VENTURE CAPITAL:

'Venture Capital' is an important source of finance for those small and medium-sized firms, which have very few avenues for raising funds. Although such a business firm may possess a huge potential for earning large profits in the future and establish itself into a larger enterprise. But the common investors are generally unwilling to invest their funds in them due to risk involved in these type of investments. In order to provide financial support to such entrepreneurial talent and business skills, the concept of venture capital emerged. In a way, venture capital is a commitment of capital, or shareholdings, for the formation and setting up of small scale enterprises at the early stages of their life cycle. Venture capitalists comprise of professionals of various fields. They provide funds (known as Venture Capital Fund) to these firms after carefully scrutinizing the projects. Their main aim is to earn huge returns on their investments, but their concepts are totally different from the traditional moneylenders. They know very well that if they may suffer losses in some project, the others will compensate the same due to high returns. They take active participation in the management of the company as well as provide the expertise and qualities of a good banker, technologist, planner and managers. Thus, the venture capitalist and the entrepreneur literally act as partners. Venture capital, rightly called as 'financing of innovation', is the financing of start-up (young) businesses with a view to grow them into large commercially successful businesses. It is defined as capital for investment which may easily be lost in risky project, but can also provide high returns; also called risk capital. Bloomberg defines it as 'An investment in a start-up business that is perceived to have excellent growth prospects but does not have access to capital markets. Type of financing sought by early-stage companies seeking to grow rapidly'. Some of the famous companies of today such as Netscape Communications, Apple Computer, Cisco Systems, Compaq (since merged with HP), Network General, Yahoo, e-Bay etc were all start-up companies financed through venture capital. The Indian examples of

successful venture backed companies include Biocon, i-Flex Solutions,Sasken, Geometric Software, Mastek Global etc. Venture financing involves significant risk-taking on the part of the venture capitalist since young businesses are subject to high rates of mortality and the venture investor could stand to lose the investment made in the company.

The venture capital recognizes different stages of financing, namely: 1. Early stage financing - This is the first stage financing when the firm is undertaking production and need additional funds for selling its products. It involves seed/ initial finance for supporting a concept or idea of an entrepreneur. The capital is provided for product development, R&D and initial marketing.

2. Expansion financing - This is the second stage financing for working capital and expansion of a business. It involves development financing so as to facilitate the public issue.

3. Acquisition/ buyout financing - This later stage involves: Acquisition financing in order to acquire another firm for further growth. Management buyout financing so as to enable the operating groups/ investors for acquiring an existing product line or business and Turnaround financing in order to revitalize and revive the sick enterprises.

Venture capital is not meant for any type of start up business. A venture capital backed business requires certain characteristics in the business model and financing structure of the company. Some of the usual features are furnished in below: Structure of a venture capital backed start up business Business structure: 1. Generally associated with a technology venture or a knowledge intensive or innovation driven business model. 2. Venture to be backed by technology that has been created or is to be created. 3. Requires product development / technology and / or market validation. 4. Product has to be successful at lab scale / prototype level (beta version) before it is commercially launched. 5. Test marketing or phased marketing is required since concept selling is involved. 6. Cash flow model requires to be established. 7. Business to be ramped up in phase. 8. Business risks are taken in phases. Investment monitoring by the VC is more of mentoring, with the VC appointing its nominees on the board of the company to bring in significant value addition apart from protecting its interests. Financial structure: 1. Starts up firms go through rounds of financing starting from the seed stage to pre- IPO stage. Financing is generally linked to pre set milestone either in terms of financial projections or strategic achievements. 2. Financial risk is taken in phases. The highest risk reward relationship is at the seed stage and the risks and rewards go down progressively as the business gets de-risked in each subsequent round of financing.

3. Promoters may or may not have sufficient financial resources. Their technology is valued and allowed to be capitalized as stock. Alternatively, investors are prepared to pay a high premium on their stock. Promoters equity is more in intellectual capital and stock options than in hard cash. 4. More suitable for financing through equity since the business model may not be able to support debt financing. Some part of the financing could be a convertible or a soft loan to prevent excessive dilution of promoters equity. 5. Tangible asset creation would be less there is a high component of intellectual property valuation. VCs are open to financing soft costs in the business plan that does not result in creating tangible assets. In other words they are not security oriented in the financing structuring. No collateral security needs to be created for VC financing unlike in bank borrowing. 6. Involves significant amount of cash burn in terms of product development and validation expenditure and seed marketing expenses. No restriction is placed on allocation of funds for working capital.

7. The business model should have the potential for very high returns to investors since the risk level is also very high. The risks are clearly understood through a due diligence process and assumed by the investors. A venture capitalist normally looks for some of the following type of attributes in a business plan before deciding to invest:

An industry or space that is currently a sunrise sector that promises to be creating a paradigm shift.

An exciting concept that has the potential for an uninhibited market. A concept that significantly improves existing processes or applications and therefore find a vast replacement market.

A business or idea that has potential for spin off businesses or revenue streams or significant possibilities for future scale up.

A start-up business that has the potential to become an attractive proposition for strategic acquisition in future by a market leader.

A firm that has the caliber to become an industry leader in due course with the right inputs.

A business that is in a cutting edge technology that could become an industry benchmark.

A company that has sufficient technology and management bandwidth to reach and sustain the leadership position that it promises to attain.

A business or technology that has a first mover advantage which can be harnessed adequately before competition catches up.

A business that has significant entry barriers for the competition either in technology or in business variables that can largely be sustained.

A firm that has an unfair advantage to begin with which could remain long enough before it is diluted by competition or regulation.

A firm that offers possibilities for multiple exit options.

There are many other types of start up firms that do not qualify for venture capital as they do satisfy the investment criteria of VC investors. These could be more of commercial ventures in manufacturing, trading and services that either address a commodity or a mass market, small scale market, or engaged in the business of volumes with thin value addition or in a generic product or service market with little technology or innovation. Such businesses do not find favour with VC investors and would therefore need to be financed differently.

INSTITUTIONAL PRIVATE EQUITY The private placement market for equity is quite large and consists of several types of institutional and non-institutional investors. The term 'private equity' is commonly associated with the institutional investors that cater to the requirement of equity capital by companies otherwise than through public offers. Private equity can be termed as 'later stage financing' as compared to venture capital, which is all about early stage financing. Private equity financing is thus a distinct model of making direct equity investments wherein investors identify good investment opportunities in well performing companies, some of them even listed, either for financing their growth or for acquisitions and buyouts. Since private equity is about later stage financing, companies that are financed are those in the growth phase of their business graduating to the next level after being successful in the initial scale of operations. Therefore, the fund requirements of such companies would be fairly large. Keeping this in view, private equity funds cater to larger deal sizes and do not normally look at transaction values less than a minimum threshold. This is quite in contrast to venture capital wherein, since the risk is significantly higher, the venture capitalist looks to gradual infusion of capital to minimize risk. Private equity investors also have a relatively moderate return expectation as compared to venture capitalists who have exponential return expectations. Therefore, it may be said that private equity market is all about investors who invest later, invest more, prefer reasonable stakes and moderate risk entailed returns. Globally, private equity is a multi-trillion dollar industry with big-ticket institutional private equity players. These funds raise billions of dollars from wealthy individuals and other types of investors for equity related business investments. Blackstone, Warburg Pincus, Citigroup, UBS, PNG and several others have large private equity funds. Some of these are stand-alone funds while the others are affiliated to investment banks as part of their fund based business.

In the context of the Indian capital market, institutional private equity is of recent origin. The Indian industry went through rapid transformation in the post-liberalisation era commencing in 1991. From 2001 onwards, Indian industry was on a consolidation drive in various sectors and companies sought to grow not only to stand up to competitive market forces in the Indian market but to attain global scale of operations to be able to have a presence in the international market. This corporate growth initiative coupled with a investor friendly system and good economic conditions led to. a spurt in private equity activity in India. In the initial stages, though private equity was largely confined to the information technology sector, thereafter it extended to several other sectors including large scale manufacturing such as pharmaceuticals and core sectors like cement, steel and infrastructure. Private equity investors showed interest even in project financing, an area dominated by large banks and specialized financial institutions. Private equity investments extend over later stage unlisted companies and many a time, in listed companies as well, a phenomenon known as PIPE in the US markets.