STRATEGIC FINANCIAL

MANAGEMENT

VENTURE CAPITAL

PRESENTAT
ION ON:

SUBMITTED BY: GROUP -4

SHIWANI SHUKLA
PRIYANKA SINGH
SENGAR
PRIYANKA SENGAR
DEEPAK YADAV
AKASH

SUBMITTED TO:
SHRUTI MISHRA
INSTITUTE OF BUSINESS
MANAGEMENT

VENTURE CAPITAL
Lesson Objectives
To understand the Concept of Venture Capital,
Types of venture capital funds, mode of operations and
terminology of venture capital.

Introduction
Venture Capital has emerged as a new financial method of
financing during the 20th century. Venture capital is the capital
provided by firms of professionals who invest alongside
management in young, rapidly growing or changing companies
that have the potential for high growth. Venture capital is a form
of equity financing especially designed for funding high risk and
high reward projects.
There is a common perception that venture capital is a means of
financing high technology projects. However, venture capital is
investment of long term finance made in:
1 Ventures promoted by technically or professionally qualified
but unproven entrepreneurs, or
2 Ventures seeking to harness commercially unproven
technology, or
3 High risk ventures.
The term venture capital represents financial investment in a
highly risky project with the objective of earning a high rate of
return. While the concept of venture capital is very old the recent
liberalization policy of the government appears to have given a
fillip to the venture capital movement in India. In the real sense,
venture capital financing is one of the most recent entrants in
the Indian capital market. There is a significant scope for venture
capital companies in our country because of increasing
emergence of technocrat entrepreneurs who lack capital to be
risked. These venture capital companies provide the necessary
risk capital to the entrepreneurs so as to meet the promoters

contribution as required by the financial institutions. In addition

to providing capital, these VCFs (venture capital firms) take an
active interest in guiding the assisted firms. A young, high tech
company that is in the early stage of financing and is not yet
ready to make a public offer of securities may seek venture
capital. Such a high risk capital is provided by venture capital
funds in the form of long-term equity finance with the hope of
earning a high rate of return primarily in the form of capital
gain. In fact, the venture capitalist acts as a partner with the
entrepreneur. Thus, a venture capitalist (VC) may provide the
seed capital for unproven ideas, products, technology oriented or
startup firms. The venture capitalists may also invest in a firm
that is unable to raise finance through the conventional means.

Features of Venture Capital

Venture capital combines the qualities of a banker, stock market
investor and entrepreneur in one.
The main features of venture capital can be summarized as
follows:
i
ii

iii

iv

High Degrees of Risk Venture capital represents

financial investment in a highly risky project with the
objective of earning a high rate of return.
Equity Participation Venture capital financing. is,
invariably, an actual or potential equity participation
wherein the objective of venture capitalist is to make
capital gain by selling the shares once the firm becomes
profitable.
Long Term Investment Venture capital financing is a
long term investment. It generally takes a long period to
encash the investment in securities made by the venture
capitalists.
Participation in Management In addition to providing
capital, venture capital funds take an active interest in

vi

the management of the assisted firms. Thus, the

approach of venture capital firms is different from that of
a traditional lender or banker. It is also different from
that of a ordinary stock market investor who merely
trades in the shares of a company without participating in
their management. It has been rightly said, venture
capital combines the qualities of banker, stock market
investor and entrepreneur in one.
Achieve Social Objectives It is different from the
development capital provided by several central and state
level government bodies in that the profit objective is the
motive behind the financing. But venture capital projects
generate employment, and balanced regional growth
indirectly due to setting up of successful new business.
Investment is liquid A venture capital is not subject to
repayment on demand as with an overdraft or following a
loan repayment schedule. The investment is realized only
when the company is sold or achieves a stock market
listing. It is lost when the company goes into liquidation.

Origin
Venture capital is a post-war phenomenon in the business world
mainly developed as a sideline activity of the rich in USA. The
concept, thus, originated in USA in 1950s when the capital
magnets like Rockfeller Group financed the new technology
companies. The concept became popular during 1960s and
1970s when several private enterprises started financing highly
risky and highly rewarding projects. To denote the risk and
adventure and some element of investment, the generic term
Venture Capital was developed. The American Research and
Development was formed as the first venture organization which
financed over 100 companies and made profit over 35 times its
investment. Since then venture capital has grown vastly in USA,
UK, Europe and Japan and has been an important contribution in
the economic development of these countries.

Types of Venture Capitalists

Generally, there are three types of organized or institutional

venture capital funds
i

Venture capital funds set up by angel investors, that is,

high network individual investors

ii

Venture capital subsidiaries of corporations - these are

established by major corporations; commercial bank
holding companies and other financial institutions

iii

Private capital firms/funds-The primary institutional

source of venture capital is a venture capital firm venture
capitalists take high risks by investing in an early stage
company with little or no history and they expect a higher
return for their high-risk equity investments in the
venture.

Modes of Finance by Venture Capitalists

Venture capitalists provide funds for long-term in any of the
following modes
1 Equity - Most of the venture capital funds provide financial
support to entrepreneurs in the form of equity by financing
49% of the total equity. This is to ensure that the ownership
and overall control remains with the entrepreneur. Since
there is a great uncertainty about the generation of cash
inflows in the initial years, equity financing is the safest
mode of financing. A debt instrument on the other hand
requires periodical servicing of debt.
2 Conditional loan - From a venture capitalist~ point of view,
equity is an unsecured instrument and hence a less
preferable option than a secured debt instrument. A
conditional loan usually involves either no interest at all or a
coupon payment at nominal rate. In addition, a royalty at
agreed rates is payable to the lender on the sales turnover.

As the units picks up in sales levels, the interest rate are

increased and royalty amounts are decreased.
3 Convertible loans - The convertible loan is subordinate to all
other loans, which may be converted into equity if interest
payments are not made within agreed time limit.

Areas of Investment
Different venture groups prefer different types of investments.
Some specialize in seed capital and early expansion while others
focus on exit financing. Biotechnology, medical services,
communications, electronic components and software companies
seem to be attracting the most attention from venture firms and
receiving the most financing. Venture capital firms finance both
early and later stage investments to maintain a balance between
risk and profitability.
In India, software sector has been attracting a lot of venture
finance.
Besides
media,
health
and
pharmaceuticals,
agribusiness and retailing are the other areas that are favored by
a lot of venture companies.

Stages of Investment Financing

Venture capital firms finance both early and later stage
investments to maintain a balance between risk and
profitability.
Venture capital firms usually recognize the following two main
stages when the investment could be made in a venture namely:
A Early Stage Financing
i
Seed Capital & Research and Development Projects.
ii
Start Ups
iii
Second Round Finance
B Later Stage Financing
i
Development Capital

ii
iii
iv
v

Expansion Finance
Replacement Capital
Turn Around
Buy Outs

A Early Stage Financing

This stage includes the following:
I

Seed Capital and R & D Projects: Venture capitalists are

more often interested in providing seed finance i. e.
making provision of very small amounts for finance
needed to turn into a business. Research and
development activities are required to be undertaken
before a product is to be launched. External finance is
often required by the entrepreneur during the
development of the product. The financial risk increases
progressively as the research phase moves into the
development phase, where a sample of the product is
tested before it is finally commercialized venture
capitalists/ firms/ funds are always ready to undertake
risks and make investments in such R & D projects
promising higher returns in future.

II

Start Ups: The most risky aspect of venture capital is the

launch of a new business after the Research and
development activities are over. At this stage, the
entrepreneur and his products or services are as yet
untried. The finance required usually falls short of his
own resources. Start-ups may include new industries /
businesses set up by the experienced persons in the area
in which they have knowledge. Others may result from
the research bodies or large corporations, where a
venture capitalist joins with an industrially experienced
or corporate partner. Still other start-ups occur when a
new company with inadequate financial resources to
commercialize new technology is promoted by an existing
company.

III

Second Round Financing: It refers to the stage when

product has already been launched in the market but has
not earned enough profits to attract new investors.
Additional funds are needed at this stage to meet the
growing needs of business. Venture Capital Institutions
(VCIs) provide larger funds at this stage than at other
early stage financing in the form of debt. The time scale
of investment is usually three to seven years.

B Later Stage Financing

Those established businesses which require additional financial
support but cannot raise capital through public issue approach
venture capital funds for financing expansion, buyouts and
turnarounds or for development capital.
I

Development Capital: It refers to the financing of an

enterprise which has overcome the highly risky stage and
have recorded profits but cannot go public, thus needs
financial support. Funds are needed for the purchase of
new equipment/ plant, expansion of marketing and
distributing facilities, launching of product into new
regions and so on. The time scale of investment is usually
one to three years and falls in medium risk category.

II

Expansion Finance: Venture capitalists perceive low risk

in ventures requiring finance for expansion purposes
either by growth implying bigger factory, large
warehouse, new factories, new products or new markets
or through purchase of exiting businesses. The time
frame of investment is usually from one to three years. It
represents the last round of financing before a planned
exit.

III

Buy Outs: It refers to the transfer of management control

by creating a separate business by separating it from
their existing owners. It may be of two types.

Management Buyouts (MBOs): In Management

Buyouts (MBOs) venture capital institutions provide
funds to enable the current operating management/
investors
to
acquire
an
existing
product
line/business. They represent an important part of
the activity of VCIs.

ii

Management Buying (MBIs): Management Buy-ins

are funds provided to enable an outside group of
manager(s) to buy an existing company. It involves
three parties: a management team, a target
company and an investor (i.e. Venture capital
institution). MBIs are more risky than MBOs and
hence are less popular because it is difficult for new
management to assess the actual potential of the
target company. Usually, MBIs are able to target the
weaker or under-performing companies.

IV

Replacement Capital-V CIs another aspect of financing is

to provide funds for the purchase of existing shares of
owners. This may be due to a variety of reasons including
personal need of finance, conflict in the family, or need
for association of a well-known name. The time scale of
investment is one to three years and involve low risk.

Turnarounds-Such form of venture capital financing

involves medium to high risk and a time scale of three to
five years. It involves buying the control of a sick
company which requires very specialised skills. It may
require rescheduling of all the companys borrowings,
change in management or even a change in ownership. A
very active hands on approach is required in the initial
crisis period where the venture capitalists may appoint
its own chairman or nominate its directors on the board.
In nutshell, venture capital firms finance both early and
later stage investments to maintain a balance between
risk and profitability. Venture capitalists evaluate

technology and study potential markets besides

considering the capability of the promoter to implement
the project while undertaking early stage investments. In
later stage investments, new markets and track record of
the business/entrepreneur is closely examined.

Factors Affecting Investment Decisions

The venture capitalists usually take into account the following
factors while making investments:
1 Strong Management Team. Venture capital firms ascertain
the strength of the management team in terms of adequacy
of level of skills,., commitment and motivation that creates a
balance between members in area such as marketing,
finance and operations, research and development, general
management, personal management and legal and tax
issues. Track record of promoters is also taken into account.
2 A Viable Idea. Before taking investment decision, venture
capital firms consider the viability of project or the idea.
Because a viable idea establishes the market for the product
or service. Why the customers will purchase the product,
who the ultimate users are, who the competition is with and
the projected growth of the industry?

3 Business Plan. The business plan should concisely describe

the nature of the business, the qualifications of the
members of the management team, how well; the business
has performed, and business projections and forecasts. The
promoters experience in the proposed or related businesses
is an important consideration. The business plan should also
meet the investment objective of the venture capitalist.
4 Project Cost and Returns A. VCI would like to undertake
investment in a venture only if future cash inflows are likely

to be more than the present cash outflows. While

calculating the Internal Rate of Return (IRR) the risk
associated with the business proposal, the length of time his
money will be tied up are taken into consideration. Project
cost, scheme of financing, sources of finance, cash inflows
for next five years are closely studied.
5 Future Market Prospects. The marketing policies adopted,
marketing strategies in relation to the competitors, market
research undertaken, market size, share and future market
prospects are some of the considerations that affect the
decision.
6 Existing Technology. Existing technology used and any
technical collaboration agreements entered into by the
promoters also to a large extent affect the investment
decision.
7 Miscellaneous Factors. Others factors which indirectly
affect the investment decisions include availability of raw
material and labor, pollution control measures undertaken,
government policies, rules and regulations applicable to the
business/industry, location of the industry etc.

Selection of Venture Capitalists

Venture capital industry has shown tremendous growth during
the last ten years. Thus, it becomes necessary for the
entrepreneurs to be careful while selecting the venture
capitalists. Following factors must be taken into consideration:
1. Approach adopted by VCs - Selection of VCs to a large extent
depends upon the approach adopted by VCs.
a Hands on approach of VCs aims at providing value
added services in an advisory role or active
involvement in marketing, recruitment and funding
technical collaborators. VCs show keen interest in the

management affairs and actively interact with the

entrepreneurs on various issues.
b Hands off approach refers to passive participation by
the venture capitalists in management affairs. VCs just
receive periodic financial statements. VCs enjoy the
right to appoint a director but this right is seldom
exercised by them. In between the above two
approaches lies an approach where V C s approach is
passive except in major decisions like change in top
management, large expansion or major acquisition.
(2) Flexibility in deals - The entrepreneurs would like to strike a
deal with such venture capitalists who are flexible and generous
in their approach. They provide them a package which best meet
the needs of the entrepreneurs. VCs having rigid attitude may
not be preferred.
(3) Exit policy - The entrepreneurs should ask clearly the venture
capitalists as to their exit policies whether it is buy back or
quotation or trade sale. To avoid conflicts, clarifications should
be sought in the beginning; the policy should not be against the
interests of the business. Depending upon the exit policy of the
VCs, selection would be made by the entrepreneurs.
(4) Fund viability and liquidity - The entrepreneurs must make
sure that the VCs has adequate liquid resources and can provide
later stage financing if the need arises, also, the VC has
committed backers and is not just interested in making quick
financial gains.
(5) Track record of the VC & its team - The scrutiny of the past
performance, time since operational, list of successful projects
financed earlier etc. should be made by the entrepreneur. The
team of VCs,their experience, commitment, guidance during bad
times are the .other consideration affecting the selection of VCs.

Procedure Followed by VCs

A Receipt of proposal. A proposal is received by the venture

capitalists in the form of a business plan. A detailed and
well-organised business plan helps the entrepreneur in
gaining the attention of the VCs and in obtaining funds. A
well-prepared business proposal serves two functions.
1. It informs the venture capitalists about the entrepreneurs
ideas.
2. It shows that the entrepreneur has detailed knowledge
about the proposed business and is aware of the all
potential problems.
B Appraisal of plan. VC appraises the business plan giving due
regard to the creditworthiness of the promoters, the nature
of the product or service to be developed, the markets to be
served and financing required. VCs also conduct costbenefit analysis by comparing future expected cash inflows
with present investment.
C Investment. If venture capital fund is satisfied with the
future profitability of the company, it will take step to invest
his own money in the equity shares of the new company
known as the assisted company.
D Provide value added services. Venture capitalists not only
invest money but also provide managerial and marketing
assistance and operational advice. They also make efforts to
accomplish the set targets which consequently results in
appreciation of their capital.
E Exit. After some years, when the assisted company has
reached a certain stage of profitability the VC sells his
shares in the stock market at high premium, thus earning
profits as well as releasing locked up funds for
redeployment in some other venture and this cycle
continues.

WHAT IS VENTURE CAPITAL?

A VC has five main characteristics:
1. A VC is a financial intermediary, meaning that it takes the investors capital and
invests it directly in portfolio companies.
2. A VC invests only in private companies. This means that once the investments
are made, the companies cannot be immediately traded on a public exchange.
3. A VC takes an active role in monitoring and helping the companies in its
portfolio.
4. A VCs primary goal is to maximize its financial return by exiting investments
through a sale or an initial public offering (IPO).
5. A VC invests to fund the internal growth of companies.

Characteristic (1) defines VCs as financial intermediaries. This is similar to a bank,

because just as a bank takes money from depositors and then loans it to businesses
and individuals, a VC fund takes money from its investors and makes equity
investments in portfolio companies. Typically, a VC fund is organized as a limited
partnership, with the venture capitalist acting as the general partner (GP) of the
fund and the investors acting as the limited partners (LP).1 If all goes well, the VC
eventually sells its stake in the portfolio company, returns the money to its limited
partners, and then starts the process all over again with a different company.
Exhibit 1-1 illustrates the key players and the flow of funds in the VC industry.
VCs are often compared toand confused withangel investors. Angel investors,
often just called angels, are similar to VCs in some ways but differ, because angels
use their own capital and, thus, do not satisfy characteristic (1). There are many
types of angels. At one extreme are the wealthy individuals with no business
background who are investing in the business of a friend or relative. At the other
end are groups of angels with relevant business or technical backgrounds who have
banded together to provide capital and advice to companies in a specific industry.
In the latter case, the angel groups look very much like VCs, but the fact that they
use their own capital changes the economics of their decisions: Since they can keep
all the returns to on their labor, they have a correspondingly lower cost of capital
and can invest in deals that would not work for a VC. Although it is difficult to get
reliable figures on angel investing, the best available survey evidence for recent
years suggests that total angel investments are approximately the same magnitude

as total VC investments.2 Although the total flow of capital is similar, angels tend
to focus on younger companies than do VCs and make a larger number of smaller
investments.

Characteristic (2) defines VC as a type of private equity. Although the definitions

of private company and public company have some nuances, the key
distinction is that a public companys securities can be traded in a formal market,
like the NYSE or the NASDAQ, whereas a private companys securities cannot.
Any company that is publicly traded in the United States must also file regular
reports with the Securities and Exchange Commission (SEC) detailing its financial
position and material changes to its business. When combined with the activities of
professional traders in public markets, this requirement to file creates significant
amounts of information about public companies. In comparison, information about
private companies is practically nonexistent. Private equity is considered to be a
category of alternative investing, where alternative stands in contrast to
traditional investing in stocks and bonds.
Characteristic (3) is central on our listand central to the success of any VC.
Without (3), a VC would only be providing capital, and his success (or failure)
would be entirely due to his ability to choose investments. Although success can,
of course, be entirely built on these choices, the comparative advantage of the VC
would be greatly improved if the investor could also help the company directly.
This help takes many forms. Most notably, VCs typically take at least one position
on the board of directors of their portfolio firms. Having board representation
allows them to provide advice and support at the highest level of the company.
(More than one VC has remarked that his job could be described as being a
professional board member.) In addition to board service, VCs often act as
unofficial recruiters and matchmakers for their portfolio firms. Young companies
often have a difficult time attracting high-quality talent to a fledgling operation,
and VCs can significantly mitigate this problem by drawing on their reputation and
industry contacts. A VC who performs these value-added services well has a
sustainable form of competitive advantage over other investors.
Because VCs are financial intermediaries, they need some mechanism to give
money back to their investors. Thus, a savvy VC will only make an investment if
he can foresee a path to exit, with proceeds of this exit returning to the VC and his
investors. Exits can occur through an IPO, with a subsequent sale of the VC stake

in the open market, through a sale of the company to another investor, or through
the sale of the company to a larger company. Because of the need to exit, VCs
avoid investments in lifestyle businesses (companies that might provide a good
income to the entrepreneurs, but have little opportunity for a sale or IPO).
Characteristic (4), the requirement to exit and the focus on financial return, is a key
distinction between venture capital and strategic investing done by large
corporations. As a perpetual entity, a corporation can afford to take stakes in other
businesses with the intention of earning income, forming long-term alliances, and
providing access to new capabilities. It is possible for the corporation to maintain
this stake indefinitely.
A strategic investor may satisfy all the other characteristics, but without the need to
exit, the strategic investor will choose and evaluate investments very differently
from a VC. In some cases, a corporation may set up an internal venture capital
division. In the industry, this is referred to as corporate venture capital. This label
can be confusing, as only sometimes do such divisions satisfy characteristic (4).
These corporate VC efforts will often have strategic objectives other than financial
returns and will have neither dedicated supplies of capital nor an expectation that
capital will be returned within a set time period. When (4) is not satisfied, the
investment activity can take on a very different flavor than the type studied in this
book.
The requirement to exit provides a clear focus for VC investing activities. There
are over 20 million businesses in the United States; more than 99 percent of these
businesses would meet the government definition of a small business.3 In
general, small businesses are difficult to exit, and only large businessesthose
in the top 1 percent of all businesseshave a realistic chance to go public or be
sold in a liquid acquisition market. It is therefore typical for VCs to invest in small
businessesbut they only do so when these small companies have a realistic
chance to grow enough to become a large company within five to seven years after
the initial investment. Such rapid growth is difficult to attain in most industries;
therefore, VCs tend to focus on high-technology industries, where new products
can potentially penetrate (or even create) large markets.
Characteristic (5) refers to internal growth, by which we mean that the
investment proceeds are used to build new businesses, not to acquire existing
businesses. Although the legendary VC investments tend to be those adventurous
VCs who backed three guys in a garage, the reality of VC investing is much
more varied. As a simple classification, we divide portfolio companies into three
stages: early-stage, mid-stage (also called expansion-stage), and late-stage. At one
extreme, early-stage companies include everything through the initial
commercialization of a product. At the other extreme, late-stage companies are

businesses with a proven product and either profits or a clear path toward
profitability. A late-stage VC portfolio company should be able to see a plausible
exit on the horizon. This leaves mid-stage (expansion) companies, who represent
the vast landscape between early-stage and late-stage. With all this territory to
cover, it is not surprising that mid-stage investments make up the majority of VC
investment.
In Section 1.4.1 of this chapter, we give more precise definitions of these stages,
along with evidence about the investment patterns by stage.
Characteristic (5) also allows us to distinguish VC from other types of private
equity. Exhibit 1-2 illustrates the overlapping structure of the four main types of
private equity investing and also shows the intersection of these types with hedge
funds, another category of alternative investments. The relationship between
private equity and hedge funds will be discussed below.
The largest rectangle in the exhibit contains all of alternative investing, of which
private equity and hedge funds are only two of many components. These
components are represented by two smaller rectangles within alternative investing.

GROWTH OF VENTURE CAPITAL IN INDIA

VENTURE CAPITAL:Venture capital (also known as VC or Venture) is a type of private equity capital
typically provided for early-stage, high-potential, and growth companies in the
interest of generating a return through an eventual realization event such as an IPO
or trade sale of the company.
Venture capital investments are generally made as cash in exchange for shares in
the invested company. It is typical for venture capital investors to identify and back
companies in high technology industries such as biotechnology and ICT
(information and communication technology). Venture capital firms typically
comprise small teams with technology backgrounds - scientists, researchers or
those with business training or deep industry experience.
VCs also take a role in managing entrepreneurial companies at an early stage, thus
adding skills as well as capital. Inherent in realizing abnormally high rates of

returns is the risk of losing all of one's investment in a given startup company. As a
consequence, most venture capital investments are done in a pool format where
several investors combine their investments into one large fund that invests in
many different startup companies. By investing in the pool format the investors are
spreading out their risk to many different investments versus taking the chance of
putting all of their monies in one startup firm.
A venture capitalist (also known as a VC) 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 (often an LP or LLC) that
primarily invests the financial capital of third-party investors in enterprises that are
too risky for the standard capital markets or bank loans.
Venture capital is also associated with job creation, the knowledge economy and
used as a proxy measure of innovation within an economic sector or geography.
Venture capital is most attractive for new companies with limited operating history
that are too small to raise capital in the public markets and have not reached the
point where they are able to secure a bank loan or complete a debt offering.
In exchange for the high risk that venture capitalists assume by investing in smaller
and less mature companies, venture capitalists usually get significant control over
company decisions, in addition to a significant portion of the company's ownership
(and consequently value).
STRUCTURE OF VENTURE CAPITAL FIRMS:Venture capital firms are typically structured as partnerships, the general partners
of which serve as the managers of the firm and will serve as investment advisors to
the venture capital funds raised.
This constituency comprises both high net worth individuals and institutions with
large amounts of available capital, such as state and private pension funds,
university financial endowments, foundations, insurance companies, and pooled
investment vehicles, called fund of funds or mutual funds.

TYPES OF VENTURE CAPITAL FIRMS:-

Depending on business type, the venture capital firm approach differs. When
approaching a VC firm, consider their portfolio:
Business Cycle: Do they invest in budding or established businesses?
Industry: What is their industry focus?
Investment: Is their typical investment sufficient for your needs?
Location: Are they regional, national or international?
Return: What is their expected return on investment?
Involvement: What is their involvement level?
Targeting specific types of firms will yield the best results when seeking VC
financing.
The National Venture Capital Association segments dozens of VC firms into ways
that might assist you in your search. Many VC firms have diverse portfolios with a
range of clients. If this is the case, finding gaps in their portfolio is one strategy
that might succeed.
ROLES WITHIN VENTURE CAPITAL FIRMS:Although the titles are not entirely uniform from firm to firm, other positions at
venture capital firms include:
Venture partners - Venture partners are expected to source potential investment
opportunities and typically are compensated only for those deals with which they
are involved.
Entrepreneur-in-residence (EIR) - EIRs are experts in a particular domain and
perform due diligence on potential deals. EIRs are engaged by venture capital
firms temporarily (six to 18 months) and are expected to develop and pitch startup
ideas to their host firm.
Principal - This is a mid-level investment professional position, and often
considered a "partnertrack" position. Principals will have been promoted from a
senior associate position or who have commensurate experience in another field
such as investment banking or management consulting.
Associate - This is typically the most junior apprentice position within a venture
capital firm. After a few successful years, an associate may move up to the "senior
associate" position and potentially principal and beyond. Associates will often have
worked for 1-2 years in another field such as investment banking or management
consulting.

ORIGINS OF MODERN PRIVATE EQUITY:Before World War II, venture capital investments (originally known as
"development capital") were primarily the domain of wealthy individuals and
families.
Today true private equity investments began to emerge marked by the founding of
the first two venture capital firms in 1946: American Research and Development
Corporation.(ARDC) and J.H. Whitney & Company. ARDC was founded by
Georges Doriot, the "father of venture capitalism" to encourage private sector
investments in businesses run by soldiers who were returning from World War II.
ARDC's significance was primarily that it was the first institutional private equity
investment firm that raised capital from sources other than wealthy families
although it had several notable investment successes as well.
ARDC is credited with the first major venture capital success story when its 1957
investment of
$70,000 in Digital Equipment Corporation (DEC) would be valued at over $355
million after the company's initial public offering in 1968.
Venture capital firms suffered a temporary downturn in 1974, when the stock
market crashed and investors were naturally wary of this new kind of investment
fund.
THE VENTURE CAPITAL FUNDS IN INDIA:The concept and origin of Venture Capital, trace its growth, and highlight the
venture capital regulations. It has briefly explained about the Chandra Sekhar
Committee recommendations, various types of Venture Capital Funds and the
venture capital process in India. A simple case on first Venture Capital Fund in
India, Technology Development & Information Company Of India Ltd., has also
developed with concluding remarks.
Introduction:The venture capital investment helps for the growth of innovative
entrepreneurships in India.
Venture capital has developed as a result of the need to provide non-conventional,
risky finance to new ventures based on innovative entrepreneurship.

Venture capital is an investment in the form of equity, quasi-equity and sometimes

debt - straight or conditional, made in new or untried concepts, promoted by a
technically or professionally qualified entrepreneur.
Venture capital means risk capital. It refers to capital investment, both equity and
debt, which carries substantial risk and uncertainties. The risk envisaged may be
very high may be so high as to result in total loss or very less so as to result in high
gains.
THE CONCEPT OF VENTURE CAPITAL:Venture capital means many things to many people. It is in fact nearly impossible
to come across one single definition of the concept.
Venture capital is defined 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.
THE ORIGIN OF VENTURE CAPITAL:In the 1920's & 1930's, the wealthy families of and individuals investors provided
the start up money for companies that would later become famous. Eastern Airlines
and Xerox are the more famous ventures financed. Among the early VC funds set
up, was the one by the Rockfeller Family, which started a special fund called
VENROCK in 1950, to finance new technology companies. General Doriot, a
professor at Harvard Business School, in 1946 set up the American Research and
Development Corporation (ARD), the first firm, as opposed to private individuals,
at MIT to finance the commercial promotion of advanced technology, developed in
the US Universities. ARD's approach was a classic VC in the sense that it used
only equity, invested for long term, and was prepared to live with losers.
ARD's investment in Digital Equipment Corporation, 1957 was a watershed in the
history of VC financing. While in its early years venture capital may have been
associated with high technology, over the years the concept has undergone a
change and it implies pooled investment in unlisted companies.
MAIN ALTERNATIVES TO VENTURE CAPITAL:-

Because of the strict requirements venture capitalists have for potential

investments, many entrepreneurs seek initial funding from angel investors, who
may be more willing to invest in highly speculative opportunities, or may have a
prior relationship with the entrepreneur.
Furthermore, many venture capital firms will only seriously evaluate an investment
in a start-up otherwise unknown to them if the company can prove at least some of
its claims about the technology and/or market potential for its product or services.
To achieve this, or even just to avoid the dilutive effects of receiving funding
before such claims are proven, many start-ups seek to self-finance until they reach
a point where they can credibly approach outside capital providers such as venture
capitalists or angel investors. This practice is called "bootstrapping".
In industries where assets can be securitized effectively because they reliably
generate future revenue streams or have a good potential for resale in case of
foreclosure, businesses may more cheaply be able to raise debt to finance their
growth. Good examples would include asset-intensive extractive industries such as
mining, or manufacturing industries.
Offshore funding is provided via specialist venture capital trusts which seek to
utilise securitization in structuring hybrid multi market transactions via an SPV
(special purpose vehicle): a corporate entity that is designed solely for the purpose
of the financing.
In addition to traditional venture capital and angel networks, groups have emerged
which allow groups of small investors or entrepreneurs themselves to compete in a
privatized business plan competition where the group itself serves as the investor
through a democratic process.
Venture capital (VC) arms of companies such as Intel, Cisco, Reliance ADAG,
Google and Yahoo are increasing their investments in early stage technology and
consumer service start-ups in India.
Early Days
In the absence of an organised Venture Capital industry until almost 1995,
individual investors and development financial institutions played the role of
venture capitalists in India. Entrepreneurs have largely depended upon private
placements, public offerings and lending by the financial institutions.
In 1973, a committee on Development of Small and Medium Enterprises
highlighted the need to foster venture capital as a source of funding new
entrepreneurs and technology. Thereafter some public sector funds were set up but
the activity of venture capital did not gather momentum as the thrust was on hightechnology projects funded on a purely financial rather than a holistic basis.

REGULATORY GUIDELINES & FRAMEWORK:Later, a study was undertaken by the World Bank, to examine the possibility of
developing Venture Capital in the private sector, based on which the Government
of India took a policy initiative and announced guidelines for Venture Capital
Funds (VCFs) in India in 1988.
However, these guidelines restricted setting up of VCFs by the banks or the
financial institutions only. Thereafter, the Government of India issued guidelines in
September 1995, for overseas investment in Venture Capital in India. For taxexemption purposes, guidelines were also issued by the Central Board of Direct
Taxes (CBDT) and the investments and flow of foreign currency into and out of
India have been governed by the Reserve Bank of India's (RBI) requirements.
Further, as a part of its mandate to regulate and to develop the Indian capital
markets, the Securities and Exchange Board of India (SEBI) framed the SEBI
(Venture Capital Funds) Regulations, 1996. These guidelines were further amended
in April 2000 with the objective of fuelling the growth of Venture Capital activities
in India.
OBJECTIVES AND VISION FOR VENTURE CAPITAL IN INDIA:Venture capitalists finance innovation and ideas which have potential for high
growth but with inherent uncertainties. This makes it a high-risk, high return
investment. Apart from finance, venture capitalists provide networking,
management and marketing support as well. In the broadest sense, therefore,
venture capital connotes financial as well as human capital.
In the global venture capital industry, investors and investee firms work together
closely in an enabling environment that allows entrepreneurs to focus on value
creating ideas and allows venture capitalists to drive the industry through
ownership of the levers of control, in return for the provision of capital, skills,
information and complementary resources. This very blend of risk financing and
hand holding of entrepreneurs by venture capitalists creates an environment
particularly suitable for knowledge and technology based enterprises.
Scientific, technology and knowledge based ideas properly supported by venture
capital can be propelled into a powerful engine of economic growth and wealth
creation in a sustainable manner. In various developed and developing economies
venture capital has played a significant developmental role. India has the second
largest English speaking scientific and technical manpower in the world.
The Indian software sector crossed the Rs.100 billion mark turnover during 1998.
The sector grew 58% on a year to year basis and exports accounted for Rs.65.3

billion while the domestic market accounted for Rs.35.1 billion. Exports grew by
67% in rupee terms and 55% in US dollar terms. The strength of software
professionals grew by 14% in 1997 and has crossed 1,60,000. The global software
sector is expected to grow at 12% to 15% per annum for the next 5 to 7 years.
Recently, there has also been greater visibility of Indian companies in the US.
Given such vast potential not only in IT and software but also in the field of service
industries, biotechnology, telecommunications, media and entertainment, medical
and health services and other technology based manufacturing and product
development, venture capital industry can play a catalytic role to put India on the
world map as a success story.
WHERE ARE VC'S INVESTING IN INDIA?

IT and IT-enabled services

Software Products (Mainly Enterprise-focused)
Wireless/Telecom/Semiconductor
Banking
PSU Disinvestments
Media/Entertainment
Bio Technology/Bio Informatics
Pharmaceuticals
Electronic Manufacturing
Retail

ISSUES AND CHALLENGES:Indian Venture Capital yet to be established as a sustainable asset class among
institutional investors. Moreover a limited amount of true "risk-capital" impacts
entrepreneurial activity. Exit challenges exist mainly due to shallow capital
markets and dull M&A environment for small companies. Most importantly, India
is yet to create a brand-name for IP-led companies, like Israel has successfully
done.
THE GROWTH
COMPARISON

OF

VENTURE

CAPITAL:

CROSS-CULTURAL

The venture capital (VC) industry plays an important role in nurturing

entrepreneurship and innovation, and its role varies from country to country. The

six countries whose VC industries are analyzed here are the United States and
Canada, whose VC industries are mature; Sweden and Denmark, which have
established small but successful VC industries; and Israel and Turkey, whose
experiences demonstrate the state of the young VC industry in transition
economies. The analysis is based on the four main determinants of the VC
industry: sources of financing, institutional infrastructure, exit mechanisms, and
entrepreneurship and innovation generators. In addition, the special role of VC
financing in the biomaterials industry is explained. Understanding the factors that
contribute to the emergence of a successful venture capital industry is important for
academics, VC associations, policy-making institutions, government agencies, and
investors themselves.
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 recognised 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. At the
same time Gujarat Venture Finance Ltd. and APIDC Venture Capital Ltd. were
started by state level financial institutions.
VENTURE CAPITAL INVESTMENTS IN INDIA:The venture capital investment in India till the year 2001 was continuously
increased and thereby drastically reduced. It is estimated that there was a
tremendous growth by almost 327 percent in 1998-99, 132 percent in 1999-00, and

40 percent in 2000-01 thereafter venture capital investors slow down their

investment. Surprisingly, there was a negative growth of 4 percent in 2001-02 it
was continued and a 54 percent drastic reduction was recorded in the year 20022003.
TYPES OF VENTURE CAPITAL FUNDS:Generally, there are three types of organised or institutional venture capital funds:
venture capital funds set up by angel investors, that is, high net worth individual
investors; venture capital subsidiaries of corporations and private venture capital
firms/ funds. Venture capital subsidiaries are established by major corporations,
commercial bank holding companies and other financial institutions. Venture funds
in India can be classified on the basis of the type of promoters. VCFs promoted by
the Central govt. controlled development financial institutions such as TDICI, by
ICICI, Risk capital and Technology Finance Corporation Limited (RCTFC) by the
Industrial Finance Corporation of India (IFCI) and Risk Capital Fund by IDBI.
VCFs promoted by the state government-controlled development finance
institutions such as
Andhra Pradesh Venture Capital Limited (APVCL) by Andhra Pradesh State
Finance Corporation (APSFC) and Gujarat Venture Finance Company Limited
(GVCFL) by Gujarat Industrial Investment Corporation (GIIC).
VCFs promoted by Public Sector banks such as Canfina by Canara Bank and SBICap by State Bank of India. VCFs promoted by the foreign banks or private sector
companies and financial institutions such as Indus Venture Fund, Credit Capital
Venture Fund and Grindlay's India Development Fund.
VENTURE CAPITAL FUNDING:Venture capitalists are typically very selective in deciding what to invest in; as a
rule of thumb, a fund may invest in one in four hundred opportunities presented to
it. Funds are most interested in ventures with exceptionally high growth potential,
as only such opportunities are likely capable of providing the financial returns and
successful exit event within the required timeframe (typically 3-7 years) that
venture capitalists expect.
Venture capitalists also are expected to nurture the companies in which they invest,
in order to increase the likelihood of reaching an IPO stage when valuations are
favorable.
Venture capitalists typically assist at four stages in the company's development:
Idea generation;

 Start-up;
Ramp up; and
Exit

There are typically six stages of financing offered in Venture Capital, that
correspond to these stages of a company's development.
Seed Money: Low level financing needed to prove a new idea (Often provided by
"angel investors")
Start-up: Early stage firms that need funding for expenses associated with
marketing and product development
First-Round: Early sales and manufacturing funds
Second-Round: Working capital for early stage companies that are selling product,
but not yet turning a profit
Third-Round: Also called Mezzanine financing, this is expansion money for a
newly profitable company
Fourth-Round: Also called bridge financing, 4th round is intended to finance the
"going public" process
WHAT DO VC'S LOOK FOR?
Venture capitalists are higher risk investors and, in accepting these risks, they
desire a higher return on their investment. The venture capitalist manages the
risk/reward ratio by only investing in businesses which fit their investment criteria
and after having completed extensive due diligence. Venture capitalists have
differing operating approaches. These differences may relate to location of the
business, the size of the investment, the stage of the company, industry
specialization, structure of the investment and involvement of the venture
capitalists in the companies activities. The entrepreneur should not be discouraged
if one venture capitalist does not wish to proceed with an investment in the
company. The rejection may not be a reflection of the quality of the business, but
rather a matter of the business not fitting with the venture capitalist's particular
investment criteria. Often entrepreneurs may want to ask the venture capitalist for
other firms that might be interested in the investment opportunity.
VENTURE CAPITAL IS NOT SUITABLE FOR ALL BUSINESSES, AS A
VENTURE CAPITALIST TYPICALLY SEEKS:
Superior Businesses:-

Venture capitalists look for companies with superior products or services targeted
at large, fast growing or untapped markets with a defensible strategic position such
as intellectual property or patents.
Quality and Depth of Management:Venture capitalists must be confident that the firm has the quality and depth in the
management team to achieve its aspirations. Venture capitalists seldom seek
managerial control, rather they want to add value to the investment where they
have particular skills including fund raising, mergers and acquisitions, international
marketing, product development, and networks.
Appropriate Investment Structure:As well as the requirement of being an attractive business opportunity, the venture
capitalist will also seek to structure a deal to produce the anticipated financial
returns to investors. This includes making an investment at a reasonable price per
share (valuation).
Exit Opportunity:Lastly, venture capitalists look for the clear exit opportunity for their investment
such as public listing or a third party acquisition of the investee company.
Once a short list of appropriate venture capitalists has been selected, the
entrepreneur can proceed to identify which investors match their funding
requirements. At this point, the entrepreneur should contact the venture capital firm
and identify an investment manager as an initial contact point. The venture capital
firm will ask prospective investee companies for information concerning the
product or service, the market analysis, how the company operates, the investment
required and how it is to be used, financial projections, and importantly questions
about the management team.
In reality, all of the above questions should be answered in the Business Plan.
Assuming the venture capitalist expresses interest in the investment opportunity, a
good business plan is a prerequisite.
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.

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.
VENTURE CAPITALISTS INVESTING IN INDIA:For a very long time, Silicon Valley venture capitalists only invested locally.
However, throughout the years, they expanded their investments worldwide. Most
recently, Matrix Partners, a leading American venture capitalist firm, had
announced a $150 million India fund, where they will provide internet, mobile,
media, entertainment, leisure, and travel services to customers in Mumbai. Sequoia
Capital, a Silicon Valley-based VC firm, wanted to take advantage of investing in
start-up companies and had acquired West bridge Capital, an Indian firm, for $350
million. It is no wonder that venture capitalist investments in India have risen
dramatically within the past few years. From 2005 to 2007, VC investments in
India grew from $320 million to about $777 million, respectively.
Some important Venture Capital Funds in India: APIDC Venture Capital Limited , 1102, Babukhan Estate, Hyderabad 500
001
Canbank Venture Capital Fund Limited, IInd Floor, Kareem Towers,
Bangalore
Gujarat Venture Capital Fund 1997, Ashram Road, Ahmedabad 380 009
Industrial Venture Capital Limited, Thyagaraya Road, Chennai 600 017
Auto Ancillary Fund Opp. Signals Enclave, New Delhi 110 010
Gujarat Venture Capital Fund 1995 Ashram Road Ahmedabad 380 009

 Karnataka Information Technology Venture Capital Fund Cunningham Rd

Bangalore
India Auto Ancillary Fund Nariman Point, Mumbai 400 021
Information Technology Fund, Nariman Point, Mumbai 400 021
Tamilnadu Infotech Fund Nariman Point, Mumbai 400 021
Orissa Venture Capital Fund Nariman Point Mumbai 400 021
Uttar Pradesh Venture Capital Fund Nariman Point, Mumbai 400 021
SICOM Venture Capital Fund Nariman Point Mumbai 400 021
Punjab Infotech Venture Fund 18 Himalaya Marg, Chandigarh 160 017
National venture fund for software and information technology industry
Nariman.

The Venture capital sector is the most vibrant industry in the financial market
today. Venture capitalists are professional investors who specialize in funding and
building young, innovative enterprises. Venture capitalists are long-term investors
who take a hands-on approach with all of their investments and actively work with
entrepreneurial management teams in order to build great companies which will
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 net worth
individuals, corporate, 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 rising, 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 invitee 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.
Venture capital should become an institutionalized industry that protects investors
and invitee 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.

Venture capital at a take-off stage in India:The venture capital industry in India is still at a nascent stage. With a view to
promote innovation, enterprise and conversion of scientific technology and
knowledge based ideas into commercial production, it is very important to promote
venture capital activity in India. Indias recent success story in the area of

information technology has shown that there is a tremendous potential for growth
of knowledge based industries. This potential is not only confined to information
technology but is equally relevant in several areas such as bio-technology,
pharmaceuticals and drugs, agriculture, food processing, telecommunications,
services, etc. Given the inherent strength by way of its skilled and cost competitive
manpower, technology, research and entrepreneurship, with proper environment
and policy support, India can achieve rapid economic growth and competitive
global strength in a sustainable manner.
A flourishing venture capital industry in India will fill the gap between the capital
requirements of
Manufacture and Service based startup enterprises and funding available from
traditional institutional lenders such as banks. The gap exists because such startups
are necessarily based on intangible assets such as human capital and on a
technology-enabled mission, often with the hope of changing the world. Very
often, they use technology developed in university and government research
laboratories that would otherwise not be converted to commercial use. However,
from the viewpoint of a traditional banker, they have neither physical assets nor a
low-risk business plan. Not surprisingly, companies such as Apple, Exodus,
Hotmail and Yahoo, to mention a few of the many successful multinational
venture-capital funded companies, initially failed to get capital as startups when
they approached traditional lenders. However, they were able to obtain finance
from independently managed venture capital funds that focus on equity or equitylinked investments in privately held, high-growth companies. Along with this
finance came smart advice, hand-on management support and other skills that
helped the entrepreneurial vision to be converted to marketable products.
A similar investor preference for start-up IT companies is being seen, though not of
the same magnitude. Yet, it is apparent that investors are willing to take higher
risks for a potentially higher reward by investing in start-up companies.
Until 1998, the venture creation phenomenon for the IT sector in India had been
quite unsatisfactory.
Some experts believe that India lacks strong anchor companies like HP and
Fairchild, which funded the start-ups of early Silicon Valley entrepreneurs. Others
believe that Indian entrepreneurs are not yet globally connected and are often
unwilling to share equity with a quality risk capital investor. There was also a
perception that startups in India do not typically attract the right managerial talent
to enable rapid growth. Finally, exit options were considered to be few, with the
general feeling that entrepreneurs were unwilling to sell their start-ups even if it
was feasible. As a result, much of the risk capital available was not quickly
deployed. However, since March
1999, things have been changing dramatically for the better.

The venture capital phenomenon has now reached a take-off stage in India. Risk
capital in all forms is becoming available more freely. As against the earlier trend,
where it was easy to raise only growth capital, even financing of ideas or seed
capital is available now. The number of players offering growth capital and the
number of investors is rising rapidly. The successful IPOs of entrepreneur-driven
Indian IT companies have had a very positive effect in attracting investors. The
Indian government initiatives in formulating policies regarding sweat equity, stock
options, tax breaks for venture capital along with overseas listings have all
contributed to the enthusiasm among investors and entrepreneurs, as has the
creation of the dot.com phenomenon.
In India, the venture capital creation process has started taking off. All the four
stages - including idea generation, start-up, growth ramp-up and exit processes are being encouraged. However, much needs to be done in all of these areas,
especially on the exit side.

India is attractive for risk capital:India certainly needs a large pool of risk capital both from home and abroad.
Examples of the US, Taiwan and Israel clearly show that this can happen. But this
is dependent on the right regulatory, legal, tax and institutional environment; the
risk-taking capacities among the budding entrepreneurs; start-up access to R&D
flowing out of national and state level laboratories; support from universities; and
infrastructure support, such as telecoms, technology parks, etc.
Steps are being taken at governmental level to improve infrastructure and R&D.
Certain NRI organizations are taking initiatives to create a corpus of US$150m to
strengthen the infrastructure of IITs. More focused attempts will be required in all
these directions.
Recent phenomena, partly ignited by success stories of Indians in the US and other
places abroad, provide the indications of a growing number of young, technically-

qualified entrepreneurs in India. Already there are success stories in India. At the
same time, an increasing number of savvy, senior management personnel have
been leaving established multinationals and Indian companies to start new
ventures. The quality of enterprise in human capital in India is on an ascending
curve.
The environment is ripe for creating the right regulatory and policy environment
for sustaining the momentum for high-technology entrepreneurship. Indians abroad
have leapfrogged the value chain of technology to reach higher levels. At home in
India, this is still to happen. By bringing venture capital and other supporting
infrastructure, this can certainly become a reality in India as well.
India is rightly poised for a big leap. What is needed is a vibrant venture capital
sector, which can leverage innovation, promote technology and harness the
ongoing knowledge explosion. This can happen by creating the right environment
and the mindset needed to understand global forces. When that happens we would
have created not Silicon Valley' but the Ind Valley' - a phenomenon for the world
to watch and reckon with.
A viable venture capital industry depends upon a continuing flow of investment
opportunities capable of growing sufficiently rapidly to the point at which they can
be sold yielding a significant annual return on investment. If such opportunities do
not exist, then the emergence of venture capital is unlikely. In the U.S. and
Israel such opportunities occurred most regularly in the information technologies.
Moreover, in every country, with the possible exception of the U.S., any serious
new opportunity has to be oriented toward the global market, because few national
markets are sufficiently large to generate the growth capable of producing
sufficient capital gains.
Since Independence, the Indian government strove to achieve autarky and the
protection of Indian markets and firms from multinational competition guided
nearly every policy the information technology industries were no exceptions.
The protectionist policy had benefits and costs. The benefit was that it contributed
to the creation of an Indian IT industry; the cost was that the industry was
backward despite the excellence of its personnel. Due to this lack of foreign
investment and despite the presence of skilled Indian personnel, India was a
technological backwater even while East Asia progressed rapidly.
In terms of experience, India contrasted favorably with most developing countries,
which had small, inefficient stock markets listing only established firms. However,
although these stock markets provided an exit opportunity, they did not provide the
capital for firm establishment. Put differently, accessible stock markets did not
create venture capital for startups; they merely provided an opportunity for raising
follow-on capital or an exit opportunity. Other institutional sources of funds .India
has a strong mutual fund sector that began in 1964 with the formation of the Unit

Trust of India (UTI), an open-ended mutual fund, promoted by a group of public

sector financial institutions. Because UTIs investment portfolio was to consist of
longer-term loans, it was meant to offer savers a return superior to bank rates. In
keeping with the risk-averse Indian environment, initially UTI invested primarily
in long-term corporate debt. However, UTI eventually became the countrys largest
public equity owner as well. This was because the government controlled interest
rates in order to reduce the borrowing costs of the large manufacturing firms that it
owned. These rates were usually set well below market rates, yet UTI and other
institutional lenders were forced to lend at these rates. In response, firms started
issuing debt that was partially convertible into equity in order to attract
institutional funds.
The largest single source of funds for U.S. venture capital funds since the 1980s
has been public and private sector pension funds. In India, there are large pension
funds but they are prohibited from investing in either equity or venture capital
vehicles, thus closing off this source of capital. In summation, prior to the late
1980s, though India did have a vibrant stock market, the rigid and numerous
regulations made it nearly impossible for the existing financial institutions to invest
in venture capital firms or in startups. Nearly all of these institutions were
politicized, and the government bureaucrats operating them were risk-adverse. On
the positive side, there was a stock market with investors amenable to purchasing
equity in fairly early-stage companies. It was also possible to bootstrap a firm
and/or secure funds from friends and family if one was well connected. However,
no financial intermediaries comfortable with backing small technology-based firms
existed prior to the mid-1980s. It is safe to say that little capital was available for
any entrepreneurial initiatives.
An entrepreneur aiming to create a firm would have to draw upon familial capital
or bootstrap their firm. An Indian venture capital industry is struggling to emerge
and given the general global downturn, the handicaps existing in the Indian
environment are threatening. As we have seen, many of the preconditions do exist,
but the obstacles are many. Some of these can be addressed directly without
affecting other aspects of the Indian political economy. Others are more deeply
rooted in the legal, political, and economic structure and will be much more
difficult to overcome without having a significant impact on other parts of the
economy. A number of these issues were addressed in a report submitted to SEBI
in January 2000 from its Committee on Venture Capital. SEBI then recommended
that the Ministry of Finance adopt many of its suggestions.
In June 2000, the Ministry of Finance adopted a number of the Committees
proposals. For example, it accepted that only SEBI should regulate and register
venture capital firms. The only criterion was to be the technical qualifications of
their promoters, whether domestic or offshore. Such registration would not impose

any capital requirements or legal structure this is very important, because it

would allow India to develop a legal structure suitable to its environment, while
offering tax pass-through for all firms registered as venture capital firms with
SEBI. This was an important achievement of the Committees report. However, the
proposed guidelines continued to prohibit finance and real estate investments.
Whether this type of micromanagement is good policy seems dubious. Also,
registered venture capital funds must invest 70 percent of their paid-in capital in
unlisted equity or equity-related, fully convertible instruments. Similarly, relatedcompany transactions would be prohibited, and not more than 25 percent of a
funds capital could be invested in a single firm. In the U.S. most of these
provisions are not law, but are codified in the limited partnership contracts and
accepted as common sense. Rather than letting the market decide which venture
capital firms are operating responsibly, the Indian government continues to specify
a variety of conditions.
A number of suggestions were not accepted even though they would assist in the
growth of venture capital. Many were related to the much larger general issues of
corporate governance. For example, there was no change in the regulations
regarding restrictions on currency no convertibility, providing employees more
flexible stock-option plans, allowing domestic venture capital firms to hold equity
in overseas startups, and regulations allowing greater flexibility in voting and
dividend rights. Reluctance to adopt these measures is understandable, because
they would strike at some of the fundamental issues of corporate governance in
India.
Thus they were seen as policy decisions that might set in motion a larger chain of
events.
At the end of 2001, the Indian venture capital environment contained several
unresolved issues. One important obstacle was the inability to pass through
unrealized gains or losses through to the venture capital fund's investors through a
direct distribution of stock or other securities unless the fund is organized as a
trust. In the US, these "in-kind distributions" are the most common method of
compensating investors. This method increases the return for socially beneficial
tax-exempt organizations such as foundations and pension funds.
Private individuals, of course, pay taxes. Allowing legal structures, such as limited
partnerships, will enable such pass-through and encourage investment in venture
capital funds
India has a large, sophisticated financial system including private and public,
formal and informal actors. In addition to formal financial institutions, informal
institutions such as family and moneylenders are important sources of capital.
India has substantial capital resources, but as Table 1 indicates, the bulk of this
capital resides in the banking system. In the formal financial system, lending is

dominated by retail banks rather than the wholesale banks or the capital markets
for debt. The primary method for firms to raise capital is through the public equity
markets, rather than through private placements.

Critical factors for success of venture capital industry:

While making the recommendations the Committee felt that the following factors
are critical for the success of the VC industry in India:
A The regulatory, tax and legal environment should play an enabling role.
Internationally, venture funds have evolved in an atmosphere of structural
flexibility, fiscal neutrality and operational adaptability.
B Resource rising, investment, management and exit should be as simple and
flexible as needed and driven by global trends
C 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 startup firms in a wide range of high growth areas.
D 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.
E

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. The hassle free entry of such Foreign Venture
Capitalists in the pattern of FIIs is even more necessary because of the
following factors:

Venture capital is a high risk area. In out of 10 projects, 8 either fails or

yield negligible returns. It is therefore in the interest of the country that
FVCIs bear such a risk.

ii

For venture capital activity, high capitalization of venture capital

companies is essential to withstand the losses in 80% of the projects. In
India, we do not have such strong companies.

iii

The FVCIs are also more experienced in providing the needed

managerial expertise and other supports.

Conclusion:In recent years the growth of Venture Capital Business has been drastically
decreasing due to many reasons. The regulator has to liberalize the stringent
policies and pave the way to the venture capital investors to park their funds in
most profitable ventures. 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 few years. 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.
BIBLIOGRAPHY:http://www.ventureitch.com

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