Institute of Information Technology & Management, New Delhi

Subject: Entrepreneurship Development Paper Code: BBA 306

Course: BBA (VI) Dr. Gagandeep Kaur Gulati

UNIT-2

OPPORTUNITY ANALYSIS

Entrepreneur is an opportunity seeker. For establishing a new business unit he constantly goes on
scanning the environment until the he finds the best of opportunities. The process by which an
opportunity is identified is described as opportunity analysis or opportunity-sensing and
identification.
The major stages in identifying business opportunity and selection of products can be
discussed as follows:

The entrepreneurial process begins with identifying an opportunity and evaluating it through an
initial screening process.

Environmental Analysis

International Environment

Today, hardly any business is unaffected by international developments. The strides in the IT
sector and telecommunications along with the steady progress of WTO negotiations relating to
removal of tariff and non-tariff barriers on trade, investment and intellectual property have truly
made the world a global economic village. Even as a local player, you cannot wish away global
competition. Today a local bakery owner has to compete with other locally available biscuits as
well as big Indian brands like Britania, Sunfest and Parley as well as a host of international
brands such as Danish Cookies.

Macro Environment

The macro environment of an entrepreneur consists of the political, technological, social, legal
and economic segments. All of these are not an immediate part of the entrepreneur’s venture yet
they have an impact on his enterprise.

Political Environment

Entrepreneurship can flourish under a stable and conducive political climate. Government
policies which give priority to growth of trade and industry, provide infrastructural facilities,
Institutional support can give a fillip to entrepreneurship. Considering the employment and
export potential, the short gestation period and the fact that small industries act as a seedbed for
nurturing and developing entrepreneurship, the Government is very supportive of the small-scale
sector. It has created an extensive Institutional framework for provision of finance, technology as
well as help in marketing is made available by government institutions like SIDO, SISI,
NIESBUD, NSIC, and SFCs etc.

Technological Environment

The level of technology, the trends and the rate of change in technology existing in a society all
have a direct impact on enterprise creation. Changes in technology, both innovation and
invention change industry structures by altering costs, quality requirements and volume
capabilities. In the advanced countries of the West more pure invention takes place which can
create new industries for example Automobile, Aeronautical, Computer Hardware,
Telecommunications, Pharmaceuticals etc. In developing economies there is usually an imitation
of the above through greater process innovation. It has been observed that many small units use
obsolete technologies and do not invest in R&D. As a result their goods are of poor quality and
lack standardization. A direct consequence of this is their inability to face competition. In many
industries the technological threshold is low and as a result the success of an entrepreneur
promotes many others to start similar businesses and he loses the initial competitive advantage.
On the other hand if he uses certain costly technology chances of others quickly becoming his
competitors is less. Apart from these the effect of technology on environmental laws issues like a
product being tested on animals or use of child labour etc also have to be kept in mind.

Socio-Cultural Environment

The customs, norms and traditions of the society also play an important role in either hindering
or promoting enterprise. For example, we sometimes say that the Gujratis are very enterprising.
In certain traditional communities of our country working of females out of the home
environment is frowned upon. Many times the choice of occupation is also dictated by the family
traditions. Many vegetarians might not like to start poultry or fishery farms in spite of their
economic potential. Socio-cultural factors are crucial for the operations of MNCs also. It is very
important for an MNC to understand the socio-cultural background of their customers in the host
country. For example when KFC and McDonalds started their operations in India, KFC took a
complacent stand regarding the acceptance of the taste of it’s chicken by the Indian customer
who was not used to a bland taste. McDonalds on the other hand has consistently innovated their
dishes with regard to the taste of the Indian consumer. It’s cheeseburger and ‘Navratra thalis’ are
just a couple of examples. The result was that while McDonalds has been steadily increasing its
operations in India, there are hardly any KFC outlets left. Socio-cultural environment is also
concerned with attitudes about work or quality concerns, ethics, values, religion etc.

Legal Environment

The laws of the country can make the process of setting up business very lengthy and difficult or
vice-versa. Many times one hears of people complaining of the bureaucratic procedures in India,
which act as a damper on new venture creation. The labour laws and legal redressal system also
have a bearing on business operations. Patents, Agreements on trade and tariffs and
environmental laws also need to be studied. Copyright, trademark infringement, dumping and
unfair competition can create legal problems in the shape of long drawn out court battles.

Economic Environment

India has today achieved a GDP of 8.5 % and aspiring for 10 % GDP in next financial year.
Liberalization, Globalization and opening of economy in India, has increased the space for
business operations. It has also opened channels for foreign investors, banks, insurance and
infrastructure companies to start operations. The resultant competition, rapid and complex
changes have generated uncertainties, which have to be handled by the entrepreneurs.

Sectorial Analysis/Industry Analysis

The purpose of industry analysis is to determine what makes an industry attractive- this is
usually indicated by either above normal profits or high growth. For such analysis one should
study the history of the industry, the future trends, new products developed in the industry,
forecasts made by the government or the industry. It is also advisable to study the existing or
potential competition, threat of substitutes and entry barriers. Sometimes there might be bilateral
agreements between countries regarding some sectors or government policy that is sector
specific or some event that throw up challenges e.g. bird flu has dealt a severe blow to the Rs.
2600 crore poultry sector in India recently.

There might be certain constraints regarding availability of technology, manpower or raw

materials, which are industry specific. Similarly there might be certain strengths of a particular
sector, which might outweigh some negative general trends. Currently the cement and steel
sector are on an upward swing with a favorable climate in the housing sector as well as
government’s thrust on building roads and flyovers.

Porter's Five Forces Model: Industry Analysis

Michael Porter had outlined the following 5 key external market forces: Supplier and Buyer
Powers, Threat of New Entry, Threat of Substitutes and Industry Rivalry. The structured
analysis of external forces within an industry allows for identifying weak links in company's
strategy going forward. At the same time, it allows for strengthening company's positions and
developing a new strategy, better equipped to withstand external pressures. Moreover, it is
essential to track the dynamics of these forces through time. For instance, industry rivalry in
one's market may seem low at the moment but may increase in the future due to a high threat of
new entry.

 Industry Rivalry encompasses market concentration, diversity of competitors, product

differentiation, excess capacity and exit barriers and cost conditions. The analysis of the
above factors should lead to development of sound recommendations. For instance, a
company operating in an industry with little product differentiation may decide to create
a unique product line to capture a bigger share of the market. Excess capacity and high
exit barriers (e.g. in the pulp and paper industry) may lead to higher competition and
price dumping by existing players. A company may choose to diversify or horizontally
integrate to safeguard itself from intensifying industry rivalry.

 Threat of Substitutes relates to the existence of alternative products that have a similar
utility as company's products but do not directly compete with them. The two important
considerations are buyer's propensity to substitute and relative prices and performance of
 substitutes.

In the case of the courier delivery industry, regular mail and email are powerful substitutes.
Although, the two services do not directly compete in the same market, they nevertheless have a
significant impact on the industry. With the increasing importance of email and other electronic
media types, sending original documents often becomes irrelevant as it is much easier and
quicker to send a file by email at no cost.

 Threat of Entry is a powerful force, predictor of future industry rivalry. When analyzing
the threat from new entrants, one should consider the following factors: economies of
scale, absolute cost advantages, capital requirements, product differentiation, access to
distribution channels, government and legal barriers, retaliation by established producers.
High economies of scale and various legal barriers prevent new players from entering the
industry. It may be in the power of an incumbent company to increase these barriers,
utilizing government lobbying for protectionist measures or for increasing relevant
licensing fees.

Online-based businesses often operate in a low entry barrier environment and are often
vulnerable in face of new entrants who can easily copy their business model. At the same time,
such companies as Facebook can maintain their dominances by leveraging economies of scale
and network effects associated with serving a vast customer base.

 Buyer Power has two main components: 1) Price sensitivity and 2) Bargaining Power.
Price sensitivity is dependent on cost of product relative to the total cost of the project
(e.g. a buyer would not pay attention to the cost of new doorknobs when completing a
major home renovation project), product differentiation (how differentiated is one's
product in the market place), competition between buyers (is the product demanded and
rare OR widely-available?).

 Bargaining Power is dependent on the size and concentration between buyers relative to
producers (the bargaining power lies with more powerful market players), buyer's
switching costs (e.g. high costs of retraining personnel in the airline industry when
carriers switch between Boeing and Airbus). Other factors that increase buyer's
bargaining power are availability of information and buyer's ability to backward integrate
(e.g. grocery chains entering food production). The Supplier's Power is generally the
same as Buyer's Power only in reverse.

SWOT Analysis

Conducting a SWOT analysis will help the entrepreneur to clearly identify his own strengths and
weaknesses as well as the opportunities and threats in the environment. Threats in the
environment can arise from competition, technological breakthroughs, change in government
policies etc. He might possess certain unique skills or abilities, which along with his knowledge
and experience can provide him a cutting edge.
  Strengths are positive internal factors that contribute to an individual’s ability to
accomplish his/her mission, goals and objectives.
 Weaknesses are negative internal factors that inhibit an individual’s ability to accomplish
his/her mission, goals and objectives.

An entrepreneur should try to magnify his strengths and overcome or compensate for his/her
weaknesses.

 Opportunities are positive external options that an individual could exploit to accomplish
his/her mission, goals and objectives.

 Threats are negative external forces that an individual could exploit to accomplish his/her
mission, goals and objectives. These could arise due to competition, change in
government policy, economic recession, technological advances etc.

An analysis of the above can give the entrepreneur a more realistic perspective of the business,
pointing out foundations on which they can build future strengths and the obstacles they must
remove for business progress.

The hierarchical approach to development of business idea is given below.

Sensing Opportunity/ Idea Generation

The starting point for any successful new venture is the basic product / service to be offered. This
idea can be either generated internally or externally .For a new entrepreneur it becomes very
difficult to filter information from the business environment, identify opportunities, evaluate
them and then crystallise one specific idea. Developing a hobby, difficulty in obtaining a
satisfactory product or service, evaluating new products being offered in the market and active
engagement in Research and Development can help in generating a number of ideas. A reading
of the Economic Times, business magazines, watching special business program on the
television, discussions with professionals, friends, even teachers, surfing the internet all help to
provide valuable inputs .A study of government policies for example tax incentives and holidays
for setting up projects in backward area can help an entrepreneur to arrive at some decision .
Attending an Entrepreneurial Development Program can provide him with a sound
understanding of all the steps one has to take to initiate and run a venture. Business consultants
can also help him to identify a product or service and develop a business plan.

For a new venture to be set up an initial environment analysis is critically required to identity
trends, changes accruing at national and international level, gather knowledge about the
government polices in terms of financial and commercial impact on the company, knowledge
about raw material ability, infrastructure and utilities availability at the proposed site, etc.

Methods/ Techniques of Idea Generation

The following are some of the key methods to help generate end test new ideas:

1. Focus Groups – these are the groups of individuals providing information in a structural
format. A moderator leads a group of people through an open, in-depth discussion rather than
simply asking questions to solicit participant response. Such groups form comments in open- end
in-depth discussions for a new product area that can result in market success. In addition to
generating new ideas, the focus group is an excellent source for initially screening ideas and
concept.

2. Brainstorming - it is a group method for obtaining new ideas and solutions. It is based on the
fact that people can be stimulated to greater creativity by meeting with others and participating in
organized group experiences. The characteristics of this method are keeping criticism away;
freewheeling of idea, high quantity of ideas, combinations and improvements of ideas. Such type
of session should be fun with no scope for domination and inhibition. Brainstorming has a
greater probability of success when the effort focuses on specific product or market area.

3. Problem inventory analysis- it is a method for obtaining new ideas and solutions by focusing
on problems. This analysis uses individuals in a manner that is analogous to focus groups to
generate new product areas. However, instead of generating new ideas, the consumers are
provided with list of problems and then asked to have discussion over it and it ultimately results
in an entirely new product idea.

BUSINESS PLAN

A project report or a business plan is a written statement of what an entrepreneur proposes to

take up. It is a kind of guide frost or course at action what the entrepreneur hopes to achieve in
his business and how is he going to achieve it. A project report serves like a kind of big road map
to reach the destination determined by entrepreneur. Hence a project report can be defined as a
well evolved course of action devised to achieve the specified objectives within a specified
period of time. It is like an operating document.

The preparation of project report is of great significance for an entrepreneur. The project
report serves two essential purposes. The first is the project report is like a road map it describes
the direction the enterprise is going in, what its goals are, where it wants to be, and how it is
going to get there. In addition it enables the entrepreneur to know that he is proceeding in the
right direction.

The second purpose of the project report is to attract lenders and investors. The preparation of
project report is beneficial for those small scale enterprises which apply for financial assistance
from the financial institutions and commercial banks. On the basis of this project report the
financial institutes make appraisal and decide whether financial assistance should be given or
not. If yes how much. Other organizations which provide various assistance like work shed/land,
raw material etc, also make decision on the basis of this project report.

Contents of A Business Plan/ Project Report

A good project report should contain the following.

(1) General information: Information on product profile and product details.

(2) Promoter: His/her educational qualification, work experience, project related experience.
(3) Location: exact location of the project, lease or freehold, location advantages.
(4) Land and building: land area, construction area, type of construction, cost of construction,
detailed plan and estimate along with plant layout.
(5) Plant and machinery: Details of machinery required, capacity, suppliers, cost, various
alternatives available, cost of miscellaneous assets.
(6) Production process: Description of production process, process chart, technical know-how,
technology alternatives available, production programme.
(7) Utilities: Water, power, steam, compressed air requirements, cost estimates sources of
utilities.
(8) Transport and communication: Mode, possibility of getting costs.
(9) Raw material: List of raw material required by quality and quantity, sources of procurement,
cost of raw material, tie-up arrangements, if any for procurement of raw material, alternative raw
material, if any.
(10) Man power: Man power requirement by skilled and semi-skilled, sources of manpower
supply, cost of procurement, requirement for training and its cost.
(11) Products: Product mix, estimated sales distribution channels, competitions and their
capacities, product standard, input-output ratio, product substitute.
(12) Market: End-users of product, distribution of market as local, national, international, trade
practices, sales promotion devices, and proposed market research.
(13) Requirement of working capital: Working capital required, sources of working capital,
need for collateral security, nature and extent of credit facilities offered and available.
(14) Requirement of funds: Break-up project cost in terms of costs of land, building machinery,
miscellaneous assets, preliminary expenses, contingencies and margin money for working
capital, arrangements for meeting the cost of setting up of the project.
(15) Cost of production and profitability of first ten years.
(16) Break-even analysis.
(17) Schedule of implementation.

OUTLINE OF A BUSINESS PLAN

1. Introductory page
(a) Name and address of the venture
(b) Names and addresses of the principals
(c) Nature of business
(d) Statement of financing needed
(e) Statement of confidentiality of the report

2. Executive Summary

3. Industry Analysis
(a) Future outlook and trends
(b) Analysis of competitors
(c) Market segmentation
(d) Industry forecasts

4. Description of Venture
(a) Product(s)/Service(s)
(b) Size of business
(c) Office equipment and personnel
(d) Background of entrepreneurs

5. Production Plan or Operations Plan

(a) Manufacturing process (amount subcontracted)
(b) Physical plant
(c) Machinery and equipment
(d) Names of suppliers of raw materials
6. Marketing Plan
(a) Pricing
(b) Distribution
(c) Promotion
(d) Product forecasts
(e) Controls
(f) e– initiatives

7. Organizational Plan
(a) Form of ownership
(b) Identification of partners or principal shareholders
(c) Authority of principals
(d) Management– team background
(e) Roles and responsibilities of members of organization
8. Assessment of Risk
(a) Evaluation of weaknesses of business
(b) New technologies
(c) Contingencies plans

9. Financial Plan
(a) Pro forma income plan
(b) Cash flow projections
(c) Pro forma balance sheet
(d) Break– even analysis
(e) Sources and applications of funds

10. Appendices (contains backup material)

(a) Resumes of principals
(b) Letters
(c) Market research data and survey results
(d) Leases or contracts
(e) Price lists from suppliers
(f) Facility layout
(g) Draft marketing brochure with or without pricing
(h) Structure of e– marketing thrusts, if any

Business plans rank no higher than 2/10 as a predictor of a new venture’s success. With all the
uncertainties involved, it is not easy to forecast or make future projections. An entrepreneurial
venture faces even greater uncertainties. It is hard to predict even revenues let alone the profits.
Thus, every investor knows that any financial projections for a new company that stretch beyond
a year are an act of imagination.
Feasibility Analysis

The entrepreneur develops an idea into a business opportunity or business concept that is then
tested in the market through a process of feasibility analysis. Feasibility analysis is used to
inform the entrepreneur about the conditions required to move forward and develop the business.
This may involve market research. Once the entrepreneur has determined that the concept is
feasible, a business plan is developed to detail how the company will be structured and to
describe its operation. The feasibility analysis answers three fundamental questions:

1. Are there customers and a market of sufficient size to make the concept feasible?
2. Do the capital requirements to start, based on estimates of sales and expenses, make sense?
3. Can an appropriate start-up team be put together to make it happen?

Feasibility Analysis: Key Questions

Viability

Testing the business concept in the real world is what actually determines if the business has
viability. Thus, the business must actually be launched and operated in the environment to
determine viability. In a business, the term viability is the point when the company is able to
generate sufficient cash flows to allow the business to survive on its own without cash infusions
from outside sources such as the entrepreneur's own resources, investors, or a bank loan.
STEPS FOR STARTING SMALL-SCALE INDUSTRIES
Steps to be taken
1. Product selection and preparation of
Project report.
2. Obtaining provisional or permanent
registration
3. For obtaining developed plots for
construction of a factory for obtaining sheds
in Industrial Estates on ownership/rental
basis
4. If agricultural land is to be used for
industrial purpose and permission from
Thasildar, to conclude lease deed.
5. Obtaining licenses for the plan,etc.
6. No objection certificate from pollution
7. Registration under the Factories Act
8. Finance Commercial banks/Industrial co-
op.banks.
9. Registration for sales tax
10. Water supply
11. Power connection
12. Processing controlled raw material
13. For imported raw materials/machinery
and components
14. Obtaining machinery on hire purchase
15. Foreign collaboration
16. ISI Certificate
17. Patent Right
18. Registration of Trade Marks
19. Marketing Assistance a) Internal
Agency to be contacted
District Industries Centres/Small Industries
service Institutes/Technical consultancy
agencies like CECRI at Karaikudi, for
specialised products.
District Industries centre/Department of
Industries and commerce.
District Industries centres.
Small Scale Industries Development
Corporation.
Respective Corporation / Municipality /
Punchait, where the unit is to be set up
Respective State pollution control Boards.
Chief Inspector of factories and Boilers.
State finance Corporations-for term loans
State Commercial Tax Office
Water supply and sewage Board.
State Electricity Board
Joint Director(SSI)
The Joint Chief Controller of imports and
exports
National Small Industries Corporation
(NSIC)-Regional offices.
The Foreign Investment Promotion Board,
Ministry of Industrial Development, Govt.
of India.
Bureau of Indian Standards Institution, New
Delhi.
The Controller of Patent and Designs.
Registrar of Trade Marks.
Respective State Small Industries
 Marketing b) Export Marketing
20. Testing, Training and other extension
facilities
Marketing corporations. Export Promotion
Council/Cells; Trade Development
Authority; State Trading corporation;
Export credit Guarantee Corporation and
Export Inspection Agency.
Small Industries Service Institutes and
Regional Testing Laboratories.

Sources of Long Term & Short Term Finance

Long Term Sources:

1. Equity Shares: The equity shares are the main source of finance, & it is contributed by
the owners of the companies. Equity capital provides the strength to the financial structure of the
company. In the case of a new company the promoters must contribute to equity shares first then
the balance of shares is issued to the public. Limited liability & voting rights are the two
important features that confor special privileged on equity shareholders to restrict their liabilities
and at the same time keep full control over the company. However the cost of equity will be very
high for their expectations will be high as they provide risk capital to the ventures. Equity capital
represents permanent capital & there is no liability for repayment. No fixed obligation as to
dividend or interest is created.

2. Preference Shares : Preference shares confor on preference shareholders two rights viz.
to receive the preference dividend & get back capital on priority basis. Investors, who like to
earn a lmited but steady return on their capital, prefer preference shares investment. A company
can issue different types of preference shares as redeemable preference shares, cumulative
preference shares, participating preference etc. These kinds confor special rights on preference
shareholders as regards the repayment of capital, payment of dividends and payment of surplus
at the time of liquidation.

3. Debentures : Debentures are very commonly used creditor ship securities. Different
types of debentures are issued to mobilize the debt capital from the public. They are secured and
carry fixed percentage of interest. Registered debentures, redeemable debentures, convertible
debentures, mortgage or secured debentures, Ordinary debentures etc. are a few types of
debentures. From investors point of view debentures are less risky & contribute a regular
income. Debentures with fixed rate of interest enable the company to take advantage of financial
leverage or trading on equity. The shareholders can retain control and earn more income on their
investment. The cost of debts is very low because the interest on debentures is a tax- deductible
expense.

4. Term Loans: Terms loans are presently the most important source of finance. Loans
obtained from banks and financial institutions are generally secured loans. They carry a fixed
rate of interest & are payable in installments. Term loans are generally repayable within a period
of 10-25 years. Term loans are employed to finance the acquisition of fixed assets & working
capital margin. Term loans provide the benefit of trading on equity. The owner retains control of
the enterprise. These loans can be rapid whenever not required. As a result the financial structure
remains flexible. Term loans are comparatively less costly source of finance.

5. Retained Earnings: Reserves & surplus build over the past are called retained earnings.
These earning can be re interested in business for modernization & expansion. From the
ownership as well as cost of capital point of view, it is as a source, similar to equity share capital.
However it should be noted that over a period of time, the retained earnings get developed into
working capital. The cost of retained earnings is very cheap compared to cost of equity. It is the
best to take up risky but very profitable projects.

6. Deferred Credits: Sometimes the suppliers of machinery provide deferred credit facility
under which payment for the machinery may be made over a period of time. The interest rate &
period of payment very rather widely. Normally the supplier offering deferred credit facility asks
for bank guarantee from the buyer.

7. Capital Subsidy & Development Loans: Central govt. provides capital subsidy to
industries set up in notified backward area. Many state govt. or state development agencies also
provide development loans/ sales tax loans & state capital subsidies. They provide this facility
for backward areas which are exclusively notified in their states.

8. Unsecured Loans & Deposits : Unsecured loans are normally provided by the promoters to
fill the gap between the promoters contribution required by financial institution & equity capital
subscribed by the promoters. They carry a lower rate of interest & cannot be taken back without
the prior permission of financial institutions.

Sources of Short Term Finance

1. Account Payable: They are created when the fir purchase raw material, supplies goods
for resale on credit terms on open account. They are interest free & securities free. Accounts
payable is a legally binding obligation of a firm. They also include bills payable.

2. Accurals : They are short term liabilities that arise when securities are received but payment
has not yet been made. Examples are wages & salaries payable, taxes payable, expenses payable
etc.

3. Commercial Paper : These consist of promissory notes with maturities of 3 to 270 days.
Commercial paper is usually issued in higher denomination & can be used only by large well
known companies which enjoy a fairly high credit rating. Individuals, insurance companies &
other institutions also purchase commercial paper. This is a very recently emerged source in
India.
 4. Cash Advance From Customers: A customer may pay for all or portion of future purchase
before receiving the goods. This form of unsecured financing provides funds to purchase raw
material & produce the final products.

5. Bank Credit: Bank credit is the major source of finance for working capital. Banks offer
both secured as well as unsecured loans to business firms such as cash credit, overdraft, loans &
advances & purchase & discounting of bills. They provide 100% finance. They insist that the
customers should bring a portion of finance from other sources.

6. Private Loans: A short term unsecured loans may be obtained from a wealthy shareholder, a
major supplier, or other party interested in assisting the firm through a short term difficulty.

7. Short term Loans from Financial Institution: LIC, GIC & UTI provide short term loans to
manufacturing companies with an excellent track record. They are unsecured loans & given for
period of one year. The rate of interest is around 18% p.a.

8. Lease Finance: Lease financing has emerged as one of the important sources of industrial
finance in recent times. Lease contract is a contract between leaser & leasee whereby t5eh former
acquires the equipment/ goods/plants as required & specified by the leasee & passes on the
goods to the leasee for use for a specific pace. The leasee in consideration promises to pay the
lessor a specified sum in a specified mode on specific interval & at a specified place.

VENTURE CAPITAL FINANCING

The dictionary meaning of “Venture”, is “a risky or daring undertaking that has no guarantee
of success”. Thus, a venture capital is a source of finance for risky and daring undertakings; and
an entrepreneurial venture is a risky and daring undertaking. Venture capital is a type of private
equity capital typically provided by outside investors to new, growth businesses. Generally made
as cash in exchange for shares in the investee company, Venture capital investments are usually
high risk, but have the potential for above-average returns.
A Venture Capitalist (VC) is a person who makes such investments. A Venture Capital
Fund is a pooled investment vehicle that primarily invests the financial capital of third-party
investors in enterprises that are too risky for the standard capital markets or bank loans.

The concept of Venture Capital

Venture capital means many things to many people. It is in fact nearly impossible to come across
one single definition of the concept.

Jane Koloski Morris, editor of the well-known industry publication, Venture Economics,
defines venture capital as 'providing seed, start-up and first stage financing' and also 'funding the
expansion of companies that have already demonstrated their business potential but do not yet
have access to the public securities market or to credit oriented institutional funding sources.
The European Venture Capital Association describes it as risk finance for entrepreneurial
growth oriented companies. It is investment for the medium or long term return seeking to
maximize medium or long term for both parties. It is a partnership with the entrepreneur in
which the investor can add value to the company because of his knowledge, experience and
contact base.

Salient Features

1. It is long term source of investment, generally for 5 to 10 years.

2. Venture capital firms opt for equity participation through shares or convertible securities and
rarely as loan at fixed rate.
3. Venture capitalist seeks participation in management of business.
4. Venture capitalist is often an active partner in business and provides his expertise in terms of
marketing, technological management and developing organizational structure.
It is easier source of funding than conventional sources but expensive (equity is always costliest
source of funding).
6. Venture capitalist is not averse to risk; only growth potential should be high.

Venture Capital in India

In India, the need for Venture Capital was recognised in the 7th five year plan and long term
fiscal policy of GOI. In 1973 a committee on Development of small and medium enterprises
highlighted the need to faster VC as a source of funding new entrepreneurs and technology. VC
financing really started in India in 1988 with the formation of Technology Development and
Information Company of India Ltd. (TDICI) - promoted by ICICI and UTI. The first private VC
fund was sponsored by Credit Capital Finance Corporation (CFC) and promoted by Bank of
India, Asian Development Bank and the Commonwealth Development Corporation viz. Credit
Capital Venture Fund. At the same time Gujarat Venture Finance Ltd. and APIDC Venture
Capital Ltd. were started by state level financial institutions. Sources of these funds were the
financial institutions, foreign institutional investors or pension funds and high net-worth
individuals.

Types of Venture Capital Funds

Generally there are three types of organized or institutional venture capital funds: venture capital
funds set up by angel investors, that is, high net worth individual investors; venture capital
subsidiaries of corporations and private venture capital firms/ funds. Venture capital subsidiaries
are established by major corporations, commercial bank holding companies and other financial
institutions. Venture funds in India can be classified on the basis of the type of promoters.

1. VCFs promoted by the Central govt. controlled development financial institutions

such as TDICI, by ICICI, Risk capital and Technology Finance Corporation Limited
(RCTFC) by the Industrial Finance Corporation of India (IFCI) and Risk Capital Fund by
IDBI.
 2. VCFs promoted by the state government-controlled development finance
institutions such as Andhra Pradesh Venture Capital Limited (APVCL) by Andhra
Pradesh State Finance Corporation (APSFC) and Gujarat Venture Finance Company
Limited (GVCFL) by Gujarat Industrial Investment Corporation (GIIC)
3. VCFs promoted by Public Sector banks such as Canfina by Canara Bank and SBI-Cap
by State Bank of India.
4. VCFs promoted by the foreign banks or private sector companies and financial
institutions such as Indus Venture Fund, Credit Capital Venture Fund and Grindlay's
India Development Fund.

The Venture Capital Investment Process:

The venture capital activity is a sequential process involving the following six steps.

1. Deal origination
2. Screening
3. Due diligence Evaluation)
4. Deal structuring
5. Post-investment activity
6. Exist

Deal origination:

In generating a deal flow, the VC investor creates a pipeline of deals or investment opportunities
that he would consider for investing in. Deal may originate in various ways. referral system,
active search system, and intermediaries. Referral system is an important source of deals. Deals
may be referred to VCFs by their parent organizations, trade partners, industry associations,
friends etc. Another deal flow is active search through networks, trade fairs, conferences,
seminars, foreign visits etc. Intermediaries is used by venture capitalists in developed countries
like USA, is certain intermediaries who match VCFs and the potential entrepreneurs.

Screening:

VCFs, before going for an in-depth analysis, carry out initial screening of all projects on the
basis of some broad criteria. For example, the screening process may limit projects to areas in
which the venture capitalist is familiar in terms of technology, or product, or market scope. The
size of investment, geographical location and stage of financing could also be used as the broad
screening criteria.

Due Diligence:

Due diligence is the industry jargon for all the activities that are associated with evaluating an
investment proposal. The venture capitalists evaluate the quality of entrepreneur before
appraising the characteristics of the product, market or technology. Most venture capitalists ask
for a business plan to make an assessment of the possible risk and return on the venture. Business
plan contains detailed information about the proposed venture. The evaluation of ventures by
VCFs in India includes;

Preliminary evaluation: The applicant required to provide a brief profile of the proposed
venture to establish prima facie eligibility.

Detailed evaluation: Once the preliminary evaluation is over, the proposal is evaluated in
greater detail. VCFs in India expect the entrepreneur to have:- Integrity, long-term vision, urge
to grow, managerial skills, commercial orientation.

VCFs in India also make the risk analysis of the proposed projects which includes: Product
risk, Market risk, Technological risk and Entrepreneurial risk. The final decision is taken in
terms of the expected risk-return trade-off as shown in Figure.

Deal Structuring:

In this process, the venture capitalist and the venture company negotiate the terms of the deals,
that is, the amount, form and price of the investment. This process is termed as deal structuring.
The agreement also include the venture capitalist's right to control the venture company and to
change its management if needed, buyback arrangements, acquisition, making initial public
offerings (IPOs), etc. Earned out arrangements specify the entrequreneur's equity share and the
objectives to be achieved.

Post Investment Activities:

Once the deal has been structured and agreement finalized, the venture capitalist generally
assumes the role of a partner and collaborator. He also gets involved in shaping of the direction
of the venture. The degree of the venture capitalist's involvement depends on his policy. It may
not, however, be desirable for a venture capitalist to get involved in the day-to-day operation of
the venture. If a financial or managerial crisis occurs, the venture capitalist may intervene, and
even install a new management team.

Exit:

Venture capitalists generally want to cash-out their gains in five to ten years after the initial
investment. They play a positive role in directing the company towards particular exit routes. A
venture may exit in one of the following ways:

1. Initial Public Offerings (IPOs)

2. Acquisition by another company
3. Purchase of the venture capitalist's shares by the promoter, or
4. Purchase of the venture capitalist's share by an outsider.

Methods of Venture Financing

Venture capital is typically available in three forms in India, they are:

Equity : All VCFs in India provide equity but generally their contribution does not exceed 49
percent of the total equity capital. Thus the effective control and majority ownership of the firm
remains with the entrepreneur. They buy shares of an enterprise with an intention to ultimately
sell them off to make capital gains.

Conditional Loan: It is repayable in the form of a royalty after the venture is able to generate
sales. No interest is paid on such loans. In India, VCFs charge royalty ranging between 2 to 15
percent; actual rate depends on other factors of the venture such as gestation period, cost-flow
patterns, riskiness and other factors of the enterprise.

Income Note: It is a hybrid security which combines the features of both conventional loan and
conditional loan. The entrepreneur has to pay both interest and royalty on sales, but at
substantially low rates.

Other Financing Methods: A few venture capitalists, particularly in the private sector, have
started introducing innovative financial securities like participating debentures, introduced by
TCFC is an example.

Some important Venture Capital Funds in India

 APIDC Venture Capital Limited, Hyderabad

 Canbank Venture Capital Fund Limited, Bangalore
 Gujarat Venture Capital Fund, Ahmedabad
 Karnataka Information Technology Venture Capital Fund Bangalore
 India Auto Ancillary Fund, Mumbai
 Information Technology Fund, Mumbai
 Tamilnadu Infotech Fund , Mumbai
 Orissa Venture Capital Fund , Mumbai
 Uttar Pradesh Venture Capital Fund, Mumbai
 Punjab Infotech Venture Fund, Chandigarh