International Journal of Research and Development - A Management Review (IJRDMR)

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VENTURE CAPITAL FINANCING AND ITS SCOPE IN INDIA

BKN Satapathy,
GIFT, Bhubaneswar
Abstract: loans, donations, issue of securities or units and makes
or proposes, to make investments in accordance with
Venture capital (VC) is a type of private equity, a form
these regulations. The funds so collected are available
of financing that is provided by firms or funds to small,
for investment in potentially highly profitable
early-stage, emerging firms that are deemed to have high
enterprises at a high risk of loss. A Venture Capitalist is
growth potential, or which have demonstrated high
an individual or a company who provides, Investment
growth (in terms of number of employees, annual
Capital, Management Expertise, Networking &
revenue, or both). Venture capital firms or funds invest
marketing support while funding and running highly
in these early-stage companies in exchange for equity, or
innovative & prospective areas of products as well as
an ownership stake, in the companies they invest in.
services. Thus, the investments made by Venture
Venture capitalists take on the risk of financing risky
Capitalists generally involves Financing new and rapidly
start-ups in the hopes that some of the firms they support
growing companies, purchasing equity securities, taking
will become successful. The start-ups are usually based
higher risk in expectation of higher reward,
on an innovative technology or business model and they
are usually from the high technology industries, such
as information technology (IT), clean
Venture Capital Financing:
technology or biotechnology.
It generally involves start up financing to help
The typical venture capital investment occurs after an
technically sound, globally competitive and potential
initial "seed funding" round. The first round of
projects to compete in the international markets with the
institutional venture capital to fund growth is called
high quality and reasonable cost aspects. The growth of
the Series A round. Venture capitalists provide this
South East Asian economies especially Hong Kong,
financing in the interest of generating a return through
Singapore, South Korea, Malaysia along with India has
an eventual "exit" event, such as the company selling
been due to the large pool of Venture Capital funds from
shares to the public for the first time in an initial public
domestic / offshore arenas.
offering (IPO) or doing a merger and acquisition (also
known as a "trade sale") of the company. Venture Capitalists draw their investment funds from a
pool of money raised from public and private investors.
Introduction These funds are deployed generally as equity capital
The term ‘Venture Capital’ is understood in many ways. (ordinary and preference shares) and some times as
In a narrow sense it refers to, investment in new and subordinated debt which is a semi secured investment in
tried enterprises that are lacking a stable record of the company (through debenture) ranking below the
growth. In a broader sense, venture capital refers to the secured lenders that often requires periodic repayment.
commitment of capital as shareholding for the Today, a VC deal can involve common equity,
formulation and setting up of small firms specializing in convertible preferred equity and subordinated debt in
new ideas or new technologies. The emerging scenario different proportions.
of global competitiveness has put an immense pressure The Venture Capital funding varies across
on the industrial sector to improve the quality level with the different stages of growth of firm.
minimization of cost of products by making use of latest
technological skills. The implication is to obtain The various stages are
adequate financing along with the necessary hi-tech 1. Pre seed Stage: Here, a relatively small
equipments to produce an innovative product which can amount of capital is provided to an entrepreneur to
succeed and grow in the present market condition. conceive and market a potential idea having good future
Venture Capital is money provided by professionals who prospects. The funded work also involves product
invest and manage young rapidly growing companies development to some extent.
that have the potential to develop into significant
economic contributors. According to SEBI regulations, 2. Seed Stage: financing is provided to complete
venture capital fund means a fund established in the product development and commence initial marketing
form of a company or trust, which raises money through formalities.
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3. Early Stage/ First Stage: finance is provided to necessary capital can be obtained from the venture
companies to initiate commercial manufacturing and capital firms who expect an above average rate of return
sales. on the investment. The financing firms expect a sound,
experienced, mature and capable management team of
4. Second Stage: In the Second Stage of
the company being financed. Since the innovative
Financing working capital is provided for the expansion
project involves a higher risk, there is an expectation of
of the company in terms of growing accounts receivable
higher returns from the project. The payback period is
and inventory.
also generally high (5 - 7 years). The various problems/
5. Third Stage: Funds provided for major queries can be outlined as follows:
expansion of a company having increasing sales volume.
(i) Requirement of an experienced management
This stage is met when the firm crosses the break even
team.
point.
(ii) Requirement of an above average rate of return
6. Bridge / Mezzanine financing or Later Stage
on investment.
Financing: Bridge / Mezzanine Financing or Later
Stage Financing is financing a company just before its (iii) Longer payback period.
IPO (Initial Public Offer). Often, bridge finance is
(iv) Uncertainty regarding the success of the
structured so that it can be repaid, from the proceeds of a
product in the market.
public offering.
(v) Questions regarding the infrastructure details of
There are basically four key elements in financing of
production like plant location, accessibility, relationship
ventures which are studied in depth by the venture
with the suppliers and creditors, transportation facilities,
capitalists. These are :
labor availability etc.
1. Management: The strength, expertise & unity
(vi) The category of potential customers and hence
of the key people on the board bring significant
the packaging and pricing details of the product.
credibility to the company. The members are to be
mature, experienced possessing working knowledge of (vii) The size of the market.
business and capable of taking potentially high risks.
(viii) Financial considerations like return on capital
2. Potential for Capital Gain: An above average employed (ROCE), cost of the project, the Internal Rate
rate of return of about 30 - 40% is required by venture of Return (IRR) of the project, total amount of funds
capitalists. The rate of return also depends upon the required, ratio of owners investment (personnel funds of
stage of the business cycle where funds are being the entrepreneur), borrowed capital, mortgage loans etc.
deployed. Earlier the stage, higher is the risk and hence in the capital employed.
the return.
THE Indian venture capital (VC) industry has witnessed
3. Realistic Financial Requirement and considerable turmoil in the last two years. Consider this:
Projections: The venture capitalist requires a realistic At least seven VC funds (VCFs) shut shop. Many others
view about the present health of the organization as well simply ran out of funds. A few set up high-cost Indian
as future projections regarding scope, nature and operations, with no funds raised or allocated for
performance of the company in terms of scale of investment. The rest of the industry appears to be busy,
operations, operating profit and further costs related to `restructuring' their investment focus, making very few
product development through Research & Development. new investments.
4. Owner's Financial Stake: The financial After a period of hectic investing, from 1998 to 2000,
resources owned & committed by the entrepreneur/ the Indian VC industry appears to be going through
owner in the business including the funds invested by difficult times. This is a time for the industry to engage
family, friends and relatives play a very important role in some serious reflection. Managers in the industry may
in increasing the viability of the business. It is an possibly disagree with me. They might argue that the
important avenue where the venture capitalist developments in the Indian industry are a mere
keeps an open eye. reflection of a larger global phenomenon. After all, have
the American and European VC industries not slowed
Problems of Venture Capital Financing:
down? That comparison though, is inappropriate. The
VCF is in its nascent stages in India. The emerging slow down and the poor performance of many funds in
scenario of global competitiveness has put an immense the Western world are part of a cyclical phenomenon.
pressure on the industrial sector to improve the quality The Indian industry, on the contrary, faces issues of a
level with minimization of cost of products by making fundamental nature. Let us examine four issues of
use of latest technological skills. The implication is to concern.
obtain adequate financing along with the necessary hi-
First, there is a serious mismatch between the kind of
tech equipments to produce an innovative product which
venture capital available in India and what the market
can succeed and grow in the present market condition.
demands. Almost all VCFs in India have been targeting
Unfortunately, our country lacks on both fronts. The
their capital at companies in the information technology,
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pharmaceuticals and some services industries, looking Last, but not the least, the industry lacks a broad-based
for expansion financing of Rs 15 crores or more. Now, and effective trade association. The Indian Venture
this is a limited market segment. Most of the industries Capital Association (IVCA) does not represent a large
mentioned above are relatively young. There are very proportion of the VCFs who are active in India. I am not
few firms in these sectors, seeking large amounts of sure of the IVCA's contributions to the VC industry
capital for expansion financing. At the same time, a either, in the ten years since it was formed. For some
large number of aspiring entrepreneurs, start-ups, early- years initially, the IVCA used to produce a delightfully
stage companies and Old Economy firms, which are uninformative annual report, many months after the end
fundamentally sound businesses, are unable to attract the of the year. For the past four years even those reports do
VC financing that they badly need in order to grow. not appear to have been published! Venture capital has
Apart from the relatively smaller amounts of funding been a remarkable catalyst of entrepreneurial activity,
that they seek, on average start-ups require considerable after the Second World War, in many developed
post-funding support from the investor to grow their countries. It has led to significant growth in industry and
businesses. That is painstaking work, for which Indian innovation. The prospects for the Indian VC industry are
VCF managers have demonstrated neither experience no less humongous. It is up to the industry to reflect on
nor training nor temperament. Old Economy firms do its current predicament and evolve a strategy to seize the
not provide the quick or glamorous exits that VCFs opportunity.
often desire.
Prospects of Venture Capital Financing:
Second, most VCFs in India are an extended arm or a
With the advent of liberalization, India has been
division of global investment institutions. International
showing remarkable growth in the economy in the past
funds represent more than 95 per cent of the VC
10 - 12 years. The government is promoting growth in
invested in India. Two consequences follow from this
capacity utilization of available and acquired resources
near-total dependence on foreign capital. One, the
and hence entrepreneurship development capital. While
investment mandates of these VCFs are often driven by
only eight domestic venture capital funds were
the parent institutions' global world view, which often
registered with SEBI during 1996-1998, 14 funds have
ignores local market needs. The homogenous investment
already been registered in 1999-2000. Institutional
preferences of VCFs outlined earlier follow from the
interest is growing and foreign venture investments are
parent institutions' global investment strategies. Two, at
also on the rise. Many state governments have also set
a portfolio level, every international VC investor in
up venture capital funds for the IT sector in partnership
India has been a victim of the depreciation of the rupee
with the local state financial institutions and SIDBI.
against the dollar. The returns produced by Indian
These include Andhra Pradesh, Karnataka, Delhi, Kerala
VCFs, measured in US dollars or other Western
and Tamil Nadu. The other states are to follow soon.
currencies, turn out to be considerably less attractive
than that measured in Indian currency. Many nations In the year 2000, the finance ministry announced the
such as the Netherlands, Portugal, Finland, Norway and liberalization of tax treatment for venture capital funds
Israel recognized the limitations of depending on foreign to promote them and to increase job creation. This is
funds at the time of evolving a policy for developing a expected to give a strong boost to the non resident
local VC industry. Their first step was to kick start Indians located in the Silicon Valley and elsewhere to
VCFs in the private sector with funds from domestic invest some of their capital, knowledge and enterprise in
institutions. Over a decade, or even less, they succeeded these ventures. A Bangalore based media company,
in creating a local VC industry that depended less and Graycell Ltd., has recently obtained VC investment
less on government support and international investors. totaling about $ 1.7 mn. The company would be creating
and marketing branded web based consumer products in
The third issue is the poor quality of corporate
the near future.
governance and lack of sensitivity among entrepreneurs
and investors, to each other's legitimate business The following points can be considered as the
aspirations. This is a universal problem and not unique harbingers of VC financing in India:-
to India. What is however unique to India is the hopeless
In a recent survey it has been shown that the VC
system of legal redress of grievances when partners
renege on contractual obligations. Often, aggrieved investments in India's I.T. - Software and services sector
parties in India agree to settlements that are unfair to (including dot com companies) - have grown from US $
150 million in 1998 to over US $ 1200 million in 2002.
them, apprehending that litigation in Indian courts could
The credit can be given to setting up of a National
be dysfunctional. This situation may not change in the
Venture Capital Fund for the Software and I.T. Industry
foreseeable future. The alternative to litigation and
(NFSIT) in association with various financial
unfair bad investments would be to invest more effort in
better identification and selection of investments and institutions of Small Industries and Development Bank
supervision of the portfolio. Indian VCF managers need of India (SIDBI). The facts reveal that VC
disbursements as on September 30, 2002 made by
to ask themselves if they are prepared to put in that extra
NFSIT totalled Rs 254.36 mn.
effort to minimize prospects for litigation in the first
place.

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Whopping investments of over USD 8.5 billion is USD 200 million investments in the Indian education
expected in Indian from Venture Capitalists (VCs) and sector by taking up strategic positions in companies
Private Equities (PEs) in next five years in at least five offering e-learning, distant learning, vocational training
identified areas such as Biotechnology and Life and the like.
Sciences, Logistics, Clean technology, Film Production
The paper further points out that venture capital
and Education,
investment is undergoing some interesting transitions.
Quoting the findings of the ASSOCHAM & Deloitte Developing economies like India and China continue to
paper, president ASSOCHAM, Sajjan Jindal said that attract investments; early stage finance is becoming
India has large opportunities in Biotechnology and Life increasingly globalize. Investors are backing consumer
Sciences on lines of retail and Real Estate. The Life and retail firms that benefit from the rise of the Indian
Sciences sector in India has been attracting specialists middle class, as well as business services that cater to
Venture Capitalists from global and local funds. the nation’s growing economic sector. The other
According to information received by the ASSOCHAM, transition is that the capital flowing to India is designed
US based Life Sciences Fund has recently invested to expand existing companies. By contrast, venture
approximately USD 20 million in a Hyderabad based capital in the United States, Europe and Israel is usually
pharmaceutical company. Devices and diagnostics are dedicated to backing new technologies or services.
other areas where investors are active. It is anticipated
In Asia, venture capitalists are still in the process of
that the Biotechnology and Life Sciences will alone
developing common evaluation criteria for investment,
attract about USD 1.5 billion investments from VCs and
unlike in mature markets, where a common criterion is
PEs by 2012.
the level of attention paid to the entrepreneur’s
Jindal said that logistics is another area in which VCs personality and experience. In Asia, different classes of
are expected to invest in excess of USD 2 billion in stocks with different voting rights are relatively
India’s maritime infrastructure and logistics as it uncommon. Asian investors thus have to rely mostly on
strengthens cargo handling facilities to meet rising common stocks and other means to manage their
demand for exports and imports. The paper mentions portfolio risk. Traditional venture capitalists are
that National Maritime Development Programme expected to actively assist their portfolio companies in
envisages huge investment to upgrade India’s maritime what are termed value-added activities. Most of the
sector of which 64% is expected to come from VCs and Asian venture capitalists’ assistance remains restricted
PEs firms. These funds are also looking at possibilities to providing advice on financial matters.
in ancillary business that supports maritime trade such
The dynamics in emerging venture capital markets differ
as warehousing and container freight stations.
from those in developed venture capital markets. The
Clean technology is still another area where VCs and emerging private equity markets focus primarily on
PEs would grow more and more active. In 2007, growth capital investments through minority equity
investors committed USD 290 million in 11 cleantech participation. Emerging venture capital markets,
investment deals compared to USD 140 million in 9 although not without challenges, present a host of
deals in 2006. The momentum is expected to continue opportunities
over the coming years given the government initiatives
India story still attracts venture capital funds
and policy focus on cleantech. It is expected that PEs
and VCs would be able to jointly garner an investment Venture capitalists raising new funds dedicated to the
of USD 3.5 billion in cleantech areas in next few years, Indian market are not finding the going tough despite a
pointed out Jindal. global slowdown impacting availability of capital.
The other prospective areas in which VCs and PEs For instance, Clearstone Venture Advisors, a global
would make huge investments include Indian film venture capital fund with over $650 million of
production and education. The Indian film industry committed capital for investment globally, plans to close
currently is worth 1.8 billion and is expected to grow its fourth fund soon. The fund, which could be over
@of over 25% and would reach a level of USD over 5 $200 million, will also have a larger share of
billion by 2011. With the newly accorded status of investments in India. The company had raised $210
industry and professionalism on film industry, it will million for its third fund, of which 20 to 25 per cent was
emerge as new venue for VCs. The ASSOCHAM dedicated for investments in India.
expects USD 0.25 billion VCs investments in this
Similarly, Seed Fund, which invests in early start-ups, is
industry in next five years.
in the process of raising its second fund. The fund,
With a booming economy and concurrent talent which will be in the range of $50-60 million, will be
shortage, denying for services from the domestic closed by the end of this year. It all depends on who is
education sector is slated to create a lucrative raising the funds. Firms like us who invest in early-
opportunities for VCs. A global private equity firm with stage companies will be least impacted as we are not
USD 36 billion in assets is planning approximately looking at immediate gains," said Pravin Gandhi,
Partner, Seed Fund.

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The strong India story is probably the reason why respect to cost, productivity, labour efficiency, technical
several funds are strengthening their India focus. These back up, flexibility to consumer demand, adaptability
include names such as Walden International and Accel and foresightedness.
India Venture Fund. Walden International recently
There is an impending demand for highly cost effective,
announced its plans to raise a $500 million global fund
quality products and hence the need for right access to
early next year to step up its investment in China and
valuable human expertise to guide and monitor along
India. Over the next 12-18 months, the global VC fund
with the necessary funds for financing the new projects.
will invest close to $150 million (around Rs 650 crore)
in India. The Government of India in an attempt to bring the
nation at par and above the developed nations has been
Mohit Bhatnagar, operating partner at Sequoia Capital,
promoting venture capital financing to new, innovative
said the firm has not seen any major drop in either the
concepts & ideas, liberalizing taxation norms providing
investments or the pipeline of deals they examine. A lot
tax incentives to venture firms, giving a Philip to the
of good companies get started globally during economic
creation of local pools of capital and holding training
downturns and India should be no different. Of course,
sessions for the emerging VC investors.
deals might take longer to close accounting for valuation
corrections, different exit strategies, etc., says There are large sectors of the economy that are ripe for
Bhatnagar. Not everyone is bullish on the future as some VC investors, like, I.T, Pharmacy, Manufacturing.
VCs said the subsequent rounds of funding will get Telecom, Retail franchises, food processing and many
impacted. more. The nation awaits for the burgeoning VC business
in India in spite of the existing shortcomings in the
VCs raising follow-on funds are not facing the problem
Indian infrastructure. Looking ahead for a bright future
as much as those raising funds for the first time, points
for India Inc.
out Arun Natarajan, founder and CEO, Venture
Intelligence. According to Venture Intelligence data, References:
during the first six months of 2008, VCs invested $380
1. Rustagi RP (2001) 'Financial Management -
million across 60 deals.This compares with $379 million
spread across 59 investments during corresponding Theory, Concepts and Problems', Galgotia Publishing
period in 2007. VCs invested $760 million across 125 Company, New Delhi.
investments during whole of 2007.Seed Fund's Gandhi 2. Brealey Richard A., & Myers Stewart C. (2000).
said most investors are cautious, hence the appetite for 'Principles of Corporate Finance', Tata Mc Graw Hill,
investment will slow down. Many also feel that India as New Delhi.
a market was too hyped-up for investment and many
went overboard with regard to valuations. Avnish Bajaj 3. ICFAI Reader, Dec. 2002.
co-founder and MD, Matrix India, said some of the 4. ICFAI Reader, Jan. 2004.
global funds coming to India will be impacted, 5.http://www.graycell.com./
especially where the fund did not have an India-
dedicated team who could bring in local expertise 6.http://www.venture/A.com

Conclusion: 7.http://www.india/infoline.com

The world is becoming increasingly competitive. 8. http://www.rediff.com/money/2008/aug/26vc.htm

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