Venture Capital Meaning Venture capital means funds made available for startup firms and small businesses

with exceptional growth potential. Venture capital is money provided by professionals who alongside management invest in young, rapidly growing companies that have the potential to develop into significant economic contributors. Definition The SEBI has defined Venture Capital Fund in its Regulation 1996 as a fund established in the form of a company or trust which raises money through loans, donations, issue of securities or units as the case may be and makes or proposes to make investments in accordance with the regulations. Jane Koloski Morris, defines venture capital as 'providing seed, start-up and first stage financing' and also 'funding the expansion of companies that have already demonstrated their business potential but do not yet have access to the public securities market or to credit oriented institutional funding sources. The European Venture Capital Association describes it as risk finance for entrepreneurial growth oriented companies. It is investment for the medium or long term return seeking to maximize medium or long term for both parties. It is a partnership with the entrepreneur in which the investor can add value to the company because of his knowledge, experience and contact base. A venture capitalist is a person or investment firm that makes venture investments, and these venture capitalists are expected to bring managerial and technical expertise as well as capital to their investments. A venture capital fund refers to a pooled investment vehicle that primarily invests the financial capital of third-party investors in enterprises that are too risky for the standard capital markets or bank loans. FEATURES OF VENTURE CAPITAL 1. EQUITY PARTICIPATION: Venture financing is potential equity participation through direct purchase of shares, options or convertible securities. However, it can also be made in the form of convertible debt and therefore, it is not exclusively equity investment. 2. LONG-TERM INVESTMENT

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Venture financing requires long-term investment attitude that necessitates the venture capital firms to wait for a long period say 5 to 10 yrs, to make large profits. PARTICIPATION IN MANAGEMENT It ensures continuing participation of the venture capitalist in the management of entrepreneurs business. It also provides business skills to the investee firms which are termed as hands on approach. HIGH RISK RETURN Some of the ventures yield very high profitable returns. The returns are essentially through capital gains at the time of exits from disinvestments in the capital market. PRIVATE EQUITY Private equity can be used to develop new products and technologies, to expand working capital, to make acquisitions, or to strengthen a company's balance sheet. WIDE SCOPE Technology finance is a sub-set of VC financing. Besides financing high-technology oriented companies, it also involves financing of small and medium sized firms until they are established.

METHODS OF VENTURE FINANCING Venture capital is typically available in three forms in India, they are: Equity: All VCFs in India provide equity but generally their contribution does not exceed 49 percent of the total equity capital. Thus, the effective control and majority ownership of the firm remains with the entrepreneur. They buy shares of an enterprise with an intention to ultimately sell them off to make capital gains. Conventional loan: Under this form of assistance, a lower rate of interest is charged till the assisted units become commercially operational, after which the loan carries higher or normal rate of interest. The loan has to be repaid according to a predetermined schedule as soon as the company is able to generate sales and income. Conditional Loan: It is repayable in the form of a royalty after the venture is able to generate sales. No interest is paid on such loans. In India, VCFs charge royalty ranging between 2 to 15 percent; actual rate depends on other factors of the venture such as gestation period, cost-flow patterns, riskiness and other factors of the enterprise. Income Note: It is a hybrid security which combines the features of both conventional loan and conditional loan. The entrepreneur has to pay both interest and royalty on sales, but at substantially low rates. Other Financing Methods: A few venture capitalists, particularly in the private sector, have started introducing innovative financial securities like participating debentures, introduced by TCFC is an example.

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Stages of Financing The selection of investment by VCI is closely related to the stages and types of investment: I Early Stage Financing (i) Seed Capital This stage is essentially an applied research phase where the concepts and ideas of the promoters constitute the basis of a pre-commercialization research project usually expected to end in a prototype which may or may not lead to a business launch. This phase gradually moves towards the development phase leading to a prototype product testing and then to commercialization The evaluation of the project by the VCIs has to ensure that the technology skills of the entrepreneur match with market opportunities. The main risk at this stage is marketing related important elements of the appraisal : the commercial acumen of the promoter to take advantage of the market opportunity , awareness of competition , the timing of launching the product and so on. The risk perception of investment at this stage is extremely high. Very few VCIs invest in the seed stage of product development. (ii) Start-up This is the stage when commercial manufacturing has to commence . Venture capital financing is here provided for product development and initial marketing. The essence of this stage is that the product / service is being commercialized for the first time. It includes several type of new projects : * Project based on relatively new or high technology * New projects by established companies * New business in which entrepreneur has good knowledge and working experience At this stage , some indication of the potential market for the new product / service is available The risk perception is high. (iii) Second Round Financing This represents the stage at which the product has already been launched in the market but the business has not, yet, become profitable enough for public offering to attract new investors. The promoter has invested his own funds but further infusion of funds by VCI is necessary. The time - scale for the investment is shorter than in the case of start-ups. The VCIs provide larger funds at this stage than in the early stages. This financing is partly in the form of debt to provide some income to them.

II Later Stage Financing This stage of venture capital financing involves established businesses which require additional financial support but cannot take recourse to public issues of capital. It includes: a) Mezzanine / Development Capital This is financing of established businesses which have overcome the extremely high-risk early stages

Have recorded profits for a few years But have yet to reach a stage when they can go public and raise money from the capital market / conventional sources. Use of such type of venture financing: * Purchase of new equipment / plant * Expansion of marketing and distribution facilities * Re-finance of existing debt * Penetration into new regions The development finance stage has a time frame of 1-3 years. It falls in medium risk category. It constitutes a significant part of the activities of many VCIs. b) Bridge / Expansion It represents last round of financing before a planned exit. Such finance is used in : * Expand business by way of growth of their own productive asset * Acquisition of other firms / assets of other firms. This finance involves low risk perception Time frame of 1-3 years. c) Buyout financing: These refer to the transfer of management control. They fall into two categories: 1. Management buyouts 2. Management buy- in 1. Management buyouts: MBO (Management buyout) has low risk as enterprise to be bought have existed for some time besides having positive cash flow to provide regular returns to the venture capitalist, who structure their investment by judicious combination of debt and equity. In management buyout, venture capitalist helps the management of a company to buy or take over the ownership of the business. This would help the management to reshuffle or reengineer the entire project. 2. Management buy- in: Management Buy-in refers to the funds provided to enable a manager or a group of managers from outside the company to buy into it. It is the most popular form of venture capital amongst later stage financing. It is less risky as venture capitalist in invests in solid, ongoing and more mature business. The funds are provided for acquiring and revitalizing an existing product line or division of a major business. d) Turnarounds These are sub-set of buyouts and involve buying the control of a sick company. Two inputs are required are money & management. The VCIs have to identify good management and operations leadership. This involves medium to high risk. Time frame of 3 to 5 years. It is gaining widespread acceptance and increasingly becoming the focus of attention. Disinvestment mechanism: There are five disinvestment channels for realization of such investments: a) Going public

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Sale of shares to Entrepreneurs Sale of the company to another company Finding a new investor Liquidation

a) Going Public: Most of the venture capital assisted firms prefers to go in for public issue to
recover their investments with profits. This process not only helps the entrepreneur but also the investor in different ways. The main benefit of going public increases the liquidity of the business firm. This liquidity will increase the percentage returns over the private placements. (If it were sold through private placements). The public issue provides another opportunity for the business firm to list its shares in the stock market. Once the shares are listed, it increases the image of the organization. In addition to this, it increases and attracts efficient persons to work in the organization. In addition to this, the commercial banks and financial institutors will forward to offer different types of loans. If the firm wishes to raise additional capital for expansion and growth, it could be done easily through the public issue. However, going public is not an easy route to exit or venture capital assisted units because; it has to observes several legal formalities of stock exchange. The company must also disclose part a considerable ar1t of information at the time of issuing the shares; this could be a sales threat with the global competition. Employees may ask for better comfort with huge hike in the salaries and perks. The expenditure incurred during the course of the issue in also substantially high, which may affect the profitability. As the company is going for public issue, its social responsibility increases and they have to be accountable to all the organs of the society, which burdens the financial affairs of the company. With all these demerits or bottlenecks going public for exit route is widely used in seal life situations.

b) Sale of shares to entrepreneur: Sometimes, promoter may prefer to have exit route through,
Over the Counter Exchange by entering into bought out deals with the member of O.T.C. He may purchase the shares with a view of entering in to the primary market at the later stage. In certain circumstances, an entrepreneur himself prefers to buy the entire shares. He may even buy the shares with the help of his own group-even the employees are allowed to do so at an agreed price for buying such shares. If necessary, the entrepreneur may approach financial institutions for loans. The price at which the stake of the V. C. assisted may be done as several methods: c) Sale of a company to another company: On many occasions, venture capitalist and the entrepreneur may agree together to sell the business unit to some other company. The reasons could be many viz., the entrepreneurs may prefer to undertake some other new company. He may find it difficult to operate the business profitably. At the time of managerial difficulties he may search for a new company which is having similar line of business. The modalities of such a sale will be made on the basis of level of operations and, the nature of venture, which may be acceptable to both the parties. d) Finding a new investor: Under this method, the venture capitalists and the investor may decide to sell the unit to another new investor who may be a venture capitalist or a corporate that is having similar line of business. But buying venture from others and

buying company may increase their operation and profitability. This provides an opportunity to exploit and can have economies of large scale operations

e) Liquidation: This is a lender of last resort, when a firm performs very badly, in other words if it incurs
continuous cash loss over the years, venture capitalist and the entrepreneur decides to close down the operations. Hence, it takes the firm to liquidation. The reason for such exercises would be many viz., stiff competition, technological failure, poor management by the entrepreneur etc.

The Venture Capital Investment Process: The venture capital activity is a sequential process involving the following six steps. 1. Deal origination 2. Screening 3. Due diligence Evaluation 4. Deal structuring 5. Post-investment activity 6. Exist 1. Deal origination: In generating a deal flow, the VC investor creates investment opportunities that he would consider for investing in. Deal may originate in various ways. Referral system, active search system, and intermediaries. Referral system is an important source of deals. Deals may be referred to VCFs by their parent organizations, trade partners, industry associations, friends etc. Another deal flow is active search through networks, trade fairs, conferences, seminars, foreign visits etc. Intermediaries is used by venture capitalists in developed countries like USA, is certain intermediaries who match VCFs and the potential entrepreneurs. 2. Screening: VCFs, before going for an in-depth analysis, carry out initial screening of all projects on the basis of some broad criteria. For example, the screening process may limit projects to areas in which the venture capitalist is familiar in terms of technology, or product, or market scope. The size of investment, geographical location and stage of financing could also be used as the broad screening criteria. 3. Due Diligence evaluation: The venture capitalists evaluate the quality of entrepreneur before appraising the characteristics of the product, market or technology. Most venture capitalists ask for a business plan to make an assessment of the possible risk and return on the venture. Business plan contains detailed information about the proposed venture. The evaluation of ventures by VCFs in India includes; a) Preliminary evaluation: The applicant required to provide a brief profile of the proposed venture to establish prima facie eligibility. b) Detailed evaluation: Once the preliminary evaluation is over, the proposal is evaluated in greater detail. VCFs in India expect the entrepreneur to have: - Integrity, long-term vision, urge to grow, managerial skills, commercial orientation.

VCFs in India also make the risk analysis of the proposed projects which includes: Product risk, Market risk, Technological risk and Entrepreneurial risk. The final decision is taken in terms of the expected risk-return trade-off. 4. Deal Structuring: In this process, the venture capitalist and the venture company negotiate the terms of the deals, that is, the amount, form and price of the investment. This process is termed as deal structuring. The agreement also include the venture capitalist's right to control the venture company and to change its management if needed, buyback arrangements, acquisition, making initial public offerings (IPOs), etc. Earned out arrangements specify the entrepreneurs equity share and the objectives to be achieved. 5. Post Investment Activities: Once the deal has been structured and agreement finalised, the venture capitalist generally assumes the role of a partner and collaborator. He also gets involved in shaping of the direction of the venture. The degree of the venture capitalist's involvement depends on his policy. It may not, however, be desirable for a venture capitalist to get involved in the day-to-day operation of the venture. If a financial or managerial crisis occurs, the venture capitalist may intervene, and even install a new management team. 6. Exit: Venture capitalists generally want to cash-out their gains in five to ten years after the initial investment. They play a positive role in directing the company towards particular exit routes. FACTOR TO BE CONSIDERED BY VENTURE CAPITALIST IN SELECTION OF INVESTMENT PROPOSAL There are basically four key elements in financing of ventures which are studied in depth by the venture capitalists. These are: 1. Management: The strength, expertise & unity of the key people on the board bring significant credibility to the company. The members are to be mature, experienced possessing working knowledge of business and capable of taking potentially high risks. 2. Potential for Capital Gain: An above average rate of return of about 30-40% is required by venture capitalists. The rate of return also depends upon the stage of the business cycle where funds are being deployed. Earlier the stage, higher is the risk and hence the return. 3. Realistic Financial Requirement and Projections: The venture capitalist requires a realistic view about the present health of the organization as well as future projections regarding scope, nature and performance of the company in terms of scale of operations, operating profit and further costs related to product development through Research & Development. 4. Owner's Financial Stake: The financial resources owned & committed by the entrepreneur/ owner in the business including the funds invested by family, friends and relatives play a very important role in increasing the viability of the business. It is an important avenue where the venture capitalist keeps an open eye. Advantages of VC Financing over Other Forms of Finance 1. It injects long term equity finance which provides a solid capital base for future growth. 2. The venture capitalist is a business partner, sharing both the risks and rewards. Venture capitalists are rewarded by business success and the capital gain.

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The venture capitalist is able to provide practical advice and assistance to the company based on past experience with other companies which were in similar situations. The venture capitalist also has a network of contacts in many areas that can add value to the company, such as in recruiting key personnel, providing contacts in international markets, introductions to strategic partners, and if needed co-investments with other venture capital firms when additional rounds of financing are required. The venture capitalist may be capable of providing additional rounds of funding should it be required to finance growth

Major problems facing by venture capitalists in India are: 1. Requirement of an experienced management team. 2. Requirement of an above average rate of return on investment. 3. Longer payback period. 4. Uncertainty regarding the success of the product in the market. 5. Questions regarding the infrastructure details of production like plant location, accessibility, relationship with the suppliers and creditors, transportation facilities, labour availability etc. 6. Skills and Training required and the cost of training. 7. Time Period: the venture capital is invested in a firm for a specified period of time. 8. Interference in Business: The Venture Capitalists generally try to interfere with the company matters and decisions and want to influence them in the direction which suits them. PROSPECTS OF VENTURE CAPITAL FINANCING With the advent of liberalization, India has been showing remarkable growth in the economy in the past 10 - 12 years. The government is promoting growth in capacity utilization of available and acquired resources and hence entrepreneurship development, by liberalizing norms regarding venture capital. While only eight domestic venture capital funds were registered with SEBI during 1996-1998, 14 funds have already been registered in 1999-2000. Institutional interest is growing and foreign venture investments are also on the rise. Many state governments have also set up venture capital funds for the IT sector in partnership with the local state financial institutions and SIDBI. These include Andhra Pradesh, Karnataka, Delhi, Kerala and TamilNadu. In the year 2000, the finance ministry announced the liberalization of tax treatment for venture capital funds to promote them & to increase job creation. This is expected to give a strong boost to the non resident Indians located in the Silicon Valley and elsewhere to invest some of their capital, knowledge and enterprise in these ventures. A Bangalore based media company, Gray cell Ltd., has recently obtained VC investment totaling about $ 1.7 mn. The company would be creating and marketing branded web based consumer products in the near future. Top cities attracting venture capital investments: CITIES Mumbai Bangalore Delhi SECTORS Software services, BPO, Media, Computer Animations, Finance & Banking All IP led companies, IT & ITES, Bio-technology Software services, ITES , Telecom

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Chennai IT , Telecom Hyderabad IT & ITES, Pharmaceuticals Pune Bio-technology, IT , BPO Venture capital industry wise segmentation

Venture Capital in India In India the Venture Capital plays a vital role in the development and growth of innovative entrepreneurships. Venture Capital activity in the past was possibly done by the developmental financial institutions like IDBI, ICICI and State Financial Corporations. These institutions promoted entities in the private sector with debt as an instrument of funding. For a long time funds raised from public were used as a source of Venture Capital. This source however depended a lot on the market vagaries. And with the minimum paid up capital requirements being raised for listing at the stock exchanges, it became difficult for smaller firms with viable projects to raise funds from public. In India, the need for Venture Capital was recognized in the 7th five year plan and long term fiscal policy of GOI. In 1973 a committee on Development of small and medium enterprises highlighted the need to faster VC as a source of funding new entrepreneurs and technology. VC financing really started in India in 1988 with the formation of Technology Development and Information Company of India Ltd. (TDICI) - promoted by ICICI and UTI. The first private VC fund was sponsored by Credit Capital Finance Corporation (CFC) and promoted by Bank of India, Asian Development Bank and the Commonwealth Development Corporation viz. Credit Capital Venture Fund. The SEBI Venture Capital Regulations were issued in 1996. According to this, venture capital fund means a fund established in the form of a company or trust, which raises monies through loans, donations, issue of securities or units as the case may be and makes or proposes to make investments in accordance with these regulations.

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. VC financing in India:1. Existence of a globally competitive high technology. 2. Globally competitive human resource capital. 3. Second Largest English speaking, scientific & technical manpower in the world. 4. Vast pool of existing and ongoing scientific and technical research carried by large number of research laboratories. 5. Initiatives taken by the Government in formulating policies to encourage investors and entrepreneurs. 6. Initiatives of the SEBI to develop a strong and vibrant capital market giving the adequate liquidity and flexibility for investors for entry and exit.