A PROJECT SUBMITTED FOR A

VENTURE CAPITAL FINANCING IN INDIA

ACKNOWLEDGEMENT

One of the pleasant aspects of preparing a project report is the opportunity to thank to
those who have contributed to make the project completion possible.

I am extremely thankful to My Mom Mrs. Shetty. Who helped me choose the topic and
active interest in the project and insights helped us formulate, redefine and implement
our approach towards the project.

We are also thankful to all those seen and unseen hands & heads, which have been of
direct or indirect, help in the completion of this project.
 PREFACE

In India, a revolution is ushering in a new economy, wherein major investment are being
made in the knowledge based industry with substantially low investment in land,
building, plant and machinery. The asset backed lending instrument adopted for the
hard for the hard core manufacturing industries, are proving to be inadequate for the
knowledge based industries that often start with just idea.

The only way to finance such industries is through Venture Capital. Venture Capital is
instrumental in bringing about industrial development, for it exploits the vast and
untapped potentialities and promotes the growth of the knowledge based industries
worldwide. In India, it has become popular in different parts of the world. Thus the role
of venture capital is very crucial, different and distinguishable to the role of traditional
finance as it deals with other money. In view of globalization venture capital has turned
out to be a boon to both business and industries.

These reports, which contain in-depth study of Venture Capital Financing in India, is
made with an intension to get through all the aspects related to the topic and to
become able to make some suggestion at the industries. This report deals with the
 concept of Venture Capital, with particular reference to India. The Report Include all
facts, rules and regulations regarding Venture Capital.

TABLE OF CONTENTS

SR.NO TOPIC PAGE NO

1 Objective Of The Study 1

2 Executive Summary 2

3 Introduction To Venture Capital 3

4 Definition And History Of Venture Capital 4

5
Scope Of Venture Capital 5
6
Features Of Venture Capital 6-7
7
Advantages And Disadvantages Of Venture 8-9
Capital
8 10
Stages Of Vc Investment
9
Growth Of Venture Capital In India 11-13
10
Present Scenario Of Venture Capital In 14
India
11
Venture Capital Investment Process 15-19
12
Methods Of Venture Financing 20
13
Difference Between Venture Capital And 21-22
Other Funds
14 Venture Capital & Alternative Financing
Comparison 23-27
15
Regulatory And Legal Framework 28-31
16
Regulation Of The Business Of Venture 32-33
Capital Fund In India
17
Key Success Factor For Venture Capital 34-35
Industry In India
18
Guidelines For Overseas Venture Capital 36-37
Investment In India
19
CHALLENGES AHEAD FOR VENTURE CAPITAL 38
FINANCING IN INDIA
20
Problems Of Venture Capital Financing In 39
India
21
Conclusion 40
22
Bibliography 41
 OBJECTIVE OF THE STUDY

Understand the concept of venture capital: Venture Capital funding is different from
traditional sources of financing. Venture capitalists finance innovation and ideas which
have potential for high growth but with inherent uncertainties. This makes it a high-risk,
high return investment.

Study venture capital industry in India: Scientific, technology and knowledge based
ideas properly supported by venture capital can be propelled into a powerful engine of
economic growth and wealth creation in a sustainable manner. In various developed
and developing economies venture capital has played a significant developmental role.

Study venture capital industry in global scenario: Venture capital has played a very
important role in U.K., Australia and Hong Kong also in development of technology
growth of exports and employment.

Study the evaluation & need of venture capital industry in India: India is still at the
level of knowledge. Given the limited infrastructure, low foreign investment and other
transitional problems, it certainly needs policy support to move to the next stage. This is
very crucial for sustainable growth and for maintaining India’s competitive edge.

1
 EXECUTIVE SUMMARY

Technology and knowledge have been and continue to drive the global economy. Given
the inherent strength by way of its human capital, technical skills, cost competitive work
force, research and entrepreneurship, India is positioned for rapid economic growth in a
substainable manner. To realize the potential, there is a need for risk finance and
venture capital funding to leverage innovation, promote technology and harness
knowledge based ideas.

Venture capital refers to money that is invested in companies during the early stages of
their development. Such funds may come from wealthy individuals, government-backed
small business Investment Companies (SBICs), or professionally managed venture capital
firms. venture capitalists generally target companies that they believe offer significant
potential for growth, and therefore an opportunity to earn a high rate of return in a
relatively short period of time. The present study on venture capital in the Indian
context mainly focuses on the venture capital process. Venture capital funding gives a
hundred percent funding to entrepreneurs. For a business owner, the process of
obtaining venture capital begins with a formal proposal. The most important element of
this proposal is a detailed business plan describing the company's goals and strategies.
The proposal should also include recent financial statements, projections of future
growth, a brief history of the company, biographies of key managers, the amount of
money requested, and a description of how the funds will be used. Experts recommend
that companies seeking equity financing evaluate several venture capital firms before
entering into a deal. Managers should also hire professionals to help them understand
the terms of the agreement to avoid giving away too much control.

Overall, venture capital can provide a valuable source of financing for growing
businesses. Because of its associated risks, however, experts generally suggest that it be
viewed as one of a number of potential sources of financing and be used in combination
with debt financing whenever possible.

2
 INTRODUCTION TO VENTURE CAPITAL

Venture capital is a growing business of recent origin in the area of industrial financing
in India. The various financial institutions set-up in India to promote industries have
done commendable work. However, these institutions do not come up to the benefit of
risky ventures when new or relatively unknown entrepreneurs undertake them. They
contend to give debt finance, mostly in the form of term loan to the promoters and their
functioning has been more akin to that of commercial banks. The financial institutions
have devised schemes such as seed capital scheme. Risk capital Fund etc.. to help new
entrepreneurs. However, to evaluate the projects and extend financial assistance they
follow the criteria such as safety, security, liquidity and profitability and not the
potential to grow. The capital market with its conventional financial instruments/
schemes does not come much to the benefit or risky venture. New institutions such as
mutual funds, leasing and hire purchase Company's have been established as another
source of finance to industries. These institutions also do not mitigate the problems of
new entrepreneurs who undertake risky and innovative ventures.

Venture capital is a financial capital provided to early-stage, high-potential, high risk,

growth start-up companies. It plays an essential role in the formation process of start-
ups, being a vital source of capital at times when firms have very constrained or no
alternative financing options. Previous research has also indicated that venture capital
plays a more fundamental role in the success and failure of new ventures than merely
providing finance

Venture capital is not a passive finance. It may be at any stage of business/ production
cycle, that is startup, expansion or to improve a product or process, which are
associated with both risk and reward. The Venture capital gains through appreciation in
the value of such investment when the new technology succeeds. Thus the primary
return sought by the investor is essentially capital gain rather than steady interest
income or dividend yield.

3
 DEFINITION OF VENTURE CAPITAL

Venture capital is a type of private equity capital typically provided by professional,

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
offer the potential for above-average returns.

The term Venture Capital is understood in many ways. In a narrow sense, it refers to,
investment in new and tried enterprises that are lacking a stable record of growth. In a
broader sense, venture capital refers to the commitment of capital as shareholding, for
the formulation and setting up of small firms specializing in new ideas or new
technologies. It is not merely an injection of funds into a new firm, it is a simultaneous
input of skill needed to set up the firm, design its marketing strategy and organize and
manage it. It is an association with successive stages of firm's development with
distinctive types of financing appropriate to each stage of development.

VENTURE CAPITAL - HISTORY

In the 1920 AND 1930's the wealthy families of and individuals investors provided the
start up money for companies that would later become famous. Eastern Airlines and
Xerox are the famous ventures they financed. Among the early Venture Capital Funds
set up was the one by Rockefeller Family that started a special called VENROCK in 1950,
to finance new technology companies.(Satyanarayan Chary,2005) USA is the birthplace
of Venture Capital Industry, as we know it today. During most its historical evolution,
the market for arranging such financing was fairly informal, relying primarily on the
resource of wealthy families. After the Second World War in 1946 the American
Research and Development was formed as first venture organization that financed over
900 companies. Venture capital had been a major contributor in development of the
advanced countries like UK, Japan and several European countries.

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 SCOPE OF VENTURE CAPITAL

Venture capital may take various forms at different stages of the project. There are four
successive stages of development of a project viz. development of a project idea,
implementation of the idea, commercial production and marketing and finally large
scale investment to exploit the economics of scale and achieve stability. Financial
institutions and banks usually start financing the project only at the second or third
stage but rarely from the first stage. But venture capitalists provide finance even from
the first stage of idea formulation. The various stages in the financing of venture capital
are described below:

 Development of an Idea: Seed Finance: In the initial stage venture capitalists

provide seed capital for translating an idea into business proposition. At this
stage investigation is made in depth which normally takes a year or more.
 Implementation Stage: Start up Finance: When the firm is set up to manufacture
a product or provide a service, start up finance is provided by the venture
capitalists. The first and second stage capital is used for full scale manufacturing
and further business growth.
 Fledging Stage: Additional Finance: In the third stage, the firm has made some
headway and entered the stage of manufacturing a product but faces teething
problems. It may not be able to generate adequate funds and so additional
round of financing is provided to develop the marketing infrastructure.
 Establishment Stage: Establishment Finance: At this stage the firm is established
in the market and expected to expand at a rapid pace. It needs further financing
for expansion and diversification so that it can reap economies of scale and
attain stability. At the end of establishment stage, the firm is listed on the stock
exchange and at this point the venture capitalist disinvests their shareholdings
through available exit routes.

Before investing in small, new or young hi-tech enterprises, the venture capitalist look
for percentage of key success factors of a venture capital project. They prefer projects
that address these problems. After assessing the viability of projects, the investors
decide for what stage they should provide venture capital so that it leads to greater
capital appreciation. All the above stages of finance involve varying degrees of risks and
venture capital industry, only after analyzing such risks, invest in one or more. Hence
they specialize in one or more but rarely all.

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 FEATURES OF VENTURE CAPITAL

The key terms found in most definition of Venture capital are high technology and high
risk, equity investment and capital gains, value addition through participation in
management.

 High Risk: The Venture capital financing is highly risky and chances of failure are
high as it provides long term start up capital to high risk-high reward ventures.
Venture capital assumes four types of risks:

 Management Risk: inability of the management teams to work together.

 Market Risk: product may fail in the market
 Product Risk: product may not be commercially viable
 Operation Risk: operations may not be cost effective resulting in increased cost
and decreased gross margins.

 High Technology: As opportunities in the low technology area tend to be few

and of lower order, and hi-tech projects generally offer higher returns than
projects in more traditional areas, Venture capital investments are made in high
technology areas using new technology. Not just high technology, any high-risk
ventures where the entrepreneur has conviction but little capital gets venture
finance. Venture capital is available for expansion of existing business or
diversification to a high-risk area. Thus technology financing had never been
primary objective but incidental to Venture capital.

 Equity Participation and Capital Gains: Investments are generally in equity and
quasi equity participation through direct purchase of shares, options, convertible
debentures where the debt holder has the option to convert the loan
instruments into stock of the borrower or a debt with warrants to equity
investment. The funds in the form of equity help to raise term loans that are
cheaper source of funds. In the early stages of business, because dividends can
be delayed. Equity investment implies that investors bear the risk of venture and
would earn a return commensurate with the success in the form of capital gains.

 Participation in Management: Venture capital provides value addition by

managerial support, monitoring and follow up assistance. It monitors physical
and financial progress as well as market development initiative. It helps by
identifying key resource persons. They want to be on the company's board of
directors and involvement, for better or worse, in the major decisions affecting

6
 the direction of the company. This is a unique philosophy of "hands on
management" where Venture capitalist acts as complementary to the
entrepreneurs. Based upon the experience with other companies, a venture
capitalist advises the promoters on project planning, monitoring, financial
management, including working capital and public issue. Venture capital investor
cannot interfere in day today management of the enterprise but keeps close
contact with the promoters or entrepreneurs to protect his investment.

 Length of Investment: Venture capitalists help companies grow, but they

eventually seek to exit the investment in three to seven years. An early stage
investment may take seven to ten years to mature, while most of the later stage
investments take only a few years. The process of having significant returns
takes several years and calls on the capacity and talent of venture capitalist and
entrepreneurs to reach fruition.

 Illiquid Investment: Venture capital investments are illiquid that is, not subject
to repayment on demand or following a repayment schedule. Investors seek
return ultimately by means of capital gains when the investment is sold at
market place. The investment is realized only on enlistment of security or it is
lost if enterprise is liquidated for unsuccessful working. It may take several years
before the first investment starts to return proceeds. In some cases the
investment may be locked for seven to ten years. Venture Capitalist understands
this illiquidity and factors in his investment decisions.

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 ADVANTAGES OF VENTURE CAPITAL

Expansion of Company: Venture capital provides large funding that a company needs to
expand its business. It has the ability for company expansion that would not be possible
through bank loans or other methods.

Expertise joining the company: Venture capitalists provide valuable expertise, advice
and industry connections. These experts have deep knowledge of specific market
standards and they can help you avoid your business from many downsides that are
usually associated with startups.

Better Management: It’s not always that being an entrepreneur one is also a good
business manager. However, since Venture Capitalists hold a percentage of equity in the
business. They will have the power to say in the management of the business. So if one
is not good at managing the business, this is a significant benefit.

No Obligation to repay: In addition, there is an obligation to repay to investors as it

would be in case of banks loans. Rather, investors take the investment risk on their own
shoulders because they believe in the company’s future success.

Value Added Services: Venture Capitalists provide HR Consultants, who are specialist in
hiring the best staff for your business. This helps in avoiding to hire the wrong person. It
also offers a number of other such services such as mentoring, alliances and also
facilitates the exit.

DISADVANTAGES OF VENTURE CAPITAL

Complex Process: It is a lengthy and complex process which needs a detailed business
plan and financial projections. Until and unless the Venture Capitalists are properly
satisfied with the business plan, whether or not it will succeed in the future, they won’t
invest. So securing a deal with a Venture Capitalist can be a long and complex process.

Loss of control: Venture Capital firms add one of their team members to your
management team, while this is usually done for ensuring the success of the business, it
can also create internal problems.

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Loss over decisions: Another big problem faced in Venture Capital funding is that you
will have to give up many key decisions on how the company will process or operate.
This is because Venture Capitalist are required to be informed about all the key decision
relating to business plans, and they usually can override such decision if they are
unsatisfied with the decision.

No Confidentiality: Generally Venture Capitalist treat information confidentially. But

they refuse to sign non- disclosure agreement due to the legal ramification of doing so.
This puts the ideas at risk, especially when they are new. Further, your investor will
expect regular information and consultation to check how things are progressing. For
example, accounts and minutes of board meetings.

Quick Liquidity: Most Venture Capitalists seek to realize their investment in the
company in three to five years. If your business plan expects a longer timetable before
providing liquidity, then Venture Capital funding may not be a suitable option for you.

9
 STAGES OF VC INVESTMENT

There are 5 Investments stages widely used by the industry to invest. These stages are
defined as under

 Seed Stage: Financing provided to new companies for use in product

development and initial marketing constitutes Seed Stage. Eligible companies
may be in the process of being setup or may have been in business for a short
time or may not have sold their product commercially. This is the financing
provided to companies when the Initial Concept of the business is being formed
 Startup: Financing provided to new companies for manufacturing and
commercializing the developed products, represent Startup. The companies may
be in their initial stages of development and finance may be extended for
creation of new infrastructure and meeting the Working Capital Margin
 Other Early Stage: Financing provided to companies that have completed the
commercial scale implementation and may require further funds to meet initial
cash and further working capital is treated as Other Early Stage. The companies
may have expended their capital and would require additional funds and may
not yet be generating profit
 Later Stage Financing: Capital provided for the growth and expansion of
established companies. Funds may be used to finance increase in production
capacity, market or product development and/ or provide additional working
capital. This would include product diversification, forward/backward
integration, besides creation of additional capacity. Capital could be provided
for companies that are breaking even or profitable or in turnaround situations
 Turnaround Financing: Capital provided for companies that are in operational or
financial difficulties where the additional funds would help in Turnaround
Situations

Earlier VC funds use to invest in Seed and Startup stages and very rarely in Turnaround
Stages, but off late the trend is changing and Venture Capitalist funds are a part of every
stage and are also actively participating in Turnaround Stages through buyouts and
takeovers

10
 GROWTH OF VENTURE CAPITAL IN INDIA

The development of the organized venture capital industry in India, as is in existence

today, was slow and belabored, circumscribed by resource constraints resulting from
the overall framework of the socialistic economic paradigms. Although funding for new
businesses was available from banks and government-owned development financial
institutions, it was provided as a collateral-based money on project-financing
basis, which made it difficult for the most new entrepreneurs, especially those who
were technology and services based, to raise money for their ideas and businesses.
Most entrepreneurs had to rely on their own financial resources, and those of their
families and well wishers or private financiers to realize their entrepreneurial
dreams.

In 1972, a committee on Development of Small and Medium Enterprises highlighted the

need to foster venture capital as a source of funding new entrepreneurs and
technology. This resulted in a few incremental steps being taken over the next decade-
and-a-half to facilitate venture capital funds into needy technologically oriented small
and medium Enterprises, namely:

National financial institutions:

Industrial Finance Corporation of India Ltd provides medium and long term finance to
industries. Risk Capital Foundation, sponsored by IFCI, was set-up in 1975 to pro-
mote and support new technologies and businesses.

Industrial Credit and Investment Corporation of India Ltd the primary objective is to
meet the foreign exchange requirements of industrial concerns and for promoting
medium and large industries in the private sector. Programme for Advancement of
Commercial Technology Scheme was introduced by ICICI in 1985 In 1988, ICICI
emerged as a venture capital provider with Unit Trust of India. As now, there are a
number of venture capital institutions in India. Financial banks like ICICI have stepped
in to this and have their own venture capital subsidiaries.

Industrial Development Bank of India coordinates the activities of other financial

institutions, supplements their resources to plan and promote the medium and
the large industries, the Seed Capital Scheme and the National Equity Scheme was
set up by IDBI in 1976. The idea of venture capital gained momentum in the budget of
1986-87. A 5% cess was levied on all know-how imports to create the corpus of
the venture fund floated by IDBI in 1987. Later, a study was undertaken by the World
Bank to examine the possibility of developing venture capital in the private

11
sector, based on which the Government of India took a policy initiative and announced
guidelines for venture capital funds (VCFs) in India in 1988.

Industrial Reconstruction Bank of India functions both as a lending and a

reconstruction agency and provides finance in term loans, in the form of term loans
underwriting guarantees etc.

Small Industries Development Bank of India for developing and financing small
scale industries.

Specialized institutions:

Risk Capital and Technology Finance Corporation Ltd Provides risk capital and
technology finance for the project envisaging promotion, transfer and adaption of
new technologies.

Technology Development and Information Company of India Ltd: The TDICI was set up
jointly with the ICICI and UTI to provide assistance in the form of project loan etc, to
small and medium industries conceived by technocrat entrepreneurs.

Tourism Finance Corporation of India Ltd Provides assistance in the form of rupee
loans, underwriting securities, equipment leasing for developing tourism industry
including holiday report, hotels, amusement parks and entertainment complex.

State level financial institutions:

State Finance Corporation provides assistance to medium and small scale

industries in their respective states.

State Industrial Development Corporations provide assistance in the form of term

loans, underwriting securities and direct subscription. Some of them engage in
preparation of feasibility reports, conducting surveys, and in developing industrial
estates. The financial investment process has evolved a lot with time in India. Earlier
there were only commercial banks and some financial institution but now with
venture capital investment institution in India has grown a lot. Business forms now
focus on expansion because they can get financial support with venture capital. The
scale and quality of the business enterprises have increased in India now with
international competition, there have been a number of growth oriented business
firms that have invested in venture capital.

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The venture capital finance in India can be categorized in to following three groups

Venture capital promoted by

Central government State government Private sector

companies

Central government: The power and authority is vested in the hands of government of
India, some of the examples of venture capital finance promoted by the Central
Government controlled development finance institutions are as follows SIDBI Venture
Capital Limited IFCI Venture Capital Funds Limited .

State Government: A Monthly Double-Blind Peer Reviewed Refereed Open Access

International e-Journal - Included in the International Serial Directories. The power and
authority is vested in the hands of state government, some of the examples of venture
capital finance promoted by the State Government controlled development finance
institutions are as follows Gujarat Venture Finance Limited, Kerala Venture Capital
Fund Pvt Ltd, Punjab InfoTech Venture Fund, Hyderabad Information Technology
Venture Enterprises Limited .

Private sector companies: The power and authority is vested in the hands of
private sector companies, some of the examples of venture capital finance
promoted by the private sector controlled are as follows IL&FS Trust Company
Limited and Infinity Venture India Fund

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 PRESENT SCENARIO OF VENTURE CAPITAL IN INDIA

The present scenario of venture capital finance is quite different. Venture capital
financing in India is open to all, provided they find the unique business idea with
growing market, an efficient management team, an innovative business model and
home-run potential. Once they find a start up with all the necessary items that make it
ideal for an investment, the Venture capitalists waste no time to back it with an aim to
gain huge profits. The success of Flipkart is no more new story and is largely because of
venture capital that the firm has managed to raise the finance. In less than seven years,
the firm has earned a revenue of over $1 billion. The investors offering venture
capital financing in India are mainly targeting sectors like technology, software
enterprise, consumer internet, online retail, healthcare, energy, advertising, real estate,
infrastructure, and private equity.

14
 VENTURE CAPITAL INVESTMENT PROCESS

Venture capital investment process is different from normal project financing. In order
to understand the investment process a review of the available literature on venture
capital finance is carried out. Tyebjee and Bruno in 1984 gave model of venture capital
investment activity with some variations is commonly used presently. As per this model
this activity is a five step process as follows:

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 such as 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.

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Screening: VCFs, before going for an in-depth analysis, carry out initial screening of all
projects on the basic 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 Indian 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 are the amount form and price of the investment.
This process is termed as deal structuring. The agreement also include the venture
capitalists right to control the venture company and to change its management if
needed, buyback arrangement specify the entrepreneurs equity share and the
objectives 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

16
gets involved in shaping of the direction of the venture. The degree of the venture
capitalists 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 exist in one of the following ways:

There are four ways for a venture capitalist to exit its investment:

 Initial Public Offer (IPO)

 Acquisition by another company
 Re-purchase of venture capitalists share by the investee company
 Purchase of venture capitalists share by a third party

Promoters Buy-back

The most popular disinvestment route in India is promoters buy-back. This route is
suited to Indian conditions because it keeps the ownership and control of the promoter
intact. The obvious limitation, however, is that in a majority of cases the market value of
the shares of the venture firm would have appreciated so much after some years that
the promoter would to be in a financial position to buy them back.

In India, the promoters are invariably given the first option to buy back equity of their
enterprise. For example, RCTO participates in the assisted firm’s equity with suitable
agreement for the promoter to repurchase it. Similarly, Confina-VCF offers an
opportunity to the promoters to buy back the shares of the assisted firm within an
agreed period at a predetermined price. If the promoter fails to buy back the shares
within the stipulated period, Confine-VCF would have the discretion to divest them in
any manner it deemed appropriate. SBI capital Markets ensures through examining the
personal assets of the promoters and their associates, which buy back, would be a
feasible option. GV would make disinvestment, in consultation with the promoter,

17
usually after the project has settled down, to a profitable level and the entrepreneur is
in a position to avail of finance under conventional schemes of assistance from banks or
other financial institutions.

Initial Public Offers (IPOs)

The benefits of disinvestments via the public issue route are improved marketability and
liquidity, better prospects for capital gains and widely known status of the venture as
well as market control through public share participation. This option has certain
limitations in the Indian context. The promotion of the public issue would be difficult
and expensive since the first generation entrepreneurs are not known in the capital
markets. Further, difficulties will be caused if the entrepreneurs business is perceived to
be an unattractive investment proposition by investors. Also, the emphasis by the Indian
investors on short-term profits and dividends may tend to make the market price
unattractive. Yet another difficulty in India until recently was that the Controller of
Capital Issues (CCI) guidelines for determining the premium on shares took into account
the book value and the cumulative average EPS till the date of the new issue. This
formula failed to give due weight age to the expected stream of earning of the venture
firm. Thus, the formula would underestimate the premium. The government has now
abolished the Capital Issues Control Act, 1947 and consequently, the office of the
controller of Capital Issues. The existing companies are now free to fix the premium on
their shares. The initial public issue for disinvestments of VCFs holding can involve high
transaction costs because of the inefficiency of the secondary market in a country like
India. Also, this option has become far less feasible for small ventures on account of the
higher listing requirement of the stock exchanges. In February 1989, the Government of
India raised the minimum capital for listing on the stock exchanges from Rs 10 million to
Rs 30 million and the minimum public offer from Rs 6 million to Rs 18 million.

Sale on the OTC Market

An active secondary capital market provides the necessary impetus to the success of
the venture capital. VCFs should be able to sell their holdings, and investors should be
able to trade shares conveniently and freely. In the USA, there exist well-developed OTC
markets where dealers trade in share on telephone/terminal and not on an exchange
floor. This mechanism enables new, small companies which are not otherwise eligible to
be listed on the stock exchange, to enlist on the OTC markets and provides liquidity to
investors. The National Association of Securities dealers Automated Quotation System

18
(NASDAQ) in the USA daily quotes over 8000 stock prices of companies backed by
venture capital.

The OTC Exchange in India was established in June 1992. The Government of India had
approved the creation for the Exchange under the Securities Contracts (Regulations) Act
in 1989. It has been promoted jointly by UTI, ICICI, SBI Capital Markets, Can Bank
Financial Services, GIC, LIC and IDBI. Since this list of market-makers (who will decide
daily prices and appoint dealers for trading) includes most of the public sector venture
financiers, it should pick up fast, and it should be possible for investors to trade in the
securities of new small and medium size enterprise.

The other disinvestment mechanisms such as the management buy outs or sale to other
venture funds are not considered to be appropriate by VCFs in India.

The growth of an enterprise follows a life cycle as shown in the diagram below. The
requirements of funds vary with the life cycle stage of the enterprise. Even before a
business plan is prepared the entrepreneur invests his time and resources in surveying
the market, finding and understanding the target customers and their needs. At the
seed stage the entrepreneur continue to fund the venture with his own fund or family
funds. At this stage the funds are needed to solicit the consultant’s services in
formulation of business plans, meeting potential customers and technology partners.
Next the funds would be required for development of the product/process and
producing prototypes, hiring key people and building up the managerial team. This is
followed by funds for assembling the manufacturing and marketing facilities in that
order. Finally the funds are needed to expand the business and attaint the critical mass
for profit generation. Venture capitalists cater to the needs of the entrepreneurs at
different stages of their enterprises. Depending upon the stage they finance, venture
capitalists are called angel investors, Venture capitalist or private equity
supplier/investor.

19
 METHODS OF VENTURE FINANCING

Equity: All VCFs in India provide equity but generally their contribution does not exceed
49% 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 change royalty ranging
between 2% to 15%; 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.

Participating Debenture: Security carries charges in 3 phases. In the start up phase,

before the venture attains operations to a minimum level, no interest is charged, after
this, low rate of interest is charged, up to a particular level of operation. Once the
venture is commercial, a high rate of interest is required to be paid.

Quasi Equity: Quasi equity instruments are converted into equity at a later date.
Convertible instruments are normally converted into equity at the book value or at
certain multiple of EPS, i.e. at a premium to par value at a later date. The premium
automatically rewards the promoter for their initiative and hand work. Since it is
performance related, it motivates the promoter to work harder so as to minimize
dilution of their control on the company. The different quasi equity instruments are
follows:

 Cumulative convertible preference shares.

 Partially convertible debentures.
 Fully convertible debentures.

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.

20
 DIFFERENCE BETWEEN VENTURE CAPITAL AND OTHER FUNDS (PRIVATE EQUITY)

Venture Capital Vs Development Funds

Venture capital differs from development funds as latter means putting up of industries
without much consideration of use of new technology or new entrepreneurial venture
but having a focus on underdeveloped areas. In majority cases it is in the form of loan
capital and proportion of equity is verythin. Development finance is security oriented
and liquidity prone. The criteria for investment are proven track record of company and
its promoters, and sufficient cash generation to provide for returns The development
bank safeguards its interest through collateral.

They have no say in working of the enterprise except safeguarding their interest by
having a nominee director. They do not play any active role in the enterprise except
ensuring flow of information and proper management information system, regular
board meetings, adherence to statutory requirements for effective management
information system, regular board meetings, adherence to statutory requirements for
effective management control where as Venture capitalist remain interested if the
overall management of the project account of high risk involved I the project till its
completion, entering into production and making available proper exit route for
liquidation of the investment. As against this fixed payments in the form of installment
of principal and interest are to be made to development.

Venture Capital Vs Seed Capital & Risk Capital

It is difficult to make a distinction between venture capital, seed capital, and risk capital
as the latter two form part of broader meaning of Venture capital. Difference between
them arises on account of application of funds and terms and conditions applicable. The
seed capital and risk funds in India are being provided basically to arrange promoter’s
contribution to the project. The objective is to provide finance and encourage
professionals to become promoters of industrial projects. The seed capital is provided to
conventional projects on the consideration of low risk and security and use conventional
techniques for appraisal. Seed capital is normally in the form low interest deferred loan
as against equity investment by Venture capital. Unlike Venture capital, Seed capital
providers neither provide any value addition nor participate in the management of the
project. Unlike Venture capital Seed capital provider is satisfied with low-normal returns
and lacks any flexibility in its approach.

21
Risk capital is also provided to established companies for adapting for new technologies.
Herein the approach is not business oriented but developmental. As a result on one
hand the success rate of units assisted by seed capital.

Finance has been lower than those provided with venture capital. On the other hand the
return to the seed/risk capital financier had been very low as compared to venture
capitalist.

Seed Capital Scheme Venture Capital Scheme

Basic Income or aid Commercial viability

Beneficiaries Very small entrepreneurs Medium and large entrepreneurs are

also covered
Size of assistance Rs. 15 lac(Max) Up to 40 percent of promoters’
equity
Appraisal process Normal Skilled and Specialized

Estimates returns 20 percent 30 percent plus

Flexibility Nil Highly flexible

Value addition Nil Multiple ways

Exit option Sell back to promoters Several, including public offer

Funding sources Owner funds Outside contribution allowed

Syndication Not done Possible

Tax concession Nil Exempted

Success rate Not good Very satisfactory

Difference between Seed Capital Scheme and Venture Capital Scheme

22
 VENTURE CAPITAL & ALTERNATIVE FINANCING COMPARISON

If we are struggling to find success in our quest for venture capital, maybe we are
looking in the wrong place. Venture capital is not for everybody. For starters, venture
capitalists tend to be very picky about where they invest. They are looking for
something to dump a lot of money that will pour even more money right back at them
in a short amount of time (typically 3-7 years). We may be planning for a steady growth
rate as opposed to the booming, overnight success that venture capitalists tend to
gravitate toward. We may not be able to turn around as large of a profit as they are
looking for in quick enough time. We may not need the amount of money that they
offer or our business may simply not be big enough.

Simply put, venture capital is not the right fit for our business and there are plenty of
other options available when it comes to finding capital.

Venture Capital & Alternative Financing Comparison

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Substitute in Early stage

 Angels: Most venture capital funds will not consider investing in anything under
$1 million to $2 million. Angels, however, are wealthy individuals who will
provide capital for a startup business. These investors have usually earned their
money as entrepreneurs and business managers and can serve as a prime
resource for advice on top of capital. On the other hand, due to typically limited
resources, angels usually have a shorter investment horizon than venture
capitalists and tend to have less tolerance for losses.

 Private Placement: An investment bank or agent may be able to raise equity for
our company by placing our unregistered securities with accredited investors.
However, you should be aware that the fees and expenses associated with this
practice are generally higher than those that come with venture and angel
investors. We will likely receive little or no business counsel from private
investors who also tend to have little tolerance for losses and under-
performance.

 Initial Public Offering: If we are somehow able to gain access to public equity
markets than an initial public offering (IPO) can be an effective way to raise
capital. Keep in mind that, while the public market’s high valuations, abundant
capital and liquidity characteristics make it attractive, the transaction costs are
high and there are ongoing legal expenses associated with public disclosure
requirements.

Later Stage Financing

 Bootstrap Financing: This method is intended to develop a foundation for your

business from scratch. Financial management is essential to make this work.
With bootstrap financing you’re building a business from nothing, which means
there is little to no margin for error in the finance department. Keep a rigid
account of all transactions and don’t stray from your budget. A few different
methods of bootstrapping include:

 Factoring: This generates cash flow through the sale of your accounts
receivable to a factor at discounted price for cash.

 Trade Credit: An option if you are able to find a vendor or supplier

that will allow you to order goods on net 30, 60 or 90 day terms. If

24
 you can sell the goods before the bill comes due then you have
generated cash flow without spending any money. Customers can
pay you up front our services.

 Leasing: Your equipment instead of purchasing it outright.

 Fund from Operations: Look for ways to tweak your business in order to reduce
the cash flowing out and increase the cash flowing in. Funding found in business
operations come free of finance charges, can reduce future financing charges
and can increase the value of your business. Month-by-month operating and
cash projections will show how well we have planned, how you can optimize the
elements of your business that generate cash and allow you to plan for new
investments and contingencies.

 Licensing: Sell licenses to technology that is non-essential to our company or

grant limited licensing to essential technology that can be shared. Throughout
licensing we can generate revenue from up-front fees, access fees, royalties or
milestone payments.

 Vendor Financing: Similar to the trade credit related to bootstrap financing,

vendors can play a big role in financing your new business. Establish vendor
relationships through our trade association and strike deals to offer their
product and pay for it at a date in the near future. Selling the product in time is
up to us. In hopes of keeping you as a customer, vendors may also be willing to
work out an arrangement if we need to finance equipment or supplies. Just
make sure to look for stability when you research a vendor’s credentials and
reputation before you sign any kind of agreement. And keep in mind that many
major suppliers own financial companies that can help you.

 Self Funding: Search between the couch cushions and in old jacket pockets for
whatever extra money you might have lying around and invest it into your
business. Obviously loose change will not be enough for extra business funding,
but take a look at your savings, investment portfolio, retirement funds and
employee buyout options from your previous employer. You won’t have to deal
with any creditors or interest and the return on your investment could be much
higher. However, make sure that you consider the risks involved with using your
own resources. How competitive is the market that you are about to enter into?

25
 How long will it take to pay you back? Will you be able to pay yourself back? Can
you afford to lose everything that you are investing if your business were to fail?
It’s important that your projected returns are more than enough to cover the
risk that you will be taking.

 State Funding: If you’re not having any luck finding funding from the federal
government take a look at what your state has to offer. There is a list of links to
state development agencies that offer an array of grants and financial assistance
for small business.

 Microloans: These types of loans can range from hundreds of dollars to low six-
figure amounts. Although some lenders regard microloans to be a waste of time
because the amount is so low, these can be a real boon for a startup business or
one that just needs to add some extra cash flow.

 Finance Debt: It may be more expensive in the long run than purchasing, but
financing your equipment, facilities and receivables can free up cash in the short
term or reduce the amount of money that you need to raise.

 Friends: Ask your friends if they have any extra money that they would like to
invest. Assure them that you will pay them back with interest or offer those
stock options or a share of the profits in return.

 Family: Maybe you have a rich uncle or a wealthy cousin that would be willing to
lend you some money get your business running or send it to the next level.
Again, make it worth their while by offering interest, stocks or a share of the
profits.

 Form a Strategic Alliance: Aligning your business with a corporation can produce
funding from upfront or access fees to your service, milestone payments and
royalties. In addition, corporate partners may be able to provide research
funding, loans and equity investments.

 Sell Some Assets: Find an interested party to buy some of your assets and then
lease them back to you. This provides an instant source of cash and you will still
be able to use whatever assets you need.

26
 Business Lines of Credit: If your business has positive cash flow and has proven
that it will cover its debts then you may be eligible for a business line of credit.
This type of financing is a common service offered by most business banks and
serves as business capital, up to an agreed upon amount, that you can access at
any time.

 Personal Credit Cards: Using personal credit cards to finance a business can be
risky but, if you take the right approach, they can also give your business a lift.
You should only consider using this type of financing for acquiring assets and
working capital. Never consider this to be a long-term option. Once your
company breaks even or moves into the black, ditch the credit cards and move
toward traditional bank financing or lease agreements.

 Business Credit Cards: Business credit cards carry similar risks as personal credit
cards but tend to be a safer alternative. While the activity on this card goes
toward your credit report, a business credit card can help you to build business
credit, keep your business expenses separate from your personal expenses and
can make tax season easier to manage.

27
 REGULATORY AND LEGAL FRAMEWORK

At present, the Venture Capital activity in India comes under the purview of different
sets of regulations namely:

 The SEBI Regulation, 1996 lays down the overall regulatory framework for
registration and operations of venture capital funds in India.

 The Indian Trust Act, 1882 or the company Act, 1956 depending on whether the
fund is set up as a trust or a company.

 The foreign investment Promotion Board and the RBI in case of an offshore
fund. These funds have to secure the permission of the FIPB while setting up in
India and need a clearance from the RBI for any repatriation of income.

 The Central Board of Direct Taxation governs the issues pertaining to income tax
on the proceed from VC funding activity. The long term capital gain tax is at
around 10% in India and the relevant clauses to VC may be found in Section 10.

 Overseas venture capital investments are subject to the Government of India

Guidelines for Overseas Venture Capital Investment in India dated September
20, 1995.

 For tax exemptions purposes venture capital funds also needs to comply with the
Income Tax Rules made under Section 10 of the Income Tax Act.

28
 MAJOR REGULATORY FRAMEWORKS FOR VENTURE CAPITAL INDUSTRY

Domestic funds with offshore contributions also require RBI approval for the pricing of
securities to be purchased in VCU likewise, at the time of disinvestment, RBI approval is
required for the pricing of the securities.

Definition of venture capital fund: The Venture Capital Fund is now defined s a fund
established in the form of a Trust, a company including a body corporate and registered
with SEBI which

 Has a dedicated pool of capital.

 Raised in the manner specified under the regulations
 To invest in venture capital undertaking in accordance with the regulation.

Definition of Venture Capital Undertaking: Venture Capital Undertaking means a

domestic company whose share is not listed on a recognized stock exchange in India.
Which is engaged in business including such activities or sectors which are specified in
the negative list by the Board with the approval of the Central Government by
notification in the Official Gazette in this behalf? The negative list includes real estate,
non-banking financial services, gold financing, activities not permitted under the
Industrial Policy of the Government of India.

Minimum contribution and fund size: The minimum investment in a Venture Capital
Fund from any investor will not be less than Rs.5 lacks and the minimum corpus of the
fund before the fund can start activities shall be at least Rs.5 corers.

Investment Criteria: The earlier investment criterion has been substituted by new
investment criteria which has the following requirements:

 Disclosure of investment strategy

 Maximum investment in single venture capital undertaking not to exceed 25% of
the corpus of the fund.
 Investment in the associated companies not permitted.
 At least 75% of the investible funds to be invested in unlisted equity shares or
equity linked instruments.
 Not more than 25% of the investible funds may be invested by way of
Subscription to initial public offer of a venture capital undertaking whose shares
are proposed to be listed subject to lack in period of one year. Debt or debt
instrument of a venture capital undertaking in which the venture capital funds
has already made an investment by way of equity.

29
It has also been provided that Venture Capital Fund seeking to avail benefit under the
relevant provisions of the Income Tax Act will be required to divest from the investment
within a period of one year from the listing of the Venture Capital Undertaking.

Disclosure and Information to Investors: In order to simplify and expedite the process
of fund raising, the requirement of filing the Placement memorandum with SEBI is
dispensed with and instead the fund will be required to submit a copy of Placement
Memorandum/ copy of contribution agreement entered to with the investors along
with the details of the fund raiser for information to SEBI. Further, the contents of the
Placement Memorandum are strengthened to provide adequate disclosure and
information to investors. SEBI will also prescribe suitable reporting requirement from
the fund on their investment activity.

QIB status for Venture Capital funds: The venture capital funds will be eligible to
participate in the IPO through book building route as qualified Institutional Buyer
subject to compliance with the SEBI (Venture Capital Fund) Regulations.

Relaxation in Takeover Code: The acquisition of share by the company or any of the
promoters from the Venture Capital Funds under the terms of agreement shall be
treated on the same footing as that of acquisition of shares by promoters/companies
from the state level financial institutions and shall be exempt from making an open offer
to other shareholders.

Investment by Mutual Funds in Venture capital Funds: In order to increase the

resources for domestic venture capital funds, Mutual Funds are permitted to invest up
to 5% of its corpus in the case of open ended schemes and up to 10% of its corpus in the
case of close ended schemes. A part from raising the resources for Venture Capital
Funds this would provide an opportunity to small investors to participate in venture
capital activities through Mutual funds.

Government of India Guidelines: The Government of India Guidelines for Overseas

Venture Capital Investment in India dated September20, 1995 will be repealed by the
MOF on notification of SEBI Venture Capital Fund Regulations.

The following will be the salient features of SEBI (foreign Venture Capital Investors)
Regulations, 2000:

Definition of Foreign Venture capital Investor: Any entity incorporated and established
outside India and proposes to make investment in Venture Capital Fund or Venture
Capital Undertaking and registered with SEBI.

30
Eligibility Criteria: Entity incorporated and established outside India in the form of
Investment Company, Trust, Partnership, Pension Fund, Mutual Fund, University Fund,
Endowment Fund, Asset Management Company, Investment Manager, Investment
Management Company or other Investment Vehicle Incorporated outside India would
be eligible for seeking registration from SEBI. SEBI for the purpose of registration shall
consider whether the applicant is regulated by an appropriate foreign regulatory
authority; or is income tax payer; or submits a certificate from its banker of its or its
promoters, track record where the applicant is neither a regulated entity nor an income
tax payer.

Investment Criteria:

 Disclosure of investment strategy.

 Maximum investment in single venture capital undertaking not to exceed 25% of
the funds committed for investment to India however it can invest its total fund
committed in one venture capital fund.
 At least 75% of the investible funds to be invested in unlisted equity shares or
equity linked instruments.
 Not more than 25%of the investible funds may be invested by way of.
 Subscription to initial offer of a venture capital undertaking whose shares are
proposed to be listed subject to lock in period of one year.
 Debt or debt instrument of a venture capital undertaking in which the venture
capital funds has already made an investment by way of equity.

Hassle Free Entry and Exit: The Foreign Venture Capital Investors proposing to make
venture capital investment under the Regulations would be granted registration by SEBI.
SEBI Registered Foreign Venture Capital Investors shall be permitted to make
investment on an automatic route within the overall sectoral ceiling of foreign
investment under Annexure III of statement of Industrial Policy without any approval
from FIPB. Further, SEBI registered FVCIs shall be granted a general permission from the
exchange control angle for inflow and outflow of funds and no prior approval of RBI
would be required for pricing, however, there would be export reporting requirement
for the amount transacted.

Trading in Unlisted Equity: The board also approved the proposal to permit OTCEI to
develop a trading window for unlisted securities where Qualified Institutional Buyers
(QIB) would be permitted to participate.

31
 REGULATION OF THE BUSINESS OF VENTURE CAPITAL FUND IN INDIA

Eligibility conditions for grant of license to a venture capital fund:

A venture capital fund shall not be granted license unless it fulfills the following
conditions, namely:

 It is incorporated as a company under the Companies Ordinance, 1984.

 It is not engaged in any business other than that of investment in venture
projects.
 It has a minimum paid-up capital of fifty million rupees raised through private
placement.
 For the purpose of managing its entire business, it has entered into a contract, in
writing, with a venture capital company and a copy of which has been filed with
the Commission.

Condition for grant of license:

No venture capital fund shall commence business unless a license is granted under
these rules. For obtaining a license a venture capital fund shall

a. Make an application to the Commission on Form V providing information

as sought in Annex therein, along with all the relevant documents;
b. Submit a bank draft payable to the Commission evidencing the payment
of non-refundable application processing fee amounting to fifty thousand
rupees; and
c. Submit an undertaking that no change in the memorandum and articles
of association and in the directors shall be made without prior written
authorization of the Commission and that all conditions for grant of
license shall be complied with.

32
Renewal of license:

The license granted to the fund under rule 10 shall be valid for one year and shall be
renewable annually on payment of a fee of twenty thousand rupees on an application
being made on Form VII.

The Commission may, after making such inquiry and after obtaining such further
information as it may consider necessary, renew the license of such fund, one year on
Form VIII on such conditions as it may deem necessary.

Private placement:

A venture capital fund shall raise and receive monies for investment in venture projects
through private placement of such securities as may be notified by the Commission,
from time to time.

Placement memorandum:

A venture capital fund shall, before soliciting placement of its securities, file with the
Commission a placement memorandum which shall inter alia give details of the terms
subject to which monies are proposed to be raised from such placements.

33
 KEY SUCCESS FACTOR FOR VENTURE CAPITAL INDUSTRY IN INDIA

Knowledge becomes the key factor for a competitive advantage for company. Venture
Capital firms need more expert knowledge in various fields. The various key success
factors for venture capital industry are as follow:

Knowledge about Govt. changing policies:

Investment, management and exit should provide flexibility to suit the business
requirements and should also be driven by global trends. Venture capital investments
have typically come from high net worth individuals who have risk taking capacity. Since
high risk is involved in venture financing, venture investors globally seek investment and
exit on very flexible terms which provides them with certain levels of protection. Such
exit should be possible through IPOs and mergers/acquisitions on a global basis and not
just within India. In this context the judgment of the judiciary raising doubts on
treatment of tax on capital gains made by firms registered in Mauritius gains
significance - changing policies with a retrospective effect is undoubtedly acting as a
dampener to fresh fund raising by Venture capital firms.

Quick Response time:

The companies have flat organization structure results in quicker decision making. The
entrepreneur is relieved of the trauma that one normally goes through in an interface
with a funding institution or a development agency. They follow a clearly defined
decision making process that works with clock like precision, which means that if they
agree on a funding schedule entrepreneur can count on them to stick it.

Knowledge about Global Environment:

With increasing global integration and mobility of capital it is important that Indian
venture capital firms as well as venture financed enterprises be able to have
opportunities for investment abroad. This would not only enhance their ability to
generate better returns but also add to their experience and expertise to function
successfully in a global environment.

34
Good Human Resource:

Venture capital should become an institutionalized industry financed and managed by

successful entrepreneurs, professional and sophisticated investors. Globally, venture
capitalist are not merely finance providers but are also closely involved with the
investee enterprises and provide expertise by way of management and marketing
support. This industry has developed its own ethos and culture. Venture capital has only
one common aspect that cuts across geography i.e. it is risk capital invested by experts
in the field. It is important that venture capital in India be allowed to develop via
professional and institutional management.

35
 GUIDELINES FOR OVERSEAS VENTURE CAPITAL INVESTMENT IN INDIA

In recognition of growing importance of Venture Capital as one of the sources of finance

for Indian industry, particularly for the smaller unlisted companies, the Government has
announced a policy governing the establishment of domestic Venture Capital
Funds/Companies. An amendment has also been carried out in the SEBI Act
empowering the Securities and Exchange Board of India (SEBI) to register and regulate
Venture Capital Funds (VCFs) and Venture Capital Companies (VCCs) through specific
regulations.

With a view to augment the availability of Venture Capital, the Government has decided
to allow overseas venture capital investments in India subject to suitable guidelines as
outlined below:

 Offshore investment may invest in approved domestic Venture Capital

Funds/Companies set up under the new policy after obtaining FIPB approval for
the investment. There is no limit to the extent of foreign contribution to a
domestic venture capital company/ fund. An offshore venture capital company
may contribute 100% of the capital of domestic venture capital fund, and may
also set up a domestic asset management company to manage the Fund.

 Establishment of an asset management company with foreign investment to

manage such funds would require FIPB approval and would be subject to the
existing norms for foreign investment in non-bank financial services companies.

 Once the initial FIPB approval has been obtained, the subsequent investment b y
the domestic venture capital company/fund in Indian companies will not require
FIPB approval. Such investments will be limited only by the general restriction
applicable to venture capital companies viz:

 A minimum lock-in period of three years will apply to all such

investments.

 VCFs and VCCs shall invest only in unlisted companies and their
investment shall be limited to 40% of the paid up capital of the company.
The ceiling will be subject to relevant equity investment limits that may
be in force from time to time in relation to areas reserved for the Small
Scale Sector.

36
  Investment in any single company by a VCF/VCC shall not exceed 20% of
the paid-up corpus of the domestic VCF/VCC.

 Income paid to offshore investors from Indian VCFs/VCCs will be subject to tax as
per the normal rates applicable to foreign investors.

 Offshore investors may also invest directly in the equity of unlisted Indian
companies without going through the route of a domestic VCF/VCC. However, in
such cases each investment will be treated as a separate act of foreign
investment and will require separate approval as required under the general
policy for foreign investment proposals.

37
 CHALLENGES AHEAD FOR VENTURE CAPITAL FINANCING IN INDIA

Venture Capital is money provided by professionals who invest and manage young
rapidly growing companies that have the potential to develop into significant economic
contributors. According to SEBI regulations, venture capital fund means a fund
established in the form of a company or trust, which raises money through loans,
donations, issue of securities or units and makes or proposes, to make investments in
accordance with these regulations. The funds so collected are available for investment
in potentially highly profitable enterprises at a high risk of loss. A Venture Capitalist is an
individual or a company who provides. Investment Capital, Management Expertise,
Networking & marketing support while funding and running highly innovative &
prospective areas of products as well as services.

Thus, the investment made by Venture Capitalists generally involves

 Financing new and rapidly growing companies.

 Purchasing equity securities.
 Taking higher risk in expectation of higher rewards.
 Having a long frame of time period, generally of more than 5 - 6 years.
 Actively working with the company's management to devise strategies
pertaining to the overall functioning of the project.
 Networking and marketing of the product /service being offered.

In an attempt to bring together highly influential Indians living across the United States,
a networking society named IND US Entrepreneurs was set up in 1992. The aim was to
get the Indian community together and to foster entrepreneurs for wealth creation. A
core group of 10 - 15 individuals worked hard to establish the organization. The group
has now over 600 members with 20 offices spread across the United States. Some of the
famous personalities belonging to this group are VinodDham, PrabhuGoel, and K.B.
Chandrashekhar

38
 PROBLEMS OF VENTURE CAPITAL FINANCING IN INDIA

VCF is in its nascent stages in India. The emerging scenario of global competitiveness has
put an immense pressure on the industrial sector to improve the quality level with
minimization of cost of products by making use of latest technological skills. The
implication is to obtain adequate financing along with the necessary hi-tech equipments
to produce an innovative product which can succeed and grow in the present market
condition. Unfortunately, our country lacks on both fronts. The necessary capital can be
obtained from the venture capital firms who expect an above average rate of return on
the investment. The financing firms expect a sound, experienced, mature and capable
management team of the company being financed. Since the innovative project involves
a higher risk, there is an expectation of higher returns from the project. The payback
period is also generally high . The various problems can be outlined as follows:

 Requirement of an experienced management team.

 Requirement of an above average rate of return on investment.
 Longer payback period.
 Uncertainty regarding the success of the product in the market.
 Questions regarding the infrastructure details of production like plant location,
accessibility, relationship with the suppliers and creditors, transportation
facilities, labor availability etc.
 The category of potential customers and hence the packaging and pricing details
of the product.
 The size of the market.
 Major competitors and their market share.
 Skills and Training required and the cost of training.

Financial considerations like return on capital employed cost of the project, the Internal
Rate of Return of the project, total amount of funds required, ratio of owners
investment borrowed capital, mortgage loans etc. in the capital employed.

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 CONCLUSION

In India, the venture capital plays a vital role in the development and growth of
innovative entrepreneurs. Venture capital activities were primarily done by only a few
institutions to promote entities in the private sector with funding for their business. In
India, funds were primarily raised by public which did not prove to be fruitful in the long
run to the small entrepreneurs. The need on venture capitals was recognised in the
7th five year plan and long term fiscal policy of the government of India.

Venture Capital financing really started in India in 1988 with the formation of
Technology Development and Information Company of India Ltd. Promoted by ICICI and
UTI. The first private VC fund was sponsored by Credit Capital Finance Corporation 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.

Therefore Venture capitalists responses are upbeat about the attractiveness of the India
as a place to do the business.

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 BIBLIOGRAPHY

BOOKS: Taneja Satish: “Venture Capital in India”

WEBSITE:

 www.indiavca.org.
 www.vcindia.com
 www.ventureintelligence.in
 www.nvca.org
 www.economictimes.indiatimes.com
 www.100ventures.com
 www.deloitte.com

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