CHAPTER 1 INTRODUCTION TO PROJECT

Concept of Venture Capital

The term venture capital comprises of two words that is, “Venture” and “Capital”.
Venture is a course of processing, the outcome of which is uncertain but to which
is attended the risk or danger of “loss”. “Capital” means recourses to start an
enterprise. To connote the risk and adventure of such a fund, the generic name
Venture Capital was coined.
Venture capital is considered as financing of high and new technology based
enterprises. It is said that Venture capital involves investment in new or relatively
untried technology, initiated by relatively new and professionally or technically
qualified entrepreneurs with inadequate funds. The conventional financiers, unlike
Venture capitals, mainly finance proven technologies and established markets.
However, high technology need not be pre- requisite 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
returns usually through substantial capital gains in the medium 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 risk investment conditions, 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
skills to exploit the market opportunities.
Venture capital is not a passive finance. It may be at any stage of
business/production cycle, that is, start up, expansion or to improve a product or
process, which are associated with both risk and reward. The Venture capital
makes higher capital gains through appreciation in the value of such investments
when the new technology succeeds. Thus the primary return sought by the investor
is essentially capital gain rather than steady interest income or dividend yield.
The most flexible definition of Venture capital is-
“The support by investors of entrepreneurial talent with finance and
business skills to exploit market opportunities and thus obtain capital gains.”
Venture capital commonly describes not only the provision of start up finance or
‘seed corn’ capital but also development capital for later stages of business. A long
term commitment of 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
Features of Venture Capital
2.2.1 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.
Venture capital assumes four types of risks, these are:
 Management risk
- Inability of management teams to work together.
 Market risk
- Product may fail in the market.
Product risk
- Product may not be commercially viable.
 Operation risk
- Operations may not be cost effective resulting in
increased cost decreased gross margins.
2.2.2 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 areas,
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 existing business or
diversification to a high risk area. Thus technology financing had never been the
primary objective but incidental to venture capital.
2.2.3 Equity Participation & Capital Gains
Investments are generally in equity and quasi equity participation through direct
purchase of shares, 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.
2.2.4 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 worse, in
the major decision affecting the direction of company. This is a unique philosophy
of “hands on management” where Venture capitalist acts as complementary to the
entrepreneurs. Based upon the experience other companies, a venture capitalist
advise 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.
2.2.5 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.
2.2.6 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 gains 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 to
locked for seven to ten years. Venture capitalist understands this illiquidity and
factors this in his investment decisions.
2.3 Difference between Venture Capital & Other Funds
2.3.1 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 of 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 control where as Venture capitalist remain interested if the overall
management of the project o 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 banks.
2.3.2 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. 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 of 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 risk-normal returns and lacks any flexibility in
its approach.
Risk capital is also provided to established companies for adapting 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

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
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 satisfactor

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

Spectrum
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 on going assistance to developing business.
Different venture capital firms have different attributes and aptitudes for different types of Venture capital
investments. Hence there are different stages of entry for different Venture capitalists and they can identify and
differentiate between types of Venture capital investments, each appropriate for the given stage of the investee
company, These are:-
1.
Early Stage Finance

Seed Capital

Start up Capital

Early/First Stage Capital

Later/Third Stage Capital
2.
Later Stage Finance

Expansion/Development Stage Capital

Replacement Finance

Management Buy Out and Buy ins

Turnarounds

Mezzanine/Bridge Finance
Not all business firms pass through each of these stages in a sequential manner. For instance seed capital is
normally not required by service based ventures. It applies largely to manufacturing or research based
activities. Similarly second round finance does not always follow early stage finance. If the business grows
successfully it is likely to develop sufficient cash to fund its own growth, so does not require venture capital for
growth.
The table below shows risk perception and time orientation for different stages of venture
capital financing.
Financing Stage
Period (funds
locked in years)
Risk perception Activity to be financed
Early stage finance
Seed
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
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S.V .Institute Of Management, Kadi
34
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.
The players:
Figure: 2.3 players in venture capital industry
2.6 The players
There are following groups of players:
· Angels and angel clubs
· Venture Capital funds
- S ma l l
- Me di um
- Large
· Corporate venture funds
· Financial service venture groups
Idea
Established
The company
Expansion
Troubleshooting
Business
Concept
Break
Even-point
Investing
In
technology
IPO
Turnaround
Medium
venture
funds
Corporate
investors
Small
venture
funds
Angels
Big venture funds + Financial funds
MRP on “venture capital industry in India”
S.V .Institute Of Management, Kadi
35
 Angels and angel clubs
Angels are wealthy individuals who invest directly into companies. They can form angel clubs to
coordinate and bundle their activities. Besides the money, angels often provide their personal
knowledge, experience and contacts to support their investees. With average deals sizes from USD
100,000 to USD 500,000 they finance companies in their early stages. Examples for angel clubs are
· Media Club, Dinner Club ,· Angel's Forum
 Small and Upstart Venture Capital Funds
These are smaller Venture Capital Companies that mostly provide seed and start- up capital. The so
called "Boutique firms" are often specialised 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 the small and medium Venture Capital funds
strong competition will clear the marketplace. There will be mergers and acquisitions leading to a
concentration of capital. Funds specialised in different business areas will form strategic
partnerships. Only the more successful funds will be able to attract new money. Examples are:
· Artemis Comaford
· Abbell Venture Fund
· Acacia Venture Partners
Medium Venture Funds
The medium venture funds finance all stages after seed stage 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
 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.
MRP on “venture capital industry in India”
S.V .Institute Of Management, Kadi
36
Examples are:
· AIG American International Group
· Cap Vest Man
· 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 echnology 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 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:
· Oracle
· Adobe
· Dell
· 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 an Venture Capital fund. However, the success of such products will depend on
the overall climate and expectations in the economy. As long as the sownturn continues without any
sign of recovery customers might prefer less risky alternatives.