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FOREWORD

Venture Capital in India

FOREWORD

The Venture capital sector is the most vibrant industry in the financial market today. Venture capital is money provided by professionals who invest alongside management in young, rapidly growing companies that have the potential to develop into significant economic contributors. Venture capital is an important source of equity for start-up companies.

Venture capital can be visualized as your ideas and our money concept of developing business. Venture capitalists are people who pool financial resources from high networth individuals, corporates, pension funds, insurance companies, etc. to invest in high risk - high return ventures that are unable to source funds from regular channels like banks and capital markets. The venture capital industry in India has really taken off in. Venture capitalists not only provide monetary resources but also help the entrepreneur with guidance in formalizing his ideas into a viable business venture.

Five critical success factors have been identified for the growth of VC in India, namely:

The regulatory, tax and legal environment should play an enabling role as internationally

venture funds have evolved in an atmosphere of structural flexibility, fiscal neutrality and operational adaptability.

Resource raising, investment, management and exit should be as simple and flexible as needed and driven by global trends.

Venture capital should become an institutionalized industry that protects investors and investee firms, operating in an environment suitable for raising the large amounts of risk capital needed and for spurring innovation through start-up firms in a wide range of high growth areas.

In view of increasing global integration and mobility of capital it is important that Indian venture capital funds as well as venture finance enterprises are able to have global exposure and investment opportunities

Infrastructure in the form of incubators and R&D need to be promoted using government support and private management as has successfully been done by countries such as the US, Israel and Taiwan. This is necessary for faster conversion of R&D and technological innovation into commercial products.With technology and knowledge based ideas set to drive the global economy in the coming millennium, and given the inherent strength by way of its human capital, technical skills, cost competitive workforce, research and entrepreneurship, India can unleash a revolution of wealth creation and rapid economic growth in a sustainable manner. However, for this to happen, there is a need for risk finance and venture capital environment which can leverage innovation, promote technology and harness knowledge based ideas.

A BRIEF HISTORY

The story of venture capital is very much like the history of mankind. In the fifteenth century, Christopher Columbus sought to travel westwards instead of eastwards from Europe and so planned to reach India. His far fetched idea did not find favour with the King of Portugal, who refused to finance him. Finally, Queen Isabella of Spain, decided to fund him and the voyages of Christopher Columbus are now empanelled in history. And thus evolved the concept of Venture Capital.

The modern venture capital industry began taking shape in the post World War 2. It is often said that people decide to become entrepreneurs because they see role models in other people who have become successful entrepreneurs. Much the same can be said about venture capitalists. The earliest members of the organized venture capital industry had several role models, including these three:

American Research and Development Corporation:

Formed in 1946, whose biggest success was Digital Equipment. The founder of ARD was General Georges Doroit, a French-born military man who is considered "the father of venture capital." In the 1950s, he taught at the Harvard Business School. His lectures on the importance of risk capital were considered quirky by the rest of the faculty, who concentrated on conventional corporate management.

J.H. Whitney & Co:

Also formed in 1946, one of whose early hits was Minute Maid juice. Jock Whitney is considered one of the industrys founders.

The Rockefeller Family:

L S Rockefeller, one of whose earliest investments was in Eastern Airlines, which is now defunct but was one of the earliest commercial airlines.

INTRODUCTION TO VENTURE CAPITAL

Venture Capital is defined as providing seed, start-up and first stage finance to companies and also funding expansion of companies that have demonstrated business potential but do not have access to public securities market or other credit oriented funding institutions.

Venture Capital is generally provided to firms with the following characteristics:

Newly floated companies that do not have access to sources such as equity capital and/or other related instruments.

Firms, manufacturing products or services that have vast growth potential.

Firms with above average profitability.

Novel products that are in the early stages of their life cycle.

Projects involving above-average risk.

Turnaround of companies.

Venture Capital derives its value from the brand equity, professional image, constructive criticism, domain knowledge, industry contacts, they bring to table at a significantly lower management agency cost.

A Venture Capital Fund (VCF) strives to provide entrepreneurs with the support they need to create up-scalable business with sustainable growth, while providing their contributors with outstanding returns on investment, for the higher risks they assume.

The three primary characteristics of venture capital funds which make them eminently suitable as a source of risk finance are:

that it is equity or quasi equity investment

it is long term investment and

it is an active form of investment.

Difference between a Venture Capitalist and Bankers/Money Managers

Banker is a manager of other people's money while the venture capitalist is basically an investor.

Venture capitalist generally invests in new ventures started by technocrats who generally are in need of entrepreneurial aid and funds.

Venture capitalists generally invest in companies that are not listed on any stock exchanges. They make profits only after the company obtains listing.

The most important difference between a venture capitalist and conventional investors and mutual funds is that he is a specialist and lends management support and also

Financial and strategic planning

Recruitment of key personnel

Obtain bank and other debt financing

Access to international markets and technology

Introduction to strategic partners and acquisition targets in the region

Regional expansion of manufacturing and marketing operations

Obtain a public listing

Difference between Venture Finance & Debt Finance

Venture FinanceDebt Finance

ObjectiveMaximize ReturnInterest payment

Holding Period2-5 yearsShort/Long term

InstrumentsCommon shares, Convertible bonds, Options, WarrantsLoan, Factoring,leasing

PricingPrice earnings ratio, net tangible assets Interest spread

CollateralVery RareYes

OwnershipYes No

ControlMinority shareholders, rights protection, board membersCovenants

Impact on B/S Reduced LeverageIncreased Leverage

Exit MechanismPublic offering, Sale to third party, Sale to entrepreneurLoan repayment

VENTURE CAPITAL IN INDIA

Most of the success stories of the popular Indian entrepreneurs like the Ambanis and Tatas had little to do with a professionally backed up investment at an early stage. In fact, till very recently, for an entrepreneur starting off on his own personal savings or loans raised through personal contacts/financial institutions.

Traditionally, the role of venture capital was an extension of the developmental financial institutions like IDBI, ICICI, SIDBI and State Finance Corporations (SFCs). The first origins of modern Venture Capital in India can be traced to the setting up of a Technology Development Fund (TDF) in the year 1987-88, through the levy of a cess on all technology import payments. TDF was meant to provide financial assistance to innovative and high-risk technological programs through the Industrial Development Bank of India. This measure was followed up in November 1988, by the issue of guidelines by the (then) Controller of Capital Issues (CCI). These stipulated the framework for the establishment and operation of funds/companies that could avail of the fiscal benefits extended to them.

However, another form of venture capital which was unique to Indian conditions also existed. That was funding of green-field projects by the small investor by subscribing to the Initial Public Offering (IPO) of the companies. Companies like Jindal Vijaynagar Steel, which raised money even before they started constructing their plants, were established through this route.

The industrys growth in India can be considered in two phases. The first phase was spurred on soon after the liberalization process began in 1991. According to former finance minister and harbinger of economic reform in the country, Manmohan Singh, the government had recognized the need for venture capital as early as 1988. That was the year in which the Technical Development and Information Corporation of India (TDICI, now ICICI ventures) was set up, soon followed by Gujarat Venture Finance Limited (GVFL). Both these organizations were

promoted by financial institutions. Sources of these funds were the financial institutions, foreign institutional investors or pension funds and high net-worth individuals. Though an attempt was

also made to raise funds from the public and fund new ventures, the venture capitalists had hardly any impact on the economic scenario for the next eight years.

However, it was realized that the concept of venture capital funding needed to be institutionalized and regulated. This funding requires different skills in assessing the proposal and monitoring the progress of the fledging enterprise. In 1996, the Securities and Exchange Board of India (SEBI) came out with guidelines for venture capital funds has to adhere to, in order to carry out activities in India. This was the beginning of the second phase in the growth of venture capital in India. The move liberated the industry from a number of bureaucratic hassles and paved the path for the entry of a number of foreign funds into India. Increased competition brought with it greater access to capital and professional business practices from the most mature markets.

There are a number of funds, which are currently operational in India and involved in funding start-up ventures. Most of them are not true venture funds, as they do not fund start-ups. What they do is provide mezzanine or bridge funding and are better known as private equity players. However, there is a strong optimistic undertone in the air. With the Indian knowledge industry finally showing signs of readiness towards competing globally and awareness of venture capitalists among entrepreneurs higher than ever before, the stage seems all set for an overdrive.

The Indian Venture Capital Association (IVCA) is the nodal center for all venture activity in the country. The association was set up in 1992 to co-ordinate the activities of venture capital financing in India and it has over the last few years, has built up an impressive database.

IVCA members function under different categories:

As companies involved in investment and fund management

As companies which set up funds and manage assets.

As companies which manage domestic funds, offshore funds, and sometimes both.

A comprehensive survey of the venture capital industry in India was done. This survey was conducted under the aegis of Indian Venture Capital Association (IVCA) by Thomson Financial (Venture Economics) and PRIME Database. The field survey was launched in October 2001 and completed in May 2002

Some Highlights of the Survey are as follows:

PRIVATE

In 2001, India ranked as third most active VC market in Asia Pacific (excluding Japan).

Venture funds invested $907.58 million in Indian companies in 2001, down 21.8% on 2000.

Number of companies receiving investment declined 62.6% to 101, from 270 in 2000.

VC funds disbursing investments declined to 57 in 2001 from 88 in 2000 but the average investment value of each deal rose from $3.85 million to $7.89 million.

Communications and media experienced the largest rise in investment in 2001, rising from $93.75 million in 2000 to $585.02 million.

Overall, India saw a shift to later stage investing with expansion stage funds accounting for 60.0% of disbursements in 2001, compared to 44.3% in 2000.

19 exits were achieved in 2001.

In India, venture funds are governed by the Securities and Exchange Board of India (SEBI) guidelines. For accessing venture capital funding the venture should be typically started by a first generation entrepreneur with high growth potential and an innovative concept. Normally these types of ventures do not have any assets to offer as collateral, which is needed to get funding from the conventional sources. Venture capital funding may be by way of investment in the equity of the new enterprise or a combination of debt and equity, though equity is the most preferred route.

There are a number of funds currently operational in India and involved in funding start-up ventures. Most of them are not true venture funds, as they do not fund start-ups. What they do is provide mezzanine or bridge funding and are better known as private equity players. However, all this has changed in the last one year. With the Indian knowledge industry finally showing signs of readiness towards competing globally and awareness of venture capitalists among entrepreneurs higher than ever before, venture capitalists are really venturing out in funding new ideas and concepts particularly in internet related areas.

Certain venture capital funds are Industry specific (i.e. they fund enterprises only in certain industries such as pharmaceuticals, Infotech or food processing) whereas others may have a much wider spectrum. Again, certain funds may have a geographic focus like Uttar Pradesh, Maharashtra, Kerala, etc whereas others may fund across different territories. The funds may be either close-ended schemes (with a fixed period of maturity) or open-ended.

CATEGORIZATION OF VC INVESTORS

The "venture funds" available could be from

Incubators

Angel Investors

Venture Capitalists (VCs)

Private Equity Players

IncubatorsAn incubator is a hardcore technocrat who works with an entrepreneur to develop a business idea, and prepares a Company for subsequent rounds of growth & funding. eVentures, Infinity are examples of incubators in India.

Angel Investors

An angel is an experienced industry-bred individual with high net worth.

Typically, an angel investor would:

invest only his chosen field of technology

take active participation in day-to-day running of the Company

invest small sums in the range of USD 1 - 3 million

not insist on detailed business plans

sanction the investment in up to a month

help company for "second round" of funding

The IndUS Entrepreneurs (TiE) is a classic group of angels like: Vinod Dham, Sailesh Mehta, Kanwal Rekhi, Prabhu Goel, Suhas Patil, Prakash Agarwal, K.B. Chandrashekhar. In India there is a lack of home grown angels except a few like Saurabh Srivastava & Atul Choksey (ex-Asian Paints).

Venture Capitalists (VCs)VCs are organizations raising funds from numerous investors & hiring experienced professional mangers to deploy the same. They typically:

invest at second stage

invest over a spectrum over industry/ies

have hand-holding mentor approach

insist on detailed business plans

invest into proven ideas/businesses

provide brand value to investee

invest between USD 2 5 million

Private Equity PlayersThey are established investment bankers. Typically:

invest into proven/established businesses

have financial partners approach

invest between USD 5 100 million

CLASSIFICATION OF VENTURE FUNDS

Venture funds in India can be classified on the basis of

Base formation Financial Institutions

1. Private venture funds like Indus, etc.

2. Regional funds like Warburg Pincus, JF Electra (mostly operating out of Hong Kong).

3. Regional funds dedicated to India like Draper, Walden, etc

4. Offshore funds like Barings, TCW, HSBC, etc.

5. Corporate ventures like Intel. To this list we can add Angels like Sivan Securities, Atul Choksey (ex Asian Paints) and others. Merchant bankers and NBFCs who specialized in "bought out" deals also fund companies. Most merchant bankers led by Enam Securities now invest in IT companies.

Invested Amount

The amount invested is generally between US$1mn or US$10mn. As most funds are of a private equity kind, size of investments has been increasing. IT companies generally require funds of about Rs30-40mn in an early stage which fall outside funding limits of most funds and that is why the government is promoting schemes to fund start ups in general, and in IT in particular.

Investment PhilosophyEarly stage funding is avoided by most of the venture capital firms since the amount of risk associated with it is higher and private capital cannot be invested. So to bring down this gap the seed capital or the early stage financing is provided by ICICI, Draper, SIDBI etc.

Value Addition

The infusion of funds by overseas funds, private individuals, angel investors and a host of financial intermediaries and the total pool of Indian Venture Capital today, stands at Rs50bn, according to industry estimates. In the last two years, there have been just 74 initial public offerings (IPOs) at the stock exchanges, leading to an investment of just Rs14.24bn. Thats less than 12% of the money raised in the previous two years. That makes the conservative estimate of Rs36bn invested in companies through the Venture Capital/Private Equity route all the more significant.

Consortium Financing

Where the project cost is high (Rs 100 million or more) and a single fund is not in a position to provide the entire venture capital required then venture funds may act in consortium with other funds and take a lead in making investment decisions. This helps in diversifying risk but however it has not been very successful in the India case.

Some of the companies that have received funding through this route include:

Mastek one of the oldest software houses in India

Geometric Software a producer of software solutions for the CAD/CAM market

SQL Star, Hyderabad based training and software development company

Satyam Infoway, the first private ISP in India

Rediff on the Net, Indian website featuring electronic shopping, news, chat, etc

Planetasia.com, Microlands subsidiary, one of Indias leading portals

Torrent Networking, pioneer of Gigabit-scaled IP routers for inter/intra nets

Selectica, provider of interactive software selection

Yantra, ITLInfosys US subsidiary, solutions for supply chain management.

The infotech companies are the most favored by venture capitalists, companies from other sectors also feature equally in their portfolios. The other sectors such as pharmaceutical, medical appliances and biotechnology industries also get much preference. With the deregulation of the telecom sector, telecommunications industries have joined the list of favorites. However, recent developments have shown that India is maturing into a more developed marketplace, unconventional investments in a gamut of industries have sprung up all over the country.

VENTURE CAPITAL INVESTMENT PROCESS

In generating a deal flow, the venture capital investor creates a pipeline of deals or investment opportunities that he would consider investing in. This is achieved primarily through plugging into an appropriate network. The most popular network obviously is the network of venture capital funds/investors. It is also common for venture capitals to develop working relationships with R&D institutions, academia, etc, which could potentially lead to business opportunities.

Understandably the composition of the network would depend on the investment focus of the venture capital funds/company. Thus venture capital funds focussing on early stage technology based deals would develop a network of R&D centers working in those areas. The network is crucial to the success of the venture capital investor. It is almost imperative for the venture capital investor to receive a large number of investment proposals from which he can select a few good investment candidates finally.

First, you need to work out a business plan. The business plan is a document that outlines the management team, product, marketing plan, capital costs and means of financing and profitability statements.

1. Initial Evaluation: This involves the initial process of assessing the feasibility of the project.

2. Due diligence: In this stage an in-depth study is conducted to analyse the feasibility of the project.

3. Deal structuring and negotiation: Having established the feasibility, the instruments that give the required return are structured.

4. Investment valuation

5. Documentation: This is the process of creating and executing legal documents to protect the interest of the venture.

6. Monitoring and Value addition: In this stage, the project is monitored by executives from the venture fund and undesirable variations from the business plan are dealt with.

7. Exit: This is the final stage where the venture capitalist devises a method to come out of the project profitably.

1. Initial Evaluation: Before any in depth analysis is done on a project, an initial screening is carried out to satisfy the venture capitalist of certain aspects of the project. These include

Competitive aspects of the product or service

Outlook of the target market and their perception of the new product

Abilities of the management team

Availability of other sources of funding

Expected returns

Time and resources required from the venture capital firm

Through this screening the venture firm builds an initial overview about the

Technical skills, experience, business sense, temperament and ethics of the promoters

The stage of the technology being used, the drivers of the technology and the direction in which it is moving.

Location and size of market and market development costs, driving forces of the market, competitors and share, distribution channels and other market related issues

Financial facts of the deal

Competitive edge available to the the company and factors affecting it significantly

Advantages from the deal for the venture capitalist

Exit options available

2.Due diligenceDue diligence is term used that includes all the activities that are associated with investigating an investment proposal to assess feasibility. It includes carrying out in-depth reference checks on the proposal related aspects such as management team, products, technology and market. Additional studies and collection of project-based data are done during this stage. The important feature to note is that venture capital due diligence focuses on the qualitative aspects of an investment opportunity.

Areas of due diligence would include

General assessment

Business plan analysis

Contract details

Collaborators

Corporate objectives

SWOT analysis

Time scale of implementation

People

Managerial abilities, past performance and credibility of promoters

Financial background and feedback about promoters from bankers and previous lenders

Details of Board of Directors and their role in the activities

Availability of skilled labour

Recruitment process

Products/services, technology and process

In this category the type of questions asked will depend on the nature of the industry into which the company is planning to enter. Some of the areas generally considered are

Technical details, manufacturing process and patent rights

Competing technologies and comparisons

Raw materials to be used, their availability and major suppliers, reliability of these suppliers

Machinery to be used and its availability

Details of various tests conducted regarding the new product

Product life-cycle

Environment and pollution related issues

Secondary data collection on the product and technology, if so available

Market

The questions asked under this head also vary depending on the type of product. Some of the main questions asked are

Main customers

Future demand for the product

Competitors in the market for the same product category and their strategy

Pricing strategy

Potential entrants and barriers to entry

Supplier and buyer bargaining power

Channels of distribution

Marketing plan to be followed

Future sales forecasts

Finance

Financial forecasts for the next 3-5 years

Analysis of financial reports and balance sheets of firms already promoted or run by the promoters of the new venture

Cost of production

Wage structure details

Accounting process to be used

Financial report of critical suppliers

Returns for the next 3-5 years and thereby the returns to the venture fund

Budgeting methods to be adopted and budgetary control systems

External financial audit if required

Sometimes, companies may have experienced operational problems during their early stages of growth or due to bad management. These could result in losses or cash flow drains on the company. Sometimes financing from venture capital may end up being used to finance these losses. They avoid this through due diligence and scrutiny of the business plan.

3. Structuring a deal:

Structuring refers to putting together the financial aspects of the deal and negotiating with the entrepreneurs to accept a venture capitals proposal and finally closing the deal. Also the

structure should take into consideration the various commercial issues (i.e. what the entrepreneur wants and what the venture capital would require to protect the investment). The instruments to be used in structuring deals are many and varied. The objective in selecting the instrument would be to maximize (or optimize) venture capitals returns/protection and yet satisfy the entrepreneurs requirements.

The instruments could be as follows:

InstrumentIssues

Equity sharesNew or vendor shares

Par value

Partially-paid shares

Preference sharesRedeemable (conditions under Company Act)

Participating

Par value

Nominal shares

LoanClean v/s Secured

Interest bearing v/s Non interest bearing

convertible v/s one with features (warrants)

1st Charge, 2nd Charge,

Loan v/s Loan stock

Maturity

WarrantsExercise price, Exercise period

OptionsExercise price, Exercise period, call, put

In India, straight equity and convertibles are popular and commonly used. Nowadays, warrants are issued as a tool to bring down pricing. A variation that was first used by PACT and TDICI was "royalty on sales". Under this, the company was given a conditional loan. If the project was successful, the company had to pay a percentage of sales as royalty and if it failed then the amount was written off.

In structuring a deal, it is important to listen to what the entrepreneur wants, but the venture capital comes up with his own solution. Even for the proposed investment amount, the venture capital decides whether or not the amount requested, is appropriate and consistent with the risk

level of the investment. The risks should be analyzed, taking into consideration the stage at which the company is in and other factors relating to the project. (e.g. exit problems, etc).

A typical proposal may include a combination of several different instruments listed above. Under normal circumstances, entrepreneurs would prefer venture capitals to invest in equity, as this would be the lowest risk option for the company. However from the venture capitals point of view, the safest instrument, but with the least return, would be a secured loan. Hence, ultimately, what you end up with would be some instruments in between which are sold to the entrepreneur. A number of factors affect the choice of instruments, such as

CategoriesFactors influencing the choice of Instrument

Company specific

Risk, current stage of operation, expected profitability, future cash flows, investment liquidity options.

Promoter specific

Current financial position of promoters, performance track record, willingness of promoters to dilute stake.

Product/Project specific

Future market potential, product life cycle, gestation period.

Macro environment

Tax options on different instruments, legal framework, policies adopted by competition.

4. Investment valuation:The investment valuation process is an exercise aimed at arriving at an acceptable price for the deal. Typically in countries where free pricing regimes exist, the valuation process goes through the following steps:

1) Evaluate future revenue and profitability

2) Forecast likely future value of the firm based on experienced market capitalization or expected acquisition proceeds depending upon the anticipated exit from the investment.

3) Target ownership positions in the investee firm so as to achieve desired appreciation on the proposed investment. The appreciation desired should yield a hurdle rate of return on a Discounted Cash Flow basis.

4) Symbolically the valuation exercise may be represented as follows:

NPV = [(Cash)/(Post)] x [(PAT x PER)] x k,

Where

a) NPV = Net Present Value of the cash flows relating to the investment comprising outflow by way of investment and inflows by way of interest/dividends (if any) and realization on exit. The rate of return used for discounting is the hurdle rate of return set by the venture capital investor.

b) Post = Pre + Cash

c) Cash represents the amount of cash being brought into the particular round of financing by the venture capital investor.

d) Pre is the pre-money valuation of the firm estimated by the investor. While technically it is measured by the intrinsic value of the firm at the time of raising capital. It is more often a matter of negotiation driven by the ownership of the company that the venture capital investor desires and the ownership that founders/management team is prepared to give away for the required amount of capital

e) PAT is the forecast Profit after tax in a year and often agreed upon by the founders and the investors (as opposed to being arrived at unilaterally). It would also be the net of preferred dividends, if any.

f) PER is the Price-Earning multiple that could be expected of a comparable firm in the industry. It is not always possible to find such a comparable fit in venture capital situations. That necessitates, therefore, a significant degree of judgement on the part of the venture capital to arrive at alternate PER scenarios.

g) k is the present value interest factor (corresponding to a discount rate r) for the investment horizon.

It is quite apparent that PER time PAT represents the value of the firm at that time and the complete expression really represents the investors share of the value of the investee firm. In reality the valuation of the firm is driven by a number of factors. The more significant among these are:

Overall economic conditions: A buoyant economy produces an optimistic long- term outlook for new products/services and therefore results in more liberal pre-money valuations.

Demand and supply of capital: when there is a surplus of venture capital of venture capital chasing a relatively limited number of venture capital deals, valuations go up. This can result in unhealthy levels of low returns for venture capital investors.

Specific rates of deals: such as the founders/management teams track record, innovation/ unique selling propositions (USPs), the product/service size of the potential market, etc affects valuations in an obvious manner.

The degree of popularity of the industry/technology in question also influences the pre-money. Computer Aided Skills Software Engineering (CASE) tools and Artificial Intelligence were one time darlings of the venture capital community that have now given place to biotech and retailing.

The standing of the individual venture capital: Well established venture capitals who are sought after by entrepreneurs for a number of reasons could get away with tighter valuations than their less known counterparts.

Investors considerations could vary significantly: A study by an American venture capital, Venture One, revealed the following trend. Large corporations who invest for strategic advantages such as access to technologies, products or markets pay twice as much as a professional venture capital investor, for a given ownership position in a company but only half as much as investors in a public offering.

Valuation offered on comparable deals around the time of investing in the deal.

Quite obviously, valuation is one of the most critical activities in the investment process. It would not be improper to say that the success for a fund will be determined by its ability to value/price the investments correctly. Sometimes the valuation process is broadly based on thumb rule metrics such as multiple of revenue. Though such methods would appear rough and ready, they are often based on fairly well established industry averages of operating profitability and assets/capital turnover ratios.

Such valuation as outlined above is possible only where complete freedom of pricing is available. In the Indian context, where until recently, the pricing of equity issues was heavily regulated, unfortunately valuation was heavily constrained.

5. DocumentationIt is the process of creating and executing legal agreements that are needed by the venture fund for guarding of investment.

Based on the type of instrument used the different types of agreements are

Equity Agreement

Income Note Agreement

Conditional Loan Agreement

Optionally Convertible Debenture Agreement etc.

There are also different agreements based on whether the agreement is with the promoters or the company. The different legal documents that are to be created and executed by the venture firm are

Shareholders agreement: This agreement is made between the venture capitalist, the company and the promoters. The agreement takes into account

Capital structure

Transfer of shares: This lays the condition for transfer of equity between the equity holders. The promoters cannot sell their shares without the prior permission of the venture capitalist.

Appointment of Board of Directors

Provisions regarding suspension/cancellation of the investment. The issues under which such cancellation or suspension takes place are default of covenants and conditions, supply of misleading information, inability to pay debts, disposal and removal of assets, refusal of disbursal by other financial institutions, proceedings against the company, and liquidation or dissolution of the company.

Equity subscription agreement: This is the agreement between the venture capitalist and the company on

Number of shares to be subscribed by the venture capitalist

Purpose of the subscription

Pre-disbursement conditions that need to be met

Submission of reports to the venture capitalist

Currency of the agreement

Deed of Undertaking: The agreement is signed between the promoters and the venture capitalist wherein the promoter agrees not to withdraw, transfer, assign, pledge, hypothecate etc their investment without prior permission of the venture capitalist. The promoters shall not diversify, expand or change product mix without permission. Income Note Agreement: It contains details of repayment, interest, royalty, conversion, dividend etc.

Conditional Loan Agreement: It contains details on the terms and conditions of the loan, security of loan, appointment of nominee directors etc.

Deed of Hypothecation, Shortfall Undertaking, Joint and Several Personal Guarantee, Power of Attorney etc.

Whenever there is a modification in any of the agreements, then a Supplementary Agreement is created for the same.

6. Monitoring and follow up:The role of the venture capitalist does not stop after the investment is made in the project. The skills of the venture capitalist are most required once the investment is made. The venture capitalist gives ongoing advice to the promoters and monitors the project continuously.

It is to be understood that the providers of venture capital are not just financiers or subscribers to the equity of the project they fund. They function as a dual capacity, as a financial partner and strategic advisor.

Venture capitalists monitor and evaluate projects regularly. They are actively involved in the management of the of the investor unit and provide expert business counsel, to ensure its survival and growth. Deviations or causes of worry may alert them to potential problems and they can suggest remedial actions or measures to avoid these problems. As professional in this unique method of financing, they may have innovative solutions to maximize the chances of success of the project. After all, the ultimate aim of the venture capitalist is the same as that of the promoters the long term profitability and viability of the investor company.

The various styles are: Hands-on Style suggests supportive and direct involvement of the venture capitalist in the assisted firm through Board representation and regularly advising the entrepreneur on matters of technology, marketing and general management. Indian venture capitalists do not generally involve themselves on a hands-on basis bit they do have board representations.

Hands-off Style involves occasional assessment of the assisted firms management and its performance with no direct management assistance being provided. Indian venture funds generally follow this approach.

Intermediate Style venture capital funds awe entitled to obtain on a regular basis information about the assisted projects.

7. Exit:One of the most crucial issues is the exit from the investment. After all, the return to the venture capitalist can be realized only at the time of exit. Exit from the investment varies from the investment to investment and from venture capital to venture capital. There are several exit routes, buy-buck by the promoters, sale to another venture capitalist or sale at the time of Initial Public Offering, to name a few. In all cases specialists will work out the method of exit and decide on what is most profitable and suitable to both the venture capitalist and the investor unit and the promoters of the project.

At present many investments of venture capitalists in India remain on paper, as they do not have any means of exit. Appropriate changes have to be made to the existing systems in order that venture capitalists find it easier to realize their investments after holding on to them for a certain period of time. This factor is even more critical to smaller and mid sized companies, which are unable to get listed on any stock exchange, as they do not meet the minimum requirements for such listings. Stock exchanges could consider how they could assist in this matter for listing of companies keeping in mind the requirement of the venture capital industry.

To provide the lenders with additional security, a Special Purpose Vehicle (SPV) can be created, which would hold the shares bought back from the venture capitalist firm in a trust until the firm achieves a certain targeted rate of return. Meanwhile a certain proportion of the firms sale proceeds can be funneled directly to the SPV amortize the debt.

An exit via the capital market is certainly less expensive but this option is open only to the more established firms. A listing on a stock exchange, which would enable the venture capitalist to easily off-load his stake, is obviously a far more feasible proposition for a firm already in

existence for a few years than for a new venture. There are stiff capital requirements for listing on either the BSE or the NSE, the minimum capital requirement is RS. 10 Crore. While the OTCEI would have been an ideal solution for a young company contemplating listing, since its inception in 1992, the Exchange has been plagued by poor liquidity, negative returns and a general lack of investor interest.

Even if the OTCEI does manage to perk up, it cannot be expected that small startups will enlist. Global experience indicates that, despite liberal admission requirements, OTCEs for unlisted securities tend to be dominated by fast growing or medium size companies.Special Purpose Vehicle:

An account, administered by a third party, that holds shares bought back by the management in trust.

Advantages of SPV

Greater security for lenders

Improves credit rating

Lowers the cost of capital

Better management of debt repayment

Enables new ventures to raise funds

Disadvantage of SPV

Less control over cash flows generated by project

Tax treatment of SPV still unclear

Administration fees can be high

Requires intensive monitoring by trustee

ACCESSING VENTURE CAPITAL

There is a surge in the number of venture funds and the amount of funding available in the last

one year. The rejection ratio is very high, with very few of the proposals going beyond even the pre-evaluation stage. Choosing a venture capital fund to match your requirement is a difficult decision. Venture capital funds are broadly of two kinds - generalists or specialists. It is critical for the company to access the right type of fund, i.e. who can add value. This backing is invaluable as focused/ specialized funds open doors, assist in future rounds and help in strategy. Hence, it is important to choose the right venture capitalist. 1. The Business Plan

The first step towards accessing venture capital funding is the preparation of the business plan. The business plan should be able to provide information regarding the promoters, amount of funding needed and the time period for which it is needed and how this funding is going to be paid back to the VC. To answer the above fundamental queries of a venture capital firm the business plan is to be structured with the necessary information.

BUSINESS PLAN COVERAGE

1. Executive summary

A brief description of the company and the type of business

A summary of the business nature

A description of the experience and expertise of the management team

A summary of the product/service and competition

A summary of financial history and projections

Funds required and equity offered to the investors

A description of use of proceeds

The timing of returns on investment and exit routes offered to the investor

2. Business background

A brief history and nature of the business

The industry details of the business involved in

A summary of the future of the business

3. Product/service

A description of the product or service

The uniqueness of the product

The present status of the product, that is a concept, prototype or product ready for market

4. Market analysis

The size of the potential market and market niche being pursued

A projection of the trends and future size of the market place

The estimated market share

A description of the competition

The marketing channel

A summary of the potential customers

The possibility of related or new markets that can be developed

5. Sales and marketing strategy

The specific marketing techniques planned to be used

The pricing plans and comparisons with pricing adopted by competitors

The planned sales force and selling strategies for various accounts and markets

The specific approaches for capitalizing on each m marketing channel and comparison with other practices within the industry

Details of advertising and promotional plans

A description of customer service-which markets will be covered by direct sales force, which by distributors, representative or resellers

6. Production/operations

A description of the production process

Details of the production costs, including labour force, equipment, technology involved, extent of subcontract or outsourcing, supplier

7. Management

An organization chart showing the corporate structure

A summary of the board of directors and key employees and details of their skills and experience A list of the remuneration for all levels of staff

A proposed plan of how to retain key staff

8. Risk factors

A description of the major problems and risks relating to the industry, the company and the products market

9. Funds requested

A description of the type of financing, such as equity only or a combination of equity and loan, and stock options to the investor

The capital structure and ownership before and after the financing

10. Return on investment and exit

Details of the timing and expected return of the investment

A summary of the exit strategies, such as initial public offering, sale to a third party or management buyout

11. Use of proceeds

Specify how the capital will be spent, i.e. what amount of capital will go to which items

12. Financial summaries

A summary of the companys financial history and projections of three to five year period

Details of the principal accounting policies of the company and the major assumptions made about the projections

Appendices

Resumes of key management and employees

Detailed financial forecast and assumptions

Market research report

Company literature and brochures and pictures of the product A good business plan shows investors the quality and depth of a companys corporate leadership and indicates managements ability to reach stated goals. These factors lie at the heart of the decision of a venture capitalist to invest in the companys future.

2. Selection of Venture Capital Fund

After the business plan is completed, the next step is to select the venture capital fund, which is suitable to your proposal. The entrepreneur should first ascertain as to the investment strategy of the VC with regards to the sector in which the VC is interested as well as the stage at which he chooses to fund the project. Based on this information the entrepreneur should shortlist the suitable VCs who match his requirement and then approach them.

Financing from venture capital funds is available at various stages and different VCs provide funding in some or all of the stages. The various stages of financing are detailed below.

Stages of Financing

Venture capital can be provided to companies at different stages. These include:

I. Early-stage Financing

Seed Financing: Seed financing is provided for product development & research and to build a management team that primarily develops the business plan.

Startup Financing: After initial product development and research is through, startup financing is provided to companies to organise their business, before the commercial launch of their products.

First Stage Financing: Is provided to those companies that have expended their initial capital and require funds to commence large-scale manufacturing and sales.

II. Expansion Financing

Second Stage Financing: This type of financing is available to provide working capital for initial expansion of companies, that are experiencing growth in accounts receivable and inventories, and is on the path of profitability.

Mezzanine Financing: When sales volumes increase tremendously, the company, through mezzanine financing is provided with funds for further plant expansion, marketing, working capital or for development of an improved product.

Bridge Financing: Bridge financing is provided to companies that plan to go public within six to twelve months. Bridge financing is repaid from underwriting proceeds.

III. Acquisition Financing

As the term denotes, this type of funding is provided to companies to acquire another company. This type of financing is also known as buyout financing. It is normally advisable to approach more than one venture capital firm simultaneously for funding as there is a possibility of delay due to the various queries put by the VC. If the application for funding is finally rejected then approaching another VC at that point and going through the same process would cause delay. If the business plan is reviewed by more than one VC this delay can be avoided as the probability of acceptance will be much higher. The only problem with the above strategy is the processing fee required by a VC along with the business plan. If you are applying to more than one VC then there would be a cost escalation for processing the application. Hence a cost benefit analysis should be gone into before using the above strategy.

Normally the review of the business plan would take a maximum of one month and disbursal for the funds to reach the entrepreneur it would take a minimum of 3 months to a maximum of 6 months. Once the initial screening and evaluation is over, it is advisable to have a person with finance background like a finance consultant to take care of details like negotiating the pricing and structuring of the deal. Of course alternatively one can involve a financial consultant right from the beginning particularly when the entrepreneur does not have a management background.

REGULATORY SYSTEM

The venture capital operations in India are regulated by The Securities Exchange Regulation Board of India (SEBI). The following legal instruments are in operation:

SEBI Act 1992.

SEBI (venture capital funds)Regulations 1996

New sector regulations issued in September 2000

Highlight of Policy and Legal Framework

VCFs can be constituted as trust fund or Company. Separate vehicle for constitution and operation of venture funds such as limited liability partnership is yet to be introduced in the country

Any company or trust proposing to undertake venture capital investments is required to obtain certificate of registration from SEBI.

VCFs before raising any funds for investment are required to file placement memorandum with SEBI. Private placement memorandum can be issued only after expiry of 21 days from submission to SEBI.

VCFs can raise funds for investment through private placement route. Individual investor is required to invest minimum of Rs. 5 lakhs in venture capital fund. Raising of funds from public is restricted.

VCFs are required to invest 80 percent of funds raised in equity or equity related securities issued by companies whose securities are not listed or which are financially weak.

VCFs are barred from investing in company or institutions providing financial services venture capital funds which desire to claim exemption from income tax are required to follow rules given hereunder:

Registration with SEBI.

Claiming Income tax exemption in respect of dividend and capital gains income.

Not more than 40 percent of equity in a venture

80 percent of monies raised for investment are required to be invested in equity shares of domestic companies whose shares are not listed on recognised stock exchange

Shares of investee companies are required to be held for a period of at least 3 years. However, these shares can be sold either if they are listed on recognised stock exchange in India.

Under the SEBI's venture capital rules:

VCFs can be either company or trust.

There is no minimum capital adequacy requirement for venture capital funds.

Are allowed to take loans, donations or issue securities.

VCFs cannot be public companies - they need to contain a restriction on inviting the public to subscribe to securities.

VCFs are only allowed to carry the business of venture capital fund - cannot engaged in any other business.

Every VCF investor has to contribute at least Rs. 5 lacs.

VCFs shall not invest in the equity capital of a financial services company. This still allows investment in financial services companies, other than by way of equity capital.

Venture capital investments are required to be restricted to domestic companies engaged in business of

(i) software

(ii) Information Technology

(iii) Production of basic drugs in pharmaceuticals sector,

(iv) Bio-technology and

(v) Agriculture and allied other sectors etc.

Also in Union Budget 2002-2003

Indian companies are being permitted to invest upto US$ 100 million overseas.

Indian companies are being permitted to make overseas investments in joint ventures abroad by market purchases without prior approval up to 50 per cent of their net worth

SWOT ANALYSIS OF INDIAN VENTURE CAPITAL

Strengths Weakness

An effort initiated from within Home grown Increased awareness of venture capital More capital under management by VCFs Industry crossed learning curve More experienced Venture Capitalists, Intermediaries, and Entrepreneurs. Growing number of foreign trained professionals.

Global competition growing.

Moving towards international standards.

Offshore funds bring strong foreign ties

Matured capital market system

Electronic trading - through NSE & BSE

Valuation addition

Irreversible reform

Regulatory framework evolving Faddish

Limited exit option

Uncertainties

Political

Policy repatriation, Taxation

Bureaucratic meddling and rigid official attitude

Industry fragmented and polarized Mixed V.C culture.

Smaller funds with illiquid investments

Domestic fund raising difficult

Lack of transparency & corporate governance

Accounting standards

Poor legal administration

Difficult due diligence

Inadequate management depth

Valuation expectations unrealistic

Technical and Market evaluation difficult

Negligible minority protection rights

Inadequate corporate laws

Poor infrastructure

Opportunities Threats

Growth capital for strong companies and Buyouts of weak companies due to growing global competition.

Financial restructuring of over leveraged companies taking place.

Acquisition of quoted small / medium cap companies.

Pre money valuations low

Vast potential exists in turn around, MBO, MBI. Change in government politics with respect to

Structuring

Taxation

Threats from within

Explositive expansion and Over Exuberance of Investors.

Greed for very high returns

ISSUES FACING THE INDIAN VENTURE CAPITAL INDUSTRYThe Indian venture capital industry, at the present, is at crossroads. Following are the major issues faced by this industry.

1. Limitations on structuring of Venture Capital Funds (VCFs):

VCFs in India are structured in the form of a company or trust fund and are required to follow a three-tier mechanism-investors, trustee company and AMC. A proper tax-efficient vehicle in the form of Limited Liability Partnership Act which is popular in USA, is not made applicable for structuring of VCFs in India. In this form of structuring, investors liability towards the fund is limited to the extent of his contribution in the fund and also formalities in structuring of fund are simpler.

2. Problem in raising of funds: In USA primary sources of funds are insurance companies, pensions funds, corporate bodies etc; while in Indian domestic financial institutions, multilateral agencies and state government undertakings are the main sources of funds for VCFs. Allowing pension funds, insurance companies to invest in the VCFs would enlarge the possibility of setting up of domestic VCFs. Further, if mutual funds are allowed to invest upto 5 percent of their corpus in VCFs by SEBI, it may lead to increased availability of fund for VCFs.

3. Lack of Inventive to Investors:

Presently, high net worth individuals and corporates are not provided with any investments in VCFs. The problem of raising funds from these sources further gets aggravated with the differential tax treatment applicable to VCFs and mutual funds. While the income of the Mutual Funds is totally tax exempted under Section 10(23D) of the Income Tax Act income

of domestic VCFs which provide assistance to small and medium enterprise is not totally exempted from tax. In absence of any inventive, it is extremely difficult for domestic VCFs to raise money from this investor group that has a good potential.

4. Absence of angel investors:

In Silicon Valley, which is a nurturing ground for venture funds financed IT companies, initial/seed stage financing is provided by the angel investors till the company becomes eligible for venture funding. There after, Venture capitalist through financial support and value-added inputs enables the company to achieve better growth rate and facilitate its listing on stock exchanges. Private equity investors typically invest at expansion/ later stages of growth of the company with large investments. In contrast to this phenomenon, Indian industry is marked by an absence of angel investors.

5. Limitations of investment instruments: As per the section 10(23FA) of the Income Tax Act, income from investments only in equity instruments of venture capital undertakings is eligible for tax exemption; whereas SEBI regulations allow investments in the form of equity shares or equity related securities issued by company whose shares are not listed on stock exchange. As VCFs normally structure the investments in venture capital undertakings by way of equity and convertible instruments such as Optionally/ Fully Convertible Debentures, Redeemable Preference shares etc., they need tax breaks on the income from equity linked instruments.

Harmonization of SEBI regulations and income tax rules of CBDT would provide much required flexibility to VCFs in structuring the investment instruments and also availing of the tax breaks. Thus investments by VCFs by instruments other than equity can also be qualified for Tax exemption.

6. Domestic VCFs vis--vis Offshore Funds:

The domestic VCFs operations in the country are governed by the regulations as prescribed by SEBI and investment restrictions as placed by CBDT for availing of the tax benefits. They pay maximum marginal tax 35percent in respect of non-exempt income such as interest through Debentures etc., while off-shore Funds which are structured in tax havens such as Mauritius are able to overcome the investment restriction of SEBI and also get exemption from Income Tax under Tax Avoidance Treaties. This denies a level playing field for the domestic investors for carrying out the similar activity in the country.

7. Limitations on industry segments:

In sharp contrast to other countries where telecom, services and software bag the largest share of venture capital investments, in India other conventional sectors dominate venture finance. Opening up of restrictions, in recent time, on investing in the services sectors such as telecommunication and related services, project consultancy, design and testing services, tourism etc, would increase the domain and growth possibilities of venture capital.

8. Anomaly between SEBI regulations and CBDT rules:

CBDT tax rules recognize investment in financially weak companies only in case of unlisted companies as venture investment whereas SEBI regulations recognize investment in financially weak companies which offers an attractive opportunity to VCFs. The same may be allowed by CBDT for availing of tax exemption on capital gains at a later stage. Also SEBI regulations do not restrict size of an investment in a company. However, as per Income tax rules, maximum investment in a company is restricted to less than 20 per cent of the raised corpus of VCF and paid up share capital in case of Venture Capital Company. Further, investment in company is also restricted upto 40 per cent of equity of investee company. VCFs may place the investment restriction for VCFs by way of maximum equity stake in the company, which could be upto 49 per cent of equity of the Investee Company.

9. Limitations on Exit Mechanism:

The VCFs which have invested in various ventures have not been able to exit from their investments due to limited exit routes and also due to unsatisfactory performance of OTCEI. The threshold limit placed by various stock exchanges acts as deterrent for listing of companies with smaller equity base. SEBI can consider lowering of threshold limit for public/listing for companies backed by VCFs. Buy-back of equity shares by the company has been permitted for unlisted companies, which would provide exit route to investment of venture capitalists.

10. Limitation on application of sweet equity and ESOP:

In the US, an entrepreneur can declare that he has nothing much to contribute except for intellectual capital and still he finds venture capitalists backing his idea with their money. And when they come together, there is a way to structure the investment deal in such a manner that the entrepreneur can still ensure a controlling stake in the venture. In the US, the concept of par value of shares does not exist that allows the different par value shares. Absence of such mechanism puts limitations in structuring the deals.

Further, as per present tax structure in India, sweet equity and ESOP issued to entrepreneur and employees gets taxed twice at the time of acquisition and divestment. Tax incidence at two points involving undue hassles to allottees of sweat equity of individual, as a perquisite in its income, to the extent of 33 per cent defeats the entire purpose of its issue.

11. Legal framework:

Lack of requisite legal framework resulting in inadequate penalties in case of suppression of facts by the promoters-results in low returns even from performing companies. This has bearing on equity investments particularly in unlisted companies.

MEASURES TO BE PROVIDED

From the experience of Venture Capital activities in the developed countries and detailed case study of venture capital in India we can derive that the following measures needs to be provided to boost Venture Capital industry in India.

1. Social Awareness:

Lack of social awareness of the existence of venture capital industry has been observed. Hardly few know about the principal objectives and functions of the existing venture capital funds in the country and thus banking of the media is required to bridge the gulf between the society and the existing venture capital funds.

2. Deregulated Economic Environment:

A less regulated and controlled business and economic environment where an attractive customer opportunity exists or could be created for high-tech and quality products.

3. Fiscal Incentives:

Though Venture Capital funds like Mutual funds are exempted from paying tax on dividend income and long-term capital gains, from equity investment, unlike Mutual funds there are pre-conditions attached to the tax shelter. So it is imperative that the Government streamlines its guidelines on tax exemption for Venture Capital Funds.

4. Enterpreneurship And Innovation:

A broad-based (and less family based) entrepreneurial traditions and societal and governmental encouragement for innovation creativity and enterprise.

5. Marketing Thrust:

A vigorous marketing thrust, promotional efforts and development strategy employing new concepts such as venture fairs, venture clubs venture networks, business incubators etc., for the growth of venture capital.

6. A Statutory Co-ordination Body:

A harmonious co-ordination needs to be maintained among the technology institutes, professional institutes and universities who are the producers of future venture capital managers. The coordinating organ so formed is expected to ventilate an outline of the latest requirements of the venture capital funds management. Central Government should come forward to promote the referred coordination organ in the form of a statutory body. The coordination organ would not only maintain link with the domestic professional institutions, technology institutes and universities but also with the global venture capital funds in order to exchange the novel ideas that can help in standardizing Indian practice on venture capital funds.

7. Technological Competitiveness:

Encouragement and funding of R&D by private and public sector companies and the government for ensuring technological competitiveness.

8. Training and Development of Venture Capital Managers:

For the success of venture capital fund, be it privately owned or public sector financial institutions, strategies need to be found to promote entrepreneurship. For this, venture capital funds need professionals with initiative, drive and vision to identify such entrepreneurs who have sound & ideas and innovative vision. Unfortunately, such professionals are not easily available particularly in developing countries like India. Therefore management schools need to develop social training programs to train venture capital mangers in which risk taking and entrepreneurial attitude needs to be incubated.

9. Broad Knowledge Base:

A more general, business and entrepreneurship oriented education system where scientist and engineers have knowledge of accounting, finance and economics and accountants understand engineering or the physical sciences.

10. Exit Routes:

For venture capital funds, exits are crucial; going public is one way for the investors to be paid back. Current rules of companies going public in India insist on sustained track record of profits. For entrepreneur driven companies where value creation is through intellectual property patents, methodologies and processes, such norms are archaic. Venture capitalists earn through value creation leading to exits and not through dividends. Venture funds would prefer the company to invest back dividends into the business. As such the question of stream of dividends pay outs prior to IPO over three years as is required in India is a hindrance.

Another exit route can be repurchases of shares by promoters but it is an expensive way of assuring investors an exit bank roll. Inter accruals alone may not be adequate to backroll the repurchases and institutional funding for such buyouts is rarely forthcoming. Though there is no legal bar on such funding, but the risk of extending against the shares of newly established company have kept away most of the bank and financial institutions. Creative financial engineering can find a way around this problem. To provide the lenders with an additional degree of security, a special purpose vehicle (SPV) can be created which would hold the shares bought back from the venture capital firms in trust until the firm achieves a certain rate of return. Meanwhile, a certain proportion of the firms sales proceeds can be funneled directly to the SPV to amortize debt.

FUTURE OF VENTURE CAPITAL INDUSTRY IN INDIA

Venture capital has been a remarkable catalyst of entrepreneurial activity, after the Second World War, in many developed countries. It has led to significant growth in industry and innovation. The prospects for the Indian VC industry are no less humongous. It is up to the industry to reflect on its current predicament and evolve a strategy to seize the opportunity.

With due emphasis being given to the industry, there is lot of scope for development. Trying to put the domestic market on par with that in the U.S. may not be justified. Capital markets in India are still growing to maturity through transparency, liquidity and accountability of promoters. With this maturity, the venture capital market would also attain its maturity. Until such time, it is not fair or easy to compare markets in India to those in the U.S. In all emerging markets, the market practice will be ahead of regulation and there could be problems galore in the process of market maturing.

Despite the slump in the new economy sectors and the collapse of the dotcoms, venture capital companies are still buoyant about the Indian technology sector and a large sum of money is waiting to be invested. According to a recent estimate by the National Association of Software and Service Companies (Nasscom), the venture capital investment in India is slated to rise to massive Rs 50,000 crore by 2008, up from Rs 2,200 crore in 2000-01.

Trends for 2003

Most VCs believe that the next year will undoubtedly be better; driven by a relatively stable economy, with growth rates again picking up. The digital signature regime implemented by April 2002 will also offer a big boost to the e-commerce sectors especially e-banking and online trading.

It is estimated that total disbursements will be in the region of $ 2 billion, and fund raising for India-centric funds could increase significantly, driven by increased European interest.

Total VC disbursements in India were to the tune of about $1.1 billion in 2002 (as compared to $1.3 billion in the previous year), according to the IVCA. VCs feel that 2003 will see VC disbursements in the $2 billion range, with India centric capital to the tune of $1 billion to be raised in 2003.

According to VCs, the Indian market is one of the preferred markets in this part of the world right now. Things are poised for change over the next 3-6 months since the valuation gap between entrepreneur expectations and VC pricing has fallen when compared to last year.

As far as the areas of investment and deal sizes are concerned, most VCs feel that the market will favour large sized deals and probably even management buyouts. Growth or mezzanine stage capital will continue to occupy centrestage according to most VCs. As for startup funding--the views are mixed. Some VCs believe that startup stage funding is likely to surface again though a larger share of the capital will possibly be invested in listed companies, others will continue to remain bearish on startups since scaling up startups is a tough business.

Thus venture funds have been an engine for economic growth for over a decade in countries like USA, Israel, Taiwan. The situation is now ripe to be replicated in India. To foster innovation, new ventures have to work in a competitive & supportive environment which also needs financial backing from venture capitalists (VCs) and angel investors who will provide the venture not just with funds, but also with strategic management support.

CONCLUSION

The Indian Venture Capital (VC) industry is just about a decade old industry as compared to that in Europe and US. In this short span it has nurtured close to 1000 ventures, mostly in SME segment and has supported budding technocrat /professionals all through. The VC industry, through its investments in high growth companies as well as companies adopting newer technologies backed by first generation entrepreneurs, has made a substantial contribution to economy. In India, however, the potential of venture capital investments is yet to be fully realized. There are around 30 Venture capital funds, which have garnered over Rs.5000 crores.

The Indian venture capital industry is dominated by public sector financial institutions. A few private sector venture capital firms have been set up recently. VCFs in India are not pure venture capitalists. They pursue both commercial as well as developmental objectives. Venture finances is made available to high-tech as well as non-tech businesses. About two-thirds of the venture capital is invested in non-tech businesses. A large number of high-tech ventures financed by VCFs are in thrust areas of national priority such as energy conservation, quality upgradation, advanced materials, bio-technology, reduced material consumption, environment protection, improved international competitiveness, development of indigenous technology etc. Yet another feature of venture financing in India is that it is not readily available for development of prototypes or setting up of pilot plants at the laboratory stage.

Thus, venture capital in India resembles more a development capital than a true venture capital (for risk, high-tech ventures).

Venture capital can play a more innovative and developmental role in a developing country like India. It could help the rehabilitation of sick units through people with ideas and turnaround management skills. A large number of small enterprises in India become sick even before the commencement of production. Venture capitalists could also assist small ancillary units to

upgrade their technologies so that they could be in line with the developments taking place in their parent companies.

Yet another area where Venture Capital Funds (VCFs) can play a significant role in developing countries is the service sector, including tourism, publishing, health-care etc. They could also provide financial assistance to people coming out of the universities, technical institutes involving high risk. This would encourage the entrepreneurial spirit. It is not only initial funding which is needed from the venture capitalists but they also should simultaneously provide management and marketing expertise, which is the real critical aspect of venture capital in developing countries. Hence, the Government of India and Venture Capital firms/funds are required to strive hard to create the favourable environment needed to take-off the venture capital finance in India.

ANNEXURE 1

Indian Scenario A Statistical Snapshot

Contributors of funds - 2002

Contributors (Rs mn)

Per cent

Foreign Institutional Investors

13,426.47

52.46

All India Financial Institutions

6,252.90

24.43

Multilateral Development Agencies

2,133.64

8.34

Other Banks

1,541.00

6.02

Foreign Investors

570.00

2.23

Private Sector

412.53

1.61

Public Sector

324.44

1.27

Nationalized Banks

278.67

1.09

Non Resident Indians

235.50

0.92

State Financial Institutions

215.00

0.84

Other Public

115.52

0.45

Insurance Companies

85.00

0.33

Mutual Funds

4.5

0.0

Total25,595.17

100.00%

Financing by investment stage

Investment Stages

2001

2002

Seed Stage

5%9%

Start up41%40%

Other Early Stage18%20%

Later Stage35%30%

Turnaround1%1%

ANNEXURE 2

Brief Profile of major players

IDBI Venture Capital Fund:This was established in1986 with the objective to finance projects whose requirements range between Rs. 5 lakhs to 2.5 crores. The promoters stake should be at least 10percent for the ventures below Rs. 50 lakhs and 15percent for those above 50 lakhs. Financial assistance is extended in the form of unsecured loans involving minimum legal formalities. Interest at concessional rate of 9percent is charged during technology development and trial run of production stage and it will be 17percent once the product is commercially traded in the market by the financially assisted firm. IDBI venture capital funds extends its financial assistance to the ventures likely to be engaged in the fields of chemicals, computer software, electronics, bio-technology, non-conventional energy, food products, refractories and medical equipments.

Technology Development and Information Company of India Limited (TDICI):This venture Capital fund was jointly floated by Industrial Credit & Investment Corporation of India (ICICI) and Unit Trust of India (UTI) to finance the projects of professional technocrats who take initiative in designing and developing indigenous technology in the country. Technology Development and Information Company of India Limited (TDICI) was launched with an authorized capital base of Rs. 20 crores and the same was targeted to be increased to Rs. 40 to 50 crores. TDICI favours the firms seeking financial assistance for developing information technology, management consultancy, pharmaceutical, veterinary biological, environmental, engineering, non-conventional sources of energy and other innovative services in the country.

Unit Trust of India (UTI)In 1988-99 UTI set-up a venture capital fund of Rs. 20 crores in collaboration with ICICI for fostering industrial development. TDICI established by UTI jointly with ICICI acts as an advisor and manager of the fund. UTI launched venture capital unit scheme (VECAUS-I) to raise resources for this fund. It has set up a second venture capital fund in March 1990 with a capital of Rs. 100 crores with the objective of financing green field ventures and steering industrial development.

Risk Capital and Technology Finance Corporation Ltd. (RCTFC)IFCI had sponsored in 1985, Risk Capital Foundation (RCF) to give positive encouragement to the new entrepreneurs. RCF was converted into RCTFC on 12th January, 1988. It provides both risk capital and technology finance and roof to innovative entrepreneurs and technocrats for their technology oriented ventures.

Small Industrial Development Bank of India (SIDBI)Small Industrial Development Bank of India (SIDBI) has decided to set-up a venture capital fund in July 1993, exclusively for support to entrepreneurs in the small sector. Initially a corpus has been created by setting apart Rs. 10 crores. The fund would be augmented in future, depending upon requirements.

Andhra Pradesh Industrial Development Corporation (APIDC)APIDC Venture Capital Ltd. (APIDC-VCL) was promoted by APIDC with an authorized capital of Rs.2 million on 29th August 1989. Its main objective is to encourage technology-based ventures particularly those started by first generation technocrat entrepreneurs and ventures involving high risk in the state of Andhra Pradesh.

Gujarat Venture Finance Limited (GVFL)GVFL has been promoted by the Gujarat Industrial Investment Corporation Limited (GIIC) in 1990, to provide financial support to the ventures whose requirements range between 25 lakhs and 2 crores. Total corpus of Rs. 24 crores of the referred venture capital fund was co-financed by GIIC, state financial corporation, some private corporates and World Bank. The firms engaged in biotechnology, surgical instruments, conservation of energy and food processing industries are financed by GVFL.

Commercial Banks Sponsored Venture Capital FundsState Bank of India, Canara Bank, Grindlays Bank and many other banks have participated in the venture capital fund building Industry in order to provide financial assistance to the projects associated with high risks. SBI venture capital is monitored through SBI capital markets. Canbanks venture capital functions through Canbank. Financial services and India Investment Fund represents the venture capital launched by Grindlays Bank.

Some of the Private Sector Venture Capital Funds

ICICI ventures Fund Management

ICICI is the leading VC with $400 million. Starting with the objective of playing the role of a value added investors with a high technology focus ICICI in 1997-98, ICICI made 10 investments worth Rs 50 crore and it further increased to 37 with an investment of Rs 277 crore during 1999-2000.The momentum continued in next period also i.e., from April 2000 to September 2000, 35 investments were made with RS 290 crores. ICICI has set a record not only in making investments but also in exiting from the companies, which made them so successful.

20th Century Venture Capital Fund:

20th century venture capital fund has been established with a corpus of Rs. 20 crores promoted by 20th century finance company limited. The fund envisages focus on sick industries and first generation entrepreneurs.

Credit Capital Venture Fund (CCVF):

CCVF (India) Limited has been formed as a subsidiary of credit capital finance corporation limited in April1989. This fund has been promoted by nearly 15 major industrial houses in the country with the objectives of reviving sick units. It is the first private managed venture fund with a subscribed capital of Rs.10 crore contributed to the extent of Rs.6.5 crore by international financial agencies and the remaining raised through public subscription.

The other venture capitalists are as follows:

Alliance Venture Capital Advisors Ltd. Baring Private Equity Partners Chrysalis Capital CDC Advisors Private Ltd. Draper International eVentures India Feedback Ventures HBSC Private Equity Management Mauritius Ltd. ICF Ventures IL & FS Venture Corporation Ltd. Indus Venture Management Ltd. Infinity Ventures JF Electra Advisors (I) Ltd. Marigold Capital Services Ltd. Pathfinder Investment Company Private Ltd. Risk Capital & Technology Finance Corp. Ltd. Walden Nikko

BIBLIOGRAPHY

I.M Panday, Venture Captial: The Indian Experience

Annual Report of Indian Venture Capital Association-1998

Hashank Rajurkar: Issues Facing the Indian Venture Capital Industry, Productivity.

The Securities and Exchange Board of India - SEBI (Venture Capital Funds) Regulations, 1996

NVCA and Venture Economics - 2002 National Venture Capital Yearbook

Various newspapers and magazines

www.nasscom.org www.indiainfoline.com www.icfaipress.org www.thehindubusinessline.com www.gvfl.com www.vcline.com

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N. L. Dalmia Institute Of Management Studies