Venture Capital

Introduction


An entrepreneur New and unknown technocrat, Possesses innovative ideas to develop a new product To turn his ideas into a successful commercial venture Funds required Finance required for such purpose is more risky in nature, because the innovative ideas of the entrepreneur have not been tried on a commercial scale if the venture proves successful, it has potential for high returns Venture Capital
  

 

long-term investment in business has potential for significant growth and financial returns provided in the form of equity apart from conditional loans and conventional loans High risk high expected returns

Classification of Venture Capital Funds



Classified based on the activities



Incubators Angel Investors Venture Capitalists Private Equity Players

Incubators


An incubator is a hard core technocrat who works with an entrepreneur to develop a business idea and prepares a company for subsequent rounds of growth and funding E.g. E-Ventures, Infinity, ICICI Winfra (JV of ICICI & West Bengal Infrastructure Development Corporation) setting up an IT incubation center.

Angel Investors
 

An experienced industry-bred individual with high net worth. Invests in his chosen field of technology and take active participation in day-to day running of the company An important link in the entire process of venture capital financing Provide funding by first round financing for risky investment like a young/startup company Bring expertise as well as money IndUS Entrepreneurs, Vinod Dham, Sailesh Mehta, Kanwal Rekhi, Prabhu Goel, Atul Choksi, Suhas Patil etc.

 

 

Venture Capitalists


Organisations that raise funds from numerous investors and hire experienced professionals to deploy the same Invest at a second stage investment Sow the capital, nurture it and when grown sell, take the profit and get out of the business

 

Private Equity
     

Established investment bankers Invest into proven/established businesses have financial partner approach Invest between USD 5 100 million Threat to venture capital financing E.g. ICICI Ventures with USD 2 billion fund to manage Major portfolio pf ICICI Ventures Air Deccan, Dr. Reddys, Biocon, Centurian Bank of Punjab, Naukari.com, Pentaloon Retail, Reliance Petroleum etc.

Ventures Capital Financing Process



Getting capital through this route is very difficult and involves many steps
    

Making a deal (Deal origination) Due diligence (Evaluation) Investment valuation Deal Structuring Exit

Making a deal
 

A continuous flow of deals is essential for a venture capital business Deals may originate in many ways


Referral system through parent organization, trade partners, industry associations, friends etc. Business plan competitions To source a new and innovative idea and short listed projects are provided necessary expertise

Screening Based on certain broad criteria e.g. industry, scale of investment, geographical location, stage of financing etc.

Due Diligence/Evaluation
 

After screening due diligence Subjective but comprehensive evaluation of quality of entrepreneur and business plan Research parameters Integrity, Urge to grow, Long-term vision, Commercial orientation, Critical competence vis--vis ventures, Ability to evaluate and react to risk, Well thought strategy to remain ahead of competition, High market growth rate, Expected returns >25% in five years, Managerial skills and Marketing skills.

Investment Evaluation
 

To ascertain the expected price for the deal Steps followed are
  

Projections on future revenues and profitability Expected market capitalization Deciding on the ownership stake based on the return expected on the proposed investment

Deal Structuring
 

To decide the amount and form of investment with protective covenants Various instruments to structure the deal equity shares, preference shares, loans, warrants, participatory notes etc.

Post Investment Activities and Exit



 

Once the investment is finalized and the deal is structured, VC assumes the role of a partner, collaborator or mentor The degree of involvement depends on their policy In case of crisis VC takes charge and some times even changes the management team Typically aim at making medium to long-term capital gain generally want cash-out gains in five-ten years after the initial investment Exit routes
    

Initial Public Offering Acquisition by another VC company Repurchase of the VCs shares by the promoters Purchase of VCs share by a third party Self liquidating process in case of debt financing

The Business Plan


           

Executive Summary Brief description of each item

Business Background Product / Service Market Analysis Sales and Marketing Strategy Production and operations Management Risk Factors Funds Requested Return on Investment and Exit Use of Proceeds Financial Summaries Appendices
   

Resume of key management and employees Detailed financial forecasts and assumptions Market research report Company literature, brochure and picture of the product

STAGES OF VENTURE CAPITAL FINANCING



Venture capital fund provides finance to the venture capital undertaking at different stages of its life cycle according to requirements.

Stages classified into two



Early stage financing

  

Seed Capital Stage Start-up Stage Second Round Financing

Later stage financing

   

Expansion Finance Replacement Finance Turn Around Finance Buoyant Deals

Early Stage Financing

Seed Capital Stage
 

Primary stage associated with research and development Concept, idea, process pertaining to high technology or innovation are tested on a laboratory scale.

Based on laboratory trial, a prototype product development is carried out and possibilities of commercial production of the product is explored.

Risk perception of investment quite high, a few venture capital funds invest in the seed capital stage of product development.

Start-up Stage


Venture capital finance available at the start-up stage of the projects which have been selected for commercial production. Start-up - Launching or beginning a new activity, but the product must have effective demand and command potential market in the country. The entrepreneurs who lack financial resources for undertaking production, approach the venture capital funds for extending funds through equity. Before making such investments, venture capital fund companies assess the managerial ability, capacity and the commitment of entrepreneur to make the project idea as success. If necessary, the venture capital funds lend managerial skills, experience, competence and supervise the implementation to achieve successful operation. High degree of risk is involved in start-up financing.

Second Round Financing



After the product has been launched in the market, further funds are needed because the business has not yet become profitable and hence new investors are difficult to attract.

Investor has invested his own funds but further infusion of funds is needed Venture capital funds provide finance at such stage, which is comparatively less risky than the first two stages.

At this stage, finance is provided in the form of debt also, on which they earn a regular income.

Later Stage Financing

  

Even when the business is established requires additional finance Cannot be take by offering shares (public issue) Venture capital funds prefer later stage financing as they anticipate income at a shorter duration and capital gains subsequently.

Types of Later stage financing



Mezzanine/Development Capital


Finance for purchase of new equipment, refinancing of existing debt, penetration into new region etc.

Expansion finance


Finance to expand business by way of acquisition of other firms, last round of financing before a planned exit

Buyouts


Transfer of management control



Management buy-outs VCs provide funds to enable the current operating management/investors to acquire existing product line or business

Can acquire a sick company and turn it around need money and management to turnaround

Management buy-ins
 

Funds provided to enable an outside group to buy an ongoing company Target are weaker or underperforming companies

Merits of Venture Capital Financing



Can provide large sums of equity finance and bring a wealth of expertise to business

Successfully attracting a VC can help the business to find easier and secure funding from other sources

VC can take part in promoting an innovative ideas which otherwise would have buried due to paucity of funds

 

Encouragement to new breed of entrepreneurs to take up risk For VC benefit from the growing economy

Demerits of Venture Capital Financing

 

Securing a deal with VC is a long and complex process To draw up a detailed business plan, entrepreneur requires professional help

If he gets through the deal negotiation stage, he will have to pay legal and accounting fees

Since VC is taking the risk, the management control may get out of the entrepreneur

Partnering the profit with the VC

SEBI Guidelines for Foreign Venture Capital Funds



Registration


A foreign venture capital investor (FVCI) must be registered with SEBI after fulfilling the following eligibility conditions and on payment of application fee of US $1000:


Its track record, professional competence, financial soundness, experience, reputation of fairness and integrity RBI has granted approval of investing in India It is an investment company, trust, partnership, pension or mutual or endowment fund, charitable institution or any other entity incorporated outside India. It is an asset/investment management company, investment manager or any other investment vehicle incorporated outside India. It is authorised to invest in Venture Capital Fund or to carry on activity as Venture Capital Fund. It is regulated by an appropriate foreign regulatory authority or is an income tax payer. Otherwise, it submits a certificate from its bankers about its promoters track record. It is a fit and proper person.

 

SEBI will grant the Certificate of Registration on receipt of the registration fee of US $10,000 on the following conditions:
 

it would appoint a domestic custodian for the custody of securities. to enter into an agreement with any bank to act as its banker for operating a special non-resident rupee/foreign currency account.

Investment Criteria


Foreign VC Investors must disclose their investment strategy to SEBI. They are permitted to invest their total funds committed in one venture capital funds, but for investing in venture capital undertakings they have to follow the norms as prescribed by SEBI domestic VCFs.

Powers of SEBI SEBI has the following powers as regards FVCls:



Power to conduct inspection/investigation in respect of conduct and affairs of FVCls. Power to issue directions in the interest of the capital market and investors. Power to suspend or cancel registration. Power to call for any information.

  

Venture Capital Funds in India is promoted by

   

All India Financial Institutions State level Financial Institutions Commercial Banks Private Sector Institutions


Indian
   

IFCI Venture Capital Funds Ltd. IDBI Venture Capital Fund ICICI Venture Funds Management Company Ltd. SIDBI Venture Capital Ltd.

Foreign