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CHAPTER I

INTRODUCTION AND DESIGN OF THE STUDY

1.1 INTRODUCTION

Technological change and development, being important ingredients of

economic growth, should be induced through an appropriate strategy. The

encouragement of the birth and progress of high-technology small firms is a major

factor on which the survival of any economy may depend. Both economists and

third world governments realized quite early the key role of new high-technology

industries in determining national economics success, and took measures to

encourage the rate of formation of new firms and their growth. In this case

whether in relation to new or existing companies, venture capital plays a

significant role.

Venture Capital is the capital committed, as shareholdings, for the

formation and setting up of firms specializing in new ideas, or new technologies,

with a large element of risk for the shareholders, but with a potential for rapid

development. A venture capital firm serves as an intermediary between investors

looking for high returns for their money and entrepreneurs in search of needed

capital for their start-ups.

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Venture capital is a post-war phenomenon in the business world. It

originated and got popularized in the USA in the sixties. In the late 1960s, a new

breed of professional investors called venture capitalists emerged in the US whose

specialty was to combine risk capital with entrepreneurial management and to use

advanced technology to launch new products and companies in the market place.

Undoubtedly it was the venture capitalists’ astute ability to assess and manage

enormous risks and export from them tremendous returns that changed the face of

America.

This surge in enthusiasm for venture capital gathered pace and it has been

developing spectacularly world-wide since the second half of the seventies. Many

governments are experimenting with this US inspired investment discipline as a

means to stimulate the fledgling enterprises, which they see as vital to their

nation’s economic growth. The United Kingdom occupies the second place after

the US in terms of investment in venture capital. Several Organisation of

Economic Co-operation and Development (OECD) countries also have designed

and implemented measures to promote venture capitalism. The growth of venture

capital in the USA, the UK and other developing countries is primarily due to the

rapidly developing potential and commercialization of science and technology.

The emergence of unlisted securities market in these countries has further

enhanced the scope of venture capital. These opportunities lured the venture

capital institutions to invest in high-tech projects under conditions of extreme

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uncertainty, as those projects were otherwise neglected by the traditional

financing institutions.

The impressive returns achieved by the U.S. venture capitalists attracted

investors from around the world. In some cases, these funds were routed through

venture capital firms based in the U.S. and managed by foreign professionals or

corporate venture capital investment operations, operated by foreign

multinationals. More frequently, European and Asian funds were invested in the

U.S. funds and invested in the U.S. startups. Despite these investments, non-U.S.

capital has only played a minor role in financing the U.S. venture capital.

Arrival of venture capital in Indian capital market, though belated, is a

welcome development. The concept was adopted in India, after realizing the

difficulties faced by new entrepreneurs with viable projects, to raise funds from

the capital market. India, Asia’s fourth largest economy, is a new market in which

everyone is learning. With steady growth between five per cent and seven per cent

in the past several years, a pace that would likely continue, India offers

tremendous opportunities for financial services even as it transforms itself slowly

from a planned economy to a free-market one. It has already witnessed the

emergence of several innovative financial instruments and services, and venture

capital is the latest entrant in this field.

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The development of venture capital is a recent phenomenon in India. It is

still in the infancy stage and requires proper framework and promotional efforts

for its fast growth. Unlike the USA, where it is normal for an entrepreneur to set

up a company or introduce a new product in the market by obtaining finance from

the venture capital funds with willingness to share the risk in returns of future

gains, in India risk financing is yet to pick up in a significant way. It can be said

that the conventional industrial finance in India is not of much help to the new

emerging enterprises. There is a need of finance for the entire duration to enable

the companies to recover from the negative cash flows in the early years. In other

words, finance is required to enable them to move from the start-up phase to the

expansion phase. Venture capital is the financing mechanism that fits with the

requirement of the new enterprise, which introduces a new product having greater

risks in returns and financial performances.

In broad terms, venture capital is the investment of long-term equity

finance where the venture capitalist earns primarily in the form of capital gain.

The underlying assumption is that the entrepreneur and the venture capitalist

would act as ‘partners’. True venture capital does not remain confined to hi-tech;

any risky idea could be financed by the venture capitalist. Venture capital can

prove to be a powerful mechanism to institutionalize innovative entrepreneurship.

A venture capitalist’s management approach differs significantly from that of a

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conventional banker, lender or a stock market investor. In fact, a venture capitalist

combines the qualities of banker, stock-market investor and entrepreneur in one.

1.2 STATEMENT OF THE PROBLEM

Venture Capital (VC) is a significant financial innovation in the twentieth

century. It is a form of financing, designed for funding high technology with high

risk and with perceived high rewards. It usually refers to financing provided by

venture capitalists, who invest, alongside innovative entrepreneurs, in relatively

new, high growth companies that have a reasonable, though not assured, potential

to develop into highly profitable ventures. Such investments may exhibit high-risk

(of failure) or high return (in terms of large appreciation in the capital invested)

characteristics.

Traditionally, the role of venture capital is an extension of the development

financial institutions (PARA BANKING). The origin of modern Venture Capital

in India can be traced to the setting up of a Technology Development Fund (TDF)

in the year 1987-88, through the levy of access on all technology import payment.

TDF was meant to provide financial assistance to innovative and high-risk

technological programs through the Industrial Development Banks of India. This

measure was followed up in November 1988, by the issue of guidelines by the

(then) Controller of Capital Issues (CCI). These stipulated the framework for the

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establishment and operation of funds companies that could avail of the fiscal

benefits extended to them.

Venture Capital has been a new type of financing for the past three decades

in India, they have been contributing to the development of economy by financing

the entrepreneurial capital requirements. The researcher wishes to study the

opportunities and prospects of the venture capital companies in India, by studying,

how far they have been contributing capital to the entrepreneurs, what is the

method of project evaluation, criteria for selecting the projects, types of industries

in which they have invested, state-wise investment and performance evaluation of

the venture capital companies, for this study ICICI Venture Fund Management

Company Limited and IFCI Indian Venture Funds Limited have been taken up for

the study.

Significance of the study:

Venture capital funds have been instrumental for the most amazing success

stories in the Silicon Valley in the USA, where the concept of venture capital was

born. There have been examples of companies backed by venture capitalists

growing to large corporation abroad. Some of the notable names are Microsoft,

Federal express, Intel, SanMicrosystems etc., However in India the venture capital

companies are yet to make their presence felt. The venture capital industry in

Tamil Nadu is still at a nascent stage but with the untapped potential, is expected

to grow rapidly in the future. There is a dire need to make a swot analysis of

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venture capital undertakings and identify the problems faced by them for their

development which will make Tamil Nadu a manufacturing hub. There lies the

need for the study.

1.3 REVIEW OF LITERATURE

A review of previous studies on Venture Capital Financing is essential to

understand its concept and characteristics and also to identify the areas already

investigated so that new areas hitherto unexplored may be studied in depth. A

number of articles have been written and research work have been done on the

subject both in India and abroad and these are reviewed in this section.

Capital market plays a very significant role in the development of any

economy. Most of the countries in the Indo-Asian region are developing and are

in a continuous process of political and economic reforms. The entire South Asian

region has great economic potential which is yet to be fully exploited. Besides its

vast population, this region is also rich in natural resources. Till recently, most

countries in this region had a closed economy. At the beginning of this decade,

some countries like India, Pakistan and Bangladesh started liberalizing their

economies. The liberilisation facilitates export opportunities for the domestic

companies and access to advanced technology from the developed countries.

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In the earlier years, individual investors and development financial

institutions played the role of venture capitalists in India and entrepreneurs largely

depended upon private placements, public offerings and the finance lent by

financial institutions. In the early seventies, the need to foster venture capital as a

source of funding new entrepreneurs and technology was highlighted by the

Committee on Development of Small and Medium Enterprises. In spite of some

public sector funds being set up, the venture capital activity did not gather

momentum. Later, a study was undertaken by the World Bank to examine the

possibility of developing venture capital in the private sector, based on which the

Government of India took a policy initiative and announced guidelines for venture

capital funds in India in 1988. However, these guidelines recommended the

setting up of venture capital funds restricted only to the banks or the financial

institutions. Internationally, however, entrepreneurs, willing to take higher risk, in

anticipation of higher returns, usually set up venture capital funds. This is in

contrast to banks and financial institutions, which are more averse to risk.

In September 1995, the Government of India issued guidelines for overseas

venture capital investment in India whereas the Central Board of Direct Taxes

(CBDT) issued guidelines to venture capital companies for tax exemption

purposes. In 1996, SEBI came out with guidelines for venture capital funds,

which paved the way for entry of foreign venture funds into India. The Finance

Minister, in the budget 1999-2000 speech announced, “For boosting high tech

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sectors and supporting first generation entrepreneurs, there is an acute need for

higher investments in venture capital activities”. Recognizing the acute need for

higher investment in venture capital activities to promote technology and

knowledge- based enterprises, SEBI appointed a committee headed by K.B.

Chandrasekhar to identify the impediments in the growth of the venture capital

industry in India and to suggest suitable measures. The committee submitted its

report on January 8, 2000 and the Finance Minister in his budget proposals 2000-

2001, announced a new regime for venture capital funds, and proclaimed SEBI as

the single-point nodal agency for registration and regulation of both domestic and

overseas venture capital funds. The new regime stipulated that no approval of

venture capital funds by tax authorities would be required and that the principle of

‘pass through’ would be applied in tax treatment of venture capital funds. The

recommendation of the Chandrasekhar Committee remains a land mark in this

regard.

One of the first articles in India on the subject was by Prasanna Chandra.1

In this article Prasanna Chandra states that the term ‘Venture Capital’, is used to

describe investments in very young companies or start-up situations which are

characterized by a high risk reward ratio. Prasanna Chandra also summaries the

salient features of venture capital financing.

1Prasanna Chandra, Venture Capital, Paper prepared for Programme on Frontiers of Financial Management, Bangalore, November 6-10, 1989.

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I.M. Pandey2 in his article ‘Venture Capital in India’ published in

Chartered Financial Analyst, July – August 1989, says that in general Venture

Capital is considered a synonym of high risk capital, that is long term funds

invested in new enterprises. In broad terms Pandey describes Venture Capital as

the investment of long-term risk equity finance where the primary reward for the

venture capitalists is an eventual capital gain. More often than not this would be a

commitment of capital or shareholdings for the formation and setting up of small

companies specializing in new ideas and new technologies.

According to Kaura and Chandra3 Venture Capital is a form of financing,

designed for funding high technology, high risk and perceived high reward

projects. While a conventional financier seeks to back projects with proven

technologies and established markets, a venture capitalist provides funds to

entrepreneurs and enterprises pursuing new and unexplored avenues. Venture

capitalist helps the promoter to actualize the project and attain commercialization.

Financial support is extended not only as a conventional loan but also with fixed

intentions of sharing the reward as well as the risk with the sponsors of the

projects. In addition to providing finance, a venture capital financier provides

2I.M. Pandey, “Venture Capital in India”, Chartered Financial Analyst, July-August, 1989.

3Mohinder N. Kaura and Sharat G. Chandra, “Venture Capital as a Medium for Financing Hi-Tech Projects”, ASCI Journal of Management, September-December, 1991.

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management support to establish the venture successfully. According to him

venture capital is a medium for translating the entrepreneurial ideas from a

research laboratory stage to the production line and further on to get the product to

the market.

A report in the Economic Times of Venture Capital4 describes the working

of venture capital finance as follows: A promoter comes forward either with a

new but as yet untried product or process and needs a financial backer to help him

to set up his plant or to buyout a part of an existing enterprise. He may not be able

to go to the regular banks for one of two reasons; the product may be untried and

there may be further teething trouble to overcome in its design and marketing.

Alternatively, the promoter may have no previous track record as an investor. In

such cases, the financier may come forward and lend his money on the

understanding that, if the enterprise succeeds it will ‘go public’, that is float shares

on the stock exchange. The more successful the venture, higher will be the profits

earned by both promoter and the financier through the sale of shares.

S.V. Kumar’s5 “the Economic Comment on Venture Capital Lessons” in

the Business World, April 12-25, 1989 describes venture capital as neither

philanthropy nor gambling.

4“Venture Capital - Lack of Incentives Hinder Growth”, Economic Times, March

20, 1992. 5S.V. Kumars, “Economic Comment on Venture Capital Lessons”, Business

World, April 12-25, 1989.

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Roger L. Cottrell6 says that there are not private sector insurance

companies or pension funds gathering regular premium income and virtually no

private banks willing to devote a small portion of their resources to the venture

capital niche. It is unlikely that such enterprises will be created in the foreseeable

future to mobilize private savings for investments.

Sanjeev Sharma7 states that anomalous and ambiguous government

guidelines seriously hamper the development of venture capital financing in India.

Guidelines according to Sharma are full of lacunae and unless they are rectified

healthy venture capital development cannot be ensured. Another deterrent to large

private participation is the risk involved in funding relatively new projects with no

proven record in market acceptability. Also the harsh and inconsistent tax policies

of the government have proved to be the industry’s bane. Prof. Rupal J. Jagirdar8

feels that though Guidelines provide for a concessional rate of capital gains tax,

the move can hardly be deemed as ‘concession’ in view of the enormous risks

involved in the activity.

Jagirdar estimates that in developing countries like India, the success ratio

of venture capitalism is 1:7, that is, for every one company that succeeds, seven

6Roger L. Cottrell, “Venture Capital Myths and Realities”, Fortune India, December 1-15, 1989.

7Sanjeev Sharma, “Venture Capital Key Source of Industrial Finance”, Financial

Express, June 21, 1992. 8Rupal J. Jagirdar, “Venture Capital – A Capital Error?”, Fortune India,

December 1-15, 1989, pp.15-19.

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might fail. Typically, the supernormal profits made on a single investment should

compensate for the numerous losses spread over the other seven. For example,

Venrock Association, a premier venture capital company in the USA the financed

the start up costs of Apple computers for $ 5 million and subsequently recovered $

83 million on disinvestments to the public. However in India if one makes such

supernormal profit one has to reckon with the high rate of tax incidence – which is

why some sort of preferential tax treatment is necessitated if venture capital is to

be a feasible proposition.

Sidney Pinto, a veteran merchant banker and a director of Credit Capital

Finance Corporation, in an interview with Dipankar Mitra9 says that the tax

exemption on capital gains for corporations is discouraging.

Economic Times has summed up the problem as “Lack of Incentives

Hinder Growth’.10 According to this report, at present there are too many hurdles

for a new entrepreneur, in India:

The author feels that in view of the current process of technological up-

gradation in the Indian industry and the emergence of high technology industries,

there is a considerable scope for technology – related risk finance.

Institutionalisation of finance for such opportunities in the form of venture capital

9Dipankar Mitra, “Adventure at Last”, Business India, June 12-25, 1989,

pp.93-96.

10“Lack of Incentives Hinder Growth”, Economic Times, March 20, 1992.

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would, therefore, go a long way in accelerating this process. The resources exist,

but the fiscal incentives to make venture capital investment a commercial risk

worth taking must be created or, if they already exist, highlighted and improved.

Basudev Dass11 attributed the reasons for slow take off of venture capital in

India to the fact that the entire Indian business ethos is corroded by black money.

Most entrepreneurs including first generation entrepreneurs are driven by income

tax, excise and wealth-tax laws into taking out large portions of a company’s real

income in black. The result is that any partner in a new venture, providing the

capital, is deprived of a full and fair return.

Nitish K. Sengupta12 feels that for promoting venture capital companies, it

is necessary to provide adequate fiscal incentives and tax concessions to venture

capital companies both for raising resources from the public and for earning an

attractive return from the investment made in promoted ventures. A liberal fiscal

incentive regime conducive to the growth of venture capital industry is absolutely

necessary in order to offset the large percentage of failures and the very small

percentage of success stories which alone contribute to the ultimate overall

profitability of venture capital.

11Basudev Dass, “New Options: Venture Capital”, Business India, January 22 –

February 4, 1990, pp.50-56. 12Nitish K. Sengupta, Unshackling of Indian Industry, Vision Books, New

Delhi, 1992.

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M. Narasimham, chairman of Credit Capital Venture Fund (India) Limited,

in his speech at the company’s Annual General Meeting on September 11, 1992,

pointed out that Guidelines need to combine effective regulations with autonomy

and operational flexibility while at the same time ensure equality of treatment in

tax and other matters as between venture capital companies promoted in public,

joint or private sector.

Bagchi13 summarizes the reasons espoused for the tardy state of affairs in

the Indian venture capital industry as: as lack of tax concessions, strict guidelines,

including definition of high-risk technology and total project size, no concept of

equity below par, lack of research and manpower skills which do not equip them

for early stage investment, and attitude of entrepreneurs.

Asim K. Mishra,14 in his article “Venture Capital Financing Evaluation

studies and Follow-up Action” published in the Chartered Accountant presents a

comprehensive policy framework for venture capital in India. The article also

deals with various issues like the institutional support and disinvestments policy

for the successful functioning of the venture capital financing. The author

concludes by suggesting that the tax incentives and legislative support play an

active role in nurturing the growth of venture capital financing.

13Pradipta Bagchi, “The Rear to Venture Out”, Economic Times, March 18,

1993.

14Asim K. Mishra, “Venture Capital Financing Evaluation Studies and Follow-up Action”, The Chartered Accountant, November 1993, pp. 361-367.

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S.P. Srivastava,15 emphasizes the role of various financial institutions in the

promotion of venture capital in India. He specifically deals with the role of IFCI,

IDBI, and ICICI. He concludes by saying that the changing economic

environment and high technology explosion are clear indication of the vast scope

for venture capital in India.

A succinct overview of the concept of venture capital and venture capital

financing in India is presented by I.M. Pandey16 in his article, “Venture Capital

the Adventure. He feels the urgent necessity for strengthening the linkages

between government policies and the policies of venture capital funds and other

financial institutions in the field of science and technology.

T. Satyanarayana Chary,17 in his article, “Venture capital finance – A case

study of APIDC-Venture capital Limited” attempts to study the emergence of

venture capital in India and specifically the working of APIDC-Venture capital

limited. He strongly suggests that the Indian venture capital companies should

change their attitude as active partners in the venture rather than as owners by

themselves to get the complete satisfaction of investee companies.

15S.P. Srivastava, “Venture Capital – An Emerging Dimension of Institutional Financing”, Southern Economist, August 15, 1992, pp. 29-30.

16I.M. Pandey, “Venture Capital – The Adventure”, Chartered Financial

Analyst, July 1994, pp.90-91.

17T. Satyanarayana Chary, “Venture Capital Finance: A Case Study of APIDC – Venture Capital Limited”, Abhigyan, January-March, 2004, pp.13-22.

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Sandhya Prakash18 emphasizes the need for considerable fine-tuning for

venture capital industry to make a suitable impact on Indian business especially in

the small sector.

Shalin J. Parikh19 in his article focuses on the venture capital as anew type

of financial intermediary. He lists the concepts of venture capital and its evolution

and the various regulatory framework within which it operates.

Bob Zider20 who is the president of Beta Group, a firm that develops and

commercialises new technology with funding, in his article, “How Venture

Capital Works” underlines the mechanics of the venture capital industry with due

stress on the perception of both the players and the beneficiaries.

“Managing Venture Capital Productivity – An Emerging Issue”21 is an

article written by Umasankar Saha wherein the discusses the economics of per

capital venture capital productivity from the view-point of the enterprise as well

as the society. He focuses the emerging issue of managing per capita venture

capital productivity efficiently to steer entrepreneurship development.

18Sandhya Prakash, “Venture Capital Comes of Age”, Indian Management,

April 2000, pp.15-21.

19Shalin J. Parikh, “Venture Capital Funds are not Non-Banking Financial Intermediaries, The Chartered Accountant, December 2002, pp.620-624.

20Bob Zider, “How Venture Capital Works”, Harvard Business Review, November-December, 1998, pp.131-139.

21Umasankar Saba, “Managing Venture Capital Productivity – An Emerging Issue”, The Management Accountant, December 1999, pp.908-916.

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A. Vinay Kumar,22 in his article, focuses on the requirements of venture

capital firms in India for selecting ventures. Venture capitalists view ventures

from the lens of these basic preferences. According to him, for seed stage funding

Indian venture capital firms look for one most important preference that is the

percentage of ownership that they can buy in the idea.

Sudhir Sethi23 in his article, “Indian Venture Capital Reforms-

Recommendations for 2001” suggests to initiate some important reforms to

revitalize the Indian venture capital industry.

Sabarinathan,24 in his article, discusses how the Indian venture capitalists

react to the boom and bust of IT business scenario. The trend of the venture

capital investments in IT business in India is elaborated in detail in this article.

Deshpande25 in his article, “Venture Capital Industry in India” makes an

evaluation regarding the venture capital financing in the developed countries like

the USA and Europe and the developing countries. He highlights how the Indian

22V. Vinay Kumar, “Venture Stage Investment Preferences of Indian Venture

Capitalists: An Exploratory Analysis of Principal Components”, The ICFAI Journal of

Applied Finance, Vol.8, No.3, May 2002, pp.40-51.

23Sudhir Sethi, “Indian Venture Capital Reforms – Recommendations for 2001”, Chartered Financial Analyst, January 2001, p.13.

24G. Sabarinathan, “Venture Capital Investment Trends in IT Businesses in India”, IIMB Management Review, March 2002, pp.79-95.

25C.S. Deshpande, “The Venture Capital Industry in India”, Saket Industrial

Digest, January, 2001, pp.44-50.

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venture capital system is different from that of the system developed in the US

and Europe.

Venture capital that fuelled the revolution of American start-up companies

especially in the info-tech industry is still to become a significant phenomenon in

India. Laments A.K. Mishra,26 in his article “Venture Capital – A Long Way to

Go.

Garry Sharp27 in his book, “The Insiders’ Guide to Raising Venture

Capital”, presents a comprehensive and unbiased coverage of venture capital

financing in a modern economy. Starting with brief introduction of venture capital

financing and various commonly used terms the book explores the need for

venture capital finance with an outline of its development, scope and the types of

investments. The book also focuses upon the management of venture capital

funding and investigates in detail its applications at various levels.

Charis Bovaird,28 in his book, “Introduction to Venture Capital Finance”,

defines the classical concepts of venture capital financing. The first part of the

book devotes attention to a working knowledge of the subject. The second part

focuses on the key strategy and management issues involved in venture capital

26A.K. Mishra, “Venture Capital – A Long Way to Go”, Indian Management, April, 1998, pp.57-59.

27Garry Sharp, The Insiders Guide to Raising Venture Capital, Kongan Page, London, 1991.

28Chris Bovaird, Introduction to Venture Capital Finance, Pitman Publishing, London, 1990.

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investments. The book mainly deals with a survey conducted by the author on

ninety-three venture capital backed companies in the UK to attain a better

understanding of the demands of entrepreneurs and the needs of those firms. The

book provides the reader with a knowledge and understanding of the advice and

assistance that entrepreneurial firms expect their venture capital firms to provide.

Rod B. McNaughton,29 in the book, “Venture Capital International

Comparisons” presents a spatially disaggregate evaluation of the organization and

functioning of the venture capital markets.

I.M. Pandey,30 in his book, “Venture Capital – The Indian Experience”,

provides a review of the development of venture capital with focus on venture

capital in Asia. Subsequently, the next explains the context of venture capital in

India and its role in technology development. The book also examines the

practices and policies followed by the venture capital firms in India. Finally the

book reviews the policy initiatives necessary for the growth of venture capital in

India.

29Rod B. McNaughton, in Milford B. Green (ed.), Venture Capital International

Comparison, London and New York, Routledge, 1991.

30I.M. Pandey, Venture Capital – The Indian Experience, Prentice-Hall of India, New Delhi, 1999.

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“Venture Capital Financing in India” a book written by J.C. Verma,31

caters to a variety of needs including those of the providers and users of venture

capital and includes an analysis of the various practices and procedures in venture

capital financing. It also profiles the venture capitalists operating in India at the

time.

M.Y. Khan,32 in his book, “Financial Services” makes an attempt to

provide a judicious mix of theory and practice of contemporary Indian financial

services sector. It covers in detail the theoretical and regulatory aspects of venture

capital financing. He discusses the theoretical framework of venture capital

financing and the salient features of such financing currently in operation in India.

Ramesh and Gupta33 in their book, “Venture Capital and the Indian

Financial Sector”, deals with various aspects involved in the valuation of venture

capital firms’ own portfolio. The book also examines the structural and legal

aspects which are of considerable importance to the venture capital industry. On

similar lines, Vasant Desai,34 L.M. Bhole,35 H.R. Machiraju36 and V.K. Bhalla37 in

their books “Management of Indian financial Institutions”, “Financial Institutions

31J.C. Verma, Venture Capital Financing in India, Response Books, New Delhi,

1997.

32M.Y. Khan, Financial Services, Tata McGraw Hill Publishing Company Ltd., New Delhi, 1997.

33S. Ramesh and Arun Gupta, Venture Capital and the Indian Financial Sector, Oxford University Press, New Delhi, 1995.

22

and Markets Structure- Growth and Innovations”, “Indian Financial System” and

“Management of Financial Services” deal with venture capital financing,

respectively.

The articles, “Finding Exit Routes”38 and “Exit Policy”39 answer relevant

questions regarding the exit routes of the Indian venture capital companies.

In his article “Venture Capitalists Tango with SEBI”,40 Sengupta and

Prasad deal with the registration formalities of Indian venture capital companies

with the SEBI. The article analyses various reasons for the registration and the

subsequent benefits available to Indian and Foreign venture capital companies

operating in India.

34Vasant Desai, Management of Indian Financial Institutions, Himalaya

Publishing House, Mumbai, 1996.

35L.M. Bhole, Financial Institutions and Markets Structure – Growth and

Innovations, Tata McGraw Hill Publishing Company Ltd., New Delhi, 1997.

36H.R. Machiraju, Indian Financial System, Vikas Publishing House Private Ltd., New Delhi, 1999.

37V.K. Bhalla, Management of Financial Services, Anmol Publications Pvt. Ltd., New Delhi, 2002.

38Snigdha Sengupta, “Finding Exit Routes”, Business World, 29 December 2003, p.9.

39Shishir Prasad, “Exit Policy”, Business World, 29 December, 2003, p.30. 40Snigdha Sengupta and Shishir Prasad, “Venture Capitalists Tango with SEBI”,

Business World, 6 October, 2003, p.18.

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The article, “New Targets for Venture Funds”,41 focuses on the need for

improving business models for venture capital to explore new markets in India.

The article “Venture Capital Distributions: Short-run and Long-run

reactions”42 examines the distribution of venture capital investments to the

investors in venture capital funds by the funds’ general partners.

The articles “Venture Capital: Its Concept and performance in India”43 and

“Venture capital financing: The emerging trends in India”,44 focus on the stages

and forms of venture financing in India.

The article “Advantage start-ups”45 points out that the venture capital

industry in India seems ready for a relaunch, with the government offering

attractive tax breaks and promise of a better return on investment looking brighter

than ever before.

41Shishir Prasad, “New Targets for Venture Funds”, Business World, 3 June 2002, pp.38-40.

42Paul Compers and Josh Lerner, “Venture Capital Distributions: Short-run and Long-run Relations”, The Journal of Finance, Vol.LIII, No.6, December, 1998, pp.2161-2183.

43Shiv Prasad and Hanuman Prasad, “Venture Capital: Its Concept and Performance in India”, Udyog Pragati, Vol.25, No.1, January-March, 2001, pp.33-41.

44M. Murugesan, “Venture Capital Financing: The Emerging Trends in India”, Banking Finance, January 2002, pp.3-8.

45Tushar Pania, “Advantage Start-Ups”, Business India, September 11-24, 1995, pp.85-89.

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Satish Taneja46 in his article “Venture Capital- How to Source it” presents

the factors influencing venture capitalists choice of investments and on analysis of

venture. He also deals with the characteristics of entrepreneurs and how to choose

the entrepreneur and a right venture capitalist.

The article “Venture capital: The Need of the Hour”47 deals with the

importance of venture capital financing in India as a part of its industrial

development programme.

Hareram Hajara,48 in his article, explains the origin, growth, and regulatory

framework of venture capital financing in India. Shedde49 portrays the investment

criteria of the venture capitalists and their supports to the organization.

The ICRA Information Services, in its publication, on “Venture Capital in

India”50 details the history, growth and pattern of venture capital investments in

India. Taori, K.J.51 in his article “Venture Capital Funding” elaborately

discusses the various aspects of venture capital financing like its history, stages,

46Satish Teneja, “Venture Capital – How to Source It”, Abhigyan, Vol.XX, No.3, October-December, 2002, pp.1-7.

47V. Mallik, “Venture Capital: The Need of the Hour”, The Chartered

Accountant, November, 1995, pp.31-33.

48Hareram Hajra, “Venture Capital Fund – A Boon to the New Breed Entrepreneurs”, The Management Accountant, April 2002, pp.265-270.

49P.D. Shedde, “Venture Capital”, Touchdown India, May 1999, pp.5-7.

50ICRA Information Services, “Venture Capital in India, October, 2001, pp.3-7.

25

forms of assistance and the exists. The article also deals with the SBI’s approach

to financing software activities.

The article ‘Waiting to take-off’52 presents the obstacles which restricted

the growth of venture capital industry in India.

Mishra53. in his article “Venture Capital: Issues, Options and Strategies”,

presents the overview of venture capital in India, stages of venture capital

financing, policy framework and various issues. Similarly, Sabarinathan54 in his

article also speaks about the vital issues relating to venture capital and IT firms in

India. The writers worth-mentioning, who elaborately discussed the legal and

operational problems in venture capital financing include: Singhvi, L.K.,55

Sadhak, H.,56 Govil Anju,57 Sudha Nagaraj,58 Hema Ramakrishnan and

Muralidhar, S.,59 and Subhash Agrawal.60

51K.J. Taori, “Venture Capital Funding”, The Journal of the Indian Institute of

Bankers, Vol.72, No.2, April-June 2001, pp.13-19.

52Lancelot Joseph and Roy Pinto”, Waiting to Take-off”, Business India, February 7-20, 2000, pp.85-88.

53A.K. Mishra, “Venture Capital: Issues, Options and Strategies”, Productivity, Vol.39, No.3, October-December, 1998, pp.414-422.

54G. Sabarinathan, “Venture Capital and IT Firms in India – Vital Issues”, IIMB

Management Review, March 2002, pp.73-78.

55L.K. Singhvi, “Venture Capital Industry in India – An Agenda for Growth”, Productivity, Vol.40, No.1, October-November, 1999.

56H. Sadhak, “Venture Capital in India”, Yojana, Vol.83(24), 1st January 1990,

pp.21-23.

26

Julia Hanna (2006) stated that the venture capital firms often consider

investments in companies located far away or in unfamiliar industries. How do

they spot these opportunities and also reduce risk? It's the power of networks,

says Harvard Business School professor Toby Stuart—and understanding how

they work in VC is just now starting to be understood. Key concepts include:

Networks are important in all industries, but especially so in VC where

investment opportunities can be located far away from the centers of venture

capital. "Spanning ties" enable investors with fixed locations and industry

expertise to learn of opportunities outside their geographic and industry domains,

while also reducing risk. Ties are more likely to form between VC firms in the

context of bandwagons, such as a "hot" IPO market, that create a rush of

excitement around particular types of companies.61

Carmen Nobel (2010) stated that the clean-tech start-ups depend on

patience and public policy to thrive—the Internet models for VC funding don't

57Govil Anju, “Venture Capital Favour Low Risk Funds”, Economic Times, July

31, Bombay, 1995.

58Sudha Nagaraj, “Venture Capital”, Computers Today, 1-15 April, 2000, pp.30-37.

59Hema Ramakrishnan and S. Muralidhar, “Venture Capital: Negative List to Cover More Turf”, Business Line, March 17, New Delhi, 2000,.

60Subhash Agrawal, “Venture Capital in India”, Financial Express, March 11,

Chennai, 2004. 61Julia Hanna, “The Money Connection—Understanding VC Networks”,

Harvard Business School, December 4, 2006.

27

apply. That's why Harvard Business School professor Joseph Lassiter is making

an unusual recommendation to his entrepreneurship students: Spend a few years

serving time in a government job. Key concepts include: MBA students and

young venture capitalists often assume that all promising start-ups can grow and

exit as fast as Internet start-ups, but they're mistaken. Clean-tech start-ups are

often stymied by a "valley of death"—that precarious stage between researching

and developing a product and going to market. The success of clean-tech

companies often is dependent on public policy, so it behooves budding VCs and

entrepreneurs to spend a few years learning the ropes in a government or

corporate job.62

A very few research works deal with venture capital financing in India. The

present study evaluates the concepts, procedures, legal and operational problems

in venture capital financing, the volume of investments made by the venture

capitalists and the perception of the investee companies of the venture capital

financing in India.

62Carmen Nobel, “Venture Capital's Disconnect with Clean Tech”, Harvard

Business School, October 18, 2010.

28

1.4 OBJECTIVES OF THE STUDY

The specific objectives are:

1. To study the conceptual and legal framework of venture capital

investment in India.

2. To Examine the Evolution and growth of venture capital in India and

abroad.

3. To analyze the profile of the selected venture capital fund Companies.

4. To identify the factors influencing venture capital undertakings in

Tamil Nadu.

5. To make a SWOT analysis of venture capital undertakings in Tamil

Nadu.

6. To make concrete suggestions based on the analysis.

1.5 RESEARCH METHODOLOGY

This part of the study describes the methodology which includes collection

of data, sampling design, period of study, operational definition of concept,

construction of questionnaire, tools of analysis, data processing and framework of

analysis.

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Data Collection

Primary Data

The present study is an empirical one based on the survey method. The first

hand data were collected from the investee companies in India through a

questionnaire and personal observation. The data relating to various problems

encountered by the investee companies in TamilNadu and their perception of the

venture capitalists were gathered through the questionnaire.

A number of discussions were held with knowledgeable persons such as

academicians, officials of the venture capital companies, entrepreneurs, and the

office bearers of IVCA for designing the questionnaire.

Secondary Data

The study mainly depends on the published and unpublished secondary

data available with Indian Venture Capital Association (IVCA), New Delhi, the

country’s umbrella association of venture capital. The IVCA has been pivotal in

persuading the government to create a framework of policies and procedures,

conducive to the creation of venture capital firms and flow of capital to India. The

data required for the study were collected from the internal records, official

circulars, business development and research files, pamphlets, and from the

internal accounting records of the IVCA. The various reports, records, and

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booklets issued and maintained by the ICICI have also been used in the study. The

information was also gathered by having informal discussions with the company

secretary and senior vice-presidents of the investee companies.

Construction of the Questionnaire

The variables to be studied were identified from the various reports and

booklets published by the financial institutions, published articles, preliminary

discussions with some selected officials of the ICICI and IFCI Venture Capital

companies. The questionnaire so drafted was circulated among a few research

scholars, and field experts for a critical review with regard to wordings, format,

sequence and the like. It was drafted in the light of their comments and a pilot

study was conducted with 15 venture capital undertakings for necessary

modifications. The questionnaire, accordingly prepared was an undisguised,

structural data-gathering instrument, suitable for a mailed questionnaire.

Period of study:

The primary data for the study was collected during 2010-2012.

1.6 SAMPLING TECHNIQUE

This research study covers venture capital undertakings assisted by ICICI

and IFCI. The venture capital companies were asked to give a list of their

beneficiary units. There were 404 beneficiary units as on December 31, 2011.The

questionnaire was administered only to 150 investee companies each 75 from

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ICICI and IFCI, Judgment Sampling Method was adopted giving due

representation to micro, small, medium and big/large industries. Thus the study

covers 150 venture capital investee undertakings.

Statistical tools applied:

The following statistical tools were applied for analyses of the study.

Percentage analysis, Mean deviation, Standard deviation, Karl Pearson Skewness,

Correlation variance, chi-square test, t-test, SWOT analysis etc.

Operational Concepts

The venture capital industry has created its own vocabulary to describe

financing methods it employs. Some of the terms and jargons commonly used in

the venture capital financing are explained below:

1. Angel

Wealthy individual who invests in entrepreneurial firms. Although angels

perform many of the same functions as venture capitalists, they invest their own

capital rather than that of institutional or other individual investors.

2. Bridge Financing

Financing a company expecting to go public within six to twelve months. It

includes pre-merger/acquisition finance provided to a company. It is the last round

of financing before the planned exit.

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3. Business Plan

A detailed feasibility report of a business venture.

4. Deal Structuring

The exact terms of the investment as negotiated between the venture

capitalist and investee company. The term includes the amount, form and price of

the investment.

5. Due Diligence

Detailed analysis and appraisal of the background of the entrepreneur and

his business plan.

6. Exit

The disinvestments by a venture capital fund/ company of the equity held

in an investee company.

7. Exit Routes

The means by which a venture capitalist disinvests his stock in an assisted

company. Usual exit routes are buy-back, an IPO or trade sale.

8. Fund of Funds

A fund that invests primarily in other venture capital funds rather than

portfolio firms, often organized by an investment adviser or investment bank.

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9. Hands-on

Management style where venture capitalists participate in day-to-day

operations of the business.

10. IPO (Initial Public Offering)

A company’s first offering of shares to public. IPO, flotation, float, going

public, and listing are just some of the terms used when a company obtains a

quotation on a stock market.

11. LBO (Leverage Buy-Out)

A buy-out or acquisition of a business using mostly debt and a small

amount of equity. Buy-out financed by another venture capitalist is known as

leveraged buy-out.

12. Management Buy-in (MBI)

The purchase of a business by one or more outside managers with the help

of a group of financial backers.

13. Management Buy-out (MBO)

The purchase of a business by its exiting managers (not owners) with the

help of a group of financial backers.

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14. Mezzanine Financing

A later stage venture capital investment with low risk. It is a mix of debt

and equity financing.

15. Private Equity

Private equity includes organizations devoted to venture capital, leveraged

buyouts, consolidations, mezzanine and distressed debt investments, and a variety

of hybrids such as venture leasing and venture factoring.

16. Venture Capitalist

A general partner or associate at a venture capital company.

17. Venture Capital Undertaking/Investee Company

A company where in a venture capitalist has made an investment. It is the

company financed by a venture capitalist.

18. Venture Capital Company (VCC)

A company which has made investments by way of acquiring equity shares

of venture capital undertakings in accordance with the prescribed guidelines.

9. Venture Capital Fund (VCF)

A fund, operating under a trust deed registered under the provisions of the

Registration Act, 1908, established to raise monies by trustees for investments

mainly by way of acquiring equity shares of a venture capital undertaking in

accordance with the prescribed guidelines.

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1.7 LIMITATIONS OF THE STUDY

Every research study suffers from errors and limitations. Some of these are

inherent in the research design, while some others become part of the study during

various stages of operations. The present study is subject to the following

constraints and limitations.

.a. The questionnaires used for this study despite pretesting, may contain a

few errors, some variables would have been left out. But efforts have been made

to minimize such errors.

b. The investee companies categorically refused to provide any financial

data particularly relating to the amount and stages of investment. Hence, the

researcher could gather only qualitative opinion from the investee companies.

Since such financial data were not made available by the respondents, they are

excluded from the study.

1.8 CHAPTER SCHEME

The present study “PROBLEMS AND PROSPECTS OF VENTURE

CAPITAL UNDERTAKINGS IN TAMIL NADU” , has been organized into

seven chapters.

36

Chapter I – ‘Introduction and Research Design’ introduces the subject

and deals with a review of related literature, statement of the problem,

significance of the study, objectives of the study, research design of the study,

source of data, period of study, operational concepts, limitations and the chapter

organization.

Chapter II – ‘Conceptual and Legal Framework of Venture Capital

Investment’ describes the concepts of venture capital and legal framework.

Chapter III – ‘An Overview of Venture Capital in India and Abroad’

presents the origin, growth and development of venture capital financing in India,

the various phases of development and the major players of the Indian venture

capital industries. Further, it highlights the performance of venture capitalists

globally.

Chapter IV – ‘Profile of the Selected Venture Capital Financing

Companies’ describes the profile of the venture capital companies namely ICICI

Venture Fund Management Company Limited and IFCI India Venture Funds

Limited.

Chapter V – ‘Factors Influencing Venture Capital Undertakings’

analyses socio-economic profile of venture capital entrepreneurs and factors

influencing venture capital undertakings.

37

Chapter VI – ‘SWOT Analysis of Venture Capital undertakings’

examines the strengths, weaknesses ,opportunities and threats of venture capital

undertakings and the problems faced by them.

Chapter VII – ‘Summary of Findings, Suggestions and Conclusion’

presents the summary of findings, suggestions and conclusion and the scope for

further research.