Académique Documents
Professionnel Documents
Culture Documents
“INTRODUCTION
TO
PROJECT”
CHAPTER 3
GLOBAL SCENARIO OF
VENTURE CAPITAL
INDUSTRY
3.1 Overview
Over the last 18 months, the venture capital industry around the globe has exper
ienced a welcome acceleration in the mature investment hotbeds – United States,
Europe and Israel – and in the emerging venture capital hotbeds China and India.
Global venture capital investment last year reached US $ 35.2 billion, the high
est level since 2001, and is maintaining a robust pace in year 2007. The acceler
ation has been bolstered by the increasing globalization of both venture capital
funds and venture backed companies and a substantial investor focus on emerging
sectors. As the dotcom market of the late 1990 has gathered the momentum, ven
ture capital stood at the nexus of hype and hope. In 2000 , they poured nearly
$95 billion into mostly young , untested companies , some no more than ideas, e
xpecting to reap rich rewards by later selling of these outfits to public .But t
he bubble burst the market for the new stock issues tanked --- and by 2003 , ven
ture capital funding had dwindled to $19 billion. The VC showed the signs of s
tabilizing as the industry were bolstered by the 2005’s strong 4thquarter, the f
inancing exceeded the $ 21.5 billion invested in venture-backed companies in 200
4, reaching $22.1billion .While that was far below 2000’s peak, it represents a
more sustainable pace of funding for both entrepreneurs and investors. In anothe
r sign of the industry firming, pension funds, foundations, and other investors
are again getting interested to invest their money in venture funds, which provi
ded seed money for young companies to grow on.
3.2 History & Evolution
Prior to World War Two, the source of capital for entrepreneurs everywhere was e
ither the government, government-sponsored institutions meant to invest in such
ventures, or informal investors (today, termed "angels") that usually had some p
rior relationship to the entrepreneur. In general, throughout history private ba
nks, quite reasonably, have been unwilling to lend money to a newly established
firm, because of the high risk and lack of collateral. After World War Two, in t
he U.S. a set of intermediaries emerged who specialized in investing in fledglin
g firms having the potential for extremely rapid growth. From its earliest beg
innings on the U.S. East Coast, venture capital gradually expanded and became an
increasingly professionalized institution. During this period, the locus of the
venture capital industry shifted from New York and Boston on the East Coast to
Silicon Valley on the West Coast. By the mid 1980s, the ideal-typical venture ca
pital firm was based in Silicon Valley and invested largely in electronics with
lesser sums devoted to biomedical technologies. Until the present, in addition t
o Silicon Valley, the two other major concentrations have been Boston and New Yo
rk City. In both Europe and Asia, there are significant concentrations of ventur
e capital in London, Israel, Hong Kong, Taiwan, and Tokyo. In the U.S., the gove
rnment has played a role in the development of venture capital, though, for the
most part, it was indirect. The indirect role, i.e., the general policies that a
lso benefited the development of the venture capital industry, was probably the
most significant. Some of the most important of these were:
The U.S. government generally practiced sound monetary and fiscal polici
es ensuring relatively low inflation with a stable financial environment and cur
rency.
U.S. tax policy, though it evolved, has been favourable to capital gains
, and a number of decreases in capital gains taxes may have had some positive ef
fect on the availability of venture capital.
With the exception of a short period in the 1970s, U.S. pension funds ha
ve been allowed to invest prudent amounts in venture capital funds.
The NASDAQ stock market, which has been the exit strategy of choice for
venture capitalists, was strictly regulated and characterized by increasing open
ness thus limiting investor s fears of fraud and deception.
This created a general macroeconomic environment of transparency and predictabil
ity, reducing risks for investors. Put differently, environmental risks stemming
from government action were minimized -- a sharp contrast to most developing na
tions. Another important policy has been a willingness to invest heavily and co
ntinuously in university research. This investment funded generations of graduat
e students in the sciences and engineering. From this research has come trained
personnel and innovations; some of who formed firms that have been funded by ven
ture capitalists. U.S. universities particularly, MIT, Stanford, and UC Berkeley
played a particularly salient role. The most important direct U.S. government
involvement in encouraging the growth of venture capital was the passage of the
Small Business Investment Act of 1958 authorizing the formation of small busines
s investment corporations (SBICs). This legislation created a vehicle for fundin
g small firms of all types. The legislation was complicated, but for the develop
ment of venture capital the following features were most significant:
It permitted individuals to form SBICs with private funds as paid-in cap
ital and then they could borrow money on a two – to – one ratio initially up to
$300,000, i.e., they could use up to $300,000 of SBA-guaranteed money for their
investment of $150,000 in private capital.
There were also tax and other benefits, such as income and a capital gai
ns pass-through and the allowance of a carried interest as compensation.
The SBIC program became one that many other nations either learned from or emula
ted. The SBIC program also provided a vehicle for banks to circumvent the Depres
sion-Era laws prohibiting commercial banks from owning more than 5 percent of in
dustrial firms. The banks SBIC subsidiaries allowed them to acquire equity in s
mall firms. This made even more capital available to fledgling firms, and was a
significant source of capital in the 1960s and 1970s. The final investment forma
t permitted SBICs to raise money in the public market. For the most part, these
public SBICs failed and/or were liquidated by the mid 1970s. After the mid 1970s
, with the exception of the bank SBICs, the SBIC program was no longer significa
nt for the venture capital industry The SBIC program experienced serious problem
s from its inception. One problem was that as a government agency it was very bu
reaucratic having many rules and regulations that were constantly changing. Desp
ite the corruption, something valuable also occurred. Namely, and especially, in
Silicon Valley, a number of individuals used their SBICs to leverage their pers
onal capital, and some were so successful that they were able to reimburse the p
rogram and raise institutional money to become formal venture capitalists. The S
BIC program accelerated their capital accumulation, and as important, government
regulations made these new venture capitalists professionalize their investment
activity, which had been informal prior to entering the program. Now-illustriou
s firms such as Sutter Hill Ventures, Institutional Venture Partners, Bank of Am
erica Ventures, and Menlo Ventures began as SBICs The historical record also ind
icates that government action can harm venture capital. The most salient example
came in 1973 when the U.S. Congress, in response to widespread corruption in pe
nsion funds, changed Federal pension fund regulations. In their haste to prohibi
t pension fund abuses, Congress passed the Employment Retirement Income Security
Act (ERISA) making pension fund managers criminally liable for losses incurred
in high-risk investments. This was interpreted to include venture capital funds;
as a result pension managers shunned venture capital nearly destroying the enti
re industry. This was only reversed after active lobbying by the newly created
National Venture Capital Association (NVCA). In 1977, it succeeded in starting
a gradual loosening process that was completed in 1982. The new interpretation o
f these pension fund guidelines contributed to first a trickle then a flood of n
ew money into venture capital funds. The most successful case of the export of S
ilicon Valley-style venture capital practice is Israel where the government play
ed an important role in encouraging the growth of venture capital.
The government has a relatively good economic record; there is a minimum of corr
uption, massive investment in military and, particularly, electronics research,
and the excellent higher educational system. The importance of the relationships
between Israelis and Jewish individuals in U.S. high-technology industry and th
e creation of the Israeli venture capital system should not be underestimated.
For example, the well-known U.S. venture capitalist, Fred Adler, began investing
in Israeli start-ups in the early 1970s, and in 1985 was involved in forming th
e first Israeli venture capital fund. Still, the creation of an Israeli venture
capital industry would wait until the 1990s, when the government funded an organ
ization, Yozma, to encourage venture capital in Israel. Yozma received $100 mill
ion from the Israeli government. It invested $8 million in ten funds that were r
equired to raise another $12 million each from "a significant foreign partner,"
presumably an overseas venture capital firm. Yozma also retained $20 million to
invest itself. These “sibling” funds were the backbone of a now vibrant communit
y that invested in excess of $1 billion in Israel in 1999 (Pricewaterhouse 2000)
. In the U.S., venture capital emerged through an organic trial-and-error proces
s, and the role of the government was limited and contradictory. In Israel the g
overnment played a vital role in a supportive environment in which private-secto
r venture capital had already emerged. The role of government differs. In the U
.S. the most important role of the government was indirect, in Israel it was lar
gely positive in assisting the growth of venture capital, in India the role of t
he government has had to be proactive in removing barriers (Dossani and Kenney 2
001). In every nation, the state has played some role in the development of ven
ture capital. Venture capital is a very sensitive institutional form due to the
high-risk nature of its investments, so the state must be careful to ensure its
policies do not adversely affect its venture capitalists. Put differently, capri
cious governmental action injects extra risk into the investment equation. Howev
er, judicious, well-planned government policies to create incentives for private
sector involvement have in the appropriate lead to the establishment of what be
came an independent self-sustaining venture capital industry.
3.3 Current Industry Trends
Round Class Distribution
The distribution of financing rounds by round class in mature markets is typical
ly 30-40% in the early stage rounds, 20-25% in second round, and 35-40% in later
rounds. In emerging market like China, the round distribution is very different
as 68% in early stage round and 25% in second round. In mature countries, the i
nvestments are made at early start up or product development phase.
Industry shifts
It is perhaps no surprise that the contraction is mostly concentrated in informa
tion technology and the business, consumer and retail industries, give the huge
number of companies financed in the technology and Internet boom of 1999-2000, a
nd the subsequent downturn. The healthcare pool, driven by investment in biophar
maceuticals and medical devices, has actually grown to some degree in the differ
ent geographies .In United States, the healthcare pool has grown consistently ov
er the last several years, both in terms of number of companies and cumulative d
ollars invested.
Key observations on the pool of private companies by industry:-
The information and technology pool has declined by just 6% since 2002;
particularly due to increasing Interest in WEB 2.0 innovations.
Since 2003, the IT pool has decreased by 27% in Europe and since 2004 17
% in Israel. Cumulative investment has declined in similar amounts.
The business, consumer and retail category has faced the steepest declin
es across the board. In US the number had fallen 54% since 2002 and 54% in Europ
e since 2003 .In Israel; it dropped 67% since 2004.
The number of healthcare companies has grown in U.S. since 2002 by 27% a
nd the capital risen 30% in last five years. Capital investment to the pool of h
ealthcare companies in Europe and Israel has also climbed, although the number o
f companies dropped by 9%in Europe since 2003 and 9% in Israel since 2004.
Clean technology is a small but increasing element of the pool. There we
re 262 clean technology companies with a cumulative invested venture capital of
US $38 billion in 2007.
Mega trends
Several global mega trends will likely have an impact on venture capital in the
next decade:-
Beyond the BRICs: - A new wave of fast growing economies is joining the
global growth leaders like Brazil, China, India, and Russia. The beginning of ve
nture capital activity has been seen in others countries such as Indonesia, Kore
a, Turkey and Vietnam.
The new multinationals: - A new breed of global company is emerging from
developing countries and redefining industries through low-cost advantage, mode
rn infrastructure, and vast customer databases in their home countries. These co
mpanies are potential acquirers of developed market companies at all stages of g
rowth.
The breadth of assets under management by these respondents was varied. The high
est number of respondents—42 percent—had managed assets totaling less than $100
million; 35 percent managed assets between $100 million and $499 million; 12 per
cent managed assets between $500 million to $1 billion; and 11 percent more than
$1 billion in assets under management There are 13 % respondents from APAC in w
hich China, India, Japan, South Korea, other Asia. 45% respondents from Middle E
ast include Israel and other area of Middle East.
Global VC investment increasing, but growth is slow and cautious.
We may live in a global economy, but the venture capital community is not broadl
y embracing global investment. Rather, roughly half of the venture community has
made a commitment to a global investment strategy and those firms are implement
ing that strategy slowly and cautiously. The intentions for growth of foreign in
vestment, as demonstrated by this year’s survey data, are modest at best.
Figure: 3.2 Percentage of venture capitalist currently investing outside home
country (U.S respondent)
3.6 China, India, Israel and Canada are primary target countries for U.S. ventur
e capitalists
There continues to be a consensus among U.S. venture capitalists regarding where
the most opportunities exists globally. Most of the U.S. firms who have investe
d globally are making investments in China, India, Israel, and Canada. However,
even in these countries, the majority of U.S. respondents are essentially dabbli
ng, making only one to two investments thus far.
Figure: 3.5 foreign investments currently held by
firms
Allocations by U.S. and non-U.S. firms alike for the most part represent less th
an 5 percent of capital invested overseas in fewer than three to five deals. Sur
vey results indicate that there will not be significant change during the next f
ive years.
RESPONSE FROM U.S. RESPONDENTS
Figure: 3.6 Primary focused location for investment (U.S) re
spondents
Here from the above chart we can see that the highest percent of respondents are
interested in China for setting up their businesses. India is the second choice
for the global investors
RESPONSE FROM (APAC) RESPONDENTS
Figure: 3.10 Percentage of venture capital firm’s portfolio companies that give
significant operation outside the country
Globally and among U.S. respondents, China has become the primary choice for rel
ocating manufacturing operations, while India is the primary choice for R&D oper
ations. Engineering operations tend to land in India as well, but China is also
a popular location. For back office activities, again, the choice is India. Howe
ver, for non-U.S. respondents, the United States is the primary choice for R&D a
nd engineering while European respondents preferred Central and Eastern Europe f
or manufacturing, R&D, and Engineering. One reason why this approach is taking
off is that investors are concerned about intellectual property and liquidity e
vents—and, in general, they feel a need to be closer to top management. This als
o reflects a new reality—that VCs are now investing in companies that operate gl
obally from day one— companies that reflects a larger global entrepreneurial sec
tor. This strategy allows the portfolio companies (and investors) to take advant
age of cost savings and access to talent in foreign markets while protecting int
ellectual property. There are, however, concerns that such a trend could result
in the U.S. losing its R&D edge.
3.9 Impediments to global investing
For all the benefits of overseas investing, VC firms encounter a variety of risk
s and challenges abroad. Both U.S. and non-U.S. firms perceive the U.S. as the c
ountry where the cost of complying with regulation is too high. In fact, the per
centage of non-U.S. respondents who indicated this as a concern leaped from 28 p
ercent last year to 41 percent this year. Globally, 4 percent more, 44 percent s
aw this issue as a concern. Forty-six percent of U.S. respondents believe the co
st of complying with corporate governance is too high.
Figure: 3.11 Top markets where the cost of complying with corporate governance
regulation too high
From the above chart we can see that most of the respondents believe that U.S. h
as high cost of complying with Corporate Governance regulation and china, India,
Israel and Canada cost of complying with corporate governance regulation too hi
gh.
CHAPTER 4
VENTURE CAPITAL
IN INDIA
CHAPTER 5
COMPREHENSIVE
STUDY OF INDIAN
MARKET
It has also been provided that Venture Capital Fund seeking to avail benefit und
er the relevant provisions of the Income Tax Act will be required to divest from
the investment within a period of one year from the listing of the Venture Capi
tal Undertaking.
Disclosure and Information to Investors: In order to simplify and expedi
te the process of fund raising, the requirement of filing the Placement memorand
um with SEBI is dispensed with and instead the fund will be required to submit a
copy of Placement Memorandum/ copy of contribution agreement entered with the i
nvestors along with the details of the fund raised for information to SEBI. Furt
her, the contents of the Placement Memorandum are strengthened to provide adequa
te disclosure and information to investors. SEBI will also prescribe suitable re
porting requirement from the fund on their investment activity.
Relaxation in Takeover Code: The acquisition of shares by the company or
any of the promoters from the Venture Capital Fund under the terms of agreement
shall be treated on the same footing as that of acquisition of shares by promot
ers/companies from the state level financial institutions and shall be exempt fr
om making an open offer to other shareholders.
Investments by Mutual Funds in Venture Capital Funds: In order to increa
se the resources for domestic venture capital funds, mutual funds are permitted
to invest upto 5% of its corpus in the case of open ended schemes and upto 10% o
f its corpus in the case of close ended schemes. Apart from raising the resource
s for Venture Capital Funds this would provide an opportunity to small investors
to participate in Venture Capital activities through mutual funds.
Government of India Guidelines: The Government of India (MOF) Guidelines
for Overseas Venture Capital Investment in India dated September 20, 1995 will
be repealed by the MOF on notification of SEBI Venture Capital Fund Regulations.