venture capital contracting in venture capital industry in india is well established, active and...

Download Venture Capital Contracting in venture capital industry in India is well established, active and relatively

Post on 28-Jul-2020

1 views

Category:

Documents

0 download

Embed Size (px)

TRANSCRIPT

  • Venture Capital Contracting in India

    A thesis submitted to the Bucerius/WHU Master of Law and Business Program in partial fulfillment of the requirements for the award of the Master of Law and Business (“MLB”) Degree

    Pranay Chandran

    July 16, 2010

    12603 words (excluding footnotes)

    Supervisor 1: Prof. G. Marcus Cole

    Supervisor 2: Mr. Manoj Menon

  • Table of Contents

    1 Introduction ..................................................................................................................................... 1

    2 Development of Venture Capital in India ....................................................................................... 4

    2.1 Development of the Indian Venture Capital Industry ..................................................................... 4

    2.1.1 Pre-liberalization ..................................................................................................................... 4

    2.1.2 Post-liberalization ................................................................................................................... 6

    3 Understanding Venture Capital ..................................................................................................... 10

    3.1 What is Venture Capital? .............................................................................................................. 10

    3.2 The Venture Capital Process ........................................................................................................ 11

    3.3 Why is Venture Capital relevant? ................................................................................................. 14

    3.4 The engineering problem .............................................................................................................. 15

    4 Rationale of Venture Capital Contracting ..................................................................................... 17

    4.1 The Risk in “Risk Capital” ........................................................................................................... 17

    4.2 Obligations of the Venture Capitalist ........................................................................................... 18

    4.3 Designing a Contract .................................................................................................................... 18

    4.4 Control Mechanisms ..................................................................................................................... 19

    4.5 Staged Financing .......................................................................................................................... 19

    4.6 Syndication .................................................................................................................................... 20

    4.7 Use of Convertible Securities ........................................................................................................ 20

    4.8 Other forms of Control .................................................................................................................. 22

    4.8.1 Board representation and management ................................................................................. 22

    4.8.2 Covenants .............................................................................................................................. 23

    4.8.3 Compensation ....................................................................................................................... 24

    4.8.4 Contingencies ........................................................................................................................ 25

    5 The Venture Capital Investor and Portfolio Company Contract ................................................... 26

    5.1 Ownership and Voting Rights ....................................................................................................... 26

    5.2 Staging .......................................................................................................................................... 27

    5.3 Securities ....................................................................................................................................... 27

    5.4 Liquidation Rights ......................................................................................................................... 28

    5.5 Conversion Rights ......................................................................................................................... 28

    5.6 Anti-Dilution Protection ............................................................................................................... 28

  • 5.7 Redemption, puts, buy-backs and calls ......................................................................................... 29

    5.8 Board structure ............................................................................................................................. 29

    5.9 Pre-emptive rights and Transfer related rights ............................................................................ 30

    5.10 Affirmative voting rights ............................................................................................................... 30

    5.11 Option carve-out & Employment contracts .................................................................................. 30

    5.12 Information rights ......................................................................................................................... 31

    6 Discussion and Analysis of Empirical Study ................................................................................ 32

    7 Conclusion .................................................................................................................................... 36

    8 Bibliography ................................................................................................................................. 37

    9 Annexure: Brief Summary of Empirical Study ................................................................................ i

  • 1

    1 Introduction

    Venture capital fulfils a void in financial markets as an intermediary providing capital to

    relatively small and young companies which may have difficulties raising finances from

    other, more conventional channels. These companies operate in fast changing markets hence

    they are faced with high levels of uncertainty leading to high degrees of information

    asymmetry for an investor. However these companies bear the potential of high rewards.

    While these firms are still privately held, venture capitalists finance them by acquiring stakes

    through equity or equity linked securities, despite the high risk components. In its evolution

    over time the venture capital industry has developed a wide range of mechanisms designed to

    overcome the variety of problems emerging in the venture capital process.1

    India today is vibrant and fast growing market for private equity in general and venture

    capital in particular. The number of deals and their aggregate value has been steadily

    increasing post-liberlaization at a phenomenal rate. As a result of the global financial

    meltdown the deal value of the private equity and venture capital industry had experienced a

    considerable dip of 62% in 2009. However India was one country that emerged relatively

    unscathed by the crisis, and by the first quarter of 2010 the GDP growth rate has returned to

    pre-crisis levels of 8% which by most conservative market estimates is expected to grow over

    the next few years. Market sources estimate that there are approximately 375 private equity

    firms currently operating in India and at least another 50 have raised or are in the process of

    raising funds and are planning to start their operations in the near future. The aggregate

    amount of funds raised by the private equity firms for investment in India is estimated to be

    approximately US$50 billion. Thus the prospects of the private equity and venture capital

    industry continue to be robust.

    In 2001 Dossani and Kenney2 examined early efforts to create a venture capital industry in

    India. In the context of cross-national transference of institutions the authors tried to

    determine whether the US style venture capital industry could be successfully transferred to

    the Indian context and if so, how: by modifying the environment, by hybridizing the

    institution itself, or by a combination of these two factors. Due to the fact that at the time of

    writing the paper, the Indian venture capital industry was still in its nascent stages, the

    conclusion of this study was necessarily deferred. The authors themselves write:

    “For India, we have argued that the environment itself has had to be and needs to continue

    being changed..... Interestingly, in India we believe that venture capital as an institution may

    actually need to be changed less than in the case of Taiwan, however this conclusion is not

    yet entirely verified.”

    Nearly ten years on, this paper seeks to pick up at the point left off. There have since been

    considerable developments in the global venture capital market, and also in India. By just

    looking at the volume of deals and funds being inve

Recommended

View more >