Você está na página 1de 30



Introduction to venture capital

Meaning of venture capital
Venture capital (VC) is money provided to seed, early-stage, emerging
and emerging growth companies. The venture capital
funds invest in companies in exchange for equity in the
companies it invests in.
It is money provided by an outside investor to finance a
new, growing, or troubled business.
Definition- Start up companies with a potential to grow need a certain
amount of investment. Wealthy investors like to invest their capital in such
businesses with a long-term growth perspective. This capital is known as venture
capital and the investors are called venture capitalists.
According to bank of England quarterly bulletin of 1984,venture capital
investment is defined as an activity by which investors support entrepreneurial
talent with finance and business skills to exploit market opportunities and thus
obtain long-term capital gains.
The venture capitalist provides the funding knowing that theres a significant risk
associated with the companys future profits and cash flow. Capital is invested in
exchange for an equity stake in the business rather than given as a loan, and the
investor hopes the investment will yield a better-than-average return.
Venture capital is an important source of funding for start-up and other companies
that have a limited operating history and dont have access to capital markets. A
venture capital firm (VC) typically looks for new and small businesses with a
perceived long-term growth potential that will result in a large payout for investors.
A venture capitalist is not necessarily just one wealthy financier. Most VCs are
limited partnerships that have a fund of pooled investment capital with which to
invest in a number of companies. They vary in size from firms that manage just a
few million dollars worth of investments to much larger VCs that may have
billions of dollars invested in companies all over the world. VCs may be a small
group of investors or an affiliate or subsidiary of a large commercial bank,

investment bank, or insurance company that makes investments on behalf clients
of the parent company or outside investors. In any case, the VC aims to use its
business knowledge, experience and expertise to fund and nurture companies that
will yield a substantial return on the VCs investment, generally within three to
seven years.


New ventures: venture capital investment is generally made in new enterprises that
use new technology to produce new products, in expectation of high gains or
sometimes, spectacular returns.
Illiquidity: Easy liquidity by cashing out in the short-term is not an option for
venture capital funding. An IPO or buyout of a venture is how venture capitalists
disinvest. A premature IPO could undermine an otherwise successful company.
Alternatively an IPO released in a poor IPO market could also stall possibilities of
cash out.
Long-term commitment: Venture capital funds need to be latched in for a period of
few years before disinvestment. Investors who do not prefer illiquidity will attach a
premium to their funds, also known as liquidity risk premium. Therefore an
investor who can wait out the time horizon will benefit from this premium.
University endowments who seek VC funds to invest in are an example of such

Difficulty in determining current market values: It is

difficult to evaluate the current market value of the
portfolio of a VC.
Limited historical risk and return data and limited
information: Venture capital funds more often than not
invest in new and cutting edge industries of a sector,
where there is little historical data or continuous trading
data. It is also difficult to estimate cash flows or the
probability of success.

Entrepreneurial/management mismatches: Entrepreneurs

may face difficulties when there is dilution of ownership
and control. Bad management choices may scuttle a
good venture. Entrepreneurs sometimes find it difficult to
step up as the venture gains size.
Fund manager incentive mismatches: Investors interested
in well performing rather than large sized funds need to
find managers who match their investment objectives.
Knowledge of competition: As we discussed earlier since
most business that are funded are from nascent
industries it is difficult to assess the competition, than say
in established industries. A complete competitive analysis
is therefore difficult to undertake for a VC fund.
Vintage Cycles: Economic conditions vary from year to
year. During some years venture capital funding is plenty
and therefore returns for them low. In poor or stressed
market condition, even good firms find it difficult to find
VC funding.
Extensive Operation Analysis and Advice: Venture capital
funds that plan to invest in technology companies may
not have the required expertise to assess them. Financial
investment knowledge alone is not sufficient. Good fund
managers therefore require both operating and financial
analysis and advising skills. A fund manager who does
not understand the business will impede rather than
improve it.

Background on the Venture Capital Industry

Venture capital is private money to fund early-stage,

high-potential/high-risk, growth companies. The provider
of the money generally wants an equity stake and a
return of capital within five to ten years through:


An initial public offering (IPO) of the company, or

A sale of the company to a strategic investor,
usually a large and well-established technology company.

Long-term harvesting through dividends and share

buybacks are generally not used by venture capital firms,
for reasons discussed below.

Most venture capital is invested in high technology

industries such as software, computer hardware,
biotechnology, clean energy, and so forth. Yet some
venture capital firms invest in scalable low-tech business
ideas like consumer products and retail. Venture capital is
directed toward new companies with a limited operating
history, which are too small to raise capital in the public
markets, secure a bank loan, or complete a debt offering.
In exchange for the high risk that venture capital firms

assume by investing in smaller and less mature

companies, they get significant control over a companys
decisions (through board seats), plus a large portion of
the companys equity (so large that founders sometimes
call them vulture capitalists).

The startup game goes like this: An aspiring

entrepreneur starts with a team, an idea, and some
artificial currency (stock). Her goal is simple: to increase
the value of the business and so the stock, so she and her
team can cash out. The trick is to swap portions of the
stock for resources that make the business more
valuable: people, more and better ideas, and money. The
initial people want stock and they bring their ideas, or
intellectual property (designs, patents, contacts, trade
secrets, etc.). The venture capital firms give cash in
stages for the team to hit milestones to prove the
business. Yet at any point, the team can pull the plug, or
the business can die if the milestones arent met and the
venture capitalists dont give more capital. Game over.
Alternatively, the company can make a promising product
and so sell itself to a corporate acquirer or to the public
markets in an IPO. The entrepreneur and her team can
cash in and leave. Or they can double down and try to be
corporate managers. Success.

Venture capital firms are typically comprised of small

teams with technology backgrounds (scientists,

researchers), with business training from investment

banks or consulting firms, or with deep industry
experience. Venture capitalists bring managerial,
governance, and technical expertise, as well as capital, to
their investments. [Note: Confusingly, both a venture
capital firm and a partner/associate of a venture firm, a
venture capitalist, are both referred to as a VC]
Venture capitalists pool together funds for their
investments from institutional investors (pension funds,
foundations, endowments) and high net worth individuals,
through creating a partnership (most commonly a limited
partnership, where the venture firm is the general
partner, or GP, and the outside investor is the limited
partner, or LP).

Venture capital and startup generation are often

associated with job creation, the knowledge economy,
and business or technological innovation. One stunning
fact comes from Robert Litan, who directs research at the
Kauffman Foundation, which specializes in promoting
entrepreneurship and innovation in America: Between
1980 and 2005, virtually all net new jobs created in the
U.S. were created by firms that were 5 years old or less . .
. That is about 40 million jobs. That means the
established firms created no new net jobs during that
period.[12] The National Venture Capital Association
estimates there were 12.1 million jobs at venture-backed
companies in the US as of 2009, and those companies
accounted for 21% of US GDP.

Some of the themes from the history of venture capital


Origins with family offices of very wealthy families such

as the Phipps, Rockefellers, and Whitneys;
The influence of one man, George Doriot, in singlehandedly creating much of the modern venture capital
Early informal partnerships in Silicon Valley due to a
confluence of factors, most importantly the high-tech
semiconductor industry and offshoots of Fairchild
Great venture firms like KPCB, Sequoia, and NEA refining
the partnership-based model of investing with
institutional capital;
The loosening of ERISA rules and the boom and busts of
the 1980s and 1990s, in which success mixed with
An industry somewhat lost in the 2000s and searching for
a viable model again.
One of the most insightful sayings about the Valley has
been repeated by Don Valentine and John Doerr, two of
the most successful venture capitalists: Silicon Valley is
a state of mind.


Business expertise. Aside from the financial backing,
obtaining venture capital financing can provide a start-up
or young business with a valuable source of guidance and
consultation. This can help with a variety of business
decisions, including financial management and human
resource management. Making better decisions in these
key areas can be vitally important as your business
Additional resources. In a number of critical areas,
including legal, tax and personnel matters, a VC firm can
provide active support, all the more important at a key
stage in the growth of a young company. Faster growth
and greater success are two potential key benefits.
Connections. Venture capitalists are typically well
connected in the business community. Tapping into these
connections could have tremendous benefits.
Because VC firms are under strict supervision by
regulatory bodies, there are very few or no unscrupulous





Loss of control. The drawbacks associated with equity

financing in general can be compounded with venture
capital financing. You could think of it as equity financing
on steroids. With a large injection of cash and
professionaland possibly aggressiveinvestors, it is
likely that your VC partners will want to be involved. The
size of their stake could determine how much say they
have in shaping your companys direction.
Minority ownership status. Depending on the size of the
VC firms stake in your company, which could be more
than 50%, you could lose management control.
Essentially, you could be giving up ownership of your own
Bottom line: Would you rather own your own business or
partner in a larger, potentially more successful one?
Most VC firms do not release all the needed funds up
front. Rather, they usually release funds in stages with an
eye on the expansion of the business. This approach may
not be suitable for the business plan and might ruin the
Usually, VC firms want to close the deal and get their
investment back within three to five years. If your
business plan contemplates a longer timetable before


providing liquidity, VC funding may not be suitable for



The first professional investor to a deal at the start-up
stage is referred to as the Series A investor. This
investment is followed by middle and later stage funding
the Series B, C,and D rounds. The final rounds include
mezzanine, late stage and pre-IPO funding. AVC may
specialize in provide just one of these series of funding, or
may offer funding for all stages of the business life cycle.
Its important to know the preferences of the VC youre
approaching, and to clearly articulate what type of
funding youre seeking:
1. Seed Capital. If youre just starting out and have no
product or organized company yet, you would be seeking
seed capital. Few VCs fund at this stage and the amount
invested would probably be small. Investment capital
may be used to create a sample product, fund market
research, or cover administrative set-up costs.
2. Startup Capital. At this stage, your company would
have a sample product available with at least one
principal working full-time. Funding at this stage is also
rare. It tends to cover recruitment of other key
management, additional market research, and finalizing
of the product or service for introduction to the
3. Early Stage Capital. Two to three years into your
venture, youve gotten your company off the ground, a
management team is in place, and sales are increasing.


At this stage, VC funding could help you increase sales to

the break-even point, improve your productivity, or
increase your companys efficiency.
4. Expansion Capital. Your company is well established,
and now you are looking to a VC to help take your
business to the next level of growth. Funding at this stage
may help you enter new markets or increase your
marketing efforts. You should seek out VCs that specialize
in later stage investing.
5. Late Stage Capital. At this stage, your company has
achieved impressive sales and revenue and you have a
second level of management in place. You may be looking
for funds to increase capacity, ramp up marketing, or
increase working capital.
You may also be looking for a partner to help you find a
merger or acquisition opportunity, or attract public
financing through a stock offering. There are VCs that
focus on this end of the business spectrum, specializing in
recapitalizations. If you are planning an IPO, a VC may
also assist with mezzanine or bridge financing shortterm financing that allows you to pay for the costs
associated with going public.
A key factor for the VC will be risk versus return. The
earlier a VC invests, the greater are the inherent risks and
the longer is the time period until the VCs exit. It follows
that the VC will expect a higher return for investing at this
early stage, typically a 10 times multiple return in four to


seven years. A later stage VC may be seeking a two to

four times multiple return within two years.
VCs would be more interested in listening to
entrepreneurs who have a perfect exit strategy planned
for investors. There are various exit option for VC to cash
out their investment:

1) Initial Public Offering (IPO) : IPO is about offering

company shares in the market for public to buy or sell.
IPO constitutes the most preferred route for VC exit as it
offers flexibility to investors in terms of time, price and
quantity. Through this route, investors can decide when to
sell, at what price to sell and in what quantity to sell
depending upon the market scenario. IPO gives a perfect
opportunity to reap benefits for their investment.
2) Mergers & Acquisition: M&A offers an opportunity to
investors to sell company shares (partially /fully) to
another company. In this case, investors doesnt have
enough flexibility since pricing,timing and quantity are
decided simultaneously during the process and thereby
investors dont have control over the exit.
Entrepreneurs and investors can sale the business to
either strategic partner for a stake or allow bigger players
in the same industry to acquire.
3) Shares buyback: Company promoters or entrepreneur
can buy back the companys shares from Investors on a
fixed price after negotiation. For investors, this is the


least preferred route since ROI in this case is capped.

However, investors would like to go for this VC exit option
only when IPO & M&A route is not available to them and
company is not doing well in terms of meeting
expectations of investors.
4) Sale to Other Strategic Investor/Venture Capital Fund:
It is quite possible that VC prefer to offload their shares to
other strategic investors which could be either bigger
angel investors or venture capital funds who are ready to
put more money into the business.
Venture Capital partners always prefer exit option which
not only gives them their investment back but also offer
minimum protected return which they could have earned
easily by putting money into the open market investment

From a company's standpoint, here is how the whole

transaction looks. The company starts up and needs
money to grow. The company seeks venture capital firms
to invest in the company. The founders of the company
create a business plan that shows what they plan to do
and what they think will happen to the company over
time (how fast it will grow, how much money it will make,
etc.). The VCs look at the plan, and if they like what they
see they invest money in the company. The first round of
money is called a seed round. Over time a company will


typically receive 3 or 4 rounds of funding before going

public or getting acquired.
In return for the money it receives, the company gives
the VCs stock in the company as well as some control
over the decisions the company makes. The company, for
example, might give the VC firm a seat on its board of
directors. The company might agree not to spend more
than $X without the VC's approval. The VCs might also
need to approve certain people who are hired, loans, etc.
In many cases, a VC firm offers more than just money. For
example, it might have good contacts in the industry or it
might have a lot of experience it can provide to the
One big negotiating point that is discussed when a VC
invests money in a company is, "How much stock should
the VC firm get in return for the money it invests?" This
question is answered by choosing a valuation for the
company. The VC firm and the people in the company
have to agree how much the company is worth. This is
the pre-money valuation of the company. Then the VC
firm invests the money and this creates a post-money
valuation. The percentage increase in the value
determines how much stock the VC firm receives. A VC
firm might typically receive anywhere from 10% to 50%
of the company in return for its investment. More or less
is possible, but that's a typical range. The original
shareholders are diluted in the process. The shareholders
own 100% of the company prior to the VC's investment. If


the VC firm gets 50% of the company, then the original

shareholders own the remaining 50%.
Dot Coms typically use Venture Capital to start up
because they need lots of cash for advertising,
equipment, and employees. They need to advertise in
order to attract visitors, and they need equipment and
employees to create the site. The amount of advertising
money needed and the speed of change in the Internet
can make bootstrapping impossible. For example, many
of the eCommerce Dot Coms typically consume $50
million to $100 million to get to the point where they can
go public. Up to half of that money can be spent on




Angels are often retired entrepreneurs or executives who
want to optimize their experiences and networks and who
like to keep abreast of business developments. But they
are motivated beyond the pure money return they
desire to serve as mentors for the next generation of

An increasing number of angels are forming angel groups

or networks so they can pool their resources of wisdom
and capital and make bigger and better investments. Top
business sectors favored by angel investors in 2013


included software, media, healthcare services, biotech,

retail, and financial services.

Angel investors usually provide funding at the seed stage,

but they dont like to invest until the business owner has
shown initiative by placing his or her own capital at risk.
According to Jeffrey Sohl of the UNH Center for Venture
Research, angel investments totaled $24.8 billion in 2013.
That money benefited 70,730 entrepreneurial enterprises
and reflected an 8.3% increase from 2012.

Like angels, venture capitalists (VCs) invest in people,
products, and ideas. While the media is full of stories
about venture capitalists investing in startups, the truth is
that VCs seldom actually do. Typically, their role comes at
a later stage after seed-funding has been satisfied.

VCs often invest as a group and are typically willing to

invest in higher risk ventures than either angels or
private equity firms. This makes them very attractive to a
diverse mix of enterprises and to businesses that are too
small to raise capital in the public markets. According to
Geri Stengels Forbes article, Want Venture Capital? Here
are 10 Must-Haves, VCs like innovative market
disruptors that are capable of catapulting a venture into a


$100 million company, one that will capture

impressive slice of markets worth $1 billion or more.


Brian DeChesares article, Private Equity vs. Venture

Capital, explains that VCs are willing to take high risks
because they generate huge returns. They often stake
less than $10 million for early stage companies, but they
invest in dozens of them. Peter Cohans January, 2014
Forbes article explains the math. Only one out of ten of
VC portfolio companies become big winners. Of the rest,
three will succeed enough to recoup investments, and the
rest go out of business.

The National Venture Capital Association reports that

their investors have a history of interest in high
technology companies, but if a product is disruptive and
promising, they will also invest in more traditional
industries like consumer and business products,
manufacturing, and healthcare services.


Private equity (PE) firms raise funds sourced from high
net-worth individuals and institutional investors such as
pension funds, insurance companies, and endowments.
They invest these funds in a large cross-section of
industries. Their investments are fewer in number than
those made by angels and VCs but much larger in value.


If one investment fails, the whole PE fund could fail. Marv

Dumon in What is Private Equity, reports that most PE
firms deal with middle market transactions ($50 million to
$500 million) and lower market transactions ($10 million
to $50 million). They seek out existing companies that are
ripe for expansion or are under-optimized. They purport
to help a healthy enterprise fulfill their business vision or
expand their products and services by providing the
needed funds.
Big PE firms like The Carlyle Group, Kohlberg Kravis
Roberts, and The Blackstone Group are known for
investing in leveraged buyout (LBO) transactions in
mature companies. In an LBO the PE firm uses its own
equity plus a large amount of debt (leverage) that they
raise at the time of the deal to acquire a company or a
business unit. The target company is supposed to have
stable cash flows. The PE firms claim they make the
companies more efficient. Through higher efficiencies and
the power of leverage they hope to earn a high return on
their equity investment.
If your business is in the position to seek funding from a
private equity firm, quantify the PE firms capabilities,
confirm their connections, and be sure their expertise is
compatible with your business sector. This due diligence
can help lead to a very positive experience.
Sebi and venture capital funding
Regulations of Venture Capital:


VCF are regulated by the SEBI (Venture Capital Fund)

Regulations, 1996. The regulation clearly states that any
company or trust proposing to carry on activity of a VCF
shall get a grant of certificate from SEBI. Section 12 (1B)
of the SEBI Act also makes it mandatory for every
domestic VCF to obtain certificate of registration from
SEBI in accordance with the regulations. Hence there is
no way that an Indian Venture Capital Fund can exist
outside SEBI Regulations. However registration of Foreign
Venture Capital Investors (FVCI) is not mandatory under
the FVCI regulations.

A VCF and registered FVCI enjoy several benefits:

No prior approval required from the Foreign Investment
Promotion Board (FIPB)
for making investments into Indian Venture Capital
Undertakings (VCUs).
As per the Reserve Bank of India Notification No. FEMA
32 /2000-RB dated
December 26, 2000, an FVCI can purchase/ sell securities/
investments at a price
that is mutually acceptable to the parties and there is no
ceiling or floor restriction
applicable to them.
A registered FVCI has been granted the status of
Qualified Institutional Buyer


(QIB), so they can subscribe to the share capital of a VCU

at the time of intial
public offer. A lock-in of one year is applicable to the
shares subscribed in an IPO.
The lock-in period applicable for the pre-issue share
capital from the date of
allotment, under the SEBI (Disclosure and Investor
Protection) Guidelines, 2000
is not applicable in case of a registered FVCI and VCF.
Under the SEBI (Substantial Acquisition of Shares and
Takeover) Regulations,
1997 if the promoters want to buy back the shares from
FVCIs, it would not come
under the public offer requirements.

SEBI regulations
Main requirements under SEBI (Venture Capital Funds)
Regulations, 1996:

The following are the eligibility criteria for grant of a

certificate of registration as per regulation 4 of SEBI
(Venture Capital Funds) Regulations 1996.
For the purpose of grant of a certificate of registration,
the applicant has to fulfil the following, namely:-


(a) if the application is made by a company, -

memorandum of association has as its main
objective, the carrying on of the activity of a venture
capital fund;

it is prohibited by its memorandum and articles of
association from making an invitation to the public to
subscribe to its securities;

its director or principal officer or employee is
not involved in any litigation connected with the
securities market which may have an adverse bearing on
the business of the applicant;

its director, principal officer or employee has
not at any time been convicted of any offence involving
moral turpitude or any economic offence.


it is a fit and proper person.

(b) if the application is made by a trust, -


the instrument of trust is in the form of a
deed and has been duly registered under the provisions
of the Indian Registration Act, 1908 (16 of 1908);

the main object of the trust is to carry on the
activity of a venture capital fund;

the directors of its trustee company, if any, or
any trustee is not involved in any litigation connected
with the securities market which may have an adverse
bearing on the business of the applicant;

the directors of its trustee company, if any, or
a trustee has not at any time, been convicted of any
offence involving moral turpitude or of any economic


the applicant is a fit and proper person.

(c) if the application is made by a body corporate

(i )
it is set up or established under the laws of the
Central or State Legislature.


the applicant is permitted to carry on the
activities of a venture capital fund.


the applicant is a fit and proper person.

the directors or the trustees, as the case may
be, of such body corporate have not been convicted of
any offence involving moral turpitude or of any economic

the directors or the trustees, as the case may
be, of such body corporate, if any, is not involved in any
litigation connected with the securities market which may
have an adverse bearing on the business of the applicant.

(d) the applicant has not been refused a certificate by the

Board or its certificate has not been suspended under
regulation 30 or cancelled under regulation 31.

Application for Registration:

An applicant should apply for registration in form A

prescribed under First Schedule of SEBI (Venture Capital
Funds) Regulations 1996 along with requisite fees. All
documents should be enclosed as specified in the form.


While applying, please ensure that the main object clause

of the memorandum of the applicant company/ trust
deed, etc., as the case may be, permits you to carry on
venture capital fund activities. While applying, please also
submit the following additional information:

A complete list of your associate companies

registered with SEBI , and also indicate the
capacity in which they are registered along with
the SEBI Registration number

State whether the applicant is registered with SEBI in any capacity.


A complete list of your group companies registered with SEBI, and

also indicate the capacity in which they are registered with SEBI along
with their SEBI Registration number.



the applicant or the intermediary, as the case may be or its

time director or managing partner has been convicted by a Court for

any offence involving moral turpitude, economic offence, securities
laws or fraud

5. Whether any winding up orders have been passed against the applicant
or the intermediary


Whether any orders under the Insolvency Act have been passed
against the applicant or any of its directors, or person in management
and has not been discharged.


Whether any order restraining prohibiting or debarring the applicant or

its whole time director from dealing in securities in the capital market has
passed by SEBI or any other regulatory authority and a period of three
years from the date of the expiry of the period specified in the order has
not elapsed;


Whether any order canceling the certificate of registration of the

applicant on the ground of its indulging in insider trading, fraudulent and
unfair trade practices or market manipulation has been passed by SEBI
and a period of three years from the date of the order has not elapsed ;


Whether any order, withdrawing or refusing to grant any license/

approval to the applicant or its whole time director which has a bearing
on the capital market, has been passed by SEBI or any other regulatory
authority and a period of three years from the date of the order has not


Whether the applicant or its group/associate companies are listed on

any of the recognised stock exchange(s) in India. If so, please furnish the

10. (a) Details of registration of your company/associate/group companies
(to be given separately), which are registered/ required to be registered
with Reserve Bank of India (RBI) as a Banking company or Non Banking
Finance Company or in any other capacity andaddress(es) of concerned
branch office(s) of RBI.
(b) Details of disciplinary action taken by RBI against you or any of your
group/associate companies. Please also inform us in case there is any
default in repayment of deposits by you or any of your group / associate
Applicant can submit no objection certificate from RBI for getting registered
with SEBI, to expedite the registration process.
Other Documents to be submitted to SEBI

Memorandum and Articles of Association of applicant company,

executed copy of trust deed if the fund is being set up as a trust and
main objective of constitution in case of body corporate.




Disclose in detail the investment strategy as required under

regulation 12(a) of the SEBI (Venture Capital Funds) Regulations,
1996. Also state the target size of the fund along with the profile of
the investors of the fund.


An undertaking to the effect that the fund will not enter into any
venture capital activity if it fails to raise a commitment of at least Rs.
five crore as required under Regulation 11(3) of SEBI (Venture
Capital Funds) Regulations, 1996.


Copies of letters of commitment from investors in support of the

target amount proposed to be raised by the fund.


Undertaking that the venture capital fund will not make investment
in any area listed under Third Schedule to SEBI (Venture Capital
Funds) Regulations, 1996.








Venture Capital Fund shall disclose the duration/ life cycle of the

Grant of Certificate of Registration

Once all above requirements have been complied with
and requisite fees as per Second Schedule to Regulations
has been paid, SEBI will grant certification of registration as a
venture capital fund.