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Session 8,9

UIET, Panjab University, Chandigarh

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Venture capital

Venture capital (VC) is financial capital provided to early-stage,high-potential, high risk, growth startup companies.

The venture capital fund makes money by owning equity in thecompanies it invests in, which usually have a novel technology orbusiness model in high technology industries, such as

biotechnology, IT, software, etc. The typical venture capital investment occurs after the seed funding

round as growth funding round (also referred to as Series A round)in the interest of generating a return through an eventualrealization event, such as an IPO or trade sale of the company.

Venture capital is a subset of private equity.

Therefore, all venture capital is private equity, but not all privateequity is venture capital.

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WHAT IS VC

Is a way financing, especially for newly startedprojects.

VC means risk finance.

The project may be innovative but risky

VC investor step in and finance the projects,participate in the management, sail through

with the entrepreneur and finally exit theproject when they find that the project issuccessful.

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In case of success of the project, they share

the return and, in case of failure , they bear

the risk.

A VC firm is a financial partner of an

entrepreneur in his project who sees him

through its implementation and commercial

operation.

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Standard Definitions From various authors andagencies

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Definition of Jane Koloski Morris, an editor of

the publication, Venture Economics

According to Jane Koloski Morris, an editor of thepublication, Venture Economics, venture capital isproviding seed, start-up and first stage

financing and also funding the expansion ofcompanies that have already demonstrated theirbusiness potential but do not yet have access tothe public securities market or to credit oriented

institutional funding sources..

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Definition of European Venture

Capital Association

The European Venture Capital Association

(EVCA) describes it as risk finance for

entrepreneurial growth oriented companies. It

is investment for the medium or long-termseeking to maximize medium or long-term

return for both parties. It is a partnership with

the entrepreneur in which the investor canadd value to the company because of his

knowledge, experience and contact base.

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Definition of International Finance

Corporation

International Finance Corporation,Washington D.C. 17C(W) defines VC as anequity or equity featured capital seeking

investment in new ideas, new companies, newproducts, new processes or new services, thatoffer the potential of high returns oninvestment.

It may also include investment in turnaroundsituations.

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Characteristics of VC

Risky projects

Early stage financing

Entrepreneur centric

Partnering

Form of finance

Turnaround investments

Long term

Prospects

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Regulations Regarding Venture Capital In India

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Securities and Exchange Board of India

(Venture Capital Funds) Regulation, 1996

In India, the Securities and Exchange Board of India has laiddown those activities that would constitute eligiblebusiness activities qualifying for the concessions availableto a recognized venture capital fund.

Securities and Exchange Board of India (Venture CapitalFunds) Regulation, 1996 the principal regulation, publishedin the Gazette of India on December 4, 1996 definesVenture Capital Funds as a fund established in the form ofor trust a Company having a dedicated pool of capital whichraises moneys through loan, donations, issue of securitiesor units as the case may be, and makes or proposes tomake investments in accordance with these regulations.

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SEBI Venture Capital Funds (VCFs) Regulations, 1996 Has adedicated pool of capital raised in a manner specified in theregulations.

Invests in venture capital undertakings (VCUs) inaccordance with these regulations.

A Venture Capital Undertaking means a domestic companywhose shares are not listed on a recognized stock exchangein India Which is engaged in the business of providing

services/production/manufacture of articles/things butdoes not include such activities/sectors as are specified inthe negative list by SEBI with government approval.

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Scope of activities of VCFs

The VCFs play an important role in supplying management and marketingexpertise to unlisted, new and small private businesses, especially intechnology-oriented and knowledge-intensive businesses or industrieswhich may have long development cycles and which usually do not haveaccess to conventional sources of capital because of the absence ofsuitable collateral and the presence of high risk.

Broadly speaking, the scope of activities of VCFs include provision ofSeed capital for industrial start-ups,

Additional capital to new businesses at various stages of their growth,

Equity financing or leverage buy-out financing to management groupsfor taking over other companies,

Bridge finance, Capital to Mature enterprises for expansion, diversification andrestructuring.

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In addition to angel investing and other seed fundingoptions, venture capital is attractive for new companieswith limited operating history that are too small toraise capital in the public markets and have not

reached the point where they are able to secure a bankloan or complete a debt offering.

In exchange for the high risk that venture capitalistsassume by investing in smaller and less maturecompanies, venture capitalists usually get significant

control over company decisions, in addition to asignificant portion of the company's ownership (andconsequently value).

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It is also a way in which public and private actorscan construct an institution that systematicallycreates networks for the new firms andindustries, so that they can progress.

This institution helps in identifying and combiningpieces of companies, like finance, technicalexpertise, know-how of marketing and businessmodels.

Once integrated, these enterprises succeed bybecoming nodes in the search networks fordesigning and building products in their domain

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The Origin of Venture Capital

The Origin of Venture Capital In the 1920's & 30's,the wealthy families of and individualsinvestors provided the start up moneyfor companies that would later become famous.Eastern Airlines and Xerox are the more famousventures they financed.

In its early years VC may have been associated

with high technology, over the years the concepthas undergone a change and as it stands today itimplies pooled investment in unlisted companies

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Origins of modern private equity/ VC

Before World War II, money orders (originally known as"development capital") were primarily the domain ofwealthy individuals and families. It was not until World WarII that what is considered today to be true private equityinvestments began to emerge marked by the founding of

the first two venture capital firms in 1946: AmericanResearch and Development Corporation. (ARDC) and J.H.Whitney & Company.

ARDC was founded by Georges Doriot, the "father ofventure capitalism"(former dean of Harvard Business

School), with Ralph Flanders and Karl Compton (formerpresident of MIT ), to encourage private sector investmentsin businesses run by soldiers who were returning fromWorld War II.

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ARDC's significance was primarily that it was the firstinstitutional private equity investment firm that raisedcapital from sources other than wealthy familiesalthough it had several notable investment successes

as well.

ARDC is credited with the first trick when its 1957investment of $70,000 in Digital EquipmentCorporation (DEC) would be valued at over $355

million after the company's initial public offering in1968 (representing a return of over 1200 times on itsinvestment and an annualized rate of return of 101%).

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Venture Capital in India

Venture Capital In India the Venture Capital playsa vital role in the development and growth

of innovative entrepreneurships. Venture Capital activity in the past was possibly

done by the developmental financial institutionslike IDBI, ICICI and State Financial Corporations.

In India, the need for Venture Capital wasrecognized in the 7th five year plan and long termfiscal policy of GOI

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Venture Capital Investments in India

Total investments in private equity and venture capitalin India increased almost 600% between2004 and2006, from USD $1.1billion to USD$7.46 billion.

Key 2007highlights include: 31% of all deals werebetween USD$10 and $25 million.

Venture capital accounted for 25% of private equitydeals (in volume terms) in 2007. PE firms obtainedexits on 65 companies, including 16 via IPOs Source

Source: The Economic Times

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Venture funds in India can be classified on

the basis of the type of promoters

Venture funds in India can be classified on the basis of thetype of promoters. VCFs promoted by the Central govt. andcontrolled and promoted by development financialinstitutions such as by ICICI, Risk capital and TechnologyFinance Corporation Limited (RCTFC) by the IndustrialFinance Corporation of India (IFCI)and Risk Capital Fund byIDBI.

VCFs promoted by the state government-controlleddevelopment finance institutions such as Andhra PradeshVenture Capital Limited (APVCL) by Andhra Pradesh StateFinance Corporation (APSFC) and Gujarat Venture FinanceCompany Limited (GVCFL) by Gujarat Industrial InvestmentCorporation (GIIC)

V t f d i I di b l ifi d

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Venture funds in India can be classified on

the basis of the type of promoters

Venture funds in India can be classified on the

basis of the type of promoters. VCFs promoted by

Public Sector banks such as Canfina by CanaraBank and SBI-Cap by State Bank of India.

VCFs promoted by the foreign banks or private

sector companies and financial institutions suchas Indus Venture Fund, Credit Capital Venture

Fund and Grindlay's India Development Fund.

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The Venture Capital Investment

Process

The Venture Capital Investment Process: Theventure capital activity is a sequential processinvolving the following six steps.

Deal origination

Screening

Valuation

Due diligence Evaluation

Deal structuring

Post-investment activity

Exit

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Deal origination:

In generating a deal flow, the VC investor creates apipeline of deals or investment opportunities that hewould consider for investing. Deals may be referred to

VCFs by their parent organizations, tradepartners, industry associations, friends etc.

Screening:

VCFs, before going for an in-depth analysis, carry outinitial screening of all projects on the basis of somebroad criteria. The size of investment, geographicallocation and stage of financing could also be used asthe broad screening criteria.

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Due Diligence:

Due diligence is the industry jargon for all the activities that areassociated with evaluating an investment proposal. The venturecapitalists evaluate the quality of entrepreneur before appraisingthe characteristics of the product, market or technology. The

evaluation of ventures by VCFs in India includes; Preliminaryevaluation (The applicant required to provide a brief profile of theproposed venture to establish prima facie eligibility& Detailedevaluation )

Valuation:

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

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Risk analysis

Product risk

Risk whether the product can be produced and

commercialized. Technically sound products mayfail on commercial basis

Market risk

Factors such as unexpected competition,

problems of marketing channels, non acceptanceby customers, quality, price etc. can be the basiccause of market risk.

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Technological risk

When technology is too complex toimplement. It may be an imported technology,

and there may be problem of assimilation andmanagement.

Entrepreneurial risk

When entrepreneur lacks managerial skills orhe is too optimistic or too pessimistic orhaving lack of experience.

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Deal Structuring:

venture capitalist and the venture companynegotiate the terms of the deals, that is, theamount, form and price of the investment. Theagreement also include the venture capitalist'sright to control the venture company and tochange its management if needed, buybackarrangements, acquisition making initial public

offerings (IPOs), etc. Earned out arrangementsspecify the entrepreneur's equity share and theobjectives to be achieved

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Post Investment Activities:

venture capitalist generally assumes the role of a partnerand collaborator. The degree of the venture capitalist'sinvolvement depends on his policy. If a financial ormanagerial crisis occurs, the venture capitalist mayintervene, and even install a new management team.Exit:

Venture capitalists generally want to cash-out their gains infive to ten years after the initial investment. Initial Public

Offerings (IPOs), Acquisition by another company, Purchaseof the venture capitalist's shares by the promoter, Purchaseof the venture capitalist's share by an outsider

A C T h l

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A Case on Technology

Development & Information Company Of India

Ltd. (TDICI ) :

TDICI was incorporated in January 1988 with thesupport of the ICICI and the UTI.

TDICI was formed under the scheme VECAUS (

Venture Capital Units Scheme) was started withan initial corpus of Rs.20 crore.

At present the TDICI is administering two UTI -mobilized funds under VECAUS-I and II, totaling

Rs.120 crore.

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Some of the projects financed by the

TDICI

MASTEK, a Mumbai based software firm, in which theTDICI invested Rs.42 lakh in equity in 1989.

TEMPTATION FOODS, located in PUNE, which exportsfrozen vegetables and fruits, went public in November1992.

RISHABH INSTRUMENTS of Nasik got Rs.40 lakh fromthe TDICI.

SYNERGY ART FOUNDATION, which runs art galleries inMumbai and Chennai and plans to set up in Pune andDelhi too, had received Rs.25 lakh from the TDICI

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Methods of venture financing

Equity:

Generally the equity capital may not exceed

49 %

Conditional loan

Is payable in the form of a royalty after the

venture is able to generate sales. Royalty can

vary from 2% to 15% depending upon

gestation period, cash flow patterns, risk etc.

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Income note

It is a hybrid security which combines thefeatures of both conventional loan and

conditional loan. The entrepreneur has to payboth interest as well as royalty.

Participating debentures

Such security carry charges in stages: in start

stage: no interest is paid, in operational stage:very low interest rate is paid, in full commercialstage: high interest rate is paid

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Conclusion

Venture Capital Business has been drastically

decreasing due to many reasons.

Liberalize the stringent policies and pave the

way to the venture capital investors

There are large sectors of the economy that

are ripe for VC investors, like,. I.T., Pharma,

Manufacturing, Telecom, Retail franchises,food processing and many more.

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THANK U!