venture capital example in india

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A case of how govt. regulations in india, beat venture financing


The Saraf Foods Investment (A)

Cornell University Johnson Graduate School of Management NBA 593 International EntrepreneurshipAuke Cnosssen, MBA 04 prepared this case study under the guidance of and with Professor Melvin Goldman as the basis for class discussion rather than to illustrate either effective or ineffective handling of a business situation.1

The Saraf Foods Investment (A)In August 1999, Vishnu Varshney, head of Gujarat Venture Finance Ltd. (GVFL), a venture capital firm in the state of Gujarat, India, was assessing the investment of GVFL in Saraf Foods Ltd. Saraf Foods was a producer of freeze dried vegetables for export. The latest monitoring report showed the financial projections for Saraf Foods for FY 1999-2000. 1998 had been a particularly bad year as a huge increase in the price of raw materials and restrictions on exports had increased costs and limited the ability to deliver products to customers. Sales volume for 1999 would be significantly below the break even volume. As a result, Saraf was now facing serious liquidity problems and needed additional funding. It had been seven years since GVFL had first put money into the venture and Varshney now had to decide whether to write off the Saraf Foods investment or to keep backing the entrepreneur and his company. Writing off the investment would mean that the return on the investment would be very low, if the assets could be sold. On the other hand, Saraf had turned out to be an honest and hard working businessman that had built up a strong relationship with his buyers. Continuing would mean a heavy time allocation by the staff of GVFL and Varshney in particular. And how would he exit?

Entrepreneurship and Venture Capital in IndiaThe Indian Government as well as state level administrations had provided various incentives and financing schemes to promote and finance small and medium enterprises (SMEs). SMEs proliferated in India, but Gujarat with its tradition of business and entrepreneurship produced many companies and two relatively successful state level financing organizations. However, these financing organizations were conservative and rarely financed companies with new or untried technologies and /or markets.The authors acknowledge the enormous support provided by GVFL and the company and particularly Messrs Varshney and Saraf. Both opened their files and gave enormous time.1


The Saraf Foods Investment (A)

Venture Capital (VC) was just being experimented with by a development financial organization (DFI) when the World Bank was developing a scheme to promote technology development in the private sector. It identified VC as having enormous potential in India and identified organizations to spearhead the effort including the Gujarat Industrial Investment Corporation. The Government of India announced guidelines for VC funds in India in 1988. With the help of the World Bank the VC industry did eventually gain momentum in the late 1980s and early 90s. The program involved setting up VC firms and recruiting and educating people with proper backgrounds. Internship programs for 18 would-be venture capitalists were set up with US firms in order to introduce the required knowledge and develop the man power. In total nine funds were set up with total capital of $180 million for 350 investments. India generally is considered entrepreneurial. However, industry was very much dominated by the public sector and several family-led large industrial conglomerates like Tata and Mahindra. Entrepreneurs tended to start as traders and build their businesses up based on retained earnings. They needed to learn to deal with inadequate financing and infrastructure and a difficult regulatory environment. For new entrepreneurs, it was particularly difficult to obtain bank finance and there was no services industry to support new entrepreneurs with few resources. The problem was far worse for those starting a business based on new technology and new markets.

Gujarat Venture Finance Ltd.GVFL, started in July 1990, was one of the first VC funds set up under the World Bank initiative. Mr. Vishnu Varshney, who had a background in equity investment, project planning and implementation, and turn-around was selected by the parent company Gujarat Industrial Investment Corporation (GIIC) to run GVFL. Mr. Varshney, a senior project manager with GIIC helped set up GVFL. He was joined and assisted early on by a very competent deputy, J M Trivedi another GIIC project manager. After a year of putting together GFVL and initiating the work, Varshney was the first venture capitalist in India to be selected to undergo the World Bank sponsored eighteen-week internship in the US. He worked at Hambro International Equity Partners in Boston in the US and attended a training program in 1991 organized by the National Venture Capital association in the US. Later on, he was one of the founding members of the Indian Venture Capital Association (IVCA) and served as Secretary and Chairman of the Association. Trivedi also was an early intern in a New York early stage VC partnership Lawrence, Smith and Horey. Key investors in GVFLs funds were GIIC, the Industrial Development Bank of India, the Commonwealth Development Corporation, the Small Industries Development Bank of India, and a few private and public sector Gujarati companies, many of whom had close relationships to GIIC. Even in the late 1990s, when many VC firms shifted towards later stage investments and private equity, GVFL remained loyal to its initial goal of stimulating entrepreneurship by investing in seed stage innovative start-ups. GVFL adopted a hands on approach believing it


The Saraf Foods Investment (A)

should work hand-in-hand with the entrepreneur. GVFL was pioneering in a number of ways. It convinced the parents and lead investors to invest all over India as well as across industries. The first fund (Gujarat Venture Capital Fund 1990) was targeted at start-up companies based on new and untried or closely held technologies, innovative products or processes and services. Since there was no experience in India to build on, GVFL took extra time to invest the funds. The broad based fund was invested in over 25 companies. The total fund size was 240 million Rs. and the fund had an intended life span of 15 years. Exhibit 1 shows the details of the fund. As of 1999, the fund was fully invested and pay-outs to investors had started. Following the success of GVCF-1990, in terms of identifying promising VC investment opportunities, GVCF-1995 was launched. Investors included many of the investors of the earlier fund. The second fund was invested nationwide and shifted in focus towards funding new as well as small to medium sized companies with a sustainable competitive edge. Total fund size was 600 million Rs. and the life span was 12 years. By the end of 1998, 240 million Rs. had been invested in 15 companies. The third fund (GVCF 1997) was started in 1997 with an emphasis on the IT industry. The fund had a size of 400 million Rs. and a life span of 12 years. The fund focused on Software and Information Technology- an area where India has established strong core competencies on a global level. Four investments totaling 71 million Rs. had been made by the end of 1998.

The Indian banking systemThe mainly government owned banking system in India had been dominated by two kinds of institutions; the commercial banks and the DFIs. DFIs traditionally provided project finance while commercial banks lent money to companies primarily to finance working capital. Project finance by DFIs was related to industrial development or expansion projects. The DFI would provide either term finance or equity financing. In the case of term financing, the DFI would get a board seat in the company. Equity financing would involve a much more active role in the company. Although the board seat would allow the DFI to stay informed on the company, it would generally not be very involved in the decision making within the company. In case of default, a DFI would normally restructure the loan and convert the defaulted interest into a term loan. Term finance loans would typically be six to eight years and would have a maximum grace period of two years. There were three key national DFIs that concentrated on the large industrial companies and projects. Other national DFIs were built for lending to agriculture and to infrastructure. DFIs for SMEs were left to the States to develop. GIIC was among the most successful regional DFIs to provide project lending and investment for SMEs. The GIIC guidelines prescribed that the maximum project cost would have to be less than Rs 50 million (in 1990 that was approximately $3.3 million, while in 1999 it was about $1.25 million)


The Saraf Foods Investment (A)

and 30 to 35% of equity would have to be brought in by the promoter of the project. Interest rates in 1991 were on the order of 21%. (inflation was in the double digits). DFIs were focused on industrial projects with significant collateral in the form of assets. Service companies, and software companies in particular, had a hard time securing loans for starting or expanding a business. Since the late 1990s there has been a trend in India of mergers between DFIs and banks. This trend was accompanied by these institutions going public and has led to innovation and to one stop financing of enterprises. Another characteristic of the lending industry in India was that loans were based on a pari pasu agreement, meaning that there was no seniority of debt. All parties involved in investing in a company had the same rights on the assets of the company. In case of financial problems, all parties thus had to agree with each other on the action to be taken. Given the nature of the financial system in India, entrepreneurs faced many difficulties financing new venture