Venture - Capital in India

Venture Capital in India
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ACKNOWLEDGEMENT
It gives me immense pleasure in presenting the project on A STUDY ON
VENTURE CAPITAL IN INDIA. Firstly, I take the opportunity in thanking our
very dear principal MRS. ANCY JOSE, then I would like to thank the almighty
and my parents without whose continuous blessings, I would not have been able to
complete this project. I would like to thank my vice principal
MS. MONA MEHTA and my project guide PROF. G.H.RAO for their great,
valuable opinions, advice and supporting me, giving me encouragement and for
providing me with the material and knowledge to make this project a success. I
convey my deep appreciation to them for sparing their valuable time and efforts, so
as to make me capable of presenting this project. A project is one such avenue to
present our view, opinions and the skills that we possess to our teachers.
I am thankful to our college for all the possible assistance and support, specially
our library by making available the required books and internet room which have
proved useful to me in successful completing my project.. I also want to thank the
University of Mumbai. I hope that I have succeeded in presenting this project to
the best of my abilities.
JAINAM DOSHI
BMS SEMESTER VI
YEAR 2018-2019
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TABLE OF CONTENT
PAGE
1) FOREWORD
2) A BRIEF HISTORY
3) INTRODUCTION TO VENTURE CAPITAL

Difference between a Venture Capitalist and Bankers/Money Managers
Difference between Venture Finance & Debt Finance
4) VENTURE CAPITAL IN INDIA
5) CATEGORIZATION OF VC INVESTORS
6) CLASSIFICATION OF VENTURE FUNDS
7) VENTURE CAPITAL INVESTMENT PROCESS
8) ACCESSING VENTURE CAPITAL
9) REGULATORY SYSTEM
10) ISSUES FACING THE INDIAN VENTURE CAPITAL
11) MEASURES TO BE PROVIDED
12) FUTURE OF VENTURE CAPITAL IN INDIA
13) CONCLUSION
14) ANNEXURE
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FOREWORD
The Venture capital sector is the most vibrant industry in the financial market
today. Venture 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. Venture capital is an important
source of equity for start-up companies.
Venture capital can be visualized as “your ideas and our money” concept of
developing business. Venture capitalists are people who pool financial resources
from high networth individuals, corporates, pension funds, insurance companies,
etc. to invest in high risk - high return ventures that are unable to source funds
from regular channels like banks and capital markets. The venture capital industry
in India has really taken off in. Venture capitalists not only provide monetary
resources but also help the entrepreneur with guidance in formalizing his ideas into
a viable business venture.
Five critical success factors have been identified for the growth of VC in India,
namely:
 The regulatory, tax and legal environment should play an enabling role as
internationally
venture funds have evolved in an atmosphere of structural flexibility, fiscal
neutrality and operational adaptability.
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 Resource raising, investment, management and exit should be as simple and

flexible as needed and driven by global trends.
 Venture capital should become an institutionalized industry that protects

investors and investee firms, operating in an environment suitable for raising
the large amounts of risk capital needed and for spurring innovation through
start-up firms in a wide range of high growth areas.
 In view of increasing global integration and mobility of capital it is important

that Indian venture capital funds as well as venture finance enterprises are able
to have global exposure and investment opportunities.
 Infrastructure in the form of incubators and R&D need to be promoted using

government support and private management as has successfully been done by
countries such as the US, Israel and Taiwan. This is necessary for faster
conversion of R&D and technological innovation into commercial products.
With technology and knowledge based ideas set to drive the global economy in the
coming millennium, and given the inherent strength by way of its human capital,
technical skills, cost competitive workforce, research and entrepreneurship, India
can unleash a revolution of wealth creation and rapid economic growth in a
sustainable manner. However, for this to happen, there is a need for risk finance
and venture capital environment which can leverage innovation, promote
technology and harness knowledge based ideas.
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A BRIEF HISTORY
The story of venture capital is very much like the history of mankind. In the
fifteenth century, Christopher Columbus sought to travel westwards instead of
eastwards from Europe and so planned to reach India. His far –fetched idea did not
find favour with the King of Portugal, who refused to finance him. Finally, Queen
Isabella of Spain, decided to fund him and the voyages of Christopher Columbus
are now empanelled in history. And thus evolved the concept of Venture Capital.
The modern venture capital industry began taking shape in the post World War 2. It
is often said that people decide to become entrepreneurs because they see role
models in other people who have become successful entrepreneurs. Much the same
can be said about venture capitalists. The earliest members of the organized
venture capital industry had several role models, including these three:
American Research and Development Corporation:

Formed in 1946, whose biggest success was Digital Equipment. The founder of
ARD was General Georges Doroit, a French-born military man who is considered
"the father of venture capital." In the 1950s, he taught at the Harvard Business
School. His lectures on the importance of risk capital were considered quirky by
the rest of the faculty, who concentrated on conventional corporate management
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INTRODUCTION TO VENTURE CAPITAL
Venture Capital is defined as providing seed, start-up and first stage finance to
companies and also funding expansion of companies that have demonstrated
business potential but do not have access to public securities market or other credit
oriented funding institutions.
Venture Capital is generally provided to firms with the following characteristics:

 Newly floated companies that do not have access to sources such as equity
capital and/or other related instruments.
 Firms, manufacturing products or services that have vast growth potential.
 Firms with above average profitability.
 Novel products that are in the early stages of their life cycle.
 Projects involving above-average risk.
 Turnaround of companies.
Venture Capital derives its value from the brand equity, professional image,
constructive criticism, domain knowledge, industry contacts, they bring to table at
a significantly lower management agency cost.
A Venture Capital Fund (VCF) strives to provide entrepreneurs with the support
they need to create up-scalable business with sustainable growth, while providing
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their contributors with outstanding returns on investment, for the higher risks they
assume.
The three primary characteristics of venture capital funds which make them
eminently suitable as a source of risk finance are:
 that it is equity or quasi equity investment
 it is long term investment and
 it is an active form of investment.
Difference between a Venture Capitalist a Bankers/Money Managers:
 Banker is a manager of other people's money while the venture capitalist is
basically an investor.
 Venture capitalist generally invests in new ventures started by technocrats who

generally are in need of entrepreneurial aid and funds.
 Venture capitalists generally invest in companies that are not listed on any stock
exchanges. They make profits only after the company obtains listing.
 The most important difference between a venture capitalist and conventional

investors and mutual funds is that he is a specialist and lends management
support and also
• Financial and strategic planning.
• Recruitment of key personnel.
• Obtain bank and other debt financing.
• Access to international markets and technology.
• Introduction to strategic partners and ac quisition targets in the region.
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• Regional expansion of manufacturing and marketing operations.

• Obtain a public listing .
Difference between Venture Finance & Debt Finance
Venture Finance Debt Finance

Objective Maximize Return Interest payment
Holding 2-5 years Short/Long term

Period
Instruments Common shares, Convertible bonds, Loan,
Options, Warrants Factoring,leasing
Pricing Price earnings ratio, net tangible Interest spread
assets
Collateral Very Rare Yes
Ownership Yes No
Control Minority shareholders, rights Covenants
protection, board members
Impact on Reduced Leverage Increased Leverage
B/S
Exit Public offering, Sale to third party, Loan repayment
Mechanism Sale to entrepreneur
VENTURE CAPITAL IN INDIA
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Most of the success stories of the popular Indian entrepreneurs like the Ambanis
and Tatas had little to do with a professionally backed up investment at an early
stage. In fact, till very recently, for an entrepreneur starting off on his own personal
savings or loans raised through personal contacts/financial institutions.
Traditionally, the role of venture capital was an extension of the developmental

financial institutions like IDBI, ICICI, SIDBI and State Finance Corporations
(SFCs). The first origins of modern Venture Capital in India can be traced to the
setting up of a Technology Development Fund (TDF) in the year 1987-88, through
the levy of a cess on all technology import payments. TDF was meant to provide
financial assistance– to innovative and high-risk technological programs through
the Industrial Development Bank of India. This measure was followed up in
November 1988, by the issue of guidelines by the (then) Controller of Capital
Issues (CCI). These stipulated the framework for the establishment and operation
of funds/companies that could avail of the fiscal benefits extended to them.
However, another form of venture capital which was unique to Indian conditions
also existed. That was funding of green-field projects by the small investor by
subscribing to the Initial Public Offering (IPO) of the companies. Companies like
Jindal Vijaynagar Steel, which raised money even before they started constructing
their plants, were established through this route.
The industry’s growth in India can be considered in two phases. The first phase
was spurred on soon after the liberalization process began in 1991. According to
former finance minister and harbinger of economic reform in the country,
Manmohan Singh, the government had recognized the need for venture capital as
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early as 1988. That was the year in which the Technical Development and
Information Corporation of India (TDICI, now ICICI ventures) was set up, soon
followed by Gujarat Venture Finance Limited (GVFL). Both these organizations
were promoted by financial institutions. Sources of these funds were the financial
institutions, foreign institutional investors or pension funds and high net-worth
individuals. Though an attempt was also made to raise funds from the public and
fund new ventures, the venture capitalists had hardly any impact on the economic
scenario for the next eight years.
However, it was realized that the concept of venture capital funding needed to be
institutionalized and regulated. This funding requires different skills in assessing
the proposal and monitoring the progress of the fledging enterprise. In 1996, the
Securities and Exchange Board of India (SEBI) came out with guidelines for
venture capital funds has to adhere to, in order to carry out activities in India. This
was the beginning of the second phase in the growth of venture capital in India.
The move liberated the industry from a number of bureaucratic hassles and paved
the path for the entry of a number of foreign funds into India. Increased
competition brought with it greater access to capital and professional business
practices from the most mature markets.
There are a number of funds, which are currently operational in India and involved
in funding start-up ventures. Most of them are not true venture funds, as they do
not fund start-ups. What they do is provide mezzanine or bridge funding and are
better known as private equity players. However, there is a strong optimistic
undertone in the air. With the Indian knowledge industry finally showing signs of
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readiness towards competing globally and awareness of venture capitalists among

entrepreneurs higher than ever before, the stage seems all set for an overdrive.
The Indian Venture Capital Association (IVCA) is the nodal center for all venture
activity in the country. The association was set up in 1992 to co-ordinate the
activities of venture capital financing in India and it has over the last few years, has
built up an impressive database.
IVCA members function under different categories:
 As companies involved in investment and fund management
 As companies which set up funds and manage assets.
 As companies which manage domestic funds, offshore funds, and sometimes
both.
A comprehensive survey of the venture capital industry in India was done. This
survey was conducted under the aegis of Indian Venture Capital Association
(IVCA) by Thomson Financial (Venture Economics) and PRIME Database. The
field survey was launched in October 2001 and completed in May 2002.
Some Highlights of the Survey are as follows:
 In 2001, India ranked as third most active VC market in Asia Pacific (excluding
Japan).
 Venture funds invested $907.58 million in Indian companies in 2001, down

21.8% on 2000.
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 Number of companies receiving investment declined 62.6% to 101, from 270 in

2000.
 VC funds disbursing investments declined to 57 in 2001 from 88 in 2000 but

the average investment value of each deal rose from $3.85 million to $7.89
million.
 Communications and media experienced the largest rise in investment in 2001,

rising from $93.75 million in 2000 to $585.02 million.
 Overall, India saw a shift to later stage investing with expansion stage funds
accounting for 60.0% of disbursements in 2001, compared to 44.3% in 2000.
 19 exits were achieved in 2001.
In India, venture funds are governed by the Securities and Exchange Board of
India (SEBI) guidelines. For accessing venture capital funding the venture should
be typically started by a first generation entrepreneur with high growth potential
and an innovative concept. Normally these types of ventures do not have any assets
to offer as collateral, which is needed to get funding from the conventional sources.
Venture capital funding may be by way of investment in the equity of the new
enterprise or a combination of debt and equity, though equity is the most preferred
route.
There are a number of funds currently operational in India and involved in funding
start-up ventures. Most of them are not true venture funds, as they do not fund
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start-ups. What they do is provide mezzanine or bridge funding and are better
known as private equity players. However, all this has changed in the last one year.
With the Indian knowledge industry finally showing signs of readiness towards
competing globally and awareness of venture capitalists among entrepreneurs
higher than ever before, venture capitalists are really venturing out in funding new
ideas and concepts particularly in internet related areas.
Certain venture capital funds are Industry specific (i.e. they fund enterprises only
in certain industries such as pharmaceuticals, Infotech or food processing) whereas
others may have a much wider spectrum. Again, certain funds may have a
geographic focus – like Uttar Pradesh, Maharashtra, Kerala, etc whereas others
may fund across different territories. The funds may be either close-ended schemes
(with a fixed period of maturity) or open-ended.
CATEGORIZATION OF VC INVESTORS
The "venture funds" available could be from:

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 Incubators.
 Angel Investors.
 Venture Capitalists (VCs).
 Private Equity Players.
Incubators:
An incubator is a hardcore technocrat who works with an entrepreneur to develop a
business idea, and prepares a Company for subsequent rounds of growth &
funding. eVentures, Infinity are examples of incubators in India.
Angel Investors:
An angel is an experienced industry-bred individual with high net worth.
Typically, an angel investor would:
 invest only his chosen field of technology.
 take active participation in day-to-day running of the Company.
 invest small sums in the range of USD 1 - 3 million.
 not insist on detailed business plans.
 sanction the investment in up to a month.
 help company for "second round" of funding.
The IndUS Entrepreneurs (TiE) is a classic group of angels like: Vinod Dham,
Sailesh Mehta, Kanwal Rekhi, Prabhu Goel, Suhas Patil, Prakash Agarwal, K.B.
Chandrashekhar. In India there is a lack of home grown angels except a few like
Saurabh Srivastava & Atul Choksey (ex-Asian Paints).
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Venture Capitalists (VCs):
VCs are organizations raising funds from numerous investors & hiring experienced
professional mangers to deploy the same. They typically:
 invest at “second” stage.
 invest over a spectrum over industry/ies.
 have hand-holding “mentor” approach.
 insist on detailed business plans.
 invest into proven ideas/businesses.
 provide “brand” value to investee.
 invest between USD 2 – 5 million.
Private Equity Players

They are established investment bankers. Typically:
 invest into proven/established businesses
 have “financial partners” approach
 invest between USD 5 –100 million
CLASSIFICATION OF VENTURE FUNDS
Venture funds in India can be classified on the basis of
 Base formation
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Financial Institutions
1. Private venture funds like Indus, etc.
2. Regional funds like Warburg Pincus, JF Electra (mostly operating out of
Hong Kong).
3. Regional funds dedicated to India like Draper, Walden, etc
4. Offshore funds like Barings, TCW, HSBC, etc.
5. Corporate ventures like Intel.
To this list we can add Angels like Sivan Securities, Atul Choksey (ex Asian
Paints) and others. Merchant bankers and NBFCs who specialized in "bought
out" deals also fund companies. Most merchant bankers led by Enam Securities
now invest in IT companies.
 Invested Amount
The amount invested is generally between US$1mn or US$10mn. As most
funds are of a private equity kind, size of investments has been increasing. IT
companies generally require funds of about Rs30-40mn in an early stage which
fall outside funding limits of most funds and that is why the government is
promoting schemes to fund start ups in general, and in IT in particular.
 Investment Philosophy
Early stage funding is avoided by most of the venture capital firms since the
amount of risk associated with it is higher and private capital cannot be
invested. So to bring down this gap the seed capital or the early stage financing
is provided by ICICI, Draper, etc.
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 Value Addition
The infusion of funds by overseas funds, private individuals, ‘angel’ investors
and a host of financial intermediaries and the total pool of Indian Venture
Capital today, stands at Rs50bn, according to industry estimates. In the last two
years, there have been just 74 initial public offerings (IPOs) at the stock
exchanges, leading to an investment of just Rs14.24bn. That’s less than 12% of
the money raised in the previous two years. That makes the conservative
estimate of Rs36bn invested in companies through the Venture Capital/Private
Equity route all the more significant.
 Consortium Financing
Where the project cost is high (Rs 100 million or more) and a single fund is not
in a position to provide the entire venture capital required then venture funds
may act in consortium with other funds and take a lead in making investment
decisions. This helps in diversifying risk but however it has not been very
successful in the India case.
Some of the companies that have received funding through this route include:
 Mastek one of the oldest software houses in India
 Geometric Software a producer of software solutions for the CAD/CAM

market
 SQL Star, Hyderabad based training and software development company

 Satyam Infoway, the first private ISP in India
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 Rediff on the Net, Indian website featuring electronic shopping, news, chat,
etc
 Planetasia.com, Microland’s subsidiary, one of India’s leading portals
 Torrent Networking, pioneer of Gigabit-scaled IP routers for inter/intra nets
 Selectica, provider of interactive software selection
 Yantra, ITLInfosys’ US subsidiary, solutions for supply chain management.
The Infotech companies are the most favored by venture capitalists, companies
from other sectors also feature equally in their portfolios. The other sectors such as
pharmaceutical, medical appliances and biotechnology industries also get much
preference. With the deregulation of the telecom sector, telecommunications
industries have joined the list of favorites. However, recent developments have
shown that India is maturing into a more developed marketplace, unconventional
investments in a gamut of industries have sprung up all over the country.
VENTURE CAPITAL INVESTMENT PROCESS
In generating a deal flow, the venture capital investor creates a pipeline of ‘deals’
or investment opportunities that he would consider investing in. This is achieved
primarily through plugging into an appropriate network. The most popular network
obviously is the network of venture capital funds/investors. It is also common for
venture capitals to develop working relationships with R&D institutions, academia,
etc, which could potentially lead to business opportunities.
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Understandably the composition of the network would depend on the investment

focus of the venture capital funds/company. Thus venture capital funds focussing
on early stage technology based deals would develop a network of R&D centers
working in those areas. The network is crucial to the success of the venture capital
investor. It is almost imperative for the venture capital investor to receive a large
number of investment proposals from which he can select a few good investment
candidates finally.
First, you need to work out a business plan. The business plan is a document that
outlines the management team, product, marketing plan, capital costs and means of
financing and profitability statements.
1. Initial Evaluation: This involves the initial process of assessing the feasibility
of the project.
2. Due diligence: In this stage an in-depth study is conducted to analyse the

feasibility of the project.
3. Deal structuring and negotiation: Having established the feasibility, the

instruments that give the required return are structured.
4. Investment valuation
5. Documentation: This is the process of creating and executing legal documents
to protect the interest of the venture.
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6. Monitoring and Value addition: In this stage, the project is monitored by

executives from the venture fund and undesirable variations from the business
plan are dealt with.
7. Exit: This is the final stage where the venture capitalist devises a method to
come out of the project profitably.
1. Initial Evaluation:
Before any in depth analysis is done on a project, an initial screening is carried
out to satisfy the venture capitalist of certain aspects of the project. These
include
 Competitive aspects of the product or service
 Outlook of the target market and their perception of the new product
 Abilities of the management team
 Availability of other sources of funding
 Expected returns
 Time and resources required from the venture capital firm
Through this screening the venture firm builds an initial overview about the
 Technical skills, experience, business sense, temperament and ethics of the
promoters
 The stage of the technology being used, the drivers of the technology and the
direction in which it is moving.
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 Location and size of market and market development costs, driving forces of
the market, competitors and share, distribution channels and other market
related issues
 Financial facts of the deal
 Competitive edge available to the the company and factors affecting it
significantly
 Advantages from the deal for the venture capitalist
 Exit options available
2. Due diligence
Due diligence is term used that includes all the activities that are associated with
investigating an investment proposal to assess feasibility. It includes carrying out
in-depth reference checks on the proposal related aspects such as management
team, products, technology and market. Additional studies and collection of
project-based data are done during this stage. The important feature to note is that
venture capital due diligence focuses on the qualitative aspects of an investment
opportunity.
Areas of due diligence would include

 General assessment
 Business plan analysis
 Contract details
 Collaborators
 Corporate objectives
 SWOT analysis
 Time scale of implementation.
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 People
 Managerial abilities, past performance and credibility of promoters
 Financial background and feedback about promoters from bankers and
previous lenders
 Details of Board of Directors and their role in the activities
 Availability of skilled labour.
 Recruitment process
 Products/services, technology and process

In this category the type of questions asked will depend on the nature of the
industry into which the company is planning to enter. Some of the areas generally
considered are
 Technical details, manufacturing process and patent rights

 Competing technologies and comparisons
 Raw materials to be used, their availability and major suppliers, reliability
of these suppliers
 Machinery to be used and its availability
 Details of various tests conducted regarding the new product
 Product life-cycle
 Environment and pollution related issues
 Secondary data collection on the product and technology, if so available
 Market
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The questions asked under this head also vary depending on the type of product.
Some of the main questions asked are
 Main customers
 Future demand for the product
 Competitors in the market for the same product category and their strategy
 Pricing strategy
 Potential entrants and barriers to entry
 Supplier and buyer bargaining power
 Channels of distribution
 Marketing plan to be followed
 Future sales forecasts
 Finance
 Financial forecasts for the next 3-5 years
 Analysis of financial reports and balance sheets of firms already promoted or
run by the promoters of the new venture
 Cost of production
 Wage structure details
 Accounting process to be used
 Financial report of critical suppliers
 Returns for the next 3-5 years and thereby the returns to the venture fund
 Budgeting methods to be adopted and budgetary control systems
 External financial audit if required
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Sometimes, companies may have experienced operational problems during their

early stages of growth or due to bad management. These could result in losses or
cash flow drains on the company. Sometimes financing from venture capital may
end up being used to finance these losses. They avoid this through due diligence
and scrutiny of the business plan.
3. Structuring a deal:
Structuring refers to putting together the financial aspects of the deal and
negotiating with the entrepreneurs to accept a venture capital’s proposal and finally
closing the deal. Also the
structure should take into consideration the various commercial issues (i.e. what
the entrepreneur wants and what the venture capital would require to protect the
investment). The instruments to be used in structuring deals are many and varied.
The objective in selecting the instrument would be to maximize (or optimize)
venture capital’s returns/protection and yet satisfy the entrepreneur’s requirements.
The instruments could be as follows:
Instrument Issues
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Equity shares New or vendor shares

Par value
Partially-paid shares
Preference Redeemable (conditions under Company
shares Act)
Participating
Par value
Nominal shares
Loan Clean v/s Secured
Interest bearing v/s Non interest bearing
convertible v/s one with features
(warrants)
1st Charge, 2nd Charge,
Loan v/s Loan stock

Warrants Exercise price, Exercise period
Options Exercise price, Exercise period, call, put
In India, straight equity and convertibles are popular and commonly used.
Nowadays, warrants are issued as a tool to bring down pricing. A variation that was
first used by PACT and TDICI was "royalty on sales". Under this, the company
was given a conditional loan. If the project was successful, the company had to pay
a percentage 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. Even for the proposed investment
amount, the venture capital decides whether or not the amount requested, is
appropriate and consistent with the risk
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level of the investment. The risks should be analyzed, taking into consideration the
stage at which the company is in and other factors relating to the project. (e.g. exit
problems, etc).A typical proposal may include a combination of several different
instruments listed above. Under normal circumstances, entrepreneurs would prefer
venture capitals to invest in equity, as this would be the lowest risk option for the
company. However from the venture capitals point of view, the safest instrument,
but with the least return, would be a secured loan. Hence, ultimately, what you end
up with would be some instruments in between which are sold to the entrepreneur.
A number of factors affect the choice of instruments, such as –
Categories Factors influencing the choice of Instrument

Company specific Risk, current stage of operation, expected profitability,
future cash flows, investment liquidity options.
Promoter specific Current financial position of promoters, performance
track record, willingness of promoters to dilute stake.
Product/Project Future market potential, product life cycle, gestation
specific
Macro environment Tax options on different instruments, legal framework,
period.
policies adopted by competition.
4. Investment valuation:
The investment valuation process is an exercise aimed at arriving at ‘an
acceptable price’ for the deal. Typically in countries where free pricing regimes
exist, the valuation process goes through the following steps:
1) Evaluate future revenue and profitability.
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2) Forecast likely future value of the firm based on experienced market

capitalization or expected acquisition proceeds depending upon the anticipated
exit from the investment.
3) Target ownership positions in the investee firm so as to achieve desired

appreciation on the proposed investment. The appreciation desired should yield
a hurdle rate of return on a Discounted Cash Flow basis.
4) Symbolically the valuation exercise may be represented as follows:

NPV = [(Cash)/(Post)] x [(PAT x PER)] x k,
Where
a) NPV = Net Present Value of the cash flows relating to the investment
comprising outflow by way of investment and inflows by way of
interest/dividends (if any) and realization on exit. The rate of return used for
discounting is the hurdle rate of return set by the venture capital investor.
b) Post = Pre + Cash
c) Cash represents the amount of cash being brought into the particular round
of financing by the venture capital investor.
d) ‘Pre’ is the pre-money valuation of the firm estimated by the investor. While
technically it is measured by the intrinsic value of the firm at the time of raising
capital. It is more often a matter of negotiation driven by the ownership of the
company that the venture capital investor desires and the ownership that
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founders/management team is prepared to give away for the required amount of

capital.
e) PAT is the forecast Profit after tax in a year and often agreed upon by the
founders and the investors (as opposed to being ‘arrived at’ unilaterally). It
would also be the net of preferred dividends, if any.
f) PER is the Price-Earning multiple that could be expected of a comparable

firm in the industry. It is not always possible to find such a ‘comparable fit’ in
venture capital situations. That necessitates, therefore, a significant degree of
judgement on the part of the venture capital to arrive at alternate PER scenarios.
g) ‘k’ is the present value interest factor (corresponding to a discount rate ‘r’)
for the investment horizon.
It is quite apparent that PER time PAT represents the value of the firm at that time
and the complete expression really represents the investor’s share of the value of
the investee firm. In reality the valuation of the firm is driven by a number of
factors. The more significant among these are:
 Overall economic conditions: A buoyant economy produces an optimistic
long- term outlook for new products/services and therefore results in more
liberal pre-money valuations.
 Demand and supply of capital: when there is a surplus of venture capital of

venture capital chasing a relatively limited number of venture capital deals,
- 29 -
valuations go up. This can result in unhealthy levels of low returns for venture
capital investors.
 Specific rates of deals: such as the founder’s/management team’s track record,

innovation/ unique selling propositions (USPs), the product/service size of the
potential market, etc affects valuations in an obvious manner.
 The degree of popularity of the industry/technology in question also

influences the pre-money. Computer Aided Skills Software Engineering
(CASE) tools and Artificial Intelligence were one time darlings of the venture
capital community that have now given place to biotech and retailing.
 The standing of the individual venture capital: Well established venture

capitals who are sought after by entrepreneurs for a number of reasons could get
away with tighter valuations than their less known counterparts.
 Investor’s considerations could vary significantly: A study by an American

venture capital, Venture One, revealed the following trend. Large corporations
who invest for strategic advantages such as access to technologies, products or
markets pay twice as much as a professional venture capital investor, for a
given ownership position in a company but only half as much as investors in a
public offering.
 Valuation offered on comparable deals around the time of investing in the deal.
- 30 -
Quite obviously, valuation is one of the most critical activities in the investment
process. It would not be improper to say that the success for a fund will be
determined by its ability to value/price the investments correctly. Sometimes the
valuation process is broadly based on thumb rule metrics such as multiple of
revenue. Though such methods would appear rough and ready, they are often based
on fairly well established industry averages of operating profitability and
assets/capital turnover ratios.
Such valuation as outlined above is possible only where complete freedom of

pricing is available. In the Indian context, where until recently, the pricing of
equity issues was heavily regulated, unfortunately valuation was heavily
constrained.
5. Documentation
It is the process of creating and executing legal agreements that are needed by the
venture fund for guarding of investment.
Based on the type of instrument used the different types of agreements are
 Equity Agreement
 Income Note Agreement
 Conditional Loan Agreement
 Optionally Convertible Debenture Agreement etc.
There are also different agreements based on whether the agreement is with the
promoters or the company. The different legal documents that are to be created and
executed by the venture firm are
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 Shareholders agreement: This agreement is made between the venture

capitalist, the company and the promoters. The agreement takes into account
 Capital structure
 Transfer of shares: This lays the condition for transfer of equity between the
equity holders. The promoters cannot sell their shares without the prior
permission of the venture capitalist.
 Appointment of Board of Directors
 Provisions regarding suspension/cancellation of the investment. The issues
under which such cancellation or suspension takes place are default of
covenants and conditions, supply of misleading information, inability to pay
debts, disposal and removal of assets, refusal of disbursal by other financial
institutions, proceedings against the company, and liquidation or dissolution
of the company.
 Equity subscription agreement: This is the agreement between the venture

capitalist and the company on
 Number of shares to be subscribed by the venture capitalist
 Purpose of the subscription
 Pre-disbursement conditions that need to be met
 Submission of reports to the venture capitalist
 Currency of the agreement.
 Deed of Undertaking: The agreement is signed between the promoters and the
venture capitalist wherein the promoter agrees not to withdraw, transfer, assign,
pledge, hypothecate etc their investment without prior permission of the venture
- 32 -
capitalist. The promoters shall not diversify, expand or change product mix
without permission.
 Income Note Agreement: It contains details of repayment, interest, royalty,

conversion, dividend etc.
 Conditional Loan Agreement: It contains details on the terms and conditions

of the loan, security of loan, appointment of nominee directors etc.
 Deed of Hypothecation, Shortfall Undertaking, Joint and Several Personal

Guarantee, Power of Attorney etc.
Whenever there is a modification in any of the agreements, then a Supplementary

Agreement is created for the same.
6. Monitoring and follow up:

The role of the venture capitalist does not stop after the investment is made in the
project. The skills of the venture capitalist are most required once the investment is
made. The venture capitalist gives ongoing advice to the promoters and monitors
the project continuously.
It is to be understood that the providers of venture capital are not just financiers or
subscribers to the equity of the project they fund. They function as a dual capacity,
as a financial partner and strategic advisor.
- 33 -
Venture capitalists monitor and evaluate projects regularly. They are actively
involved in the management of the of the investor unit and provide expert business
counsel, to ensure its survival and growth. Deviations or causes of worry may alert
them to potential problems and they can suggest remedial actions or measures to
avoid these problems. As professional in this unique method of financing, they
may have innovative solutions to maximize the chances of success of the project.
After all, the ultimate aim of the venture capitalist is the same as that of the
promoters – the long term profitability and viability of the investor company.
The various styles are:

Hands-on Style suggests supportive and direct involvement of the venture
capitalist in the assisted firm through Board representation and regularly advising
the entrepreneur on matters of technology, marketing and general management.
Indian venture capitalists do not generally involve themselves on a hands-on basis
bit they do have board representations.
Hands-off Style involves occasional assessment of the assisted firms management

and its performance with no direct management assistance being provided. Indian
venture funds generally follow this approach.
Intermediate Style venture capital funds awe entitled to obtain on a regular basis
information about the assisted projects.
7. Exit:
One of the most crucial issues is the exit from the investment. After all, the return
to the venture capitalist can be realized only at the time of exit. Exit from the
investment varies from the investment to investment and from venture capital to
- 34 -
venture capital. There are several exit routes, buy-buck by the promoters, sale to
another venture capitalist or sale at the time of Initial Public Offering, to name a
few. In all cases specialists will work out the method of exit and decide on what is
most profitable and suitable to both the venture capitalist and the investor unit and
the promoters of the project.
At present many investments of venture capitalists in India remain on paper, as

they do not have any means of exit. Appropriate changes have to be made to the
existing systems in order that venture capitalists find it easier to realize their
investments after holding on to them for a certain period of time. This factor is
even more critical to smaller and mid sized companies, which are unable to get
listed on any stock exchange, as they do not meet the minimum requirements for
such listings. Stock exchanges could consider how they could assist in this matter
for listing of companies keeping in mind the requirement of the venture capital
industry.
To provide the lenders with additional security, a Special Purpose Vehicle (SPV)
can be created, which would hold the shares bought back from the venture
capitalist firm in a trust until the firm achieves a certain targeted rate of return.
Meanwhile a certain proportion of the firm’s sale proceeds can be funneled directly
to the SPV amortize the debt. An exit via the capital market is certainly less
expensive but this option is open only to the more established firms. A listing on a
stock exchange, which would enable the venture capitalist to easily off-load his
stake, is obviously a far more feasible proposition for a firm already in existence
for a few years than for a new venture. There are stiff capital requirements for
listing on either the BSE or the NSE, the minimum capital requirement is RS. 10
- 35 -
Crore. While the OTCEI would have been an ideal solution for a young company
contemplating listing, since its inception in 1992, the Exchange has been plagued
by poor liquidity, negative returns and a general lack of investor interest.
Even if the OTCEI does manage to perk up, it cannot be expected that small
startups will enlist. Global experience indicates that, despite liberal admission
requirements, OTCEs for unlisted securities tend to be dominated by fast growing
or medium size companies.
Special Purpose Vehicle:
An account, administered by a third party, that holds shares bought back by the
management in trust.
- 36 -
Advantages of SPV
 Greater security for lenders
 Improves credit rating
 Lowers the cost of capital
Disadvantage of SPV
 Less control over cash flows generated by project
 Tax treatment of SPV still unclear
 Administration fees can be high
ACCESSING VENTURE CAPITAL
There is a surge in the number of venture funds and the amount of funding
- 37 -
available in the last one year. The rejection ratio is very high, with very few of the
proposals going beyond even the pre-evaluation stage. Choosing a venture capital
fund to match your requirement is a difficult decision. Venture capital funds are
broadly of two kinds - generalists or specialists. It is critical for the company to
access the right type of fund, i.e. who can add value. This backing is invaluable as
focused/ specialized funds open doors, assist in future rounds and help in strategy.
Hence, it is important to choose the right venture capitalist.
1. The Business Plan

The first step towards accessing venture capital funding is the preparation of the
business plan. The business plan should be able to provide information regarding
the promoters, amount of funding needed and the time period for which it is
needed and how this funding is going to be paid back to the VC. To answer the
above fundamental queries of a venture capital firm the business plan is to be
structured with the necessary information.
BUSINESS PLAN COVERAGE
1. Executive summary
 A brief description of the company and the type of business
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 A summary of the business nature

 A description of the experience and expertise of the management team
 A summary of the product/service and competition
 A summary of financial history and projections
 Funds required and equity offered to the investors
 A description of use of proceeds
 The timing of returns on investment and exit routes offered to the investor
2. Business background
 A brief history and nature of the business

 The industry details of the business involved in
 A summary of the future of the business
3. Product/service
 A description of the product or service

 The uniqueness of the product
 The present status of the product, that is a concept, prototype or product ready
for market
4. Market analysis
 The size of the potential market and market niche being pursued
 A projection of the trends and future size of the market place
 The estimated market share
 A description of the competition
 The marketing channel
 A summary of the potential customers
 The possibility of related or new markets that can be developed
5. Sales and marketing strategy
 The specific marketing techniques planned to be used

 The pricing plans and comparisons with pricing adopted by competitors
 The planned sales force and selling strategies for various accounts and markets
- 39 -
 The specific approaches for capitalizing on each m marketing channel and

comparison with other practices within the industry
 Details of advertising and promotional plans
 A description of customer service-which markets will be covered by direct sales
force, which by distributors, representative or resellers
6. Production/operations
 A description of the production process

 Details of the production costs, including labour force, equipment, technology
involved, extent of subcontract or outsourcing, supplier
7. Management
 An organization chart showing the corporate structure

 A summary of the board of directors and key employees and details of their
skills and experience A list of the remuneration for all levels of staff
 A proposed plan of how to retain key staff.
8. Risk factors
 A description of the major problems and risks relating to the industry, the
company and the products market.
9. Funds requested
 A description of the type of financing, such as equity only or a combination of

equity and loan, and stock options to the investor
 The capital structure and ownership before and after the financing.
10.Return on investment and exit
 Details of the timing and expected return of the investment

 A summary of the exit strategies, such as initial public offering, sale to a third
party or management buyout
- 40 -
11.Use of proceeds
 Specify how the capital will be spent, i.e. what amount of capital will go to
which items
12.Financial summaries
 A summary of the company’s financial history and projections of three to five

year period
 Details of the principal accounting policies of the company and the major
assumptions made about the projections
Appendices
 Resumes of key management and employees

 Detailed financial forecast and assumptions
 Market research report
 Company literature and brochures and pictures of the product
A good business plan shows investors the quality and depth of a company’s
corporate leadership and indicates management’s ability to reach stated goals.
These factors lie at the heart of the decision of a venture capitalist to invest in the
company’s future.
2. Selection of Venture Capital Fund

After the business plan is completed, the next step is to select the venture capital
fund, which is suitable to your proposal. The entrepreneur should first ascertain as
to the investment strategy of the VC with regards to the sector in which the VC is
interested as well as the stage at which he chooses to fund the project. Based on
this information the entrepreneur should shortlist the suitable VCs who match his
requirement and then approach them.
- 41 -
Financing from venture capital funds is available at various stages and different
VCs provide funding in some or all of the stages.
Stages of Financing
Venture capital can be provided to companies at different stages. These include:
I. Early-stage Financing
 Seed Financing: Seed financing is provided for product development &
research and to build a management team that primarily develops the
business plan.
 Startup Financing: After initial product development and research is

through, startup financing is provided to companies to organise their
business, before the commercial launch of their products.
 First Stage Financing: Is provided to those companies that have

expended their initial capital and require funds to commence large-scale
manufacturing and sales.
II. Expansion Financing

 Second Stage Financing: This type of financing is available to provide
working capital for initial expansion of companies, that are experiencing
growth in accounts receivable and inventories, and is on the path of
profitability.
- 42 -
 Mezzanine Financing: When sales volumes increase tremendously, the

company, through mezzanine financing is provided with funds for further
plant expansion, marketing, working capital or for development of an
improved product.
 Bridge Financing: Bridge financing is provided to companies that plan

to go public within six to twelve months. Bridge financing is repaid from
underwriting proceeds.
III. Acquisition Financing

As the term denotes, this type of funding is provided to companies to acquire
another company. This type of financing is also known as buyout financing. It is
normally advisable to approach more than one venture capital firm
simultaneously for funding as there is a possibility of delay due to the various
queries put by the VC. If the application for funding is finally rejected then
approaching another VC at that point and going through the same process
would cause delay. If the business plan is reviewed by more than one VC this
delay can be avoided as the probability of acceptance will be much higher. The
only problem with the above strategy is the processing fee required by a VC
along with the business plan. If you are applying to more than one VC then
there would be a cost escalation for processing the application. Hence a cost
benefit analysis should be gone into before using the above strategy.
Normally the review of the business plan would take a maximum of one month and
disbursal for the funds to reach the entrepreneur it would take a minimum of 3
- 43 -
months to a maximum of 6 months. Once the initial screening and evaluation is

over, it is advisable to have a person with finance background like a finance
consultant to take care of details like negotiating the pricing and structuring of the
deal. Of course alternatively one can involve a financial consultant right from the
beginning particularly when the entrepreneur does not have a management
background.
REGULATORY SYSTEM
- 44 -
The venture capital operations in India are regulated by The Securities Exchange
Regulation Board of India (SEBI). The following legal instruments are in
operation:
 SEBI Act 1992.
 SEBI (venture capital funds)‘Regulations’ 1996
 New sector regulations issued in September 2000
Highlight of Policy and Legal Framework

 VCFs can be constituted as trust fund or Company. Separate vehicle for
constitution and operation of venture funds such as limited liability
partnership is yet to be introduced in the country.
 Any company or trust proposing to undertake venture capital investments is

required to obtain certificate of registration from SEBI.
 VCFs before raising any funds for investment are required to file placement
memorandum with SEBI. Private placement memorandum can be issued
only after expiry of 21 days from submission to SEBI.
 VCFs can raise funds for investment through private placement route.
Individual investor is required to invest minimum of Rs. 5 lakhs in venture
capital fund. Raising of funds from public is restricted.
- 45 -
 VCFs are required to invest 80 percent of funds raised in equity or equity

related securities issued by companies whose securities are not listed or
which are financially weak.
 VCFs are barred from investing in company or institutions providing financial
services venture capital funds which desire to claim exemption from income
tax are required to follow rules given hereunder:
 Registration with SEBI.
 Claiming Income tax exemption in respect of dividend and capital gains
income.
 Not more than 40 percent of equity in a venture
 80 percent of monies raised for investment are required to be invested in
equity shares of domestic companies whose shares are not listed on
recognised stock exchange
 Shares of investee companies are required to be held for a period of at least 3
years. However, these shares can be sold either if they are listed on recognised
stock exchange in India.
Under the SEBI's venture capital rules:

 VCFs can be either company or trust.
 There is no minimum capital adequacy requirement for venture capital
funds.
 Are allowed to take loans, donations or issue securities.
 VCFs cannot be public companies - they need to contain a restriction on
inviting the public to subscribe to securities.
- 46 -
 VCFs are only allowed to carry the business of venture capital fund - cannot
engaged in any other business.
 Every VCF investor has to contribute at least Rs. 5 lacs.
 VCFs shall not invest in the equity capital of a financial services company.
This still allows investment in financial services companies, other than by
way of equity capital.
Venture capital investments are required to be restricted to domestic companies
engaged in business of
(i) software
(ii) Information Technology
(iii) Production of basic drugs in pharmaceuticals sector,
(iv) Bio-technology and
(v) Agriculture and allied other sectors etc.
Also in Union Budget 2002-2003

 Indian companies are being permitted to invest upto US$ 100 million overseas.
 Indian companies are being permitted to make overseas investments in joint
ventures abroad by market purchases without prior approval up to 50 per cent of
their net worth
- 47 -
SWOT ANALYSIS OF INDIAN VENTURE CAPITAL
Strengths Weakness
 An effort initiated from within – Home  Faddish

grown  Limited exit option
 Increased awareness of venture capital  Uncertainties
 More capital under management by - Political
VCFs - Policy repatriation, Taxation
 Industry crossed learning curve  Bureaucratic meddling and rigid
 More experienced Venture Capitalists, official attitude
Intermediaries, and Entrepreneurs.  Industry fragmented and polarized
 Growing number of foreign trained – Mixed V.C culture.
professionals.  Smaller funds with illiquid
 Global competition growing. investments
 Moving towards international  Domestic fund raising difficult
standards.  Lack of transparency & corporate
 Offshore funds bring strong foreign ties governance
 Matured capital market system  Accounting standards
 Electronic trading - through NSE &  Poor legal administration
BSE  Difficult due diligence
 Valuation addition  Inadequate management depth
 Irreversible reform  Valuation expectations unrealistic
- 48 -
 Regulatory framework evolving  Technical and Market evaluation

difficult
 Negligible minority protection
rights
 Inadequate corporate laws
 Poor infrastructure
Opportunities Threats
 Growth capital for strong companies  Change in government politics with

and Buyouts of weak companies due respect to –
to growing global competition.  Structuring
 Financial restructuring of over  Taxation
leveraged companies taking place.
 Acquisition of quoted small / medium  Threats from within
cap companies.  Explositive expansion and Over
 Pre money valuations low Exuberance of Investors.
 Vast potential exists in turn around,  Greed for very high returns
MBO, MBI.
- 49 -
ISSUES FACING THE INDIAN VENTURE CAPITAL INDUSTRY
The Indian venture capital industry, at the present, is at crossroads. Following are
the major issues faced by this industry.
1. Limitations on structuring of Venture Capital Funds (VCFs):

VCFs in India are structured in the form of a company or trust fund and are
required to follow a three-tier mechanism-investors, trustee company and AMC.
A proper tax-efficient vehicle in the form of ‘Limited Liability Partnership Act’
which is popular in USA, is not made applicable for structuring of VCFs in
India. In this form of structuring, investors’ liability towards the fund is limited
to the extent of his contribution in the fund and also formalities in structuring of
fund are simpler.
2. Problem in raising of funds:

In USA primary sources of funds are insurance companies, pensions funds,
corporate bodies etc; while in Indian domestic financial institutions, multilateral
agencies and state government undertakings are the main sources of funds for
VCFs. Allowing pension funds, insurance companies to invest in the VCFs
would enlarge the possibility of setting up of domestic VCFs. Further, if mutual
funds are allowed to invest upto 5 percent of their corpus in VCFs by SEBI, it
may lead to increased availability of fund for VCFs.
- 50 -
3. Lack of Inventive to Investors:

Presently, high net worth individuals and corporates are not provided with any
investments in VCFs. The problem of raising funds from these sources further
gets aggravated with the differential tax treatment applicable to VCFs and
mutual funds. While the income of the Mutual Funds is totally tax exempted
under Section 10(23D) of the Income Tax Act income of domestic VCFs which
provide assistance to small and medium enterprise is not totally exempted from
tax. In absence of any inventive, it is extremely difficult for domestic VCFs to
raise money from this investor group that has a good potential.
4. Absence of ‘angel investors’:

In Silicon Valley, which is a nurturing ground for venture funds financed IT
companies, initial/seed stage financing is provided by the angel investors till the
company becomes eligible for venture funding. There after, Venture capitalist
through financial support and value-added inputs enables the company to
achieve better growth rate and facilitate its listing on stock exchanges. Private
equity investors typically invest at expansion/ later stages of growth of the
company with large investments. In contrast to this phenomenon, Indian industry
is marked by an absence of angel investors.
5. Limitations of investment instruments:

As per the section 10(23FA) of the Income Tax Act, income from investments
only in equity instruments of venture capital undertakings is eligible for tax
exemption; whereas SEBI regulations allow investments in the form of equity
shares or equity related securities issued by company whose shares are not listed
- 51 -
on stock exchange. As VCFs normally structure the investments in venture

capital undertakings by way of equity and convertible instruments such as
Optionally/ Fully Convertible Debentures, Redeemable Preference shares etc.,
they need tax breaks on the income from equity linked instruments.
Harmonization of SEBI regulations and income tax rules of CBDT would

provide much required flexibility to VCFs in structuring the investment
instruments and also availing of the tax breaks. Thus investments by VCFs by
instruments other than equity can also be qualified for Tax exemption.
6. Domestic VCFs vis-à-vis Offshore Funds:

The domestic VCFs operations in the country are governed by the regulations as
prescribed by SEBI and investment restrictions as placed by CBDT for availing
of the tax benefits. They pay maximum marginal tax 35percent in respect of non-
exempt income such as interest through Debentures etc., while off-shore Funds
which are structured in tax havens such as Mauritius are able to overcome the
investment restriction of SEBI and also get exemption from Income Tax under
Tax Avoidance Treaties. This denies a level playing field for the domestic
investors for carrying out the similar activity in the country.
7. Limitations on industry segments:

In sharp contrast to other countries where telecom, services and software bag
the largest share of venture capital investments, in India other conventional
sectors dominate venture finance. Opening up of restrictions, in recent time, on
investing in the services sectors such as telecommunication and related services,
- 52 -
project consultancy, design and testing services, tourism etc, would increase the
domain and growth possibilities of venture capital.
8. Anomaly between SEBI regulations and CBDT rules:

CBDT tax rules recognize investment in financially weak companies only in
case of unlisted companies as venture investment whereas SEBI regulations
recognize investment in financially weak companies which offers an attractive
opportunity to VCFs. The same may be allowed by CBDT for availing of tax
exemption on capital gains at a later stage. Also SEBI regulations do not restrict
size of an investment in a company. However, as per Income tax rules,
maximum investment in a company is restricted to less than 20 per cent of the
raised corpus of VCF and paid up share capital in case of Venture Capital
Company. Further, investment in company is also restricted upto 40 per cent of
equity of investee company. VCFs may place the investment restriction for
VCFs by way of maximum equity stake in the company, which could be upto
49 per cent of equity of the Investee Company.
9. Limitations on Exit Mechanism:

The VCFs which have invested in various ventures have not been able to exit
from their investments due to limited exit routes and also due to unsatisfactory
performance of OTCEI. The threshold limit placed by various stock exchanges
acts as deterrent for listing of companies with smaller equity base. SEBI can
consider lowering of threshold limit for public/listing for companies backed by
- 53 -
VCFs. Buy-back of equity shares by the company has been permitted for
unlisted companies, which would provide exit route to investment of venture
capitalists.
10. Limitation on application of sweet equity and ESOP:

In the US, an entrepreneur can declare that he has nothing much to contribute
except for ‘intellectual’ capital and still he finds venture capitalists backing his
idea with their money. And when they come together, there is a way to
structure the investment deal in such a manner that the entrepreneur can still
ensure a controlling stake in the venture. In the US, the concept of par value of
shares does not exist that allows the different par value shares. Absence of such
mechanism puts limitations in structuring the deals.
Further, as per present tax structure in India, sweet equity and ESOP issued to
entrepreneur and employees gets taxed twice at the time of acquisition and
divestment. Tax incidence at two points involving undue hassles to allottees of
sweat equity of individual, as a perquisite in its income, to the extent of 33 per
cent defeats the entire purpose of its issue.
11. Legal framework:

Lack of requisite legal framework resulting in inadequate penalties in case of
suppression of facts by the promoters-results in low returns even from
performing companies. This has bearing on equity investments particularly in
unlisted companies.
- 54 -
MEASURES TO BE PROVIDED
From the experience of Venture Capital activities in the developed countries and
detailed case study of venture capital in India we can derive that the following
measures needs to be provided to boost Venture Capital industry in India.
1. Social Awareness:
Lack of social awareness of the existence of venture capital industry has been
observed. Hardly few know about the principal objectives and functions of the
existing venture capital funds in the country and thus banking of the media is
required to bridge the gulf between the society and the existing venture capital
funds.
2. Deregulated Economic Environment: A less regulated and controlled business

and economic environment where an attractive customer opportunity exists or
could be created for high-tech and quality products.
3. Fiscal Incentives:
Though Venture Capital funds like Mutual funds are exempted from paying tax
on dividend income and long-term capital gains, from equity investment, unlike
Mutual funds there are pre-conditions attached to the tax shelter. So it is
imperative that the Government streamlines its guidelines on tax exemption for
Venture Capital Funds.
- 55 -
4. Enterpreneurship And Innovation:

A broad-based (and less family based) entrepreneurial traditions and societal
and governmental encouragement for innovation creativity and enterprise.
5. Marketing Thrust:
A vigorous marketing thrust, promotional efforts and development strategy
employing new concepts such as venture fairs, venture clubs venture networks,
business incubators etc., for the growth of venture capital.
6. A Statutory Co-ordination Body:

A harmonious co-ordination needs to be maintained among the technology
institutes, professional institutes and universities who are the producers of
future venture capital managers. The coordinating organ so formed is expected
to ventilate an outline of the latest requirements of the venture capital funds
management. Central Government should come forward to promote the referred
coordination organ in the form of a statutory body. The coordination organ
would not only maintain link with the domestic professional institutions,
technology institutes and universities but also with the global venture capital
funds in order to exchange the novel ideas that can help in standardizing Indian
practice on venture capital funds.
7. Technological Competitiveness:
Encouragement and funding of R&D by private and public sector companies
and the government for ensuring technological competitiveness.
- 56 -
8. Training and Development of Venture Capital Managers:

For the success of venture capital fund, be it privately owned or public sector
financial institutions, strategies need to be found to promote entrepreneurship.
For this, venture capital funds need professionals with initiative, drive and vision
to identify such entrepreneurs who have sound & ideas and innovative vision.
Unfortunately, such professionals are not easily available particularly in
developing countries like India. Therefore management schools need to develop
social training programs to train venture capital mangers in which risk taking and
entrepreneurial attitude needs to be incubated.
9. Broad Knowledge Base:

A more general, business and entrepreneurship oriented education system where
scientist and engineers have knowledge of accounting, finance and economics
and accountants understand engineering or the physical sciences.
10. Exit Routes:

For venture capital funds, exits are crucial; going public is one way for the
investors to be paid back. Current rules of companies going public in India
insist on sustained track record of profits. For entrepreneur driven companies
where value creation is through intellectual property patents, methodologies and
processes, such norms are archaic. Venture capitalists earn through value
creation leading to exits and not through dividends. Venture funds would prefer
the company to invest back dividends into the business. As such the question of
stream of dividends pay outs prior to IPO over three years as is required in India
is a hindrance. Another exit route can be repurchases of shares by promoters but
- 57 -
it is an expensive way of assuring investors an exit bank roll. Inter accruals

alone may not be adequate to backroll the repurchases and institutional funding
for such buyouts is rarely forthcoming. Though there is no legal bar on such
funding, but the risk of extending against the shares of newly established
company have kept away most of the bank and financial institutions. Creative
financial engineering can find a way around this problem. To provide the
lenders with an additional degree of security, a special purpose vehicle (SPV)
can be created which would hold the shares bought back from the venture
capital firms in trust until the firm achieves a certain rate of return.
- 58 -
FUTURE OF VENTURE CAPITAL INDUSTRY IN INDIA
Venture capital has been a remarkable catalyst of entrepreneurial activity, after the
Second World War, in many developed countries. It has led to significant growth in
industry and innovation. The prospects for the Indian VC industry are no less
humongous. It is up to the industry to reflect on its current predicament and evolve
a strategy to seize the opportunity.
With due emphasis being given to the industry, there is lot of scope for
development. Trying to put the domestic market on par with that in the U.S. may
not be justified. Capital markets in India are still growing to maturity through
transparency, liquidity and accountability of promoters. With this maturity, the
venture capital market would also attain its maturity. Until such time, it is not fair
or easy to compare markets in India to those in the U.S. In all emerging markets,
the market practice will be ahead of regulation and there could be problems galore
in the process of market maturing.
Despite the slump in the new economy sectors and the collapse of the dotcoms,
venture capital companies are still buoyant about the Indian technology sector and
a large sum of money is waiting to be invested. According to a recent estimate by
the National Association of Software and Service Companies (Nasscom), the
venture capital investment in India is slated to rise to massive Rs 50,000 crore by
2008, up from Rs 2,200 crore in 2000-01.
- 59 -
Trends for 2003

 Most VCs believe that the next year will undoubtedly be better; driven by a
relatively stable economy, with growth rates again picking up. The digital
signature regime implemented by April 2002 will also offer a big boost to
the e-commerce sectors especially e-banking and online trading.
 It is estimated that total disbursements will be in the region of $ 2 billion,

and fund raising for India-centric funds could increase significantly, driven
by increased European interest.
 Total VC disbursements in India were to the tune of about $1.1 billion in

2002 (as compared to $1.3 billion in the previous year), according to the
IVCA. VCs feel that 2003 will see VC disbursements in the $2 billion range,
with India centric capital to the tune of $1 billion to be raised in 2003.
 According to VCs, the Indian market is one of the preferred markets in this
part of the world right now. Things are poised for change over the next 3-6
months since the valuation gap between entrepreneur expectations and VC
pricing has fallen when compared to last year.
 As far as the areas of investment and deal sizes are concerned, most VCs
feel that the market will favour large sized deals and probably even
- 60 -
management buyouts. Growth or mezzanine stage capital will continue to

occupy centrestage according to most VCs. As for startup funding--the views
are mixed. Some VCs believe that startup stage funding is likely to surface
again though a larger share of the capital will possibly be invested in listed
companies, others will continue to remain bearish on startups since scaling
up startups is a tough business.
Thus venture funds have been an engine for economic growth for over a decade in
countries like USA, Israel, Taiwan. The situation is now ripe to be replicated in
India. To foster innovation, new ventures have to work in a competitive &
supportive environment which also needs financial backing from venture
capitalists (VCs) and angel investors who will provide the venture not just with
funds, but also with strategic management support.
- 61 -
CONCLUSION
The Indian Venture Capital (VC) industry is just about a decade old industry as
compared to that in Europe and US. In this short span it has nurtured close to 1000
ventures, mostly in SME segment and has supported budding technocrat
/professionals all through. The VC industry, through its investments 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.
There are around 30 Venture capital funds, which have garnered over Rs.5000
crores.
The Indian venture capital industry is dominated by public sector financial

institutions. A few private sector venture capital firms have been set up recently.
VCFs in India are not pure venture capitalists. They pursue both commercial as
well as developmental objectives. Venture finances is made available to high-tech
as well as non-tech businesses. About two-thirds of the venture capital is invested
in non-tech businesses. A large number of high-tech ventures financed by VCFs are
in thrust areas of national priority such as energy conservation, quality
upgradation, advanced materials, bio-technology, reduced material consumption,
environment protection, improved international competitiveness, development of
indigenous technology etc. Yet another feature of venture financing in India is that
it is not readily available for development of prototypes or setting up of pilot plants
at the laboratory stage.
- 62 -
“Thus, venture capital in India resembles more a development capital than a

true venture capital (for risk, high-tech ventures)”.
Venture capital can play a more innovative and developmental role in a developing
country like India. It could help the rehabilitation of sick units through people with
ideas and turnaround management skills. A large number of small enterprises in
India become sick even before the commencement of production. Venture
capitalists could also assist small ancillary units to upgrade their technologies so
that they could be in line with the developments taking place in their parent
companies.
Yet another area where Venture Capital Funds (VCFs) can play a significant role in
developing countries is the service sector, including tourism, publishing, health-
care etc. They could also provide financial assistance to people coming out of the
universities, technical institutes involving high risk. This would encourage the
entrepreneurial spirit. It is not only initial funding which is needed from the
venture capitalists but they also should simultaneously provide management and
marketing expertise, which is the real critical aspect of venture capital in
developing countries. Hence, the Government of India and Venture Capital
firms/funds are required to strive hard to create the favourable environment needed
to take-off the venture capital finance in India.
- 63 -
ANNEXURE
Brief Profile of major players
 IDBI Venture Capital Fund:

This was established in1986 with the objective to finance projects whose
requirements range between Rs. 5 lakhs to 2.5 crores. The promoters’ stake
should be at least 10percent for the ventures below Rs. 50 lakhs and 15percent
for those above 50 lakhs. Financial assistance is extended in the form of
unsecured loans involving minimum legal formalities. Interest at concessional
rate of 9percent is charged during technology development and trial run of
production stage and it will be 17percent once the product is commercially
traded in the market by the financially assisted firm. IDBI venture capital funds
extends its financial assistance to the ventures likely to be engaged in the fields
of chemicals, computer software, electronics, bio-technology, non-conventional
energy, food products, refractories and medical equipments.
 Technology Development and Information Company of India Limited

(TDICI):
This venture Capital fund was jointly floated by Industrial Credit & Investment
Corporation of India (ICICI) and Unit Trust of India (UTI) to finance the
projects of professional technocrats who take initiative in designing and
developing indigenous technology in the country. Technology Development and
Information Company of India Limited (TDICI) was launched with an
authorized capital base of Rs. 20 crores and the same was targeted to be
- 64 -
increased to Rs. 40 to 50 crores. TDICI favours the firms seeking financial

assistance for developing information technology, management consultancy,
pharmaceutical, veterinary biological, environmental, engineering, non-
conventional sources of energy and other innovative services in the country.
 Unit Trust of India (UTI)

In 1988-99 UTI set-up a venture capital fund of Rs. 20 crores in collaboration
with ICICI for fostering industrial development. TDICI established by UTI
jointly with ICICI acts as an advisor and manager of the fund. UTI launched
venture capital unit scheme (VECAUS-I) to raise resources for this fund. It has
set up a second venture capital fund in March 1990 with a capital of Rs. 100
crores with the objective of financing green field ventures and steering
industrial development.
 Risk Capital and Technology Finance Corporation Ltd. (RCTFC)

IFCI had sponsored in 1985, Risk Capital Foundation (RCF) to give positive
encouragement to the new entrepreneurs. RCF was converted into RCTFC on
12th January, 1988. It provides both risk capital and technology finance and
roof to innovative entrepreneurs and technocrats for their technology oriented
ventures.
 Small Industrial Development Bank of India (SIDBI)

Small Industrial Development Bank of India (SIDBI) has decided to set-up a
venture capital fund in July 1993, exclusively for support to entrepreneurs in the
small sector. Initially a corpus has been created by setting apart Rs. 10 crores.
The fund would be augmented in future, depending upon requirements.
- 65 -
 Andhra Pradesh Industrial Development Corporation (APIDC)

APIDC Venture Capital Ltd. (APIDC-VCL) was promoted by APIDC with an
authorized capital of Rs.2 million on 29th August 1989. Its main objective is to
encourage technology-based ventures particularly those started by first
generation technocrat entrepreneurs and ventures involving high risk in the state
of Andhra Pradesh.
 Gujarat Venture Finance Limited (GVFL)
GVFL has been promoted by the Gujarat Industrial Investment Corporation
Limited (GIIC) in 1990, to provide financial support to the ventures whose
requirements range between 25 lakhs and 2 crores. Total corpus of Rs. 24 crores
of the referred venture capital fund was co-financed by GIIC, state financial
corporation, some private corporates and World Bank. The firms engaged in
biotechnology, surgical instruments, conservation of energy and food
processing industries are financed by GVFL.
 Commercial Banks Sponsored Venture Capital Funds

State Bank of India, Canara Bank, Grindlays Bank and many other banks have
participated in the venture capital fund building Industry in order to provide
financial assistance to the projects associated with high risks. SBI venture
capital is monitored through SBI capital markets. Canbanks venture capital
functions through Canbank. Financial services and India Investment Fund
represents the venture capital launched by Grindlays Bank.
Some of the Private Sector Venture Capital Funds
- 66 -
 ICICI ventures Fund Management

ICICI is the leading VC with $400 million. Starting with the objective of
playing the role of a value added investors with a high technology focus ICICI
in 1997-98, ICICI made 10 investments worth Rs 50 crore and it further
increased to 37 with an investment of Rs 277 crore during 1999-2000.The
momentum continued in next period also i.e., from April 2000 to September
2000, 35 investments were made with RS 290 crores. ICICI has set a record not
only in making investments but also in exiting from the companies, which made
them so successful.
 20th Century Venture Capital Fund:
20th century venture capital fund has been established with a corpus of Rs. 20
crores promoted by 20th century finance company limited. The fund envisages
focus on sick industries and first generation entrepreneurs.
 Credit Capital Venture Fund (CCVF):

CCVF (India) Limited has been formed as a subsidiary of credit capital finance
corporation limited in April1989. This fund has been promoted by nearly 15
major industrial houses in the country with the objectives of reviving sick units.
It is the first private managed venture fund with a subscribed capital of Rs.10
crore contributed to the extent of Rs.6.5 crore by international financial
agencies and the remaining raised through public subscription.
- 67 -
BIBLIOGRAPHY
 I.M Panday, Venture Captial: The Indian Experience
 Annual Report of Indian Venture Capital Association-1998
 Hashank Rajurkar: Issues Facing the Indian Venture Capital Industry,

Productivity.
 The Securities and Exchange Board of India - SEBI (Venture Capital Funds)
Regulations, 1996
 NVCA and Venture Economics - 2002 National Venture Capital Yearbook
 Various newspapers and magazines
 www.nasscom.org
 www.indiainfoline.com
 www.icfaipress.org
 www.thehindubusinessline.com
 www.gvfl.com
 www.vcline.com
- 68 -

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Venture Capital in India

3) INTRODUCTION TO VENTURE CAPITAL

6) CLASSIFICATION OF VENTURE FUNDS

7) VENTURE CAPITAL INVESTMENT PROCESS

8) ACCESSING VENTURE CAPITAL

10) ISSUES FACING THE INDIAN VENTURE CAPITAL

11) MEASURES TO BE PROVIDED

12) FUTURE OF VENTURE CAPITAL IN INDIA

 Resource raising, investment, management and exit should be as simple and

 Venture capital should become an institutionalized industry that protects

 In view of increasing global integration and mobility of capital it is important

 Infrastructure in the form of incubators and R&D need to be promoted using

American Research and Development Corporation:

INTRODUCTION TO VENTURE CAPITAL

Venture Capital is generally provided to firms with the following characteristics:

 Venture capitalist generally invests in new ventures started by technocrats who

 The most important difference between a venture capitalist and conventional

• Regional expansion of manufacturing and marketing operations.

Difference between Venture Finance & Debt Finance

Venture Finance Debt Finance

Holding 2-5 years Short/Long term

VENTURE CAPITAL IN INDIA

Traditionally, the role of venture capital was an extension of the developmental

readiness towards competing globally and awareness of venture capitalists among

Some Highlights of the Survey are as follows:

 Venture funds invested $907.58 million in Indian companies in 2001, down

 Number of companies receiving investment declined 62.6% to 101, from 270 in

 VC funds disbursing investments declined to 57 in 2001 from 88 in 2000 but

 Communications and media experienced the largest rise in investment in 2001,

 19 exits were achieved in 2001.

The "venture funds" available could be from:

Venture Capitalists (VCs):

Private Equity Players

CLASSIFICATION OF VENTURE FUNDS

Venture funds in India can be classified on the basis of

 Mastek one of the oldest software houses in India

 Geometric Software a producer of software solutions for the CAD/CAM

 SQL Star, Hyderabad based training and software development company

VENTURE CAPITAL INVESTMENT PROCESS

Understandably the composition of the network would depend on the investment

2. Due diligence: In this stage an in-depth study is conducted to analyse the

3. Deal structuring and negotiation: Having established the feasibility, the

6. Monitoring and Value addition: In this stage, the project is monitored by

Areas of due diligence would include

 Products/services, technology and process

 Technical details, manufacturing process and patent rights

Sometimes, companies may have experienced operational problems during their

The instruments could be as follows:

Equity shares New or vendor shares

1st Charge, 2nd Charge,

Loan v/s Loan stock

Categories Factors influencing the choice of Instrument

1) Evaluate future revenue and profitability.

2) Forecast likely future value of the firm based on experienced market

3) Target ownership positions in the investee firm so as to achieve desired

4) Symbolically the valuation exercise may be represented as follows:

b) Post = Pre + Cash

founders/management team is prepared to give away for the required amount of

f) PER is the Price-Earning multiple that could be expected of a comparable

 Demand and supply of capital: when there is a surplus of venture capital of

 Specific rates of deals: such as the founder’s/management team’s track record,

 The degree of popularity of the industry/technology in question also

 The standing of the individual venture capital: Well established venture