INTRODUCTION

A number of technocrats are seeking to set up shop on their own and capitalize on opportunities. In
the highly dynamic economic climate that surrounds us today, few traditional business models
may survive. Countries across the globe are realizing that it is not the conglomerates and the
gigantic corporations that fuel economic growth any more. he essence of any economy today is
the small and medium enterprises. !or e"ample, in the #$, %&' of the e"ports are created by
companies with less than (& employees and only )' are created by companies with %&& or more
employees. his growing trend can be attributed to rapid advances in technology in the last decade.
*nowledge driven industries like Infoech, health+care, entertainment and services have become
the cynosure of bourses worldwide. In these sectors, it is innovation and technical capability that are
big business+drivers. his is a paradigm shift from the earlier physical production and economies
of scale model. ,owever, starting an enterprise is never easy. here are a number of parameters
that contribute to its success or downfall. -"perience, integrity, prudence and a clear understanding
of the market are among the sought after .ualities of a promoter. ,owever, there are other factors,
which lie beyond the control of the entrepreneur. /rominent among these is the timely infusion of
funds. his is where the venture capitalist comes in, with money, business sense and a lot more.
What is Venture Capital???
he venture capital investment helps for the growth of innovative entrepreneurships in India.
0enture capital has developed as a result of the need to provide non+conventional, risky finance to
new ventures based on innovative entrepreneurship. 0enture capital is an investment in the form of
e.uity, .uasi+e.uity and sometimes debt + straight or conditional, made in new or untried concepts,
promoted by a technically or professionally .ualified entrepreneur. 0enture capital means risk
capital. It refers to capital investment, both e.uity and debt, which carries substantial risk and
uncertainties. he risk envisaged may be very high may be so high as to result in total loss or very
less so as to result in high gains
The concept of Venture Capital
0enture 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, 0enture -conomics, defines
venture capital as 'providing seed, start-up and first stage financing' and also 'funding the
1
expansion of companies that have already demonstrated their usiness potential ut do not
yet have access to the pulic securities market or to credit oriented institutional funding
sources.
he !uropean Venture Capital "ssociation describes it as risk finance for entrepreneurial growth
oriented companies. It is investment for the medium or long term return seeking to ma"imize
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, e"perience and contact base.
Meaning of venture capital#
0enture capital is money provided by professionals who invest alongside management in young,
rapidly growing companies that have the potential to develop into significant economic
contributors. 0enture capital is an important source of e.uity for start+up companies.
/rofessionally managed venture capital firms generally are private partnerships or closely+held
corporations funded by private and public pension funds, endowment funds, foundations,
corporations, wealthy individuals, foreign investors, and the venture capitalists themselves.
0enture capitalists generally2
!inance new and rapidly growing companies
/urchase e.uity securities
Assist in the development of new products or services
Add value to the company through active participation
ake higher risks with the e"pectation of higher rewards
,ave a long+term orientation
3hen considering an investment, venture capitalists carefully screen the technical and business
merits of the proposed company. 0enture capitalists only invest in a small percentage of the
businesses they review and have a long+term perspective. hey also actively work with the
company4s management, especially with contacts and strategy formulation.
0enture capitalists mitigate the risk of investing by developing a portfolio of young companies in a
single venture fund. 5any times they co+invest with other professional venture capital firms. In
addition, many venture partnerships manage multiple funds simultaneously. !or decades, venture
capitalists have nurtured the growth of America4s high technology and entrepreneurial communities
(
resulting in significant 6ob creation, economic growth and international competitiveness.
Companies such as 7igital -.uipment Corporation, Apple, !ederal -"press, Compa., $un
5icrosystems, Intel, 5icrosoft and 8enetech are famous e"amples of companies that received
venture capital early in their development.
9
PRIVATE EQUITY INVESTING
0enture capital investing has grown from a small investment pool in the 1:;&s and early 1:)&s to a
mainstream asset class that is a viable and significant part of the institutional and corporate
investment portfolio. <ecently, some investors have been referring to venture investing and buyout
investing as =private e.uity investing.= his term can be confusing because some in the investment
industry use the term =private e.uity= to refer only to buyout fund investing. In any case, an
institutional investor will allocate (' to 9' of their institutional portfolio for investment in
alternative assets such as private e.uity or venture capital as part of their overall asset allocation.
Currently, over %&' of investments in venture capital>private e.uity comes from institutional public
and private pension funds, with the balance coming from endowments, foundations, insurance
companies, banks, individuals and other entities who seek to diversify their portfolio with this
investment class.
$hat is a Venture Capitalist%
he typical person+on+the+street depiction of a venture capitalist is that of a wealthy financier who
wants to fund start+up companies. he perception is that a person who develops a brand new
change+the+world invention needs capital? thus, if they cant get capital from a bank or from their
own pockets, they enlist the help of a venture capitalist.
In truth, venture capital and private e.uity firms are pools of capital, typically organized as a limited
partnership that invests in companies that represent the opportunity for a high rate of return within
five to seven years. he venture capitalist may look at several hundred investment opportunities
before investing in only a few selected companies with favorable investment opportunities. !ar
from being simply passive financiers, venture capitalists foster growth in companies through their
involvement in the management, strategic marketing and planning of their investee companies.
hey are entrepreneurs first and financiers second.
-ven individuals may be venture capitalists. In the early days of venture capital investment, in the
1:%&s and 1:;&s, individual investors were the archetypal venture investor. 3hile this type of
individual investment did not totally disappear, the modern venture firm emerged as the dominant
venture investment vehicle. ,owever, in the last few years, individuals have again become a potent
and increasingly larger part of the early stage start+up venture life cycle. hese =angel investors=
will mentor a company and provide needed capital and e"pertise to help develop companies. Angel
@
investors may either be wealthy people with management e"pertise or retired business men and
women who seek the opportunity for first+hand business development.
Fat!r t! "e !nsi#ere# "$ %enture apitalist in seleti!n !& in%est'ent pr!p!sal
here are basically four key elements in financing of ventures which are studied in depth by the
venture capitalists. hese are2
&' Management2 he strength, e"pertise A unity of the key people on the board bring significant
credibility to the company. he members are to be mature, e"perienced possessing working
knowledge of business and capable of taking potentially high risks.
(' )otential for Capital *ain # An above average rate of return of about 9& + @&' is re.uired by
venture capitalists. he rate of return also depends upon the stage of the business cycle where funds
are being deployed. -arlier the stage, higher is the risk and hence the return.
+' ,ealistic -inancial ,e.uirement and )ro/ections # he venture capitalist re.uires a realistic
view about the present health of the organization as well as future pro6ections regarding scope,
nature and performance of the company in terms of scale of operations, operating profit and further
costs related to product development through <esearch A 7evelopment.
0' 12ner's -inancial 3take # he financial resources owned A committed by the entrepreneur>
owner in the business including the funds invested by family, friends and relatives play a very
important role in increasing the viability of the business. It is an important avenue where the
venture capitalist keeps an open eye.
A (rie& )ist!r$
he concept of venture capital is not new. 0enture capitalists often relate the story of Christopher
Columbus. In the fifteenth century, he sought to travel westwards instead of eastwards from -urope
and so planned to reach India. ,is far+fetched idea did not find favor with the *ing of /ortugal, who
refused to finance him. !inally, Bueen Isabella of $pain decided to fund him and the voyages of
Christopher Columbus are now empanelled in history.
he modern venture capital industry began taking shape in the post C 3orld 3ar II years. It is often
said that people decide to become entrepreneurs because they see role models in other people who
have become successful entrepreneurs. 5uch the same thing can be said about venture capitalists.
%
he earliest members of the organized venture capital industry had several role models, including
these three2
"merican ,esearch and 4evelopment Corporation, formed in 1:@;, whose biggest success was
7igital -.uipment. he founder of A<7 was 8eneral 8eorges 7oroit, a !rench+born military man
who is considered 5the father of venture capital'5 In the 1:%&s, he taught at the ,arvard Dusiness
$chool. ,is lectures on the importance of risk capital were considered .uirky by the rest of the
faculty, who concentrated on conventional corporate management.
J'6' $hitney 7 Co also formed in 1:@;, one of whose early hits was 5inute 5aid 6uice. Eock
3hitney is considered one of the industrys founders.
The ,ockefeller -amily, and in particular, F $ <ockefeller, one of whose earliest investments was
in -astern Airlines, which is now defunct but was one of the earliest commercial airlines.
he $econd 3orld 3ar produced an abundance of technological innovation, primarily with military
applications. hey include, for e"ample, some of the earliest work on micro circuitry. Indeed, E.,.
3hitneys investment in 5inute 5aid was intended to commercialize an orange 6uice concentrate
that had been developed to provide nourishment for troops in the field.
In the mid+1:%&s, the #.$. federal government wanted to speed the development of advanced
technologies. In 1:%), the !ederal <eserve $ystem conducted a study that concluded that a shortage
of entrepreneurial financing was a chief obstacle to the development of what it called
5entrepreneurial usinesses'5 As a response this a number of $mall Dusiness Investment
Companies G$DICH were established to =leverage= their private capital by borrowing from the
federal government at below+market interest rates. $oon commercial banks were allowed to form
$DICs and within four years, nearly ;&& $DICs were in operation.
At the same time a number of venture capital firms were forming private partnerships outside the
$DIC format. hese partnerships added to the venture capitalists toolkit, by offering a degree of
fle"ibility that $DICs lack. 3ithin a decade, private venture capital partnerships passed $DICs in
total capital under management.
he 1:;&s saw a tremendous bull I/I market that allowed venture capital firms to demonstrate
their ability to create companies and produce huge investment returns. !or e"ample, when 7igital
-.uipment went public in 1:;J it provided A<7 with 1&1' annualized <eturn on Investment
G<IIH. he #$K)&,&&& 7igital invested to start the company in 1:%: had a market value of
;
#$K9)mn. As a result, venture capital became a hot market, particularly for wealthy individuals and
families. ,owever, it was still considered too risky for institutional investors.
In the 1:)&s, though, venture capital suffered a double+whammy. !irst, a red+hot I/I market
brought over 1,&&& venture+backed companies to market in 1:;J, the public markets went into a
seven+year slump. here were a lot of disappointed stock market investors and a lot of disappointed
venture capital investors too. hen in 1:)@, after Congress legislation against the abuse of pension
fund money, all high+risk investment of these funds was halted. As a result of poor public market
and the pension fund legislation, venture capital fund raising hit rock bottom in 1:)%.
3ell, things could only get better from there. Deginning in 1:)J, a series of legislative and
regulatory changes gradually improved the climate for venture investing. !irst Congress slashed the
capital gains ta" rate to (J' from @:.%'. hen the Fabor 7epartment issued a clarification that
eliminated the pension funds act as an obstacle to venture investing. At around the same time, there
was a number of high+profile I/Is by venture+backed companies. hese included !ederal -"press
in 1:)J, and Apple Computer and 8enetech Inc in 1:J1. his rekindled interest in venture capital
on the part of wealthy families and institutional investors. Indeed, in the 1:J&s, the venture capital
industry began its greatest period of growth. In 1:J&, venture firms raised and invested less than
#$K;&& million. hat number soared to nearly #$K@bn by 1:J). he decade also marked the
e"plosion in the buy+out business.
he late 1:J&s marked the transition of the primary source of venture capital funds from wealthy
individuals and families to endowment, pension and other institutional funds. he surge in capital in
the 1:J&s had predictable results. <eturns on venture capital investments plunged. 5any investors
went into the funds anticipating returns of 9&' or higher. hat was probably an unrealistic
e"pectation to begin with. he consensus today is that private e.uity investments generally should
give the investor an internal rate of return something to the order of 1%' to (%', depending upon
the degree of risk the firm is taking.
,owever, by 1::&, the average long+term return on venture capital funds fell below J', leading to
yet another downturn in venture funding. 7isappointed families and institutions withdrew from
venture investing in droves in the 1:J:+:1 periods. he economic recovery and the I/I boom of
1::1+:@ have gone a long way towards reversing the trend in both private e.uity investment
performance and partnership commitments.
In 1::J, the venture capital industry in the #nited $tates continued its seventh straight year of
growth. It raised #$K(%bn in committed capital for investments by venture firms, who invested
)
over #$K1;bn into domestic growth companies #$ firms have traditionally been the biggest
participants in venture deals, but non+#$ venture investment is growing. In India, venture funding
more than doubled from K@(& million in (&&( to almost K1 billion in (&&9. !or the first half of
(&&@, venture capital investment rose 9(' from (&&9.
Venture Capital in INDIA
0enture capital was introduced in India in mid eighties by All India !inancial Institutions with the
inauguration of <isk Capital !oundation G<C!H sponsored by I!CI with a view to encourage the
technologists and the professional to promote new industries. Conse.uently the government of India
promoted the venture capital during 1:J;+J) by creating a venture capital fund in the conte"t of
structural development and growth of small+scale business enterprises. $ince then several venture
capital firms>funds G0C!sH are incorporated by !inancial Institutions G!IsH, /ublic $ector Danks
G/$DsH, and /rivate Danks and /rivate !inancial companies.
he Indian 0enture Capital Industry GI0CIH is 6ust about a decade old industry as compared
to that in -urope and #$. In this short span it has nurtured close to one thousand ventures, mostly in
$5- segment and has supported building technocrat>professionals all through. he 0C industry,
through its investment in high growth companies as well as companies adopting newer technologies
backed by first generation entrepreneurs, has made a substantial contribution to economy. In India,
however, the potential of venture capital investments is yet to be fully realized. here are around
thirty venture capital funds, which have garnered over <s. %&&& Crores. he venture capital
investments in India at <s. 1&&&.&% crore as in 1::), representing &.1 percent of 87/, as compared
to %.% per cent in countries such as ,ong *ong.
In%est'ent Phil!s!ph$
0enture capitalists can be generalists, investing in various industry sectors, or various geographic
locations, or various stages of a companys life. Alternatively, they may be specialists in one or two
industry sectors, or may seek to invest in only a localized geographic area.
Lot all venture capitalists invest in =start+ups.= 3hile venture firms will invest in companies that
are in their initial start+up modes, venture capitalists will also invest in companies at various stages
of the business life cycle. A venture capitalist may invest before there is a real product or company
organized Gso called =seed investing=H, or may provide capital to start up a company in its first or
second stages of development known as =early stage investing.= Also, the venture capitalist may
provide needed financing to help a company grow beyond a critical mass to become more
successful G=e"pansion stage financing=H.
J
he venture capitalist may invest in a company throughout the companys life cycle and therefore
some funds focus on later stage investing by providing financing to help the company grow to a
critical mass to attract public financing through a stock offering. Alternatively, the venture capitalist
may help the company attract a merger or ac.uisition with another company by providing li.uidity
and e"it for the companys founders.
At the other end of the spectrum, some venture funds specialize in the ac.uisition, turnaround or
recapitalization of public and private companies that represent favorable investment opportunities.
here are venture funds that will be broadly diversified and will invest in companies in various
industry sectors as diverse as semiconductors, software, retailing and restaurants and others that
may be specialists in only one technology.
3hile high technology investment makes up most of the venture investing in the #.$., and the
venture industry gets a lot of attention for its high technology investments, venture capitalists also
invest in companies such as construction, industrial products, business services, etc. here are
several firms that have specialized in retail company investment and others that have a focus in
investing only in =socially responsible= start+up endeavors.
he basic principal underlying venture capital C invest in high+risk pro6ects with the anticipation of
high returns. hese funds are then invested in several fledging enterprises, which re.uire funding,
but are unable to access it through the conventional sources such as banks and financial institutions.
ypically first generation entrepreneurs start such enterprises. $uch enterprises generally do not
have any ma6or collateral to offer as security, hence banks and financial institutions are averse to
funding them. 0enture capital funding may be by way of investment in the e.uity of the new
enterprise or a combination of debt and e.uity, though e.uity is the most preferred route.
$ince most of the ventures financed through this route are in new areas Gworldwide venture capital
follows =hot industries= like Infoech, electronics and biotechnologyH, the probability of success is
very low. All pro6ects financed do not give a high return. $ome pro6ects fail and some give
moderate returns. he investment, however, is a long+term risk capital as such pro6ects normally
take 9 to ) years to generate substantial returns. 0enture capitalists offer =more than money= to the
venture and seek to add value to the investee unit by active participation in its management. hey
monitor and evaluate the pro6ect on a continuous basis.
he venture capitalist is however not worried about failure of an investee company, because the
deal which succeeds, nets a very high return on his investments C high enough to make up for the
:
losses sustained in unsuccessful pro6ects. he returns generally come in the form of selling the
stocks when they get listed on the stock e"change or by a timely sale of his stake in the company to
a strategic buyer. he idea is to cash in on an increased appreciation of the share value of the
company at the time of disinvestment in the investee company. If the venture fails Gmore often than
notH, the entire amount gets written off. /robably, that is one reason why venture capitalists assess
several pro6ects and invest only in a handful after careful scrutiny of the management and
marketability of the pro6ect.
o conclude, a venture financier is one who funds a start up company, in most cases promoted by a
first generation technocrat promoter with e.uity. A venture capitalist is not a lender, but an e.uity
partner. ,e cannot survive on minimalism. ,e is driven by ma"imization2 wealth ma"imization.
0enture capitalists are sources of e"pertise for the companies they finance. -"it is preferably
through listing on stock e"changes. his method has been e"tremely successful in #$A, and
venture funds have been credited with the success of technology companies in $ilicon 0alley. he
entire technology industry thrives on it
8ength of investment2
0enture capitalists will help companies grow, but they eventually seek to e"it the investment in
three to seven years. An early stage investment make take seven to ten years to mature, while a later
stage investment many only take a few years, so the appetite for the investment life cycle must be
congruent with the limited partnerships appetite for li.uidity. he venture investment is neither a
short term nor a li.uid investment, but an investment that must be made with careful diligence and
e"pertise..
Sta*es !& Venture Capital Fun#in*
he 0enture Capital funding varies across the different stages of growth of a firm. he various
stages are2
1&
2
3tart-up 3tage
Lewly formed companies without significant operating histories are considered to be in the start+up
stage. 5ost entrepreneurs fund this stage of a companys development with their own funds as well
as investments from angel investors. Angels are wealthy individuals, friends, or family members
that personally invest in a company. Angels are the most common source of first round funding for
technology businesses and angel rounds usually less that K1 million. hey often will back
companies that are at the concept stage and have a limited track record with respect to customers
and revenue. hese investors tend to invest only in local companies or for people that they already
know personally.
3eed or !arly 3tage
$eed or early stage rounds often involve investments of less than K% million for companies that have
promising concepts validated by key customers but have not yet achieved cash flow break+even.
Irganized groups of angel investors as well as early stage venture capital funds usually provide
these types of investments. ypically, seed and early venture capital funds will not invest in
companies outside their geographic area Gusually 1&&+1%& miles from the 0Cs officeH as they often
actively work with management on a variety of operational issues.
*ro2th 3tage
11
8rowth stage investments focus on companies that have a proven business model and either are
already profitable or offer a clear path to sustainable profitability. hese investments tend to be in
the K%+(& million range and are intended to help the company increase its market penetration
significantly. he pool of potential venture capital investors is very robust for growth stage
investments, with firms across the #nited $tates willing to participate in investment rounds at this
stage.
8ate 3tage
Fate stage venture capital investments tend to be for relatively mature, profitable companies seeking
to raise K1&M million for significant strategic initiatives Gi.e. investment in sales A marketing,
e"pansion overseas, ma6or infrastructure build+outs, strategic ac.uisitions, etc.H that will create
ma6or advantages over their competition. hese opportunities are usually funded by syndicates of
well+established venture capital firms who manage large funds.
9uyouts and ,ecapitali:ations
Duyouts and recapitalizations are becoming more prevalent for mature technology companies that
are stable and profitable. In these transactions, e"isting shareholders sell some or all of their shares
to a venture capital firm in return for cash. hese venture capital firms may also provide additional
capital to fuel growth in con6unction with an e"it for some or all of the companys e"isting
shareholders.
1(
PRIVATE EQUITY+ AN INTRODUCTION
/rivate -.uity is a broad term denoting any investment in an asset class consisting of e.uity
securities in operating companies that are not publicly traded on a stock e"change. 5ore accurately,
private e.uity refers to the manner in which the funds have been raised, namely on the private
markets, as opposed to the public markets. Investments in private e.uity most often involve either
an investment of capital into an operating company or the ac.uisition of an operating company. It is
typically a transformational, value+added, active investment strategy.
),;V"T! !<=;T> -;,M3
/rivate e.uity firms invest in companies at various stages of their development ranging from their
very beginnings to their demise. /- firm is an investment manager that makes investments in the
private e.uity through a variety of loosely affiliated investment strategies including Feveraged
Duyout, 0enture Capital and 8rowth Capital.
/rivate e.uity firms, with their investors, will ac.uire a controlling or substantial minority position
in a company and then look to ma"imize the value of that investment. In turn they receive a
periodic management fee as well as a share in the profits earned Gcarried interestH from each private
e.uity fund managed./rivate e.uity firms generally receive a return on their investments through an
I/I, a merger or ac.uisition, a recapitalization.
$6> ),;V"T! !<=;T>%
Capital to a company is like life in human body. he companies engaged in the traditional line of
business procure necessary financial capital from the public issues, financial institutions,
commercial banks, mutual funds, lease financing, debt instruments, hire purchase etc. Dut the
companies face great difficulty while raising capital for newly floated companies as at the initial
stages of the business the risk is very high and the return is uncertain.
$imilarly, small+scale enterprises G$$-4sH are also unable to raise funds because it is highly risky
venture, are less profitable and do not possess ade.uate tangible assets to offer as security. $o, they
have two options left+ either to raise capital through I/I or to obtain loans. Dut most of the $$-4s
are unable to fulfill the listing re.uirements in terms of sales and minimum size of share issues.
5oreover, common investors hesitate to invest in such companies even though the growth rate is
19
high because of high degree of risk involved. As far as loans are concerned, lenders charge
relatively high rate of interest to compensate for the high degree of risk involved.
he spectacular success of companies like 8-, 5icrosoft, !ederal -"press, Infosys and <eliance
give a sense that new venture creation is a sign of future productivity gains. $o how such companies
shall be financedN he /rivate -.uity market is an important source of funds for new firms, private
middle+market firms, firms in financial distress, and public firms seeking buyout financing. Iver
the last 1% years it has been the fastest growing market for corporate finance as compared to bond
market and others. oday the private e.uity market is roughly one+si"th the size of the commercial
bank loan and commercial paper markets in terms of outstanding, and in recent years private e.uity
capital raised by partnerships has matched, and sometimes e"ceeded, funds raised through initial
public offerings and gross issuance of public high+yield corporate bonds.
T>)!3 1- ),;V"T! !<=;T>
/rivate -.uity investments can be divided into the following categories2
&' 8everaged 9uyout
A leveraged Duyout Gor FDI or highly+leveraged transaction G,FH or ObootstrapP transactionH
refers to a strategy of making e.uity investments as part of a transaction in which a company,
business unit or business assets is ac.uired from the current shareholders typically with the use of
financial leverage. he companies involved in these transactions are typically mature and generate
operating cash flows.
Feveraged buyouts involve a financial sponsor agreeing to an ac.uisition without itself committing all
the capital re.uired for the ac.uisition. o do this, the financial sponsor will raise ac.uisition debt
which ultimately looks to the cash flows of the ac.uisition target to make interest and principal
payments. Ac.uisition debt in an FDI is often non+recourse to the financial sponsor and has no claim
on other investment managed by the financial sponsor. herefore, an FDI transaction4s financial
structure is particularly attractive to a fund4s limited partners, allowing them the benefits of leverage
but greatly limiting the degree of recourse of that leverage. his kind of financing structure leverage
benefits to an FDI4s financial sponsor in two ways2
he investor itself only needs to provide a fraction of the capital for the ac.uisition, and
he returns to the investor will be enhanced Gas long as the return on assets e"ceeds the cost of
the debtH.
1@
As a percentage of the purchase price for a leverage buyout target, the amount of debt used to
finance a transaction varies according the financial condition and history of the ac.uisition target,
market conditions, the willingness of lenders to e"tend credit Gboth to the FDI4s financial sponsors and
the company to be ac.uiredH as well as the interest costs and the ability of the company to cover
those costs. ,istorically the debt portion of a FDI will range from ;&'+:&' of the purchase price,
although during certain periods the debt ratio can be higher or lower than the historical averages.

(' Venture capital
0enture capital is a broad subcategory of private e.uity that refers to e.uity investments made,
typically in less mature companies, for the launch, early development, or e"pansion of a business.
0enture investment is most often found in the application of new technology, new marketing
concepts and new products that have yet to be proven.
0enture capital is often sub+divided by the stage of development of the company ranging from early
stage capital used for the launch of start+up companies to late stage and growth capital that is often
used to fund e"pansion of e"isting business that are generating revenue but may not yet be
profitable or generating cash flow to fund future growth. -ntrepreneurs often develop products and
ideas that re.uire substantial capital during the formative stages of their companies4 life cycles.
5any entrepreneurs do not have sufficient funds to finance pro6ects themselves, and they prefer
outside financing. o compensate the risk of failure, venture capitalist4s seeks higher return from
1%
these investments. 0enture Capital is often most closely associated with fast growing technology
and biotechnology fields.
+ '*ro2th capital
8rowth capital refers to e.uity investments, most often significant minority investments, in
relatively mature companies that are looking for capital to e"pand or restructure operations, enter
new markets or finance a ma6or ac.uisition without a change of control of the business. Companies
that seek growth capital will often do so in order to finance a transformational event in their life
cycle. hese companies are likely to be more mature than venture capital funded companies, able to
generate revenue and operating profits but unable to generate sufficient cash to fund ma6or
e"pansions, ac.uisitions or other investments. he primary owner of the company may not be
willing to take the financial risk alone. Dy selling part of the company to private e.uity, the owner
can take out some value and share the risk of growth with partners.
0 '4istressed and 3pecial 3ituations
7istressed or $pecial $ituations are a broad category referring to investments in e.uity or debt
securities of financially stressed companies. he =distressed= category encompasses two broad sub+
strategies including2
=7istressed+to+Control= or =Foan+to+Iwn= strategies where the investor ac.uires debt
securities in the hopes of emerging from a corporate restructuring in control of the
company4s e.uity?
=$pecial $ituations= or =urnaround= strategies where an investor will provide debt and
e.uity investments, often =rescue financing= to companies undergoing operational or
financial challenges.
? 'Me::anine capital
5ezzanine capital refers to subordinated debt or preferred e.uity securities that often represent the
most 6unior portion of a company4s capital structure that is senior to the company4s common e.uity.
his form of financing is often used by private e.uity investors to reduce the amount of e.uity
capital re.uired to finance a leveraged buyout or ma6or e"pansion. 5ezzanine capital, which is
often used by smaller companies that are unable to access the high yield market, allows such
companies to borrow additional capital beyond the levels that traditional lenders are willing to
provide through bank loans. In compensation for the increased risk, mezzanine debt holders re.uire
a higher return for their investment than secured or other more senior lenders.
@' 3econdaries
1;
$econdary investments refer to investments made in e"isting private e.uity assets. hese
transactions can involve the sale of private e.uity fund interests or portfolios of direct investments
in privately held companies through the purchase of these investments from e"isting institutional
investors. Dy its nature, the private e.uity asset class is illi.uid, intended to be a long+term
investment for buy+and+hold investors. $econdary investments provide institutional investors with
the ability to improve vintage diversification, particularly for investors that are new to the asset
class. $econdaries also typically e"perience a different cash flow profile, diminishing the effect of
investing in new private e.uity funds. Iften investments in secondaries are made through third
party fund vehicle, structured similar to a fund of funds although many large institutional investors
have purchased private e.uity fund interests through secondary transactions. $ellers of private
e.uity fund investments sell not only the investments in the fund but also their remaining unfunded
commitments to the funds.
1)
T6! 3T"*!3 1- ),;V"T! !<=;T>
/rivate -.uity investments can be classified into2
Q $eed stage !inancing provided to research, assess and develop an initial concept before a business
has reached the start+up phase
Q $tart+up stage financing for product development and initial marketing.
Q -"pansion stage financing for growth and e"pansion of a company which is breaking even or
trading profitably.
Q <eplacement capital /urchase of shares from another investor or to reduce gearing via the
refinancing of debt.
he above stages can be e"plained by the diagram which is shown below +2
1J
"4V"AT"*!3 1- ),;V"T! !<=;T>
Investing in a private e.uity fund has a lot of advantages compared to other investment areas? here
are some advantages of private e.uity for not only investors but also the companies that private
e.uity firms ac.uire2
"dvantages for ;nvestors#
Dy definition, private e.uity firms work outside the public eye and do not have to follow the
same transparency standards that public firms and funds must adhere to. his allows private
e.uity firms to reform the companies without the constraint of having to report .uarterly to
the $-DI, <IC or similar distractions.
/rivate e.uity firms generally perform very rigorous due diligence on potential investments.
Dy utilizing a team of researchers the private e.uity firm is able to identify most risks that
would not otherwise be found.
he management receives carried interest, a portion of the profits, so managers and their
staff are motivated to produce good results to investors. Although carried interest is often
criticized for taking money from the investors, it is a very big incentive for managers.
!conomic 3cenario+
India is one of the fastest growing economies in the world, with enormous growth potential in
many industries. his means that capital re.uirements are high, translating into an ideal hunting
ground for /- funds.
"undance of skilled laor C
India offers a huge advantage in the form of its highly talented and skilled labor pool, which can
lead to the success of the firms in which investment is made through the private e.uity route.
he funds are not 6ust bullish about the businesses in India but have also grabbed a fair share of
highly rated managers like 0ivek /aul, <a6eev 8upta, Avnish Da6a6, Akhil 8upta, and Likhil
*hattau. /- funds are invariably on the lookout for high profile managers, not only to manage
their own funds but also as their representative on the board of companies in which they have
invested.
3uccess of several sectors C
1:
India has firmly established itself as the worlds I superpower with almost all ma6or software
development companies having an Indian development centre. It is also becoming the the hub of
back office operations, and a leading provider of D/I and */I services. his has led to greater
confidence in the future growth potential of Indian companies.
Mature -inancial markets C
Capital markets have stabilized in the recent past with regulators like $-DI keeping a firm
watch on the market development. his means both increased opportunities as well as an easier
and painless e"it route for /- funds. he emergence of entrepreneurs in India who consider /-
their full time occupation is also a positive sign. Desides, there are well established corporate
houses diversifying their surplus investment, as a strategy for their assets allocation, through /-
funds without involving themselves directly in the operations of target companies.
3uccessful M7"s+
A recent spate of mergers and ac.uisitions has given rise to yet another way of e"iting from
Indian companies for private e.uity investors.
3uccessful track record C
he first generation of private e.uity players have realized significant success in the last several
years. !or instance, 3arburg /incus earned huge returns out from its investments in Indian
companies like Dharti elecom.
"dvantages for Company#
/rivate e.uity managers are paid very well and so it is easy to attract high caliber,
e"perienced managers that tend to perform very well. he same goes for lower level
employees at private e.uity firms, they tend to be the top young business school graduates.
his helps the company to utilize best talent in the industry without shelling out even a
single penny from its pocket.
/- helps a company to prepare for stock market listing GI/IH as the e"it route of investment.
It opens up enormous opportunities for companies to raise funds. he continuous scrutiny by
stock market participants, $-DI A <IC facilitates efficiency improvement and proper
strategic decisions.
(&
/- helps those companies which cannot raise money from the market. Dy private e.uity
company get money from the investors, which help in the growth of the company.
4;3"4V"AT"*!3 1- ),;V"T! !<=;T>
4isadvantages for ;nvestors#
4ifficult to access for small 7 medium investors-
private e.uity Fimited /artnership funds may only be marketed to institutions and very wealthy
individuals? in addition the minimum investment accepted is usually more than R1mn.
,elative illi.uidity C
/rivate -.uity funds normally invest in a unlisted space and they find it difficult to e"it the
investment at their wish, since it re.uire concentrated efforts to find a suitable investor for
unlisted company. -ven in the listed space, the impact cost remains very high due to sheer
magnitude of scale.
A long term investment perspective is necessary to achieve gains for a private e.uity
investment programme because the investment programme depends on the company growth. It
depends on the gap between entry and e"it of the investor.
)olitical condition B
India, being divided into a number of states, causes an investment decision to be affected by
politics. Changes in regulation and infrastructure development are often sidelined due to friction
and conflict between the state and the federal government.
Competition from China B
China is a direct competitor of India and most of the private e.uity investors, eyeing the Asian
region, draw a comparison across both the countries to decide where their money should be
parked. he new state+ofthe+ art airports in China bear a stark contrast to the abysmal conditions
of the terminals in Indias main cities.
6igh costs B
private e.uity managers charge relatively high fees for managing capital committed by e"ternal
investors Ggenerally around ('H and, if the fund performs well, take a sizeable proportion
Ggenerally (&'H of realised returns in e"cess of investment hurdle rates.
(1
4isadvantages for Company#
It is a lengthy process since private e.uity managers conduct detailed market, financial,
legal, environmental and management due diligence, which could take several months
before they make final decisions on investing.
-ntrepreneurs have to give up some of their companys shares to a private e.uity investor,
i.e. control. Decause investor have some control over the company, so it is not easy for the
entrepreneur to take decision independently. ,e have to take advice of the investor to take
decision and it causes delay in the process.
he private e.uity managers have control over the timing of a sale of Ga part ofH the
business.
Fack of promotion in investment across sectors + /- funds are being channelized into only a
few sectors like I, infrastructure A real estate and telecommunications, to the e"clusion of
the remaining industries, desperately in need of funds for growth.
((
,ET)ODS OF VENTURE FINANCING
0enture capital is typically available in three forms in India, they are2
!.uity2 All 0C!s in India provide e.uity but generally their contribution does not e"ceed @:
percent of the total e.uity capital. hus, the effective control and ma6ority ownership of the firm
remains with the entrepreneur. hey buy shares of an enterprise with an intention to ultimately sell
them off to make capital gains.
Conditional 8oan2 It is repayable in the form of a royalty after the venture is able to generate sales.
Lo interest is paid on such loans. In India, 0C!s charge royalty ranging between ( to 1% percent?
actual rate depends on other factors of the venture such as gestation period, cost+flow patterns,
riskiness and other factors of the enterprise.
;ncome Aote # It is a hybrid security which combines the features of both conventional loan and
conditional loan. he entrepreneur has to pay both interest and royalty on sales, but at substantially
low rates.
1ther -inancing Methods2 A few venture capitalists, particularly in the private sector, have started
introducing innovative financial securities like participating debentures, introduced by C!C is an
e"ample.
Venture Capital Fun# Operati!n
0enture capitalists are very selective in deciding what to invest in. A common figure is that they
invest only in about one in four hundred ventures presented to them.
hey are only interested in ventures with high growth potential. Inly ventures with high growth
potential are capable of providing the return that venture capitalists e"pect, and structure their
businesses to e"pect. Decause many businesses cannot create the growth re.uired having an e"it
event within the re.uired timeframe, venture capital is not suitable for everyone.
0enture capitalists usually e"pect to be able to assign personnel to key management positions and
also to obtain one or more seats on the company4s board of directors. his is to put people in place,
a phrase that has sometimes .uite unfortunate implications as it was used in many accounting
scandals to refer to a strategy of placing incompetent or easily bypassed individuals in positions of
due diligence and formal legal responsibility, enabling others to rob stockholders blind. Inly a tiny
(9
portion of venture capitalists, however, have been found liable in the large scale frauds that rocked
American GmostlyH finance in (&&& and (&&1.
0enture capitalists e"pect to be able to sell their stock, warrants, options, convertibles, or other
forms of e.uity in three to ten years2 this is referred to as harvesting. 0enture capitalists know that
not all their investments will pay+off. he failure rate of investments can be high? anywhere from
(&' to :&' of the enterprises funded fail to return the invested capital.
5any venture capitalists try to mitigate this problem through diversification. hey invest in
companies in different industries and different countries so that the systematic risk of their total
portfolio is reduced. Ithers concentrate their investments in the industry that they are familiar with.
In either case, they work on the assumption that for every ten investments they make, two will be
failures, two will be successful, and si" will be marginally successful. hey e"pect that the two
successes will pay for the time given to, and risk e"posure of the other eight. In good times, the
funds that do succeed may offer returns of 9&& to 1&&&' to investors.
0enture capital partners Galso known as =venture capitalists= or =0Cs=H may be former chief
e"ecutives at firms similar to those which the partnership funds. Investors in venture capital funds
are typically large institutions with large amounts of available capital, such as state and private
pension funds, university endowments, insurance companies and pooled investment vehicles.
5ost venture capital funds have a fi"ed life of ten yearsSthis model was pioneered by some of the
most successful funds in $ilicon 0alley through the 1:J&s to invest in technological trends broadly
but only during their period of ascendance, to cut e"posure to management and marketing risks of
any individual firm or its product.
In such a fund, the investors have a fi"ed commitment to the fund that is =called down= by the 0Cs
over time as the fund makes its investments. In a typical venture capital fund, the 0Cs receive an
annual =management fee= e.ual to (' of the committed capital to the fund and (&' of the net
profits of the fund. Decause a fund may run out of capital prior to the end of its life, larger 0Cs
usually have several overlapping funds at the same timeSthis lets the larger firm keep specialists in
all stage of the development of firms almost constantly engaged. $maller firms tend to thrive or fail
with their initial industry contactsSby the time the fund cashes out, an entirely new generation of
technologies and people is ascending, whom they do not know well, and so it is prudent to re+assess
and shift industries or personnel rather than attempt to simply invest more in the industry or people
it already knows
(@
Assessin* Venture Capital
0enture funds, both domestic and offshore, have been around in India for some years now. ,owever
it is only in the past 1( to 1J months, they have come into the limelight. he re6ection ratio is very
high, about 1& in 1&& get beyond pre evaluation stage, and 1 gets funded.
0enture capital funds are broadly of two kinds + generalists or specialists. It is critical for the
company to access the right type of fund, ie who can add value. his backing is invaluable as
focused>specialized funds open doors, assist in future rounds and help in strategy. ,ence, it is
important to choose the right venture capitalist.
he standard parameters used by venture capitalists are very similar to any investment decision.
he only difference being e"it. If one buys a listed security, one can e"it at a price but with an
unlisted security, e"it becomes difficult. he key factors which they look for in
The Management
5ost businesses are people driven, with success or failure depending on the performance of the
team. It is important to distinguish the entrepreneur from the professional management team. he
value of the idea, the vision, putting the team together, getting the funding in place is amongst
others, some key aspects of the role of the entrepreneur. 0enture capitalists will insist on a
professional team coming in, including a C-I to e"ecute the idea. Ine+man armies are passe.
Integrity and commitment are attributes sought for. he venture capitalist can provide the strategic
vision, but the team e"ecutes it. As a famous $ilicon 0alley saying goes =$uccess is e"ecution,
strategy is a dream=.
The ;dea
he idea and its potential for commercialization are critical. 0enture funds look for a scalable
model, at a country or a regional level. Itherwise the entire game would be reduced to a manpower
or machine multiplication e"ercise. !or e"ample, it is very easy for ,industan Fever to double sales
of Firil + a soap without incremental cape", while 8u6arat Ambu6a needs to spend at least <s@bn
before it can increase sales by 1mn ton. 7istinctive competitive advantages must e"ist in the form
of scale, technology, brands, distribution, etc which will make it difficult for competition to enter.
Valuation
(%
All investment decisions are sensitive to this. An old stock market saying =-very stock is a buy at a
price and vice versa=. 5ost deals fail because of valuation e"pectation mismatch. In India, while
calculating returns, venture capital funds will take into account issues like rupee depreciation,
political instability, which adds to the risk premia, thus suppressing valuations. Finked to valuation
is the stake, which the fund takes. In India, entrepreneurs are still uncomfortable with the venture
capital =taking control= in a seed stage pro6ect.
!xit
3ithout e"it, gains cannot be booked. -"it may be in the form of a strategic sale or>and I/I.
a"ation issues come up at the time. Any fund would discuss all e"it options before closing a deal.
$ometimes, the fund insists on a buy back clause to ensure an e"it.
)ortfolio 9alancing
5ost venture funds try and achieve portfolio balancing as they invest in different stages of the
company life cycle. !or e"ample, a venture capital has invested in a portfolio of companies
predominantly at seed stage? they will focus on e"pansion stage pro6ects for future investments to
balance the investment portfolio. his would enable them to have a phased e"it. In summary,
venture capital funds go through a certain due diligence to finalize the deal. his includes
evaluation of the management team, strategy, e"ecution and commercialization plans. his is
supplemented by legal and accounting due diligence, typically carried out by an e"ternal agency. In
India, the entire process takes about ; months. -ntrepreneurs are advised to keep that in mind
before looking to raise funds. he actual cash inflow might get delayed because of regulatory
issues. It is interesting to note that in #$A, at times angels write checks across the table.
Finanin* Opti!ns in General
he possibility of raising a substantial part of pro6ect finances in India through both e.uity and debt
instruments are among the key advantages of investing in India.
he Indian banking system has shown remarkable growth over the last two decades. he rapid
growth and increasing comple"ity of the financial markets, especially the capital market have
brought about measures for further development and improvement in the working of these markets.
Danks and development financial institutions led by ICICI, I7DI and I!CI were providers of term
loans for funding pro6ects. he options were limited to conventional businesses, i.e. manufacturing
centric. $ervices sector was ignored because of the =collateral= issue.
(;
-.uity was raised from the capital markets using the I/I route. he bull markets of the :&s, fuelled
by ,arshad 5ehta and the !IIs, ensured that GadH venture capital was easily available.
5anufacturing companies e"ploited this to the full.
he services sector was ignored, like software, media, etc. Fack of understanding of these sectors
was also responsible for the same. If we look back to 1::1 or even 1::(, the situation as regards
financial outlay available to Indian software companies was poor. 5ost software companies found it
e"tremely difficult to source seed capital, working capital or even venture capital.
5ost software companies started off undercapitalized, and had to rely on loans or overdraft
facilities to provide working capital. his approach forced them to generate revenue in the short
term, rather than investing in product development. he situation fortunately has changed.
()

T)E VENTURE CAPITA- PROCESS
he 0enture Capital Investment /rocess2
he venture capital activity is a se.uential process involving the following si" steps.
1. 7eal origination
(. $creening
9. 7ue diligence -valuation
@. 7eal structuring
%. /ost+investment activity
;. -"it
(J
(:
4eal origination#
In generating a deal flow, the 0C investor creates a pipeline of deals or investment opportunities
that he would consider for investing in. 7eal may originate in various ways. referral system, active
search system, and intermediaries. <eferral system is an important source of deals. 7eals may be
referred to 0C!s by their parent organizations, trade partners, industry associations, friends etc.
Another deal flow is active search through networks, trade fairs, conferences, seminars, foreign
visits etc. Intermediaries is used by venture capitalists in developed countries like #$A, is certain
intermediaries who match 0C!s and the potential entrepreneurs.
3creening#
0C!s, before going for an in+depth analysis, carry out initial screening of all pro6ects on the basis of
some broad criteria. !or e"ample, the screening process may limit pro6ects to areas in which the
venture capitalist is familiar in terms of technology, or product, or market scope. he size of
investment, geographical location and stage of financing could also be used as the broad screening
criteria.
4ue 4iligence#
7ue diligence is the industry 6argon for all the activities that are associated with evaluating an
investment proposal. he venture capitalists evaluate the .uality of entrepreneur before appraising
the characteristics of the product, market or technology. 5ost venture capitalists ask for a business
plan to make an assessment of the possible risk and return on the venture. Dusiness plan contains
detailed information about the proposed venture. he evaluation of ventures by 0C!s in India
includes?
/reliminary evaluation2 he applicant re.uired to provide a brief profile of the proposed venture to
establish prima facie eligibility.
7etailed evaluation2 Ince the preliminary evaluation is over, the proposal is evaluated in greater
detail. 0C!s in India e"pect the entrepreneur to have2+ Integrity, long+term vision, urge to grow,
managerial skills, commercial orientation.
0C!s in India also make the risk analysis of the proposed pro6ects which includes2 /roduct risk,
5arket risk, echnological risk and -ntrepreneurial risk. he final decision is taken in terms of the
e"pected risk+return trade+off as shown in !igure.
7eal $tructuring2 $tructuring refers to putting together the financial aspects of the deal and
negotiating with the entrepreneurs to accept a venture capitals proposal and finally closing the deal.
o do a good 6ob in structuring, one needs to be knowledgeable in areas of accounting, cash flow,
finance, legal and ta"ation. Also the structure should take into consideration the various commercial
9&
issues Gie what the entrepreneur wants and what the venture capital would re.uire protecting the
investmentH. 7ocumentation refers to the legal aspects of the paperwork in putting the deal together.
he instruments to be used in structuring deals are many and varied. he ob6ective in selecting the
instrument would be to ma"imize Gor optimizeH venture capitals returns>protection and yet satisfies
the entrepreneurs re.uirements. he instruments could be as follows2
;nstrument ;ssues
Foan Clean vs secured
Interest bearing vs non interest bearing
convertible vs one with features GwarrantsH
1st Charge, (nd Charge,
loan vs loan stock
5aturity
/reference shares redeemable Gconditions under Company ActH
participating
par value
nominal shares
3arrants e"ercise price, e"piry period
Common shares new or vendor shares
par value
partially+paid shares
In India, straight e.uity and convertibles are popular and commonly used. Lowadays, warrants are
issued as a tool to bring down pricing.
A variation that was first used by /AC and 7ICI was =royalty on sales=. #nder this, the company
was given a conditional loan. If the pro6ect was successful, the company had to pay a ' age of sales
as royalty and if it failed then the amount was written off. In structuring a deal, it is important to
listen to what the entrepreneur wants, but the venture capital comes up with his own solution. -ven
91
for the proposed investment amount, the venture capital decides whether or not the amount
re.uested, is appropriate and consistent with the risk level of the investment. he risks should be
analyzed, taking into consideration the stage at which the company is in and other factors relating to
the pro6ect. Geg e"it problems, etcH.
)ost ;nvestment "ctivities2
Ince the deal has been structured and agreement finalized, the venture capitalist generally assumes
the role of a partner and collaborator. ,e also gets involved in shaping of the direction of the
venture. he degree of the venture capitalist4s 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.
!xit#
0enture capitalists generally want to cash+out their gains in five to ten years after the initial
investment. hey play a positive role in directing the company towards particular e"it routes. A
venture may e"it in one of the following ways2
1. Initial /ublic Ifferings GI/IsH
(. Ac.uisition by another company
9. /urchase of the venture capitalist4s shares by the promoter,
@. /urchase of the venture capitalist4s share by an outsider
9(
PRO(-E,S OF VENTURE CAPITA- IN INDIAN CONTE.T
Ine can ask why venture funding is so successful in #$A and faced a number of problems in India.
he biggest problem was a mindset change from =collateral funding= to high risk high return
funding. 5ost of the pioneers in the industry were people with credit background and e"posure to
manufacturing industries. -"posure to fast growing intellectual property business and services
sector was almost zero. 5oreover 0C! is in its nascent stages in India. he emerging scenario of
global competitiveness has put an immense pressure on the industrial sector to improve the .uality
level with minimization of cost of products by making use of latest technological skills. he
implication is to obtain ade.uate financing along with the necessary hi+tech e.uipments to produce
an innovative product which can succeed and grow in the present market condition. #nfortunately,
our country lacks on both fronts. he necessary capital can be obtained from the venture capital
firms who e"pect an above average rate of return on the investment. he financing firms e"pect a
sound, e"perienced, mature and capable management team of the company being financed. $ince
the innovative pro6ect involves a higher risk, there is an e"pectation of higher returns from the
pro6ect. he payback period is also generally high G% + ) yearsH. he other issues that led to such a
situation include2
8icense ,a/ and The ;)1 9oom
ill early :&s, under the license ra6 regime, only commodity centric businesses thrived in a deficit
situation. o fund a cement plant, venture capital is not needed. 3hat was needed was ability to get
a license and then get the pro6ect funded by the banks and 7!Is. In most cases, the promoters were
well+established industrial houses, with no apparent need for funds. 5ost of these entities were
capable of raising funds from conventional sources, including term loans from institutions and
e.uity markets.
3calaility
he Indian software segment has recorded an impressive growth over the last few years and earns
large revenues from its e"port earnings, yet our share in the global market is less than 1 per cent.
3ithin the software industry, the value chain ranges from body shopping at the bottom to strategic
consulting at the top. ,igher value addition and profitability as well as significant market presence
take place at the higher end of the value chain. If the industry has to grow further and survive the
flu" it would only be through innovation. !or any venture idea to succeed there should be a product
that has a growing market with a scalable business model. he I industry Gwhich is most suited for
99
venture funding because of its =ideas= natureH in India till recently had a service centric business
model. /roducts developed for Indian markets lack scale.
Mindsets
0enture capital as an activity was virtually non+e"istent in India. 5ost venture capital companies
want to provide capital on a secured debt basis, to established businesses with profitable operating
histories. 5ost of the venture capital units were offshoots of financial institutions and banks and the
lending mindset continued. rue venture capital is capital that is used to help launch products and
ideas of tomorrow. Abroad, this problem is solved by the presence of Tangel investors. hey are
typically wealthy individuals who not only provide venture finance but also help entrepreneurs to
shape their business and make their venture successful.
,eturns, Taxes and ,egulations
here is a multiplicity of regulators like $-DI and <DI. 7omestic venture funds are set up under the
Indian rusts Act of 1JJ( as per $-DI guidelines, while offshore funds routed through 5auritius
follow <DI guidelines. Abroad, such funds are made under the Fimited /artnership Act, which
brings advantages in terms of ta"ation. he government must allow pension funds and insurance
companies to invest in venture capitals as in #$A where corporate contributions to venture funds
are large.
!xit
he e"it routes available to the venture capitalists were restricted to the I/I route. Defore
deregulation, pricing was dependent on the erstwhile CCI regulations. In general, all issues were
under priced. -ven now $-DI guidelines make it difficult for pricing issues for an easy e"it. 8iven
the failure of the IC-I and the revised guidelines, small companies could not hope for a D$->
L$- listing. 8iven the dull market for mergers and ac.uisitions, strategic sale was also not
available.
Valuation
he recent phenomenon is valuation mismatches. hanks to the software boom, most promoters
have sky high valuation e"pectations. 8iven this, it is difficult for deals to reach financial closure as
promoters do not agree to a valuation. his coupled with the fancy for software stocks in the
bourses means that most companies are preponing their I/Is. Conse.uently, the number and
.uality of deals available to the venture funds gets reduced
9@
$ome other ma6or problems facing by venture capitalist in India are2
a. <e.uirement of an e"perienced management team.
b. <e.uirement of an above average rate of return on investment.
c. #ncertainty regarding the success of the product in the market.
d. Buestions regarding the infrastructure details of production like plant location, accessibility,
relationship with the suppliers and creditors, transportation facilities, labour availability etc.
e. he category of potential customers and hence the packaging and pricing details of the
product.
f. he size of the market.
g. 5a6or competitors and their market share.
h. $kills and raining re.uired and the cost of training.
i. !inancial considerations like return on capital employed G<IC-H, cost of the pro6ect, the
Internal <ate of <eturn GI<<H of the pro6ect, total amount of funds re.uired, ratio of owners
investment Gpersonnel funds of the entrepreneurH, borrowed capital, mortgage loans etc. in
the capital employed.
Pr!spets !& Venture Capital Finanin*
3ith the advent of liberalization, India has been showing remarkable growth in the economy in the
past 1& + 1( years. he government is promoting growth in capacity utilization of available and
ac.uired resources and hence entrepreneurship development, by liberalizing norms regarding
venture capital. 3hile only eight domestic venture capital funds were registered with $-DI during
1::;+1::J, 1@ funds have already been registered in 1:::+(&&&. Institutional interest is growing
and foreign venture investments are also on the rise. 5any state governments have also set up
venture capital funds for the I sector in partnership with the local state financial institutions and
$I7DI. hese include Andhra /aradesh, *arnataka, 7elhi, *erala and amil Ladu. he other states
are to follow soon.
In the year (&&&, the finance ministry announced the liberalization of ta" treatment for venture
capital funds to promote them A to increase 6ob creation. his is e"pected to give a strong boost to
9%
the non resident Indians located in the $ilicon 0alley and elsewhere to invest some of their capital,
knowledge and enterprise in these ventures. A Dangalore based media company, 8ray cell Ftd., has
recently obtained 0C investment totaling about K 1.) mn. he company would be creating and
marketing branded web based consumer products in the near future.
he following points can be considered as the harbingers of 0C financing in India2+
a. -"istence of a globally competitive high technology.
b. 8lobally competitive human resource capital.
c. $econd Fargest -nglish speaking, scientific A technical manpower in the world.
d. 0ast pool of e"isting and ongoing scientific and technical research carried by large number
of research laboratories.
e. Initiatives taken by the 8overnment in formulating policies to encourage investors and
entrepreneurs.
f. Initiatives of the $-DI to develop a strong and vibrant capital market giving the ade.uate
li.uidity and fle"ibility for investors for entry and e"it.
In a recent survey it has been shown that the 0C investments in India4s I.. + $oftware and services
sector Gincluding dot com companiesH+ have grown from #$ K 1%& million in 1::J to over #$K 1(&&
million in (&&J. he credit can be given to setting up of a Lational 0enture Capital !und for the
$oftware and I.. Industry GL!$IH in association with various financial institutions of $mall
Industries and 7evelopment Dank of India G$I7DIH. he facts reveal that 0C disbursements as on
$eptember 9&, (&&( made by L!$I totaled <s (%@.9; mn.
S!ure ///0e%aluese%r%e0!'
9;
CASE STUDY
0+Fink, the operator of 5eru a"is, began as a 5umbai+based operator of ta"icabs in (&&;. /rior to
5erus launch, cabs could not be reserved over the phone. he company owned a license from the
state to operate radio ta"is, but lacked funds for e"pansion.
he /- firm, I0!, invested IL< ( billion in 0Fink in (&&;, and took a ma6ority holding, enabling
the introduction of the 5eru brand. Apart from enabling scale, I0! brought in professionals. I0!
facilitated the recruitment process, attracting high+end talent from reputed companies, including
global organisations. It also created the franchising model based on a study of similar systems
globally, focused on air+conditioned cabs fitted with high technology, including data terminals and
8/$ systems in each 5eru cab. I0! also helped 0+Fink raise debt to purchase vehicles, standing in
as guarantor.
5eru e"panded by enrolling franchisees from the e"isting owners of ta"i licenses. he company
also added operations in ,yderabad, 7elhi and Dangalore. Dy 5arch (&1&, the company operated
9)
CIL$#5-< CI5/ALI-$
M!,= T"C;
Dearlier kno2n as V 8ink )vt' 8td'E
over @,&&& cabs, with plans to e"pand to 1&,&&&, thus consolidating its position as the largest
ta"icab operator in India.
!or better comfort of the passengers and to keep up with the changing times 5eru has been
upgrading its technology regularly. <ecently, the company installed an Iracle -</ system,
implemented by Accenture, which makes 5eru Cabs the first radio cabs service company in the
world to implement -</ systems.
As recognition of the pro+active and holistic approach to I adoption and the seamless alignment of
I with the business strategy, 5eru Cabs once again won 4LA$$CI5CLDC I #ser Award (&&:4
for the second time in a row.
;M)"CT 1- )! 1A M!,=
I0!s investment in 5eru was unusual for /- because of the relatively early stage at which funds
were committed. he taking of a ma6ority holding was also not typical of India, though more akin to
the western model. he difference with the western model was that the management of 5eru was
retained and strengthened. hus, 5eru was a test+bed of two new business ideas2 whether investing
in an idea at such an early stage made sense? and whether control the of e"isting management by the
/- firm would work.
he impact on 5eru is evident. he 5eru brand has become synonymous with airconditioned radio
ta"is. 3ithout /- investment, the companys professionalisation and development tra6ectory would
undoubtedly be slower? technological sophistication would likely have been lower, as well. he
combination of these two factors is that 5eru is not 6ust the largest ta"icab operator in India, but its
most technologically sophisticated.
;M)"CT 1- )! 1A T6! ;A4=3T,>
5eru took considerable risk in creating the 5eru brand. his is because the cost to users is
regulated by the state and does not differ between ta"icabs. 5eru relied on achieving a certain scale
of operations that would 6ustify the e"tra costs of airconditioning and I+enabled services.
,aving succeeded in this effort, 5erus impact on the industry is becoming evident in the shift to
me+too services offered by individual operators and the rise of competing franchises
9J
9:
FINDINGS
7uring the preparation of my report I have analyzed many things which are
following2+
A number of people in India feel that financial institution are not only
conservatives but they also have a bias for foreign technology A they do not
trust on the abilities of entrepreneurs.
$ome venture fails due to few e"it options. eam ignorant of international
standards. he team usually a two or three man team. It does not possess the
re.uired depth In top management. he team is often found to have
technical skills but does not possess the overall organization building skills
team is often short sited.
0enture capitalists in India consider the entrepreneurs integrity Aurge to
grow as the most critical aspect or venture evaluation.
-i'itati!ns !& Stu#$
&' he biggest limitation was time because the time was not sufficient as
there was lot of information to be got A to have it interpretation
(' he data re.uired was secondary A that was not easily available.
+' $tudy by its nature is suggestive A not conclusive
0' -"penses were high in collecting A searching the data.
@&
SUGGESTIONS
&' he investment should be in turnaround stage. $ince there are
many sick industries in India and the number is growing each
year, the venture capitalists that have specialized knowledge in
management can help sick industries. It would also be highly
profitable if the venture capitalist replace management either
good ones in the sick industries.
(' It is recommended that the venture capitalists should retain their
basic feature that is tasking high risk. he present situation may
compel venture capitalists to opt for less risky opportunities but
is against the spirit of venture capitalism. he established fact is
big gains are possible in high risk pro6ects.
+' here should be a greater role for the venture capitalists in the
promotion of entrepreneurship. he 0enture capitalists should
promote entrepreneur forums, clubs and institutions of learning
to enhance the .uality of entrepreneurship.

@1
CONC-USION
0enture capital can play a more innovation and development role in a
developing country like India. It could help the rehabilitation of sick unit
through people with ideas and turnaround management skill. A large number of
small enterprises in India because sick unit even before the commencement of
production of production. 0enture capitalist could also be in line with the
developments taking place in their parent companies.
Uet another area where can play a significant role in developing countries is the
service sector including tourism, publishing, healthcare etc. they could also
provide financial assistance to people coming out of the universities, technical
institutes etc. who wish to start their own venture with or without high+tech
content, but involving high risk. his would encourage the entrepreneurial
spirit.
It is not only initial funding which is need from the venture capitalists, but the
should also simultaneously provide management and marketing e"pertise+a real
critical aspect of venture capitalists, but they also simultaneously provide
management and marketing e"pertise+a real critical aspect of venture capital in
developing countries. 3hich can improve their effectiveness by setting up
venture capital cell in <A7 and other scientific generation, providing
syndicated or consortium financing and acing as business incubators.
@(
REFERENCES
&' 911K3
I.5. /anday+ venture capital development process in India
I. 5. /anday+ venture capital the Indian e"perience,
(' V",;1=3 A!$3 )")!,3
+' ;AT!,A!T
www.indiainfoline.com
www.vcapital.com
www.investopedia.com
www.vcinstitute.com
www.wikipedia.com
@9