INTRODUCTION OF VENTURE CAPITAL

The venture capital investment assist in fostering innovative entrepreneurship in India. It has
developed as an outcome of the requirement to provide non-conventional, risky finance to
new ventures based on innovative entrepreneurship. An investment in the shape of equity and
at times debt- straight or conditional, Venture capital is made in new ventures, promoted by a
technically or professionally qualified entrepreneur. Venture capital implies risk capital. It
comprises of capital investment, both equity and debt, which carries enormous risk and
uncertainties.

Venture capital has different meanings for different people. It is in fact almost next to
impossible to define it with the help of a single definition. Jane Koloski Morris, editor of the
well-known industry publication, Venture Economics, defines venture capital as 'providing
seed, start-up and first stage financing' and also 'funding the expansion of companies that
have already demonstrated their business potential but do not yet have access to the public
securities market or to credit oriented institutional funding sources. The European Venture
Capital Association describes it as risk finance for entrepreneurial growth oriented
companies. It is investment for the medium or long term return seeking to maximize medium
or long term for both parties. It is a partnership with the entrepreneur in which the investor
can add value to the company because of his knowledge, experience and contact base.
According to SEBI Venture Capital Funds (VCFs) Regulations, 1996, A Venture Capital
Fund means a fund established in the form of a trust/company; including a body corporate,
and registered with SEBI which

(i) has a dedicated pool of capital raised in a manner specified in the regulations and

(ii) invests in venture capital undertakings (VCUs) in accordance with these regulations. A
Venture Capital Undertaking means a domestic company (i) whose shares are not listed on a
recognized stock exchange in India and (ii) which is engaged in the business of providing
services/production/manufacture of articles/things but does not include such activities/sectors
as are specified in the negative list by SEBI with government approval-namely, real estate,
nonbanking financial companies (NBFCs), gold financing, activities not permitted under the
industrial policy of the Government and any other activity which may be specified by SEBI
in consultation with the Government from time to time. Before the onset of venture capital,
Development Finance Institutions (DFIs) had been partially playing the role of venture
capitalists by offering assistance for direct equity participation. The requirement for venture
capital was felt in the mid-eighties .The venture capital industry in India evolved in the late
1980s with Government of India according a legal status to venture capital operations in 1988
and has been beguiling attention ever since. Technology Development and Information
Company of India Ltd. (TDICI), an equal joint venture of ICICI and UTI, was the first
organization to commence its venture capital operations in India. TDICI was the investment
manager and the funds were registered as UTI’s Venture Capital Unit Scheme (VECAUS).
Thereafter in 1996 the regulatory framework of the industry was defined by SEBI (Venture
Capital Fund) Regulations, 1996, followed by the SEBI (Foreign Venture Capital Investor)
Regulations, 2000 on the recommendation of Chandrasekhar committee stimulating growth
in the industry. With the passage of time venture capital have scaled astral heights. During
January- September 2015, 323 deals were inked, enticing an investment of $1.4 billion.
According to data from Venture Intelligence, a research company, investments made in first
nine months of 2015 have surpassed the previous historical high of $1.2 billion (304 deals)
recorded in whole of 2014. The Indian government budget for 2014-15 was a presage of
creating an investor friendly environment with a slew of provisions and funds earmarked for
start-ups in India. At the same time, a start-up fund worth INR 10000 crore was going to be
earmarked. Thus everything sounded positive and all these developments were harbinger of
halcyon days for angel investors and venture capitalists (VCs).

Venture Capital in India

Evolution of Venture Capital

In 1983, the first analysis was reported on risk capital in India. It indicated that new
companies often face barriers while entering into the capital market and also for raising
equity finance which weakens their future expansion and growth. It also indicated that on the
whole, there is a need to assess the equity cult by ensuring competitive return on equity
investment. This all came out as institutional inadequacies and resulted in the evolution of
Venture Capital.

In India, IFCO was the first institution to initiate the idea of Venture Capital when it
established the Risk Capital Foundation in 1975. It provided the seed capital to all small and
risky projects. However, the concept of Venture Capital got its recognition for the first time
in the budget for the year 1986-87.

Objectives of Venture Capital in India

It allows for the working together of capitalists and startups/businesses closely and for the
promoting of entrepreneurs to focus on making more and more ideas.

 It creates an environment suitable for knowledge and technology-based

enterprises.
 It helps to boost scientific, technology and knowledge-based ideas into a powerful
engine of economic growth and wealth creation in a suitable manner.
 It aims to play a catalytic role to India on the world map as a success story.
What is Venture Capital?

It is a private or institutional investment made to start-up companies and small businesses that
are believed to have long-term growth potential.

Venture Capital is money invested in businesses that are small; or exist only as an initial
stage but have huge potential to grow.

Definition of venture capital

Venture capital, also called VC, refers to the financing of a startup company by typically
high-wealth investors who think the business has potential to grow substantially in the long
run. Typically, VCs only invest in startup companies up to a certain percentage.

Importance of Venture Capital

Venture Capital institutions lets entrepreneurs convert their knowledge into viable projects
with the assistance of such Venture Capital institutions.

 It helps new products with modern technology become commercially feasible.

 It promotes export oriented units to earn more foreign exchange.
 It not only provide the financial institution but also assist in management, technical
and others.
 It strengthens the capital market which not only improves the borrowing concern
but also creates a situation whereby they can raise their own capital through capital
market.
 It promotes modern technology through the process where financial institutions
encourage business ventures with new technology.
 Many sick companies get a turn around after getting proper nursing from such
Venture Capital institutions.

Features of Venture Capital

High-risk investment: It is highly risky and the chances of failure are much higher as it
provides long-term startup capital to high risk-high reward ventures.

High Tech projects: Generally, venture capital investments are made in high tech projects or
areas using new technologies as they have higher returns.

Participation in Management: Venture Capitalists act complementary to the entrepreneurs,

for better or worse, in making decisions for the direction of the company.

Length of Investment: The investors eventually seek to exit in three to seven years. The
process takes several years for having significant returns and also need the talent of venture
capitalist and entrepreneurs to reach completion.

Illiquid Investment: It is an investment that is not subject to repayment on demand or a

repayment schedule.

The venture capital funding process typically involves four phases in the company’s
development:

 Idea generation
 Start-up
 Ramp up
 Exit

Step 1: Idea generation and submission of the Business Plan

The initial step in approaching a Venture Capital is to submit a business plan. The plan
should include the below points:

 There should be an executive summary of the business proposal

 Description of the opportunity and the market potential and size
 Review on the existing and expected competitive scenario
 Detailed financial projections
 Details of the management of the company

There is detailed analysis done of the submitted plan, by the Venture Capital to decide
whether to take up the project or no.

Step 2: Introductory Meeting

Once the preliminary study is done by the VC and they find the project as per their
preferences, there is a one-to-one meeting that is called for discussing the project in detail.
After the meeting the VC finally decides whether or not to move forward to the due diligence
stage of the process.
Step 3: Due Diligence
The due diligence phase varies depending upon the nature of the business proposal. This
process involves solving of queries related to customer references, product and business
strategy evaluations, management interviews, and other such exchanges of information
during this time period.

Step 4: Term Sheets and Funding

If the due diligence phase is satisfactory, the VC offers a term sheet, which is a non-binding
document explaining the basic terms and conditions of the investment agreement. The term
sheet is generally negotiable and must be agreed upon by all parties, after which on
completion of legal documents and legal due diligence, funds are made available.

Types of Venture Capital funding

The various types of venture capital are classified as per their applications at various stages of
a business. The three principal types of venture capital are early stage financing, expansion
financing and acquisition/buyout financing.
The venture capital funding procedure gets complete in six stages of financing corresponding
to the periods of a company’s development

 Seed money: Low level financing for proving and fructifying a new idea
 Start-up: New firms needing funds for expenses related with marketingand product
development
 First-Round: Manufacturing and early sales funding
 Second-Round: Operational capital given for early stage companies which are selling
products, but not returning a profit
 Third-Round: Also known as Mezzanine financing, this is the money for expanding a
newly beneficial company
 Fourth-Round: Also calledbridge financing, 4th round is proposed for financing the
"going public" process

A) Early Stage Financing:

Early stage financing has three sub divisions seed financing, start up financing and first stage
financing.

 Seed financing is defined as a small amount that an entrepreneur receives for the
purpose of being eligible for a start up loan.
 Start up financing is given to companies for the purpose of finishing the development
of products and services.
 First Stage financing: Companies that have spent all their starting capital and need
finance for beginning business activities at the full-scale are the major beneficiaries of
the First Stage Financing.

B) Expansion Financing:
Expansion financing may be categorized into second-stage financing, bridge financing and
third stage financing or mezzanine financing.
Second-stage financing is provided to companies for the purpose of beginning their
expansion. It is also known as mezzanine financing. It is provided for the purpose of assisting
a particular company to expand in a major way. Bridge financing may be provided as a short
term interest only finance option as well as a form of monetary assistance to companies that
employ the Initial Public Offers as a major business strategy.

C) Acquisition or Buyout Financing:

Acquisition or buyout financing is categorized into acquisition finance and management or
leveraged buyout financing. Acquisition financing assists a company to acquire certain parts
or an entire company. Management or leveraged buyout financing helps a particular
management group to obtain a particular product of another company.

Advantages of Venture Capital

Expansion of Company: Venture capital provides large funding that a company needs to
expand its business. It has the ability for company expansion that would not be possible
through bank loans or other methods.

Expertise joining the company: Venture capitalists provide valuable expertise, advice and
industry connections. These experts have deep knowledge of specific market standards and
they can help you avoid your business from many downsides that are usually associated with
startups.

Better Management: It’s not always that being an entrepreneur one is also a good business
manager. However, since Venture Capitalists hold a percentage of equity in the business.
They will have the power to say in the management of the business. So if one is not good at
managing the business, this is a significant benefit.

No Obligation to repay: In addition, there is an obligation to repay to investors as it would

be in case of banks loans. Rather, investors take the investment risk on their own shoulders
because they believe in the company’s future success.

Value Added Services: Venture Capitalists provide HR Consultants, who are specialist in
hiring the best staff for your business. This helps in avoiding to hire the wrong person. It also
offers a number of other such services such as mentoring, alliances and also facilitates the
exit.

Disadvantages of Venture Capital

Complex Process: It is a lengthy and complex process which needs a detailed business plan
and financial projections. Until and unless the Venture Capitalists are properly satisfied with
the business plan, whether or not it will succeed in the future, they won’t invest. So securing
a deal with a Venture Capitalist can be a long and complex process.

Loss of control: Venture Capital firms add one of their team members to your management
team, while this is usually done for ensuring the success of the business, it can also create
internal problems.

Loss over decisions: Another big problem faced in Venture Capital funding is that you will
have to give up many key decisions on how the company will process or operate. This is
because Venture Capitalist are required to be informed about all the key decision relating to
business plans, and they usually can override such decision if they are unsatisfied with the
decision.

No Confidentiality: Generally Venture Capitalist treat information confidentially. But they

refuse to sign non- disclosure agreement due to the legal ramification of doing so. This puts
the ideas at risk, especially when they are new. Further, your investor will expect regular
information and consultation to check how things are progressing. For example, accounts and
minutes of board meetings.

Quick Liquidity: Most Venture Capitalists seek to realize their investment in the company in
three to five years. If your business plan expects a longer timetable before providing liquidity,
then Venture Capital funding may not be a suitable option for you.