BYDR. RATNA SINHAASSOCIATE PROFESSOR

ISBR BUSINESS SCHOOL

BANGALORE

VENTURECAPITAL FINANCING

LEARNING OBJECTIVES

• Private Equity and Venture Capital: Introduction, Rudiments of valuing and financing a venture, Stages of venture development and financing, Financial analysis of Venture capital firms (VCCs), Structuring the deal/ Financial Instrument, Investment nurturing, valuation of VC portfolio, Initial Public offerings of stock –Managing internal and seasoned equity offerings.

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VENTURE CAPITAL

• Venture: - Course or proceedings outcome is uncertain. This is attended by the risk or danger of loss.

• Capital: Resources to start the enterprise.

• In short lending capital to growing company

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EVOLUTION

• Traced to USA in 19th and 20th century.• 1946 – American Research and development

Organization was established as VC organization.

• Real development -1958 in USA when Business development act was passed.

• 1960 Japan followed the concept.

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NOTION OF VENTURE CAPITAL

• Venture capital (VC) is a significant financial innovation of the twentieth century.

• Venture capital is the investment of long-term equity finance where the venture capitalist earns his return primarily in the form of capital gains.

• The underlying assumption is that the entrepreneur and the venture capitalist would act together in the interest of the enterprise as ‘partners’.

• Venture capital company is defined as “ a financing company which joins an entrepreneur, as a co-promoter in a project and shares the risks and rewards of the enterprise”

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DEFINITIONS

• James Koloski Morries- VC is defined as providing seed , start up and first stage capital, funding expansion to companies that has demonstrated their business potential, but do not have access to public securities or credit oriented institutional funding sources. Also provide management in leveraged buy out financing.

• 1995 finance bill- long term equity investment in novel technology, based projects with potential for growth and financial return.

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FEATURES OF VENTURE CAPITAL

• Equity Participation.• Long-term Investments.• Participation in Management.

Venture capitalist combines the qualities of bankers, stock market investors and entrepreneur in one.

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CHARACTERISTICS

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FEATURES

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1. Generally Equity participant

2. May be also convertible debenture or long term Loan

3. Available for commercialization of new Idea.

Investment in high risk and high

growth projects

Act as Co-PromotersContinuous Involvement

Once the venture reaches full

potential divest his investment

Investment in small medium

scale enterprises.Also provide

inputs in design, strategy

Disinvestment Mechanism

1.Promoter’s buyback2.Public Issue3.Sale to other VCs4.Sale in OTC Market5.Management buyouts

PROMOTER’S BUYBACK

OBJECTIVES

• Encourage indigenous technology and commercial application

• Adopt and modify imported technology for indian environment

• Setting up pilot projects

• Technological innovations and modernization

• Develop appropriate technology

• Meeting the cost of market survey and market promotion

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STAGES IN VENTURE FINANCING

THE BUSINESS PLAN

• The first step for a company (or an entrepreneur) proposing a new venture in obtaining venture capital is to prepare a business plan for the consideration of a venture capitalist.

• The business plan should explain the nature of the proposed venture’s business, what it wants to achieve and how it is going to do it.

• The length of the business plan depends on the particular circumstances.

• It should use simple language and all technical details should be explained without jargons.

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ESSENTIAL ELEMENTS OF A BUSINESS PLAN

1. Executive summary2. Background on the venture3. The product or service4. Market analysis5. Marketing6. Business operations7. The management team8. Financial projections9. Amount and use of finance required and exit opportunities

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WHAT DOES A VENTURE CAPITALIST LOOK FOR

IN A VENTURE?

• Superior businesses

• Quality and depth of management

• Corporate governance and structure

• Appropriate investment structure

• Exit plan

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THE PROCESS OF VENTURE CAPITAL FINANCING

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VENTURE CAPITAL INVESTMENT PROCESS

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METHODS OF VENTURE FINANCING

• Equity- generally not exceed 49%. Retained till the projects make profit

• Conditional Loan: lower interest till the unit makes profit. Paid back as per predetermined schedule

• Income Note: both interest and royalty

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OTHER FINANCING METHODS

1. Participating Debentures: Three stages- till the venture operates to minimum level- no interest. Then low interest up to particular level. Once on attaining recommended level – high interest

2. Partially Convertible Debentures: 3. Cumulative Convertible Preference Shares4. Deferred Shares- ordinary shares right deferred for

certain number of years.5. Convertible Loan Stock: Unsecured long term loan

converted to shares6. Special Ordinary Shares: Voting rights but no

commitment to dividends:7. Preferred Ordinary Shares: voting rights + modest

dividend+ right share in profit

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DISINVESTMENT MECHANISMS

• Buyback by Promoters• Initial Public Offerings• Secondary Stock Market• Management Buyouts

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METHOD OF

VALUATIONS

CONVENTIONAL METHOD

• Take into account time at which the investee company start the venture and time at which exit.

• Look into

– Annual revenue

– Expected future earnings

– Future market valuations

– Present Value

– Minimum percentage of ownership-

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FIRST CHICOGO

• Gives allowance to starting point and exit point.

• Considers entire earning stream

• Steps

– Alternative scenario and probability-success, sideways survival, failure

– Present Value of VC

– Expected Value of VC

– Maximum Percentage of ownership

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REVENUE MULTIPLIER

• Revenue multiplier is used

• Annual revenue x estimated revenue multiplier

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DEVELOPMENT OF VENTURE CAPITAL IN INDIA

• The concept of venture capital was formally introduced in India in 1987, when the government announced the creation of a venture fund, to be operated by the Industrial Development Bank of India (IDBI).

• VCFs in India can be categorized into the following four groups:1. VCFs promoted by the central (federal) government-controlled development

finance institutions

2. VCFs promoted by the central (federal) government-controlled development finance institutions

3. VCFs promoted by the public sector banks

4. VCFs promoted by the foreign banks and private sector

companies and financial institutions

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FUTURE PROSPECTS OF VENTURE FINANCING

• Rehabilitation of sick units.

• Assist small ancillary units to upgrade their technologies.

• Provide financial assistance to people coming out of universities etc.

• VCFs can play a significant role in the service sector including tourism, publishing, health care, etc.

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SUCCESS OF VENTURE CAPITAL

• Entrepreneurial Tradition• Unregulated Economic Environment• Disinvestment Avenues• Fiscal Incentives• Broad Based Education• Venture Capital Managers• Promotion Efforts• Institute Industry Linkage• R&D Activities

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SEBI AND VENTURE CAPITAL FUNDS

• Domestic VC– Registered with SEBI- SEBI (Venture Capital

Fund ) Regulations1996.– Not registered

• Foreign VC – Registered with SEBI- SEBI (Foreign Venture

Capital Fund ) Regulations2000.– Not registered

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REGULATIONS- DOMESTIC

• Definition– Fund established by trust, company, body corporate and

registered with SEBI• Dedicated pool of fund• Raised as specified by the regulations• To invest in VC as specified by regulation

• Venture capital undertaking:– Not listed – Not in the line of negative list- real estate, NBFC, Gold

financing, activities not permitted under industrial policy

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REGULATIONS- DOMESTIC

• Minimum corpus – Rs 5 crore• Max investment in any venture not more than

25% of corpus• Investment in associated company not

permitted• At least 75% of investible fund to be invested

in unlisted equity shares or equity linked instruments.

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REGULATIONS- DOMESTIC

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

– Subscription of IPO of a venture capital whose shares are proposed to be listed subject to lock in period of one year.

– Debt or debt instrument• Eligible as QIB in book building process.• Investment by mutual fund can invest up to 5%

incase of open ended fund and 10% close ended fund in VC fund to increase the resource.

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REGULATIONS- FOREIGN

• Entity incorporated and established outside India– Investment company, trust, partnership, mutual fund, pension

fund, AMC, etc incorporated outside India.– Regulated by foreign authority, Income tax payer, or submit

certificate from banker, or promoters track record- SEBI can consider the above for registration.

• Not more than 25% of investible funds may be invested by way of– Subscription of IPO of a venture capital whose shares are

proposed to be listed subject to lock in period of one year.– Debt or debt instrument

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ANGEL FINANCE

• Wealthy individuals

• Financial support in return for equity shares. Support, advice and promote

• Types five groups

– Corporate angels- senior management position such as business development. Those taken retirement

– Entrepreneur –own and operate

– Enthusiast – involve in deals normally above 65 years

– Micro Management-very active and normally demand position in board

– Professional – investors occupation such as doctor, lawyer and accountant invest in company that offer product or service

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COMPARISONBasis of difference

Business Angels Venture Capitals

Personal Entrepreneur InvestorsFirms funded Small Small MediumDue diligence Minimal ExtensiveLocation of Investment

Of concern Not Important

Contract Used Simple ComprehensiveMonitoring Active ,hands on Strategic

Exiting Of lesser concern Highly Important

Rate of return Of lesser Concern Highly Important33

CONSTANT DIVIDEND PER SHARE POLICY

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Fixed rate or percentage on paid up capital as dividend. When the company reaches new level of earning and expect to maintain dividend is increased

THANKS