multi mutual funds

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MRP on venture capital industry in India

CHAPTER 1

INTRODUCTION TO

PROJECT TITLE

S.V .Institute Of Management, Kadi 1


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1.1 objective:

To understand concept of Venture Capital.

To understand Venture Capital industry in global scenario.

To study the evolution and need of Venture Capital Industry in India.

To understand the legal framework formulated by SEBI to encourage Venturecapital activity in Indian Economy.

To find out opportunity and threats those hinder and encourage Venture CapitalIndustry in India.

To know the impact of political and economical factors on Venture Capitalinvestment.

1.2 Limitation of project

Limitations:

A study of this type cannot be without limitations. It has been observed that venture capitalsare very secretive about their performance as well as about their investments. This attitudehas been a major hurdle in data collection. However venture capital funds/companies that

are members of Indian venture capital association are included in the study. Financialanalysis has been restricted by and large to members of IVCA.

1.3 Research Design & Instruments

In India neither venture capital theory has been developed nor are there manycomprehensive books on the subject. Even the number of research papers available is verylimited. The research design used is descriptive in nature. (The attempt has been made tocollect maximum facts and figures available on the availability of venture capital in India,

nature of assistance granted, future projected demand for this financing, analysis of theproblems faced by the entrepreneurs in getting venture capital, analysis of the venturecapitalists and social and environmental impact on the existing framework.)

The research is based on secondary data collected from the published material. The datawas also collected from the publications and press releases of venture capital associations inIndia.

Scanning the business papers filled the gaps in information. The Economic times, FinancialExpress and Business Standards were scanned for any article or news item related toventure capital. Sufficient amount of data about the venture capital has been derived fromthese reports.



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Scope:

The scope of the research includes all type of venture capital firms whether setup as acompany or a trust fund. Venture capital companies and funds irrespective of the fact thatthey are registered with SEBI of India or not are part of this study. Angel investors have

been kept out of the study as it was not feasible to collect authenticated information aboutthem.



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CHAPTER 2

CONCEPT

2.1 Concept of Venture Capital



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The term venture capital comprises of two words that is, Venture and Capital. Ventureis a course of processing, the outcome of which is uncertain but to which is attended therisk or danger of loss. Capital means recourses to start an enterprise. To connote therisk 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. Itis said that Venture capital involves investment in new or relatively untried technology,initiated by relatively new and professionally or technically qualified entrepreneurs withinadequate 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 highrisk of venture capital is compensated by the possibility of high returns usually throughsubstantial capital gains in the medium term. Venture capital in broader sense is not solelyan 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 associationwith successive stages of companys development under highly risk investment conditions,with distinctive type of financing appropriate to each stage of development. Investors jointhe entrepreneurs as co-partners and support the project with finance and business skills toexploit 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 appreciationin the value of such investments when the new technology succeeds. Thus the primaryreturn sought by the investor is essentially capital gain rather than steady interest income ordividend yield.

The most flexible definition of Venture capital is-

The support by investors of entrepreneurial talent with finance and business skillsto exploit market opportunities and thus obtain capital gains.

Venture capital commonly describes not only the provision of start up finance or seedcorn capital but also development capital for later stages of business. A long termcommitment 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 ofcustomers business.

2.2 Features of Venture Capital

2.2.1 High Risk



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By definition the Venture capital financing is highly risky and chances of failure are high asit provides long term start up capital to high risk-high reward ventures. Venture capitalassumes 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 inincreased cost decreased gross margins.

2.2.2 High TechAs 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, venturecapital investments are made in high tech. areas using new technologies or producinginnovative goods by using new technology. Not just high technology, any high riskventures where the entrepreneur has conviction but little capital gets venture finance.Venture capital is available for expansion of existing business or diversification to a highrisk area. Thus technology financing had never been the primary objective but incidental toventure capital.

2.2.3 Equity Participation & Capital Gains

Investments are generally in equity and quasi equity participation through direct purchaseof shares, options, convertible debentures where the debt holder has the option to convertthe loan instruments into stock of the borrower or a debt with warrants to equityinvestment. The funds in the form of equity help to raise term loans that are cheaper sourceof funds. In the early stage of business, because dividends can be delayed, equityinvestment implies that investors bear the risk of venture and would earn a returncommensurate 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 upassistance. It monitors physical and financial progress as well as market developmentinitiative. It helps by identifying key resource person. They want one seat on the companys

board of directors and involvement, for better or worse, in the major decision affecting thedirection of company. This is a unique philosophy of hands on management whereVenture capitalist acts as complementary to the entrepreneurs. Based upon the experienceother 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 withthe promoters or entrepreneurs to protect his investment.



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equity investment by Venture capital. Unlike Venture capital, Seed capital providers neitherprovide any value addition nor participate in the management of the project. Unlike Venturecapital Seed capital provider is satisfied with low risk-normal returns and lacks anyflexibility 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 thesuccess rate of units assisted by Seed capital/RiskFinance has been lower than those provided with venture capital. On the other hand thereturn to the seed/risk capital financier had been very low as compared to venture capitalist.

Seed Capital Scheme Venture capital SchemeBasis Income or aid Commercial viabilityBeneficiaries Very small entrepreneurs Medium and large

entrepreneurs are alsocovered

Size of assistance Rs. 15 Lac (Max) Up to 40 percent of promoters equity

Appraisal process Normal Skilled and specializedEstimates returns 20 percent 30 percent plusFlexibility Nil Highly flexibleValue addition Nil Multiple waysExit option Sell back to promoters Several ,including Public

offerFunding sources Owner funds Outside contribution allowed

Syndication Not done PossibleTax concession Nil ExemptedSuccess rate Not good Very satisfactory

Table 2.1: Difference between Seed Capital Scheme and Venture capital Scheme

2.3.3 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 acommon expectation of capital gains yet their objectives and intents are totally different.

2.4 The Venture Capital

The growth of an enterprise follows a life cycle as shown in the diagram below. Therequirements 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 themarket, finding and understanding the target customers and their needs. At the seed stage



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the entrepreneur continue to fund the venture with his own or family funds. At this stage thefunds are needed to solicit the consultants services in formulation of business plans,meeting potential customers and technology partners. Next the funds would be required fordevelopment 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 expandthe business and attaint the critical mass for profit generation. Venture capitalists cater tothe needs of the entrepreneurs at different stages of their enterprises. Depending upon thestage they finance, venture capitalists are called angel investors, venture capitalist or privateequity supplier/investor.

Figure 2.1: Venture Capital Spectrum

Venture capital was started as early stage financing of relatively small but rapidly growingcompanies. However various reasons forced venture capitalists to be more and moreinvolved in expansion financing to support the development of existing portfoliocompanies. With increasing demand of capital from newer business, Venture capitalists

began to operate across a broader spectrum of investment interest. This diversity ofopportunities enabled Venture capitalists to balance their activities in term of timeinvolvement, risk acceptance and reward potential, while providing on going assistance todeveloping business.


FamilyPartners

IPO

Start up

PersonalAngelInvestor

VentureCapital

PrivateEquity

PublicEquity

Public Equity forRestructuringBuyouts

TimeConcept

Product

Development

Expansion

Building a sustainable business

BusinessPlan

Seed Capital


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Different venture capital firms have different attributes and aptitudes for different types ofVenture capital investments. Hence there are different stages of entry for different Venturecapitalists and they can identify and differentiate between types of Venture capitalinvestments, 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. Forinstance seed capital is normally not required by service based ventures. It applies largely tomanufacturing or research based activities. Similarly second round finance does not alwaysfollow early stage finance. If the business grows successfully it is likely to developsufficient 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 financeSeed

7-10 Extreme For supporting a concept or idea or R & D for productdevelopment

Start up 5-9 Very high Initializing operations or developing prototypes

First stage 3-7 High Start commercial productionand marketingSecond stage 3-5 Sufficiently

highExpand market & growingworking capital need

Later stage finance 1-3 Medium Market expansion,acquisition & productdevelopment for profitmaking company

Buy out-in 1-3 Medium Acquisition financing

Turnaround 3-5 Medium to high Turning around a sick

companyMezzanine 1-3 Low Facilitating public issue



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Table 2.2: Venture Capital- Financing Stages

2.4.1 Seed Capital

It is an idea or concept as opposed to a business. European Venture capital associationdefines seed capital as The financing of the initial product development or capital providedto 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:

Absence of ready product market Absence of complete management team Product/ process still in R & D stage Initial period / licensing stage of technology transfer

Broadly speaking seed capital investment may take 7 to 10 years to achieve realization. It isthe earliest and therefore riskiest stage of Venture capital investment. The new technologyand 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 theiradaptation, commencement and eventual success. However, while the earliest stage offinancing is fraught with risk, it also provides greater potential for realizing significantgains in long term. Typically seed enterprises lack asset base or track record to obtainfinance from conventional sources and are largely dependent upon entrepreneurs personalresources. Seed capital is provided after being satisfied that the entrepreneur has used up hisown 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 humanassets (a good management team) so often sought by venture capitalists.

Volume of Investment Activity

It has been observed that Venture capitalist seldom make seed capital investment and theseare relatively small by comparison to other forms of venture finance. The absence ofinterest in providing a significant amount of seed capital can be attributed to the followingthree 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 onthe performance of all but the smallest venture capitalists portfolio. Larger venturecapitalists avoid seed capital investments. This is because the small investments areseen to be cost inefficient in terms of time required to analyze, structure and managethem.

b) The time horizon to realization for most seed capital investments is typically 7-10 yearswhich 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 isextended. These types of obsolescence are particularly likely to occur with high

technology investments particularly in the fields related to Information Technology.



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2.4.2 Start up Capital

It is stage 2 in the venture capital cycle and is distinguishable from seed capitalinvestments. 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 closertowards establishment of a going concern. Here in the business concept has been fullyinvestigated 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, initialmarketing and establishment of product facility.

The characteristics of start-up capital are:-

i. Establishment of company or business. The company is either being organized or isestablished recently. New business activity could be based on experts, experience or a spin-

off from R & D.

ii. Establishment of most but not all the members of the team. The skills and fitness tothe job and situation of the entrepreneurs team is an important factor for start up finance.

iii. Development of business plan or idea. The business plan should be fully developedyet the acceptability of the product by the market is uncertain. The company has not yetstarted trading.

In the start up preposition venture capitalists investment criteria shifts from idea to peopleinvolved in the venture and the market opportunity. Before committing any finance at thisstage, Venture capitalist however, assesses the managerial ability and the capacity of theentrepreneur, besides the skills, suitability and competence of the managerial team are alsoevaluated. If required they supply managerial skills and supervision for implementation.The time horizon for start up capital will be typically 6 or 8 years. Failure rate for start up is2 out of 3. Start up needs funds by way of both first round investment and subsequentfollow-up investments. The risk tends t be lower relative to seed capital situation. The riskis controlled by initially investing a smaller amount of capital in start-ups. The decision onadditional 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 financenormally 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

Despite potential for specular returns most venture firms avoid investing in start-ups. Onereason for the paucity of start up financing may be high discount rate that venture capitalistapplies to venture proposals at this level of risk and maturity. They often prefer to spreadtheir risk by sharing the financing. Thus syndicates of investors often participate in start upfinance.

2.4.3 Early Stage Finance



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It is also called first stage capital is provided to entrepreneur who has a proven product, tostart commercial production and marketing, not covering market expansion, de-risking andacquisition costs.

At this stage the company passed into early success stage of its life cycle. A provenmanagement team is put into this stage, a product is established and an identifiable marketis being targeted.

British Venture Capital Association has vividly defined early stage finance as: Financeprovided to companies that have completed the product development stage and requirefurther 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 growingbusiness.

Short term prospective for dramatic growth in revenue and profits.

The early stage finance usually takes 4 to 6 years time horizon to realization. Early stagefinance is the earliest in which two of the fundamentals of business are in place i.e. fullyassembled 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 thusprompting venture capitalist that, have financed the start up stage to provide furtherfinancing. The management risk is shifted from factors internal to the firm (lack ofmanagement, lack of product etc.) to factors external to the firm (competitive pressures, insufficient will of financial institutions to provide adequate capital, risk of productobsolescence etc.)

At this stage, capital needs, both fixed and working capital needs are greatest. Further, sincefirms do not have foundation of a trading record, finance will be difficult to obtain and soVenture capital particularly equity investment without associated debt burden is key tosurvival 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 andincurred the challenge of a larger competition.



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b) There is a risk of product obsolescence. This is more so whenthe firm is involved in high-tech business like computer,information technology etc.

2.4.4 Second Stage Finance

It is the capital provided for marketing and meeting the growing working capital needs ofan enterprise that has commenced the production but does not have positive cash flowssufficient to take care of its growing needs. Second stage finance, the second trench ofEarly State 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 butwhose financial needs have subsequently exploded. This may be second or even thirdinjection 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 break even but thesurplus generated is insufficient to meet the firms needs.

Second round financing typically comes in after start up and early stage funding and sohave shorter time to maturity, generally ranging from 3 to 7 years. This stage of financinghas both positive and negative reasons.

Negative reasons include:

I Cost overruns in market development.II Failure of new product to live up to sales forecast.III Need to re-position products through a new marketing

campaign.IV Need to re-define the product in the market place once the

product deficiency is revealed.

Positive reasons include:

I Sales appear to be exceeding forecasts and the enterprise needs to acquire assets to gearup for production volumes greater than forecasts.II High growth enterprises expand faster than their working capital permit, thus

needing additional finance. Aim is to provide working capital for initial expansion of anenterprise to meet needs of increasing stocks and receivables.

It is additional injection of funds and is an acceptable part of venture capital. Oftenprovision for such additional finance can be included in the original financing package asan option, subject to certain management performance targets.

2.4.5 Later Stage Finance



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It is called third stage capital is provided to an enterprise that has established commercialproduction and basic marketing set-up, typically for market expansion, acquisition, productdevelopment etc. It is provided for market expansion of the enterprise. The enterpriseseligible for this round of finance have following characteristics.

I. Established business, having already passed the risky early stage.II. Expanding high yield, capital growth and good profitability.III. Reputed market position and an established formal organization structure.

Funds are utilized for further plant expansion, marketing, working capital or developmentof improved products. Third stage financing is a mix of equity with debt or subordinatedebt. As it is half way between equity and debt in US it is called mezzanine finance. It isalso called last round of finance in run up to the trade sale or public offer.

Venture capitalist s prefer later stage investment vis a vis early stage investments, as therate 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 procedures of financial control.The time horizon for realization is shorter, ranging from 3 to 5 years. This helps the venturecapitalists to balance their own portfolio of investment as it provides a running yield toventure capitalists. Further the loan component in third stage finance provides taxadvantage 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 profits exponentially by achievingthe 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 byway of acquisitions. Anyhow, expansion needs finance and venture capitalists support bothorganic growth as well as acquisitions for expansion.

At this stage the real market feedback is used to analyze competition. It may be found thatthe entrepreneur needs to develop his managerial team for handling growth and managing alarger business.

Realization horizon for expansion / development investment is one to three years. It isfavored 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 markets or entering exports byenterprise with established business that has already achieved break even and has startedmaking profits.

Replacement Finance



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It means substituting one shareholder for another, rather than raising new capital resultingin the change of ownership pattern. Venture capitalist purchase shares from theentrepreneurs and their associates enabling them to reduce their shareholding in unlistedcompanies. They also buy ordinary shares from non-promoters and convert them to

preference shares with fixed dividend coupon. Later, on sale of the company or its listing

on stock exchange, these are re-converted to ordinary shares. Thus Venture capitalist makesa capital gain in a period of 1 to 5 years.

Buy - out / Buy - in Financing

It is a recent development and a new form of investment by venture capitalist. The fundsprovided to the current operating management to acquire or purchase a significant shareholding in the business they manage are called management buyout.

Management Buy-in refers to the funds provided to enable a manager or a group ofmanagers from outside the company to buy into it.

It is the most popular form of venture capital amongst later stage financing. It is less riskyas 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 majorbusiness. MBO (Management buyout) has low risk as enterprise to be bought have existedfor some time besides having positive cash flow to provide regular returns to the venturecapitalist, who structure their investment by judicious combination of debt and equity. Oflate there has been a gradual shift away from start up and early finance to wards MBOopportunities. 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 ofhigher degree of risk. When an established enterprise becomes sick, it needs finance as wellas management assistance foe a major restructuring to revitalize growth of profits.Unquoted company at an early stage of development often has higher debt than equity; itscash flows are slowing down due to lack of managerial skill and inability to exploit themarket potential. The sick companies at the later stages of development do not normallyhave high debt burden but lack competent staff at various levels. Such enterprises arecompelled to relinquish control to new management. The venture capitalist has to carry outthe 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 lastround of financing before the planned exit. Venture capitalist help in building a stable andexperienced 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



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Post Investment Activities:

Once the deal has been structured and agreement finalised, the venture capitalist generallyassumes the role of a partner and collaborator. He also gets involved in shaping of thedirection of the venture. The degree of the venture capitalist's 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 venturecapitalist 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 initialinvestment. They play a positive role in directing the company towards particular exitroutes. A venture may exit 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

Promoters Buy-back

The most popular disinvestments route in India is promoters buy-back. This route is suitedto Indian conditions because it keeps the ownership and control of the promoter intact. The

obvious limitation, however, is that in a majority of cases the market value of the shares ofthe venture firm would have appreciated so much after some years that the promoter wouldnot be in a financial position to buy them back.

In India, the promoters are invariably given the first option to buy back equity of theirenterprises. For example, RCTC participates in the assisted firms equity with suitableagreement for the promoter to repurchase it. Similarly, Canfina-VCF offers an opportunityto the promoters to buy back the shares of the assisted firm within an agreed period at a

predetermined price. If the promoter fails to buy back the shares within the stipulatedperiod, Canfina-VCF would have the discretion to divest them in any manner it deemedappropriate. SBI capital Markets ensures through examining the personal assets of the

promoters and their associates, which buy back, would be a feasible option. GVFL wouldmake disinvestments, in consultation with the promoter, usually after the project has settleddown, to a profitable level and the entrepreneur is in a position to avail of finance underconventional schemes of assistance from banks or other financial institutions.Initial Public Offers (IPOs)

The benefits of disinvestments via the public issue route are, improved marketability andliquidity, better prospects for capital gains and widely known status of the venture as wellas market control through public share participation. This option has certain limitations inthe 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



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CHAPTER 3

GLOBAL SCENARIO OFVENTURE CAPITAL

INDUSTRY



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3.1 Overview

Over the last 18 months, the venture capital industry around the globe hasexperienced a welcome acceleration in the mature investment hotbeds UnitedStates, Europe and Israel and in the emerging venture capital hotbeds China andIndia. Global venture capital investment last year reached US $ 35.2 billion, thehighest level since 2001, and is maintaining a robust pace in year 2007. Theacceleration has been bolstered by the increasing globalization of both venturecapital funds and venture backed companies and a substantial investor focus onemerging sectors.

As the dotcom market of the late 1990 has gathered the momentum, venture capitalstood at the nexus of hype and hope. In 2000 , they poured nearly $95 billion intomostly young , untested companies , some no more than ideas, expecting to reaprich rewards by later selling of these outfits to public .But the bubble burst themarket for the new stock issues tanked --- and by 2003 , venture capital funding haddwindled to $19 billion.

The VC showed the signs of stabilizing as the industry were bolstered by the 2005sstrong 4th quarter, the financing exceeded the $ 21.5 billion invested in venture-

backed companies in 2004, reaching $22.1billion .While that was far below 2000speak, it represents a more sustainable pace of funding for both entrepreneurs andinvestors. In another sign of the industry firming, pension funds, foundations, andother investors are again getting interested to invest their money in venture funds,which provided seed money for young companies to grow on.

3.2 History & Evolution

Prior to World War Two, the source of capital for entrepreneurs everywhere waseither the government, government-sponsored institutions meant to invest in suchventures, or informal investors (today, termed "angels") that usually had some priorrelationship to the entrepreneur. In general, throughout history private banks, quitereasonably, have been unwilling to lend money to a newly established firm, becauseof the high risk and lack of collateral. After World War Two, in the U.S. a set ofintermediaries emerged who specialized in investing in fledgling firms having the

potential for extremely rapid growth.

From its earliest beginnings on the U.S. East Coast, venture capital graduallyexpanded and became an increasingly professionalized institution. During this

period, the locus of the venture capital industry shifted from New York and Bostonon the East Coast to Silicon Valley on the West Coast. By the mid 1980s, the ideal-typical venture capital firm was based in Silicon Valley and invested largely inelectronics with lesser sums devoted to biomedical technologies. Until the present,

in addition to Silicon Valley, the two other major concentrations have been Bostonand New York City.



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3.4 GLOBAL TREND IN VENTURE CAPITAL INDUSTRY

The 2007 Global Venture Capital Survey was sponsored by Deloitte & Touche LLPin conjunction with the National Venture Capital Association and other venturecapital associations* throughout the world. It was administered in April and May2007 to venture capitalists (VCs) in the Americas, Asia Pacific, Europe, the MiddleEast, and Africa.

There were 528 responses from general partners, with 45 percent of respondentsfrom the United States and 31 percent from Europe. A complete geographic

breakdown of respondents is as follows:

Figure: 3.1 Primary focused location for investment (APAC) respondents

The breadth of assets under management by these respondents was varied. Thehighest number of respondents42 percenthad managed assets totaling less than$100 million; 35 percent managed assets between $100 million and $499 million; 12

percent managed assets between $500 million to $1 billion; and 11 percent morethan $1 billion in assets under managementThere are 13 % respondents from APAC in which China, India, Japan, South Korea,

other Asia. 45% respondents from Middle East include Israel and other area ofMiddle East.

Global VC investment increasing, but growth is slow and cautious.

We may live in a global economy, but the venture capital community is not broadlyembracing global investment. Rather, roughly half of the venture community hasmade a commitment to a global investment strategy and those firms are



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U.S. venture capitalists

There continues to be a consensus among U.S. venture capitalists regarding wherethe most opportunities exists globally. Most of the U.S. firms who have invested

globally are making investments in China, India, Israel, and Canada. However, evenin these countries, the majority of U.S. respondents are essentially dabbling, makingonly one to two investments thus far.

FOREIGN INVESTMENT CURRENTLY HELD BY FIRMS

53%

23%

8%

4%

12%

1-2 investment

3-5 investment

6-10 investment

11-15investment

16+ investment

Figure: 3.5 Foreign investment currently held by firms

Allocations by U.S. and non-U.S. firms alike for the most part represent less than 5percent of capital invested overseas in fewer than three to five deals. Survey resultsindicate that there will not be significant change during the next five years.

RESPONSE FROM U.S. RESPONDENTS



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TOP MARKETS WHERE THE COST OF COMPLYING WITH CORPORATE

GOVERNANCE REGULATION TOO HIGH

44

8 7 5 5 4 3 3 3 3

46

9 9 7 5 3 5 5 3 2

41

7 52

5 52 2 4

5

05

101520253035404550

U.S.

UK&Ir

eland

ca

nada

India

Austria,

Germ

any,

Switze

rland

Israel

China

No

rdic

cou

ntries

Fr

ance,

Itally

Benelux

global

US

Non US

Figure: 3.11 Top markets where the cost of complying with corporate governanceregulation too high

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



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equity, conditional loans or income notes for technologies development and innovativeproducts. It also provides finance assistance to entrepreneurs.

The government of Andhra Pradesh has also promoted the Andhra Pradesh IndustrialDevelopment Corporation (APIDC) venture capital ltd. To provide VC financing in Andhra

Pradesh.

Promoted by commercial banks

Canbank Venture Capital Fund, State Bank Venture Capital Fund and Grindlays bankVenture Capital Fund have been set up by the respective commercial banks to undertake vcactivities.

The State Bank Venture Capital Funds provides financial assistance for bought out deal aswell as new companies in the form of equity which it disinvests after the commercializationof the project.

Canbank Venture Capital Fund provides financial assistance for proven but yet to bcommercially exploited technologies. It provides assistance both in the form of equity andconditional loans.

Private Venture Capital Funds

Several private sector venture capital funds have been established in India such as the 20 th

Centure Venture Capital Company, Indus Venture Capital Fund, Infrastructure Leasing and

Financial Services Ltd.Some of the companies that have received funding through this route include:

Mastek, on of the oldest softwear house in India Ruskan software, Pune based software consultancy SQL Star, Hyderabad-based training and software development consultancy Satyam infoway, the first private ISP in India Hinditron, makers of embedded software Selectia, provider of interactive software selectior Yantra, ITLInfosys US subsidiary, solution for supply chain management Rediff on the Net, Indian website featuring electronic shopping, news,chat etc.

4.2 INDUSTRY LIFE CYCLE:



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Technology involved should be new, relatively untried, very closely held, in theprocess of being taken from pilot to commercial stage or incorporate some significantimprovement over the existing ones in India

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 11 VC funds became operational either through reorganizingthe businesses or through new entities.

All these followed the Government of India guidelines for venture capital activities andhave primarily supported technology oriented innovative businesses started by firstgeneration entrepreneurs. Most of these were operated more like a financing operation. Themain feature of this phase was that the concept got accepted. VCs became operational inIndia before the liberalization process started. The context was not fully ripe for the growthof VCs. Till 1995; the VCs operated like any bank but provided funds without collateral.The first stage of the venture capital industry in India was plagued by in experiencedmanagement, mandates to invest in certain states and sectors and general regulatory

problems. Many public issues by small and medium companies have shown that the Indianinvestor is becoming increasingly wary of investing in the projects of new and unknown

promoters.

The liberation of the economy and toning up of the capital market changed the economiclandscape. The decisions relating to issue of stocks and shares was handled by an officenamely: Controller of Capital Issues (CCI). According to 1988 VC guideline, any

organization requiring to start venture funds have to forward an application to CCI.Subsequent to the liberalization of the economy in 1991, the office of CCI was abolished inMay 1992 and the powers were vested in Securities and Exchange Board of India. TheSecurities and Exchange Board of India Act, 1992 empowers SEBI under section 11(2)thereof to register and regulate the working of venture capital funds. This was done in 1996,through a government notification. The power to control venture funds has been given toSEBI only in 1995 and the notification came out in 1996. Till this time, venture funds weredominated by Indian firms. The new regulations became the harbinger of the second phaseof the VC growth.

4.2.2 Phase II - Entry of Foreign Venture Capital funds (VCF) between 1995 -1999

The second phase of VC growth attracted many foreign institutional investors.During thisperiod overseas and private domestic venture capitalists began investing in VCF. The newregulations in 1996 helped in this. Though the changes proposed in 1996 had a salutaryeffect, the development of venture capital continued to be inhibited because of theregulatory regime and restricted the FDI environment. To facilitate the growth of venturefunds, SEBI appointed a committee to recommend the changes needed in the VC fundingcontext. This coincided with the IT boom as well as the success of Silicon Valley start-ups.In other words, VC growth and IT growth co-evolved in India

4.2.3 Phase III - (2000 onwards) - VC becomes risk averse and activity declines:



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There are 160 venture capital firms/funds in India. In 2006 it is only but in 2007 thenumber of venture capital firms are 146. The reason is good position of capitalmarket. But in 2008 no. of venture capital firms increase by only 14. the reason iscrashdown of capital market by 51% from January to November 2008. The No. ofventure capital funds are increasing year by year.

2000 2001 2002 2003 2004 2005 2006 2007 2008841 77 78 81 86 89 105 146 160www.nasscom.org, strategic review 2008 published by (National Associationof Software and Service Companies)

Venture capital growth and industrial clustering have a strong positive correlation.Foreign direct investment, starting of R&D centres, availability of venture capitaland growth of entrepreneurial firms are getting concentrated into five clusters. Thecost of monitoring and the cost of skill acquisition are lower in clusters, especiallyfor innovation. Entry costs are also lower in clusters. Creating entrepreneurship andstimulating innovation in clusters have to become a major concern of public policymakers. This is essential because only when the cultural context is conducive for riskmanagement venture capital will take-of. Clusters support innovation and facilitatesrisk bearing. VCs prefer clusters because the information costs are lower. Policiesfor promoting dispersion of industries are becoming redundant after the economicliberalization.

The venture capital firm invest their money in most developing sectors like healthcare, IT-ITes,, telecom, Bio-technology, Media& Entretainment, shipping & ligisticsetc.

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4.4 Venture Capital investment Q3, 2008.

Venture Capital firms invested $274 million over 49 deals in India during the three monthsending September 2008. The VC investment activity during the period was significantlyhigher compared to the same quarter last year (which had witnessed 36 investments worth

$252 million) as well as the immediate previous quarter ($165 million invested across 28deals).

The latest numbers take the total VC investments in the first nine months of 2008 to $661million (across 108 deals) as against the $648 million (across 97 deals) during thecorresponding period in 2007.

4.4.1 Top InvestmentsThe largest investment reported during Q3 2008 was the $18 million raised by onlinetutoring services provider TutorVista from existing investors Sequoia Capital India andLightSpeed Ventures.

Table: 4.1 Top venture capital investments

4.4.2 Investments by Industry

S.V .Institute Of Management, Kadi

Top VC Investments

Company

TutorVista

Sector

Online Services(Remote Tutoring)

Amount(US$ M)

18.0

Investors

Sequoia Capital India,Lightspeed Ventures

ConnectivaSystems

Communications Tech(Revenue Assurance)

17.0 IFC, NEA-IUV, SAPVentures, Others

SeventymmOnline Services (VideoRental)

12.0 NEA-IUV, ePlanet Ventures,Matrix Partners India,DFJ

Equitas MicroFinance

Microfinance 12.0 Bellwether, Others

HaloSource Water Purifiers 11.5 Origo Sino-India, UnileverTech Ventures

50


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Information Technology and IT-Enabled Services (IT & ITES) industry retained its statusas the favorite among VC investors during Q3 08.

VC Investments by IndustryIndustry Volume

Q3 08

No. of Deals

YTD**

Value

Q3 08

(US $ M)

YTD

IT & ITES 25 58 147 361

BFSI 5 8 34 54

Engg & Construction 3 4 23 33

Healthcare & LifeSciences

6 12 4 52

Education 2 3 17 23

Other Services 1 6 15 29

Manufacturing 2 2 13 13

Media 2 5 11 19

Energy 2 6 6 48

Travel & Transport 1 2 4 14

Retail - 1 - 10

Telecom - 1 - 5

Table: 4.2 Venture capital investment by industry

Led by the $12 million investment by Bellwether and others into Chennai-basedmicrofinance firm Equitas, BFSI emerged as the second largest (in value terms) for VCinvestments during the period. Other microfinance firms that attracted investments duringQ3 08 included Kolkata-based Arohan Financial Services (which raised funding from LokCapital and others) and Guwahati-based Asomi Finance (IFC and Aavishkaar Goodwell).



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4.8 Key considerations

For investor/venture capitalist

Ideal entrepreneur

A venture capital (VC) who is financing the firm would as the first necessity assess andgauge the promoters. Because in the case of start-up where the product or the technology isyet to be tested, the only thing they can trust and their investment on the people behind it.While investing in a company what a VC is essentially looking for is a partnership andtherefore the first decision making criterion is the character and personality of the

promoters.

However from a venture capitalists perspective, the ideal entrepreneur,

1. is qualified in a hot area of interest2. Delivers sales or technical advances such as FDA approval with reasonable

probability3. Tells a compelling story and is presentable to outside investors,4. Recognizes the need for speed to an ipo for liquidity,5. Has a good reputation and can provide references that show competences and skill,6. Understand the need for a team with a variety of skill and therefore sees why equityhas to be allocated to other people7. Works diligently toward a goal but maintains flexibility8. Get along with the investor group

9. Understands the cost of capital and typical deal structures and is not offended bythem10. Is sought after by many VCs11. Has a realistic expectation about process and outcome.

Besides the ideal entrepreneur, the investor tries to ensure the following for himself.

1 Reasonable reward given in the level of risk.2 Sufficient influence on the management of the company through boardrepresentation.3 Minimization of taxes.

4 Ease in achieving future liquidity on the investment.5 Flexibility of structure that will allow room to enable additional investment later,incentives for future management and retention of stocks if management leaves6 Balance-sheet attractiveness to suppliers and debt financier7 Retention of key employees through adequate equity participation

4.9 Venture financing practices and procedures

Entrepreneurs who need VC financing for their enterprises should have sufficientinformation to be able to choose a VC company or fund suitable for their requirement andhave a broad understanding of the procedures required to be followed for obtaining

financial assistance at different stages of implementation of their projects.Basically theyneed to develop a business plan or prototype to get venture finance.



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CHAPTER 5

COMPREHENSIVE

STUDY OF INDIANMARKET



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This method is intended to develop a foundation for your business from scratch.Financial management is essential to make this work. With bootstrap financingyoure building a business from nothing, which means there is little to no margin forerror in the finance department. Keep a rigid account of all transactions and dontstray from your budget.

A few different methods of bootstrapping include :

Factoring, which generates cash flow through the sale of your accounts receivableto a factor at a discounted price forscash.

Trade Credit is an option if you are able to find a vendor or supplier that will allowyou to order goods on net 30, 60 or 90 day terms. If you can sell the goods beforethe bill comes due then you have generated cash flow without spending anysmoney.Customers can pay you up front our services.

Leasing your equipment instead of purchasing it outright.

2. Fund From Operations

Look for ways to tweak your business in order to reduce the cash flowing out andincrease the cash flowing in. Funding found in business operations come free offinance charges, can reduce future financing charges and can increase the value ofyour business. Month-by-month operating and cash projections will show how well

we have planned, how you can optimize the elements of your business that generatecash and allow you to plan for new investments and contingencies.

3. Licensing

Sell licenses to technology that is non-essential to our company or grant limitedlicensing to essential technology that can be shared. Through outlicensing we cangenerate revenue from up-front fees, access fees, royalties or milestone payments.

4. Vendor Financing

Similar to the trade credit related to bootstrap financing, vendors can play a big rolein financing your new business. Establish vendor relationships through our tradeassociation and strike deals to offer their product and pay for it at a date in the nearfuture. Selling the product in time is up to us. In hopes of keeping you as a customer,vendors may also be willing to work out an arrangement if we need to financeequipment or supplies. Just make sure to look for stability when you research avendors credentials and reputation before you sign any kind of agreement. Andkeep in mind that many major suppliers (GE Small Business Solutions,IBM GlobalFinancing) own financial companies that can help you.

5. Self Funding

http://www.gemoney.com/small_business/index.htmlhttp://www-03.ibm.com/financing/us/http://www-03.ibm.com/financing/us/http://www.gemoney.com/small_business/index.htmlhttp://www-03.ibm.com/financing/us/http://www-03.ibm.com/financing/us/


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11. Friends

Ask your friends if they have any extra money that they would like to invest. Assurethem that you will pay them back with interest or offer them stock options or a shareof the profits in return.

12. Family

Maybe you have a rich uncle or a wealthy cousin that would be willing to lend yousome money get your business running or send it to the next level. Again, make itworth their while by offering interest, stocks or a share of the profits.

13. Form A Strategic Alliance

Aligning your business with a corporation can produce funding from upfront oraccess fees to your service, milestone payments and royalties. In addition, corporate

partners may be able to provide research funding, loans and equity investments.

14. Sell Some Assets

Find an interested party to buy some of your assets (computers, equipment, real

estate, etc) and then lease them back to you. This provides an instant source ofcash and you will still be able to use whatever assets you need.

15. Business Lines of Credit

If your business has positive cash flow and has proven that it will cover its debtsthen you may be eligible for a business line of credit. This type of financing is acommon service offered by most business banks and serves as business capital, up toan agreed upon amount, that you can access at any time.

16. Personal Credit Cards

Using personal credit cards to finance a business can be risky but, if you take theright approach, they can also give your business a lift. You should only considerusing this type of financing for acquiring assets and working capital. Never considerthis to be a long-term option. Once your company breaks even or moves into the

black, ditch the credit cards and move toward traditional bank financing or leaseagreements.

17. Business Credit Cards



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As per Union Budget 2007 and its broad guidelines, Government proposed to limitpass-through status to venture capital funds (VCFs) making investment in nine areas.These nine areas are biotechnology, information technology, nanotechnology, seedresearch and development, R&D for pharma sectors, dairy industry, poultry industryand production of bio-fuels. Pass-through status means that the incomes earned byfunds are taxable now.

Liberalization:

With the advent of liberalization, India has been showing remarkable growth in theeconomy in the past 10 - 12 years. The government is promoting growth in capacityutilization of available and acquired resources and hence entrepreneurshipdevelopment, by liberalizing norms regarding venture capital. In the year 2000, the

finance ministry announced the liberalization of tax treatment for venture capitalfunds to promote them & to increase job creation. This is expected to give a strongboost to the non resident Indians located in the Silicon valley and elsewhere to investsome of their capital, knowledge and enterprise in these ventures.

5.2.2 ECONOMIC FACTORS:



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MERGER & ACQUISITION :

Venture backed liquidity events by year 2001-2008 through M&A

Quarter/Year

TotalM&ADeals

M&A Dealswith

DisclosedValues

TotalDisclosed

M&AValue($M)

AverageM&AsDealSize($M)

2002 318 152 7,916.4 52.12003 290 122 7,721.1 63.32004 339 186 15,440.6 83.0

2005-1 81 45 4,351.9 96.72005-2 81 34 4,725.0 139.02005-3 101 48 18,056.0 376.22005-4 87 39 2,594.0 66.52005 350 166 29,727.0 179.1

2006-1 107 52 5,607.5 107.82006-2 105 40 4,018.5 100.52006-3 94 42 3,894.8 92.72006-4 62 26 5,616.8 216.02006 368 160 19,137.6 119.6

2007-1 82 29 4,540.3 156.62007-2 87 36 3,972.3 110.32007-3 100 52 10,810.0 207.92007-4 86 43 9,084.1 211.32007 355 160 28,406.7 177.5

2008-1 70 28 3,602.4 128.72008-2 50 14 2,397.3 171.22008 120 42 5,999.7 142.9

www.thomsonreuters.com

Table: 5.1 Venture backed liquidity events by year 2001-2008 through M&A

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VENTURE BACKED LIQUIDITY BY EVENTS

8512.6

5999.7

169

120

0

1000

2000

3000

4000

5000

60007000

8000

9000

FIRST TWO QUARTER OF

2007

FIRST TWO QUARTER OF

2008

VALUEOFDEAL

0

20

40

60

80

100

120140

160

180

No.OFDEAL

Value of Deals No. of Deals

Figure: 5.3 Venture backed M & A deals

MERGERS AND ACQUISITIONS VOLUME DECLINES

In the second quarter of 2008, 50 venture-backed M&A deals were completed, 14 ofwhich had an aggregate deal value of $2.4 billion. M&A volume of 120 transactions

in the first half of 2008 was down 28 percent from the first half of 2007 when 169transactions were completed. The average disclosed deal value for the quarter was$171.2 million. Due to this V/C is directly affected negatively because M&A is theexit route for Venture capital industry. The reason behind decreasing No. of M&Adeals is crashdown of SENSEX by 51%



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Quarter/Year

No.ofIPO's

Total OfferAmount

Average IPOOffer

Amount

($M) ($M)

2002 22 2,109.10 95.9

2003 29 2,022.70 69.8

2004 93 11,014.90 118.4

2005-1 10 720.7 72.1

2005-2 10 714.1 71.4

2005-3 19 1,458.10 76.7

2005-4 18 1,592.10 92.2

2005 57 4,485.00 78.7

2006-1 10 540.8 54.1

2006-2 19 2,011.00 105.8

2006-3 8 934.2 116.8

2006-4 20 1,631.10 81.62006 57 5,117.10 89.8

2007-1 18 2,190.60 121.7

2007-2 25 4,146.80 165.9

2007-3 12 945.2 78.8

2007-4 31 3,043.80 98.2

2007 86 10,326.30 120.1

2008-1 5 282.7 56.52008-2 0 0 n/a

2008 5 282.7 56.5

www.thomsonreuters.com

Table: 5.2 Number of IPOs during 2002-2008

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GDP GROWTH RATE

GDP V/S VC GROWTH RATE

8.57.5

9.69.4240.91

33.33

251.06

89.79

0

2

4

6

8

10

12

2004 2005 2006 2007

GDP

GROWTHRATE(%)

0

50

100

150

200

250

300

VC

GROWTHRATE(%)

GDP GROWTH RATE VC GROWTH RATE

Source :CII (Confederation of Indian Industry) July 2008 Presentation

Figure: 5.5 GDP V/S Venture capital growth rate

IMPACT

In above chart there was a positive relation ship there was between GDP growthrate. But in 2007 the growth of VC was decline to 89.79% from 240.91% in 2006

but here the value of deal was increasing. In 2008 the growth rate is 9% and projectthe next year GDP 8% to 9%. So there is a hope, the growth of VC industry can beincreased.

India is the 4th largest economy in terms of PPP. GDP of India is US$ 3787.3 billionin PPP terms.

Taking Indian Purchasing Power Parity (PPP) into consideration, this would beequivalent to $22 billion worth of investment in the US. Since about $1.75 billion(or approximately 40% of $4.4 billion) has been already raised, even if only $2.2

billion is raised by December 2006.

Evalueserve cautions that there will be a glut of VC money for earlystageinvestments in India. This will be especially true if the VCs continue to invest only

in currently favourite sectors such as IT, BPO, software and hardware products,telecom, and consumer Internet.



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IMPRESSIVE GROWTH IN SERVICES SECTOR :

Source : Confederation of Indian Industry, July 2008

Most of the venture capital industry invest their money in IT companies, hotels,transport, communication, bio-technology, BIFS etc. This shows an impressivegrowth year by year. This are emerging sectors for venture capital industry.

SENSEX CRASHDOWN

SENSEX IN 2008

9092.72

9788.06

12860.4314564.53

14355.75

13461.6

16415.5717287.31

15644.44

17578.72

17648.71

0

2000

4000

6000

8000

10000

12000

14000

16000

1800020000

JAN

FEB

MAR

CH

APRIL M

AYJU

NEJU

LYAU

GSE

PTOCT

NOV

www.bseindia.comFigure: 5.7 SENSEX in 2008


Items 2005-06 2006-07 2007-08(AE)Services 10.34 11.9 10.7Trade, hotels, transport &communication

11.51 11.8 12.0

Financial, real estate &business services

11.41 13.9 11.8

Community, social andpersonal services

7.21 6.9 7.3

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IMPACT

The SENSEX is down by 51% from January 2008 to Nov 2008. So one company istry to come up with IPO. IPO in first two quarter of 2007 is 43 and value of IPO is

6337.4 and in first two quarter of 2008 there is only 5 IPO and value is only 282.7through VC company go for exit. Because IPO is one of the exit route for Venturecapitalist from the company. It is also favorable for venture capital company becauseno one try to come up with IPO so they must go to the venture capital for money

SMALL SCALE INDUSTRIES

No. deals V/S No. of SMEs

5671

146

299

387

109.49

113.95

118.59

123.42

128.44

050

100

150

200

250

300

350

400

450

2003 2004 2005 2006 2007

100

105

110

115

120

125

130

No. of deals No. of SMEs

Source: www.MSME.org.in, Economiv Survey 2007-08,chapter 8

Figure: 5.8 No. of deals V/S No. of SMEs

IMPACTVC, to be able to contribute to developing entrepreneurship in India, needs toconcentrate its investment in small and medium enterprises. A Package forPromotion of Micro and Small Enterprises was announced in February 2007.This includes measures addressing concerns of credit, fiscal support, cluster-baseddevelopment, infrastructure, technology, and marketing. Capacity building ofMSME Associations and support to women entrepreneurs are the other importantfeatures of this package. SMEs have been allowed to manage their direct/indirectexposure to foreign exchange risk by booking/canceling/roll over of forwardcontracts without prior permission of RBI.

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To boost the micro and small enterprise sector, the bank has decided to refinance anamount of 7000 crore to the Small Industries Development Bank of India, which will

be available up to March 31, 2010. The Central Bank said that it is also working on asimilar refinance facility for the National Housing Bank (NHB) of an amount of Rs4, 000 crore.

INTEREST RATE :

INTEREST RATE

6.11

7.987.23

8.73 9.11

0

2

4

6

8

10

MA

RCH--06

MA

RCH--07

MA

RCH--08

JUNE--

08

JULY--

08

PE

RCENT

Sources:- The Macro economic and monetary development annual statement on monetarypolicy, First Quarter Review 2008-09

Figure: 5.9 Interest Rate

IMPACT :

The interest rate increase year by year. It is 6.11% in March-2006 and now in July2008 it is 9.11%. venture capital firms generally borrow from banks now if interestrates are increasing interest cost of venture capital firms will also increase which ledreduce the profitability of Venture Capital firms. Because if anyone is investing inany option he will look for good return, so here if they will maintain their own

profits they will have to give less return to investors then investors will go for otheroptions. Here increase in bank rates affect Venture Capital firms in both ways from

the suppliers as well as buyers side.



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CURRENCY RISK :

Exchange Rate(INR/US$)

45.75 47.7348.42 45.95 44.87 44.09 45.11

40.01

0

10

20

30

40

50

60

2000-

01

2001-

02

2002-

03

2003-

04

2004-

05

2005-

06

2006-

07

2007-

08

EXCHANGERA

Figure: 5.10 Exchange Rate(INR/US$)

IMPACT

From the above chart we can see that exchange rate is highly fluctuated. Nowadaysthe exchange rate touches to 50 Rs. Per dollar. Now due to globalization venture

capital firms are entering at global level. Nowa for a particular country currency riskcan be defined in two ways.

Indian venture capital are concentrated on global level due to increasingopportunity in global level. They make a deal with global company. So thereis directly affect the movement of exchange rate.

In second way , Foreign institutional investor incest their money Indian stockmarket and nowadays due to crash down of market the investment of FII isdecreasing. Due to this nobody like to bring IPO. It is directly affected toventure capital company because IPO is one way for exist.



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Again,partlybecause the Indian economy was a socialistic and closed economyand partly because Indian entrepreneurs are not as proficient at businessdevelopment as their counterparts in the US, Indian start-ups lack financialtransparency and often have limited experience in implementing effectivefinancial processes. This usually makes the task of the Venture Capital muchmore difficult not only during the due-diligence phase, but also in helping thestart-upgrow rapidly.

FACTOR FAVOURABLE UNFAVOURABLE BOTHMERGER&

ACQUISITION,IPO

INFLATION RATE

GDP GROWTHRATE

SENSEXCRASHDOWN

SMALL SCALEINDUSTRIES

INTEREST RATE

CURRENCY RISK :

EXPORT &IMPORT

REPO RATE

Table: 5.3 Result of Economic factors

5.2.3 SOCIAL FACTORS:



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UNEMPLOYMENT RATE

8.8 8.89.5 9.2 8.9

7.87.2

0

2

46

8

10

2002 2003 2004 2005 2006 2007 2008

PERCENTAGE

www.indexmundi.com

Figure: 5.13 Unemployment rate

In India the unemployment rate is very high. No doubt it is decreasing year by year.It is 9.5% in 2004 and now it is 7.2% in 2008. Here there is a great opportunity forVenture capital firm because there is a huge untapped market and they requireamount fr strting the business.

According to one survey by National Entrepreneurship Development Board(NEBD), Ministry of SSI & ARI, Govt. of India, on Entry barriers toentrepreneurship as perceived by youth. In this survey out of 1625 respondents19.2% people have future plan to become entrepreneur for starting the business and80.8% persons are not ready for business. But out of this 80.8% persons 58.3%

person are ready for becoming entrepreneurship if they get help in finance, project

idea, and training for business and management. So here there is a great opportunityfor venture capital firms.

INDIAN ENTREPRENEUR LACKS IN MARKETING, SALES ANDBUSINESS DEVELOPMENT EXPERTISE :

An Indian entrepreneur is found to be quite adept technically and definitely at parwithsimilar entrepreneurs indeveloped countries. However, entrepreneurs in Indiagenerally lacked expertise in marketing, sales andbusiness development areas,especially when compared totheircounterparts in the US.Furthermore, since Indiahad socialistic economic policies during 1947-1992, there isa lack of good talentinmarketingandsalesprofessionals who can thrive in an extremely competitiveenvironment.

Hence,finding the appropriate marketing,sales and business development peopleis one area where Indian start-ups need help.Thisproblem is furtherexacerbatedbecause the Indian economy has been growing at 8%andmoststart-ups have tocompete for talent not only with other companies who are exporting similar ordissimilar products and services butalso with many Indian domestic companies. Infact, finding and retaining the right talent has become an issue not only inmarketing, sales and business development but also in research, technical and

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advanced development areas. Finally, if the eventual market were a developedcountry, then such expertise can be potentially found in that country. However, ifthemarket forthe corresponding productor service is India, China or some otherdeveloping nation, then findingsuchpeople canbea Herculean task!

INDIAN ENTREPRENEURS ARE HESISTANT TO GIVE UPCONTROL :

Indianentrepreneurs are usually hesitant about giving up control. In fact,most ofthe entrepreneurs in India currently receive their initial funding from family andfriends, and even if they do not do so, the Indian social system is such thatrelatives and friends still end up being a major influence. Also, company canborrow money from bank and other financial institution at lower than Venture

capital rather give substantial share to the VC.

Consequently, the Venture Capital will have to provide a very clear valueproposition to the start-ups and cannot simply state that they bring value to thetable justbecause they are well connected, etc. In fact, webelieve that in somecases theVenture Capital may evenhave togo to the extreme ofclosing contractsand bringing in the revenue on behalf of a start-up rather than simply openingdoors by providing thecontacts in theirRolodex.

ORIGIN OF IMMIGRANT ENTREPRENEUR



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DEMOGRAPHIC FACTOR

AGE &UNEMPLOYMENT RATE

INDIAN ENTREPRENEURLACKSIN MARKETING,SALES AND BUSINESSDEVELOPMENTEXPERTISE

INDIAN

ENTREPRENEURS AREHESISTANT TO GIVE UPCONTROL

ORIGIN OF IMMIGRANTENTREPRENEUR

Table: 5.5 Result of demographic factors

5.2.4 GEOGRAPHIC FACTOR :



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1. EMERGING CITIES

TOP CITIES ATTRACTING VENTURE CPITALINVESTMENTS(2007)

City NO. Of Deals Value(US$M)Mumbai 109 5995

Delhi (Include Noida& Gurgaon)

63 2688

Bangalore 49 685Hyderabad 41 1380

Chennai 32 824Ahmedabad 14 492

Kolkata 12 339

Table: 5.6 Top cities attracting venture capital investment

Cities SectorsMumbai Software services, BPO, Media, Computer

Graphics, Animation, Finance and BankingBangalore All IP-led companies; IT and IT-enabled

services, BiotechnologyDelhi Software services, IT enabled services,

Telecom.Chennai IT and TelecomHyderabad IT and IT enabled services, PharmaPune Biotech, IT, BPO

Source: IVCA

Table: 5.7 city wise sectorial investment by venture capital

In Venture Capital industry most of the deals are made in emerging city likeMumbai, Delhi, Bangalore, Chennai, Kolkata. In this industry Venture Capital firms

invest their money in most highly risk and emerging sector like bio-technology, IT-ITES, real estate, healthcare and this sectors are highly developed in this emergingcity. So there is a great opportunity for Venture Capital to invest their money in thiscity.



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3 Exit route barriers:

Here the venture capital company can exit through IPO or through merger andacquisition with other companies. Now-a-days, from the below given table and currentcrash in stock market we can see that the comparison between M&A deals and IPO inthe year 2007 and 2008 (first two quarters of both years). Now in the year 2007 therewere 189 M&A deals while in 2008 number of M&A deals are 120 only. In addition in2007 number of IPO were 43 which are 5 only in the year 2008. So there is a crucial

problem for the Venture Capital firms to get their funds back from the companies inwhich they have invested. Now if new player will enter he will have to collect morefunds and will also have to wait for the return. The risk is also high in current marketfor the Venture Capital firms. So entry barrier is high for new entrants.

Quarter/Year

TotalM&ADeals

M&A DealswithDisclosedValues

TotalDisclosedM&A Value($M)

AverageM&AsDealSize($M)

No.ofIPO's

Total OfferAmount($M)

Average IPOOfferAmount($M)

2007-1 82 29 4,540.3 156.6 18 2,190.6 121.72007-2 87 36 3,972.3 110.3 25 4,146.8 165.92008-1 70 28 3,602.4 128.7 5 282.7 56.52008-2 50 14 2,397.3 171.2 0 0.0 n/a

Source: www.thomsonreuters.com.Table: 5.9 M& A deals and IPOs in 2007-08 (Q-1 & Q-2 )

4. Learning and experience curve effect: Venture capital funds, before goingfor an in-depth analysis, carry out initial screening of all projects on the basis ofsome broad criteria. Main screening criteria are

Size of investment Geographical location Stage of financing

Knowledge about product and market

So the existing firms can have the benefit of experience in the industry, so on the basisof their capabilities they can use that experience for the shake of the firm. But newfirms dont have the experience in the industry so they may have a loss from this side.So threat from new entrants is low from this point of view also. Experience person can

become competitive advantage.

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5. Time constraint:

As we have discussed above risk associated with early stage of financing is veryhigh compared to other stages because of uncertainty attached with early stage. Butfrom the below given table we can say that the business cant satisfy the investor.

Stage wise financing :

Financing Stage Period (fundslocked in years)

Riskperception

Activity to be financed

Early stage financeSeed

7-10 Extreme For supporting a conceptor idea or R & D for

product developmentStart up 5-9 Very high Initializing operations or

developing prototypesFirst stage 3-7 High Start commercialproduction and marketing

Second stage 3-5 Sufficientlyhigh

Expand market & growingworking capital need

Later stage finance 1-3 Medium Market expansion,acquisition & productdevelopment for profitmaking company

Buy out-in 1-3 Medium Acquisition financing

Turnaround 3-5 Medium tohigh

Turning around a sickcompany

Mezzanine 1-3 Low Facilitating public issueSource : Satish Taneja, Venture capital india, first edition, Galgotiapublishing company, page no. 18

Table: 5.10 stage wise financing

From the above we can say that threat from new entrants are low to moderate.

Because there are high entry barriers.

5.3.2 Rivalry among competitors:



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Investment pattern:

In venture capital industry, firms are investing on some basic criteria which theyhave decided by their own requirements. Here some companies are investing insome particular industries and some of them have also decided the stage of financingthe company. So Venture Capital firm investing in early seed stage does not directly

compete with the firm investing in the later stage, one investing in LBO, MBO andMBI deals. So the competition between stages is moderate while It is high within thestages. So the overall competition ismoderate to high.

Company Seedstage

Start upstage

Earlystage

Laterstage

IDBI venture fund 50 63 1 2ICICI venture funds 5 109 68 73SIDBI 5 19 2 3RCTC veture capital fund scheme 6 43 3 7

CANBANK VC fund LTD 2 40 3 13Gujrat venture capital funds 1995 0 7 0 8Industrial venture capital Ltd. 8 17 19 12

(source: Venture Capital in India by Satish Taneja , Galgotia PublishingCompany, Pg No.245 to 288)

Table: 5.12 companies stage wise investment

3. Effect of Globalization:


Top VC Investments

Company

TutorVista

Sector

Online Services(Remote Tutoring)

Amount(US$ M)

18.0

Investors

Sequoia Capital India,Lightspeed Ventures

ConnectivaSystemsSeventymm

CommunicationsTech (RevenueAssurance)

17.0 IFC, NEA-IUV, SAPVentures, Others

Online Services(Video Rental)

12.0 NEA-IUV, ePlanetVentures, Matrix PartnersIndia,DFJ

Equitas MicroFinance

Microfinance 12.0 Bellwether, Others

HaloSource Water Purifiers 11.5 Origo Sino-India, UnileverTech Ventures

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Formerly whenever money was invested in a company, many factors wereconsidered---the kind of market available for the product, the economic viability,and its place in the stock market. Today however globalization is a factor to contendwith. The investors want to be the 1st in the market to be associated with somethingthat is really hot and are prepared to take the high risk factor in their stride

because they know that it is likely to produce tremendously high returns. sobecause of less concerned about other factors investors are looking only for thereturns thus the competition among players is moderate to high.

4. Fast growing market

CAGR OF VC

1160

14234

0

2000

4000

6000

8000

10000

12000

14000

16000

2000 2007

VALUEOFDEALS

43%

Source: www.ivca.com

Figure: 5.18 CAGR of venture capital industryWe can see from the chart that the market is growing at 43% CAGR. As we knowmarket will grow only if the demand for services is increasing which will attract new

entrants to the market and will also led the existing players think on the matter howto handle new entrants and how to compete with other existing players. So thegrowth rate will increase the competition among rivalry.

5. Emerging sectors:

In todays world new entrepreneurs are entering in businesses which lead to increase incompetition and also give ari

multi mutual funds

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