converted into the Risk Capital and
Technology Finance Corporation of India Ltd.
•
1989 - Unit Trust of India sponsored venture capital unit schemes.
State Bank of India operated through its subsidiary SBI Caps.
ICICI flagged off a new venture capital company called Technology
Development and Information Company of India (TDICI)
Canara Bank has set up a separate Asset Management Company
Features of Venture Capital Agencies
•
•
•
•
•
•
Investment in high-risk, high-returns ventures
Participation in management
Expertise in managing funds
Raises funds from several sources
Diversification of the portfolio
Exit after specified time
Funding Agency
• A funding body or agency is an organization
that provides research funding in the form
of research grants or scholarships. These
include arts councils and research councils for
the funding of science.
Reliance Venture
• Is a corporate venture capital company based
in Mumbai, Maharashtra.
• It has been promoted by the Reliance ADA
Group. It has advised and invested in deals to the
tune of over $4 billion in various companies.
• It has invested in companies such as India's
largest online travel portal, Yatra.com, Stoke Inc.,
Pelago Inc., E-Band Communications and two
MIT-startups and Scalable Display Technologies.
• It was recently ranked 30th in the Red Herring
Top 100 Global Venture Capital Firms in 2009
Helion Venture Partners
• Helion Ventures Partners is a $600 million venture
fund based in Mauritius.
• It invests in early to mid-stage companies in India
in sectors such as Outsourcing, Internet, Mobile,
Technology Products, Retail, Education and
Financial Services.
• Helion is advised by a team of advisors based in
India. The advisors help the fund to select
companies to invest in.
• And post investment the advisors work with the
companies in areas such as finance, HR,
technology, marketing and operations.
Helion Venture Partners
• Helion Ventures Partners is a $600 million venture fund
based in Mauritius.
• It invests in early to mid-stage companies in India in
sectors such as Outsourcing, Internet, Mobile,
Technology Products, Retail, Education and Financial
Services.
• Helion is advised by a team of advisors based in India.
The advisors help the fund to select companies to
invest in.
• And post investment the advisors work with the
companies in areas such as finance, HR, technology,
marketing and operations.