CHAPTER 1

Growth of venture capital financing in India: An Introduction and

overview
This chapter provides an introduction of the topic by broadly explaining the phenomenon of
inclusive growth and brief introduction about venture capital financing. In the first section, a
general background of the topic is provided along with the rationale of research, objectives. In
the remainder of the chapter, the expected implications of this research to both practical and
research shall be presented and wrapped with the structure of the thesis.

1.1 Introduction
The growth of venture capital in India has followed a gradual sequence of events. The idea of
venture capital financing was adopted at the instance of the central government and government
– sponsored institutions. The need for venture capital financing was first highlighted in 1972 by
the Committee on Development of small and medium entrepreneurs under the chairmanship of
R.S. Bhatt (popularly known as the Bhatt Committee) which drew attention to the problems of
new entrepreneurs and technologists in setting up industries.
Venture capital is long-term stable capital provided to early-stage, high-potential, and growth
start-up companies. Venture capital funds generally invest in novel and scalable technology or
business models in technology industries, such as software engineering, consumer internet,
biotechnology and other industries. Venture capital funds usually require proof of concept prior
to their investment. Venture capital funds bring domain knowledge and expertise.
Wright and Robbie (1998) defined venture capital as, “this is the investment for long term by a
number of investors in risky equity where their prime aim is eventual going and they are not
interested in any periodical income or dividends.”
Cumming and Macintosh (2003) defined venture capital as, “financial intermediaries who get
capital investment from various institutional investors, high net worth people from the various

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economic sectors and make investment of these pooled deposits in small and private business
which have high technology and have a lot of potential for high growth.”
In general term we can say that venture capital means capital which is planned to invest into a
highly risky firm with good growth potential. Venture capitalist is a person who works as an
intermediary between investors who give their fund to invest and new companies which gets risk
capital on another hand.
According to above definitions venture capital organization can be kept into following three
categories:
 Independents
 Captives
 Semi-captives
Independent venture capital organisations are those organisations which have many investors. It
dilutes its ownership into many investors. These investors are the main source of funding the
capital. In captives‟ venture capital organisations, these companies are setup by the parent
companies and resources are supplied by the main companies.
In semi captive organisations, these organizations are set up by one company but a large amount
of fund is invested by third party investors.
In figure 1.1, private equity can be categorized into three sub groups: Informal Venture Capital,
Formal Venture Capital and Other Private equity. When wealthy individuals invest their fund
into venture firm this is called informal venture Capital and these investors are termed as
business angels. In formal venture capital a company pools funds from the various people and
invest into the venture firms. This company manages the vast pool of business angels. Generally
when business angels invest their money into venture firms at their own, they invest into the
early stage away. These business angels are very profitable for the business economy (Freear,
2003).

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 Sources of
Financing New
Venture Firms

Equity Debt

Risk Capital Semi Equity Soft Loan Traditional loan

Public Equity Private Equity: in

Private Companies

Informal Venture Formal Venture Other private

Capital Investment
made by Private
Individuals investing
their own money
Capital Investments equity: e.g. later
made by Professional stage investment,
firms. Active and MBO etc.
time limited
Partnership. Focus
on early stage

Figure – 1.1

Classification of Sources of Financing New Venture Firms

Source: Own Construction

In figure 1.1 all the available sources for financing a new venture firm have been shown. These
sources are introduced as below:

1) Equity: Equity means exchanging a portion of the ownership of the business for a
financial investment in the business. The ownership stake resulting from an equity
investment allows the investor to share in the company‟s profits. Equity involves a

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 permanent investment in a company and is not repaid by the company at a later date.
Equity capital is divided into two parts:
a. Risk Capital (Public Equity and Private Equity): Private venture capital
partnerships are perhaps the largest source of risk capital as compared to public
equity. They generally look for businesses that have the capability to generate a
30-percent return on investment each year. They like to actively participate in the
planning and management of the businesses they finance and have very large
capital bases--up to $500 million--to invest at all stages.
b. Semi-equity:
2) Debt: Debt financing involves borrowing funds from creditors with the stipulation of
repaying the borrowed funds plus interest at a specified future time. For the creditors
(those lending the funds to the business), the reward for providing the debt financing is
the interest on the amount lent to the borrower. Debt financing may be of two types:
a. Soft Loan:
b. Traditional loan:
1.2 Characteristics of venture capital concept
A venture capitalist always invests into a high growth and highly risky firm and helps the
management with guidance and expertise. There are following characteristics of the venture
capital concepts:
1.2.1 Financing of risky ventures and high investment returns
Generally venture capital investment is done into highly risky ventures because they have small
cap and there can be hundred per cent investment loss. These companies are not having any good
operation history. According to the various reports published by National Venture Capital
Association from time to time, usually a venture capital firm can make a return between twenty
five per cent and thirty five per cent of total revenue generated. (Source: Year Book 2015,
NVCA)
1.2.2 Provisions of equity capital and minority interest

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Venture capital is generally invested in the form of equity capital. This investment is made in
ordinary shares and preference shares. In this way venture capital organisations are always
minority stockholders in the investee companies.
1.2.3 Management support and monitoring
Venture capital concept and its nature are just like operations of any financial institutions. But it
has one more uniqueness that it always supports the investee company in terms of guidance,
management support etc. So the entire venture capital concept revolves around the helping of
investee companies which received help in modern business practices. So the venture capital
firms always watch that investee companies work according to the decided plans and terms and
conditions.
1.2.4 Limited time horizon and longer investment process
Venture capital is invested usually for five to ten years after they exit from the investment. This
process restricts venture capital to be invested for a limited time period rather than into unlimited
equities.

1.3 Venture capital investment process

This is the process by which a venture capital company invests into a venture. The initial point is
how it raises the fund from the different sources. There is a five step approach developed by
Tybee, Bruno and Isakson (2000). Starting at the very beginning, there are six early stages in the
investment financing of a firm: seed, startup, expansion, mezzanine, buyout, and (if needed)
turnaround. Most venture outlays focus on the seed, startup, and expansion stages.
A tiny fraction of venture capital money, about two per cent, goes in earliest-stage financing,
called seed money, which constitutes funds for initial research to prove a concept. A significant
proportion of venture capital is invested to support product development and initial marketing
(often referred to as startup funds). In figure 1.2 the investment disbursement of startup and seed
activities has been shown:

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 Figure 1.2
Venture capital investment in startup/seed activities
Source: Thomson Venture Economics/National Venture Capital Association
It is very clear form the above figure that from 1980-02, startup/seed activities had constituted
$21.4 billion out of the total US$ 339.9 billion invested in all the business stages, accounting for
approximately 6.3 per cent of all US venture capital disbursements. Startup/seed activities rose
from $157.5 million in 1980 to a first peak of $1.5 billion in 1986, a nearly ten fold increase.
They then had fallen to $241 million in 1991, for an 83.9 per cent decline. Seed/early money,
then, ramped up to a peak of $3.3 billion in 1999, leading the high-tech (and medical) boom and
other sectors as well. The latest reduction was also vivid: a 90 per cent decline from 1999 to a
low of $352 million in 2002. It had remained approximately the same last year, at $354 million.
This early set might be driven by funds availability and optimism or pessimism. However, it also
might reflect how many promising ideas had been generated at that point by ongoing innovation
and the advance of knowledge. The early seed cycle would also partly drive the later cycles.
The set for overall venture placements was also highly volatile, as shown in the table below. The
following figure shows the percentage change in the value of venture capital and venture capital-
backed IPOs, compared with the previous year, in 1983–2003.

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In figure 1.3, the five steps of venture capital investment process has been shown i.e. planning
for objectives of investments, search for the better options available, and identifying different
opportunities for investment purposes, selecting the best deal after proper screening of the
proposals, monitoring and evaluation of the fund.

1. Establish fund
 Planning for Investment objectives
 Search options to get capital for investment

2. Deal flow
 Do the activities for creating opportunity
 Identifying opportunities

3. Decisions for investment

 Screening and evaluating the deal
 Selecting and deselecting deal
 Negotiating the structure deal

4. Monitoring and value addition

 Developing the strategies
 Search options to get capital for investment

5. Exit from the venture

 Planning for sale of investment
 Search options for exit from venture

Figure 1.3
Venture Capital Investment Process
Source: http://business.mapsofindia.com/venturecapital-process & Isaksson, 2006, p.43

As illustrated in the figure 1.3, in the first stage of establishing fund, a venture capital process
starts when the venture capital firm is established. It depends on the structure of the firm that

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how they will go ahead. First they decides their objectives, means what they have to achieve and
from where they will collect the fund to be invested. They look into various options from where
they can generate funds. However, most venture capital firms start their operations by raising a
fund from which the investments are made (Gompers and Lerner, 1998). The fund is frequently
collected from a variety of sources (e.g. banks, pension funds, insurance companies) (EVCA,
2006)
In the Second stage of deal flow, it tries to search the various opportunities where it can invest
the collected fund and generate sufficient profit. Tyebjee and Bruno (1984) found that the
behavior of venture capitalists in seeking out deals was to wait passively for deal proposals to be
put to them. Sweeting (1991) also found that most deals were referred by third parties and that
venture capitalists rarely try to discover new investment opportunities proactively.
In the third stage, it tries to select the best deal and make further negotiations for the best deal to
be finalized. When the deal is finalized, venture capital firm make investments, gives advice for
better decision and actively participate into management and supports with special expertise.
Research has shown that for each project that is accepted, venture capitalists reject most of the
proposals in the screening process (Mason and Harrison, 1999). The investment evaluation phase
is an important and very time consuming activity. It includes a complete examination of the
venture (due diligence), which then receives funding based on very specific conditions. Tybjee
and Bruno (1981) found that venture capitalist spends almost fifty per cent of his/her time
screening and evaluating.
An important step in the negotiation process is to determine the current value of the firm. The
valuation process is an exercise aimed at arriving at an acceptable price for the deal.
Manigart et al. (2000) examined the valuation methods used by venture capital investors in the
United States, Great Britain, France, Belgium and Holland and investigated issues concerned the
valuation of venture capitalists investment decisions and the importance of accounting and
financial information.
In the last stage, it makes plans to exit from the venture. The most crucial stage in any venture
capital investment is its exit from the enterprise. Generally, the goal of the venture capitalist is to
sell the investment in a period ranging from three to seven years at a considerable gain.

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A venture capital company has, almost by definition, a time limit for the investments they enter
(i.e. their business idea is to buy, develop and sell). The time horizon can be in the range from 3-
4 years up to 10 years, usually depending upon the venture capitalists investment strategy
(Bygrave and Timmons, 1992). A venture capitalist that, for instance, has chosen to invest in
start-ups usually will hold that investment during a longer time period than a venture capitalist
that is specialized in mezzanine investments (Bygrave and Timmons, 1992). Even though exit
strategies intuitively are placed as the last part of the process, they are considered throughout the
investment period. Venture capitalists will not consider making an investment unless they have a
good idea about a possible exit scenario.
The venture capital process usually ends with one of the following five exit mechanisms
(Macintosh, 2002):
 Initial Public Offering (IPO): The venture‟s shares are offered in a public sale on an
established share market.
 Acquisition (or trade sale): The whole venture is sold to another company.
 Secondary sale: The venture capital firm‟s sell their part of the venture‟s shares only.
 Buyback or management Buy-out: Either the entrepreneur or the management of the firm
buys back the venture capital company's shares of the firm.
 Reconstruction, liquidation or bankruptcy: If the project fails the venture capital firm‟s
last resort is to restructure or close down the venture.

The different possible routes for exit from venture investment or disinvestments have been
shown in figure 1.4. The venture capital process is complete when the company is sold through
either a listing on the stock market or the acquisition of the firm by another firm, or when the
company fails. For this reason, the venture capitalist is a temporary investor and usually a
member of the firm's board of directors only until the investment is liquidated.

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 Repurchase

Venture Capital Investment

repurchases by management
Involmentry Exit
Trade Sale
Companies usually fail and
Company sold to going to liquidation
commercial buyer

Venture Capital
Exit

Routes

Stock Market Flotation Refinancing

Through issuing of IPO Purchase of the venture capital

share by a long term financial
institution

Figure 1.4

Venture capital possible exit routes

Source: own construction

The firm is a product to be sold, not to be retained (Kenney and von Burg 1999). The venture
capital process requires that investments should be liquidated, so there must be the possibility of
exiting the firm. Nations that erect impediments to any of the exit paths (including bankruptcy)
are choosing to handicap the development of the institution of venture capital. Most recently,
Jeng and Wells (2000) found that the single strongest driver of venture capital investing was the
number of IPOs.

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1.4 Venture capital financing stages

There are many stages of the investee companies which a venture capital company may choose
to invest in. Management experts have different opinions about these stages because of the
different economic environment. In figure 1.5, all the stages of venture capital financing have
been shown:

Seed stage

Start-up stage

Early development stage

Expansion stage

Profitable but cash poor stage

Rapid growth stage

Mezzanines or bridge stage

Harvest or exit stage

Figure 1.5

Venture Capital Financing Stages

Source: own construction

1.4.1 Seed stage A person with an idea, discovery or invention – the budding entrepreneur – will first
commit his savings to test his concept. Failing this, or when extra funding is required, he will turn to his
immediate family and friends with a request for financial support. However, funding needs are likely to
rapidly exceed the entrepreneur's own and immediate entourage resources, especially if his concept
proves worthy of further development. This is the phase where seed finance is required. This is the stage
in which an entrepreneur first develops a concept and makes a vision for the Venture. In this stage

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entrepreneurs spend good time but less capital because actual business production does not start at this
stage. Financing is done by the entrepreneur and other business angels.
1.4.2 Start-up stage It starts when first stage seed capital has been successful. The main
activities in this stage are testing of proto type, recruiting the management team and further
developing the vision of business which had been generated in the seed stage. Actual production
does not start in this stage. But large amount of finance is required in this stage because of heavy
work load. Financing is done by venture capital companies and business angels.
1.4.3 Early development stage It can be said as the first stage of investment because it starts
when product development and market testing have already been done. In this stage a large
amount of fund is required for investing into fixed cost assets such as plant and equipment
because in this stage company goes for commercial productions and for sale of the products.
Generally business angels provide fund in this stage.
1.4.4 Expansion stage As the company expands; its needs for capital will also grow (Andrew J.
Sherman 1997). Capital may be required to increase the production capacity, to develop products
and markets or to provide supplementary working capital. By this stage, the company will have
the sales revenue and most likely it will be generating a profit, which, however, may be
inadequate to fund its expansion. It may, therefore, revert to its capital provider for second-
/third-stage finance. In this stage, a customer satisfying product has already been become
successful in the market and company sees huge potential for generating profit in the market
further. But cash inflow in this stage is very low and capital investment requirement is very high
for expansion. Venture capitalists, banks and government are the financer in this stage. In this
stage, venture tries to make profit which will carry it to break-even point. This stage is having
cost minimization process.
1.4.5 Profitable but cash poor stage In this stage, venture sees whether there is a huge growth
and sales potential in the market through which huge profit can be generated. But in this stage,
cash flow is very low and it cannot satisfy the needs of a large capital requirement for fast
expansion. In this stage there are three financers in the market: first is venture capitalist, second
is a bank and third are retained earnings.

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1.4.6 Rapid growth stage In this stage financing and investment activities increases many folds
because a good growth has already been achieved. In this stage default risk is very low because
good growth has already been achieved and profit margins are very high. Funds are still required
to maintain the level of the growth. This funding is done only by venture capitalist and banks.
1.4.7 Mezzanines or bridge stage In this stage venture capitalist has already thought to exit
from the venture and exit time is very well confirmed to venture capitalist. At this stage funding
is done very strategically. In this stage venture capitalists and banks are the major fund providing
agencies.
1.4.8 Harvest or exit Stage The exit strategy is the venture capital‟s way of cashing out on its
investment in a portfolio company. A venture capital often hopes to sell its equity (stock,
warrants, options, convertibles, etc.) in a portfolio company for a period of three to seven years,
ideally through an initial public offering of the company. The company becomes liquid through
the sale of its stock to the public and the venture capital sells its stock to reap its return. This is
the stage when venture capitalist liquidates its investment for cash. There are three methods to
exit which are very popularly known. In the first method, venture can issue initial public offer to
venture capitalist. In the second method, venture can acquire entire investment from venture
capitalist and can pay for entire investment and in the third method; venture can go for leverage
buyout. While an IPO may be the most visible and glamorous form of exit, it‟s not the most
common. Most companies are sold through a merger or acquisition event before an IPO can
occur. If the portfolio company is bought out or merges with another company, the venture
capital receives stock or cash from the event. Another alternative may be the reorganization of a
portfolio company‟s debt and equity mixture, called a recapitalization. The venture capital
exchanges its equity for cash, the management team gains equity incentives, and the company is
positioned for future growth.

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1.5 Advantages of venture capital
The major advantages of venture capital are briefly listed below:
1.5.1 Venture capital comes into a company as an equity fund which gives a solid financial
base for future growth.
1.5.2 Venture capitalist is always a partner into risk and profit as well. In terms of profit it gets
periodical income and capital gains.
1.5.3 The venture capitalist share vital information with the ventures which it knows for the
growth of the company and gives active guidance and advice for the success of the
company.
1.5.4 Venture capitalist has a lot of contacts. It can give contacts of international market which
can add values to company. It can also arrange some other sources of the funds, if
needed.
1.5.5 It can provide additional funds when it is required by the venture in due course of running
the company successfully.

1.6 Disadvantages of venture capital

The major disadvantages of venture capital are briefly listed below:
1.6.1 There is an agreement between the two parties. First is the venture capitalist and the
second is venture. Venture capitalist has ownership rights in the company. If the deal is
not negotiated properly, there are chances that venture capitalist may capture the entire
company.
1.6.2 Venture capitalist has the right to drive the firm and if deal is not going properly it can
pass information, which may or may not be accepted to the other partners.

1.7 Factors determining the venture capital requirement

There are many factors which determine the total capital requirement for a newly set up business
like, size of the business, nature of the business and total available resources etc. In figure 1.6,
the following factors which are necessary for determining the venture capital requirement, have
been shown:

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 Nature of the Business

Size of the Business

Length of Production Cycle

Seasonal Variations

Working Capital Cycle

Business Angel

Figure 1.6

Source: own construction

Factors determining the VC requirement

1.7.1 Nature of business Public utility undertakings have less requirement of fund because it
has cash sales after supplying services such as water, electricity etc. Firms which are engaged in
financial services, require few funds to be invested into its inventory. But firms, engaged into
manufacturing those goods which are tangible, need huge capital for investing into fixed assets
such as plant, machinery, land etc and for investing into inventory.
1.7.2 Size of the firm If the size of the firm is small, it needs less working capital but if size of
the firm is big, it needs large working capital.
1.7.3 Length of the production cycle Some firms need short length of the production cycle.
There is not much requirement of working capital to be invested into inventory. On the other
hand, some firms have longer production cycle. These companies need large working capital.
1.7.4 Seasonal variations In a busy season firms needs more working capital and in stock
seasons it needs less working capital. So the firm has to arrange this capital according to its
needs and requirements.

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1.7.5 Working capital cycle Length of the working capital cycle determines the requirement
of the working capital. Longer the working capital cycle, larger the working capital requirement
and shorter the working capital cycle lesser the requirement of working capital.
1.7.6 Business cycle when there is a boom in the industry, more working capital is required in
the firm because there is rise in sales prices and firm thinks about the expansion. But when there
is a time of depression, the business do not show good sign of growth, sale is also declining. In
this case also, firms need larger amount of working capital.
In this case it is observed that in both the cases we need working capital in large amount. In the
first case it is required to expend the company and in the Second case it is required to save the
company when there is a number of defaulters for the company when they default companies are
is cash crunch and they need immediate fund.

1.8 Venture capital process

Venture capital process includes the stages from where investment into a venture starts and ends.
It starts from number of sources. In the figure 1.7 below entire venture capital process has been
depicted.

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 Figure 1.7
Venture Capital Process

Source: Accessed from http://www.ivca.in/reports/2014/ivca_Book.pdf

There are five steps in venture capital process:

1.8.1 Fund raising This is the first step in the venture capital process. A venture capitalist has a
number of sources such as banks corporations, endowment funds and high net-worth individuals.
A venture capitalist has many sources of fund. First it collects funds from the banks. He applies
loan from the bank on his own reputation or keeping his valuable items on the stake for higher
margins. Banks also support venture capitalist because, these parties have already proved their
success in the market and banks are sure about the success of next investment.

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The second source of fund is corporations. These corporations have a lot of fund which is idle
and they want to invest it. They give this fund to venture capitalist and venture capitalists invest
this fund into venture.
The third source of finance is high net worth individuals. These individuals are interested into
investment. But they need high return. So they like to invest their money in venture capital firms
and venture capital firm will invest this money into ventures where their money will be growing
very fast.
1.8.2 Evaluation and investment The Second step in venture capital investment process is
evaluation of the project and making investments. The evaluation process starts in the following
flow:
1.8.2.1 Idea and concept evaluation
1.8.2.2 Research
1.8.2.3 Market characteristics
1.8.2.4 Competition
1.8.2.5 Technology
1.8.2.6 Valuation model

In the evaluation process, first of all idea and concept are evaluated, whether fund will be safe or
it will be balanced to invest into this new idea or concept. The second step in this process is that
a venture capitalist has to do extensive research. This research will be evaluating various market
characteristics, impacting the investment. It also evaluates competition which is prevailing into
the current market conditions and in the technology. In technology, generally, it is evaluated to
know whether this technology will be accessible for a long time or it will be obsolete in a very
short spam of life. In valuation model, a venture capitalist evaluates the project for financial
feasibility. What should be the return on investment? Further, venture capitalist makes
comparison with the various investment stages. When evaluation is completed, financing the
venture starts.
1.8.3 Monitoring In this step, venture capitalist looks into its portfolio companies. How they are
working. They give proper advice for further development and enhancing the business
opportunities for the ventures and achieving the required targets for the ventures. Continuous and
close monitoring is necessary for the ventures, because it must be ensured that all the investment
and working is taking place according to the stipulated terms and conditions of the agreements.

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1.8.4 Exit In this step of venture capital process, a venture capitalist tries to exit from the
company and he uses three techniques for this purpose. The first technique is the redemption of
Shares. In this technique venture will pay entire amount to venture capitalist and venture
capitalist will return his entire share holding to the promoters.
In the second process venture capitalist uses merger and acquisitions technique. It merges or
acquires the entire venture for certain amount and in the third technique it will go for initial
public offers of the venture and become general partner or limited partner of the company.
1.8.5 Distribution In this process entire shareholding is distributed between general partners and
limited partners. General partners are those partners who are having shareholding of the
company and take active role in day to day operations of the company and on the other hand,
limited partners do not take active role in the day to day operation of the company. Their
liabilities are limited to their shareholding only.
But this entire process is never ending process because now again these two partners are ready to
fund their money to any venture capitalist, so that they can invest their money further into any
new ventures. In this way this is a never ending process.
1.9 Growth of venture capital in India
The development of venture capital industry had been in many phases and this development was
very slow and belabored because this industry had seen many resource constraints because of the
slow economic development in India.

There was always a fear that venture capital firms and ventures might be defaulter, so bank were
interested to fund only those ventures where collateral-based funding was required. These
circumstances had created problems for new ventures and entrepreneurs because banks were not
interested to finance new ventures which were technology and service based. In the early days it
was full of fear that these projects might default and banks might lose their money. This situation
had created a problem for the fund raising activity for new projects.

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There were the following phases which Indian venture capital industry had seen:

Phase – 1: 1987 – 1994

 Setting up to Technology
Development & Information Company
of India and Regional fund

Phase – 2: 1995 – 1998

 Entry of Foreign Venture Capital

Funds

Phase - 3: 2000 onwards

 Emergence of new venture capital

firms

Phase – 4: Current

 Global Venture Capital and Private

Equity firms actively investing in
India

Figure 1.8
Development phases of venture capital industry in India
Source: own construction

1.9.1 Phase 1 Early development

1.9.1.1 In 1972, a committee was constituted that emphasized for venture capital as a
source of funding new entrepreneurs.
1.9.1.2 In 1975, Industrial financial corporation of India (IFCI) had founded risk capital
and its sole aim was to finance new technologies.

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1.9.1.3 Industrial development bank of India (IDBI) had set-up seed capital financing and
equity capital financing scheme in 1976.
1.9.1.4 In 1985, Industrial Credit and Investment Corporation of India (ICICI) had started
programme for advancement of commercial technology (PACT).
1.9.1.5 These phases had seen only collateral based funding and this phase did not see
any dynamism in venture capital industry because new entrepreneurs were not having any
assets which they could have kept as collateral. So they were unable to get the sufficient
finance from the banks, though they were having excellent idea in their mind but it was
not properly supported by any financial institution.
1.9.1.6 Setting-up of a ICICI and Regional Funds:
 Before 1986, there was no organized venture capital industry in India. So none of
the practical purpose could be solved due to this constraint. But budge of 1986-87
included this point and after that this idea got momentum in India. A corpus was
created by levying a 5 per cent cess on all technology which was imported to
India.
 World bank had done a study for developing venture capital for private sector and
based on this study government of India started working on this direction and
developed a policy framework and guidelines for venture capital fund in 1988. It
gave a sudden momentum for venture capital industry in India.
 After this fund, other funds had been emerged in Indians financial system. But
initially only government owned banks and financial institution were among
which funded the new ventures and after that some private sector companies were
also came into the picture for this industry.
Source:https://shodhganga.inflibnetnet.ac.in/bitstream/10603/54276/9/09_chapter%203.p
df, accessed on 15th October, 2014.

1.9.2 Phase 2 Entry of foreign venture capital funds

1.9.2.1 First time in September 1995, Government of India had issued guidelines for
foreign investment in venture capital in India. These guidelines were framed to give
momentum for overseas investment of the fund in India.

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1.9.2.2 Central board of direct taxes (CBDT) had also framed and issued guidelines for
giving tax-exemption for this sector and reserve bank of India had also issued
guidelines for foreign fund investment into Indian venture.
1.9.2.3 Security and exchange board of India (SEBI) had also framed SEBI venture
capital fund regulation in year 1996.
1.9.2.4 These guidelines of security and exchange board of India were amended in
April 2000 and their main objective was to improve the growth of venture capital
activities in India.
Source: Annual reports of SEBI, CBDT, 2000 and K. B. Chandrasekhar Report.
1.9.3 Phase 3 Emergences of successful India-centric venture capital firms
1.9.3.1 To increase the growth of venture capital industry in India, Government of India
formed a committee of SEBI and this committee had submitted its report in July 2000.
1.9.3.2 Recommendations of the report were accepted and duly implemented main
recommendations are as follows:
 SEBI would be the main regulator for venture capital fund in India.
 All venture capital firms, which were having regulatory compliance they
were given tax pass through status. It means, they were kept in special tax
category and tax-incentives were given to these firms.
 All the foreign venture capital investors must also be getting themselves
registered with security and exchange board of India.
1.9.3.3 In year 2000, Due to downfall in stock market, NASDAQ had lost 60 per cent
of its value. This incidence had a major impact on the venture capital market. Indian
venture capital market was also impacted due to this downturn in US economy.
1.9.3.4 Because of this incidence venture capital firms had started to invest money only
in mature companies because they wanted to reduce the risk.
1.9.3.5 Decline in the market had its impact till 2003 and after that market started
picking up.
1.9.4 Global venture capital firms and private equity firms had started investing in
India:

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 1.9.4.1 Indian economy was growing very fast and it had got a growth rate of seven per
cent to eight per cent and its service and manufacturing sector was growing with twelve
per cent to fourteen per cent (Source: SEBI Reports 2003). Investors had started to fund
new projects after 2004.
1.9.4.2 In this phase, number of deals had increased rapidly and its size as well.
1.9.4.3 Till 2009, venture capitalist were showing their interest into those companies
which had already established.
1.9.4.4 Venture capital firms did like to invest into growing firm or in those deals
which were in their later stage.
1.9.4.5 Now the numbers of limited partners, who had invested in venture capital firms,
had been increased because of better return and high growth in venture capital firms
and stock market.
1.9.4.6 In this Stage, Preferred regions for VC investment were Mumbai, Delhi and
NCR followed by Banglore. Although companies in South India attracted a higher
number of Investments. City Group was the most active investor with a portfolio across
energy, engineering and constructions, manufacturing.
1.9.4.7 In this phase, ICICI ventures, Goldman Sachs and Helion Ventures were also
other active investors among other venture capital firms which had invested a lot of
fund in the different industries.
Sources:
 ICICI Annual Report, 1984-85, p. 12.
 IVCA Annual Reports 2003-2006.
 K.B. Chandrasekhar Report- SEBI Committee Report, downloadable from the
SEBI website- www.sebi.gov.in

1.10 Venture Capital Market: The Indian Scenario

Venture capital in India is classified as a sub-set of the asset class „private equity‟; other
categories include growth/expansion private equity, later stage private equity and pre-IPO and
private investment in public enterprises (PIPE) deals. According to a number of sources, the total
investments in private equity and venture capital had increased almost six hundred per cent
between 2004 and 2006, from US$1.1 billion to US$7.46 billion (IVCA database 2006). This

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incredible growth had been fostered by a combination of country-specific factors that distinguish
India‟s investment environment. These include:
1.10.1 Consistent economic growth From 2002-2006, the growth performance of India had
been averaged 8.5 per cent per year. Over the past fiscal year, it was 9.4 per cent and had been
estimated to touch 10 per cent in the year 2008. The rapid, consistent growth had positioned
India as the world‟s 12th largest economy in 2006, with GDP of US$900 billion, or the third
largest (after the US and China) in terms of purchasing power parity terms (International
Monetary Fund reports 2006). Market liberalization, the global ambitions of Indian companies
and an entrepreneurial culture point to the fact that the dynamic growth would likely to be
continued.
1.10.2 Public equity market India had a deep and broad public securities market, which was an
essential factor for private equity investors. The Bombay Stock Exchange was the oldest stock
exchange in Asia, and was established in the year 1875. The SENSEX, a basket of thirty stocks
was representing a sample of large liquid and representative companies in India (oil/ power,
realty, auto, banking, FMCG etc.) and was considered to be the pulse of the Indian stock market.
In a twelve month period from 2006 to 2007, the BSE SENSEX had a 47 per cent increase in
total volume/deals, outperforming stock markets in other emerging markets (SEBI Reports
2007).
According to Reserve Bank of India indicators in 2007, Indian companies had issued $42.6
billion in debt and equity worldwide up from $32 billion in 2006. In 2003, the amount was $5.8
billion (RBI Reports 2007).
1.10.3 World class differential capabilities: India‟s higher education system had lead the
country to a central and pilot position in a number of growth sectors, such as information
technology and IT enabled sectors, software development, healthcare services, pharmaceutical
and automotive components making companies. Both manufacturing and the services sectors had
witnessed increased in the overall growth.
1.10.4 Rising domestic market: Although India‟s GDP per capital at about US$800 might
appear low, the middle class had been defined as those with incomes between US$4,400-
US$22,000 which had increased to thirteen million households or about fifty million people. As
a result India had been experiencing surging demand for consumer durable goods such as cellular

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mobile phones – the ownership of which had increased to US$180 million in August 2007. In the
past year, „mobile‟ India had been adding seven to eight million users per month.
1.11 Venture capital funds in India
Venture capital funds can be categorized into five groups:
i. Venture capital funds which are promoted by central government controlled Institutions.
a) ICICI venture fund Ltd.
b) IFCI ventures capital funds ltd. (IVCF)
c) SIDBI venture capital ltd (SVCL)
ii. Venture capital funds which are founded by state government controlled finance
institutions.
a) Punjab InfoTech venture fund
b) Gujrat venture finance ltd (GVFL)
c) Kerala venture capital fund pvt. ltd.
iii. Those founded by public banks –
a) Canbank Venture Capital Fund.
b) SBI Capital Market Ltd.
iv. Those founded by private sector –
a) IL & FS Trust Company Ltd.
b) Infinity Venture India Fund.
v. Those founded as overseas venture capital fund –
a) Walden International Investment Group.
b) HSBC Private Equity Management Mauritius Ltd.

1.12Regulatory environment for venture capital in India

1.12.1 Regulations by the SECURITIES AND EXCHANGE BOARD OF INDIA

1.12.2 Regulations under the INCOME TAX ACT 1961

1.12.1 Rules and regulation by securities exchange board of India

1.12.1.1 Venture capital funds are regulated by the SEBI (venture capital fund) regulations,
1996.

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1.12.1.2 This fund may be set up by a company or by a trust after obtaining certificate of
registration from SEBI by applying for the same to SEBI. After obtaining the certificate
they will have to follow the guidelines of SEBI Act, 1992.
1.12.1.3 The minimum investment in a venture capital fund from any investor would not be less
than Rs. 5 lakh and the minimum corpus of the fund before it could start activities
should be at least Rs. 5 crore.
1.12.1.4 According to SEBI act any venture capital firm may invest only in equity and equity
related scheme and it can invest only in listed company. If a company is financially
sick, VCF can invest into that company as well and this company may be listed or
unlisted.
1.12.1.5 There is no restriction of SEBI for investment into a particular sector except financial
services.
1.12.1.6 A venture capital firm is not allowed to make investment into equity shares of
companies which provide financial services.
1.12.1.7 The securities issued by a venture capital company cannot be allowed to be listed on
any stock exchange before four years of issuance.
1.12.1.8 If venture capital firm is set up as a trust for a particular scheme, It will be wound up
i. When time for which a scheme is launched is over.
ii. If trusties think that investors will be in profit, if this scheme is closed.
iii. If seventy five per cent of the investors give consent to wind up the scheme.
iv. If SEBI directs to wind up the scheme in the interest of the investors.

1.12.2 Regulations under the Income Tax Act 1961

1.12.2.1 Venture capital firms get tax exemptions under section 10 (23FA), if venture capital
firms comply with income tax rules.
1.12.2.2 According to this act, venture capital fund may invest only in equities of unlisted
companies.
1.12.2.3 According to this act, a venture capital fund will have to hold the investment in a
venture for a minimum period of three years or more.

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1.12.2.4 According to this rule, a venture capital firm will invest only forty per cent of the paid
up capital of the venture and twenty per cent of total fund of venture capital fund.
1.12.2.5 According to new amendments, now a venture capital firm may invest up to twenty five
per cent of total paid up capital of the single venture.
1.12.2.6 There are restrictions for particular sectored investment of the venture capital firm. It
means that they can invest only in the specified companies.

1.13 Size and number of deals According to rules and guidelines issued by SEBI, A venture
capital firm may invest only in equities and equities related schemes of any unlisted company. A
venture capital fund will have to hold the entire investment in a venture for a specific period.
Figure 1.9 shows how much amount and how many deals were concluded from year 2000 to year
2010.
Deal Size Number of deals

Figure 1.9

Size and number of venture capital deals (2000-2010)

Source: Gilde Investment Management 2011

Figure 1.9 shows that in year 2000, total investment was very low but in year 2004 it had
increased more than 2000 US$ Billion and in year 2007 it had increased to its highest level more

27
that 14,000 US$ Billion. After that it had started decreasing in the next two years and in year
2010 again it had increased and had reached around 800 US$ Billion. Number of deal size in the
first two years had decreased and after that till 2007 it had increased. After that it had started
decreasing till 2009 and in the next year 2010 it again had increased.
The following figure 1.10 shows quarterly performance of venture capital fund in India. In 2009,
first three quarters had shown moderate growth and in the first quarter of 2010, deal value had
increased drastically but in the Second quarter of 2010, this deal value had decreased a lot. In the
third quarter of year 2010, it had increased and next three quarters had shown moderate growth.
After that, performance had decreased a lot. When we see at the number of deals in the first few
quarters, it had decreased and after that it had increased for many quarters and for one quarter it
has decreased and for another next quarter it has increased.

Figure 1.10

Quarterly Performance of Venture Capital Fund in India

Source: NVCA Database 2012

It is very clear from the above figure that the quarterly performance of venture capital fund in
India was less satisfactory. The numbers of deals in the first quarter of the year 2010 was not

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much fluctuating as compared to the first quarter of the year 2009. The numbers of deals in the
first quarter of the year 2011 had shown remarkable fluctuations.
Figure 1.11 shows that how many firms had shown increase and decrease in the overall growth
of the market. Brazil, China and India had shown a remarkable growth in increase in number of
venture capital firm whereas Canada, France, Germany, Israel, UK and US had shown a decrease
in number of venture capital firms.

Figure 1.11
Expected Growth in Next 5 Years
Source: Gilde Investment Management 2011

China had shown a significant increase in the total number of venture capital firms. The expected
growth for India was approximately twenty one per cent compared to the expected growth of

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China which was forty eight per cent. At this point the government of India had taken some
corrective measures for increasing the number of venture capital firms in India.

Figure 1.12 shows stage wise investment into Indian companies between 2006 and 2010. In the
early stage nine per cent of the total amount was invested. In the growth stage seventeen per cent
of the total amount was invested. In the later stage, this amount was increased to thirty three per
cent of the total amount. In the PIPE stage, this amount reduced to twenty eight per cent and we
see that in pre-IPO stage this amount was four per cent of the total investment.

Figure 1.12

Stage wise Investment

Source: Bygrave W. D., Hay M. and J. B. Peeters (1999)

The following figure 1.13 shows the total funding between 2006 and 2010 into various sector of
Indian economy. This figure shows that Information technology and Information technology
evaluated services were having thirteen percent of total investment. Computer hardware had only
one percent share of total investment. Healthcare industry had attracted five percent of total
funding.

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Manufacturing sector had attracted ten percent of total funding and in amount term it was
4249.22 million US$. There was fifteen percent investment into engineering and construction
sector. Telecom and Media had also attracted seventeen per cent of the total shares.

Figure 1.13

Total Funding (2005-06 to 2010-11)

Source: TSJ Venture Intelligence, 2012

From the above figure it comes to know that the percentage of total funding was the higher in the
financial services sector which was twenty four per cent approximately. The second higher
amount of investment was in telecom and media sector.
Transportation and Logistics had attracted five percent of the total investment. This sector had
been invested least amount as compared to other sectors. Financial services had been invested by
most of the amount and it was twenty four percent of the total amounts. There was only six per
cent in non financial services and others sectors had attracted only four percent.

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