20750325 REPORT on Venture Capital

7/28/2019 20750325 REPORT on Venture Capital

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FINAL REPORT

ON

Study of Venture Capital

in India and its AspectsSubmitted in partial fulfilment of the requirement ofMBA Degree of

Maharshi Dayanand University, Rohtak

Under the supervision of:

Mr Vivek Bhatia

Faculty International Business, ITM Gurgaon

Submitted by:

sandeep arora

07-MBA-127

Session 2007-2009

Institute of Technology and Management

Gurgaon


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Acknowledgement

No Learning is proper and effective withoutProper Guidance

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

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

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

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

situation.

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

period was a heavy task.

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

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

operation of people to make it successful.

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

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

their continuous support in my research and writing efforts.

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

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

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

I am extremely grateful to management of Institute of Technology &

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

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

guidance and blessings


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Table of Content

1. Introduction

2. SignificanceofStudy

3. Objective of Study

4. ResearchMethodology

Literature Review

ConceptualFramework

Operational Definition

5. Analysis & Interpretation

6. Findings

7. Suggestions

8. Conclusion

9. Limitation

10. Bibliographies

11. Annexure

ANNEXUREI NAMEOFVENTURECAPITALFIRMS

OUTSIDEOFINDIA

ANNEXUREIINAMEOFVENTURECAPITALFIRMSIN

INDIA.


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Introduction

Anumberof technocratsareseeking tosetupshopon theirownandcapitalizeon

opportunities.Inthehighlydynamiceconomicclimatethatsurroundsustoday,few

traditionalbusinessmodelsmay survive.Countries across the globe are realizing

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

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

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

withlessthan20employeesandonly7%arecreatedbycompanieswith500ormore

employees.Thisgrowingtrendcanbeattributedtorapidadvancesintechnologyin

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

entertainmentandserviceshavebecomethecynosureofboursesworldwide.Inthese

sectors,itisinnovationandtechnicalcapabilitythatarebigbusiness-drivers.Thisis

aparadigm shift from the earlierphysicalproduction and economies of scale

model. However, starting an enterprise is never easy. There are a number of

parametersthatcontributetoitssuccessordownfall.Experience,integrity,prudence

and a clear understanding of the market are among the sought after qualities of a

promoter. However, there are other factors, which liebeyond the control of the

entrepreneur.Prominentamongtheseis the timely infusionoffunds.This iswhere

theventurecapitalistcomesin,withmoney,businesssenseandalotmore.


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What is Venture Capital???

Theventurecapitalinvestmenthelpsforthegrowthofinnovativeentrepreneurships

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

conventional, risky finance to new venturesbased on innovative entrepreneurship.

Venturecapital isan investment in the formofequity,quasi-equityandsometimes

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

technically orprofessionally qualified entrepreneur. Venture capital means risk

capital.Itreferstocapitalinvestment,bothequityanddebt,whichcarriessubstantial

risk anduncertainties. The risk envisaged maybe very high maybe sohigh as to

resultintotallossorverylesssoastoresultinhighgains

TheconceptofVentureCapital

Venturecapitalmeansmanythingstomanypeople.Itisinfactnearlyimpossibleto

comeacrossonesingledefinitionoftheconcept.

Jane Koloski Morris, editor of the well known industrypublication, Venture

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

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

demonstrated theirbusinesspotentialbutdonotyethaveaccess to thepublic

securitiesmarketortocreditorientedinstitutionalfundingsources.

The European Venture Capital Association describes it as risk finance for

entrepreneurialgrowthorientedcompanies.Itisinvestmentfor themediumor long

term return seeking to maximize medium or long term forbothparties. It is a

partnershipwiththeentrepreneurinwhichtheinvestorcanaddvaluetothecompany

becauseofhisknowledge,experienceandcontactbase.

Meaningofventurecapital:

Venture capital is money provided by professionals who invest alongside

managementinyoung,rapidlygrowingcompaniesthathavethepotentialtodevelop

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

equityforstart-upcompanies.


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Professionally managed venture capital firms generally areprivatepartnerships or

closely-held corporations fundedbyprivate andpublicpension funds, endowment

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

venturecapitaliststhemselves.

Venturecapitalistsgenerally:

Financenewandrapidlygrowingcompanies

Purchaseequitysecurities

Assistinthedevelopmentofnewproductsorservices

Addvaluetothecompanythroughactiveparticipation

Takehigherriskswiththeexpectationofhigherrewards

Havealong-termorientation

When considering an investment, venture capitalists carefully screen the technical

andbusiness merits of theproposed company. Venture capitalists only invest in a

smallpercentage of thebusinesses they review and have a long-termperspective.

They also activelyworkwith the company's management, especiallywith contacts

andstrategyformulation.

Venturecapitalistsmitigatetheriskofinvestingbydevelopingaportfolioofyoung

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

professional venture capital firms. In addition, many venturepartnerships manage

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

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

significant job creation, economic growth and international competitiveness.

Companies such as Digital Equipment Corporation, Apple, Federal Express,

Compaq,SunMicrosystems,Intel,MicrosoftandGenetecharefamousexamplesof

companiesthatreceivedventurecapitalearlyintheirdevelopment.

(Source:NationalVentureCapitalAssociation1999Yearbook)


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PrivateEquityInvesting

Venturecapitalinvestinghasgrownfromasmallinvestmentpool inthe1960sand

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

institutionalandcorporateinvestmentportfolio.Recently,someinvestorshavebeen

referringtoventureinvestingandbuyoutinvestingas"privateequityinvesting."This

termcanbeconfusingbecausesomeintheinvestmentindustryusetheterm"private

equity"toreferonlytobuyoutfundinvesting.Inanycase,aninstitutional investor

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

assetssuchasprivateequityorventurecapitalaspartoftheiroverallassetallocation.

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

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

endowments,foundations,insurancecompanies,banks,individualsandotherentities

whoseektodiversifytheirportfoliowiththisinvestmentclass.

WhatisaVentureCapitalist?

Thetypicalperson-on-the-streetdepictionofaventurecapitalististhatofawealthyfinancierwhowantstofundstart-upcompanies.Theperceptionisthatapersonwho

developsabrandnewchange-the-world inventionneedscapital; thus, if they cant

getcapitalfromabankorfromtheirownpockets, theyenlistthehelpofaventure

capitalist.

In truth, venture capital andprivate equity firms arepools of capital, typically

organized as a limitedpartnership that invests in companies that represent the

opportunityforahighrateofreturnwithinfivetosevenyears.Theventurecapitalist

maylookatseveralhundredinvestmentopportunitiesbeforeinvestinginonlyafew

selectedcompanieswithfavorable investmentopportunities.Farfrombeingsimply

passive financiers, venture capitalists foster growth in companies through their

involvement in themanagement, strategicmarketingandplanningof their investee

companies.Theyareentrepreneursfirstandfinancierssecond.

Even individuals maybe venture capitalists. In the early days of venture capitalinvestment,inthe1950sand1960s,individualinvestorswerethearchetypalventure


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

modernventurefirmemergedasthedominantventureinvestmentvehicle.However,

inthelastfewyears,individualshaveagainbecomeapotentandincreasinglylarger

partoftheearlystagestart-upventurelifecycle.These"angelinvestors"willmentora company andprovide needed capital and expertise to help develop companies.

Angelinvestorsmayeitherbewealthypeoplewithmanagementexpertiseorretired

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

development.

Factor to be considered by venture capitalist in

selection of investmentproposalTherearebasicallyfourkeyelements infinancingofventureswhicharestudiedin

depth by the venture capitalists. These are:

1. Management: The strength, expertise & unity of the keypeople on theboard

bring significant credibility to the company. The members are to be mature,

experienced possessing working knowledge of business and capable of taking

potentiallyhighrisks.

2.Potential for Capital Gain: Anaboveaveragerateofreturnofabout30-40%is

requiredbyventurecapitalists.Therateofreturnalsodependsuponthestageofthe

businesscyclewhere fundsarebeingdeployed.Earlier thestage,higher is the risk

andhencethereturn.

3. Realistic Financial Requirement and Projections: The venture capitalist

requiresarealisticviewaboutthepresenthealthoftheorganizationaswellasfuture

projections regarding scope, nature andperformance of the company in terms of

scaleofoperations,operatingprofitandfurthercostsrelatedtoproductdevelopment

throughResearch&Development.

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

entrepreneur/owner in thebusiness including the fundsinvestedbyfamily, friends

andrelativesplayaveryimportantroleinincreasingtheviabilityofthebusiness.It

isanimportantavenuewheretheventurecapitalistkeepsanopeneye.


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A Brief History

Theconceptofventurecapitalisnotnew.Venturecapitalistsoftenrelatethestoryof

ChristopherColumbus.Inthefifteenthcentury,hesoughttotravelwestwardsinstead

ofeastwardsfromEuropeandsoplannedtoreachIndia.Hisfar-fetchedideadidnot

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

IsabellaofSpaindecidedtofundhimandthevoyagesofChristopherColumbusare

nowempanelledinhistory.

ThemodernventurecapitalindustrybegantakingshapeinthepostWorldWarII

years. It isoften said thatpeopledecide tobecomeentrepreneursbecause they see

role models inotherpeople who havebecome successful entrepreneurs. Much the

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

organizedventurecapitalindustryhadseveralrolemodels,includingthesethree:

American Research and Development Corporation, formed in 1946, whose

biggestsuccesswasDigitalEquipment.ThefounderofARDwasGeneralGeorges

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

capital."Inthe1950s,hetaughtattheHarvardBusinessSchool.Hislecturesonthe

importance of risk capital were considered quirkyby the rest of the faculty, who

concentratedonconventionalcorporatemanagement.

J.H.Whitney&Coalsoformedin1946,oneofwhoseearlyhitswasMinuteMaid

juice.JockWhitneyisconsideredoneoftheindustrysfounders.

TheRockefellerFamily, and inparticular,LSRockefeller, oneofwhoseearliest

investmentswasinEasternAirlines,whichisnowdefunctbutwasoneoftheearliest

commercialairlines.

The Second World War produced an abundance of technological innovation,

primarilywithmilitaryapplications.Theyinclude,forexample,someoftheearliest

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


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intended to commercialize an orangejuice concentrate that hadbeen developed to

providenourishmentfortroopsinthefield.

Inthemid-1950s,theU.S.federalgovernmentwantedtospeedthedevelopmentof

advancedtechnologies.In1957,theFederalReserveSystemconductedastudythat

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

developmentofwhat it called"entrepreneurialbusinesses."Asa response this a

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

"leverage"theirprivatecapitalbyborrowingfromthefederalgovernmentatbelow-

market interest rates. Soon commercialbanks were allowed to form SBICs and

withinfouryears,nearly600SBICswereinoperation.

Atthesametimeanumberofventurecapitalfirmswereformingprivatepartnerships

outsidetheSBICformat.Thesepartnershipsaddedtotheventurecapitaliststoolkit,

byofferingadegreeofflexibilitythatSBICslack.Withinadecade,privateventure

capitalpartnershipspassedSBICsintotalcapitalundermanagement.

The1960ssawatremendousbullIPOmarket thatallowedventurecapital firmsto

demonstrate theirability tocreatecompaniesandproducehuge investment returns.

For example, when Digital Equipment wentpublic in 1968 itprovided ARD with

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

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

capitalbecame a hot market,particularly for wealthy individuals and families.

However,itwasstillconsideredtooriskyforinstitutionalinvestors.

Inthe1970s,though,venturecapitalsufferedadouble-whammy.First,ared-hotIPO

marketbroughtover1,000venture-backedcompaniestomarketin1968,thepublic

marketswentintoaseven-yearslump.Therewerealotofdisappointedstockmarket

investorsandalotofdisappointedventurecapitalinvestorstoo.Thenin1974,after

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

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

pensionfundlegislation,venturecapitalfundraisinghitrockbottomin1975.

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

legislative and regulatory changes gradually improved the climate for venture


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investing.FirstCongressslashedthecapitalgainstaxrateto28%from49.5%.Then

theLaborDepartmentissuedaclarificationthateliminatedthepensionfundsactas

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

high-profileIPOsbyventure-backedcompanies.TheseincludedFederalExpress in1978, and Apple Computer and Genetech Inc in 1981. This rekindled interest in

venturecapitalonthepartofwealthyfamiliesandinstitutionalinvestors.Indeed,in

the1980s,theventurecapitalindustrybeganitsgreatestperiodofgrowth.In1980,

venturefirmsraisedandinvestedless thanUS$600million.Thatnumbersoaredto

nearly US$4bnby 1987. The decade also marked the explosion in thebuy-out

business.

Thelate1980smarkedthetransitionof theprimarysourceofventurecapitalfunds

fromwealthyindividualsandfamiliestoendowment,pensionandotherinstitutional

funds.Thesurgeincapital in the1980shadpredictableresults.Returnsonventure

capitalinvestmentsplunged.Manyinvestorswentintothefundsanticipatingreturns

of30%orhigher.Thatwasprobablyanunrealisticexpectation tobeginwith.The

consensustodayisthatprivateequityinvestmentsgenerallyshouldgivetheinvestor

aninternalrateofreturnsomethingtotheorderof15%to25%,dependinguponthe

degreeofriskthefirmistaking.

However,by1990,theaveragelong-termreturnonventurecapitalfundsfellbelow

8%,leading toyetanotherdownturn inventurefunding.Disappointedfamiliesand

institutionswithdrewfromventure investing indroves in the1989-91periods.The

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

reversing the trend inbothprivate equity investmentperformance andpartnership

commitments.

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

straightyearofgrowth. It raisedUS$25bn incommittedcapital for investmentsby

venture firms, who invested over US$16bn into domestic growth companies US

firms have traditionallybeen thebiggestparticipants in venture deals,but non-US

venture investment is growing. In India, venture fundingmore thandoubled from

$420millionin2002toalmost$1billionin2003.Forthefirsthalfof2004,venture

capitalinvestmentrose32%from2003.


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Venture Capital in INDIA

Venture capital was introduced in India in mid eightiesby All India Financial

Institutions with the inauguration of Risk Capital Foundation (RCF) sponsoredby

IFCIwithaviewtoencouragethetechnologistsandtheprofessionaltopromotenew

industries. Consequently the government of Indiapromoted the venture capital

during 1986-87by creating a venture capital fund in the context of structural

development and growth of small-scalebusiness enterprises. Since then several

venturecapital firms/funds (VCFs)are incorporatedbyFinancial Institutions (FIs),

PublicSectorBanks(PSBs),and PrivateBanksandPrivateFinancialcompanies.

The Indian Venture Capital Industry (IVCI) isjust about a decade old

industry as compared to that in Europe and US. In this short span it has nurtured

closetoonethousandventures,mostlyinSMEsegmentandhassupportedbuilding

technocrat/professionals allthrough.TheVCindustry,throughitsinvestmentinhigh

growthcompaniesaswellascompaniesadoptingnewertechnologiesbackedbyfirstgenerationentrepreneurs,hasmadeasubstantialcontribution toeconomy.In India,

however,thepotentialofventurecapitalinvestmentsisyettobefullyrealized.There

arearound thirtyventurecapitalfunds,whichhavegarneredoverRs.5000Crores.

TheventurecapitalinvestmentsinIndiaatRs.1000.05croreasin1997,representing

0.1percentofGDP,ascomparedto5.5percentincountriessuchasHongKong.

Investment Philosophy


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Venturecapitalistscanbegeneralists,investinginvariousindustrysectors,orvarious

geographiclocations,orvariousstagesofacompanyslife.Alternatively,theymay

bespecialistsinoneortwoindustrysectors,ormayseektoinvestinonlyalocalized

geographicarea.

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

companiesthatareintheirinitialstart-upmodes,venturecapitalistswillalsoinvest

in companies at various stages of thebusiness life cycle.Aventure capitalistmay

invest before there is a real product or company organized (so called "seed

investing"),ormayprovidecapitaltostartupacompanyinitsfirstorsecondstages

of development known as "early stage investing." Also, the venture capitalist may

provideneededfinancingtohelpacompanygrowbeyondacriticalmasstobecome

moresuccessful("expansionstagefinancing").

Theventurecapitalistmayinvestinacompanythroughoutthecompanyslifecycle

and therefore some funds focus on later stage investingbyproviding financing to

helpthecompanygrowtoacriticalmasstoattractpublicfinancingthroughastock

offering.Alternatively,theventurecapitalistmayhelpthecompanyattractamerger

or acquisition with another company by providing liquidity and exit for thecompanysfounders.

At theotherendof the spectrum, someventure funds specialize in theacquisition,

turnaround or recapitalization of public and private companies that represent

favorableinvestmentopportunities.

Thereareventurefundsthatwillbebroadlydiversifiedandwillinvestincompanies

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

restaurantsandothersthatmaybespecialistsinonlyonetechnology.

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

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

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

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

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

onlyin"sociallyresponsible"start-upendeavors.


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Thebasicprincipalunderlyingventurecapitalinvestinhigh-riskprojectswiththe

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

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

conventional sources such as banks and financial institutions. Typically firstgeneration entrepreneurs start such enterprises. Such enterprises generally do not

haveanymajorcollateraltoofferassecurity,hencebanksandfinancialinstitutions

areaversetofundingthem.Venturecapitalfundingmaybebywayofinvestmentin

theequityofthenewenterpriseoracombinationofdebtandequity,thoughequityis

themostpreferredroute.

Sincemostoftheventuresfinancedthroughthisrouteareinnewareas(worldwide

venture capital follows "hot industries" like InfoTech, electronics and

biotechnology), theprobabilityofsuccess isvery low.Allprojects financeddonot

give a high return. Some projects fail and some give moderate returns. The

investment,however,isalong-termriskcapitalassuchprojectsnormallytake3to7

yearstogeneratesubstantialreturns.Venturecapitalistsoffer"morethanmoney"to

theventureand seek to addvalue to the investeeunitbyactiveparticipation in its

management.Theymonitorandevaluatetheprojectonacontinuousbasis.

Theventurecapitalistishowevernotworriedaboutfailureofaninvesteecompany,

becausethedealwhichsucceeds,netsaveryhighreturnonhis investmentshigh

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

generally come in the formof selling the stockswhen theyget listedon the stock

exchangeorbya timely saleofhis stake in thecompany toastrategicbuyer.The

ideaistocashinonanincreasedappreciationofthesharevalueofthecompanyat

the timeofdisinvestment in the investeecompany. If theventure fails (moreoften

thannot),theentireamountgetswrittenoff.Probably,thatisonereasonwhyventure

capitalistsassessseveralprojectsandinvestonlyinahandfulaftercarefulscrutinyof

themanagementandmarketabilityoftheproject.

Toconclude,aventurefinancierisonewhofundsastartupcompany,inmostcases

promotedbyafirstgenerationtechnocratpromoterwithequity.Aventurecapitalist

isnotalender,butanequitypartner.Hecannotsurviveonminimalism.Heisdriven

bymaximization:wealthmaximization.Venturecapitalists are sourcesof expertise


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forthecompaniestheyfinance.Exitispreferablythroughlistingonstockexchanges.

This method hasbeen extremely successful in USA, and venture funds havebeen

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

technologyindustrythrivesonit

Length of investment:

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

investmentinthreetosevenyears.Anearlystageinvestmentmaketakeseventoten

years tomature,while a later stage investmentmanyonly takea fewyears, so the

appetite for the investment life cycle must be congruent with the limited

partnershipsappetiteforliquidity.Theventureinvestmentisneitherashorttermnoraliquidinvestment,butaninvestmentthatmustbemadewithcarefuldiligenceand

expertise.


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Stages of Venture Capital Funding

TheVentureCapital fundingvariesacross thedifferent stagesofgrowthof a firm.

Thevariousstagesare:

:

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

entrepreneur toconceiveandmarket apotential ideahavinggood futureprospects.

Thefundedworkalsoinvolvesproductdevelopmenttosomeextent.

2. Seed Stage: Financing isprovided to completeproduct development and

commenceinitialmarketingformalities.

3. Early Stage / First Stage: Finance isprovided to companies to initiate

commercialmanufacturingandsales.

4.Second Stage:IntheSecondStageofFinancingworkingcapitalisprovidedfor

theexpansionofthecompanyintermsofgrowingaccountsreceivableandinventory.

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

increasing sales volume. This stage is met when the firm crosses thebreak even

point.

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

MezzanineFinancingorLaterStageFinancingisfinancingacompanyjustbeforeits

IPO(InitialPublicOffer).Often,bridgefinanceisstructuredsothatitcanberepaid,

fromtheproceedsofapublicoffering.


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Methods of Venture Financing

VenturecapitalistypicallyavailableinthreeformsinIndia,theyare:

Equity: AllVCFsinIndiaprovideequitybutgenerallytheircontributiondoesnot

exceed49percentofthetotalequitycapital. Thus,theeffectivecontrolandmajority

ownership of the firm remains with the entrepreneur. Theybuy shares of an

enterprisewithanintentiontoultimatelysellthemofftomakecapitalgains.

Conditional Loan:Itisrepayableintheformofaroyaltyaftertheventureisable

togenerate sales.No interest ispaidon such loans. In India,VCFs charge royalty

rangingbetween2to15percent;actualratedependsonotherfactorsoftheventure

such as gestationperiod, cost-flowpatterns, riskiness and other factors of the

enterprise.

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

conventionalloanandconditionalloan.Theentrepreneurhastopaybothinterestand

royaltyonsales,butatsubstantiallylowrates.

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

private sector, have started introducing innovative financial securities like

participatingdebentures,introducedbyTCFCisanexample.


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Venture Capital Fund Operation

Venturecapitalistsareveryselectiveindecidingwhattoinvestin.Acommonfigure

isthattheyinvestonlyinaboutoneinfourhundredventurespresentedtothem.

Theyareonlyinterestedinventureswithhighgrowthpotential.Onlyventureswith

high growthpotential are capable ofproviding the return that venture capitalists

expect, and structure theirbusinesses to expect. Because manybusinesses cannot

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

venturecapitalisnotsuitableforeveryone.

Venturecapitalistsusuallyexpecttobeabletoassignpersonneltokeymanagement

positionsandalsotoobtainoneormoreseatsonthe company's board of directors.

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

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

placing incompetent or easily bypassed individuals in positions ofdue diligence and

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

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

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

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

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

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

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

funded fail to return the invested capital.

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

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

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

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

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

will be successful, and six will be marginally successful. They expect that the two

successes will pay for the time given to, and risk exposure of the other eight. In good

times, the funds that do succeed may offer returns of 300 to 1000% to investors.
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Venture capital partners (also known as "venture capitalists" or "VCs") may be

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

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

of available capital, such as state and privatepension funds, university endowments,insurance companies and pooled investment vehicles.

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

by some of the most successful funds in Silicon Valley through the1980s to invest in

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

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

In such a fund, the investors have a fixed commitment to the fund that is "called

down" by the VCs over time as the fund makes its investments. In a typical venture

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

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

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

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

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

thrive or fail with their initial industry contactsby the time the fund cashes out, anentirely new generation of technologies and people is ascending, whom they do not

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

than attempt to simply invest more in the industry or people it already knows
http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Chief+executive+officer&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Pension&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Endowment&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Insurance&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Pooling&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Silicon+Valley&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=1980s&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=1980s&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Chief+executive+officer&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Pension&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Endowment&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Insurance&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Pooling&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Silicon+Valley&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=1980s&gwp=8&curtab=2222_1


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Significance of Study

Venture capitalists not only support high technologyprojects they also fianc any

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

existingbusinessoronehasanew&promisingprojecttoexploit(b)ifonecannot

obtainaconventional loan the requirement termswouldcreateaburdenduring the

periodthefirmisstrugglingtogrown.

ItistheambitionofmanytalentedpeopleinIndiatosetuptheirownventureifthey

couldgetadequate&reliablesupport.Financialinvestmentprovidesloans&equity.

Buttheydonotprovidemanagementsupport,whichisoftenneededby

entrepreneurs.Buttheventurecapitalindustriesprovidesuchsupportalongwith

capitalalso.Venturecapitalist actsapartnernotafinancier.


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Objective of the Study

Whenwearegoingtostudysomethingthereisspecificpurposeforourstudy.Itmay

beforourcourse,ashobby,forpassingourtime,tofindoutgenuinesolutionforany

problemortodrawoutcertaininferencesoutoftheavailabledata.Theobjectivesof

mystudyare:

TofindouttheventurecapitalinvestmentvolumeinIndia.

TostudytheproblemfacedbyventurecapitalistinIndia.

Tostudythefutureprospectsofventurecapitalfinancing

Objective No. 1

To Find out the venture capital investment

volume in India

MethodsofFinancing


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Instruments Rsmillion Percent

EquityShares 6,318.12 63.18

RedeemablePreferenceShares 2,154.46 21.54

NonConvertibleDebt 873.01 8.73

ConvertibleInstruments 580.02 5.8

OtherInstruments 75.85 0.75

Total 10,000.46 100

Rs million

6,318.12

2,154.46

873.01 580.0275.85

0.00

1,000.002,000.00

3,000.00

4,000.00

5,000.00

6,000.00

7,000.00

Equity

Shares

Redeemable

Preference

Shares

Non

Convertible

Debt

Convertible

Instruments

Other

Instruments

Interpretation:Thisdiagramshowstheventurecapitalfinancinginequityshare

andsecondlytheyinvestinredeemablepreferencesharestogethigherreturns.

ContributorsofFunds


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Contributors Rs.mn Percent

ForeignInstitutionalInvestors 13,426.47 52.46%

AllIndiaFinancialInstitutions 6,252.90 24.43%

MultilateralDevelopmentAgencies 2,133.64 8.34%

OtherBanks 1,541.00 6.02%

ForeignInvestors 570 2.23%

PrivateSector 412.53 1.61%

PublicSector 324.44 1.27%

NationalizedBanks 278.67 1.09%

NonResidentIndians 235.5 0.92%

StateFinancialInstitutions 215 0.84%

OtherPublic 115.52 0.45%

InsuranceCompanies 85 0.33%

MutualFunds 4.5 0.02%

Total 25,595.17 100.00%

Interpretation:ThistableshowsthehighestcontributionoffundFIIand

secondlyAIFItodeveloptheIndustry.


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FinancingByInvestmentStage

InvestmentStages Rsmillion Number

Start-up 3,813.00 297

Laterstage 3,338.99 154

Otherearlystage 1,825.77 124

Seedstage 963.2 107

Turnaroundfinancing 59.5 9

Total 10,000.46 691

Rs million

3,813.003,338.99

1,825.77

963.2

59.50.00

500.001,000.001,500.002,000.002,500.003,000.003,500.004,000.004,500.00

Start-up Later stage Other earlystage

Seed stage Turnaroundfinancing

Interpretation:Thisdiagramshowsthehighestfinanceisreceivedbytheventure

instartupstageofanyventure.


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FinancingByIndustry

Industry Rsmillion

Industrialproducts,machinery 2,599.32

ComputerSoftware 1,832

ConsumerRelated 1,412.74

Medical 623.8

Food,foodprocessing 500.06

Otherelectronics 436.54

Tel&DataCommunications 385.09

Biotechnology 376.46

Energyrelated 249.56

ComputerHardware 203.36

Miscellaneous 1,380.85

Total 10,000.46


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Rs million

2,599.32

1,832

1,412.74

623.8500.06 436.54 385.09 376.46

249.56 203.36

1,380.85

0.00

500.00

1,000.00

1,500.00

2,000.00

2,500.00

3,000.00

Ind

ustrial

pro

ducts,

Co

mputer

So

ftware

Con

sumer

Related

M

edical

Food,food

proc

essing

O

ther

elec

tronics

Tel&D

ata

Communications

Biotech

nology

Energy

related

Computer

Har

dware

Miscella

neous

Interpretation: In this diagram highest finance receivedby industrialproducts

andmachineryandsecondlyfinancereceivedbycomputersoftware.


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FinancingByStates

Investment RsmillionMaharashtra

2,566

TamilNadu1531

AndhraPradesh1372

Gujarat1102

Karnataka1046

WestBengal312

Haryana300

Delhi294

UttarPradesh

283MadhyaPradesh

231

Kerala135

Goa105

Rajasthan87

Punjab84

Orissa35

Dadra&NagarHaveli32

HimachalPradesh28

Pondicherry22


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Bihar16

Overseas413

Total9994

SourceIVCA(2005-06)

Rs million

2,566

15311372

1102 1046

312 300 294

0

500

1,000

1,500

2,000

2,500

3,000

Maha

rashtra

TamilNa

du

AndhraPrade

sh

Gujarat

Karnata

ka

WestBeng

al

Haryana

Delhi

Interpretation: In thisdiagramhighest financegivenby theMaharashtra to the

venturestopromotethestateeconomygrowth.


30/62


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Assessing Venture Capital

Venturefunds,bothdomesticandoffshore,havebeenaroundinIndiaforsomeyears

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

limelight.Therejectionratioisveryhigh,about10in100getbeyondpreevaluation

stage,and1getsfunded.

Venturecapitalfundsarebroadlyoftwokinds-generalistsorspecialists.Itiscritical

forthecompanytoaccesstherighttypeoffund,iewhocanaddvalue.Thisbacking

is invaluable as focused/specialized funds open doors, assist in future rounds and

helpinstrategy.Hence,itisimportanttochoosetherightventurecapitalist.

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

investmentdecision.Theonlydifferencebeingexit.Ifonebuysalistedsecurity,one

can exit at apricebut with an unlisted security, exitbecomes difficult. The key

factorswhichtheylookforin

TheManagement

Most businesses are people driven, with success or failure depending on the

performance of the team. It is important to distinguish the entrepreneur from the

professionalmanagement team. Thevalueof the idea, thevision,putting the team

together,gettingthefundinginplaceisamongstothers,somekeyaspectsoftherole

oftheentrepreneur.Venturecapitalistswillinsistonaprofessionalteamcomingin,

including a CEO to execute the idea. One-man armies arepasse. Integrity and

commitmentareattributessoughtfor.Theventurecapitalistcanprovidethestrategic

vision,buttheteamexecutesit.AsafamousSiliconValleysayinggoes"Successis

execution,strategyisadream".

TheIdea

Theideaanditspotentialforcommercializationarecritical.Venturefundslookfora

scalablemodel,atacountryoraregionallevel.Otherwisetheentiregamewouldbe

reduced toamanpowerormachinemultiplicationexercise.For example, it isvery

easyforHindustanLevertodoublesalesofLiril-asoapwithoutincrementalcapex,


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whileGujaratAmbujaneedstospendat leastRs4bnbeforeitcanincreasesalesby

1mn ton. Distinctive competitive advantages must exist in the form of scale,

technology,brands,distribution, etcwhichwillmake it difficult forcompetition to

enter.

Valuation

All investment decisions are sensitive to this. An old stock market saying "Every

stock is abuy at aprice and vice versa". Most deals failbecause of valuation

expectationmismatch.InIndia,whilecalculatingreturns,venturecapitalfundswill

take intoaccount issues like rupeedepreciation,political instability,which adds to

theriskpremia,thussuppressingvaluations.Linkedtovaluationisthestake,whichthefundtakes.InIndia,entrepreneursarestilluncomfortablewiththeventurecapital

"takingcontrol"inaseedstageproject.

Exit

Without exit, gains cannotbebooked. Exit maybe in the form of a strategic sale

or/and IPO. Taxation issues come up at the time. Any fund would discuss all exit

optionsbefore closing a deal.Sometimes, the fund insistson abuyback clause toensureanexit.

PortfolioBalancing

Most venture funds try and achieveportfoliobalancing as they invest in different

stages of the company life cycle.For example, a venture capital has invested in a

portfolio of companiespredominantly at seed stage; they will focus on expansion

stageprojectsforfutureinvestmentstobalancetheinvestmentportfolio.Thiswould

enablethemtohaveaphasedexit. Insummary,venturecapitalfundsgothrougha

certainduediligencetofinalizethedeal.Thisincludesevaluationofthemanagement

team,strategy,executionandcommercializationplans.Thisissupplementedbylegal

andaccountingduediligence, typicallycarriedoutbyanexternalagency.In India,

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

mindbeforelookingtoraisefunds.Theactualcashinflowmightgetdelayedbecause

ofregulatoryissues.ItisinterestingtonotethatinUSA,attimesangelswritechecksacrossthetable.


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Financing Options in General

ThepossibilityofraisingasubstantialpartofprojectfinancesinIndiathroughboth

equityanddebtinstrumentsareamongthekeyadvantagesofinvestinginIndia.

TheIndianbankingsystemhasshownremarkablegrowthoverthelasttwodecades.

Therapidgrowthandincreasingcomplexityofthefinancialmarkets,especiallythe

capital market have brought about measures for further development and

improvement in the working of these markets. Banks and development financialinstitutions ledby ICICI, IDBI and IFCIwereproviders of term loans for funding

projects. The options were limited to conventionalbusinesses, i.e. manufacturing

centric.Servicessectorwasignoredbecauseofthe"collateral"issue.

EquitywasraisedfromthecapitalmarketsusingtheIPOroute.Thebullmarketsof

the90s,fuelledbyHarshadMehtaandtheFIIs,ensuredthat(ad) venturecapitalwas

easilyavailable.Manufacturingcompaniesexploitedthistothefull.

Theservicessectorwasignored,likesoftware,media,etc.Lackofunderstandingof

these sectors was also responsible for the same. If we lookback to 1991 or even

1992,thesituationasregardsfinancialoutlayavailabletoIndiansoftwarecompanies

waspoor. Most software companies found it extremely difficult to source seed

capital,workingcapitalorevenventurecapital.

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

loansoroverdraftfacilitiestoprovideworkingcapital.Thisapproachforcedthemto

generaterevenueintheshortterm,ratherthaninvestinginproductdevelopment.The

situationfortunatelyhaschanged.


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Research Methodology

REDMEN & MORY defines,Research as a systematized effort to gain now

knowledge.Itisacarefulinvestigationforsearchofnewfactsinanybranchofknowledge.The

purposeofresearchmethodologysectionistodescribetheprocedureforconduction

thestudy.It includes researchdesign,samplesize,datacollectionandprocedureof

analysisofresearchinstrument.

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

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

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

RESEARCH DESIGN:

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

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

variance.

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

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

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

from which sources by what procedures.

Its found that researchdesign ispurely and simply the framework for a study that

guidesthecollectionandanalysisofrequireddata.

Researchdesignisbroadlyclassifiedinto

Exploratoryresearchdesign

Descriptiveresearchdesign

Casualresearchdesign

This research is a Exploratory research. The majorpurpose of this research is

descriptionofstateofaffairsasitexistsatpresent.


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DATA COLLECTION

Secondarydata

Secondarydata is thedatawhichisalreadycollectedbysomeoneandcompliedfor

differentpurposeswhichareusedinresearchforthisstudy.Itincludes:-

Internet

Magazine

Journal

Newspaper


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Literature Review

AccordingtoSubashandNair,(May2005)

According to thesespersons though the modern concept of venture capital stated

during 1946 and nowpracticedby almost all economies around the world, there

seemstobeaslowdownofventurecapitalactivitiesafter2000.Theremaybealong

listofreasonsforthissituation,wherepeoplefeelmoreriskytoputtheirmoneyin

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

globallyisgiventoreallystageventures.Inalltheyearspeoplearoundtheworldhas

seenthepotentialityofventurecapitalinpromotingdifferenteconomiesoftheworld

by improving thestandardof livingof thepeoplebyexpandingbusinessactivities,

increasingemploymentandalsogeneratingmorerevenuetothegovernment

AccordingToKumar,(June2003)

This study focus on the industry should concentrate more on early stagebusiness

opportunitiesinsteadoflaterstage.Itistheexperienceworldoverandespeciallyin

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

exceptional returns for the industry. He also suggests that individual capitalists

shouldfollowafocusedinvestmentstrategy.Thespecializationshouldbeinaboard

technologysegment.

AccordingtoKumarandKaura,(March2006)

Thepresent study reports four factors which are usedby the venture capitalist to

screennewventureproposals.UsingKendalls tau-c analysis, the studybringsout

strongassociationbetweenseveralvariablepair.Broadly,theanalysisfindsthat:

Successfulventureteamsputinsustainedeffortsoidentifiedtargetmarkets.

Theyarehighlymeticulouswhileattendingtothedetails.

Theseteamsareadeptatdealingwithriskbecauseoftheirimpeccablepast

experience.

Indianventurecapitalistsdonot seem tobemuchenamoredof technology

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

showsignsofbeinghi-tech.


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The studybrings out four important variables which are highly unique to

successfulventureinIndia.Theyare:

Abilityto evaluateandreacttorisk

Attentiontodetails

Marketshare

Profits.

Evaluating risk seems tobeanareawhereunsuccessfulventure fail.Since

successfulteamsfocusonestablishedmarketsandmeticulouslypursuethese

marketstogainmarketshare,theyachievedesiredprofits.

AccordingtoKumar,(May2004)

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

capitalfinance.Theearlystagefinancingwhichincludesseeds,startup&earlystage

investment was always the majorpart of the total investment. Whenever venture

capitalistsinvestinventurecertainbasicpreferenceplayacrucialroleininvestment

decision. Two such considerations are location preferences and ownership

preferences.Seedstagefinanceisprovidedtonewcompaniesfortheuseinproduct

development& initial marketing companymaybe in theprocess of setting up the

businessormaybe in thebusinessforshortperiodbuthavenot reach thestageof

commercialization.

AccordingtoKumar,(March, 2004)

Theindustryshouldconcentratemoreanearlystagebusinessopportunitiesinsteadof

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

America that the early stage opportunities have generated exceptional for the

industry. It is recommended that the venture capitalists should retain theirbasic

feature that taking retain theirbasic feature that is taking high risk. Thepresent

situationmaycompelventurecapitalists toopt for less riskyopportunitiesbut it is

againstthespritofventurecapitalism.Theestablishedfactisbiggainsarepossible

inhighriskprojects.


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AccordingtoChary,(September2005)

Therehasbeenaplethoraof literatureonventurecapital finance,which ishelping

thepractitionersviz.,venturecapitalfinancecompaniesandfundmanageforbetter

understanding the role of venture capital in economic development. There are

number of studies on the venture capital and activities of venture capitalists in

developedcountries.

AccordingtoVijayalakshman&Dalvi, ((Jan., 2006)

WheneverIndianpolicymakershavetoencourageanyindustry.Theusualpracticeis

to grant that the industry taxbreaks for a limitedperiod. This definitely acts as a

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

understanding of the industry requirement framing and implementation of

aggregativestrategyforitsdevelopment.VCfundsarenotevenregisteredwithSEBI

in spiteofall thebenefitavailable.VCindustryisone,whichwill todaypreparea

baseforastrongtomorrow.WhatisneedforthedevelopmentofVCindustryisnot

only tax breaks but simpler procedures legislation for simplified exit forminvestment,moretransparencyandlegalbackingtoparticipate inbusinessamongst

otherthings.

AccordingtoKumar,(July, 2005)

Oneoftheintegralaspectsofventurefundingisventurecapitalist'sinvolvementwith

theentrepreneurialteam.Therelationshipthroughbroadinteractionwasexploredby

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

regardtoboardinteraction.Whileitisimportantinlargefirmstherelativepowerof

smallconventionalfirms,boardinteractiongenerallyisundermined.Rosensteinet.a.

(1993) studied the finer aspects ofboards in the venture funded companies in the

USA.From98candidatesinthesample,thestudyattemptedtobringoutthechanges

intheboardsize,boardcompositionandcontrolandtheirrelationtovalueaddedto

thefundedunit.Theempiricalanalysisyieldedresultswhereinthesizeoftheboard

increasedafterventurefunding,indicatingmoretransparencyinboardoperations.


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

deal structuring andpost investment staging of venture capitalists through venture

capitalists'co-investingstrategy.Thestudyfindsthateventhroughventurecapitalists

fixtightmilestonesandtimelinestheythemselvescontributetomanyofthedelaysthatareexperiencedbyatypicalstartupfirm.Thisisbecauseofthehierarchicalco-

investingpartners and the lack of understanding within the venture capitalist co-

investorsastowhatroletheyindividuallyplayinthedevelopmentoftheirportfolio

company.

AccordingtoRobbie,(1997)

Robbies,et.al.(1997)highlightsthemonitoringpoliciesoffundedunitsbyventure

capitalists and studies the performance targets, monitoring information, and

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

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

responsesweregatheredinthestudy.Thefindingsrelatedtoperformancetargetsand

othermonitoringissueswereconsiderableadditiontotheliteratureinthesubject.

The issuesconcerningboardofdirectors' role inventurebacked companies

arewidelydebatedtopicsinacademicresearch.ThefindingsofthestudybyFriedet.

al.(1998)emphasizethattheboardofdirectorsareamoreinvolvedintheventure-

backedfirmsthanboardswheremembersdonothavelargeownershipatstake.The

studyprovides an empirical evidence of variation in theboards' involvement and

showsitsrelevanceinperformancemanagementoffundedunits.

AccordingtoMishra,(July2004)

There is abundant empirical research conducted in developed countries which

addresstherelativeinvestmentevaluationcriteriatakenintoaccountinthescreening

process for new venture investmentproposals. Zopunidis (1994)provides a useful

summaryofthepreviousresearchinthisfield.Theidentificationofselectioncriteria

hasbeen researchedusingdifferentmethodologies suchas simple ratingof criteria

(perpetualanddealspecificresponses)Knight,1986;Dixon,1991;HallandHofer,

1993;Rah,JungandLee,1994),constructanalysis(FriedandHisrich,1994),verbal

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


40/62

(Muzyka,BirleyandLeleux,1996;Shepherd,1999).Multimethods (caseanalysis,

study of administrative records,published interviews, questionnaire andpersonal

interviews)approachhasalsobeenused(Riquelme,1994)toenhanceunderstanding

of investmentcriteriaandalsoextendit tootheraspectsof investmentprocess likedealstructuringanddivestment.


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Conceptual Frame Work

The Venture Capital ProcessTheVentureCapitalInvestmentProcess:

Theventurecapitalactivityisasequentialprocessinvolvingthefollowingsixsteps.

1.Dealorigination2.Screening3.DuediligenceEvaluation4.Dealstructuring5.Post-investmentactivity6.Exit


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VentureCapitalInvestmentProcess


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Deal origination:

Ingeneratingadealflow,theVCinvestorcreatesapipelineofdealsorinvestment

opportunitiesthathewouldconsiderforinvestingin.Dealmayoriginateinvarious

ways.referralsystem,activesearchsystem,andintermediaries.Referralsystemisanimportant source of deals. Deals may be referred to VCFs by their parent

organizations,tradepartners,industryassociations,friendsetc.Anotherdealflowis

activesearchthroughnetworks,tradefairs,conferences,seminars,foreignvisitsetc.

Intermediaries is usedby venture capitalists in developed countries like USA, is

certainintermediarieswhomatchVCFsandthepotentialentrepreneurs.

Screening:

VCFs,beforegoingforanin-depthanalysis,carryoutinitialscreeningofallprojectson thebasis of somebroad criteria. For example, the screeningprocess may limit

projectstoareasinwhichtheventurecapitalistisfamiliarintermsoftechnology,or

product,ormarketscope.Thesizeofinvestment,geographicallocationandstageof

financingcouldalsobeusedasthebroadscreeningcriteria.

Due Diligence:

Due diligence is the industryjargon for all the activities that are associated with

evaluating an investmentproposal. The venture capitalists evaluate the quality ofentrepreneur before appraising the characteristics of the product, market or

technology.Mostventurecapitalistsaskforabusinessplantomakeanassessmentof

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

informationabouttheproposedventure.TheevaluationofventuresbyVCFsinIndia

includes;

Preliminary evaluation: The applicant required toprovide abriefprofile of the

proposedventuretoestablishprimafacieeligibility.

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

evaluatedingreaterdetail.VCFsinIndiaexpecttheentrepreneurtohave:- Integrity,

long-termvision,urgetogrow,managerialskills,commercialorientation.

VCFsinIndiaalsomaketheriskanalysisof theproposedprojectswhichincludes:

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

decisionistakenintermsoftheexpectedrisk-returntrade-offasshowninFigure.


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DealStructuring: Structuringrefers toputting together the financial aspectsof the

dealandnegotiatingwiththeentrepreneurstoacceptaventurecapitalsproposaland

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

knowledgeable in areasof accounting, cash flow, finance, legal and taxation.Alsothe structure should take into consideration thevariouscommercial issues (iewhat

the entrepreneur wants and what the venture capital would requireprotecting the

investment).Documentation refers to the legal aspects of thepaperwork inputting

the deal together. The instruments tobe used in structuring deals are many and

varied.Theobjectiveinselectingtheinstrumentwouldbetomaximize(oroptimize)

venturecapitalsreturns/protectionandyetsatisfiestheentrepreneursrequirements.

Theinstrumentscouldbeasfollows:

Instrument Issues

Loan Cleanvssecured

Interestbearingvsnoninterestbearing

convertiblevsonewithfeatures(warrants)

1stCharge,2ndCharge,

loanvsloanstock

Maturity

Preferenceshares redeemable(conditionsunderCompanyAct)

participating

parvalue

nominalshares

Warrants exerciseprice,expiryperiod

Commonshares neworvendorshares

parvalue


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partially-paidshares

InIndia,straightequityandconvertiblesarepopularandcommonlyused.Nowadays,

warrantsareissuedasatooltobringdownpricing.

Avariation thatwas firstusedbyPACTandTDICIwas"royaltyonsales".Under

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

companyhadtopaya%ageofsalesasroyaltyandifitfailedthentheamountwas

written off. In structuring a deal, it is important to listen to what the entrepreneur

wants,buttheventurecapitalcomesupwithhisownsolution.Evenfortheproposed

investmentamount,theventurecapitaldecideswhetherornottheamountrequested,

isappropriateandconsistentwiththeriskleveloftheinvestment.Therisksshould

beanalyzed,takingintoconsiderationthestageatwhichthecompanyisinandother

factorsrelatingtotheproject.(egexitproblems,etc).

Post Investment Activities:

Once the deal hasbeen structured and agreement finalized, the venture capitalist

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

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

involvementdependsonhispolicy.Itmaynot,however,bedesirableforaventure

capitalisttogetinvolvedintheday-to-dayoperationoftheventure.Ifafinancialor

managerialcrisisoccurs,theventurecapitalistmayintervene,andeveninstallanew

managementteam.

Exit:

Venturecapitalistsgenerallywanttocash-outtheirgainsinfivetotenyearsafterthe

initialinvestment.Theyplayapositiveroleindirectingthecompanytowards

particularexitroutes.Aventuremayexitinoneofthefollowingways:

1.InitialPublicOfferings(IPOs)

2.Acquisitionbyanothercompany

3.Purchaseoftheventurecapitalist'ssharesbythepromoter,

4.Purchaseoftheventurecapitalist'ssharebyanoutsider


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Objective No.2

To study theproblemsfaced by venture

capitalist in India.

ProblemsofVenture Capital in Indian Context

Onecan ask why venture funding is so successful inUSA and faced anumber of

problems in India. Thebiggestproblem was a mindset change from "collateral

funding"tohighriskhighreturnfunding.Mostofthepioneersintheindustrywerepeoplewithcreditbackgroundandexposuretomanufacturingindustries.Exposureto

fast growing intellectualpropertybusiness and services sector was almost zero.

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

competitivenesshasputanimmensepressureontheindustrialsectortoimprovethe

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

technologicalskills.The implication is toobtainadequate financingalongwith the

necessary hi-tech equipments toproduce an innovativeproduct which can succeed

andgrowinthepresentmarketcondition.Unfortunately,ourcountrylacksonboth

fronts. The necessary capital canbe obtained from the venture capital firms who

expectanaboveaveragerateofreturnontheinvestment.Thefinancingfirmsexpect

asound,experienced,matureandcapablemanagement teamof thecompanybeing

financed.Sincetheinnovativeprojectinvolvesahigherrisk,thereisanexpectation

ofhigherreturnsfromtheproject.Thepaybackperiodisalsogenerallyhigh(5-7

years).Theotherissuesthatledtosuchasituationinclude:

LicenseRajandTheIPOBoom

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

thrivedinadeficitsituation.Tofundacementplant,venturecapital isnotneeded.

Whatwasneededwasabilitytogetalicenseandthengettheprojectfundedbythe

banks and DFIs. In most cases, thepromoters were well-established industrial

houses, with no apparent need for funds. Most of these entities were capable of


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raisingfundsfromconventionalsources, includingtermloansfrominstitutionsand

equitymarkets.

Scalability

The Indian software segment has recorded an impressivegrowth over the last few

yearsandearns largerevenuesfromitsexportearnings,yetour sharein theglobal

market is less than1percent.Withinthesoftwareindustry, thevaluechainranges

frombody shopping at thebottom to strategic consulting at the top. Higher value

addition andprofitability as well as significant marketpresence takeplace at the

higherendofthevaluechain.Iftheindustryhastogrowfurtherandsurvivetheflux

itwouldonlybethroughinnovation.Foranyventureideatosucceedthereshouldbe

aproductthathasagrowingmarketwithascalablebusinessmodel.TheITindustry

(whichismostsuitedforventurefundingbecauseof its"ideas"nature) inIndiatill

recentlyhadaservicecentricbusinessmodel.ProductsdevelopedforIndianmarkets

lackscale.

Mindsets

Venture capital as an activity was virtually non-existent in India. Most venture

capital companies want toprovide capital on a secured debtbasis, to established

businesseswithprofitableoperatinghistories.Mostoftheventurecapitalunitswere

offshootsoffinancialinstitutionsandbanksandthelendingmindsetcontinued.True

venturecapitaliscapitalthatisusedtohelplaunchproductsandideasoftomorrow.

Abroad, thisproblem is solvedby thepresence of `angel investors. They are

typically wealthy individuals who not onlyprovide venture financebut also helpentrepreneurstoshapetheirbusinessandmaketheirventuresuccessful.

Returns,TaxesandRegulations

ThereisamultiplicityofregulatorslikeSEBIandRBI.Domesticventurefundsare

setupunder the IndianTrustsActof1882asperSEBIguidelines,while offshore

fundsroutedthroughMauritiusfollowRBIguidelines.Abroad,suchfundsaremade

undertheLimitedPartnershipAct,whichbringsadvantagesintermsoftaxation.The


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governmentmustallowpensionfundsandinsurancecompaniestoinvestinventure

capitalsasinUSAwherecorporatecontributionstoventurefundsarelarge.


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Exit

Theexit routesavailable to theventurecapitalistswererestricted to theIPOroute.

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

general,allissueswereunderpriced.EvennowSEBIguidelinesmakeitdifficultfor

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

guidelines,smallcompaniescouldnothopeforaBSE/NSElisting.Giventhedull

marketformergersandacquisitions,strategicsalewasalsonotavailable.

Valuation

Therecentphenomenonisvaluationmismatches.Thankstothesoftwareboom,most

promotershaveskyhighvaluationexpectations.Giventhis,itisdifficultfordealsto

reachfinancialclosureaspromotersdonotagreetoavaluation.Thiscoupledwith

thefancyforsoftwarestocksintheboursesmeansthatmostcompaniesare

preponingtheirIPOs.Consequently,thenumberandqualityofdealsavailabletothe

venturefundsgetsreduced

SomeothermajorproblemsfacingbyventurecapitalistinIndiaare:

a. Requirementofanexperiencedmanagementteam.

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

Longerpaybackperiod.

c. Uncertaintyregardingthesuccessoftheproductinthemarket.

d. Questions regarding the infrastructure details of production like plantlocation, accessibility, relationship with the suppliers and creditors,

transportationfacilities,labouravailabilityetc.

e. The category ofpotential customers and hence thepackaging andpricing

detailsoftheproduct.

f. Thesizeofthemarket.

g. Major competitorsandtheirmarketshare.


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h. SkillsandTrainingrequiredandthecostoftraining.

i. Financialconsiderationslikereturnoncapitalemployed(ROCE),costofthe

project,theInternalRateofReturn(IRR)oftheproject,totalamountoffunds

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

borrowedcapital,mortgageloansetc.inthecapitalemployed.

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


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ObjectiveNo. 3

To study thefutureprospect of Venture

Capital Financing.

ProspectsofVenture Capital Financing

Withtheadventof liberalization,Indiahasbeenshowingremarkablegrowthinthe

economyinthepast10-12years.Thegovernmentispromotinggrowthincapacity

utilization of available and acquired resources and hence entrepreneurship

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

domestic venture capital funds were registered with SEBI during 1996-1998, 14

fundshavealreadybeenregisteredin1999-2000.Institutionalinterestisgrowingand

foreignventureinvestmentsarealsoontherise.Manystategovernmentshavealso

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

financial institutionsandSIDBI.TheseincludeAndhraParadesh,Karnataka,Delhi,Kerala and Tamil Nadu. The other states are to follow soon.

Intheyear2000, thefinanceministryannouncedtheliberalizationof taxtreatment

forventurecapitalfundstopromotethem&toincreasejobcreation.Thisisexpected

togiveastrongboost to thenonresident Indians located intheSiliconValleyand

elsewheretoinvestsomeoftheircapital,knowledgeandenterpriseintheseventures.

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

investmenttotalingabout$1.7mn.Thecompanywouldbecreatingandmarketing

brandedwebbasedconsumerproductsinthenearfuture.

ThefollowingpointscanbeconsideredastheharbingersofVCfinancinginIndia:-

a. Existenceofagloballycompetitivehightechnology.b. Globallycompetitivehumanresourcecapital.

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


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d. Vastpoolofexistingandongoingscientificandtechnicalresearchcarriedby

largenumberofresearchlaboratories.

e. Initiatives takenby the Government in formulatingpolicies to encourage

investorsandentrepreneurs.

f. InitiativesoftheSEBItodevelopastrongandvibrantcapitalmarketgiving

theadequateliquidityandflexibilityforinvestorsforentryandexit.

InarecentsurveyithasbeenshownthattheVCinvestmentsinIndia'sI.T.-Software

andservicessector(includingdotcomcompanies)-havegrownfromUS$150million

in1998 tooverUS$1200million in2008.Thecreditcanbegiventosettingupofa

National Venture Capital Fund for the Software and I.T. Industry (NFSIT) in

association with various financial institutions of Small Industries and Development

Bank of India (SIDBI). The facts reveal that VC disbursements as on September 30,

2002madebyNFSITtotaledRs254.36mn.

Sourcewww.evaluesevrve.com
http://www.evaluesevrve.com/http://www.evaluesevrve.com/http://www.evaluesevrve.com/


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Findings

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

following:-

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

conservativesbuttheyalsohaveabiasforforeigntechnology&theydonottrust

ontheabilitiesofentrepreneurs.


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Someventure failsdue to fewexitoptions.Teams are ignorantof international

standards. The team usually a two or three man team. It does notpossess the

required depth In top management. The team is often found to have technical

skillsbutdoesnotpossess theoverallorganizationbuildingskills teamisoftenshortsited.

VenturecapitalistsinIndiaconsidertheentrepreneursintegrity&urgetogrowas

themostcriticalaspectorventureevaluation.


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Limitations of Study1. Thebiggestlimitationwastimebecausethetimewasnotsufficientasthere

waslotofinformationtobegot&tohaveitinterpretation

2. Thedatarequiredwassecondary&thatwasnoteasilyavailable.

3. Studybyitsnatureissuggestive&notconclusive

4. Expenseswerehighincollecting&searchingthedata.


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Suggestions

1. The investment shouldbe in turnaroundstage.Since therearemany

sick industries in India and the number is growing each year, the

venture capitalists that have specialized knowledge in management

can help sick industries. It would alsobe highlyprofitable if the

venture capitalist replace management either good ones in the sick

industries.

2. Itisrecommendedthattheventurecapitalistsshouldretaintheirbasic

feature that is tasking high risk. Thepresent situation may compel

venturecapitaliststooptforlessriskyopportunitiesbutisagainstthe

spirit of venture capitalism. The established fact isbig gains are

possibleinhighriskprojects.

3. There shouldbe a greater role for the venture capitalists in the

promotion of entrepreneurship. The Venture capitalists should

promote entrepreneur forums, clubs and institutions of learning to

enhancethequalityofentrepreneurship.


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Bibliography

1. JOURNALS

APPLIED FINANCE VENTURE STAGE INVESTMENT

PREFERENCEININDIA,VINAYKUMAR,MAY, 2004.

ICFAIJOURNALOFAPPLIEDFINANCEMAY-JUNE

VIKALPAVOLULMLE28,APRIL-JUNE2003

ICFAIJOURNALOFAPPLIEDFINANCE,JULY-AUG.

2. BOOKS

I.M.Panday-venturecapitaldevelopmentprocessinIndia

I.M.Panday-venturecapitaltheIndianexperience,

3. VARIOUSNEWSPAPERS

4. INTERNET

www.indiainfoline.com

www.vcapital.com

www.investopedia.com

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


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ANNEXURE I

Venturecapitalfirms

Examplesofventurecapitalfirmsinclude:

AccedePartners

AustinVentures

AtlasVenture

BatteryVentures

BenchmarkCapital

CharlesRiverVentures

DoughtyHansonTechnologyVentures

FidelityVentures

Health Cap

HummerWimbled

InsightVenturePartners

MobiusVentureCapital

MohrDavidowVentures

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


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SequoiaCapital

Trelys

ANNEXUREII

SomeimportantVentureCapitalFundsinIndia

1.APIDCVentureCapitalLimited, ,BabukhanEstate,Hyderabad500001

2.CanbankVentureCapitalFundLimited,IIndFloor,KareemTowers,Bangalore.

3.GujaratVentureCapitalFund1997,AshramRoad,Ahmedabad380009

4.IndustrialVentureCapitalLimited,ThyagarayaRoad,Chennai 600017

5.GujaratVentureCapitalFund1995AshramRoadAhmedabad380009

6.KarnatakaInformationTechnologyVentureCapitalFundCunninghamRdBangalore

7.IndiaAutoAncillaryFundNarimanPoint,Mumbai400021

8.InformationTechnologyFund,NarimanPoint,Mumbai400021

9.TamilnaduInfoTechFundNarimanPoint,Mumbai400021

10.OrissaVentureCapitalFundNarimanPointMumbai400021

11.UttarPradeshVentureCapitalFundNarimanPoint,Mumbai40002112.SICOMVentureCapitalFundNarimanPointMumbai400021
http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Sequoia+Capital&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Sequoia+Capital&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Sequoia+Capital&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Trelys&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Sequoia+Capital&gwp=8&curtab=2222_1http://www.answers.com/main/ntquery?method=4&dsid=2222&dekey=Trelys&gwp=8&curtab=2222_1


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Conclusion

Venture capital canplay a more innovation and development role in a developing

country like India. It couldhelp the rehabilitationof sickunit throughpeoplewith

ideasandturnaroundmanagementskill.AlargenumberofsmallenterprisesinIndia

because sick unit evenbefore the commencement ofproduction ofproduction.

Venturecapitalist couldalsobe in linewith thedevelopments takingplace in their

parentcompanies.

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

servicesectorincludingtourism,publishing,healthcareetc.theycouldalsoprovide

financialassistancetopeoplecomingoutoftheuniversities,technicalinstitutesetc.

whowishtostarttheirownventurewithorwithouthigh-techcontent, butinvolving

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

funding which is need from the venture capitalists, but the should also

simultaneouslyprovidemanagementandmarketingexpertise-arealcriticalaspectof

venturecapitalists,buttheyalsosimultaneouslyprovidemanagementandmarketing

expertise-arealcriticalaspectofventurecapitalindevelopingcountries. Whichcan

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

scientific generation,providing syndicated or consortium financing and acing as

businessincubators.

Documents

20750325 REPORT on Venture Capital