venture capital and entrepreneurial finance

8/8/2019 Venture Capital and Entrepreneurial Finance

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“VENTURE CAPITAL AND ENTREPRENEURAL FINANCE”

Y.M.Satish1, Jalauk.M.Ujalambkar 2, Nandana.Bhat3

ABSTRACT

Venture capital is a growing business of recent origin in the area of industrial financing in India.

The various financial institutions set-up in India to promote industries have done commendable

work. However, these institutions do not come up to the benefit of risky ventures when they are

undertaken by new or relatively unknown entrepreneurs. They contend to give debt finance,

mostly in the form of term loan to the promoters and their functioning has been more akin to that

of commercial banks. The financial institutions have devised schemes such as seed capital

scheme, Risk capital Fund etc., to help new entrepreneurs. However, to evaluate the projects and

extend financial assistance they follow the criteria such as safety, security, liquidity and

profitability and not potentially. The capital market with its conventional financial instruments/

schemes does not come much to the benefit or risky venture. New institutions such as mutual

funds, leasing and hire purchase Company’s have been established as another leasing and hire

purchase Company’s have been established as another source of finance to industries. These

institutions also do not mitigate the problems of new entrepreneurs who undertake risky and

innovative ventures.

India is poised for technological revolution with the emergence of new breed of entrepreneurs

with required professional temperament and technical knowhow. To make the innovative

technology of the entrepreneurs a successful business venture, support in all respects and more particularly in the form of financial assistance is all the more essential.

This paper highlights the current status of entrepreneurs in India and financial problems faced by

them along with this, the paper includes the solutions for these problems in terms of venture

capital, its trends and current status in India and growth potential of the venture capital is

concentrated.

This paper also distinguishes the venture capital from regular source of finance to the

entrepreneurs.

1. Asst. Professor, Department of Management Studies, M S Ramaiah Institute of Technology.

2. Student, Department of Management Studies, M S Ramaiah Institute of Technology.

3. Student, Department of Management Studies, M S Ramaiah Institute of Technology.



INTRODUCTION

A form of equity financing designed especially for funding high risk and high reward project is

known as Venture Capital. Venture capital plays an important role in financing hi tech projects,

besides helping research and development projects to turn into commercial production. By

financing the technology, venture capital assists in fostering the growth and development of

entrepreneurs. In western countries, much of this capital is used for establishing technology and

expanding business.

Venture capital derives its value from brand equity, professional image, constructive criticism,

domain knowledge, industry contacts etc as they bring to table the benefits at a significantly

lower management agency cost.

A Venture capital fund strives to provide entrepreneurs with the support they need to create

upscaleable business with sustainable growth, while providing their contributors with

outstanding returns on investment for the higher risks they assume.

Venture capital fund activities generally include financing new and rapidly growing companies

that are specially knowledge-based, sustainable, upscaleable companies, purchase equity/quesi-

equity securities, assisting in the development of new products or services, adding value to the

company through active participation, taking higher risks with the expectation of higher rewards

and having a long-term orientation.



VENTURE CAPITAL

Venture Capital (VC) represents funds made available for startup firms and small businesses that have the

potential to grow exceptionally. In most of the cases, an appreciable degree of managerial and technical

expertise is also provided. VC is a private equity capital and is also referred to as risk capital.

Venture Capital is typically provided for early-stage, high-potential, growth companies with a

view to generate an appreciable return. The investments are generally made in the form of cash in

exchange for shares in the invested company. The European Venture Capital Association has described it

as “risk finance for entrepreneurial growth oriented companies, and investments for medium or long

term to maximize returns. It is a partnership with the entrepreneur in which the investor can add value

to the company because of his knowledge and experience.”

Venture Capital typically comes from institutional investors and high net worth individuals

and is pooled together by dedicated investment firms. In India SEBI guidelines govern the operations of

the venture capital funds.

Characteristics of Venture Capital

Equity Participation

Venture financing is actual or potential equity participation through direct purchase of shares, options or

convertible securities. The objective is to make capital gains by selling of the investment once the

enterprise becomes profitable.

Long- term Investment

Venture financing is a long term illiquid investment in that it is not repayable on demand. It requires a

long-term investment attitude that requires VC firms to wait for a long period, say 5 to 10 years, to make

appreciable profits.

Participation in Management

Venture financing ensures continued participation of the venture capitalist in the management of the

business. This helps protect and enhance the investment through active involvement and support to the

business. More than finance, the venture capitalist gives his marketing, technology, planning and

management skills to the new firm.

http://www.investorwords.com/2130/funds.html


http://www.investorwords.com/4698/startup.html

http://www.investorwords.com/1967/firm.html

http://www.businessdictionary.com/definition/small-business.html


http://www.businessdictionary.com/definition/expertise.html

http://www.investorwords.com/4296/risk_capital.html

http://en.wikipedia.org/wiki/Growth_investing


http://en.wikipedia.org/wiki/Institutional_investors

http://en.wikipedia.org/wiki/High_net_worth_individuals


http://www.investorwords.com/4698/startup.html

http://www.investorwords.com/1967/firm.html


http://www.businessdictionary.com/definition/expertise.html

http://www.investorwords.com/4296/risk_capital.html


http://en.wikipedia.org/wiki/Institutional_investors





Stages of Financing

Source: 1000ventures.com

Seed or Concept Stage Financing: While in this stage, the venture is still in an idea formation

stage and its product and service is not fully developed. The investor is usually given a small

amount of capital to come up with a working prototype of the intended product.

Start-up Financing: The venture capitalist provides the start-up financing when the firm is set

up to manufacture a product or provide a service. This is to facilitate full scale manufacturing

and further business growth

First-stage Financing: With the venture finally launched & initial transactions achieved, sales

tend to grow upwards. The funding from this stage is used to propel sales, attain established

breakeven, increase production, enhance productivity, cut unit costs, and build the corporate

infrastructure and the distribution system.

Second-stage Financing: Sales at this stage start to increase at a fast pace. The company rapidly

accumulates account receivables and inventory. As this is a period of rapid growth, capital from

this stage is used for funding expansion activities such as meeting increasing marketing expenses

to enter new markets, to finance rapidly increasing account receivables, and to add product lines

where applicable.



Third stage Financing: At this stage, the future of the firm is very bright as sales continue to

grow rapidly, Customers are happy. Money from this stage is used to increase plant capacity,

marketing, working capital, product improvement and further expansion.

Bridge Financing: At this stage, the firm is a success and investment bankers agree to take it

public within about 6 months’ time. Bridge financing is a short-term form of financing used to

prepare a company for its IPO.

Methods of Venture Financing

The financing pattern of the deal is an extremely important element in venture financing.

Venture financing can take different form such as those outlined below.

Equity: Equity is the most desirable form of financing. VC firms participating in equity do so

through direct purchase of shares but their stake does not exceed 49%. These shares are retained

by them till the assisted projects making profit. The shares are then sold either to the promoter at

a negotiated price under buy back agreement or to the general public in the secondary market at a

profit.

Conditional Loan: In this form of venture financing, an interest free loan is provided during the

implementation period under the condition that royalty be paid on sales. The loan is to be repaid

according to a pre-determined schedule as soon as the company starts generating sales and

income. No interest is paid on these loans. In India, royalty charges are typically between 2 and

15 %; the actual rate depends on various factors such as gestation period, cost flow patterns, risk

and other factors.

Conventional Loan: In this form of assistance, a lower fixed rate of interest is charged till the

assisted units become commercially operational, after which the loan carries normal or higher rate of interest. The loan has to be repaid according to a pre-determined schedule of repayment

as per terms of loan agreement.

Income Note: This method is unique to India. It is a hybrid security which combines the feature

of both conventional and conditional loan. The entrepreneur has to pay both interest and royalty

on sales, but at substantially low rates.



VENTURE CAPITAL IN INDIA

The venture capital industry in India is of relatively recent origin. The venture capital funds and

venture capital companies in India were regulated by the Guidelines issued by the Controller of

Capital Issues, Government of India, in 1988. In 1995, Securities and Exchange Board of India

Act was amended which empowered SEBI to register and regulate the Venture Capital Funds in

India. Subsequently, in December, 1996 SEBI issued its regulations in this regard. These

regulations replaced the Government Guidelines issued earlier.

Financial Problems faced by Entrepreneurs:

Source: Problems Entrepreneurs Face, by Gwen Richtermeyer, Ph.D.Director.

Venture Capital Funds in India: Venture funds in India can be classified on the basis of

the type of promoters:

1.VCFs promoted by the Central govt. controlled development financial institutions

Technology Development and Information Company of India Ltd. (TDICI), by ICICI

• Risk capital and Technology Finance Corporation Limited (RCTFC) by the IndustrialFinance Corporation of India (IFCI)



• Risk Capital Fund by IDBI.

2. VCFs promoted by the state government-controlled development finance institutions

• Andhra Pradesh Venture Capital Limited (APVCL) by Andhra Pradesh State Finance

Corporation (APSFC) and

• Gujarat Venture Finance Company Limited (GVCFL) by Gujarat Industrial InvestmentCorporation (GIIC)

3. VCFs promoted by Public Sector banks

• Can Bank Venture Capital Fund by Canara Bank

• SBI-Cap by State Bank of India.

4. VCFs promoted by the foreign banks or private sector companies and financial

institutions such as:

• Indus Venture Fund

• Credit Capital Venture Fund

• Grindlay's India Development Fund.

How to Finance Startup Business:

How entrepreneurs finance their company is one of the most critical decisions that they willmake during the course of their startup. The structure of their financing will be one of the keydrivers of the financial return from their venture. There are financing structures for companiesthat have small potential and structures for companies that have big potential. There is not a onesize fits all strategy for capitalizing a company.

Ultimately, financing a startup properly boils down to aligning the financing structure with the business opportunity and capital needs. In other words, the way in which you elect to financeyour company should at a high-level be determined by 1) how big of a business opportunity it presents and 2) how much capital is required to breakeven. While there are a number of other considerations, but I would argue that these are the first two dimensions to consider as theyshould help entrepreneurs more quickly find the right direction for their financial strategy. The2x2 chart below should help to illustrate how to think about which fundraising category that theyare in.



Venture Capital: If you have a big idea that can generate at least $50M in revenue and the business requires millions of dollars to get the company to a cash flow positive position, youshould probably pursue venture capital.

Not Viable: If your business requires significant capital, but is not poised to become a large business you may not be able to find a viable funding source. You will either need to find dumb money or trick savvy investors into believing your company has bigger prospects. If your company falls into this category, you should probably go back to the drawing board and find

another opportunity to pursue.

Bootstrap: If you have the potential to build a small business - one that generates single-digit or low double-digit millions in revenue - while requiring little capital to achieve breakeven, youhave a lifestyle business. In my opinion lifestyles business are best financed when the founderstake as little outside capital as possible - these are companies where it's really only exciting for founders if they own a large percentage of the equity. Additionally, by raising less capitalentrepreneurs will be able to avoid accruing a large amount of liquidity preference. If there is asignificant amount of liquidity preference in the company, it may be difficult for theentrepreneurs to realize a meaningful payout when the sell the company.

http://www.markpeterdavis.com/getventure/2009/05/what-is-dumb-money.html


http://www.markpeterdavis.com/getventure/2008/07/preferred-sto-2.html


http://www.markpeterdavis.com/.a/6a00e0098c5051883301157115a21e970c-pi






Industry Investments:

The above graph shows the venture capital investment in different industries till 2006. It is

observed from the figure that major portion of the investments is in construction and real estate

and bio technology industries.

Fresh Investments:

From the above figure it can be observed that major portion of the fresh investment of venture

capital finance will be in construction and real estate along with IT services.



The Opportunity

• High Growth in Technology and Knowledge based Industries (KBI)

• KBI growing fast and mostly global, less affected by domestic issues.

•

Several emerging centers of innovation – biotech, wireless, IT, semiconductor, pharmaceutical.

• Ability to build market leading companies in India that serve both global and domestic

markets.

• India moving beyond supplier of low-cost services to higher-value products.

• Quality of entrepreneurship on ascending curve.

Growth of Venture Capital in India:

Source: Indian Venture Capital Association



IT Service Sector

The following graph indicates the growth of venture capital and angel investments in India's IT

software and services sector:

It must be noted that during 1999, approximately 80 percent of the estimated US$ 30 billionworth of venture capital invested in United States, went to technology firms. India too, with itsstrengths in innovation and IT technology has attracted several Venture Capital firms. In 2000alone, 20 new venture capital funds have registered with SEBI, taking the total number to 30. Infact, VC or Angel investments in high tech firms in India have grown by over 5,000 percent fromRs. 70 crore to projected Rs. 2,200 crore between 1996 and 2000. And this figure is expected togrow to Rs. 50,000 crore by 2008.

In 2000 alone, 20 new venture capital funds have registered with SEBI, takingthe total number to 30. In fact, VC or Angel investments in high tech firms in Indiahave grown by over 5,000 percent from Rs. 70 crore to projected Rs. 2,200 crorebetween 1996 and 2000. And this figure is expected to grow to Rs. 50,000 crore by2008.

An analysis of financing by investment stages indicate the following figures:



Further, the major contributors to the funds were:

National Venture Capital Fund for Software and Information Technology Small IndustriesDevelopment Bank of India (SIDBI), in association with Ministry of Information Technology,Govt. of India, has set up a 10 year close ended venture capital fund called the "National VentureFund for Software and IT industry" (NFSIT).

Prime Minister, Atal Behari Vajpayee launched this fund in December 1999. NFSIT has a corpusfund of Rs. 100 crore and is a dedicated IT Fund with a focus on small-scale sector. Theobjective of the fund, besides meeting total financial requirements of the units, is to enable theseunits to achieve rapid growth rates and develop and maintain global competitiveness. The fundendeavors to develop international networking and enable assisted units to attract co-investments

from international venture capitalists. International linkages will help the assisted units to get alisting with foreign stock markets viz. NASDAQ; thereby achieving better valuations andoffering alternate exit routes to the investors.

A portion of the Fund has been earmarked for incubation projects that involve high risks andmight be used for development of software products. Software products require rigorous risk evaluation for which high degrees of expertise including international linkages are required. Thefund managed to attract a number of high-class professionals as investment managers in theAsset Management Company.



Narayana Murthy as venture Capitalist:

Infosys Technologies, India's second-largest software exporter, said on Thursday its chairman's

wife sold company shares worth $92million for setting up a venture capital fund. Sudha Murthy,

wife of Infosys co-founder and chief mentor N.R. Narayana Murthy, sold 2 million shares, or

about 22 percent of her total holding, on the Bombay Stock Exchange on Thursday, the company

said in a filing.

Narayana Murthy had earlier sold 0.13 per cent of his stake in Infosys for Rs 174.30 crore to setup a venture capital fund. Murthy had sold eight lakh shares of Infosys for an aggregate value of

Rs 174.30 crore through market sale on the Bombay and National Stock exchange.

Murthy said his new venture capital fund will be called 'Catamaran', and will help entrepreneurs

across sectors such as healthcare, retail, technology with early stage investments. The Venture

Capital Fund will encourage and support young entrepreneurs having brilliant business ideas.

The Fund will primarily invest in India and may on a case-to-case basis consider investment

overseas. In order to ensure the agility of his new venture fund, the Infosys founder will initially

hire some 3-4 young, smart individuals to be based in Bangalore.



CONCLUSION

The venture capital funds can play a catalytic role in the development of entrepreneurship skill

that remains unexploited among the young and energetic technocrats in India. VCFs can help

promote new technology and hi-tech industries, which involve high risk but promises attractive

rate of return.

Venture capital is a growing business of recent origin in the area of industrial financing in India.

The various financial institutions set-up in India to promote industries have done commendable

work. However, these institutions do not come up to the benefit of risky ventures when they are

undertaken by new or relatively unknown entrepreneurs.

India is poised for technological revolution with the emergence of new breed of entrepreneurs

with required professional temperament and technical knowhow. To make the innovative

technology of the entrepreneurs a successful business venture, support in all respects and more

particularly in the form of financial assistance is all the more essential.



REFERENCES

• VC Deloitte Survey 2006

• Creating an Environment:Developing Venture Capital in India

• Rafiq Dossani and Martin Kenney May 2001

• Venture capital investment in the indian market sajai singh, partner, j. sagar associates,

Bangalore, India.

• Chary T Satyanarayana, Venture Capital: Concepts and Application, Macmillian, 2005.

• Pandey I M, Financial Management, 9e, Vikas Publication, Chapter 23, Pg 455 – 486.

• Mishra A K, 2004, Indian Venture Capitalists (VCs): Investment Evaluation Criteria ,

ICFAI Journal of Applied Finance, Vol. 10, No. 7, pp. 71-93.

• www.ivca.org

• www.wikipedia.org

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