ANAND Venture

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Project ReportOn

A STUDY OF VENTURE CAPITAL IN INDIA

In partial fulfillment of the requirement of

MASTER OF MANAGEMENT STUDIES COURSE

Project GuideMr. C.R.S. Pillai

Submitted By:Anand M. Jain

(Roll No- 74)

Pillais Institute of Management Studies and Research(2010- 12)


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ACKNOWLEDGEMENT

The project of this magnitude would not have been completed singly. Firstly I want togive my hearty thanks to all mighty who made the world and me also.There are many other people without whom the completion of the project would nothave been possible. Some have contributed towards this directly while other have

provided indirectly.It gives me immense pleasure to thank Ms.Pooja Patil and Ms. Hema(HR) for

providing me summer training in his reputed organization.I am indebted to Mr. Ajay Deshmukh of Genext Venture Capital for theirguidance and cooperation in completing this project.Last but not the least I would like to convey my heartiest gratitude to all Members ofGenext Venture Capital who helped a lot during my summer training.

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DECLARATION

I Anand M. Jain a student of MMS III Semester of PIMSR College, Mumbai herebydeclare that the research project report titled Study Of Venture Capital In Indiais my original work and the same has not been submitted for the award of any otherdiploma or degree.

Place: Navi Mumbai

Date: Anand M. Jain

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EXECUTIVE SUMMARY

Venture capital is a growing business of recent origin in the area of industrial financing in

India. The various financial institution set-ups in India to promote industries have done

commendable work. However, these institutions do not come up to benefit risky ventures

when they are undertaken by new or relatively unknown entrepreneurs. They contend to give

debt finance, mostly in the form of term loans to the promoters and their functioning has been

more akin to that of commercial banks.

Starting and growing a business always require capital. There are a number of alternative

methods to fund growth. These include the owner or proprietors own capital, arranging debt

finance, or seeking an equity partner, as is the case with private equity and venture capital.

Venture capital is a means of equity financing for rapidly-growing private companies.

Finance may be required for the start-up, development/expansion or purchase of a company.

Venture Capital firms invest funds on a professional basis, often focusing on a limited sectorof specialization (eg. IT, Infrastructure, Health/Life Sciences, Clean Technology, etc.).

Indian Venture capital and Private Equity Association(IVCA) is a member based national

organization that represents venture capital and private equity firms, promotes the industry

within India and throughout the world and encourages investment in high growth companies.

IVCA member comprise venture capital firms, institutional investors, banks, incubators,

angel groups, corporate advisors, accountants, lawyers, government bodies, academic

institutions and other service providers to the venture capital and private equity industry.

Members represent most of the active venture capital providers and private equity firms in

India. These firms provide capital for seed ventures, early stage companies, later stage

expansion, and growth finance for management buyouts/buy-ins of established companies.

Venture capitalists have been catalytic in bringing forth technological innovation in USA. A

similar act can also be performed in India. As venture capital has good scope in India for

three reasons:

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First: The abundance of talent is available in the country. The low cost high quality Indian

workforce that has helped the computer users worldwide in Y2K project is demonstrated

asset.

Second: A good number of successful Indian entrepreneurs in Silicon Valley should have a

demonstration effect for venture capitalists to invest in Indian talent at home.

Third: The opening up of Indian economy and its integration with the world economy is

providing a wide variety of niche market for Indian entrepreneurs to grow and prove

themselves.

Setting the stage - Venture Capital in India Phase I - Formation of TDICI in the 80s and regional funds as GVFL & APIDC in

the early 90s.

Phase II - Entry of Foreign Venture Capital funds (VCF) between 1995-1999 Phase III - (2000 onwards). Emergence of successful India-centric VC firms Phase IV (current) Global VCs and PE firms actively investing in India 150 Funds active in the last 3 years (Government,Overseas, Corporate, Domestic)

The Opportunity High Growth in Technology and Knowledge based Industries (KBI) KBI growing fast and mostly global, less affected bydomestic issues. Several emerging centers of innovation biotech,wireless, IT, semiconductor,

pharmaceutical. Ability to build market leading companies in India that serve both global and

domestic markets.

India moving beyond supplier of low-cost services to higher-value products.Quality of entrepreneurship on ascending curve.

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TABLE OF CONTENTS

SR.NO NAME OF THE CONTENTS PAGENO.

1 INTRODUCTION 7

2 FEATURES OF VENTURE CAPITAL 13

3 VENTURE CAPITAL INVESTMENT

PROCESS

30

4 METHODS OF VENTURE FINANCING 37

5 EVOLUTION OF VENTURE CAPITALINDUSTRY IN INDIA

39

6 REGULATORY AND LEGALFRAMEWORK

47

7 KEY SUCCESS FACTOR FOR VENTURECAPITAL INDUSTRY IN INDIA

57

8 RECOMMENDATIONS 629 FINDINGS 67

10 CONCLUSION 68

ANNEXTURE (QUESTIONNAIRE

BIBLIOGRAPHY

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CHAPTER 1INTRODUCTION:

Gen Next Ventures Private Limited is an early stage venture capital firm focused

on IT investing with offices in Mumbai, India. Founded in 1997, as Idealab Capital

Partners, Gen Next Ventures is responsible for the early-stage funding of many

successful startups including PayPal (IPO, acquired by eBay), Overture.com (IPO,acquired by Yahoo), Internet Brands/CarsDirect (NASDAQ: INET), NetZero/United

Online (NASDAQ: UNTD), MP3.com (IPO, acquired by Vivendi), Meru Networks

(NASDAQ: MERU), Integrien (acquired by VMware), Ankeena (acquired by Juniper),

Kazeon Systems (Acquired by EMC) and Mimosa Systems (acquired by Iron

Mountain).

Managing Directors

Mr.Anil Sharma, Founder Mr.Vijay Deshmukh

Mr.Avadesh Yadav

Mr.Sumant Mandal

Ms.Sunita Agrawal

Venture capital (VC) is financial capitalprovided to early-stage, high-potential, high

risk, growthstartup companies. The venture capital fundmakes money by

owning equityin the companies it invests in, which usually have a novel technology

orbusiness model in high technology industries, such as biotechnology, IT, software,

etc. The typical venture capital investment occurs after the seed fundinground as

growth funding round (also referred as Series A round) in the interest of generating a

return through an eventual realization event, such as an IPO ortrade sale of the

company. Venture capital is a subset ofprivate equity. Therefore all venture capital

is private equity, but not all private equity is venture capital.[1]

In addition to angel investingand otherseed fundingoptions, venture capital is

attractive for new companies with limited operating history that are too small to raise

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capital in the public markets and have not reached the point where they are able to

secure a bank loan or complete a debt offering. In exchange for the high risk that

venture capitalists assume by investing in smaller and less mature companies,

venture capitalists usually get significant control over company decisions, in addition

to a significant portion of the company's ownership (and consequently value).

Venture capital is also associated with job creation (accounting for 21% of US GDP),

[2]the knowledge economy, and used as a proxy measure of innovation within an

economic sector or geography. Every year there are nearly 2 million businesses

created in the USA, and only 600-800 get venture capital funding. According to the

National Venture Capital Association 11% of private sector jobs come from venture

backed companies and venture backed revenue accounts for 21% of US GDP.

Growth capital (also called expansion capital and growth equity) is a type

ofprivate equityinvestment, most often a minority investment, in relatively mature

companies that are looking for capital to expand or restructure operations, enter new

markets or finance a significant acquisition without a change of control of the

business.[1]

Companies that seek growth capital will often do so in order to finance a

transformational event in their lifecycle. These companies are likely to be more

mature than venture capital funded companies, able to generate revenue and

operating profits but unable to generate sufficient cash to fund major expansions,

acquisitions or other investments. Because of this lack of scale these companies

generally can find few alternative conduits to secure capital for growth, so access to

growth equity can be critical to pursue necessary facility expansion, sales and

marketing initiatives, equipment purchases, and new product development.[2]Growth

capital can also be used to effect a restructuring of a company's balance sheet,

particularly to reduce the amount ofleverage (or debt) the company has on

its balance sheet.

Growth capital is often structured as eithercommon equityorpreferred equity,

although certain investors will use various hybrid securitiesthat include a contractual

return (i.e., interest payments) in addition to an ownership interest in the company.

Often, companies that seek growth capital investments are not good candidates to

borrow additionaldebt, either because of the stability of the company's earnings or

because of its existing debt levels.

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Origins of modern private equity

Before World War II, money orders (originally known as "development capital") were primarily

the domain of wealthy individuals and families. It was not until after World War II that what is

considered today to be true private equity investments began to emerge marked by the

founding of the first two venture capital firms in 1946: American Research and Development

Corporation. (ARDC) and J.H. Whitney & Company.[4]

ARDC was founded by Georges Doriot, the "father of venture capitalism"[5] (former dean

ofHarvard Business Schooland founder ofINSEAD), with Ralph Flandersand Karl

Compton (former president ofMIT), to encourage private sector investments in businesses

run by soldiers who were returning from World War II. ARDC's significance was primarily that

it was the first institutional private equity investment firm that raised capital from sources

other than wealthy families although it had several notable investment successes as well.

[6] ARDC is credited with the first trick when its 1957 investment of $70,000 in Digital

Equipment Corporation(DEC) would be valued at over $355 million after the company's initial

public offering in 1968 (representing a return of over 1200 times on its investment and

an annualized rate of return of 101%).[7]

Former employees of ARDC went on and established several prominent venture capital firms

including Greylock Partners (founded in 1965 by Charlie Waite and Bill Elfers) and Morgan,

Holland Ventures, the predecessor of Flagship Ventures (founded in 1982 by James

Morgan). [8] ARDC continued investing until 1971 with the retirement of Doriot. In 1972, Doriot

merged ARDC with Textron after having invested in over 150 companies.

J.H. Whitney & Company was founded by John Hay Whitneyand his partnerBenno Schmidt.Whitney had been investing since the 1930s, founding Pioneer Pictures in 1933 andacquiring a 15% interest in Technicolor Corporationwith his cousin Cornelius VanderbiltWhitney. By far Whitney's most famous investment was in Florida Foods Corporation. Thecompany developed an innovative method for delivering nutrition to American soldiers, whichlater came to be known as Minute Maid orange juice and was sold to The Coca-ColaCompanyin 1960. J.H. Whitney & Companycontinues to make investments in leveragedbuyouttransactions and raised $750 million for its sixthinstitutional private equity fundin2005.re capital (also known as VC or Venture) is provided as seed funding to early-stage,high-potential, growth companies and more often after the seed funding round as growthfunding round (also referred as series A round) in the interest of generating a return throughan eventual realization event such as an IPO ortrade sale of the company. To put it simply,an investment firm will give money to a growing company. The growing company will thenuse this money to advertise, do research, build infrastructure, develop products etc. Theinvestment firm is called a venture capital firm, and the money that it gives is called venturecapital. The venture capital firm makes money by owning a stake in the firm it invests in. Thefirms that a venture capital firm will invest in usually have a novel technology orbusinessmodel. Venture capital investments are generally made in cash in exchange for shares in theinvested company. It is typical for venture capital investors to identify and back companies inhigh technology industries, such asbiotechnology and IT (Information Technology).

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Venture capital typically comes from institutional investors and high net worth individuals,and is pooled together by dedicated investment firms.

Venture capital firms typically comprise small teams with technology backgrounds(scientists, researchers) or those with business training or deep industry experience.

OBJECTIVES OF THE STUDY Understand the concept of venture capital. Venture Capital funding is

different from traditional sources of financing. Venture capitalists finance innovation

and ideas which have potential for high growth but with inherent uncertainties. This

makes it a high-risk, high return investment. Study venture capital industry in India . Scientific, technology and

knowledge based ideas properly supported by venture capital can be propelled into a

powerful engine of economic growth and wealth creation in a sustainable manner. In

various developed and developing economies venture capital has played a significant

developmental role.

Study venture capital industry in global scenario . Venture capital

has played a very important role in U.K., Australia and Hong Kong also in

development of technology growth of exports and employment.

Study the evaluation & need of venture capital industry in

India. India is still at the level of knowledge. Given the limited infrastructure,

low foreign investment and other transitional problems, it certainly needs policy

support to move to the next stage. This is very crucial for sustainable growth and for

maintaining Indias competitive edge

Understand the legal framework formulated by SEBI to

encourage venture capital activity in Indian economy. Promotingsound public policy on issues related to tax, regulation and securities through

representation to the Securities and Exchange Board of India (SEBI), Ministry of

Finance (MoF), Reserve Bank of India (RBI) and other Government departments

Find out opportunities that encourage & threats those hinderventure capital industry in India.

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To know the impact of political & economical factors on

venture capital investment.

LIMITATION OF PROJECT

A study of this type cannot be without limitations. It has been observed those venture capitals

are very secretive about their investments. This attitude is a major hindrance for data

collection. However venture capital funds/companies that are members of Indian venture

capital association are to be included in the study.

SCOPE OF THE PROJECT

The scope of the research includes all types of venture capital firms set up as a company &

funds irrespective of the fact that they are registered with SEBI of India or not part of this

study.

RESEARCH DESIGN AND METHODOLOGY

In India neither venture capital theory has been developed nor are there many comprehensive

books on the subject. Even the number of research papers available is very limited. The

research design used is descriptive in nature. (The attempt has been made to collect

maximum facts and figures available on the availability of venture capital in India, nature of

assistance granted, future projected demand for this financing, analysis of the problems faced

by the entrepreneurs in getting venture capital, analysis of the venture capitalists and social

and environmental impact on the existing framework.)

The research is based on secondary data collected from the published material. The data was

also collected from the publications and press releases of venture capital associations in

India.

Scanning the business papers filled the gaps in information. The Economic times, Financial

Express and Business Standards were scanned for any article or news item related to venture

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capital. Sufficient amount of data about the venture capital has been derived from this

project.

CONCEPT OF VENTURE CAPITAL

The term venture capital comprises of two words that is, Venture and capital. Venture

is a course of processing the outcome of which is uncertain but to which is attended the risk

or danger of Loss. Capital means recourses to start an enterprise. To connote the risk and

adventure of such a fund, the generic name Venture Capital was coined.

Venture capital is considered as financing of high and new technology based enterprises. It is

said that Venture capital involves investment in new or relatively untried technology,

initiated by relatively new and professionally or technically qualified entrepreneurs with

inadequate funds. The conventional financiers, unlike Venture capitals mainly finance proven

technologies and established markets. However, high technology need not be prerequisite for

venture capital.

Venture capital has also been described as unsecured risk financing. The relatively high risk

of venture capital is compensated by the possibility of high return usually through substantial

capital gains in term. Venture capital in broader sense is not solely an injection of funds into

a new firm, it is also an input of skills needed to set up the firm, design its marketing strategy,

organize and manage it. Thus it is a long term association with successive stages of

companys development under highly risky investment condition with distinctive type of

financing appropriate to each stage of development. Investors join the entrepreneurs as co-

partners and support the project with finance and business skill to exploit the market

opportunities.

Venture capital is not a passive finance. It may be at any stage of business/ production cycle,

that is startup, expansion or to improve a product or process, which are associated with both

risk and reward. The Venture capital gains through appreciation in the value of such

investment when the new technology succeeds. Thus the primary return sought by the

investor is essentially capital gain rather than steady interest income or dividend yield.

The most flexible Definition of Venture Capital is:-

The support by investors of entrepreneurial talent with finance and business skills to

exploit market opportunities and thus obtain capital gains.

Venture capital commonly describes not only the provision of start up finance or seed corn

capital but also development capital for later stages of business. A long term commitment of

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funds is involved in the form of equity investments, with the aim of eventual capital gains

rather than income and active involvement in the management of customers business.

Growth of PE/VC in India 2004 2010(US$ millions)

INVESTMENT BY SECTORS

INVESTMENT BY STAGE*PIPE-Private Investment in public equity

VC Investments by stage:2009

2009 VC Trends

US$7.5bn invested in 2009 across 299 deals. IT & ITES retained its status as the favorite industry among PE investors, followed

by manufacturing and real estate. Largest PE deal was $900M LBO of Flextronics by Kohlberg Kravis Roberts

(KKR). M&A and IPO activity continued to remain strong.

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Stage of Company No. of Deals Amount (US$M)Early Stage 59 236

Growth stage 42 393

Late stage 104 3663PIPE 61 1314Buyout 11 1125Others 22 769


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2009 VC Investments by industry Total

US$7.5Bn

Top Cities attracting VC InvestmentCity No. Of Deals Value(US $M)Mumbai 69 1780

Delhi 41 395Bangalore 40 1525Chennai 22 354

Hyderabad 17 492Pune 10 1114

CHAPTER2

FEATURES OF VENTURE CAPITAL

High Risk High Tech Equity Participation & Capital Gains Participation In Management Length Of Investment

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Illiquid Investment

High RiskBy definition the Venture capital financing is highly risky and chances of failure are high as

it provides long term start up capital to high risk- high reward ventures. Ventures capital

assumes four type of risks, these are:

Management risk -Inability of management teams to work together.

Market risk -Product may fail in the market.

Product risk-Product may not be commercially viable.

Operation risk-Operation may not be cost effective resulting in increased cost

decreased gross margin.

High TechAs opportunities in the low technology area tend to be few of lower order, and hi-tech

projects generally offer higher returns than projects in more traditional area, venture capital

investments are made in high tech. areas using new technologies or producing innovative

goods by using new technology. Not just high technology, any high risk ventures where theentrepreneur has conviction but little capital gets venture finance. Venture capital is available

for expansion of existing business or diversification to a high risk area. Thus technology

financing had never been the primary objective but incidental to venture capital.

Equity Participation & Capital GainsInvestments are generally in equity and quasi equity participation through direct purchase of

share, options, convertible debentures where the debt holder has the option to convert the

loan instruments into stock of the borrower or a debt with warrants to equity investment. The

funds in the form of equity help to raise term loans that are cheaper source of funds. In the

early stage of business, because dividends can be delayed, equity investment implies that

investors bear the risk of venture and would earn a return commensurate with success in the

form of capital gains.

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Participation In managementVenture capital provides value addition by managerial support, monitoring and follow up

assistance. It monitors physical and financial progress as well as market development

initiative. It helps by identifying key resource person. They want one seat on the companys

board of directors and involvement, for better or worse, in the major decision affecting the

direction of company. This is a unique philosophy of hand on management where Venture

capitalist acts as complementary to the entrepreneurs. Based upon the experience other

companies, a venture capitalist advice the promoters on project planning, monitoring,

financial management, including working capital and public issue. Venture capital investor

cannot interfere in day today management of the enterprise but keeps a close contact with the

promoters or entrepreneurs to protect his investment.

Length of InvestmentVenture capitalist help companies grow, but they eventually seek to exit the investment in

three to seven years. An early stage investment may take seven to ten years to mature, while

most of the later stage investment takes only a few years. The process of having significant

returns takes several years and calls on the capacity and talent of venture capitalist and

entrepreneurs to reach fruition.

Illiquid InvestmentVenture capital investments are illiquid, that is not subject to repayment on demand or

following a repayment schedule. Investors seek return ultimately by means of capital gain

when the investment is sold at market place. The investment is realized only on enlistment of

security or it is lost if enterprise is liquidated for unsuccessful working. It may take several

years before the first investment starts too locked for seven to ten years. Venture capitalist

understands this illiquidity and factors this in his investment decision.

THE VENTURE CAPITAL

S PECTRUM /STAGES

The growth of an enterprise follows a life cycle as shown in the diagram below. The

requirements of funds vary with the life cycle stage of the enterprise. Even before a business

plan is prepared the entrepreneur invests his time and resources in surveying the market,

finding and understanding the target customers and their needs. At the seed stage the

entrepreneur continue to fund the venture with his own fund or family funds. At this stage the

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fund are needed to solicit the consultants services in formulation of business plans, meeting

potential customers and technology partners. Next the funds would be required for

development of the product/process and producing prototypes, hiring key people and building

up the managerial team. This is followed by funds for assembling the manufacturing and

marketing facilities in that order. Finally the funds are needed to expand the business and

attaint the critical mass for profit generation. Venture capitalists cater to the needs of the

entrepreneurs at different stages of their enterprises. Depending upon the stage they finance,

venture capitalists are called angel investors, venture capitalist or private equity

supplier/investor.

Venture capital was started as early stage financing of relatively small but rapidly growing

companies. However various reasons forced venture capitalists to be more and more involved

in expansion financing to support the development of existing portfolio companies. With

increasing demand of capital from newer business, venture capitalists began to operate across

a broader spectrum of investment interest. This diversity of opportunities enabled venture

capitalists to balance their activities in term of time involvement, risk acceptance and reward

potential, while providing ongoing assistance to developing business.

Different Venture capital firms have different attributes and aptitudes for different types of

Venture capital investments. Hence there are different stages of entry for different venture

capitalists and they can identify and differentiate between types of venture capital

investments, each appropriate for the given stage of the investee company, these are:-

1. Early stage Finance

Seed capital

Start up Capital

Early/First Stage Capital

Later/Third Stage capital

1. Later Stage Finance

Expansion/Development Stage Capital

Replacement Finance

Management Buy Out and Buy Ins

Turnarounds

Mezzanine/Bridge Finance

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Not all business firms pass through each of these stages in sequential manner. For instance

seed capital is normally not required by service based ventures. It applies largely to

manufacturing or research based activities. Similarly second round finance does not always

follow early stage finance. If the business grows successfully it is likely to develop sufficient

cash to fund its own growth, so does not require venture capital for growth.

Seed Capital

It is an idea or concept as opposed to a business. European venture capital association defines

seed capital as The financing of the initial product development or capital provided to an

entrepreneur to prove the feasibility of a project and to qualify for start up capital.

The characteristics of the seed capital may be enumerated as follows:

Absence of ready product market

Absence of complete management team

Product/process still in R & D stage

Initial period/licensing stage of technology transfer

Broadly speaking seed capital investment may take 7 to 10 year to achieve realization. It is

the earliest and therefore riskiest stage of Venture capital investment. The new technology

and innovations being attempted have equal chance of success and failure. Such projects,

particularly hi-tech, projects sink a lot of cash and need a strong financial support for their

adaptation, commencement and eventual success. However, while the earliest stage of

financing is fraught with risk, it also provides greater potential for realizing significant gains

in long term. Typically seed enterprises lack asset base or track record to obtain finance from

conventional sources and are largely dependent upon entrepreneurs personal resources. Seed

capital is provided after being satisfied that the entrepreneur has used up his own resources

and carried out his idea to a stage of acceptance and has initiated research. The asset

underlying the seed capital is often technology or an idea as opposed to human assets (a good

management taem0 so often sought by venture capitalists.

Volume of Investment Activity

It has been observed that Venture capitalist seldom make seed capital investment and these

are relatively small by comparison to other forms of Venture finance. The absence of interest

in providing a significant amount of seed capital can be attributed to the following three

factors:-

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a) Seed capital projects by their very nature require a relatively small amount of capital.

The success or failure of an individual seed capital investment will have little impact

on the performance of all but the smallest venture capital investments. This is

because the small investments are seen to be cost inefficient in terms of time required

to analyze structure manage them.

b) The time horizon to realization for most seed capital investment is typically 7-10

years which is longer than all but most long-term oriented investors will desire.

c) The risk of product and technology obsolescence increases as the time to realization I

extended. These types of obsolescence are particularly likely to occur with high

technology investments particularly in the fields related to Information Technology.

Start Up Capital

It is stage second in the venture capital cycle and is distinguishable from seed capital

investments. An entrepreneur often needs finance when the business is just starting. The start

up stage involves starting a new business. Here in the entrepreneur has moved closer towards

establishment of a going concern. Here in the business concept has been fully investigated

and the business risk now becomes that of turning the concept into product.

Start up capital is defined as; Capital needed to finance the product development, initial

marketing and establishment of product facility.

The characteristics of start-up capital are:-

a) Establishment of company or business: the company is either being organized or is

established recently. New business activity could be based on experts, experience or

a spin-off from R & D.

b) Establishment of most but not all the members of the team: the skills and fitness

to the job and situation of the entrepreneurs team is an important factor for start up

finance.

c) Development of business plan or idea: the business plan should be fully developed

yet the acceptability of the product by the market is uncertain. The company has not

yet started trading.

In the start up preposition Venture capitalists investment criteria shifts from idea to people

involved in the venture and the market opportunity. Before committing any finance at this

stage, venture capitalist however, assesses the managerial ability and the capacity of the

entrepreneur, besides the skills, suitability and competence of the managerial team are also

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evaluated. If required they supply managerial skill and supervision for implementation. The

time horizon for start up capital will be typically 6 or 8 years. Failure rate for start up is 2 out

of 3. Start up needs funds by way of both first round investment and subsequent follow-up

investments. The risk tends to be lower relative to seed capital situation. The risk is

controlled by initially investing a smaller amount of capital in start-ups. The decision on

additional financing is based upon the successful performance of the company. However, the

term to realization of a start up investment remains longer than the term of finance normally

provided by the majority of financial institutions. Longer time scale for using exit route

demands continued watch on start up projects.

Volume of Investment Activity

Despite potential for secular returns most venture firms avoid investing in start-ups. One

reason for the paucity of start up financing may be high discount rate that venture capitalist

applies to venture proposals at this level of risk and maturity. They often prefer to spread

their risk by sharing the financing. Thus syndicates of investors often participate in start up

finance.

Early Stage FinanceIt is also called first stage capital is provided to entrepreneur who has a proven product, to

start commercial production and marketing, not covering market expansion, de-risking and

acquisition costs.

At this stage the company passed into early success stage of its life cycle. A proven

management team is put into this stage, a product is established and an identifiable market is

being targeted.

British Venture capital Association has vividly defined early stage finance as: Finance

provided to companies that have completed the product development stage and require

further funds to initiate commercial manufacturing and sales but may not be generating

profits.

The characteristics of early stage finance may be:-

Little or no sales revenue.

Cash flow and profit still negative.

A small but enthusiastic management team which consists of people with technical

and specialist background and with little experience in the management of growing

business.

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Short term prospective for dramatic growth in revenue and profits.

The early stage finance usually takes 4 to 6 years time horizon to realization. Early stage

finance is the earliest in which two of the fundamentals of business are in place i.e. fully

assembled management team and a marketable product. A company needs this round of

finance because of any of the following reasons:-

Project overruns on product development.

Initial loss after start up phase.

The firm needs additional equity funds, which are not available from other sources thus

prompting venture capitalist that, have financed the start up stage to provide further

financing. The management risk is shifted from factors internal to the firm (lack of

management, lack of product etc.) to factor external to the firm (competitive pressures, in

sufficient will of financial institutions to provide adequate capital, risk of product

obsolescence etc.)

At this stage, capital needs, both fixed and working capital needs are greatest. Further, since

firms do not have foundation of a trading record, finance will be difficult to obtain and so

venture capital particularly equity investment without associated debt burden is key to

survival of the business.

The following risks are normally associated to firms at this stage:-

a) The early stage firms may have drawn the attention of and incurred the challenge of a

larger competition.

b) There is a risk of product obsolescence. This is more so when the firm is involved in

high-tech business like computer, information technology etc.

Second stage FinanceIt is the capital provided for marketing and meeting the growing working capital needs of an

enterprise that has commenced the production but does not have positive cash flows

sufficient to take care of its growing needs. Second stage finance, the second trench of Early

Stage Finance is also referred to as follow on finance and can be defined as the provision of

capital to the firm which has previously been in receipt of external capital but whose financial

needs have subsequently exploded. This may be second or even third injection of capital.

The characteristics of a second stage finance are:

A developed product on the market

A full management team in place

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Sales revenue being generated from one or more products

There are losses in the firm or at best there may be a breakeven but the surplus

generated is insufficient to meet the firms needs.

Second round financing typically comes in after start up and early stage funding and so have

shorter time to maturity, generally ranging from 3 to 7 years. This stage of financing has both

positive and negative reasons.

Negative reasons include:

Cost overruns in market development

Failure of new product to live up to sales forecast.

Need to re-position products through a new marketing campaign

Need to re-define the product in the market place once the product deficiency is

revealed.

Positive reasons include:

Sales appear to be exceeding forecasts and the enterprise needs to acquire assets to

gear up for production volumes greater than forecasts.

High growth enterprises expand faster than their working capital permit, thus needing

additional finance. Aim is to provide working capital for initial expansion of an

enterprise to meet needs of increasing stocks and receivables.

It is additional injection of funds and is an acceptable part of venture capital. Often provision

for such additional finance can be included in the original financing packages as an option,

subject to certain management performance targets.

Later Stage FinanceIt is called third stage capital is provided to an enterprise that has established commercial

production and basic marketing set-up, typically for market expansion, acquisition productdevelopment etc. it is provided for market expansion of the enterprise.

The enterprises eligible for this round of finance have following characteristics:

Established business, having already passed the risky early stage.

Expanding high yield, capital growth and good profitability.

Reputed market position and an established formal organization structure.

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Funds are utilized for further plant expansion, marketing, working capital or development of

improved products. Third stage financing is a mix of equity with debt or subordinate debt.

As it is half way between equity and debt in US it is called mezzanine finance. It is also

called last round of finance in run up to the trade sale or public offer.

Venture capitalists prefer later stage investment vis a Vis early stage investments, as the rate

of failure in later stage financing is low. It is because firms at this stage have a past

performance data, track record of management, established procedures of financial control.

The time horizon for realization is shorter, ranging from 3 to 5 years. This helps the venture

capitalists to balance their own portfolio of investment as it provides a running yield to

venture capitalists. Further the loan component in third stage finance provides tax advantage

and superior return to the investors.

There are four sub divisions of later stage finance:

Expansion/Development Finance

Replacement Finance

Buyout Financing

Turnaround Finance

Expansion/ Development finance

An enterprise established in a given market increases its profit exponentially by achieving the

economies of scale. This expansion can be achieved either through an organic growth, that is

by expanding production capacity and setting up proper distribution system or by way of

acquisitions. Anyhow, expansion needs finance and venture capitalists support both organic

growth as well as acquisitions for expansion.

At this stage the real market feedback is used to analyze competition. It may be found that the

entrepreneur needs to develop his managerial team for handling growth and managing a

larger business.

Realization horizon for expansion/development investment is one to three years. It is favored

by venture capitalist as it offers higher rewards in shorter period with lower risk. Funds are

needed for new or larger factories and warehouses, production capacities, developing

improved or new products, developing new markets or entering exports by enterprise with

established business that has already achieved break even and has started making profits.

Replacement Finance

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It means substituting one shareholder for another, rather than raising new capital resulting in

the change of ownership pattern. Venture capitalist purchase share from the entrepreneurs

and their associates enabling them to reduce their shareholding in unlisted companies. They

also buy dividend coupon. Later, on sale of the company or its listing on stock exchange,

these are re-converted to ordinary shares. Thus Venture capitalist makes a capital gain in a

period of 1 to 5 years

Buy-out / Buy-in Financing

It is a resent development and a new form of investment by venture capitalist. The funds

provided to the current operating management to acquire or purchase a significant share

holding in the business they manage are called management buyout.

Management Buy-in refers to the funds provided to enable a manager or a group of managers

from outside the company to buy into it.

It is the most popular form of venture capital

tal amongst stage financing. It is less risky as venture capitalist in invests in solid, ongoing

and more mature business. The funds are provided for acquiring and revitalizing an existing

product line or division of a major business. MBO (Management buyout) has low risk as

enterprise to be bought have existed for some time besides having positive cash flow to

provide regular returns to the venture capitalist, who structure their investment by judicious

combination of debt and equity. Of late there has been a gradual shift away from start up and

early finance towards MBO opportunities. This shift is because of lower risk than start up

investments.

Turnaround Finance

It is rare form later stage finance which most of the venture capitalist avoid because of higher

degree of risk. When an established enterprise becomes sick, it needs finance as well as

management assistance for a major restructuring to revitalize growth of profits. Unquoted

company at an early stage of development often has higher debt than equity; its cash flows

are slowing down due to lack of managerial skill and inability to exploit the market potential.

The sick companies at the later stages of development do not normally have high debt burden

but lack competent staff at various levels. Such enterprises are compelled to relinquish

control to new management. The venture capitalist has to carry out the recovery process

using hands on management in 2 to 5 years. The risk profile and anticipated rewards are akin

to early stage investment.

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Bridge Finance

It is the pre-public offering or pre-merger/acquisition finance to a company. It is the last

round of financing before the planned exit. Venture capitalist help in building a stable and

experienced management team that will help the company in its initial public offer. Most of

the time bridge finance helps improves the valuation of the company. Bridge finance often

has a realization period of 6 months to one year and hence the risk involved is low. The

bridge finance is paid back from the proceeds of the public issue.

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CHAPTER 3

VENTURE CAPITAL INVESTMENT

PROCESS

Venture capital investment process is different from normal project financing. In order to

understand the investment process a review of the available literature on venture capital

finance is carried out. Tyebjee and Bruno in 1984 gave model of venture capital investment

activity with some variations is commonly used presently. As per this model this activity is a

five step process as follows:

1. Deal Organization

2. Screening

3. Evaluation or due Diligence

4. Deal Structuring

5. Post Investment Activity and Exit

Deal Origination:In generating a deal flow, the VC investor creates a pipeline of deals or investment

opportunities that he would consider for investing in. deal may originate in various ways.

Referral system, active search system, and intermediaries. Referral system is an important

source of deals. Deals may be referred to VCFs by their parent organizations, trade partners,

industry associations, friends etc. Another deal flow is active search through networks, trade

fairs, conferences, seminars, foreign visits etc. intermediaries is used by venture capitalists in

developed countries like USA, is certain intermediaries who match VCFs and the potential

entrepreneurs.

Screening:VCFs, before going for an in-depth analysis, carry out initial screening of all projects on the

basic of some broad criteria. For example, the screening process may limit projects to areas in

which the venture capitalist is familiar in terms of technology, or product, or market scope.

The size of investment, geographical location and stage of financing could also be used as the

broad screening criteria.

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Due Diligence:

Due diligence is the industry jargon for all the activities that are associated with evaluating an

investment proposal. The Venture capitalists evaluate the quality of entrepreneur before

appraising the characteristics of the product, market or technology. Most venture capitalists

ask for a business plan to make an assessment of the possible risk and return on the venture.

Business plan contains detailed information about the proposed venture. The evaluation of

ventures by VCFs in Indian includes; Preliminary evaluation: the applicant required to

provide a brief profile of the proposed venture to establish prima facie eligibility.

Detailed evaluation: once the preliminary evaluation is over, the proposal is evaluated

in greater detail. VCFs in India expect the entrepreneur to have: - integrity, long-term vision,

urge to grow, managerial skills, commercial orientation.

VCFs in India also make the risk analysis of the proposed projects which includes: product

risk, market risk, technological risk and entrepreneurial risk. The final decision is taken in

terms of the expected risk-return trade-off as shown in figure.

Deal Structuring:In this process, the venture capitalist and the venture company negotiate the terms of the

deals, that are the amount form and price of the investment. This process is termed as deal

structuring. The agreement also include the venture capitalists right to control the venturecompany and to change its management if needed, buyback arrangement specify the

entrepreneurs equity share and the objectives share and the objectives to be achieved.

Post Investment Activities:Once the deal has been structured and agreement finalized, the venture capitalist generally

assumes the role of a partner and collaborator. He also gets involved in shaping of the

direction of the venture. The degree of the venture capitalists involvement depends on his

policy. It may not, however be desirable for a venture capitalist to get involved in the day-to-

day operation of the venture. If a financial or managerial crisis occurs, the venture capitalist

may intervene, and even install a new management team.

Exit:

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Venture capitalists generally want to cash-out their gains in five to ten years after the initial

investment. They play a positive role in directing the company towards particular exit routes.

A venture may exist in one of the following ways:

There are four ways for a venture capitalist to exit its investment:

Initial Public Offer (IPO)

Acquisition by another company

Re-purchase of venture capitalists share by the investee company

Purchase of venture capitalists share by a third party

Promoters Buy-back

The most popular disinvestment route in India is promoters buy-back. This route is suited to

Indian conditions because it keeps the ownership and control of the promoter intact. The

obvious limitation, however, is that in a majority of cases the market value of the shares of

the venture firm would have appreciated so much after some years that the promoter would to

be in a financial position to buy them back.

In India, the promoters are invariably given the first option to buy back equity of their

enterprise. For example, RCTO participates in the assisted firms equity with suitable

agreement for the promoter to repurchase it. Similarly, Confina-VCF offers an opportunity to

the promoters to buy back the shares of the assisted firm within an agreed period at a

predetermined price. If the promoter fails to buy back the shares within the stipulated period,

Confine-VCF would have the discretion to divest them in any manner it deemed appropriate.

SBI capital Markets ensures through examining the personal assets of the promoters and their

associates, which buy back, would be a feasible option. GV would make disinvestment, in

consultation with the promoter, usually after the project has settled down, to a profitable level

and the entrepreneur is in a position to avail of finance under conventional schemes of

assistance from banks or other financial institutions.

Initial Public Offers (IPOs)

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The benefits of disinvestments via the public issue route are improved marketability and

liquidity, better prospects for capital gains and widely known status of the venture as well as

market control through public share participation. This option has certain limitations in the

Indian context. The promotion of the public issue would be difficult and expensive since the

first generation entrepreneurs are not known in the capital markets. Further, difficulties will

be caused if the entrepreneurs business is perceived to be an unattractive investment

proposition by investors. Also, the emphasis by the Indian investors on short-term profits and

dividends may tend to make the market price unattractive. Yet another difficulty in India until

recently was that the Controller of Capital Issues (CCI) guidelines for determining the

premium on shares took into account the book value and the cumulative average EPS till the

date of the new issue. This formula failed to give due weight age to the expected stream of

earning of the venture firm. Thus, the formula would underestimate the premium. Thegovernment has now abolished the Capital Issues Control Act, 1947 and consequently, the

office of the controller of Capital Issues. The existing companies are now free to fix the

premium on their shares. The initial public issue for disinvestments of VCFs holding can

involve high transaction costs because of the inefficiency of the secondary market in a

country like India. Also, this option has become far less feasible for small ventures on

account of the higher listing requirement of the stock exchanges. In February 1989, the

Government of India raised the minimum capital for listing on the stock exchanges from Rs

10 million to Rs 30 million and the minimum public offer from Rs 6 million to Rs 18 million.

Sale on the OTC Market

An active secondary capital market provides the necessary impetus to the success of the

venture capital. VCFs should be able to sell their holdings, and investors should be able to

trade shares conveniently and freely. In the USA, there exist well-developed OTC markets

where dealers trade in share on telephone/terminal and not on an exchange floor. This

mechanism enables new, small companies which are not otherwise eligible to be listed on the

stock exchange, to enlist on the OTC markets and provides liquidity to investors. The

National Association of Securities dealers Automated Quotation System (NASDAQ) in the

USA daily quotes over 8000 stock prices of companies backed by venture capital.

The OTC Exchange in India was established in June 1992. The Government of India had

approved the creation for the Exchange under the Securities Contracts (Regulations) Act in

1989. It has been promoted jointly by UTI, ICICI, SBI Capital Markets, Can Bank Financial

Services, GIC, LIC and IDBI. Since this list of market-makers (who will decide daily prices

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and appoint dealers for trading) includes most of the public sector venture financiers, it

should pick up fast, and it should be possible for investors to trade in the securities of new

small and medium size enterprise.

The other disinvestment mechanisms such as the management buy outs or sale to other

venture funds are not considered to be appropriate by VCFs in India.

The growth of an enterprise follows a life cycle as shown in the diagram below. The

requirements of funds vary with the life cycle stage of the enterprise. Even before a business

plan is prepared the entrepreneur invests his time and resources in surveying the market,

finding and understanding the target customers and their needs. At the seed stage the

entrepreneur continue to fund the venture with his own fund or family funds. At this stage the

funds are needed to solicit the consultants services in formulation of business plans, meeting

potential customers and technology partners. Next the funds would be required for

development of the product/process and producing prototypes, hiring key people and building

up the managerial team. This is followed by funds for assembling the manufacturing and

marketing facilities in that order. Finally the funds are needed to expand the business and

attaint the critical mass for profit generation. Venture capitalists cater to the needs of the

entrepreneurs at different stages of their enterprises. Depending upon the stage they finance,

venture capitalists are called angel investors, Venture capitalist or private equity

supplier/investor.

CHAPTER4

METHODS OF VENTURE FINANCINGVenture Capital is typically available in three forms in India, they are:

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EVOLUTION OF VENTURE CAPITALINDUSTRY IN INDIA

The first major analysis on risk capital for India was reported in 1983. It indicated that new

companies often confront serious barriers to entry into capital market for raising equity

finance which undermines their future prospects of expansion and diversification. It also

indicated that on the whole there is a need to review the equity cult among the masses by

ensuring competitive return on equity investment. This brought out the institutional

inadequacies with respect to the evolution of venture capital.

In India, the Industrial Finance Corporation of India (IFCO) initiated the idea of Venture

Capital when it established the Risk Capital Foundation in 1975 to provide seed capital to

small and risky projects. However the concept of venture capital financing got statutory

recognition for the first time in the fiscal budget for the year 1986-87.

The venture Capital companies operating at present can be divided into four groups:

Promoted by All-India Development Financial Institutions

Promoted by State Level Financial Institutions

Promoted by Commercial Banks

Private Venture Capitalists.

Promoted by all India Development Financial InstitutionsThe IDBI started a Venture Capital in 1976 as per the long term fiscal policy of government

of India, with an initial of Rs. 10 Cr. which raised by imposing a chess of 5% on all payment

made for the import of technology know-how projects requiring funds from Rs.5 Lacks to

Rs.2.5Cr. Were considered for financing. Promoters contribution ranged from this fund was

available at a concessional interest rate of 9% (during gestation period) which could be

increased at later stages.

The ICICI provided the required impetus to Venture Capital activities in India, 1986 it started

providing venture Capital finance in 1998 it promoted, along with the Unit trust of India

(UTI) Technology Development and information Company of India (TDICI) as first venture

Capital company registered under the companies act, 1956. The TDICI may provide financial

assistance to venture capital undertaking which are set up by technocrat entrepreneurs, or

technology information and guidance services.

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The risk capital foundation established by the industrial finance corporation of India (IFCI) in

1975, was converted in 1988 into the Risk Capital and Technology Finance Company

(RCTC) as a subsidiary company of the IFCI the rate provides assistance in the form of

conventional loans, interest free conditional loans on profit and risk sharing basis or equity

participation in extends financial support to high technology projects for technological up

gradations. The RCTC has been renamed as IFCI Venture Capital Funds Ltd. (IVCF)

Promoted by State Level Financial InstitutionsIn India, the State Level Financial Institutions in some states such as Madhya Pradesh,

Gujarat, Uttar prades, etc., have done an excellent job and have provided venture capital to a

small scale enterprise. Several successful entrepreneurs have been the beneficiaries of the

liberal funding environment. In 1990, the Gujarat Industrial Investment Corporation,

promoted the Gujarat Venture Financial Ltd (GVFL) along with other promoters such as the

IDBI, the World Bank, etc., the GVFL provides financial assistance to business in the form of

equity, conditional loans or income notes for technologies development and innovative

products. It also provides finance assistance to entrepreneurs.

The government of Andhra Pradesh has also promoted the Andhra Pradesh Industrial

Development Corporation (APIDC) venture capital ltd. to provide venture capital financing

in Andhra Pradesh.

Promoted by Commercial BanksCanbank Venture Capital Fund, State bank Venture Capital Fund and Grindlays bank

Venture Capital Fund have been set up the respective commercial banks to undertake venture

capital activities.

The State bank Venture Capital funds provides financial assistance for bought out deal as

well as new companies in the form of equity which it disinvests after the commercialization

of the project.

Canbank Venture Capital Funds provides financial assistance for proven but yet to be

commercially exploited technologies. It provides assistance both in the form of equity and

conditional loans.

Private venture Capital FundsSeveral private sector venture capital funds have been established in India such as the 20 th

Centure Venture Capital Company, Indus venture capital Funds, Infrastructure Leasing and

financial Services Ltd.

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Some of the companies that have received funding through this route include:

Mastek, one of the oldest software house in India

Ruskan software, Pune based software consultancy

SQL Star, Hyderabad based training and software development consultancy

Satyam Infoway, the first private ISP in India

Hinditrom, makers of embedded software

Selectia, provider of interaction software selectior

Yantra, ITL Infosys US subsidiary, solution for supply chain management

Rediff on the Net, India website featuring electronic shopping, news, chat etc.

OBJECTIVE AND VISION FOR VENTURECAPITAL IN INDIA

Venture capitalists finance innovation and ideas which have potential for high growth but

with inherent uncertainties. This makes it a high-risk, high return investment. Apart from

finance, venture capitalists provide networking, management and marketing support as well.

In the broadest sense, therefore, venture capital connotes financial as well as human capital.

In the global venture capital industry, investors and investee firms work together closely in an

enabling environment that allows entrepreneurs to focus on value creating ideas and allows

venture capitalists to drive the industry through ownership of the levers of control, in return

for the provision of capital, skills, information and complementary resources. This very blend

of risk financing and hand holding of entrepreneurs by venture capitalists creates an

environment particularly suitable for knowledge and technology based enterprises.

Scientific, technology and knowledge based ideas properly supported by venture capital can

be propelled into a powerful engine of economic growth and wealth creation in a sustainable

manner. In various developed and developing economies venture capital has played a

significant developmental role. India, along with Israel, Taiwan and the United States, is

recognized for its globally competitive high technology and human capital. India has the

second largest English speaking scientific and technical manpower in the world.

The Indian software sector crossed the Rs 100 billion mark turnover during 1998. The sector

grew 58% on a year to year basis and exports accounted for Rs 65.3 billion while the

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domestic market accounted for Rs 35.1 billion. Exports grew by 67% in rupee terms and 55%

in US dollar terms. The strength of software professionals grew by 14% in 1997 and has

crossed 1, 60000. The global software sector is expected to grow at 12% to 15% per annum

for the next 5 to 7 years.

Recently, there has also been greater visibility of Indian companies in the US.

Given such vast potential not only in IT and software but also in the field of service

industries, biotechnology, telecommunications, media and entertainment, medical and health

services and other technology based manufacturing and product development, venture capital

industry can play a catalytic role to put India on the world map as a success story.

2009 VENTURE CAPITAL INVESTMENT ININDIA

Venture Capital firms invested $475 million in 92 deals during 2009, down from the $836

million invested across 153 deals in the previous year, according to a study by Venture

Intelligence and Global-India Venture Capital Association.

Venture capital firms, however, began to increase the pace of their investments in Indian

companies in the October-December quarter, making 42 investments worth $265 million,

compared to 23 investments worth $102 million in the comparative period a year earlier, the

study said.

"The strong recovery in investment activity in the last quarter of 2009, as well the rising

interest among global investors towards emerging markets like India, is quite encouraging for

the growth of the sector," Sudhir Sethi, director of the Global-India Venture Capital

Association, said in a statement.

"During 2010, we expect significant follow-on investments into companies that raised Seriesa round (first round) in the past two to three years as well as a rise in exit activity as the

global economic recovery gathers pace," he added.

NEED FOR GROWTH OF VENTURECAPITAL IN INDIA

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People in developing countries are poor in part because they have far less capital than people

in industrial countries. Because of this shortage, workers have little in the way of specialized

machinery and equipment, and firms lack money to obtain more equipment. As a result,

productivity of workers in developing countries is low compared with that of workers in

industrial countries. Financial-resource flows from industrial to developing countries are an

obvious means to overcome this inequality. But financial resources are not enough. Some

developing countries have natural resources such as oil or minerals that, when sold on world

markets, have provided large amounts of money. In many cases the money has failed to

stimulate sustained economic growth or increased productivity and income for the average

person. In part, failure to use capital productively results from the way these resources flow.

In some countries the government gets the money, which it uses to perpetuate itself through

military spending or through increased consumption spending. In other cases, resources flowto wealthy individuals who use them to maintain high levels of conspicuous consumption.

India is still developing country. In India, a revolution is ushering in a new economy, wherein

entrepreneurs mind set is taking a shift from risk adverse business to investment in new ideas

which involve high risk. The conventional industrial finance in India is not of much help to

these new emerging enterprises. Therefore there is a need of financing mechanism that will

fit with the requirement of entrepreneurs and thus it needs venture capital industry to grow in

India.

Few reasons for which active Venture Capital Industry is important for India include:

Innovation: Needs risk capital in a largely regulated, conservation, legacy financial

system

Job Creation: large pool of skilled graduates in the first and second tier cities

Patient capital: Not flighty, unlike FIIs

Creating new Industry Clusters: Media, Retail, Call Centers and back office

processing, trickling down to organized effort of support services like Office services,

Catering, Transportation.

CHAPTER 6

REGULATORY AND LEGAL FRAMEWORKAt present, the Venture Capital activity in India comes under the purview of different sets of

regulations namely:

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MAJOR REGULATORY FRAMEWORKSFOR VENTURE CAPITAL INDUSTRY

Major Regulatory frameworks for venture capital industry

In addition to the above, offshore funds also require FIPB/RBI approval for investment in

domestic funds as well as in Venture Capital Undertakings (VCU). Domestic funds with

offshore contributions also require RBI approval for the pricing of securities to be purchased

in VCU likewise, at the time of disinvestment, RBI approval is required for the pricing of the

securities.

Definition of venture capital fund: The Venture Capital Fund is now defined s a fund

established in the form of a Trust, a company including a body corporate and registered with

SEBI which:

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SEBI (VCF) Reg. 1996 SEBI(FVCI) Reg.2000 SCR Act.1956 SEBI(SAST) Reg.1997 SEBI(DIP)Guidelines,2000 SEBI Act,1992

FEMA,1999

Transfer orissue ofsecurity

by apersonresidentoutsideIndiaregulation2000

FDI policy Investment

approvals Press Notes

IT Act,1961

DTAA

Singa

pore

Mauritius

Other

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Disclosure and Information to Investors: in order to simplify and expedite the process of

fund raising, the requirement of filing the Placement memorandum with SEBI is dispensed

with and instead the fund will be required to submit a copy of Placement Memorandum/ copy

of contribution agreement entered to with the investors along with the details of the fund

raiser for information to SEBI. Further, the contents of the Placement Memorandum are

strengthened to provide adequate disclosure and information to investors. SEBI will also

prescribe suitable reporting requirement from the fund on their investment activity.

QIB status for Venture Capital funds: the venture capital funds will be eligible to

participate in the IPO through book building route as qualified Institutional Buyer subject to

compliance with the SEBI (Venture Capital Fund) Regulations.

Relaxation in Takeover Code: the acquisition of share by the company or any of the

promoters from the Venture Capital Funds under the terms of agreement shall be treated on

the same footing as that of acquisition of shares by promoters/companies from the state level

financial institutions and shall be exempt from making an open offer to other shareholders.

Investment by Mutual Funds in Venture capital Funds: in order to increase the resources

for domestic venture capital funds, Mutual Funds are permitted to invest up to 5% of its

corpus in the case of open ended schemes and up to 10% of its corpus in the case of close

ended schemes. A part from raising the resources for Venture Capital Funds this would

provide an opportunity to small investors to participate in venture capital activities through

Mutual funds.

Government of India Guidelines: the Government of India (MOF) Guidelines for Overseas

Venture Capital Investment in India dated September20, 1995 will be repealed by the MOF

on notification of SEBI Venture Capital Fund Regulations.

The following will be the salient features of SEBI (foreign Venture Capital Investors)

Regulations, 2000:

Definition of Foreign Venture capital Investor: any entity incorporated and established

outside India and proposes to make investment in Venture Capital Fund or Venture Capital

Undertaking and registered with SEBI.

Eligibility Criteria: entity incorporated and established outside India in the form of

Investment Company, Trust, Partnership, Pension Fund, Mutual Fund, University Fund,

Endowment Fund, Asset Management Company, Investment Manager, Investment

Management Company or other Investment Vehicle Incorporated outside India would be

eligible for seeking registration from SEBI. SEBI for the purpose of registration shall

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consider whether the applicant is regulated by an appropriate foreign regulatory authority; or

is income tax payer; or submits a certificate from its banker of its or its promoters, track

record where the applicant is neither a regulated entity nor an income tax payer.

Investment Criteria:

Disclosure of investment strategy;

Maximum investment in single venture capital undertaking not to exceed 25% of

the funds committed for investment to India however it can invest its total fund

committed in one venture capital fund;

Atleast 75% of the investible funds to be invested in unlisted equity shares or

equity linked instruments.

Not more than 25%of the investible funds may be invested by way of:

Subscription to initial offer of a venture capital undertaking whose shares

are proposed to be listed subject to lock in period of one year;

Debt or debt instrument of a venture capital undertaking in which the

venture capital funds has already made an investment by way of equity.

Hassle Free Entry and Exit: the Foreign Venture Capital Investors proposing to make

venture capital investment under the Regulations would be granted registration by SEBI.

SEBI Registered Foreign Venture Capital Investors shall be permitted to make investment on

an automatic route within the overall sectoral ceiling of foreign investment under Annexure

III of statement of Industrial Policy without any approval from FIPB. Further, SEBI

registered FVCIs shall be granted a general permission from the exchange control angle for

inflow and outflow of funds and no prior approval of RBI would be required for pricing,

however, there would be export reporting requirement for the amount transacted.

Trading in Unlisted Equity: the board also approved the proposal to permit OTCEI to

develop a trading window for unlisted securities where Qualified Institutional Buyers (QIB)

would be permitted to participate.

REGULATION OF THE BUSINESS OF

VENTURE CAPITAL FUND IN INDIA

Eligibility conditions for grant of license to a venture capital fund.-(1) A venture capital fund shall not be granted license unless it fulfills the following

conditions, namely:-

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a) It is incorporated as a company under the Companies Ordinance, 1984 (XLVII of

1984);

b) It is not engaged in any business other than that of investment in venture projects;

c) It has a minimum paid-up capital of fifty million rupees raised through private

placement; and

d) For the purpose of managing its entire business, it has entered into a contract, in

writing, with a venture capital company and a copy of which has been filed with the

Commission.

(2) The board of venture capital fund shall not have a director, who is on the board of any

venture project being financed by the fund.

Condition for grant of license.-(1) No venture capital fund shall commence business unless a license is granted under these

rules.

(2) For obtaining a license a venture capital fund shall

a. Make an application to the Commission on Form V providing information as

sought in Annex therein, along with all the relevant documents;

b. Submit a bank draft payable to the Commission evidencing the payment of

non-refundable application processing fee amounting to fifty thousand

rupees; and

c. Submit an undertaking that no change in the memorandum and articles of

association and in the directors shall be made without prior written

authorization of the Commission and that all conditions for grant of license

shall be complied with.

(3) On being satisfied that a venture capital fund is eligible for the grant of a license and that

it would be in the public interest so to do, the Commission may grant a license in form VI.

(4) Without prejudice to any other conditions under these rules, the Commission may while

granting license imposes any conditions, as it may deem necessary.

Terms and conditions of operation. - Unless granted a general or specific waiver

by the Commission, a venture capital fund shall

a. Not expose more than forty per cent of its equity to any single group of

companies; Explanation. - For the purposes of this rule group of companies

shall mean companies managed by the members of one family including

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spouse, dependent lineal ascendants and descendants and dependent brothers

and sisters.

b. Disclose in its accounts all investments in companies and group of

companies exceeding ten per cent of paid-up capital of venture capital fund;

c. ensure that the maximum exposure of the venture capital fund to its directors,

affiliated companies and companies in which any of the directors and their

family members including spouse, dependent lineal ascendants and

descendants and dependent brothers and sisters hold controlling interest shall

not exceed ten per cent of the overall portfolio of venture capital; and

d. Not accept any investment from any investor, which is less than one million

rupees.

Renewal of license. (1) The license granted to the fund under rule 10 shall be valid for one year and shall be

renewable annually on payment of a fee of twenty thousand rupees on an application being

made on Form VII.

(2) The Commission may, after making such inquiry and after obtaining such further

information as it may consider necessary, renew the license of such fund, one year on Form

VIII on such conditions as it may deem necessary.

Private placement.-A venture capital fund shall raise and receive monies for investment in venture projects

through private placement of such securities as may be notified by the Commission, from

time to time.

Placement memorandum.-A venture capital fund shall, before soliciting placement of its securities, file with the

Commission a placement memorandum which shall inter alia give details of the terms subjectto which monies are proposed to be raised from such placements.

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CHAPTER 7

KEY SUCCESS FACTOR FOR VENTURE

CAPITAL INDUSTRY IN INDIA

Knowledge becomes the key factor for a competitive advantage for company. Venture

Capital firms need more expert knowledge in various fields. The various key success factors

for venture capital industry are as follow:

Knowledge about Govt. changing policies:

Investment, management and exit should provide flexibility to suit the business requirements

and should also be driven by global trends. Venture capital investments have typically come

from high net worth individuals who have risk taking capacity. Since high risk is involved in

venture financing, venture investors globally seek investment and exit on very flexible terms

which provides them with certain levels of protection. Such exit should be possible through

IPOs and mergers/acquisitions on a global basis and not just within India. In this context the

judgment of the judiciary raising doubts on treatment of tax on capital gains made by firms

regist

ANAND Venture

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