PROJECT REPORT

On
A STUDY OF THE VENTURE CAPITAL AND PRIVATE EQUITY

INDUSTRY IN INDIA

FOR
THE PARTIAL FULFILLMENT OF THE AWARD OF THE DEGREE OF
MASTER OF BUSINESS ADMINSTRATION
FROM GGS IP UNIVERSITY
DELHI

BATCH: 2010-12

SUBMITTED BY: SUBMITTED TO:

ANAMIKA SRIVASTAVA PROF. PAWAN KUMAR

ARMY INSTITUTE OF MANAGEMENT & TECHNOLOGY,

GREATER NOIDA (UP) 201306

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 Supervisor Certificate

This is to certify that Anamika Srivastava a student of Master of Business

Administration, Batch MBA07, Army Institute Management & Technology,
Greater Noida, has successfully completed his project under my supervision.

During this period, he worked on the project titled

--------------------------------------------------------- in partial fulfillment for the award
of the degree of Master of Business Administration of GGSIP University, Delhi.

To the best of my knowledge the project work done by the candidate has not been
submitted to any university for award of any degree. His performance and conduct
has been good.

Prof. Pawan Kumar

AIMT-Gr. Noida

Date:

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 ACKNOWLEDGEMENT

I want to show our sincere gratitude to all those who made this study possible. First of all
I am thankful to the helpful staff and the faculty of Army Institute of Management and
Technology. One of the most important tasks in every good study is its critical evaluation
and feedback which was performed by our supervisor Prof. Pawan Kumar. I am very
thankful to our supervisor for investing his precious time to discuss and criticize this
study in depth, and explained the meaning of different concepts and how to think when it
comes to problem discussions and theoretical discussions. My sincere thanks go to my
family members, who indirectly participated in this study by encouraging and supporting
me.

Anamika Srivastava
Course MBA07

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Executive Summary

The report aims to provide a comprehensive insight into the private equity and venture
capital business model and investment process. The report also provides an insight into
and an outlook for the Indian private equity industry. An Illustrative case study is also
provided to enhance the knowledge an understanding of the reader. This report, which
contains in-depth study of Venture Capital Industry inIndia, is made with an intension to
get through all the aspects related to thetopic and to become able to make some
suggestion at the industry.
I review the theory and evidence on venture capital (VC) and other private equity: why
professional private equity exists, what private equity managers do with their portfolio
companies, what returns they earn, who earns more and why, what determines the design
of contracts signed between private equity managers and their portfolio companies and
private equity managers and their investors (limited partners), and how/whether these
contractual designs affect outcomes. Findings high light the importance of private
ownership, and information asymmetry and illiquidity associated with it, as a key
explanatory factor of what makes private equity different from other asset classes.
Venture capitalists have been catalytic in bringing forth technological innovation in USA.
A similar act can also be performed in India. As venture capital has good scope in India
for three reasons:

First:The abundance of talent is available in the country. The low cost high quality Indian
workforce that has helped the computer users world wide inY2K project is demonstrated
asset.
Second: A good number of successful Indian entrepreneurs in Silicon Valley should have
a demonstration effect for venture capitalists to invest in Indian talent at home.
Third: The opening up of Indian economy and its integration with the world economy is
providing a wide variety of niche market for Indian entrepreneurs to grow and prove
themselves. The topic deals with a specific aspect of business especially small business
and the provision of risk- capital so essential to their birth, survival and profitable growth.
It is not concerned with the banking instruments for short term finances e.g. overdrafts
and loans..

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TABLE OF CONTENT

Chapter-1....Executive Summary

Chapter-2....Introduction

Chapter-3.... Objective of the Research Undertaken

Chapter-4.... Literature Review

Chapter-5....The Concept of Private Equity and Venture Capital

Chapter -6....Research Methodology

Chapter-7....Evolution of the Indian Private Equity and Venture

Capital Industry

Chapter-8....Data Analysis

Chapter-9.... Findings

Chapter-10....Conclusions

Chapter-11....Bibliography

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INTRODUCTION

Starting and building a prosperous business is an ambition of many Indians and has been
a vital source of job creation in India. But getting a company off the ground and/or
expanding it requires money, and raising the right kind of finance is still a major
difficulty for Indias SMEs.
Capital is required at various stages in a business life cycle. There is early-stage (seed)
capital, which is needed to get the venture started. This mostly comes from the
entrepreneurs savings, or friends and family, or angel investors. Then, there is the next
stage where, once the basic ideas are validated, capital is needed for ramping up the
venture. This is where venture capital(VC) companies come in. The next need for capital
is for growth and this can come from private equity or from the capital markets. The lack
of capital is a barrier to growth that can rarely be overcome by recourse to family, friends,
business angels or banks.
There are a number of alternative methods to fund growth. These include the owner or
proprietors own capital, arranging debt finance, or seeking an equity partner, as is the
case with private equity (PE) and venture capital. Private equity is a broad term that
refers to any type of non-public ownership equity securities that are not listed on a public
exchange. Private equity encompasses both early stage (venture capital) and later stage
(buy-out, expansion) investing. In the broadest sense, it can also include mezzanine, fund
of funds and secondary investing.
Private equity and venture capital is an increasingly important source of finance for
Indian high-growth potential companies. The goal of private equity and venture capital is
to help more businesses achieve their ambitions for growth by providing them with
finance, strategic advice and information at critical stages of their development.
Although overall awareness of private equity and venture capital in India has improved in
recent years, a clear understanding of its mechanics is required. This is even more
obvious in the case of smaller firms and family-owned businesses. The lack of
information, along with the fear of relinquishing control through the exchange of shares
for cash flow, prevents those companies to call on private equity and venture capital.

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OBJECTIVE

The report aims to provide a comprehensive insight into the private equity and
venture capital business model and investment process.

It also provided an insight into and an outlook for the Indian private equity
industry.

It also attempted to enhance the readers understanding of the subject with

illustrative case studies.

RESEARCH METHODOLOGY

Research is Descriptive in nature

Research is based on secondary data like newspaper, magazines, journals and

article.

It includes not only a description of the relationship between the entrepreneur and
the private equity fund managers, the stages towards an eventual agreement, the
follow-up to and the exit from an investment, but also how funds are structured.

LITERATURE REVIEW

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1-The Indian Private Equity and Venture Capital Association was established
in 1993 and is based in New Delhi, the capital of India. IVCA is a member based
national organization that representsVenture capital and Private equity firms,
promotes the industry within India and throughout the world and encourages
investment in high growth companies. It enables the development of venture
capital and private equity industry in India and to support entrepreneurial activity
and innovation. The IVCA also serves as a powerful platform for investment
funds to interact with each other. In 2006, the total amount of private equity and
venture capital in India reached US$7.5 billion across 299 deals.
IVCA members comprise Venture capital firms, Institutional
investors, Banks, Business incubators, Angel investor groups, Financial
advisers, Accountants, Lawyers, Government bodies, Academic institutions and
other service providers to the venture capital and private equity industry.
Members represent most of the active venture capital and private equity firms in
India. These firms provide capital for seed ventures, early stage companies, later
stage expansion, and growth finance for management buy-ins/buy-outs of
established companies. So far, the biggest member firm of IVCA is ICICI
Ventures which currently has a $750 million fund, and has $450 million under
management.
2- Topic - Private equity investments in india: a legal and structural overview
By-Siddharth Shah of Nishith Desai Association,Mumbai.
Source: NASSCOM: Study on Indian Capital Industry
The Indian private equity scenario has undergone a sea change over the last five
years or so. There has been a considerable interest, both domestic as well as
international, in the private equity sector which is evident from the fact that the
total private equity funds (more commonly understood in the Indian context as
venture capital funds (VCF)) committed to investments in India has increased
exponentially. The following table gives the statistics of growth of the venture
capital industry in India.

The Concept of Private Equity and Venture Capital

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Companies engaged in the traditional line of business procure necessary financial capital
from the public issues, financial institutions, commercial banks, lease financing, debt
instruments, hire purchase etc. But the companies face great difficulty while raising
capital for newly floated companies as at the initial stages of the business the risk is very
high and the return is uncertain.
Similarly, small-scale enterprises (SSE's) are also unable to raise funds because it is
highly risky venture, are less profitable and do not possess adequate tangible assets to
offer as security. So, they have two options left- either to raise capital through IPO or to
obtain loans. But most of the SSE's are unable to fulfill the listing requirements in terms
of sales and minimum size of share issues. Moreover, common investors hesitate to invest
in such companies even though the growth rate is high because of high degree of risk
involved. As far as loans are concerned, lenders charge relatively high rate of interest to
compensate for the high degree of risk involved.
So how such companies shall be financed? The Private Equity and Venture Capital
market is an important source of funds for new firms, private middle-market firms, firms
in financial distress, and public firms seeking buyout financing.
Private equity is the provision of equity capital by financial investors over the medium
or long term to non-quoted companies with high growth potential.
Venture capital is, strictly speaking, a subset of private equity and refers to equity
investments made for the launch, early development, or expansion of a business. It has a
particular emphasis on entrepreneurial undertakings rather than on mature businesses.
Venture capitalists are professional money managers who provide risk capital to
businesses. Venture capitalists come in many forms and specialise in different ways, but
all share the common trait of making investments at an early stage in privately held
companies that have the potential to provide them a very high rate of return on their
investment.
Private equity covers not only the financing required to create a business, but also
includes financing in the subsequent development stages of its life cycle. When financing
is required by a management team to buy an existing company from its current
stakeholders, such a transaction is called a buyout. Private equity and venture capital may
refer to different stages of the investment but the essential definition remains the same: it
is the provision of capital, after a process of negotiation between the investment fund
manager and the entrepreneur, with the aim of developing the business and creating
value.

Characteristics of PE and VC Investments

The main characteristics of VC are long time horizon, lack of liquidity, high risk, equity
participation and participation in management.
Long Time Horizon

This type of venture financing is a long-term illiquid investment; it is not repayable on

demand. It requires long-term investment attitude that necessitates the VC firms to wait
for a longer period, say 5-10 years, to make substantial profits.
Lack of Liquidity

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Because VC investments are made in private companies, the investments are illiquid until
the company goes public or is sold and the proceeds are distributed to the limited
partners. The partnership usually has a four-stage cycle over its 12 year life.
Years 1-3: period of intense investment activity
Years 4-6: Growth period, follow-on investment
Years 7-9: Harvest period, cash mgmt and exit strategies
Years 9-12: Liquidation
High Risk

Within a given portfolio of VC investments the return will vary widely. A few will return
many times the initial investments, others will fail completely, and many will simply
struggle and become part of what is commonly known as the living dead.
Equity participation

This type of venture financing is actual or potential equity participation through direct
purchase of shares, options or convertible securities. The objective is to make capital
gains by sellingoff the investment once the enterprise becomes profitable.
Participation in management

Venture financing of this type ensures continuing participation of the venture capitalist in
the management of the entrepreneurs business. This hands-on management approach
helps him to protect and enhance his investment by actively involving and supporting the
entrepreneur. More than finance, venture capitalist gives him marketing, technology,
planning and management skills to the new firm.

Alternatives to Private Equity and Venture Capital

There are several alternatives to private equity: self-financing, debt or raising capital via a
stock market flotation.
Private equity versus self-financing

Self-financing, either on your own, by friends, family, or business angels can be

relatively easy and quick but it is seldom a viable long-term solution for a growth
business. Personal relationships can become entangled with the business and the joint
shareholders rarely play an effective role in supporting the entrepreneur.
Private equity versus debt

As creditors of the company, lenders demand guarantees either personal or from the
company. Companies with few or no assets, or entrepreneurs already deeply involved in
their project, will find it hard or even impossible to produce these guarantees. However,
the loan has no impact on the share structure of the company and the lender will not
intervene in the running of the company.
By comparison, a private equity investor brings capital, does not require interest
payments, is subject to the risks of the company like any other shareholder and will only
profit if the company grows

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 Private equity versus raising capital via a stock market flotation

A private equity investment is a medium to long-term investment, which does not provide
the same liquidity as a stock market flotation and which ties the investor closely to the
company.

Risk involved in VC financing

VC investments generally are high-risk investments offering-above-average

returns. In order to cash their investments, VCs sell their stocks, warrants,
options, convertibles, or other forms of equity in three to seven years.

Venture capitalists know that not all their investments will pay off. The failure
rate of investments can be high, anywhere from 20 per cent to 90 per cent. In case
a venture fails, then the entire funding by the venture capitalist is written off.
Many venture capitalists try to mitigate the risk of failure through diversification.
They invest in companies in different industries and different countries so that the
risk across their portfolios is minimised. Others concentrate their investments in
the industry that they are familiar with.

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The Private Equity Business Model

The private equity business model involves different players and can be broken down into
four main phases.

Creation of a fund and underwriting by professional investors

After obtaining the agreement of the controlling authorities, private equity firms (known
as private equity management companies or General Partners (GPs)), establish
investment funds that collect capital from investors (known as Limited Partners or LPs).
The private equity firms use this capital to buy high-potential companies (known as the
portfolio or investee companies).
Thus, private equity fund managers invite institutional investors and individuals with
particular expertise or significant assets, to subscribe to an investment fund for a set
period (on average ten years), which will take equity stakes in high-potential companies
following a clearly defined investment strategy. This can be according to the size of the
target companies, their sector, stage of development and/or geographical location. These
investors are often known as sophisticated or professional investors, because they
understand the risks inherent in this type of operation. The fund raising period lasts for
six months to one year.

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As investment funds are for the most part closed, institutional investors cannot leave
those funds before their term (or they will have great difficulty in doing so). This
financial stability is one of the clear advantages for the entrepreneur who seeks a private
equity investment.

Investing the fund

Once the target amount of capital has been raised, the subscription is closed. The private
equity investment managers then seek high-growth companies to invest in, following the
investment strategy they proposed to the institutional investors.
In some cases, private equity investment funds will come together and form a financial
syndicate to make an investment. This will happen if the risks are high or if the amount
of capital required in the operation is particularly substantial. One of the investment funds
will represent the group in the syndicates dealings with the entrepreneur. This
representative will follow a mandate negotiated with his partners.
The private equity management team essentially makes investments in the first five years
of the fund.

Managing the investment

The fund managers run their investment operations and prepare exit strategies depending
on market conditions, agreements drawn up in advance with the entrepreneurs and
opportunities for disposal.
Because the fund manager on behalf of the investors is concerned with creating value in
the company, he will follow his investment over the long term and will participate in any
subsequent rounds of financing required.

Redistribution

When fund managers decide to exit their investment, the capital recovered from the exit
is redistributed to the original investors on a pro-rata basis depending on the size of their
initial investment.
These reimbursements, along with the capital gains, allow the institutional investors to
honour their insurance contracts, pensions or savings deposits.
Institutional investors are looking for significant profit from their investment to
compensate for the fact that their capital is tied up for long and to ensure that they can
reimburse the money allocated to them by their clients (the savers and pensioners).
When all the capital collected from the investors has been invested and when certain
investments have already been exited, the fund managers may launch a second fund.
Their credibility in attracting new investors depends on their historical performance
because they will be in competition with other managers in the asset management market.

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The Life Cycle of a Private Equity/Venture Capital Deal
There are various stages in a venture capital or private equity deal.
Screening an Investment
Business plan evaluation and Preliminary Due Diligence
Detailed Due Diligence
Investment valuation
Deal Structuring
Documentation
Managing the Investment
Exit Options

We take a detailed look at each of the activities.

Screening an Investment

The success of private equity funds depends on the selection of right kind of investment.
General partners rely on relationships with investment bankers, brokers, consultants,
lawyers, and accountants to obtain leads; they also count on referrals from firms they
successfully financed in the past.
Before going in or an in-depth analysis of the business proposal, the PE/VC firm will
carry out an initial screening of all projects on the basis of broad criteria. For example,
the VC firm will restrict itself to projects that the venture capitalist is familiar in terms of
technology, or product or market scope. The size of investment, geographical location
and stage of financing could also be used as a broad screening criterion.

Business plan evaluation and Preliminary Due Diligence

The investment process begins when the company submits a business plan broadly
outlining the following:
Company background history and development
Promoters/Directors/Management background
Operating and ownership structure of the company
Product or services competitive advantages
Markets size, growth and competition
Medium and long-term expansion strategy
Historical financial summary and note on prior equity financings, if any
Future projections with key milestones
Amount of capital required and its proposed use

An initial meeting with the companys management to understand the business and
explore the strategy and operating plan in greater detail is convened. Follow-up meetings
with the management team of the company including visits to the offices/manufacturing

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facilities enables to assess management and operational capabilities, check personnel and
industry references and thus develop a more detailed understanding of the company, its
strategy and its operating plan.

Detailed Due Diligence

Proposals that survive these preliminary reviews become the subject of a more
comprehensive due diligence process that can last up to six weeks. This phase includes
visits to the firm; meetings and telephone discussions with key employees, customers,
suppliers, and creditors; and the retention of outside lawyers, accountants, and industry
consultants.
Detailed due diligence includes business, financial & legal due diligence. The business
due diligence comprises evaluation of the product/services, the management team and
their background, technology (if any), market, competition, differentiators, financial plan
and exit opportunities.
Due diligence can provide information and insight on:
the operations
the risks of a transaction
the value at which a transaction should be undertaken
the warranties and indemnities that should be obtained from the vendor

Strategic Due Diligence

Strategic due diligence considers an investment in the context of its industry and asks a
simple question: Does it make sense will the investment benefit the organization?
Optimally, this is the first step in the due diligence process. Strategic due diligence will
provide the organizations the information to drive change and improve profitability or
help the investor determine that the deal is not worth pursuing. This stage reveals whether
the potential synergies are strong enough to warrant perusal of the deal.

Legal and Financial Due Diligence

The legal and financial due diligence process is very critical to determine whether the
company concerned presents a good investment opportunity to the investor, and also to
determine the other important aspects of the deal such as valuation of the company, status
of various compliances, the nature of representations and indemnities to be taken from
the company and its founders, etc. Financial due diligence analyses, qualitatively and
quantitatively, how an organization has performed financially to get a sense of earnings
on a normalized basis.

Operational Due Diligence

Operational due diligence looks at a transaction to determine what the investor can do to
realize improvements in productivity and profitability. This includes examining work

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centers, material flow, scrap generation, and inventory levels in short, employing lean
manufacturing principles to achieve maximum profitability.

IT Due Diligence

IT due diligence considers questions such as: Whats the current level of technology? Is it
up to date? How well does the company use the existing technology? Is it sufficient to
allow the organization to continue to grow? How much money will the buyer need to
invest to provide the company the company with the tools it needs to operate effectively?

Human Capital Due Diligence

When an acquisition fails, its frequently due to people or related issues. Key managers
and scarce talent leave unexpectedly. Valuable operating synergies evaporate because
cultural differences between companies arent understood or are simply ignored. Cuts in
pay or benefits programs create ill will, which reduces productivity.

Investment Valuation

One of the areas which need to be covered in the agreement between the entrepreneur and
the private equity firm is the value of the company. The financial valuation process is an
exercise aimed at arriving at an acceptable price for the deal.
Venture Capital Valuation is different from our normal valuation due to:
Higher Risk & Higher Uncertainty
Potential higher rewards
Exit & Liquidity more important
Key to success is the kind of valuation for the VC investor as well as Entrepreneur

There is no pure quantitative method of valuing a company because the exercise is based
on hypotheses that are always slightly subjective.
This is why valuations are the subject of long negotiations and often differ from one
investor to another. However, there are certain recognized methods and investors
generally use a combination of those, depending on the type of the business they are
investing in and how developed it is.
When the investment is complete, the entrepreneur and the investor will find themselves
on the same side of the table.
Valuation methods can be categorized into:
Methods based on discounted cash flows.
Methods based on comparing your company to other companies quoted and
unquoted in the same business sector in terms of profits, cash flow, net worth,
turnover, etc.
Methods based on opportunity cost, i.e. the profitability offered by an investment
with the same level of risk.

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Discounted cash flow (DCF)

This method, and its variations, can be used when the company already has a positive
cash flow, when this cash flow can be estimated with a degree of certainty and when the
discount rate can easily be approximated. This rate is based on the rate of a risk-free
investment, for example a state bond, to which a premium is added. The level of the
premium depends on the estimated level of risk.
Steps in DCF/ (Adjusted Present Value) APV Approach
Step 1: Calculate Free Cash Flow (FCFs) to an all equity firm for a period of
years until company reaches Steady State
Step 2: Discount these FCFs at a discount rate (k)
Step 3: Calculate terminal value as the present value of growing perpetuity of
FCFs assuming some growth rate in FCFs and discounting by k.
Step 4: Value Tax shields of debt financing separately (trD) and discount by a rate
that reflects riskiness of cash flows
Step 5: Step 1-4 gives you Enterprise Value. To determine equity value subtract
market value of debt (PV of interest payments)

We have to use APV and not WACC in this approach for the following reasons:
Capital Structure involves hybrid structure not easily classified as equity or debt.
Capital Structure Changes over time.
Interest Tax shields change as well as companys tax status changes over time.

Comparative methods
The most frequently used comparative method is known as the price/earnings ratio, using
the estimated price/earnings ratio of a similar quoted company. This ratio is applied to the
estimated earnings of the target company, in the belief that the markets have correctly
assessed future values.
Since it is fairly simple, this method is widely used. It reflects fairly well the mood of the
market in a specific sector, and it simplifies the hypotheses needed to estimate growth
and risk.
However, several corrective measures need to be carried out and so the price/earnings
ratio of an unquoted company is lower than that of a quoted company for the following
reasons:
its shares cannot be freely bought and sold (they are illiquid)
its results can be more cyclical than those of an established company
the cost of making and monitoring a private equity investment is much higher

Other comparative criteria are sometimes used in the same way:

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 Price/EBITDA ratio (Earnings before Interest, Taxes, Depreciation and
Amortization), which is more focused on the firms operations and excludes
exceptional items.
Price/net worth ratio, which is largely calculated on the basis of accounting
standards.

This method does not apply to service-sector firms with few fixed assets.
Price/turnover ratio, which can even be used for companies in difficulty.

Earnings and net worth are largely determined by how inventory, depreciation and
exceptional charges are accounted for, but turnover is an almost intangible item. The
price/turnover ratio is therefore more stable than the price/earnings ratio or the price/net
worth ratio, but it does not reveal any problems related to cost control.
Venture Capital Method
Step 1: Forecast Cash flow to equity for a period of years.
Step 2: Estimate the time when VC plans to exit the investment
Step 3; Value the exit based on an assumed multiple of earnings or sales; the
multiple is based on industry comparables.
Step4: Discount the interim cash flow and exit value at rates ranging from 25%-
80%
Step 5: Determine the VCs Stake.

Opportunity cost
This method assesses the current value of different options available to the investor. In
short, the investor will study the profitability of other investments with the same risk
level and apply this to your company.
Whichever valuation method or combination of methods is used, be aware that start-
up companies are financed almost exclusively with equity, based on the expected rate of
growth. Earnings and cash flow are negative at the beginning and the concept of net
worth has little value.

Deal Structuring

Once the venture has been evaluated as viable, the venture capitalist and the venture
company negotiate the terms of the deal, viz., the amount, form and price of the
investment. This process is called as deal structuring.

Structuring the Instrument

Having gone through the initial stages of due diligence and negotiations, and after having
addressed the entry level exchange control issues, the next concern an investor is likely to
look at is what kind of instrument it should get against its investment, and what level of
protections and risks the investor should bear in mind with respect to these investments.
Some of the usual reasons in an Indian context why a foreign investor would prefer an
instrument other than equity shares are outlined below:

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 The investor may wish to get a preference on dividend or liquidation or both.
The investor may wish to get disproportionate voting rights on its investment in
return for the strategic value such investor may bring to the table.
Indian corporate and securities laws may place certain restrictions with respect to
equity shares which may not suit the commercial understanding between the
parties.
The investor may seek liquidity in overseas markets and the maximum flexibility
in terms of exit options.

Instruments Denominated in Indian Rupees

1. Convertible Preference Shares - Under Indian company law, a preference share
by definition gets a preference over the other shareholders as to dividends and
recovery of capital in the event of liquidation. A convertible preference share is a
preference share that is converted to equity shares based on a specified conversion
ratio upon maturity.
2. Convertible Debentures - Debentures are debt instruments. In the case of a
convertible debenture, the debenture holder would receive interest from the
company till the maturity date, after which the debentures would be converted
into equity shares ranking on par with the other equity shares of the company.
Convertible debentures too are treated the same as equity shares .
3. Warrants - These are convertible instruments that can be converted into equity
shares at the convenience of the holder, by paying a conversion price. A warrant is
a right to subscribe to equity shares at a later stage. Warrants which have been
issued and are outstanding are not taken into consideration for the purpose of
reckoning sectoral investment caps.

Some Important Clauses in Share Purchase Agreement:

Rights, Preference & Privileges:

o Dividend Provision
o Liquidation Preferences
o Conversion
o Anti-Dilution Provisions
o Voting Rights
o Protective Provisions
Information & Registration Rights:
o Information rights
o Demand Rights
o Piggy back Registration
o Registration Expense
Board Representation
Use of Proceeds

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 Employment Relationship
Drag Along Rights
Right of First Refusal
Tag Along Rights
Confidential information& inventions Assignment
o Confidential Agreement
o Stock Purchase agreement
o Redemption
o Voting Agreement
o Conditions of closing
o Expenses
Finders
Closing (clear cut-off date)
Expiration of the term sheet/offer
Jurisdiction
Details of Council
Clause of Confidentiality for the SPA

The exit methods that are commonly used are:

Initial Public Offering
Buy-back by Promoters
Trade Sale
Secondary Buy-out
Liquidation

Initial public offering (IPO)

The ideal exit route for a private equity fund is through the stock market following the
listing of the investee companys equity stock. This route is available when the investee
company has successfully implemented its project and has started generating income.

Trade Sale
A trade sale, also referred to as M&A (Mergers & Acquisitions), of privately held
company equity is a popular type of exit strategy and refers to the sale of company shares
to industrial investors. Large and small companies often complement each other and an
alliance between them allows one of them to secure a strategic advantage or complete its
own business activities. A buyer is therefore often willing to pay a premium to acquire a
complementary business.

Company Buy-back

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Company buy-back is one of the exit routes for private equity funds. It is the process by
which a company buys back the stake held by a financial investor, i.e. a private equity
firm.

Liquidation of the company

When a business performs poorly it may be easier to liquidate the company and sell off
assets like land, buildings, machinery and equipments. This exit route is not desirable.
The investee company does not operate well and there is demand and pressure to pay off
its liabilities in cash. The company becomes insolvent, is unable to continue operations
and is forced into liquidation.

Strategies for Value Creation

The Indian private equity scene has hit the big leagues with impressive investments over
the recent past. Growing fund sizes, presence of all the private equity biggies and
increased deal values all augur favorably for the Indian economy.
The valuations of many Indian firms are getting larger and PE firms have to employ both
the generic as well as the non-traditional strategies to ensure adequate ROIs.

Differentiate
The most important strategy as we know is that of differentiating. Differentiating is the
most critical way for any firm to create value. PE firms could provide the latest
technology and global expertise. PE backed firms can look forward to better and larger
investments based on domain knowledge of the fund managers and the management of
the Indian firms.
Restructuring
PE backed firms are leaner in structure elsewhere and this could be a good model for
India. Indian Debt market are still at a very nascent stage thus PE can bring in financially
innovative product into the portfolio of the company and make a necessary change in
capital structure of the firm through financial reengineering, which will affect the bottom-
line and squeeze out better performance.
Improve Performance
A generic strategy employed right after the transfer of ownership. There is a sole focus on
key performance indicators (KPIs) or cash flows alone for the firm instead of the usual
earnings, EBIDTA etc. This focus allows the management and the firm to think and focus
in one direction and become more efficient and effective.
Better Management Focus
PE firm's global expertise in business performance should be leveraged to manage the
firms better. Another generic strategy is to bring in key industry experts on board. The
technical and business expertise of these individuals creates an intangible value for the
firm. PE firm allows the leverage for the management to think big and long term.
Internal effectiveness
Top line (organic) growth is virtually a risk-free way for the performance of the firm to
grow. This is primarily as internal effort which requires little cash, however it requires an
alignment of the firm internally and externally to achieve the key goals

Regroup and Realign

21
This strategy has already been mentioned in parts. This would target reducing
complexities and concentrating on core competencies. This strategy would create
immense value in medium to long term for the stakeholders. PE firms should look to
employ this strategy once they rope in the required management and increased the
internal effectiveness of the firm.
Expansion through Organic and Inorganic growth
This is a simple buy or build strategy that the firms can undertake. The capital injected by
PE could be utilized to further add capacities to the organization or M&A exercise could
be carried out to increase the firms' operations.
Strategies for Public-Private Partnership (PPP)
PPPs are being viewed as the key long term business opportunity for large-scale private
investment in infrastructure and economic development of the country. They provide an
enormous business prospect for private institutions with the potential of attractive future
returns.The role of the government is to identify well structured, financially viable PPP
projects and build a repository of these.

Performance/ Evaluation of Private Equity Investment

Monitoring

If an investor is to take an active approach to monitoring the activities of a fund holding,

this can be a resource consuming exercise. Larger investors may be offered a place on the
funds Advisory Board, which generally focuses on investor and conflict issues.
Some investors will review in detail the investment case for each of the funds
investments. In some instances the opportunity to co-invest may be made available.
Investors should expect that the IRRs reported by their portfolio funds will show a J-
curve profile.

Measuring Performance

IRR and Multiple

Performance over time is typically measured as internal rate of return and absolute gains
are measured as a multiple of original cost. The IRR is defined as the discount rate used
to equate the cash inflows from realizations, partial realizations or its mark-to-market (the
expected value of an investment at the end of a measurement period). The IRR
calculation covers only the time when the capital is actually invested and is weighted by
the amount invested at each moment.

Peer Group Benchmarking

When comparing a funds performance with that of other private equity funds, it is
important to compare like with that of other private equity funds, it is important to
compare like with like. First, one should compare funds in the same sector. For example,
to compare a buyout fund with a venture capital fund would be meaningless. Comparing
two mid-market pan-India buyout funds against each other would be appropriate.

22
The Different Types of Private Equity Investment Funds
Private equity funds differ in their areas of specialization, their shareholders and their
management structures.
Independent private equity funds are those in which third parties are the main
source of capital and in which no one shareholder holds a majority stake. An
independent fund is the most common type of private equity fund.
Captive funds are those in which one shareholder contributes most of the capital,
i.e. where the parent organization allocates money to the fund from its own
internal sources
Semi-captive funds are funds in which, although the main shareholder
contributes a large part of the capital, a significant share of the capital is raised
from third parties. Semi-captive funds can be subsidiaries of a financial
institution, an insurance company or an industrial company that operate as an
independent company

Private Equity Funds classified based on Lifespan

The legal structures relating to private equity investment funds vary from country to
country but there are two main types: funds with a limited lifespan, in general ten years,
and funds with an unlimited lifespan.

Fund Specializations
Very few funds are purely generalist (i.e. with no sector or business type specialization)
and the majority of private equity funds have decided to specialize in certain industrial
sectors or services or in companies at a certain stage of development, of a particular size
or with a specific geographical coverage (regional, national or international).
Seed
Seed financing is designed to research, assess and develop an idea or initial concept
before a company has reached the start-up phase.
Though it is rare for specialized financial operators to contribute capital to such ventures,
there are some seed experts.
Start-up
Start-up financing is used for product development and initial marketing. Businesses may
still be in the creation phase or have just started operations and have not yet sold their
product commercially.
At this stage, the capital is mainly required for research and development of the product
and to train personnel. This is especially true in technology sectors such as electronics,
IT, life sciences or biotechnology.
The risk of failure for these companies is high and investors need to be stringent in their
choice of projects.
Post-creation
At this stage, the business has already developed its product and needs capital to begin
making and selling it. It has not yet generated any profits.

23
Expansion/Development/Growth
In the case of expansion, the business has reached or is approaching breakeven. This is a
period of high growth and capital is used to increase production capacity and sales power,
to develop new products, finance acquisitions and/or increase the working capital of the
business.
Mezzanine Capital
Mezzanine capital refers to a subordinated debt or preferred equity instrument that
represents a claim on a company's assets which is senior only to that of the common
shares. Mezzanine financings can be structured either as debt (typically
an unsecured and subordinated note) or preferred stock.
Mezzanine capital is often a more expensive financing source for a company than secured
debt or senior debt..
Transfer/Succession &Leveraged Buyouts
The total or partial retirement of the head of a company is often an opportunity to
implement a leveraged operation (capital contributions in the form of both debt and
equity) to undertake a buyout or a buyin.

Evolution of the Indian Private Equity and Venture Capital Industry

To look back in time - the growth of the industry in India can be considered in two
phases.
The first origins of modern Venture Capital in India can be traced to as early as 1973
when the government recognized the need for venture capital when a committee on
Development of Small and Medium Enterprises highlighted the need to foster VC as a
source of funding new entrepreneurs and technology. A Technology Development Fund
(TDF) was setup in the year 1976 and it was meant to provide financial assistance to
innovative and high-risk technological programs through IDBI.

The first phase was spurred on soon after the liberalization process began in 1991.
According to former finance minister of economic reform in the country, the government
had recognized the need for venture capital as 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). This
was followed suit by multiple financial institutions that launched various funds, which
essentially invested proprietary capital in small and medium enterprises during the next
decade
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.

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In 1998, only 8 domestic venture capital funds were registered with SEBI which by the
turn of the century climbed up to 19, a number of them being foreign funds. In 1999-
2000, there was a spurt of technology and internet companies in India, which attracted
huge amount of capital. This period, while not necessarily the most lucrative for venture
capitalists, was one of fostering the understanding of the concept of venture
capital/private equity in India. These guidelines were further amended in April 2000 with
the objective of fuelling the growth of VC activities in India.
Today, the Indian venture capital/private equity industry has developed even further.

Capital Inflows into India

Due to the change in the Government of India's policies post- liberalization, in 1991 and
subsequent privatization and globalization endeavours, India has seen significantly large
inflows of foreign direct investments (FDI). The sources of these investments are largely
attributable to the private equity activities. As depicted in figure below, the last 2 years
have seen more FDI activity than the entire period of 1991 to 2000. FDI peaked in 2007
when India was reckoned as a global hot-spot and as a fallout of the global economic
crisis, there has been a slight tapering in FDI inflows.

*Upto Feb 2010

Source: Department of Industrial Policy and Promotion, Ministry of Commerce &
Industry

Out of the FDI Inflows the amount of money attributed to Private Equity Deals is shown
below:

25
Source: VCCEdge

The number of deals executed was highest in 2007-2008 as shown below. This reflects
the fact that the investor confidence was at its peak. Subsequently, after the global
economic downturn the confidence levels in the economy were at its lowest and thus
there was a sharp fall in the number of deals executed in 2009.

Source: VCCEdge

The largest contributors to this boom as shown from the figure below have come from tax
havens such as Mauritius. India has a Double Taxation Avoidance Treaty with some
countries which has made destinations such as Mauritius, Cyprus, Singapore lucrative
locations to set up funds as an offshore entity. Structuring of offshore funds and the
subsequent tax benefits have been explained in detail later in this report.

26
Source: Department of Industrial Policy and Promotion, Ministry of Commerce &
Industry

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Sectors Attracting FDI

Traditionally, investments by VCs and the PE investors have been in high growth sectors
such as Information Technology until early 2001. With the technology slowdown
following the dot-com bust, VCs and PEs have diversified their interest into other high
potential sectors such as pharmaceuticals (especially biotech), manufacturing,
infrastructure, banking, media and entertainment, retailing, Public Sector Undertakings
disinvestments and business process outsourcing (BPO and IT-enabled services).

The chart below shows the percentage break-up of sector-wise FDI August 1991 and
September 2005. A majority of foreign investment has gone into the old economy sectors
like fuel, power, industrial machinery, etc. It is only over the past few years that new
economy sectors like services (including software services and business process
outsourcing) and telecom have attracted significant amounts of investment. The first
phase of reforms ushered in a great deal of liberalization in the old economy sector and as
a result, there was a sudden spurt of foreign investment in these sectors, with the services
sector attracting the majority of investments after the electrical equipments sector.

Source: Department of Industrial Policy and Promotion, Ministry of Commerce &

Industry

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The industry wise split-up of total investments for the ten industry classes over the five-
year period are given in the figure below.

Source: Venture Intelligence

Prior to 2004, a majority of PE-VC investments were in the IT & ITES sector, with the
manufacturing sector accounting for the remaining. This trend is evident even in 2004
with IT and ITES industry bagging more than 42% of the total investments. However,
this picture has dramatically changed now. During the years 2004-2007, there was robust
growth in PE investments in technology-led, capital intensive sectors like Telecom,
Energy, Transportation and Infrastructure in addition to the initial drivers like IT & ITES,
BPO, Healthcare and Biotechnology.
The industry-wise share of total PE investments in India over the five year period is given
below.

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Comparison of Investment Pie in 2004 and 2008

This indicates that the PE-VC investment in India is maturing and hence becoming more
inclusive and broad based. This is best illustrated by the fact that there is a steep decline
in the share of IT & ITES and Healthcare as a percentage of total investments, the share

30
of sectors like Engineering & Construction, Telecom & Media and Transportation &
Logistics have considerably gone up over the same period.
While four out of the 10 industries accounted for more than 80% investment in 2004, the
investment picture appears relatively less skewed and much more uniformly distributed
across the 10 sectors in 2008. The figures below illustrate this shift in the distribution of
total investment among the 10 industries from 2004 to 2008.

Investment Details: Stage-wise

Source: VCCEdge

In India Private Equity deals dominate the PE-VC space as can be seen above. Angel
investors are reluctant to invest in high risk ventures. One of the primary objectives of
PE-VC Financing is to fill the void left by traditional financial institutions in funding
innovative, promising entrepreneurial businesses that are inherently risky. The
results from the report indicate that most PE -VC funds are inclined towards generating
handsome returns in shortest possible time, without fulfilling
the broader objectives of providing risk capital to innovative businesses.
A further break up of these deals in the period 2005-2009 is shown below:

31
Source: Venture Intelligence

In India, 50% of the deals are done in late and growth stages of a company, with a third
of all deals done in the late stage. This indicates that investors prefer stable and
established businesses to invest in as compared to relatively new and untested businesses.
Though the percentage share of early stage investments has increased in recent times,
investors have become more risk averse in recent times due to the economic conditions
across the globe.
Median and Average Deal Size

Source: VCCEdge
Since 2007-2008 average deal size has come down significantly suggesting that the big
money deals are not happening often any more. The median deal size has also gone down
suggesting that more than half the deals in 2008 were less than 8 million US $. In the first
quarter of 2010 the average deal and median deal size has gone up suggesting a revival of

32
the economy along with a revival in appetite of taking risks and making bigger
investments. In contrast to the economic scenarios in most developed economies, India
continues to offer investors refreshing opportunities in an economy which is growing at a
healthy pace and has its fundamentals in place.

Exits
During 2004-2009, there were about 114 VC exits of which 62 were M&A deals, 15 IPO
and 36 secondary sale/buybacks. There is an average exit multiple of 4.63X and an
average IRR of 40.15%. The year 2007 witnessed maximum number of VC exits at 33
with an average multiple of 5.9X. And, 2008 saw the lowest number at eight exits with
highest return multiple of 21X. In 2009, 13 exits were made at an average of 2.8X.

Source: VCCircle, IDG

During 2004-2009, 60 exits were made through strategic sale (2.8X), 22 through
secondary sale (9.4X), 16 through buyback (2.7X) and 15 through IPO (4.2X). IPOs have
not fared so well as they have a dependency on the capital markets. There are also
concerns within the minds of the public as some feel private equity firms choose this
option to maximize their profits and do so at high valuations.

33
Source: VCCircle, IDG

Some Successful PE Deals

Exit
Company PE Investors Industry Multiple
i-flex Solutions Citibank IT & ITES 23.4
Bharti Airtel Warburg Pincus Telecommunications 6.5
Ambuja Cements Warburg Pincus Cement 3.1
Suzlon Chrys Capital, CVC Energy 26-30
Mphasis BFL Baring India IT & ITES 15-17
Excelsoft
Technologies UTI Ventures IT & ITES 50
Educomp Gaja capital, Carlyle
Solutions Group Education 22.5
Infoedge ICICI Ventures IT & ITES 17.5
Glenmark Pharma Actis Pharmaceuticals 10.3
Polaris Citibank IT & ITES 10.5
Moser Baer Electra Electronics 10.2
Source: Economic Times, VCCircle, Venture Intelligence

34
Summary of Deals in Q1 of 2010

Source: VCCEdge

Source: VCCEdge

As we can see above investments are taking place in sectors such as consumer
discretionary, consumer staples, financial services and utilities.
Consumer Discretionary consists of businesses that sell nonessential goods and services.
Companies in this sector include retailers, media companies, consumer services
companies, consumer durables and apparel companies, and automobiles and components
companies. This accounted for 440 mn US $ of investments.

35
Consumer Staple industries manufacture and sell food/beverages, tobacco, prescription
drugs and household products.
Utilities industry includes companies that offer services like electric power, steam supply,
natural gas, and sewage removal.
Though the number of deals in Information Technology is high, the average deal size is
quite small. The Financial Services Industry continues to attract high amount of private
equity funding.
These deals are a reflection of the mood in the economy and are corroborated by the fact
that essential as well as non essential goods and services are both attracting private equity
funding. This suggests that the revival in the Indian economy and the private equity
industry is broad based.

Legal and Regulatory Environment

Domestic and offshore venture capital funds investing in India are regulated by the
Securities and Exchange Board of India (SEBI). Until recently, SEBI only regulated
domestic venture capital funds under the SEBI Venture Capital Fund Regulations.
However, a need was felt to monitor foreign private equity investment.

The SEBI (Venture Capital Funds) Regulations, 1996

Domestic VCFs are regulated by SEBI under the VCF Regulations. Under the VCF
Regulations, a domestic VCF can be organized either in the form of a trust or as a
company including a body corporate and registered under these regulations.
Investment conditions and restrictions
In addition to the investment restrictions and conditions applicable to FVCIs, the
following conditions would apply to a VCF:
A VCF cannot invest more than 25% of its aggregate Capital Commitments in any
one VCU.
Minimum investment to be accepted from any investor should be Indian Rupees
500,000 except in the case of employees, principal officers or directors of the
VCF, employees of the manager of the VCF where lower amounts may be
accepted.
Minimum capital commitments from its investors should be Indian Rupees 50
million in any scheme launched or fund set up by a Venture Capital Fund.
A VCF cannot invest in associate companies. 'Associate company' means a
company in which a director or trustee or sponsor or settlor of the VCF or the
investment manager holds either individually or collectively, equity shares in
excess of 15% of its paid-up equity share capital of VCU.
A fund can make investments in undertakings subject to the following restrictions:
i. at least 66.67% of the funds invested has to be invested in unlisted
equity shares or equity linked instruments;
ii. no more than 33.33% of the funds invested can be invested by way of:

36
 a. subscription to the initial public offer of a VCU whose shares are
proposed to be listed subject to a lock-in period of one year;

b. debt or debt instrument of a VCU in which the fund has already

made an equity investment.

c. preferential allotment of equity shares of a listed company, subject

to a lock-in period of one year.

d. the equity shares or equity linked instruments of a financially weak

or a sick industrial company whose shares are listed.

e. Special Purpose Vehicles which are created by a venture capital

fund for the purpose of facilitating or promoting investment in
accordance with these regulations.

The SEBI Venture Capital Funds Regulations restrict funds from listing their
securities for a period of three years from the date of their issue.

Further, prior to the enactment of the Finance Act 2007, a VCF was able to enjoy certain
tax advantages so long as the VCF was registered with the Securities and Exchange
Board of India and other conditions were met. A VCF, under these circumstances, was
treated as a pass-through or flow-

The SEBI (Foreign Venture Capital Investors) Regulations, 2000 (FVCI

Regulations)

In India, both domestic and offshore venture capital funds investing in India are regulated
by the SEBI. Earlier, SEBI only regulated the domestic VCFs, however, in September
2000, SEBI announced a new set of guidelines enabling foreign venture capital and
private equity investors to register with SEBI under the new guidelines, the SEBI
(Foreign Venture Capital Investors) Regulations, 2000 ("FVCI Regulations"). The FVCI
Regulations were substantially amended by the SEBI vide the SEBI (FVCI)
(Amendment) Regulations, 2004.
Foreign private equity players can invest in India either directly under the foreign direct
investment (FDI) regime or under the Foreign Venture Capital Investor regime. Although
it is not mandatory to register with SEBI as an FVCI, to encourage foreign investors to
register with SEBI several benefits have been granted to registered foreign venture capital
investors. These benefits are discussed later in this section.
Eligibility Criteria
For granting the certificate to an applicant as a Foreign Venture Capital Investor, the
Board shall consider the following conditions for eligibility:
The applicants track record, professional competence, financial soundness,
experience, general reputation of fairness and integrity.
Whether the applicant has been granted necessary approval by the Reserve Bank
of India for making investments in India.

37
 Whether the applicant is an investment company, investment trust, investment
partnership, pension fund, mutual fund, endowment fund, university fund,
charitable institution or any other entity incorporated outside India.
Whether the applicant is an asset management company, investment manager or
investment management company or any other investment vehicle incorporated
outside India.
Whether the applicant is authorized to invest in venture capital fund or carry on
activity as a foreign venture capital investors.
Whether the applicant is regulated by an appropriate foreign regulatory authority
or is an income tax payer; or submits a certificate from its banker of its or its
promoter's track record where the applicant is neither a regulated entity nor an
income tax payer.
The applicant has not been refused a certificate by the Board
Whether the applicant is a fit and proper person

Investment conditions and restrictions

The investment restrictions applicable to FVCI are similar to those applicable to funds
under the Venture Capital Funds Regulations (as listed above) except for the following:
there is no minimum corpus or capital commitment requirement for FVCIs;
there is no minimum individual contribution prescribed under the FVCI
Regulations; and
for determining the maximum investment in a single undertaking (which is
25% of the corpus), the funds earmarked for India will be taken into
consideration.

The FVCI Regulations make it mandatory for a FVCI to appoint a domestic custodian for
the securities and to enter into an arrangement with a designated bank to open a special
non-resident Indian rupee or foreign currency account.

Benefits of FVCI registration

India still has exchange controls. Although any fresh issue of shares by an Indian
company in most industries has been made automatic under the Foreign Exchange
Management (Transfer or Issue of Security by a Person Resident Outside India)
Regulations, 2000 (FDI Regulations), any purchase of shares of an Indian company by a
non-resident from a resident still needs to be approved by the Foreign Investment
Promotion Board (FIPB) and the RBI.
Under the FDI Regulations, a non-resident buying shares in an unlisted company must
pay a minimum price linked to the net asset value of the shares.
The transfer of shares from FVCIs to promoters is exempted from the public
offer provisions under the SEBI (Substantial Acquisitions of Shares and
Takeover) Regulations, 1997, if the portfolio company gets listed on a stock
exchange after the investment..

38
 Under the SEBI (Disclosure and Investor Protection) Guidelines, 2000, the
pre-issue share capital of a company, which is in the process of an initial
public offering, is locked-in for a period of one year from the date of
allotment. But an exemption has been granted to venture capital funds
registered under the SEBI VCF Regulations and SEBI FVCI Regulations.
FVCIs (as well as Venture Capital Funds) by virtue of being a QIB, are
eligible to subscribe to the securities of Indian listed companies under the
Qualified Institutional Placement route as prescribed under Chapter XIII A of
the SEBI (Disclosure and Investor Protection) Guidelines, 2000("DIP
Guidelines").
Under the DIP Guidelines, the entire pre-issue share capital of a company
going in for an IPO is locked for a period of one-year from the date of
allotment in the public issue.
Generally the definition of a 'Promoter' under the SEBI (Disclosure and
Investor Protection) Guidelines, 2000 is very broad and includes any person(s)
who is in overall control of the company, or has a role to play in the
formulation of a plan pursuant to which securities of the company are offered
to the public (for example, decision of a company considering an IPO) or any
person(s) named as promoter in any offer document of the company.
The restriction on investment in companies whose securities are listed is being viewed by
both domestic and offshore private equity players as a significant barrier considering the
number of opportunities existing in underperforming listed entities.

Structure of Funds

Domestic funds

For domestic venture funds (in which the funds are raised within India), the most
common approach is to use a domestic vehicle to pool funds from the investors and a
separate investment adviser to carry on asset management activities. The choice of
entities for setting up the pooling vehicle is between a trust and a company. The corporate
structure poses certain disadvantages as compared to a trust structure. Some of the
significant ones are:

Distribution of income by way of dividends can only be out of profits or retained

earnings. In the event the VCF does not earn profits on an investment or has
accumulated losses, it will not be able to distribute the income as dividend to its
shareholders/investors.
Redemption of equity is still highly regulated and can be done only out of profits
or fresh issue of shares (of a different class than those being redeemed). Thus, in a
loss situation it would be difficult to redeem shares.

39
 Even winding up of a company takes a significantly long time, anywhere between
1-3 years, making the winding up of a fund a cumbersome and long drawn
process.

Offshore fundsCommonly there are two alternatives available to offshore investors

participating in Indian venture capital investments. They can either use an offshore
structure or a unified structure.

Offshore structureUnder this structure an investment vehicle (Fund), which could be

an ordinary company, an LLC or an LP organized in a tax favorable jurisdiction outside
India will pool investments from investors. The Fund will then make investments directly
into Indian portfolio companies. There would generally be an offshore investment
manager (IM) for managing the assets of the fund and an investment advisor (IAA)
in India for identifying deals and to carry out preliminary due diligence on prospective
investment opportunities. The IAA could be a 100% subsidiary of IM. As per the FDI
regulations, the minimum capitalization of the IAA would have to be US$ 500,000. The
structure would be as follows:

Unified structure
This structure is generally used where domestic (i.e., Indian) investors are expected to
participate in the fund. Under this structure, a trust or a company is organized in India.
The domestic investors would directly contribute to the trust whereas overseas investors
pool their investments in an offshore vehicle and this offshore vehicle invests in the
domestic trust. The portfolio investments are made by the trust which is registered with
the Securities and Exchange Board of India (SEBI) as a VC fund.

Future of the Indian Private Equity and Venture Capital Industry

The future outlook for PE-VC funding over medium-to-long term looks very promising
for India. Though India has emerged as a leading destination for PE-VC investments in
the global stage in the last five years, it needs to consolidate over these gains and grow
further.
India needs to attract and retain more and more PE-VC investors to meet the ever
increasing need for funds across the sectors to fuel its economic growth as well as to
nurture and promote its entrepreneurial talent.
This can be achieved only through coordinated efforts by the government, regulatory
agencies and most importantly the industry itself to create a positive and vibrant
investment environment for PE-VC financing in India. Thus we can say that, while India
is one of the leading PE-VC markets in the world, it still has many miles to go in terms of
fulfilling the expectations of Indian entrepreneurs and investee companies.
One of the primary objectives of PE-VC Financing is to fill the void left by traditional
financial institutions in funding innovative, promising entrepreneurial businesses that are
inherently risky.

The results from the report indicate that most PE -VC funds are inclined
towards generating handsome returns in shortest possible time, without fulfilling

40
the broader objectives of providing risk capital to innovative businesses. Suitable policy
incentives should be formulated to encourage start -up/ early stage investments especially
in small and medium enterprises and promising ideas by new entrepreneurs. Also policies
that are designed should actively support and reward follow-up investments. Also we
need to increase the participation of Indian financial institutions in these funds and in a
way insulate this industry from the global economic volatility.

Conclusion

Private Equity and Venture Capital Funding have played a pivotal role in technology-
driven innovation worldwide. They also play a pivotal role in the growth of start-ups as
well as SMEs. The inherent risks that exist in start-ups and SMEs make it difficult for the
entrepreneurs to raise the necessary capital from conventional sources like banks and
primary capital markets. PE and VC funds typically fill the void left by traditional
financial institutions in financing these high risks, high potential ventures. In recent
years, PE funds have also emerged as an essential source of funding for financing
expansion of well established firms.
Venture Capital and Private Equity can be a win-win situation for all the stakeholders
involved. Businesses and entrepreneurs have more avenues to access capital, that too at
favourable terms. This helps them grow much faster than the conventional means of
financing would enable them to encash the innumerable opportunities available in a
rapidly emerging economy like Indias at the right time. As businesses grow, more people
get employed and the benefits of this growth permeate through the different strata of
society. Investors can benefit from growing businesses in a rapidly growing economy and
achieve growth multiples that not many other economies in the world can match.
With the Indian economy growing strongly and other macroeconomic factors and policies
favourably complementing the growth, India has emerged as an attractive investment
decision. Global investors looking for investment opportunities in emerging markets in
order to tap the growth potential as well as to diversify and mitigate their risk are getting
increasingly attracted to Indian markets. Consequently Indias share in global pool of
private equity investments is steadily rising.
The PE-VC regime in India is still evolving and the government is quite upbeat on the
prospects of the industry. India continues to offer great investment opportunities across
industries and these are likely to attract a lot more venture capital funds, both domestic
and offshore. PE-VC investments in India have become more inclusive over the years and
not just restricted to few industry sectors. The regulators have also made it clear they are
willing to encourage the inflow of venture capital investments into the country. Further,
the current slowdown resulting in attractive valuations makes this an opportune time for
private equity investors to look at India as an investment destination.

41
Bibliography
Websites & Organizations
www.vccircle.com
www.ventureintelligence.in
www.indianvca.org
www.indiape.com
www.iciciventures.com
www.privateequity.com
www.altasset.net
www.privateequityvaluation.com
www.bvca.com
www.evca.com
www.nvca.com
www.sebi.gov.in
www.nishithdesai.com
www.privateequityasia.net
www.ventureahead.com
www.vcexperts.com
www.avcj.com
www.vcindia.com
www.economictimes.com
www.livemint.com
www.dipp.nic.in
www.kayaclinic.com
www.icicisecurities.com

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