VENTURE CAPITAL

CONCEPT:
Venture capital assistance refers to the financing of new high risk ventures promoted by
qualified entrepreneurs who lack the necessary experience and funds to give shape to their
ideas.
The proposals involving new or substantially new or relatively untried technology put
forward by professionally or technically qualified persons involving very high risk factors
fail to attract investment from public, thus resulting in the death even before they could be
tried.
It is a form of participation in equity, to companies with high growth potential in return for
minority shareholding in the business or the irrevocable right to acquire it.
In addition, it provides some value addition in the form of management advice and
contribution to overall strategy.
The relatively high risks are compensated by the possibility of high return, usually through
substantial capital gains in the medium term.
DEFINITION:
Venture Capital is defined as an activity by which investors support entrepreneurial talent with
finance and business skills to exploit market opportunities and thus obtain long-term capital
gains.
This organized financing activity connected with relatively new enterprises
having very high potential for growth due to advanced technology, new products or services, or
other valued innovations in order to achieve substantial capital gains.
Money provided by investors to startup firms and small businesses with perceived long-term
growth potential. This is a very important source of funding for startups that do not have access
to capital markets. It typically entails high risk for the investor, but it has the potential for aboveaverage returns.
FEATURES:

It is basically equity finance in relatively new companies when it is too early for the company

to go into capital market to raise funds.

It is a long term investment in growth oriented small/medium firms. The acquisition of
outstanding shares from other share holders cannot be considered venture capital. It is a new
long term capital that is injected to enable the business to grow rapidly.

There is a substantial degree of involvement of the venture capital institutions / venture

capitalists with the business requiring fund. The objective is to provide business/managerial

skill only and not interfere in the management.

Venture capital financing involves high risk return spectrum. Some of the ventures yield
very high returns while others may end up in heavy losses (though had potential of profitable

returns.
It is not only technology finance, but it essentially involves the financing of small and
medium sized firms through early stages of their development until they are established and
are able to raise finance from the conventional, industrial finance market. The scope of

venture capital activity is fairly wide.

Liquidity of venture capital investment depends on the success of the new venture or product.
The investment can be disinvested either to promoters of business or in the markets.

STEPS IN VENTURE CAPITAL FINANCING

1. SELECTION OF INVESTMENT
The first step in the venture capital financing is selection of investment.
The starting point of evaluation process by the venture capital institution is evaluating the
business plan of the venture capital undertaking.
The appraisal is similar to the feasibility studies of the financial institutions for grant of
term loans and other financial institutions.
In addition, project history, track record of entrepreneur, market potential study,
projections of future turnover, profitability, review of likely threats from technological
obsolescence or competing technologies, preliminary views on preferred exits and so on
is reviewed.
2. STAGES OF FINANCING
The stages of financing can be grouped into Early stage and Later stage.
Early Stage Financing:
This stage includes seed capital or pre start-up, start-up and second round financing.
Seed capital:
It refers to capital required by an entrepreneur to conduct research at precommercialisation stage. It is provided by the venture capitalist for translating an idea
into business proposition. This may end in a prototype which may or may not lead to a
business launch.

 The next phase is the development phase leading to product testing and then to
commercialistaion.
At this phase, the venture capital institution will evaluate the project to ensure that the
technology skill of the entrepreneur matches with the market opportunities.
The main risk at this stage is marketing related. The marketing opportunity, competition
in the market, timing of the launching of the product etc are to be appraised.
The risk perception at this stage is extremely high.
Start-up:
This is the stage when commercial manufacturing has to commence for the first time.
Venture capital is provided for product development and initial marketing.
Second Round Financing:
This represents a stage at which the product has already been launched in the market but
the business has not yet, become profitable enough for raising fund from general public.
Up to this stage the promoter has invested his own funds but further infusion of funds by
the venture capital institution is necessary.
The time scale of investment is shorter and the venture capital institution provide larger
funds at this stage than at other early stage financing.
Later stage Financing:
This stage of venture capital financing involves established businesses which require
additional financial support. At this stage the firm is not strong enough to go for public offer as it
has not reached profit earning stage. This stage involves the following types of capital:
Development / Mezzanine Capital:
Purchase of new equipment/plant, expansion of marketing and distribution facilities,
refinance of existing debt, penetration into new regions, and induction of new
management and so on.
This finance has a time frame of one to three years and falls in medium risk category.
Bridge/Expansion Capital:
This finance involves low risk and a time frame of one to three years.
The finance is used to expand business by way of growth of their own productive asset or
by acquisition of other firms / assets of other firms.
It represents the last round of financing from venture capital institutions before a planned
exit.
Buyouts:
These refer to the transfer of management control. They fall into two categories:
management buy-outs and management buy-ins.

 Management buy-outs: Venture capital institutions provide funds to enable the current
operating management / investors to acquire an existing product line / business.
Management buy-ins: Venture capital institutions provide funds to enable an outside
group (group of mangers) to buy an ongoing company. They usually bring three elements
together: A management team, a target company and an investor (venture capital
institution).
Turnarounds: It involves buying the control of sick units. Two kinds of inputs are
required in a turn around money and management. The venture capital institutions
have to identify good management and operations leadership.
3. FINANCIAL ANALYSIS:
In order to decide the required venture capital percentage ownership, the venture capital
investments are to be valued. There are three methods which can be adopted:
Conventional Venture Capitalist Valuation method
The First Chicago Method
Revenue Multiplier Method
4. STRUCTURING THE FINANCIAL INSTRUMENTS:
It is required to decide the type of financial instruments through which the venture capital
investment is to be made. It may be in the form of equity finance or debt finance.
Equity Instruments: Ordinary equity shares, non voting equity shares, preference shares,
cumulative preference shares, participating preference shares, cumulative convertible
participatory preferred ordinary shares, convertible redeemable preference shares etc.
Debt Instruments: Conditional loan, Conventional loans, Non-convertible Debentures,
Partly convertible Debentures, Zero interest coupons, Deep discount bonds.
5. INVESTMENT NURTURING / AFTERCARE:
The conventional financial institutions keep away from the management and operations of
the concerns which they finance. But venture capital institutions take more care in the
working of the concerns. They take part in the management and take care of the development
of the concern.
Different styles are adopted for nurturing the venture capital undertaking. They are:
a. Hands-on nurturing: It refers to constant and continuous involvement in the operations
of the investee company by representation in the Board of Directors.
b. Hands-off nurturing: The venture capital institution does not have any direct
involvement. It plays only a passive role in the management of the company.
c. Hands-holding nurturing: The venture capital institution participates in the decision
making process only when it is approached by the investee company.
The venture capital institution has the right to make sure the assistance provided by it is
properly utilized and managed. For this, the following techniques are used: Personal
discussions, Plant visits, Feedback through nominee directors, periodic reports etc.

6. VALUATION OF PORTFOLIO:
The investments by the venture capital institution in the investee company have to be valued
from time to time. The valuation is done in the following ways:
1). Equity Investments
(a) Quoted Market Value Method
(b) Fair Market Value Method
2). Debt Investments
(a) Market Value Method
(b) Fair Value Method
7. EXIT / DISINVESTMENT
This is the last stage in the venture capital finance. After having promoted a company and has
reached the working stage the venture capital institution has to take a decision to exit and to
realize the investment so as to make a profit or to minimize its losses.
For this the following techniques are adopted:
1. Disinvestment of equity
(a) Going Public
(b) Sale of shares to entrepreneurs / employees
2. Trade sales ( entire company is sold to another company)
3. Sale to new investors (the equity of the venture capital institution is sold to a new
investor)
4. Liquidation (an involuntary exit forced on to the venture capital institution as a result
of totally failed investment)

ORIGIN AND THE CURRENT INDIAN SCENARIO

The venture capital industry in India is of relatively recent origin. Before its emergence, the
development finance institutions (DFIs) had been partially playing the role of venture capitalists
by providing assistance for direct equity participation to ventures in the pre-public issue stage
and by selectively supporting new technologies.
The need for venture capital in the country was felt around 1985 when a
lot of inventors burnt their figures by investing in fledging enterprises with unproven projects
which were not yet commercialized after the setback in the stock markets and the amendment in
the securities Contracts Regulation Act barring companies having an equity capital of less than
Rs 3 Crores from being listed on stock exchanges.
Against the background of these two developments, the creation of a venture capital fund on an
experimental basis was announced in the document on Long-Term Fiscal Policy presented in
Parliament by the Ministry of Finance in December 1985. The concept was operationalised in

the fiscal budget for 1987-88 when a cess up to 5% was introduced on all technology import
payments to create a pool of funds.
Although Development Financial Institutions started coming out with
venture capital schemes as early as 1986 to provide finance to technology based entrepreneurs
for their R&D efforts at innovative products/processes, the real thrust was provided by the
Finance Minister in the budget speech for 1988-89 announcing the formulation of a scheme
under which venture capital funds / venture capital companies would be enabled to invest in
fledging enterprises and be eligible for concessional treatment of capital gains to non corporate
entities.
In recognition of the growing importance of venture capital as one of the sources of finance for
the Indian industry, particularly for the smaller, unlisted companies, the Government of India
announced a policy governing the establishment of domestic venture capital funds or venture
capital companies. Till 1995 they were paying a 20% tax on capital gains from investments.
During the budget speech for 1995-96, the Finance Minister announced exemption from tax on
income by way of dividends and long term capital gains from equity investments made by
approved venture capital funds or venture capital companies in unlisted companies in
manufacturing sector, including software units excluding other service industries.
With a view to augment the availability of venture capital, the Government of India issued
guidelines in 1995 for overseas venture capital investment in India. The SEBI Venture Capital
Fund Regulations were issued in 1996. Recognising the acute need for higher investment in
venture capital activities, SEBI appointed the Chandrasekhar committee to identify the
impediments in the growth of venture capital industry in the country and suggest suitable
measures for its rapid growth. The recommendations of the panel had been accepted in principle
and those concerning SEBI had been implemented.
The venture capital funds were regulated by the SEBI Venture Capital Funds Regulation, 2000
and SEBI Foreign Venture Capital Investors Regulation Act, 2000. The SEBI Alternative
Investment Fund Regulations, 2012 has replaced the SEBI Venture Capital Fund Regulations.

INVESTMENT BANKING PERSPECTIVES IN PRIVATE EQUITY

Private equity firms, on the other hand, are groups of investors that use collected pools of capital
from wealthy individuals, pension funds, insurance companies, endowments, etc. to invest

businesses. Private equity funds make money from a) convincing capital holders to give them
large pools of money and charging a % on these pools and b) generating returns on their
investments. They are investors, not advisors.
The two business models do intersect. Investment banks (often through a dedicated group with
the bank focused on financial sponsors) will pitch buyout ideas with the aim of convincing a PE
shop to pursue a deal. Additionally, a full-service investment bank will seek to provide financing
for PE deals.
There is less standardization in private equity various funds will engage their associates in
different ways, but there are several functions that are fairly common, and private equity
associates will participate in all these functions to some extent. They can be boiled down into
four different areas:

Fundraising
Screening for and making investments
Managing investments and portfolio companies
Exit strategy