“VENTURE CAPITAL”

PROJECT
SUBMITTED TO

UNIVERSITY OF MUMBAI

SUBMITTED BY

RITU MEHTA

UNDER THE GUIDANCE OF

PROF. NILESH RUGHANI

MITHIBAI COLLEGE.
VILE PARLE(WEST).MUMBAI

OCTOBER 2018

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 PROJECT TITLE:-

“VENTURE
CAPITAL”

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 DECLARATION

I, the undersigned, student of MITHIBAI COLLEGE of MASTERS

OF COMMERCE(ADVANCED ACCOUNTANCY) Second year

hereby declare that I have completed this Project of “Venture Capital”

in the academic year 2018-21019.

The information submitted in this project is true and original to the best

of my knowledge.

Ritu Mehta

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 CERTIFICATE

This is to certify that Miss Ritu Mehta has successfully completed the
project work as partial fulfillments of the requirement for the Masters
of Commerce (Advanced Accountancy) in the academic year 2018-
2019.

Signature of Project Head Head

Mr. Nilesh Rughani

Date:

College Seal

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 ACKNOWLEDGEMENT

One of the pleasant aspects of preparing a project report is the

opportunity to thank to those who have contributed to make the project
completion possible.

I am extremely thankful to Mr. Nilesh Rughani. Whose active

interest in the project and insights helped us formulate, redefine and
implement our approach towards the project.

We are also thankful to all those seen and unseen hands & heads,
which have been of direct or indirect, help in the completion of this
project.

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 Table of contents
Sr. No. Particular Page No.

Main page 1
Declaration 2
Certification 3
Acknowledgment 4
1. Introduction 8-39
 Concept Of Venture Capital 9
 Features Of Venture Capital 11
 Venture Capital Spectrum/Stages 14
 Venture Capital Investment Process 27
 Methods Of Venture Financing 31
 Difference Between Venture Capital And Other 33
Funds(Private Equity)
 Players Venture Capital Industry 36

3. Analysis I- Global Scenario Of Venture Capital Industry 40-57

 Overview 41
 Current Industry Trends 42
 Growth Of Venture Capital In Global 45
 2017 Global Venture Capital Industry Survey 47
 China, India And Israel Will Be Most Attractive Growth Of 50
Venture Capital
 Primary Reasons For Venture Capital Investors Expanding 51
Globally
 Investing Globally By Investing Locally 55
 Impediments To Global Investing 57
4. Analysis II- Venture Capital In India 58-80

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  Venture Capital Industry Life Cycle In India 59

 Growth Of Venture Capital In India 60

 2017 Venture Capital Investment In India 65

 Need For Growth Of Venture Capital In India 67

 Regulatory And Legal Framework 69

 Major Regulatory Framework For Venture Capital Industry 70

 Key Success Factor For Venture Capital Industry In India 71

 Industrial Attractiveness 74

 Domestic Economic Factors 76

 Problems Of Venture Capital Financing In India 80

5. Summary 84-84
6. Recommendations 85-92
7. Conclusion 93
8. Bibliography & Webliography 94

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INTRODUCTION

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  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
company’s 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
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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 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 customer’s business.

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  FEATURES OF VENTURE CAPITAL

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

 High Risk

By 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:

o Management risk -Inability of management teams to work together.

o Market risk -Product may fail in the market.
o Product risk -Product may not be commercially viable.
o Operation risk -Operation may not be cost effective resulting in
increased cost decreased gross margin.

 High Tech

As 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 the entrepreneur has conviction but
little capital gets venture finance. Venture capital is available for expansion of

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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 Gains

Investments 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.

 Participation In management

Venture 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 company’s board of directors and involvement, for better or
w orse, 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.

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  Length of Investment

Venture 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 Investment

Venture 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.

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  THE VENTURE CAPITAL SPECTRUM/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 fund are needed to solicit the
consultant’s 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.

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 Introduction stage

Growth
Stage
Later Stage

Seed Capital Early Stage

Second
Stage

Startup Capital

Venture Capital Spectrum/Stage

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

2. Later Stage Finance

 Expansion/Development Stage Capital

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  Replacement Finance
 Management Buy Out and Buy Ins
 Turnarounds
 Mezzanine/Bridge Finance

The table below shows risk perception and time orientation for different stages of
venture capital financing.

Financing Stage Period (funds Risk Activity to be financed

locked in years) perception

Early stage finance 7-10 Extreme For supporting a concept

or idea or R & D for
product development
Start up 5-9 Very high Initializing operations or
developing prototypes
First stage 3-7 High Start commercial
production and marketing
Second stage 3-5 Sufficiently Expand market & growing
high working capital need
Later stage finance 1-3 Medium Market expansion,
acquisition & product
development for profit
making company
Buy out-in 1-3 Medium Acquisition financing
Turnaround 1-3 Medium to high Turning around a sick
company
Mezzanine 1-3 Low Facilitating public issue

Venture Capital- Financing Stages

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  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:

o Absence of ready product market

o Absence of complete management team
o Product/process still in R & D stage
o 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 entrepreneur’s 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.

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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:-

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.”
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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 entrepreneur’s 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 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

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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 investor’s often participate in start up finance.

 Early Stage Finance

It 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.
 Short term prospective for dramatic growth in revenue and profits.

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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 Finance

It 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

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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
 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 firm’s 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
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 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 Finance

It 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 product development 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.

“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

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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

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markets or entering exports by enterprise with established business that has
already achieved break even and has started making profits.

Replacement Finance

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 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

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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.

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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  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

Investors

Screening

VC MGT Fund
Selection

Investment
process

Structuring
Prospective
Investee

 Deal Origination:

Monitoring
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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.

 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.

 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

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process is termed as deal structuring. The agreement also include the venture
capitalists right to control the venture company 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:

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

Initial Public Offers (IPOs)

The benefits of disinvestments via the public issue route are improved
marketability and liquidity, better prospects for capital gains and widely known

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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.

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.

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  METHODS OF VENTURE FINANCING

Venture Capital is typically available in three forms in India, they are:

 Equity: All VCFs in India provide equity but generally their contribution
does not exceed 49% of the total equity capital. Thus, the effective control
and majority ownership of the firm remains with the entrepreneur. They
buy shares of an enterprise with an intention to ultimately sell them off to
make capital gains.
 Conditional Loan: it is repayable in the form of a royalty after the venture
is able to generate sales. No interest is paid on such loans. In India, VCFs
change royalty ranging between 2% to 15%; actual rate depends on other
factors of the venture such as gestation period, cost flow patterns, riskiness
and other factors of the enterprise.
 Income Note: it is a hybrid security which combines the features of both
conventional loan and conditional loan. The entrepreneur has to pay both
interest and royalty on sales, but at substantially low rates.
 Participating Debenture: such security carries charges in 3 phases. In the
start up phase, before the venture attains operations to a minimum level, no
interest is charged, after this, low rate of interest is charged, up to a
particular level of operation. Once the venture is commercial, a high rate of
interest is required to be paid.
 Quasi Equity: quasi equity instruments are converted into equity at a later
date. Convertible instruments are normally converted into equity at the
book value or at certain multiple of EPS, i.e. at a premium to par value at a
later date. The premium automatically rewards the promoter for their
initiative and hand work. Since it is performance related, it motivates the
promoter to work harder so as to minimize dilution of their control on the
company. The different quasi equity instruments are follows:

Venture Capital Page No: 31

 o Cumulative convertible preference shares.
o Partially convertible debentures.
o Fully convertible debentures.

 Other Financing methods: a few venture capitalists, particularly in the

private sector, have started introducing innovative financial securities like
participating debentures, introduced by TCFC is an example.

Venture Capital Page No: 32

  DIFFERENCE BETWEEN VENTURE CAPITAL
AND OTHER FUNDS (PRIVATE EQUITY)

 Venture Capital Vs Development Funds

Venture capital differs from development funds as latter means putting up of

industries without much consideration of use of new technology or new
entrepreneurial venture but having a focus on underdeveloped areas (locations).
In majority cases it is in the form of loan capital and proportion of equity is very
thin. Development finance is security oriented and liquidity prone. The criteria
for investment are proven track record of company and its promoters, and
sufficient cash generation to provide for returns (principal and interest). The
development bank safeguards its interest through collateral.

They have no say in working of the enterprise except safeguarding their interest
by having a nominee director. They do not play any active role in the enterprise
except ensuring flow of information and proper management information system,
regular board meetings, adherence to statutory requirements for effective
management information system, regular board meetings, adherence to statutory
requirements for effective management control where as Venture capitalist
remain interested if the overall management of the project account of high risk
involved I the project till its completion, entering into production and making
available proper exit route for liquidation of the investment. As against this fixed
payments in the form of installment of principal and interest are to be made to
development.

 Venture Capital Vs Seed Capital & Risk Capital

It is difficult to make a distinction between venture capital, seed capital, and risk
capital as the latter two form part of broader meaning of Venture capital.

Venture Capital Page No: 33

Difference between them arises on account of application of funds and terms and
conditions applicable. The seed capital and risk funds in India are being provided
basically to arrange promoter’s contribution to the project. The objective is to
provide finance and encourage professionals to become promoters of industrial
projects. The seed capital is provided to conventional projects on the
consideration of low risk and security and use conventional techniques for
appraisal. Seed capital is normally in the form low interest deferred loan as
against equity investment by Venture capital. Unlike Venture capital, Seed
capital providers neither provide any value addition nor participate in the
management of the project. Unlike Venture capital Seed capital provider is
satisfied with low-normal returns and lacks any flexibility in its approach.

Risk capital is also provided to established companies for adapting for new
technologies. Herein the approach is not business oriented but developmental. As
a result on one hand the success rate of units assisted by seed capital/risk.

Finance has been lower than those provided with venture capital. On the other
hand the return to the seed/risk capital financier had been very low as compared
to venture capitalist.

Seed Capital Scheme Venture Capital Scheme

Basic Income or aid Commercial viability
Beneficiaries Very small entrepreneurs Medium and large
entrepreneurs are also covered
Size of assistance Rs. 15 lac(Max) Up to 40 percent of promoters’
equity
Appraisal process Normal Skilled and Specialized
Estimates returns 20 percent 30 percent plus
Flexibility Nil Highly flexible

Venture Capital Page No: 34

Value addition Nil Multiple ways
Exit option Sell back to promoters Several, including public offer
Funding sources Owner funds Outside contribution allowed
Syndication Not done Possible
Tax concession Nil Exempted
Success rate Not good Very satisfactory

Difference between Seed Capital Scheme and Venture Capital Scheme

 Venture Capital Vs Bought Out Deals

The important difference between the venture capital and bought out deals is that
bought outs are not based upon high risk- high reward principal. Further unlike
venture capital they do not provide equity finance at different stages of the
enterprise. However both have a common expectation of capital gains yet their
objectives and intents are totally different.

Venture Capital Page No: 35

  PLAYERS IN VENTURE CAPITAL INDUSTRY

Idea Established the Expansion Troubleshooting

company

Business Break Investing In IPO Turnaround

concept Even-point technology

Angle Small Medium

Venture Corporate venture
Fund investors funds

Big Venture Funds + Financial Funds

Players in Venture Capital Industry

There are following group of players:

 Angels and angel clubs

 Venture capital funds
o Small
o Medium
o Large
 Corporate Venture funds
 Financial service venture groups

Venture Capital Page No: 36

  Angels and angel clubs

Angels are wealthy individuals who invest directly into companies. They can
form angel clubs to coordinate and bundle their activities. Beside the money,
angels often provide their personal knowledge, experience and contacts to
support their investees. With average deals sizes from USD100, 000 to USD
500,000 they finance companies in their early stages. Examples for angel clubs
are –Media Club, Dinner Club, and Angel’s forum

 Small and Upstart Capital Funds

These are smaller Venture Capital Companies that mostly provide seed and
startup capital. The so called “Boutique firms” are often specialized in certain
industries or market segments. Their capitalization is about USD 20 to USD 50
million (is this deals size or total money under management or money under
management per fund?). As for small and medium Venture capital funds strong
competition will clear the market place. There will be mergers and acquisitions
leading to a concentration of capital. Funds specialized in different business areas
will form strategic partnerships. Only the more successful funds will be able to
attract new money. Examples are:

o Artemis Comaford
o Abbell Venture Fund
o Acacia Venture Partners

 Medium Venture Funds

The medium venture funds finance all stages after seed and operate in all
business segments. They provide money for deals up to USD 250 million. Single
funds have up to USD 5 billion under management. An example is Accel
Partners

Venture Capital Page No: 37

  Large Venture Funds

As the medium funds, large funds operate in all business sectors and provide all
types of capital for companies after seed stage. They often operate internationally
and finance deals up to USD 500 million the large funds will try to improve their
position by mergers and acquisitions with other funds to improve size, reputation
and their financial muscle. In addition they will to diversify. Possible areas to
enter are other financial services by means of M&As with financial services
corporations and the consulting business. For the latter one the funds have a rich
resource of expertise and contacts in house. In a declining market for their core
activity and with lots of tumbling companies out there is no reason why Venture
Capital funds should offer advice and consulting only to their investees.

Examples are:

o AIG American International Group

o Cap Vest man
o 3i

 Corporate Venture Funds

These Venture Capital funds are set up and owned by technology companies.
Their aim is to widen the parent company’s technology base in an win-win-
situation for both, the investor and the investee. In general, corporate funds invest
in growing or maturing companies, often when the investee wishes to make
additional investments in technology or product development. The average deals
size is between USD 2 million and USD 5 million. The large funds will try to
improve their position by mergers and acquisitions with other funds to improve
size, reputation and their financial muscle. In addition they will to diversify.
Possible areas to enter are other financial services by means of M&As with
financial services corporations and the consulting business. For the latter one the

Venture Capital Page No: 38

funds have a rich resource of expertise and contents in house. In a declining
market for their core activity and with lots of tumbling companies out there is no
reason why Venture Capital funds should offer advice and consulting only to
their investees. Examples are:

o Oracle
o Adobe
o Dell
o Kyocera

As an example, Adobe systems launched a $40m venture fund in 1994 to invest

in companies strategic to its core business, such as Cascade Systems Inc and
lantana research Corporation-has been successfully boosting demand for its core
products, so that Adobe recently launched a second $40m fund.

 Financial Funds:

A solution for financial funds could be a shift to a higher securisation of Venture

Capital activities. That means that the parent companies shift the risk to their
customers by creating new products such as stakes in a Venture Capital fund.
However, the success of such products will depend on the overall climate and
expectations in the economy. As long as the sown turn continues without any
sign of recovery customers might prefer less risky alternatives.

Venture Capital Page No: 39

GLOBAL SCENARIO

OF VENTURE

CAPITAL INDUSTRY

Venture Capital Page No: 40

  OVERVIEW

The global economic downturn has many venture capitalists altering strategies,
including reducing investment levels in the short term, according to the 2017
Global Venture Capital Survey by Deloitte Touche Tohmatsu and the National
Venture Capital Association. Fifty-one percent of the survey respondents are
decreasing the number of companies in which they plan to invest and just 13
percent are increasing this activity.

The 2017 Global Venture Capital survey, which measured the opinions of more
than 750 venture capitalists worldwide, also shines headlights into the post-
recession landscape. The cleantech sector is poised to become the leading
investment category and the globalization of the venture capital industry will
intensify the latter posing significant competitive questions for the United States
and opportunities for emerging markets such as China.

“While the recession has slowed the pace of venture investing in the short term, it
may very well have expedited the global evolution of the industry in the long
run,” said Mark Jensen, national managing partner of Deloitte LLP’s Venture
Capital Services. “In recent years, many entrepreneurs who have been educated
in the United States have returned home to start companies in their home
countries. The playing field continues to level out in terms of new innovation hot
spots, broader access to capital and growing regional ecosystems that foster risk
taking and capital formation.”

Venture Capital Page No: 41

  CURRENT INDUSTRY TRENDS

 Round Class Distribution

The distribution of financing rounds by round class in mature markets is typically

30-40% in the early stage rounds, 20-25% in second round, and 35-40% in later
rounds. In emerging market like China, the round distribution is very different as
68% in early stage and 25% in second round. In mature countries, the
investments are made at early start up or product development phase.

 Industry Shifts

It is perhaps no surprise that contraction is mostly concentrated in information

technology and the business, consumer and retail industries, give the huge
number of companies financed in the technology and Internet boom of 1999-
2000, and the subsequent down turn. The healthcare pool, driven by investment
in biopharmaceuticals and medical devices, has actually grown to some degree in
the different geographies. In United States, the healthcare pool has grown
consistently over the last several years, both in terms of number of companies
and cumulative dollars invested.

Key observations on the pool of private companies by industry:-

o The information and technology pool has declined by just 6% since 2012;
particularly due to increasing Interest in WEB 2.0 innovations.

o Since 2013, the cumulative investment has declined in similar amounts.

o The business, consumer and retail category has faced the steepest declines
across the board. In US the number had fallen 54% since 2012 and 54% in
Europe since 2013. In Israel; it dropped 67% since 2014.

Venture Capital Page No: 42

 o The number of healthcare companies has grown in U.S. since 2012 by 27%
and the capital risen 30% in last five years. Capital investment to the pool
of healthcare of companies dropped by 95 in Europe since 2013 and 9% in
Israel since 2014.

o Clean technology is a small but increasing element of the pool. There were
262 clean technology companies with a cumulative invested venture
capital of U.S. $38 billion in 2017.

 Mega Trends

Several global mega trends will likely have an impact on venture capital in the
next decade:-

o Beyond the BRICs: - A new wave of fast growing economies is joining

the global growth leaders like Brazil, China, India And Russia. The
beginning of venture capital activity has been seen in others countries
such as Indonesia, Korea, Turkey and Vietnam.
o The new multinationals: - A new breed of global company is emerging
from developing countries and redefining industries through low-cost
advantage, modern infrastructure, and vast customer databases in their
home countries. These companies are potential acquirers of developed
market companies at all stages of growth.
o Globalization of capital: - Changes in economic and financial landscape
are creating significant regional shifts in IPO activity. These changes
have also sparked global consolidation alliances among stock
exchanges.
o Transformation of the CFO’s role and function: - With the globalization
and increasingly complex regulatory environment, CFOs have a wider
range of responsibilities and finance function has been transformed to
face broader mandates.

Venture Capital Page No: 43

 o Clean Technology: - Clean technology is poised to become the first
break through sector of 21st century. Encompassing energy, air and
water treatment, industrial efficiency improvements, new material and
waste management etc. are playing very vital role globally because of
which VC investors are enjoying rewards.

Venture Capital Page No: 44

  GROWTH OF VENTURE CAPITAL IN GLOBAL

Growth of venture capital in global

Clean technology venture investments in North America, Europe, China and

India totaled US$5.6 billion in 557 deals. However, as these figures are
preliminary, the firms expect the final figures could be up by as much as 10%.

"Utilities continue to bring their capital and access to credit to the cleantech
sector and are playing a key role in getting more projects off the ground. In 2017
we saw a surge in utility Power Purchase Agreement (PPA) announcements with
Solar Thermal and Solar PV accounting for 80% of the total PPAs, while Wind
saw increased capacity announcements in the second half of the year aided by the
extension of the production tax credit," said Scott Smith, U.S. Clean Tech leader
for Deloitte. "Additional project financing came from large corporations whose

Venture Capital Page No: 45

direct investments in cleantech increased by 14% in the second half of 2017
compared to the same period in 2015. Leading global utilities and non-utilities
are likely to continue to see cleantech projects as an attractive investment from an
economical and regulatory perspective."

Venture investment was down 33% in 2017, compared to US$8.5 billion in 2016,
yet investment in cleantech declined less than other sectors, despite the economic
recession.

The largest deal in all sectors was Solyndra’s US$198 million to expand its CIGS
thin film production. The company has since filed for an IPO.

Venture Capital Page No: 46

  2017 GLOBAL VENTURE CAPITAL INDUSTRY
SURVEY

The 2017 Global Venture Capital Survey was sponsored by the Global Deloitte
Telecom, Media & Technology (DTT TMT) industry group, in conjunction with
the following venture capital associations throughout the world:
 Brazilian Association of Private Equity & Venture Capital (ABVCAP)
 British Private Equity & Venture Capital Association (BVCA)
 Canada’s Venture Capital & Private Equity Association (CVCA)
 European Private Equity & Venture Capital Association (EVCA)
 Emerging Markets Private Equity Association (EMPEA)
 Indian Venture Capital Association (IVCA)
 Israel Venture Association (IVA)
 Latin American Venture Capital Association (LAVCA)
 Malaysian Venture Capital and Private Equity Association (MVCA)
 National Venture Capital Association (NVCA)
 Singapore Venture Capital & Private Equity Association (SVCA)
 Taiwan Private Equity & Venture Capital Association (TVCA)
 Zero2IPO

The survey conducted with venture capitalists (VCs) in the Americas, Asia
pacific (AP), Europe and Israel. There were 725 responses from general partners
of venture capital firm with assets under management ranging from less than
$100 million to greater than $1 billion.

Multiple responses from the same firm were allowed, as the survey was a general
measurement of the state of global investing from all general partners, not
attitudes of specific firm. If respondents did not answer a question, the count for
the question was adjusted accordingly.

Venture Capital Page No: 47

The highest number of respondents—35 percent—claimed assets under
management totaling between $100 million and $499 million. Another 34 percent
had managed assets that were less than $100 million, 17 percent had managed
assets greater than $1 billion, and 14 percent had between $500 million and $1
billion in assets under management.

40%
35% Assets under Management
35%

30%

25%

20% 18% 17%

16%
14%
15%

10%

5%

0%
$1-$49 million $50-$99 million $100-$499 million $500-$1 billion >$1 billion

Geographically, the breakdown of responses continues to be fairly representative of

both the size and location of firms in the venture capital industry around the world.
Forty-four percent of the respondents were from the United States, 21 percent from
European countries (excluding the UK), 16 percent from Asia Pacific countries, 10
percent from the Americas (excluding the U.S.), 7 percent from the UK, and 2 percent
Location ofeondents from Israel.
7%
16%
AP
Europe
Israel
21% The Americas
44%
U.S.
UK
10% 2%

Venture Capital Page No: 48

 Firm type
28%

Venture Capitl

Private Equity and

Venture Capital

72%

Seventy-two percent of the respondents had a primary investment focus on venture

capital while 28 percent were primarily focused on private equity and venture capital.
And, this year, 52 percent of venture capitalists noted that they are investing outside of
their home country.

Given the severity of the current global recession, this year's survey focused on issues
surrounding its impact on venture capitalists. The survey questions asked how the
global recession is affecting strategy; how future investments are being planned, both
by sector and region; what the anticipated size of the next fund will be and who VCs
think their limited partners will be. We also wanted to know what countries they
believe have the most to gain and lose in this new economy, as well as what they feel
the role of government should be in fostering innovation.

This year's report looks broadly at the results in a global context, but an appendix is
included that breaks out survey responses by geographic regions—the U.S., the
Americas (excluding the U.S.) Europe (excluding the UK), UK, AP and Israel. If you
are interested in responses of investors in a specific region, we encourage you to check
the appendix for those charts.

Venture Capital Page No: 49

  CHINA, INDIA AND ISRAEL WILL BE MOST
ATTRACTIVE GROWTH OF VENTURE CAPITAL

While overall investment levels are expected to be lower, the KPMG survey
found that 2017 funding will be targeted toward key geographic regions and
industry segments. In addition, the KPMG survey found that venture investors do
not see the IPO market improving for at least a year, and only a small portion of
portfolios are poised for exit in 2017.

While overall investment levels are expected to be lower, the KPMG survey
found that 2017 funding will be targeted toward key geographic regions and
industry segments. Respondents indicated that China, India and Israel will be the
most attractive regions for venture capital, while cleantech, life sciences, mobile
and digital entertainment will remain the hot industries.

‘While overall funding will decrease, venture capitalists will continue to invest in
those areas they feel will provide the best return on investment,’ said Brian
Hughes, KPMG partner based in Philadelphia and co-leader of its venture capital
practice. ‘Not surprisingly, they continue to be bullish on emerging markets and
industry sectors, such as cleantech, that project near term growth.’

In polling 270 venture capitalists, corporate buyers and entrepreneurs, KPMG

found that 73 per cent of respondents expect their firm’s revenue to stay the same
or increase in 2017. In fact, 52 per cent expect revenue growth to increase,
including 37 percent who predict revenue growth in excess of 10 percent. Only
26 per cent see declining revenues in the year ahead.

The outlook on sustained revenue growth is the silver lining to a tough year that
has seen the fewest venture capital portfolio companies go public since 1977. In
fact, the KPMG survey found that venture capitalists expect the negative IPO

Venture Capital Page No: 50

trend to continue in 2017, with 88 per cent of respondents expecting IPO activity
to stay the same or to decline further. Additionally, 82 per cent of venture
capitalists surveyed indicated that they do not anticipate recovery in the IPO
market for at least 12 months. The outlook on IPO activity has clearly impacted
venture capital exit opportunities, and 80 per cent of respondents said less than
20 per cent of their portfolio is poised for exit in 2017.

The decline in IPO opportunities coupled with the expected, continued regression
in valuations of venture-backed companies, may influence the venture capital
community to see acquisitions as liquidity and exit opportunities. When asked
about valuation of venture backed companies, 84 per cent of respondents
predicted decreasing valuations, while only six percent see an increase. With
valuations declining, 58 percent of respondents see M&A increasing next year.

‘There is no question that economic and market conditions have made the current
environment difficult for venture capitalists,’ said Packy Kelly, KPMG partner
based in Silicon Valley and co-leader of its venture capital practice. ‘These
conditions may lead investment firms to focus on the health of existing portfolio
companies and slow the pace of investment. But the commercialization of
products in the clean tech sector probably contributes to a large degree to the
expected growth in revenue of emerging companies.

According to the KPMG survey, the outlook on investment levels and deal
volume for 2017 mirrors the views on IPO activity. In fact, 74 per cent of
respondents expect overall venture investment to decrease and 82 per cent see a
decline in deal volume. While it is uncertain when venture investment will trend
back up, 50 per cent of venture capitalists surveyed do not expect that up-tick to
occur until the second half of 2017, while 32 per cent predict it will not happen
until 2018 or beyond. Only 18 per cent predict the turnaround in venture funding
will start in the first two quarters of 2017.

Venture Capital Page No: 51

While overall investment levels are expected to be lower, the KPMG survey
found that 2017 funding will be targeted toward key geographic regions and
industry segments. Respondents indicated that China, India and Israel will be the
most attractive regions for venture capital, while clean tech, life sciences, mobile
and digital entertainment will remain the hot industries. ‘While overall funding
will decrease, venture capitalists will continue to invest in those areas they feel
will provide the best return on investment,’ said Brian Hughes, KPMG partner
based in Philadelphia and co-leader of its venture capital practice. ‘Not
surprisingly, they continue to be bullish on emerging markets and industry
sectors, such as cleantech, that project near term growth.”

Another indication of the current market conditions’ negative impact on the

venture community can be seen in attitudes toward start-up investing. Ninety-
seven per cent of venture capitalists surveyed said the credit crisis will have an
adverse effect on the availability of venture financing to start-up companies, and
73 per cent said it will be harder to get debt or lease financing.

Venture Capital Page No: 52

  PRIMARY REASONS FOR VENTURE CAPITAL
INVESTORS EXPANDING GLOBALLY

Among the primary reasons VCs around the world are interested in investing
globally is to take advantage of higher quality deal flow- particularly in the
United States, China, parts of Europe, and Israel. This is especially true for non-
U.S. firms. A second reason is the emergence of an entrepreneurial environment,
again and notably in China, but also India. Among U.S. firms, this latter rationale
is the most significant motivation for investing globally. Other motivators include
access to quality entrepreneurs, diversification of industry and geographic risk
and access to foreign markets.

40
34 global US non US
35
31
30 28

25 22
19
20 17
16 16
14 14
15 12 12 12 12
11
9
10
5 5 6
5 2 3

Primary reasons why investors expanding globally venture

Venture Capital Page No: 53

Above chart reveals that 19% U.S. respondents are expand globally for
generating high quality deal flow. And 31% believe that expand globally for
getting benefit of emergence of entrepreneurial environment. Whit 17%
respondents of non U.S are expanding globally for diversification of industry and
geographic risk. All respondents are least concerned about low cost of locations.

Venture Capital Page No: 54

  INVESTING GLOBALLY BY INVESTING LOCALLY

One way to build a comfort zone for global investing and to take advantage of
opportunities abroad is to invest locally in companies with operations outside their
home country, as opposed to investing directly in foreign countries. This year, there
was a significant increase in the number of respondents who indicated that a sizeable
number of their portfolio companies have a considerable amount of operations outside
the country in which they are headquartered.

A significant number, 88 percent of U.S. respondents and 82 percent of non-U.S.

respondents, indicated that at least some portion of their portfolio has significant
operations outside of the country of headquarters. Again, moderation is evident as
more than half of those indicated that less than 25 percent of their portfolio had
significant foreign operations. Nonetheless, these numbers have increased significantly
from prior years and reflect an increased trend in this method of investment.

35
32 32 32
30
30
25
25
21
20 18 18
17
15 15
15
12 12
9
10
5
5 3
2 2

0
0% 1-10% 11-25% 26-50% 51-75% 76-100%

Global U.S. Non- U.S.

Percentage of venture capital firms portfolio companies that give significant

operation outside the country

Globally and among U.S. respondents, China has become the primary choice for

Venture Capital Page No: 55

relocating manufacturing operations, while India is the primary choice For R&D
operations. Engineering operations tend to land in India as well, but China is also a
popular location. For back office activities, again the choice is India. However, for
non-U.S. respondents, the United States is the primary choice for R&D and
engineering while European respondents preferred Central and Eastern Europe for
manufacturing R&D and Engineering.

One reason why this approach is taking off is that investors are concerned about
intellectual property and liquidity events and in general they feel a need to be closer to
top management. This also reflects a new reality from day one companies that reflect a
larger global entrepreneurial sector. This strategy allows the portfolio companies (and
investors) to take advantage of cost saving and access o talent in foreign markets while
protecting intellectual property. There are however concerns that such a trend could
result in the U.S. losing its R&D edge.

Venture Capital Page No: 56

  IMPEDIMENTS TO GLOBAL INVESTING

For all the benefits of overseas investing, VC firms encounter a variety of risks and
challenges abroad. Both U.S. firms and non-U.S. firms perceive the U.S as the country
where the cost of complying with regulation is too high. In fact, the percentage of non-
U.S. respondents who indicated this as a concern leaped from 28% last year to 41%
this year. Globally, 4% more, 44% saw this issue as a concern. 46% of U.S.
respondents believe the cost of complying with corporate governance is too high.

Top markets where the cost of complying with corporate governance regulation
too high

From the above chart we can see that most of the respondents believe that U.S. has
high cost of complying with Corporate Governance regulation and China, India, Israel
and Canada cost of complying with corporate governance regulation too high.

Venture Capital Page No: 57

 VENTURE
CAPITAL IN
INDIA

Venture Capital Page No: 58

  VENTURE CAPITAL INDUSTRY LIFE CYCLE IN
INDIA

From the industry life cycle we can know in which stage venture capital are
standing. On the basis of this management can make future strategies of their
business.

Introduction Growth

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

The growth of venture capital in India has four separate phases:

 Phase I- formation of TDICI in 80’s and regional funds as GVFL &

APIDC in early 90s.

The first phase was the initial phase in which the concept of venture capital got
wider acceptance. The first period did not really experience any substantial
growth of venture capitals. The 1980’s were marked by an increasing
disillusionment with the trajectory of the economic system and a belief that
liberalization was needed. The liberalization process started in 1985 in a limited
way. The concept of venture capital received official recognition in 1988 with the
announcement of the venture capital guidelines.

Venture Capital Page No: 59

During 1988 to 1992 about 9 venture capital institutions came up in India.
Though the venture capital funds should operate as open entities, Government of
India controlled them rigidly. One of the major forces that induced Government
of India to start venture funding was the World Bank. The initial funding has
been provided by World Bank. The most important feature of the 1988 rules was
that venture capital funds received the benefit of a relatively low capital gains tax
rate which was lower than the corporate rate. The 1988 guidelines stipulated
venture capital funding firms should meet the following criteria:

o Technology involved should be new, relatively untried, very closely held,

in the process of being taken from pilot to commercial stage or
incorporate some significant improvement over the existing ones in India.
o Promoters/entrepreneurs using the technology should be relatively new,
professionally or technically qualified, with inadequate resources to
finance the project.

Between 1988 and 1994 about 11venture capital funds became operational either
through reorganizing the business or through new entities.

 Phase II- Entry of Foreign Venture Capital Funds (VCF) between 1995-
1999

The second phase of venture capital growth attracted many foreign institutional
investors. During this period overseas and private domestic venture capitalists
began investing in VCF. The new regulations in 1996 helped in this. Though the
changes proposed in 1996 had a salutary effect, the development of venture
capital continued to be inhibited because of the regulatory regime and restricted
the FDI environment. To facilitate the growth of venture funds, SEBI appointed a
committee to recommend the changes needed in the venture capital funding
context. This coincided with the IT boom as well as the success of Silicon Valley

Venture Capital Page No: 60

startups. In other words, venture capital growth and IT growth co-evolved in
India.

 Phase III-(2000 onwards)- Venture capital becomes risk averse and

activity declines:

Not surprisingly, the investing in India came “crashing down” when NASDAQ
lost 60% of its value during the second quarter of 2000 and public markets
(including those in India) also declined substantially. Consequently, during 2001-
2003, the venture capitals started investing less money and in money and in more
mature companies in an effort to minimize the risks. This decline broadly
continued until 2003.

 Phase IV- (2004 onward)- Global venture capitals firms actively investing
in India

Since India’s economy has been growing at 7%-8% a year, and since some
sectors, including the services sector and the high end manufacturing sector, have
been growing at 12%-14% a year investors renewed their interest and started
investing again in 2004 the number of deals and the total dollars invested in India
has been increasing substantially.

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  GROWTH OF VENTURE CAPITAL IN INDIA

Growth of Venture Capital in India

The venture capital is growing 43% CAGR. However, in spite of the venture
capital scenario improving, several specific Venture Capital funds are setting up
shop in India, with the year 2015 having been a landmark year for venture capital
in India. The no of deals are increasing year by year. The no of deal in 2013 only
56 and now in 2013 it touch the 387 deals. The introduction stage of venture
capital industry in India is completed in 2013 after that growing stage of India
venture capital industry is starrted.

Tere are 160 venture capital firms/funds in India. In 2014 it is only but in 2015
the number of venture capital firms are 146. The reason is good position of
capital market. But in 2016 no of venture capital firms increase by only 14 the
reason is crashdown of capital market by 51%. The no of venture capital funds
are increasing year by year

2008 2009 2010 2011 2012 2013 2014 2015 2016

81 77 78 81 86 89 105 146 160

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Venture capital growth and industrial clustering have a strong positive
correlation. Foreign diect investment, starting of R&D centres, availability of
venture capital and growth of entreneurial firms are getting concentrated into five
clusters. The cost of mnitoring and the cost of skill acquisition are lower in
clusters, especially for innovation. Entry costs are also lower in clusters. Cerating
enetrepreneursship and stimulating innovation in clusters have to become a major
concern of public policy makers. This is essential becouse only when the cultural
context is conductive for risk management venture capital will take-of. Clusters
support innovation and facilitates risk bearing. Venture capital prefer clusters
because the information costs are lower. Policies for promoting dispersion of
industries are becoming redundant after the economic liberalization.

The venture capital firm invest their money in most developning sectors like
health care, IT-ITes, Telecom, Bio-technology, Media & Entretainment, shipping
& ligistics etc.

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 Total investment

1284 988
685
1101
3979

1628

478
1638
615
1839

IT & ITES BFSI Healtcare & Lifesciences

Media & Entertinment Telecom Manufacturing
Eng & constrution Energy Shipping & Logistics
Others

Total sector wise venture capital investment

Now venture capital is nascent stage in India. Now due to growth of sector, the
venture capital industry is also growing. The top most players in the industries
are ICICI venture capital fund, IT&FS venture capital fund, Canbank.

Venture Capital Page No: 64

  2017 VENTURE CAPITAL INVESTMENT IN INDIA

Venture Capital firms invested $475 million in 92 deals during 2017, 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 2017, 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 2018, we expect significant follow-on investments into companies that

raised Series a 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.

The information technology and IT-enabled services industry retained its status
as the favorite among venture capital investors during 2017, but the industry's
share declined to about 43% of total investments from about 55% in 2016. Other
industries that attracted significant investor attention during the period included
financial services, healthcare and life sciences, and alternative energy. Within IT
and IT-enabled services, online services companies retained their status as the
favorite sector, accounting for about 39% of the investments during 2017.

Venture Capital Page No: 65

 Investment in Area

10%
15%
50%

25%

South India (47% in the total value) Western India (29% in the total value)
North India (12% in the total value) East India (12% in the total value)

Companies based in south India accounted for 50% of all venture capital
investments (47% by value) during 2017. Their peers in western India accounted
for 25% of the pie (29% by value) while companies in north India accounted for
15% of the investments (12% by value).

Among cities, companies headquartered in Bangalore and Mumbai were the

favorites among venture capital investors during 2017, with the former attracting
29 investments and the latter 15. The Delhi National Capital Region accounted
for 11 investments, followed by Hyderabad with 9 investments.

Venture Capital Page No: 66

  NEED FOR GROWTH OF VENTURE CAPITAL IN
INDIA

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
flow to 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.

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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.

Venture Capital Page No: 68

  REGULATORY AND LEGAL FRAMEWORK

At present, the Venture Capital activity in India comes under the purview of
different sets of regulations namely:

 The SEBI (Venture Capital Funds) Regulation, 1996[Regulations] lays

down the overall regulatory framework for registration and operations
of venture capital funds in India.
 The Indian Trust Act, 1882 or the company Act, 1956 depending on
whether the fund is set up as a trust or a company.
 The foreign investment Promotion Board (FIPB) and the RBI in case of
an offshore fund. These funds have to secure the permission of the
FIPB while setting up in India and need a clearance from the RBI for
any repatriation of income.
 The Central Board of Direct Taxation (CBDT) governs the issues
pertaining to income tax on the proceed from VC funding activity. The
long term capital gain tax is at around 10% in India and the relevant
clauses to VC may be found in Section 10(sub section 23)
 Overseas venture capital investments are subject to the Government of
India Guidelines for Overseas Venture Capital Investment in India
dated September 20, 1995.
 For tax exemptions purposes venture capital funds also needs to comply
with the Income Tax Rules made under Section 10(23FA) of the
Income Tax Act.

Venture Capital Page No: 69

  MAJOR REGULATORY FRAMEWORKS FOR
VENTURE CAPITAL INDUSTRY

VC & FVCI

SEBI RBI FIPB TAX

 SEBI (VCF) Reg. 1996  FEMA, 1999  FDI policy  IT Act, 1961
 SEBI(FVCI) Reg.2000  Transfer or issue  Investment  DTAA
 SCR Act.1956 of security by a approvals  Singapore
 SEBI(SAST) Reg.1997 person resident  Press Notes  Mauritius
 SEBI(DIP)Guidelines,2000 outside India  Others
 SEBI Act,1992 regulation 2000

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.

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  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 registered in Mauritius gains significance - changing
policies with a retrospective effect is undoubtedly acting as a dampener to fresh
fund raising by Venture capital firms.

 Quick Response time :

The companies have flat organization structure results in quicker decision

making. The entrepreneur is relieved of the trauma that one normally goes
through in an interface with a funding institution or a development agency. They
follow a clearly defined decision making process that works with clock like
precision, which means that if they agree on a funding schedule entrepreneur can
count on them to stick it.

Venture Capital Page No: 71

  Knowledge about Global Environment

With increasing global integration and mobility of capital it is important that

Indian venture capital firms as well as venture financed enterprises be able to
have opportunities for investment abroad. This would not only enhance their
ability to generate better returns but also add to their experience and expertise to
function successfully in a global environment.

 Good Human Resource :

Venture capital should become an institutionalized industry financed and

managed by successful entrepreneurs, professional and sophisticated investors.
Globally, venture capitalist are not merely finance providers but are also closely
involved with the investee enterprises and provide expertise by way of
management and marketing support. This industry has developed its own ethos
and culture. Venture capital has only one common aspect that cuts across
geography i.e. it is risk capital invested by experts in the field. It is important that
venture capital in India be allowed to develop via professional and institutional
management.

 Balance between three factors

Venture Capital backed companies can provide high returns. However, despite of
success stories like Apple, FedEx of Microsoft, a lot of these deals fail. It is said
that only one out of ten companies succeed. That's why every deal has an element
of potential profit and an element of risk, depending on the deals size. To be
successful, a Venture Capital Company must manage the balance between these
three factors.

Venture Capital Page No: 72

 Financial markets and
the industries to invest in

Knowledge

Risk management skills Possible investees and

and contacts to investors external expertise

Frame work for key success factor

Knowledge is key, to get the balance in this "Magic Triangle". With knowledge
we mean knowledge about the financial markets and the industries to invest in,
risk management skills and contacts to investors, possible investees and external
expertise. High profits, achievable by larger deals, are not only important for the
financial performance of the Venture Capital Company. As a good track record
they are also a vital argument to attract funds which are the basis for larger deals.
However, larger deals imply higher risks of losses. Many Venture Capital
companies try to share and limit their risks. Solutions could be alliances and
careful portfolio management. There are Venture Capital firms that refuse to
invest in e-start-up because they perceive it as too risky to follow today's type.

Venture Capital Page No: 73

  INDUSTRIAL ATTRACTIVENESS
 Market growth rate

CAGR OF VC

16000 14234
14000
VALUE OF DEALS

12000
10000
8000 43%
6000
4000
2000 1160
0
2000 2007

CAGR of venture capital industry

From the above graph we can say that Venture capital industry is growing at the
CAGR of 43%. And the value of deals in 2009 was 1160 which increased to
14234 in the year of 2016. This shows substantial increase in the number of
deals. This attracts the new entrepreneur to enter in the industry.

 Intensity of competition:

Number of venture capital firms in India

Here the number of venture capital firms is increasing year by year. In 2011 it is
only 77 now it has been increased to 160 in the year of 2016. The reason behind
that is there is over all growth in the GDP and also substantial growth position in
sectors like biotechnology, IT-ES, retailing, telecom etc. due to this more players
are eager to establish their foothold in the industry.

 Regulatory policy

Venture Capital Page No: 74

Minimum contribution and fund size: the minimum investment in a Venture
Capital Fund from any investor will not be less than Rs. 5 lacs and the minimum
corpus of the fund before the fund can start activities shall be at least Rs. 5
crores. And the foreign players can easily enter in the venture capital industry of
India. An offshore venture capital company may contribute 100% of the capital
of domestic venture capital fund. There are other hurdles to enter in the industry
so there is favorable condition for them to enter in to venture capital industry in
India.

Venture Capital Page No: 75

  DOMESTIC ECONOMIC FACTORS:

 GDP growth rate

GDP V/S VC Growth rate

There was a positive relationship there was between GDP growth rates. But in
2015 the growth of Venture Capital was decline to 89.79% from 240.91% in
2014 but here the value of deal was increasing. In 2016 the growth rate is 9% and
project the next year GDP 8% to 9%. So here we can conclude that there is good
growth prospect for the venture capital players to enter in the horizon of India.

Inflation V/S Venture capital growth rate

The inflation rate is decreased to 4.5 in 2013 from 7.4 in 2012. At same time the
growth of Venture Capital is also declining to 33.33% in 2013 from 251.06% in
2012. From the above chart we can conclude that inflation and Venture Capital
has positive relationship. Now in June 2016 the inflation rate was 11.9 and the
NO. Of deal in first two quarter in 2016 was 170 and value of deal was 6390
US$mn and in third quarter of 2016 there was only four deals. And in October
the inflation touch the 13.01%. Due to increase in inflation rate the people will go
to spend more. Thus, their savings will decrease. So more money will come into
the market and demand of the products will increase continuously. Now due to
growth of any sector will attract new entrepreneur to enter in the industry. For
that they must need funds. So there is a great opportunity for venture capital
industry to attract this new entrepreneur.

SMALL SCALE INDUSTRIES

Venture Capital Page No: 76

 Growth of small and medium scale industries

Venture Capital, to be able to contribute to developing entrepreneurship in India,

needs to concentrate its investment in small and medium enterprises. A “Package
for Promotion of Micro and Small Enterprises” was announced in February 2015.
This includes measures addressing concerns of credit, fiscal support, cluster-
based development, infrastructure, technology, and marketing. Capacity building
of MSME Associations and support to women entrepreneurs are the other
important features of this package. SMEs have been allowed to manage their
direct/indirect exposure to foreign exchange risk by booking/canceling/rollover
of forward contracts without prior permission of RBI.

To boost the micro and small enterprise sector, the bank has decided to refinance
an amount of 7000 crore to the Small Industries Development Bank of India,
which will be available up to March 31, 2020. The Central Bank said that it is
also working on a similar refinance facility for the National Housing Bank
(NHB) of an amount of Rs 4, 000 crore.

 EXPORT AND IMPORT

Value of export import

The value of Import and export are increasing year by year. In 2012-13 the value
of import and export are 52.7 and 61.4 US $bn respectively and in 2015-16 the
value of import and export are 155.7 and 185.7 US $bn. It means industry needs
more money for import and export. So it is an opportunity for venture capital. On
the other side when company going to export the company must have good
contact with other country’s company. So for that venture capital industry is

Venture Capital Page No: 77

useful because they have good contact and affiliation network with other
country’s company.

Industry Profitability:

The venture capital firms invest their money in most emerging sectors like
biotechnology, IT-ES, retailing, infrastructure which gives higher return but also
they all involved risk in substantial amount.

Possible result of venture capital investments

No. of companies out of 10 Annual rate of

investments return
Failure 4 0%
Viable 3 15%
Solid 2 50%
Superstars 1 100%
Blended average 24.5

Success ratio of venture capital deals

From the above table we can see the success ratio of the venture capital
investment. 40% of the investments are getting failure and only 10% of them are
able to give 100% return. And the average return by the venture capitalists is only
24.5% which is not extra ordinary. This type of returns can be found in many
other investment options. So there isn’t any special reason to invest in venture
capital.

 Product innovation:

Venture Capital Page No: 78

Venture capital firms are coming with new ideas of investment to attract the
buyers to their firms. For this purpose they are introducing new types of funds
and schemes.

For example, IFCI Venture Capital Funds Limited (IVCF) has launched three
new funds in emerging sectors of the economy namely:

i) India Automotive Component Manufacturers Private Equity Fund –1-Domestic

(IACM-1-D) with a target corpus of Euro 60 million equivalent to Rs.396 crores.
This Fund will be dedicated for investment mainly in Indian Automotive
Component companies and in other related/ emerging sectors.

ii) India Enterprise Development Fund (IEDF), a Venture Capital fund set up
with target corpus of Rs.250 crores to invest in knowledge based projects in key
sectors of Indian economy with outstanding growth prospects.

iii) Green India Venture Fund (GIVF), a Venture Capital fund setup with a target
corpus of Euro 50 million (approx. Rs.330 crores) with the objective to invest in
commercially viable Clean Development Mechanism (CDM), energy efficient
and other commercially viable projects with an aim to reduce negative ecological
impact, efficient usage of resources such as energy, power etc and other related
sectors/projects. The summary of the Funds:

Launching of new funds by IFCI

Funds IACM –1 GIVF IEDF

Objective To invest in Indian The objective of To invest in
companies engaged GIVF would be to knowledge based
in, amongst others, invest in companies projects with
the automotive parts setting up Clean relatively high entry
and components Development barriers, critical

Venture Capital Page No: 79

 manufacturing sector Mechanism (CDM) applications,
in order to generate projects and other prospects for high
high returns for its commercially viable growth and global
investors. projects/ business. scalability in
diversified and/ or
emerging sectors.
Size Euro 60 million (INR Euro 50 million INR 250 Cr
396 Cr) (INR 330 Cr) with
green shoe option
Nature of Fund PE Fund VC Fund VC Fund
Tenure 8 yrs. With two 10 years with two 10 years with two
prolongation option of prolongation options prolongation options
1 year each of 1 year each of 1 year each.
Expected returns 20% p.a. 20% p.a. 20% p.a.
Size of Rs. 6 to 40 Cr Rs. 2 to 30 Cr Rs. 2 to 25 Cr
investment
Management fee 2% of the total 2% of the total 2% of the total
subscription amount subscription amount subscription amount
Launching of new funds by IFCI

The SICOM venture capital firm introduce SME opportunity fund for small scale
industries.

Venture Capital Page No: 80

  PROBLEMS OF VENTURE CAPITAL FINANCING
IN INDIA:

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

competitiveness has put an immense pressure on the industrial sector to improve
the quality level with minimization of cost of products by making use of latest
technological skills. The implication is to obtain adequate financing along with
the necessary hi-tech equipments to produce an innovative product which can
succeed and grow in the present market condition. Unfortunately, our country
lacks on both fronts. The necessary capital can be obtained from the venture
capital firms who expect an above average rate of return on the investment. The
financing firms expect a sound, experienced, mature and capable management
team of the company being financed. Since the innovative project involves a
higher risk, there is an expectation of higher returns from the project. The
payback period is also generally high (5 - 7 years). The various problems/ queries
can be outlined as follows:

o Requirement of an experienced management team.

o Requirement of an above average rate of return on investment.
o Longer payback period.
o Uncertainty regarding the success of the product in the market.
o Questions regarding the infrastructure details of production like plant
location, accessibility, relationship with the suppliers and creditors,
transportation facilities, labor availability etc.
o The category of potential customers and hence the packaging and pricing
details of the product.
o The size of the market.
o Major competitors and their market share.
o Skills and Training required and the cost of training.

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 o Financial considerations like return on capital employed (ROCE), cost of
the project, the Internal Rate of Return (IRR) of the project, total amount
of funds required, ratio of owners investment (personnel funds of the
entrepreneur), borrowed capital, mortgage loans etc. in the capital
employed.

Venture Capital Page No: 82

 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 proprietor’s 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 sector of 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

Venture Capital Page No: 83

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:

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.

Venture Capital Page No: 84

 RECOMMENDATIONS:
 Multiplicity of regulations – need for harmonization
and nodal Regulator:

Presently there are three set of Regulations dealing with venture capital activity
i.e. SEBI (Venture Capital Regulations) 1996, Guidelines for Overseas Venture
Capital Investments issued by Department of Economic Affairs in the MOF in
the year 1995 and CBDT Guidelines for Venture Capital Companies in 1995
which was modified in 1999. The need is to consolidate and substitute all these
with one single regulation of SEBI to provide for uniformity, hassle free single
window clearance. There is already a pattern available in this regard; the mutual
funds have only one set of regulations and once a mutual fund is registered with
SEBI, the tax exemption by CBDT and inflow of funds from abroad is available
automatically. Similarly, in the case of FIIs, tax benefits and foreign
inflows/outflows are automatically available once these entities are registered
with SEBI. Therefore, SEBI should be the nodal regulator for VCFs to provide
uniform, hassle free, single window regulatory framework. On the pattern of FIIs,
Foreign Venture Capital Investors (FVCIs) also need to be registered with SEBI.

 Tax passes through for Venture Capital Funds:

VCFs are a dedicated pool of capital and therefore operate in fiscal neutrality and
are treated as pass through vehicles. In any case, the investors of VCFs are
subjected to tax. Similarly, the investee companies pay taxes on their earnings.
There is a well established successful precedent in the case of Mutual Funds
which once registered with SEBI are automatically entitled to tax exemption at
pool level. It is an established principle that taxation should be only at one level

Venture Capital Page No: 85

and therefore taxation at the level of VCFs as well as investors amount to double
taxation. Since like mutual funds VCF is also a pool of capital of investors, it
needs to be treated as a tax pass through. Once registered with SEBI, it should be
entitled to automatic tax pass through at the pool level while maintaining taxation
at the investor level without any other requirement under Income Tax Act.

 Mobilization of Global and Domestic resources:

 Foreign Venture Capital Investors (FVCIs):

Presently, FIIs registered with SEBI can freely invest and disinvest without
taking FIPB/RBI approvals. This has brought positive investments of more than
US $10 billion. At present, foreign venture capital investors can make direct
investment in venture capital undertakings or through a domestic venture capital
fund by taking FIPB / RBI approvals. This investment being long term and in
the nature of risk finance for start-up enterprises, needs to be encouraged.
Therefore, at least on par with FIIs, FVCIs should be registered with SEBI and
having once registered, they should have the same facility of hassle free
investments and disinvestments without any requirement for approval from FIPB
/ RBI. This is in line with the present policy of automatic approvals followed by
the Government. Further, generally foreign investors invest through the
Mauritius-route and do not pay tax in India under a tax treaty. FVCIs therefore
should be provided tax exemption. This provision will put all FVCIs, whether
investing through the Mauritius route or not, on the same footing. This will help
the development of a vibrant India-based venture capital industry with the
advantage of best international practices, thus enabling a jump-starting of the
process of innovation. The hassle free entry of such FVCIs on the pattern of FIIs
is even more necessary because of the following factors:

Venture Capital Page No: 86

 o Venture capital is a high risk area. In out of 10 projects, 8 either fail or
yield negligible returns. It is therefore in the interest of the country that
FVCIs bear such a risk.
o For venture capital activity, high capitalization of venture capital
companies is essential to withstand the losses in 80% of the projects. In
India, we do not have such strong companies.
o The FVCIs are also more experienced in providing the needed managerial
expertise and other supports.

 Augmenting the Domestic Pool of Resources:

The present pool of funds available for venture capital is very limited and is
predominantly contributed by foreign funds to the extent of 80 percent. The pool
of domestic venture capital needs to be augmented by increasing the list of
sophisticated institutional investors permitted to invest in venture capital funds.
This should include banks, mutual funds and insurance companies’ up to
prudential limits. Later, as expertise grows and the venture capital industry
matures, other institutional investors, such as pension funds, should also be
permitted. The venture capital funding is high-risk investment and should be
restricted to sophisticated investors. However, investing in venture capital funds
can be a valuable return-enhancing tool for such investors while the increase in
risk at the portfolio level would be minimal. Internationally, over 50% of
venture capital comes from pension funds, banks, mutual funds, insurance funds
and charitable institutions.

Venture Capital Page No: 87

  Flexibility in Investment and Exit:

 Allowing multiple flexible structures:

Eligibility for registration as venture capital funds should be neutral to firm

structure. The government should consider creating new structures, such as
limited partnerships, limited liability partnerships and limited liability
corporations. At present, venture capital funds can be structured as trusts or
companies in order to be eligible for registration with SEBI. Internationally,
limited partnerships, Limited Liability Partnership and limited liability
corporations have provided the necessary flexibility in risk-sharing,
compensation arrangements amongst investors and tax pass through. Therefore,
these structures are commonly used and widely accepted globally specially in
USA. Hence, it is necessary to provide for alternative eligible structures.

 Flexibility in the matter of investment ceiling and sectoral restrictions:

70% of a venture capital fund’s investible funds must be invested in unlisted

equity or equity-linked instruments, while the rest may be invested in other
instruments. Though sectoral restrictions for investment by VCFs are not
consistent with the very concept of venture funding, certain restrictions could be
put by specifying a negative list which could include areas such as finance
companies, real estate, gold-finance, activities not legally permitted and any other
sectors which could be notified by SEBI in consultation with the Government.
Investments by VCFs in associated companies should also not be permitted.
Further, not more than 25% of a fund’s corpus may be invested in a single firm.
The investment ceiling has been recommended in order to increase focus on
equity or equity-linked instruments of unlisted startup companies. As the
venture capital industry matures, investors in venture capital funds will set their
own prudential restrictions.

Venture Capital Page No: 88

  Changes in buy back requirements for unlisted securities:

A venture capital fund incorporated as a company/ venture capital undertaking

should be allowed to buy back up to 100% of its paid up capital out of the sale
proceeds of investments and assets and not necessarily out of its free reserves and
share premium account or proceeds of fresh issue. Such purchases will be exempt
from the SEBI takeover code. A venture-financed undertaking will be allowed
to make an issue of capital within 6 months of buying back its own shares instead
of 24 months as at present. Further, negotiated deals may be permitted in unlisted
securities where one of the parties to the transaction is VCF.

 Relaxation in IPO norms:

The IPO norms of 3 year track record or the project being funded by the banks or
financial institutions should be relaxed to include the companies funded by the
registered VCFs also. The issuer company may float IPO without having three
years track record if the project cost to the extent of 10% is funded by the
registered VCF. Venture capital holding however shall be subject to lock in
period of one year. Further, when shares are acquired by VCF in a preferential
allotment after listing or as part of firm allotment in an IPO, the same shall be
subject to lock in for a period of one year. Those companies which are funded by
Venture capitalists and their securities are listed on the stock exchanges outside
the country; these companies should be permitted to list their shares on the Indian
stock exchanges.

Relaxation in Takeover Code:

The venture capital fund while exercising its call or put option as per the terms of
agreement should be exempt from applicability of takeover code and 1969
circular under section 16 of SC(R) A issued by the Government of India.

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Issue of Shares with Differential Right with regard to voting and dividend:

In order to facilitate investment by VCF in new enterprises, the Companies Act

may be amended so as to permit issue of shares by unlisted public companies
with a differential right in regard to voting and dividend. Such flexibility already
exists under the Indian Companies Act in the case of private companies which
are not subsidiaries of public limited companies.

QIB Market for unlisted securities:

A market for trading in unlisted securities by QIBs is developed.

NOC Requirement:

In the case of transfer of securities by FVCI to any other person, the RBI
requirement of obtaining NOC from joint venture partner or other shareholders
should be dispensed with.

RBI Pricing Norms:

At present, investment/disinvestment by FVCI is subject to approval of pricing

by RBI which curtails operational flexibility and needs to be dispensed with.

 Global integration and opportunities:

 Incentives for Employees:

The limits for overseas investment by Indian Resident Employees under the
Employee Stock Option Scheme in a foreign company should be raised from
present ceilings of US$10,000 over 5 years, and US$50,000 over 5 years for
employees of software companies in their ADRs/GDRs, to a common ceiling of
US$100,000 over 5 years. Foreign employees of an Indian company may invest
in the Indian company to a ceiling of US$100,000 over 5 years.

Venture Capital Page No: 90

  Incentives for Shareholders:

The shareholders of an Indian company that has venture capital funding and is
desirous of swapping its shares with that of a foreign company should be
permitted to do so. Similarly, if an Indian company having venture funding and
is desirous of issuing an ADR/GDR, venture capital shareholders (holding
saleable stock) of the domestic company and desirous of disinvesting their shares
through the ADR/GDR should be permitted to do so. Internationally, 70% of
successful startups are acquired through a stock-swap transaction rather than
being purchased for cash or going public through an IPO. Such flexibility
should be available for Indian startups as well. Similarly, shareholders can take
advantage of the higher valuations in overseas markets while divesting their
holdings.

 Global investment opportunity for Domestic Venture Capital Funds

(DVCF):

DVCFs should be permitted to invest higher of 25% of the fund’s corpus or US

$10 million or to the extent of foreign contribution in the fund’s corpus in
unlisted equity or equity-linked investments of a foreign company. Such
investments will fall within the overall ceiling of 70% of the fund’s corpus. This
will allow DVCFs to invest in synergistic startups offshore and also provide them
with global management exposure.

 Infrastructure and R&D :

Infrastructure development needs to be prioritized using government support and

private management of capital through programmers similar to the Small
Business Investment Companies in the United States, promoting incubators and
increasing university and research laboratory linkages with venture-financed

Venture Capital Page No: 91

startup firms. This would spur technological innovation and faster conversion of
research into commercial products.

 Self Regulatory Organization (SRO):

A strong SRO should be encouraged for evolution of standard practices, code of

conduct, creating awareness by dissemination of information about the industry.
Implementation of these recommendations would lead to creation of an enabling
regulatory and institutional environment to facilitate faster growth of venture
capital industry in the country. Apart from increasing the domestic pool of
venture capital, around US$ 10 billion are expected to be brought in by offshore
investors over 3/5 years on conservative estimates. This would in turn lead to
increase in the value of products and services adding up to US$100 billion to
GDP by 2015. Venture supported enterprises would convert into quality IPOs
providing over all benefit and protection to the investors. Additionally, judging
from the global experience, this will result into substantial and sustainable
employment generation of around 3 million jobs in skilled sector alone over next
five years. Spin off effect of such activity would create other support services and
further employment. This can put India on a path of rapid economic growth and
a position of strength in global economy.

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 CONCLUSION
The study provides that the maturity if the still nascent Indian Venture Capital
market is imminent.

Venture Capitalists in Indian have notice of newer avenues and regions to

expand. VCs have moved beyond IT service but are cautious in exploring the
right business model, for finding opportunities that generate better returns for
their investors.

In terms of impediments to expansion, few concerning factors to VCs include;

unfavorable political and regulatory environment compared to other countries,
difficulty in achieving successful exists and administrative delays in
documentation and approval.

In spite of few non attracting factors, Indian opportunities are no doubt promising
which is evident by the large number of new entrants in past years as well in
coming days. Nonetheless the market is challenging for successful investment.

Therefore Venture capitalists responses are upbeat about the attractiveness of the
India as a place to do the business.

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 BIBLIOGRAPHY AND WEBLIOGRAPHY

 BOOKS:

 Taneja Satish, “Venture Capital in India”.

 Chary T Satyanarayana, “Venture Capital – Concepts & Applications ”

 MAGAZINE:

 Sharma Kapil, an Analysis of Venture Capital Industry in India.

 REPORT:

 Trends of Venture Capital in India, survey Report by Deloitte, 2017.

 Global Trends of Venture Capital, survey report by Deloitte, 2017.
 Economic survey 2016-17,

 WEBSITE:

 www.ivca.org
 www.indiavca.org.
 www.vcindia.com
 www.ventureintelligence.in
 www.nvca.org
 www.economictimes.indiatimes.com
 www.100ventures.com
 www.google.com
 www.deloitte.com

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