UNIVERSITY OF MUMBAI Academic Year 2007 - 2008 SHRI CHINAI COLLEGE OF COMMERECE AND ECONOMICS ANDHERI (EAST)

Project Report On Venture Capital Project Guide Prof. Nishikant Jha

Presented By: PRIYA CHATURVEDI T.Y.B.COM (Banking & Insurance) Roll No.12 Semester V

Declaration
I, Miss. Priya Chaturvedi student of T.Y.B.Com (Banking & Insurance) Semester Vth , SHRI CHINAI COLLEGE OF COMMERCE & ECONOMICS. Hereby declare that I have completed this project on VENTURE CAPITAL in the academic year 2007-2008. The information submitted is true and original to the best of my knowledge.

Signature of the Student (PRIYA CHATURVEDI)

CERTIFICATE
I, Prof. NISHIKANT JHA hereby certify that Miss.Priya Chaturvedi student of T.Y.B.Com (Banking & Insurance), SHRI CHINAI COLLEGE OF COMMERCE & ECONOMICS, has completed her project on VENTURE CAPITAL in the academic year 2007-2008. The information submitted is true and original to the best of my knowledge.

Signature of Project Guide

(NISHIKANT JHA) ACKNOWLEDGEMENT This goes to all who have knowingly or unknowingly been a great support for me to accomplish this piece of work. Entrance, hard work, gradual progress and an exciting year, that is how I have reached this level and now as I stand at the threshold of the aside world, I take a look of the past year which I have spent in this college, our performance with the devotion of the profession and all the fun I had was like a beautiful dream come true. First of all I would like to take this opportunity to thank the Mumbai University for having projects as a part of the Banking and Insurance curriculum. Many people have influenced the shape and content of this project, and many supported me through it. Secondly, I would like to thank my College Principal Dr. MALINI JOHARI for supporting in everything and then our Coordinator, Prof. NISHIKANT JHA for encouraging me in everything I did and for supporting me. I express my sincere gratitude to Prof. NISHIKANT for being my Project Guide and for assigning me a project on Venture Capital which is an interesting and exhaustive subject. Prof. NISHIKANT JHA has been an inspiration and role model for this topic. His guidance and active support has made it possible to complete the assignment. I also would like to thank my parents and friends who have helped and encouraged me throughout the working of the project. I would also like to thanks the customers who have helped in making my survey successful.

EXECUTIVE SUMMARY
Venture Capital is defined as providing seed, start-up and first stage finance to companies and also funding expansion of companies that have demonstrated business potential but do not have access to public securities market or other credit oriented funding institutions. A Venture Capital Fund (VCF) strives to provide entrepreneurs with the support they need to create up-scalable business with sustainable growth, while providing their contributors with outstanding returns on investment, for the higher risks they assume. The industrys growth in India can be considered in two phases. The first phase was spurred on soon after the liberalization process began in 1991. The second phase was considered from 1996, where SEBI came out with guidelines for venture capital funds has to adhere to, in order to carry out activities in India. This was the beginning of the second phase in the growth of venture capital in India. The Indian venture capital industry, at the present, is at crossroads. There are some major issues faced by this industry which are as follows, like Limitations on structuring of venture capital funds, Problem in raising of funds, Absence of angel investors, Limitation on investment instrument, Limitation on Exit Mechanism, Legal framework, etc. Venture capital industry in India is still in its early stages and to give it a proper fillip it is important to develop related infrastructure as has been successfully done internationally specially in US, Taiwan and Israel. Following areas need due attention. The Indian government has been highly supportive of growth in technology and knowledgebased sectors. All VC funds registered with SEBI are exempted from income tax. The benefits received by contributors to the VC funds are also tax exempt. The government has opened up new sectors for venture funding like real estate, bullion. FDIs have been proposed through automatic route for venture funds like biotechnology. Technology based companies have always been the anchors for venture capitalists. In the past, the focus has been on IT, communication and biotechnology. But there are many niche areas where significant value can be created. Entertainment and digital media is also a new, emerging area. The Venture Capital market in its nascent stage so, there is a good scope for the

venture capitalist in India in near future. It has a huge potential to establish itself in the emerging market

INDEX
SR.NO. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. CONTENTS Foreword Origin of Venture Capital Venture Capital - Meaning Venture Capital Flow Chart Venture Capital in India Types of Venture Capital Investors Classification OF Venture Capital funds Stages of f financing by Venture Capitalist Venture Capital Investment Process Assessing Venture Capital Undertaking Assessing Venture Capital Fund Exit Routes Regulatory Framework For Venture Capital In India SWOT Analysis of the Indian Venture Capital Industry Issued Faced by the Indian Venture Capital Industry Future of Venture Capital in India Current Trends Survey : Gandhi & Associates Survey Form Consumers Report Annexure Conclusion Bibliography PAGE NO. 1-1 1-2 2-3 3-3 5-5 6-6 6-7 7-8 8-8 9-12 12-14 14-16 17-17 18-20 21-21 21-22 22-23 24-25 26-26 27-28 28-29

1 .FORWARD
The Venture capital sector is the most vibrant industry in the financial market today. Venture capital is money provided by professionals who invest alongside management in young, rapidly growing companies that 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. Resources raising, investment, management and exit should be as simple and flexible as needed and driven by global trends. Venture capital should become as institutionalized industry that protects investors and investor 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.

ORIGIN OF VENTURE CAPITAL

The story of venture capital is very much like the history of mankind. In the fifteenth century, Christopher Columbus sought to travel westwards instead of eastwards from Europe and so planned to reach India. His far- fetched idea did not find favour with the King of Portugal, who refused to finance him. Finally, Queen Isabella of Spain decided to fund him and the voyages of Christopher Columbus are now empanelled in history. And thus evolved the concept of Venture Capital.

The modern venture capital industry began taking shape in the post World War 2. It is often said that people decide to become entrepreneurs because they see role models in other people who have become successful entrepreneurs because they see role models in other people who have become successful entrepreneurs. Much the same can be said about venture capitalists. The earliest members of the organized venture capital industry had several role models, including these three : American Research and Development Corporation: Formed in 1946, whose biggest success was Digital Equipment. The founder of ARD was General Georges Doroit, a French-born military man who is considered the father of venture capital. In the 1950s, he taught at the Harvard Business School. His lectures on the importance of risk capital were considered quirky by the rest of the faculty, who concentrated on conventional corporate management. J.H. Whitney & Co: Also formed in 1946, one of those early hits was Minute Maid juice. Jock Whitney is considered one of the industrys founders. The Rockefeller Family: L S Rockefeller, one of those earliest investments was in Eastern Airlines, which is now defunct but was one of the earliest commercial airlines.

3. VENTURE CAPITAL
Venture Capital is defined as providing seed, start-up and first stage finance to companies and also funding expansion of companies that have demonstrated business potential but do not have access to public securities market or other credit oriented funding institutions. Venture Capital is generally provided to firms with the following characteristics:

Newly floated companies that do not have access to sources such as equity capital and/or other related instruments. Firms, manufacturing products or services that have vast growth potential. Firms with above average profitability. Novel products that are in the early stages of their life cycle. Projects involving above-average risk. Turnaround of companies

Venture Capital derives its value from the brand equity, professional image, constructive criticism, domain knowledge, industry contacts; they bring to table at a significantly lower management agency cost. A Venture Capital Fund (VCF) strives to provide entrepreneurs with the support they need to create up-scalable business with sustainable growth, while providing their contributors with outstanding returns on investment, for the higher risks they assume. The three primary characteristics of venture capital funds which make them eminently suitable as a source of risk finance are: That it is equity or quasi equity investment It is long term investment and It is an active form of investment.

Venture capitalists When someone refers to venture capitalist, the image that comes in mind is Mr. Money bags. We all think of venture capitalists as someone who is sitting on millions of dollars and who with the wave of his magic wand turns your dreams into reality. Well, if thats what you think is all about why run after him play Santa yourself Venture Capitalists is like any other professional who is paid for doing his job, yes, venture capitalist is nothing but a fund manager whose job is to manage funds

that are raised. A venture capitalist gets a fee to invest in companies that interest his investors. Difference between a Venture Capitalist and Bankers/Money Managers. Banker is a manager of other peoples money while the venture capitalist is basically an investor. Venture capitalist generally invests in new ventures started by technocrats who generally are in need of entrepreneurial aid and funds. Venture capitalists generally invest in companies that are not listed on any stock exchanges. They make profits only after the company obtains listing. The most important difference between a venture capitalist and conventional investors and mutual funds is that he is a specialist and lends management support and also Financial and strategic planning Recruitment of key personnel Obtain bank and debt financing Access to international markets and technology Introduction to strategic partners and acquisition targets in the region Regional expansion of manufacturing and marketing operations Obtain a public listing

VENTURE CAPITAL FLOW CHART

VENTURE CAPITAL IN INDIA

Institutionalization of VC in India To establish the process of institutionalisation of Venture Capital Funding (VCF) in India it is important to examine the growth of this industry within the context of the larger political and economic system. The development of the venture capital industry in India in the 1980s seemed almost utopian. Indias highly bureaucratised economy, a conservative social and business outlook and a risk averse financial system provided little encouragement and institutional space for the venture capital industry to advance. The earliest mention of venture capital came in 1973. A committee appointed by the Indian government to examine the promotion of development of SMEs highlighted the need to endorse venture capital as a source of funding new entrepreneurs and technology. The Indian economy is a dualistic economy, dominated by a few massive Public Sector Undertakings (PSUs) on the one hand and private sector industry giants such as the Tatas and Birlas on the other. An entrepreneur starting a sunrise industry would have to do so on his own personal savings or loans raised through personal contacts and financial institutions. In 1988, the World Bank, encouraging economic liberalization in third world countries, undertook a study to examine the possibility of developing venture capital funding chiefly in the private sector. Accordingly, the Indian government issued its first guidelines to legalise venture capital operations. They allowed state controlled banks and financial institutions to establish venture capital subsidiaries. As a result venture capital funding became an extension for developing financial institutions such as ICICI, IDBI, SIDBI, and State Finance Corporations.

In the absence of an independent and organized venture capital industry in India until almost 1998, individual investors and developmental financial institutions played the

role of venture capitalists. Entrepreneurs were largely dependent on private placements, public offerings and lending by financial institutions.

The growth of the venture capital industry in India can be divided into 2 phases. The first phase began post reform with liberalization of the Indian economy. The Technical Development and Information Corporation of India (TDICI, now ICICI ventures) and the Gujarat Venture Finance Limited (GVFL) were set up. Sources of these funds were financial institutions, foreign institutional investors or pension funds and high net-worth individuals. The second phase of venture capital growth in India began with the realization that venture capital funding, as an industry has to be regulated. Subsequently, the Government of India issued guidelines in September 1995 for overseas investment in venture capital in India. In 1996, the Securities and Exchange Board of India (SEBI) came out with guidelines for venture capital funds. The move liberated the industry from a number of bureaucratic hassles and paved the way for greater access to capital. Moreover, competition brought professional business practices from the mature markets in the west. In 1997, venture capital funding became prominent in the IT sector. All venture capital funds that were as of then being employed in other sectors, changed their focus to the IT and Telecom industry. With the IT boom today, the Indian venture capital industry has finally turned the curve. However it is still striving hard to successfully and wholly take off. During the recession from 1999 2001 most of the venture capitalists either closed down or shifted focus. Almost all of them with the exception of one or two like GvFL centered on successful firms for their growth and expansion. Venture capital firms also got engaged into funding buyouts, privatization and restructuring. Currently, just

a few firms are taking the risk of investing into the start-up technology based companies. The success achieved in the IT sector, has encouraged VCF in several other sectors like bio-technology, pharmaceuticals and drugs, agriculture, food processing, telecommunications, call centers, business process outsourcing (BPO) and services. With proper policy support and financing of risk capital, entrepreneurship in small and medium sector can succeed. State Governments have now started taking an active part in the venture capital Industry. States like Andhra Pradesh have APIDC-VCL, which is a joint venture between the Ventureast Group and the Andhra Pradesh Industrial Development Corporation funding SMEs like bio-technology firms, pharma etc. First-generation entrepreneurs are now finding it easier to raise venture funds. More venture funds are now being invested in low technology enterprise as is seen in the case of ICICI Ventures that has a stake in Shoppers Stop.

There are a number of funds, which are 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, there is a strong optimistic undertone in the air. With the Indian knowledge industry finally showing signs of readiness towards competing globally and awareness of venture capitalists among entrepreneurs higher than ever before, the stage seems all set for an overdrive. The Indian Venture Capital Association (IVCA), is the nodal center for all venture activity in the country. The association was set up in 1992 and over the last few years, has built up an impressive database. According to the IVCA, the pool of funds available for investment to its 20 members in 1997 was Rs25.6bn. Out of this, Rs10 bn had been invested in 691 projects. Certain venture capital funds are Industry specific(ie they fund enterprises only in certain industries such as pharmaceuticals, infotech or food processing) whereas others may have a much wider spectrum. Again, certain funds may have a geographic focus like Uttar Pradesh, Maharashtra, Kerala, etc whereas others may fund across different territories. The funds may be either close-endedschemes (with a fixed period

of maturity) or open-ended. The growth of venture capital in India from 2000-2006 is as follows:

As in the above chart, it is observed that venture capital had a great fall from 2000 to 2003 from US$ 280 million to US$ 56 million. 2004 was a good start from venture capital in India. And there more chances of increase in venture capital in India.

TYPES OF VC INVESTORS

The venture funds available could be from Incubators Angel investors Venture Capitalists (VCs) Private Equity Players

Incubators An incubator is a hardcore technocrat who works with an entrepreneur to develop a business idea, and prepares a company for subsequent rounds of growth & funding. E-Ventures, Infinity is examples of incubators in India.

Angel Investors An angel is an experienced industry-bred individual with high net worth. Typically, an angel investor would: Invest only his chosen field of technology Take active participation in day-to-day running of the company Invest small sums in the range of USD 1-3 million Not insist on detailed business plans Sanction the investment in up to a month Help company for second round of funding

The INDUS Entrepreneurs (TiE) is a classic group of angels like: Vinod dham, Sailesh Mehta, Kanwal Rekhi, Prabhu Goel, Suhas Patil, Prakash Agrawal, K.B

Chandrashekhar. In India there is a lack of home grown angels except a few like Saurabh Srivastava & Atul Choksey (ex- Asian paints).

Venture Capitalists (VCs) VCs are organizations raising funds from numerous investors & hiring experienced professional managers to deploy the same. They typically: Invest at second stage Invest over a spectrum over industry/ies Have hand-holding mentor approach Insist on detailed business plans Invest into proven ideas/businesses Provide brand value to investee Invest between USD 2-5 million

Private Equity Players They are established investment bankers. Typically: Invest into proven/established businesses Have financial partners approach Invest between USD 5- 100 million

6.Classification of VC funds

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

Base formation Financial Institutions Led By ICICI Ventures, RCTC, ILFS, etc. Private venture funds like Indus, etc. Regional funds like Warburg Pincus, JF Electra (mostly operating out of Hong Kong). Regional funds dedicated to India like Draper, Walden, etc. Offshore funds like Barings, TCW, HSBC, etc. Corporate ventures like Intel. To this list we can add Angels like Sivan Securities, Atul Choksey (ex Asian Paints) and others. Merchant bankers and NBFCs who specialized in "bought out" deals also fund companies. Most merchant bankers led by Enam Securities now invest in IT companies.

Investment Philosophy Early stage funding is avoided by most funds apart from ICICI ventures, Draper, SIDBI and Angels. Funding growth or mezzanine funding till pre IPO is the segment where most players operate. In this context, most funds in India are private equity investors.

Size Of Investment The size of investment is generally less than US$1mn, US$1-5mn, US$5-10mn, and greater than US$10mn. As most funds are of a private equity kind, size of investments has been increasing. IT companies generally require funds of about Rs30-40mn in an early stage which fall outside funding limits of most funds and that is why the government is promoting schemes to fund start ups in general, and in IT in particular.

Value AdditionThe venture funds can have a totally "hands on" approach towards their investment like Draper or "hands off" like Chase. ICICI Ventures falls in the limited exposure category. In general, venture funds who fund seed or start ups have a closer interaction with the companies and advice on strategy, etc while the private equity funds treat their exposure like any other listed investment. This is partially justified, as they tend to invest in more mature stories. A list of the members registered with the IVCA as of June 1999, has been provided in the Annexure. However, in addition to the organized sector, there are a number of players operating in India whose activity is not monitored by the association. Add together the infusion of funds by overseas funds, private individuals, angel investors and a host of financial intermediaries and the total pool of Indian Venture Capital today, stands at Rs50bn, according to industry estimates! The primary markets in the country have remained depressed for quite some time now. In the last two years, there have been just 74 initial public offerings (IPOs) at the stock exchanges, leading to an investment of just Rs14.24bn. Thats less than 12% of the money raised in the previous two years. That makes the conservative estimate of Rs36bn invested in companies through the Venture Capital/private Equity route all the more significant. Some of the companies that have received funding through this route include: Mastek, one of the oldest software houses in India Geometric Software, a producer of software solutions for the CAD/CAM market Ruksun Software, Pune-based software consultancy SQL Star, Hyderabad based training and software development company Microland, networking hardware and services company based in Bangalore Satyam Infoway, the first private ISP in India Hinditron, makers of embedded software PowerTel Boca, distributor of telecomputing products for the Indian market

 Rediff on the Net, Indian website featuring electronic shopping, news, chat, etc Entevo, security and enterprise resource management software products Planetasia.com, Microlands subsidiary, one of Indias leading portals Torrent Networking, pioneer of Gigabit-scaled IP routers for inter/intra nets Selectica, provider of interactive software selection

Though the infotech companies are among the most favored by venture capitalists, companies from other sectors also feature equally in their portfolios. The healthcare sector with pharmaceutical, medical appliances and biotechnology industries also get much attention in India. With the deregulation of the telecom sector, telecommunications industries like Zip Telecom and media companies like UTV and Television Eighteen have joined the list of favorites. So far, these trends have been in keeping with the global course. However, recent developments have shown that India is maturing into a more developed marketplace; unconventional investments in a gamut of industries have sprung up all over the country. This includes: Indus League Clothing, a company set up by eight former employees of readymade garments giant Madura, who set up shop on their own to develop a unique virtual organization that will license global apparel brands and sell them, without owning any manufacturing units. They dream to build a network of 2,500 outlets in three years and to be among the top three readymade brands. Shoppers Stop, Mumbais premier departmental store innovates with retailing and decides to go global. This deal is facing some problems in getting regulatory approvals. Airfreight, the courier-company which has been growing at a rapid pace and needed funds for heavy investments in technology, networking and aircrafts. Pizza Corner, a Chennai based pizza delivery company that is set to take on global giants like Pizza Hut and Dominos Pizza with its innovative servicing strategy.

Consortium financing Where the project cost is high (Rs 100 million or more) and a single fund is not in a position to provide the entire venture capital required then venture funds might act in consortium with other funds and take a lead in making investment decisions. This helps in diversifying risk but however it has not been very successful in the India case.

STAGES OF FINANCING BY VENTURE CAPITALIST

Venture capital can be provided to companies at different stages. These include: I. Early- stage Financing Seed Financing: Seed financing is provided for product development & research and to build a management team that primarily develops the business plan. Startup Financing: After initial product development and through, startup financing is provided to companies to

research is

organize their business, before the commercial launch of their products. have large-scale First Stage Financing: Is provided to those companies that exhausted their initial capital and require funds to commence manufacturing and sales.

II.

Expansion Financing Second Stage Financing: This type of financing is available to provide working capital for initial expansion of companies, that are experiencing growth in accounts receivable and inventories, and is on the path of profitability. Mezzanine Financing: When sales volumes increase tremendously,

the company, through mezzanine financing is provided with funds for further plant expansion, marketing, working capital or for development of an improved product. Bridge Financing: Bridge financing is provided to companies that plan to go public within six to twelve months. Bridge financing is repaid from underwriting proceeds.

III.

Acquisition Financing As the term denotes, this type of funding is provided to companies to acquire another company. This type of financing is also known as buyout financing. It is normally advisable to approach more than one venture capital firm simultaneously for funding, as there is a possibility of delay due to the various queries put by the VC. If the application for funding were finally rejected then approaching another VC at that point and going through the same process would cause delay. If more than one VC reviews the business plan this delay can be avoided, as the probability of acceptance will be much higher. The only problem with the above strategy is the processing fee required by a VC along with the business plan. If you were applying to more than one VC then there would be a cost escalation for processing the application. Hence a cost benefit analysis should be gone into before using the above strategy. Normally the review of the business plan would take a maximum of one month and disbursal for the funds to reach the entrepreneur it would take a minimum of 3 months to a maximum of 6 months. Once the initial screening and evaluation is over, it is advisable to have a person with finance background like a finance consultant to take care of details like negotiating the pricing and structuring of the deal. Of course alternatively one can involve a financial consultant right from the beginning particularly when the entrepreneur does not have a management background.

8. Corporate Venturing (Investment process)

Venture Capital Process

Generating a deal flow

Due diligence

Exit

Investment Valuation Price and structuring the deal

Monitoring & nurturing

ValueAddition

Even though investor and the entire process that goes into the wooing the venture capital with your plan. First, you need to work out a business plan. The business plan is a document that outlines the management team, product, marketing plan, capital costs and means of financing and profitability statements. The venture capital investment process has variances/features that are context specific and vary from industry, timing and region. However, activities in a venture capital fund follow a typical sequence. The typical stages in an investment cycle are as below: Generating a deal flow Due diligence Investment valuation Pricing and structuring the deal Value Addition and monitoring Exit

I] Generating A Deal Flow In generating a deal flow, the venture capital investor creates a pipeline of deals or investment opportunities that he would consider for investing in. This is achieved primarily through plugging into an appropriate network. The most popular network obviously is the network of venture capital funds/investors.

It is also common for venture capitals to develop working relationships with R&D institutions, academia, etc, which could potentially lead to business opportunities. Understandably the composition of the network would depend on the investment focus of the venture capital funds/company. Thus venture capital funds focussing on early stage technology based deals would develop a network of R&D centers working in those areas. The network is crucial to the success of the venture capital investor. It is almost imperative for the venture capital investor to receive a large number of investment proposals from which he can select a few good investment candidates finally. Successful venture capital investors in the USA examine hundreds of business plans in order to make three or four investments in a year.-It is important to note the difference between the profile of the investment opportunities that a venture capital would examine and those pursued by a conventional credit oriented agency or an investment institution. By definition, the venture capital investor focuses on opportunities with a high degree of innovation. The deal flow composition and the technique of generating a deal flow can vary from country to country. In India, different venture capital funds/companies have their own methods varying from promotional seminars with R&D institutions and industry associations to direct advertising campaigns targeted at various segments. A clear pattern between the investment focus of a fund and the constitution of the deal generation network is discernible even in the Indian context.

II] Due Diligence Due diligence is the industry jargon for all the activities that are associated with evaluating an investment proposal. It includes carrying out reference checks on the proposal related aspects such as management team, products, technology and market.

The important feature to note is that venture capital due diligence focuses on the qualitative aspects of an investment opportunity. It is also not unusual for venture capital fund/companies to set up an investment screen. The screen is a set of qualitative (sometimes quantitative criteria such as revenue are also used) criteria that help venture capital funds/companies to quickly decide on whether an investment opportunity warrants further diligence. Screens can be sometimes elaborate and rigorous and sometimes specific and brief. The nature of screen criteria is also a function of investment focus of the firm at that point. Venture capital investors rely extensively on reference checks with leading lights in the specific areas of concern being addressed in the due diligence. A venture capitalist tries to maximize the upside potential of any project. He tries to structure his investment in such a manner that he can get the benefit of the upside potential ie he would like to exit at a time when he can get maximum return on his investment in the project. Hence his due diligence appraisal has to keep this fact in mind. New Financing Sometimes, companies may have experienced operational problems during their early stages of growth or due to bad management. These could result in losses or cash flow drains on the company. Sometimes financing from venture capital may end up being used to finance these losses. They avoid this through due diligence and scrutiny of the business plan. Inter-Company Transactions When investments are made in a company that is part of a group, inter-company transactions must be analyzed.

III] Investment Valuation The investment valuation process is an exercise aimed at arriving at an acceptable price for the deal. Typically in countries where free pricing regimes exist, the valuation process goes through the following steps: Evaluate future revenue and profitability

 Forecast likely future value of the firm based on experienced market capitalization or expected acquisition proceeds depending upon the anticipated exit from the investment. Target an ownership position in the investee firm so as to achieve desired appreciation on the proposed investment. The appreciation desired should yield a hurdle rate of return on a Discounted Cash Flow basis. Symbolically the valuation exercise may be represented as follows: NPV = [(Cash)/(Post)] x [(PAT x PER)] x k, where NPV = Net Present Value of the cash flows relating to the investment comprising outflow by way of investment and inflows by way of interest/dividends (if any) and realization on exit. The rate of return used for discounting is the hurdle rate of return set by the venture capital investor. Post = Pre + Cash Cash represents the amount of cash being brought into the particular round of financing by the venture capital investor. Pre is the pre-money valuation of the firm estimated by the investor. While technically it is measured by the intrinsic value of the firm at the time of raising capital. It is more often a matter of negotiation driven by the ownership of the company that the venture capital investor desires and the ownership that founders/management team is prepared to give away for the required amount of capital PAT is the forecast Profit after tax in a year and often agreed upon by the founders and the investors (as opposed to being arrived at unilaterally). It would also be the net of preferred dividends, if any. PER is the Price-Earning multiple that could be expected of a comparable firm in the industry. It is not always possible to find such a comparable fit in venture capital situations. That necessitates, therefore, a significant degree of judgement on the part of the venture capital to arrive at alternate PER scenarios. k is the present value interest factor (corresponding to a discount rate r) for the investment horizon.

It is quite apparent that PER time PAT represents the value of the firm at that time and the complete expression really represents the investors share of the value of the investee firm. The following example illustrates this framework: Example: Best Mousetrap Limited (BML) has developed a prototype that needs to be commercialized. BML needs cash of Rs2mn to establish production facilities and set up a marketing program. BML expects the company will go public in the third year and have revenues of Rs70mn and a PAT margin of 10% on sales. Assume, for the sake of convenience that there would be no further addition to the equity capital of the company. Prudent Fund Managers (PFM) propose to lead a syndicate of like minded investors with a hurdle rate of return of 75% (discounted) over a five year period based on BMLs sales and profitability expectations. Firms with comparable sales and profitability and risk profiles trade at 12 times earnings on the stock exchange. The following would be the sequence of computations: In order to get a 75% return p.a. the initial investment of Rs2 million must yield an accumulation of 2 x (1.75)5 = Rs32.8mn on disinvestment in year 5. BMLs market capitalization in five years is likely to be Rs (70 x 0.1 x 12) million = Rs84mn. Percentage ownership in BML that is required to yield the desired accumulation will be (32.8/84) x 100 = 39% Therefore the post money valuation of BML At the time of raising capital will be equal to Rs(2/0.39) million = Rs5.1 million which implies that a pre-money valuation of Rs3.1 million for BML Another popular variant of the above method is the First Chicago Method (FCM) developed by Stanley Golder, a leading professional venture capital manager. FCM assumes three possible scenarios success, sideways survival and failure. Outcomes under these three scenarios are probability weighted to arrive at an expected rate of return:In reality the valuation of the firm is driven by a number of factors. The more significant among these are: Overall economic conditions: A buoyant economy produces an optimistic long- term outlook for new products/services and therefore results in more liberal pre-money valuations.

 Demand and supply of capital: when there is a surplus of venture capital of venture capital chasing a relatively limited number of venture capital deals, valuations go up. This can result in unhealthy levels of low returns for venture capital investors. Specific rates of deals: such as the founders/management teams track record, innovation/ unique selling propositions (USPs), the product/service size of the potential market, etc affects valuations in an obvious manner. The degree of popularity of the industry/technology in question also influences the pre-money. Computer Aided Skills Software Engineering (CASE) tools and Artificial Intelligence were one time darlings of the venture capital community that have now given place to biotech and retailing. The standing of the individual venture capital Well established venture capitals who are sought after by entrepreneurs for a number of reasons could get away with tighter valuations than their less known counterparts. Investors considerations could vary significantly. A study by an American venture capital, VentureOne, revealed the following trend. Large corporations who invest for strategic advantages such as access to technologies, products or markets pay twice as much as a professional venture capital investor, for a given ownership position in a company but only half as much as investors in a public offering. Valuation offered on comparable deals around the time of investing in the deal. Quite obviously, valuation is one of the most critical activities in the investment process. It would not be improper to say that the success for a fund will be determined by its ability to value/price the investments correctly. Sometimes the valuation process is broadly based on thumb rule metrics such as multiple of revenue. Though such methods would appear rough and ready, they are often based on fairly well established industry averages of operating profitability and assets/capital turnover ratios Such valuation as outlined above is possible only where complete freedom of pricing is available. In the Indian context, where until recently, the pricing of equity issues was heavily regulated, unfortunately valuation was heavily constrained.

IV] Structuring A Deal Structuring refers to putting together the financial aspects of the deal and negotiating with the entrepreneurs to accept a venture capitals proposal and finally closing the deal. To do a good job in structuring, one needs to be knowledgeable in areas of accounting, cash flow, finance, legal and taxation. Also the structure should take into consideration the various commercial issues (ie what the entrepreneur wants and what the venture capital would require to protect the investment). Documentation refers to the legal aspects of the paperwork in putting the deal together. The instruments to be used in structuring deals are many and varied. The objective in selecting the instrument would be to maximize (or optimize) venture capitals returns/protection and yet satisfy the entrepreneurs requirements. The instruments could be as follows:

Instrument Loan

Issues clean vs secured Interest bearing vs non interest bearing convertible vs one with features (warrants) 1st Charge, 2nd Charge, Stock maturity

Preference shares

redeemable (conditions under Company Act) participating Par value nominal shares

Warrants Common shares

exercise price, expiry period New or vendor shares Par value partially-paid shares

Options

exercise price, expiry period, call, put

In India, straight equity and convertibles are popular and commonly used. Nowadays, warrants are issued as a tool to bring down pricing. A variation that was first used by PACT and TDICI was "royalty on sales". Under this, the company was given a conditional loan. If the project was successful, the company had to pay a % age of sales as royalty and if it failed then the amount was written off. In structuring a deal, it is important to listen to what the entrepreneur wants, but the venture capital comes up with his own solution. Even for the proposed investment amount, the venture capital decides whether or not the amount requested, is appropriate and consistent with the risk level of the investment. The risks should be analyzed, taking into consideration the stage at which the company is in and other factors relating to the project. (eg exit problems, etc). Promoter Shares As venture capital is to finance growth, venture capital investment should ideally be used for financing expansion projects (eg new plant, capital equipment, additional working capital). On the other hand, entrepreneurs may want to sell away part of their interests in order to lock-in a profit for their work in building up the company. In such a case, the structuring may include some vendor shares, with the bulk of financing going into buying new shares to finance growth. Handling Directors And Shareholders Loans Frequently, a company has existing directors and shareholders loans prior to inviting venture capitalists to invest. As the money from venture capital is put into the company to finance growth, it is preferable to structure the deal to require these loans to be repaid back to the shareholders/directors only upon IPOs/exits and at some mutually agreed period (eg 1 or 2 years after investment). This will increase the financial commitment of the entrepreneur and the shareholders of the project. A typical proposal may include a combination of several different instruments listed above. Under normal circumstances, entrepreneurs would prefer venture capitals to invest in equity as this would be the lowest risk option for the company. However from the venture capitals point of view, the safest instrument, but with the least return,

would be a secured loan. Hence, ultimately, what you end up with would be some instruments in between which are sold to the entrepreneur.

V] Monitoring and Follow Up The role of the venture capitalist does not stop after the investment is made in the project. The skills of the venture capitalist are most required once the investment is made. The venture capitalist gives ongoing advice to the promoters and monitors the project continuously. It is to be understood that the providers of venture capital are not just financiers or subscribers to the equity of the project they fund. They function as a dual capacity, as a financial partner and strategic advisor. Venture capitalists monitor and evaluate projects regularly. They keep a hand on the pulse of the project. They are actively involved in the management of the of the investee unit and provide expert business counsel, to ensure its survival and growth. Deviations or causes of worry may alert them to potential problems and they can suggest remedial actions or measures to avoid these problems. As professional in this unique method of financing, they may have innovative solutions to maximize the chances of success of the project. After all, the ultimate aim of the venture capitalist is the same as that of the promoters the long term profitability and viability of the investee company.

VI] Exit One of the most crucial issues is the exit from the investment. After all, the return to the venture capitalist can be realized only at the time of exit. Exit from the investment varies from the investment to investment and from venture capital to venture capital. There are several exit routes, buy-buck by the promoters, sale to another venture capitalist or sale at the time of Initial Public Offering, to name a few. In all cases specialists will work out the method of exit and decide on what is most profitable and suitable to both the venture capitalist and the investee unit and the promoters of the project.

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. This factor is even more critical to smaller and mid sized companies, which are unable to get listed on any stock exchange, as they do not meet the minimum requirements for such listings. Stock exchanges could consider how they could assist in this matter for listing of companies keeping in mind the requirement of the venture capital industry

9. ACCESSING VENTURE CAPITAL UNDERTAKING

Venture funds, both domestic and offshore, have been around in India for some years now. However it is only in the past 12 to 18 months, they have come into the limelight. The rejection ratio is very high, about 10 in 100 get beyond pre evaluation stage, and I get funded. Venture capital funds are broadly of two kinds generalists or specialists. It is critical for the company to access the right type of fund, i.e. who can add value. This backing is invaluable as focused / specialized funds open doors,assist in future rounds and help in strategy. Hence, it is important to choose the right venture capitalist. The standard parameters used by venture capitalists are very similar to any investment decision. The only difference being exit. If one buys a listed security, one can exit at a price but with an unlisted security, exit becomes difficult. The key factors which they look for in The Management Most businesses are people driven, with success or failure depending on the performance of the team. It is important to distinguish the entrepreneur from the professional management team. The value of the idea, the vision, putting the team together, getting the funding in place are amongst others, some key aspects of the role of the entrepreneur. Venture capitalists will insist on a professional team coming in, including a CEO to execute the idea. One-man armies are passe. Integrity and commitment are attributes sought for.

The venture capitalist can provide the strategic vision, but the team executes it. As a famous Silicon Valley saying goes "Success is execution, strategy is a dream".

The Idea

The idea and its potential for commercialization are critical. Venture funds look for a scalable model, at a country or a regional level. Otherwise the entire game would be reduced to a manpower or machine multiplication exercise. For example, it is very easy for Hindustan Lever to double sales of Liril - a soap without incremental capex, while Gujarat Ambuja needs to spend at least Rs4bn before it can increase sales by 1mn ton. Distinctive competitive advantages must exist in the form of scale, technology, brands, distribution, etc which will make it difficult for competition to enter. Valuation All investment decisions are sensitive to this. An old stock market saying "Every stock is a buy at a price and vice versa". Most deals fail because of valuation expectation mismatch. In India, while calculating returns, venture capital funds will take into account issues like rupee depreciation, political instability, which adds to the risk premia, thus suppressing valuations. Linked to valuation is the stake, which the fund takes. In India, entrepreneurs are still uncomfortable with the venture capital "taking control" in a seed stage project. Exit Without exit, gains cannot be booked. Exit may be in the form of a strategic sale or/and IPO. Taxation issues come up at the time. Any fund would discuss all exit options before closing a deal. Sometimes, the fund insists on a buy back clause to ensure an exit. Portfolio Balancing Most venture funds try and achieve portfolio balancing as they invest in different stages of the company life cycle. For example, a venture capital has invested in a portfolio of companies predominantly at seed stage, they will focus on expansion stage projects for future investments to balance the investment portfolio. This would enable them to have a phased exit.

In summary, venture capital funds go through a certain due diligence to finalize the deal. This includes evaluation of the management team, strategy, execution and commercialization plans. This is supplemented by legal and accounting due diligence, typically carried out by an external agency. In India, the entire process takes about 6 months. Entrepreneurs are advised to keep that in mind before looking to raise funds. The actual cash inflow might get delayed because of regulatory issues. It is interesting to note that in USA, at times angels write checks across the table.

10. ACCESSING VENTURE CAPITAL FUND

The Business Plan The first step towards accessing venture capital funding is the preparation of the business plan. The business plan should be able to provide information regarding the promoters, amount of funding needed and the time period for which it is needed and how this funding is going to be paid back to the VC. To answer the above fundamental queries of a venture capital firm the business plan is to be structured with the necessary information.

Business Plan Coverage Executive summary A brief description of the company and the type of business A summary of the business nature A description of the experience and expertise of the management team A summary of the product/service and competition A summary of financial history and projections Funds required and equity offered to the investors A description of use of proceeds The timing of returns on investment and exit routes offered to the investor

Business background A brief history and nature of the business The industry details of the business involved in A summary of the future of the business

Product / Service A description of the product or service The uniqueness of the product

The present status of the product, that is a concept, prototype or product ready for market

Market analysis The size of the potential market and market niche being pursued A projection of the trends and future size of the market place The estimated market share A description of the competition The marketing channel A summary of the potential customers The possibility of related or new markets that can be developed

Sales and marketing strategy The specific marketing techniques planned to be used The pricing plans and comparisons with pricing adopted by competitors The planned sales force and selling strategies for various accounts and markets The specific approaches for capitalizing on each marketing channel and comparison with other practices within the industry Details of advertising and promotional plans A description of customer service- which markets will be covered by direct sales force, which by distributors, representative or resellers Production operations A description of the production process Details of the production costs, including labour force, equipment, technology involved, extent of subcontract or outsourcing, supplier

Management An organization chart showing the corporate structure A summary of the board of directors and key employees and details of their skills and experience .A list of the remuneration for all levels of staff A proposed plan of how to retain key staff

Risk factors A description of the major problems and risks relating to the industry, the company and the products market

Funds requested A description of the type of financing, such as equity only or a combination of equity and loan, and stock options to the investor The capital structure and ownership before and after the financing

Return on investment and exit Details of the timing and expected return of the investment A summary of the exit strategies, such as initial public offering, sale to a third party or management buyout

Use of proceeds Specify how the capital will be spent, i.e.; what amount of capital will go to which items. Financial summaries A summary of the companys financial history and projections of three to five year period

Details of the principal accounting policies of the company and the major assumptions made about the projections

Appendices Resumes of key management and employees Detailed financial forecast and assumptions Market research report Company literature and brochures and pictures of the product

A good business plan shows investors the quality and depth of a companys corporate leadership and indicates managements ability to reach stated goals. These factors lie at the heart of the decision of a venture capitalist to invest in the companys future.

Selection of Venture capital fund After the business plan is completed, the next step is to select the venture capital fund, which is suitable to your proposal. The entrepreneur should first ascertain as to the investment strategy of the VC with regards to the sector in which the VC is interested as well as the stage at which he chooses to fund the project. Based on this information the entrepreneur should shortlist the suitable VCs who match his requirement and then approach them

Financing from venture capital funds is available at various stages and different VCs provide funding in some or all of the stages.

EXIT ROUTES
After the unit has settled down to a profitable working and the enterprise is in a position to raise funds through conventional resources like capital market, financial institution or commercial banks, the venture capitalist liquidate their investment and make an exit from the investee company. The ultimate objective of a Venture Capitalist is to realize from his investment by selling off the same at a substantial capital gain. Infect at the time of making their investment, the venture capitalist plan their potential exit. The investee company has to prepare and make suitable adjustments in its capital structure at the time of realization by the venture capitalist. The convertible preference shares and convertible loans must be converted to ordinary equity before the exit by the venture capitalist. In case of non- convertible preference shares and loans by the venture capitalist these are to be redeemed. At exit the special rights granted to the venture capitalist cease to operate and venture capital firms normally withdraw their nominees from the board of the investee company. The venture capitalist firms have a motto exit at the maximum possible profit or at a minimum possible loss in case of a failed investment. The exit can be voluntary or involuntary. Liquidation or receivership of a failed venture is a case of involuntary exit. The voluntary exit can have four altenative routes for disinvestment: Buy back of shares by promoters or company. Sale of stock (shares) Selling to a new investor Strategic/ Trade sale

BUY BACK / SHARES REPURCHASE Buy back or shares repurchase has the following forms:

The investee company has to buyback its own shares for cash from its venture capitalist using its internal accruals The promoters and their group buys back the equity stake of venture capitalist. The employees stock trusts are formed which, in turn, buy the share holding of the venture capitalist in the company.

The route is suited to the Indian conditions because it keeps the ownership and control of the promoters intact. Indian entrepreneurs are often very touchy about ownership and control of their business. Hence in India, first a buy back option is normally given to the promoters or to the company and only on their refusal the other disinvestments routes are looked into. The exact price is mutually negotiated between the entrepreneur and the venture capitalist. The price is determined considering the book value of shares, future earning potential of the venture, Price/Earning ratio of similar listed companies. The companies were not allowed to buy back their shares in India; however, with effect from the amendment in the companies act (1999) the companies can do so now. SALE OF SHARES ON THE STOCK EXCHANGE The venture capitalist can exit by getting the company listed on the stock exchange and selling his equity in the primary or secondary market using any of the following three methods: Sale of shares on stock exchange after listing shares. Venture capitalists generally invest at the start up stage and propose to disinvest their holding after the company brings out an IPO for raising funds for expansion. This listing on stock exchange provides an exit route from investment. Initial Public Offer (IPO)/ Offer for sale When the existing entrepreneurs opt out of buy back, the venture capitalists opt for disinvesting their stocks through public offering. Disinvestments on OTC An active capital market supports the venture capital activities. It enables the venture capitalists to get a suitable valuation for their investment. Besides the regular stock exchange a well developed OTC market where dealers can trade

in shares. The OTC market enables the new and smaller companies not eligible for listing on a regular stock exchange to be listed at an OTC exchange and thus provide liquidity to the investors. As per the recommendations of a number of committees, an OTC exchange was required in India. As a result Over The Counter Exchange of India (OTCEI) was set up. SELLING TO AN INVESTOR`

Many a times for their exit venture capitalist and /or the promoters locate a new investor, a corporate body or another venture capital firm. The new investors are normally those who find some sort of synergy between the investee company and their existing operations such that the relationship is useful to both the companies. This route is also used when the promoters want to get rid of the venture capitalist. Some venture capitalists, as a policy concentrate their activities to startups and early stage investments. Such venture capital funds exit paving way for the venture capital fund specializing in the later stage investment or buy out deals. Often a growing venture needs second stage financing, if the existing venture capitalist as a policy does not commit funds for the second stage it normally locates another venture capitalist that finds the investment attractive enough to enter. CORPORATE / TRADE SALE The venture capital firm and the entrepreneur together sell the enterprise to a third party mostly a corporate entity. Herein the promoters also exit from the venture along with the venture capitalist.This is called a corporate, strategic or trade sale. The reasons for this sale can be varied, difficulty in running the business profitability or a perceived competition from more established big business houses having huge resources and business synergy. On the other hand, where operations of an existing venture are modest, a higher exit valuation may be achieved in the market rather than by a trade sale,

as the market investors are usually swayed by the appeal of the sector in which the venture operates rather than the quality of its specific business operations. Modalities The modalities of the trade sale differ from case to case depending upon the nature of operations, its size, the requirements of the buyer, etc. The sale can be in cash, against the shares of the acquiring company or the combination of the two. The equity owners get the shares of the buyer company in lieu of the shares bein sold by them. Such sales have the advantage that the seller does not have to pay any tax as the transaction involves only exchange of shares. At times, it is through a management buy- out or buy-in, which in turn may be financed partially by another venture capital fund. It is important to note that in India if the investee company is a listed company at the time of trade sale, then the provisions of listing agreement are attracted besides the provisions of the SEBI regulations of merger and acquisitions are also applicable. Management Buy-Outs Venture capital buy-outs are both a successful investment strategy for venture capital investment as well as an efficient exit route. Buy-out financed by another venture capitalist primarily by providing debt is known as leveraged buy-out. Buy-out without participation by another investor is called management buy-out. Here in the current management group purchases the stake of the venture capitalist. The stock options and sweat equity have made management buy-out possible in India. Management buy-outs are important in venture capital market for various reasons: MBOs provide an opportunity to managers to become entrepreneurs. Venture capital investment in buy-out has a lower investment risk than early stage investment. MBOs help smaller enterprises to adapt to technological changes. Buy-in is similar to buy-out but involves new management from outside and improvement in the operations of the venture. Incoming new management is often

unfamiliar with the operations of the venture hence the acquiring company may feel that the continuity of the existing entrepreneur will be beneficial for the business; the services of the original entrepreneur are retained. This helps in implementing the remaining parts of the original ideas and also provides continuity to the venture. PRE-REQUISITE FOR THE EFFICIENT EXIT MECHANISM Legal framework Smooth procedures for sale / transfer of enterprises Efficient stock market Mechanism for listing and trading of equity of smaller companies.

REGULATORY CAPITAININDIA.

FRAMEWORK

FOR

VENTURE

In his budget speech for 1988-89, the finance minister declared that a scheme will be formulated under which Ventures Capital Companies / Funds will be enabled to invest in new companies and be eligible for the concessional treatment of capital gains available to non-corporate entities. Such companies will have to comply with the following guidelines.

The minimum size of a venture capital company would be Rs.10 crore. If it desires to raise fund from the public the promoters share shall be less than 10 per cent. Venture capital assistance should go mainly to enterprises where the risk element is comparatively high due to the technology involved being relatively new, untried or very closely held, and/or the entrepreneur being relatively new and not affluent though otherwise qualified and the size being modest. The assistances should be mainly for equity support though loan support to supplement this may also be given. Thus, venture capital assistance will be given to those entrepreneurs which satisfy the following Total investment not to parameters exceed Rs.10 crores. :

New or relatively untried or very closely held or being taken from pilot to commercial state or which incorporate some significant improvement over the existing ones in India. Relatively new, professionally or technically qualified with inadequate resources or banking to finance the project. A venture capital is required to invest at least 75 per cent of its funds in venture capital activity. A venture capital is firm can raise funds through pubic issues and/or private placement to finance VCF/VCCs. Foreign equity upto 25 per cent multilateral / international financial organizations, development finance institutes, reputed mutual funds, etc., would be permitted provide these are management neutral and are for medium to long-term investments.

A venture capital fund will be managed by professional such as bankers, managers and administration and persons with adequate experience of industry, finance, accounts etc.

The changed financial and fiscal environment during post liberalization period hold out bright future of venture capital in India. With falling tax rates equity becomes attractive, and promoters want to put in maximum funds. In new companies today. The debt-equity ratio is generally 2:1. The promoter has to compulsorily contribute 25 percent of the projects cost, not just the equity. However because industry is more competitive today promoters are willing to contribute as much as 40 per cent of the project cost. Banks and other finance institutions being risk averse will fund a new venture. Under the circumstances these entrepreneurs will be left with no option but to resort to venture capital firm, to fill the gap in their contribution to project cost. This is very likely to continue as professional start their contribution to project cost. This is very likely to continue as professional start their own units, ancillarisation takes place and large companies began sourcing their requirement rather than making every thing themselves.

SWOT ANALYSIS OF INDIAN VENTURE CAPITAL

STRENGHTS An effort WEAKNESS Faddish More by More capital VCFs under Industry taxation difficult Moving towards administration towards Electronic trading Valuation addition Irreversible reform Regulatory framework unrealistic laws Technical and Market Negligible Inadequate minority corporate evaluation difficult protection rights Difficult due diligence Inadequate Valuation expectations Lack of transparency Accounting standards Poor legal & corporate governance Bureaucratic meddling Industry Smaller fragmented funds with and rigid official attitude experienced and polarized- Mixed V.C culture illiquid investments Domestic fund raising Limited exit option Uncertainties Policy repatriation,

initiated

from within Home grown Increased awareness of venture capital management

crossed learning curve. Venture Capitalists, Intermediaries, and Entrepreneurs. growing. market system evolving through NSE & BSE. international standards Offshore funds bring Matured strong foreign ties Growing number of Global competition foreign trained professionals.

management depth

OPPORTUNITIES Growth

capital

THREATS for 1.

Change in government

strong companies and Buyouts of weak companies due to growing global competition place. low Vast potential exists in turn around, MBO, MBI. Acquisition of quoted Pre money valuations small/ medium cap companies. Financial restructuring have over leveraged companies taking

policies with respect to Structuring Threats from within Explosive 2. Taxation expansion and over Exuberance of investors Greed fro very high returns.

ISSUED FACED BY VENTURE CAPITAL IN INDIA

The Indian venture capital industry, at the present, is at crossroads. Following are the major issues faced by this industry.

1. Limitation on structuring of Venture Capital Funds (VCFs):

VCFs in

India are structured in the form of a company or trust fund and are required to follow a three-tier mechanism-investors, trustee company and AMC. A proper tax-efficient vehicle in the form of Limited Liability Partnership Act, which is popular in USA, is not made applicable for structuring of VCFs in India. In this form of structuring, investors liability towards the fund is limited to the extent of his contribution in the fund and also formalities in structuring of fund are simpler. 2. Problem in raising of funds: In USA primary sources of funds are insurance companies, pensions funds, corporate bodies etc; while in Indian domestic financial institutions, multilateral agencies and state government undertakings are the main sources of funds for VCFs. Allowing Pension funds, Insurance companies to invest in the VCFs would enlarge the possibility of setting up of domestic VCFs. Further, if Mutual Funds are allowed to invest upto 5 percent of their corpus in VCFs by SEBI, it may lead to increased availability of fund for VCFs. 3. Lack of Inventive to Investors: Presently, high net worth individuals and corporate are not provided with any investments in VCFs. The problem of raising funds from these sources further gets aggravated with the differential

tax treatment applicable to VCFs and mutual funds. While the income of the Mutual funds is totally tax exempted under Section 10(23D) of the Income Tax Act income of domestic VCFs, which provide assistance to small, and medium enterprise is not totally exempted from tax. In absence of any inventive, it is extremely difficult for domestic VCFs to raise money from this investor group that has a good potential. 4. Absence of angel investors: In Silicon Valley, which is a nurturing ground for venture funds financed IT companies; initial/ seed stage financing is provided by the angel investors till the company becomes eligible for venture funding . There after Venture Capitalist through financial support and valueadded inputs enables the company to achieve better growth rate and facilitate its listng on stock exchanges. Private equity investors typically invest at expansion/ later stages of growth of the company with large investments. In contrast to this phenomenon, Indian industry is marked by an absence of angel investors. 5. Limitations of investment instruments: As per the section 10(23FA) of the Income Tax Act, income from investments only in equity instruments of venture capital undertakings is eligible for tax exemption; whereas SEBI regulations allow investments in the form of equity shares or equity related securities issued by company whose shares are not listed on stock exchange. As VCFs normally structure the investments in venture capital undertakings by way of equity and convertible instruments such as Optionally/ Fully Convertible Debentures, Redeemable Preference shares etc., they need tax breaks on the income from equity linked instruments. 6. Domestic VCFs vis--vis Offshore Funds: The domestic VCFs operations in the country are governed by the regulations as prescribed by SEBI and investment restrictions as placed by CBDT for availing of the tax benefits. They pay maximum marginal tax 35 percent in respect of non-exempt income such as interest through Debentures etc., while off- shore funds which are structured in tax havens such as Mauritius are able to overcome the investment restriction of SEBI and also get exemption from Income Tax under Tax Avoidance Treaties. This denies a level playing field for the domestic investors for carrying out the similar activity in the country.

7. Limitation on industry segments: In sharp contrast to other countries where telecom, services and software bag the largest share of venture capital investments, in India other conventional sectors dominate venture finance. Opening up of restrictions, in recent time, on investing in the services sectors such as telecommunication and related services, project consultancy, design and testing services, tourism etc, would increase the domain and growth possibilities of venture capital. 8. Anomaly between SEBI regulations and CBDT rules: CBDT tax rules recognize investment in financially weak companies only in case of unlisted companies as venture investment whereas SEBI regulations recognize investment in financially weak companies, which offers an attractive opportunity to VCFs. The same may be allowed by CBDT for availing of tax exemption on capital gains at a later stage. Also SEBI regulations do not restrict size of an investment in a company. However, as per Income tax rules, maximum investment in a company is restricted to less than 20 per cent of the raised corpus of VCF and paid up share capital in case of Venture Capital Company. Further, investment in company is also restricted upto 40 per cent of equity of Investee Company. VCFs may place the investment restriction for VCFs by way of maximum equity stake in the company, which could be upto 49 per cent of equity of the Investee Company. 9. Limitations on Exit Mechanism: The VCFs , which have invested in various ventures, have not been able to exit from their investments due to limited exit routes and also due to unsatisfactory performance of OTCEI . The threshold limit placed by various stock exchanges acts as deterrent for listing of companies with smaller equity base. SEBI can consider lowering of threshold limit for public/listing for companies backed by VCFs. Buy-back of equity shares by the company has been permitted for unlisted companies, which would provide exit route to investment of venture capitalists. 10. Legal Framework: Lack of requisite legal framework resulting in adequate penalties in case of suppression of facts by the promoters-results in low returns even from performing companies. This has bearing on equity investments particularly in unlisted companies.

FUTURE OF VENTURE CAPITAL IN INDIA

Rapidly changing economic environment accelerated by the high technology explosion, emerging needs of new generation of entrepreneurs in the process and inadequacy of the existing venture capital funds/schemes are indicative of the tremendous scope for venture capital in India and pointers to the need for the creation of a sound and broad-based venture capital movement India. There are many entrepreneurs in India with a good project idea but no previous entrepreneurial track record to leverage their firms, handle customers and bankers. Venture capital can open a new window for such entrepreneurs and help them to launch their projects successfully. With rapid international march of technology, demand for newer technology and products in India has gone up tremendously. the pace of development of new and indigenous technology in the country has been slack in view of the fact that several process developed in laboratories are not commercialized because of unwillingness of people to take entrepreneurial risks, i.e. risk their funds as also undergo the ordeal of marketing the products and process. In such a situation, venture financing assumes more significance. It can act not only act as a financial catalyst but also provide strong impetus for entrepreneurs to develop products involving newer technologies and commercialize them. This will give a fillip to the development of new technology and would go a long way in broadening the industrial base, creation of jobs, provide a thrust to exports and help in the overall enrichment of the economy. In addition, venture capital will be needed urgently to solve the serious problems of sickness which has plagued many Indian Industries. There are large number of sick companies which offer opportunities for turn-around, either through a change in the product line or use of existing facilities in a different way or in any other manner. What is needed is the supply of equity to persons who have fertile ideas, necessary

expertise and competence and who can bring about improvements in some units. Another type of situation commonly found in our country is where the local group and a multi-national company may be ready to enter into a joint venture but the former does not have sufficient funds to put up its share of the equity and the latter is restricted to a certain percentage. For the personal reasons or because of competition, the local group may not be keen to invite any one in its industry or any major private investor to contribute equity and may prefer a venture capital company, as a less intimately involved and temporary shareholder. Venture capitalists can also lend their expertise and standing to the entrepreneurs. A large number of smaller units serving as ancillaries to major industrial groups need capital, expertise and contacts of venture capitalist for upgradation of their technology in tune with the demands from the major industrial units. It is generally found that small suppliers are faced with a choice of going out of business, losing their major client, being acquired by the client or obtaining at an exorbitant rate from a source outside the industry. Venture capitalist can help these units and save them from the crisis. In service sector, which has Immense growth prospects in India, venture capitalists can play significant role in tapping its potentiality to the full. For instance, venture capitalists can provide capital and expertise to organizations selling antique, remodeled jewellery, builders of resort hotels, baby and health care market, retirement homes and small houses. In view of the above, it will be desirable to establish a separate national venture capital fund tow which the financial institutions and banks can contribute. In scope and content such a national venture capital fund should cover: (i) all the aspects of venture capital financing in all the three stages of conceptual, developmental an exploitation phases in the process of commercialization of the technological innovation and (ii) as may of the risk stages-development, manufacturing, marketing, management and growth as possible under Indian Conditions. The fund should offer a comprehensive package of technical, commercial, managerial and financial assistance

and services to building entrepreneurs and be a position to offer innovative solutions to the varied problems faced by them in business promotion, transfer and innovation. To this end, the proposed national venture capital fund should have at its command multi-disciplinary technical expertise. The major thrust of this fund should be on the promotion of viable new business in India to take advantage of the on coming high technology revolution and setting up of high growth industries so as to take the Indian economy to commanding heights.

QUESTIONAIRE

1. What are the criterias used by the Gandhi & associates?

Gandhi & associates looks at a ventures commercial potential, development impact, social benefits, environmental impact, and its impression of the entrepreneur(s) promoting the company

2. How is the financing done?

Aavishkaar's primary financing instrument is common equity. Where appropriate, it will consider limited debt financing, in ventures where equity investment is or has been made.

Our companys financing instrument is done through convertible preference shares, it also consider equity shares.

3. What are the activities done from the time of investment to the time of sale?

Aavishkaars will work in partnership with your management in a hands-on and active manner to ensure that the business achieves its goals. This will occur formally through Aavishkaar's role on the Board as well as informally through introductions to investors and strategic partnerships, technology advice, public relations, strategic planning, and follow-on financing, among others

The activities conducted by our company from the time of investment are to look after the management of the company and advise them regarding any deal or other affairs of the company. 4. Which is the best option for Exit? IPO Could be the best Option for exit as both buy-back and IPO have a lengthy procedure but IPO is more preferable.

5. According to you, what would be the future of venture capital in India? The future of venture capital in India would be very bright. There are expectations of high growth of venture capital in our country.

First schedule-from SURVEY REPORT

1) Are you aware about venture capital?

Yes No

2) Which company of venture capital would you prefer?

Indian Foreign

3) Have you ever invested in any venture capital company?

Yes No

4) According to you, venture capital is profitable or not?

Yes No

5) Do you think the procedure of venture capital is?

Convenient Lengthy

6) Do you think after the establishment of venture capital in India, there is growth in entrepreneurship?

Yes No

ANNEXURE

From A Securities and exchange board of India (Venture capital funds) regulation ,1996 (see regulation) Application for grant of certificate of registration as venture capital fund Securities and exchange board of India Mittal court, (B) wing ,first floor Nariman point, Mumbai400021 India

Instruction: This form is meant for use by the company or trust (hereinafter referred to as the applicant ) for application for grant of certificate of Registration as venture capital fund. The application should complete his form and submit it along with all supporting documents to board at its head office at Mumbai.

This application shall be considered by board provided it is complete in all respect. All answer must be legible. Information which needs to be supplied in more detail may give on separate sheets which should be attracted to the application form. The application must be signed and all signatures must be original. The application must be accompanied by an application fee as specified the second Schedule to these regulation. 1. Name, address of the registered office, address for corresponding telephone number(s), telex number(s), fax number(s), of application and the name of the contact person. 2. Please indicate to which of the following categories he application belongs. A company established under the companies act, 1956 (1 of 1956) A trust set up under the Indian trust act, 1882 (2 of 1882) 3. Date and place of incorporation or establishment and date of commencement if business (enclosed certificate of incorporation, memorandum and articles of associate or trust deed in terms of which incorporated or established). 4. a. Detail of member of the board of trustee or directors of the trustee company, as the case may be, in case the application has been set up as a trust b. Details of member of bard of directors of venture capital fund I case the application has been sent up as accompany. 5. Please state whether the applicant, his partner, director or principal officer is involved in any litigation connected with the securities market which has an adverse bearing on business of applicant; or has at any time has been convicted for any moral turpitude or at any time has been found guilty of any economic offence. In case the application is trust, the above information should be provided for the member of the board of trustee or of the above mentioned person connected with the Trustee company .if yes, the details thereof. 6. Please also state whether there has been any instance of violation or non-adherence

to the securities laws, code of ethics/conduct, code of business rules, for which the applicant, or its parent or holding company or affiliate may have been subject to economic, or criminal, liability, or suspended 7. Details of asset management company, if any. (enclose copy of agreement with the asset management company). 8. Declaration statement(to be given as below). We hereby agree and declare that the information supplied in the application, including the attachment sheets, is complete and true. AND we further agree that, we shall notify the Securities and Exchange Board of India immediately any change in the information provided in the application. We further agree that, we shall notify the securities and Exchange board of India Act, 1992, and the securities and Exchange board of India (venture capital fund) Regulation, 1996, and Government of India guidelines/ instruction as may be announced by the securities and Exchange board of India from time to time. We further agree that as a condition of registration, we shall abide by such operational instructions/ directives as may be issued by the securities and Exchange board of India from time to time. For and on behalf of (Name of the applicant) Authorized signatory ...(Name) (Signature) Place:

1996 Certificate of registration as venture capital fund I. In exercise of the powers conferred by sub-section (1) of section 12 of the securities And exchange Board of India Act, 1992, (15 of 1992 ) read with the regulation made There under, the board hereby grants a certificate of registration to ------------------------------------------------------------------------as a venture capital fund subject to the conditions specified in the Act and in the regulations made there under. II. The Registration Number of the venture capital fund is IN/VC/ / Date: Place: MUMBAI By order Sd/For and on behalf of Securities and Exchange Board

CONCLUSION
It is essential that Venture Capital Funding agencies play a major role in providing capital to industrial enterprises especially the SMEs if the Indian economy has to grow rapidly. There is a strong case for Venture Capital Funding for SMEs. Judging from the success in the IT, Biotechnology, Retail and Pharma sectors the VCF agencies can explore possibilities of funding SMEs in manufacturing and other sectors also. The government has brought in suitable regulations through the RBI, SEBI and other institutions to facilitate Venture Capital Funding. VCF agencies should aggressively promote funding and nurture promising SMEs The PSBs and FIs in India who were reluctant to foray into venture capital funding have now realised its potential and are willing to partner Indian VCF agencies by providing funds. VCF agencies should not only engage in funding but also provide managerial guidance and support to SME s to compete in the present global environment and enable them to achieve turnovers and profits, which will ultimately result in the enterprise going public in the shortest period. Venture Capital supported enterprises can convert into quality initial public offerings (IPOs), resulting in capital from pension funds and

investors flowing into VC funds. It will also provide protection to investors, especially small investors. Further it will result in substantial and sustainable employment generation by creating related ancillary units and support services. Finally, research laboratories under CSIR, defense laboratories, universities and technical institutes are carrying out a lot of scientific and technical research. A suitable venture capital environment can help in identifying and converting some of this research into commercial production in the Small and Medium Scale sectors. Thus, it is apparent that venture capital funding should be encouraged to facilitate development in small and medium enterprise which in turn leads to overall growth in the Indian economy.

BIBLIOGRAPHY
Reference Books & Magazines Venture Capital, The Indian Experience by I M T Tandey Issues Facing Indian Venture Capital Industry by H Rajurkar Business World India Today Newspapers The Times of India Economics Times Indian Express Financial Express Websites www.indiainfoline.com

www.icfaipress.org www.webcrawler.com www.namasthenri.com