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Chapter 8 VENTURE CAPITAL
“Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Learning goals: Understand the venture capital concept and its features. Provide a picture of venture capital investment process. Trace the evolution and progress of venture capital. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Present the stages of development of Indian venture capital industry.
Understand the technical terms associated with the concept Modern concept of VC originated in the US in 1946 Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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VC Success strories: Praj Industries, Renewable Energy Systems, Mastek, Biocon, Naukri.com.
Apple, Intel, Microsoft, Google, Sun Microsystems, Digital and Federal Express etc Approximately 741 venture capital firms in the US and they manage approximately $257 billion. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Favorable impact on entrepreneurial development in an economy.
Concept of venture capital has certain characteristics that distinguish it from the conventional forms of financing through loans or equity participation. Favorable impact on entrepreneurial development in an economy. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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VC : DEFINITION VC: A method of financing projects especially which are newly started. Financing projects which may be innovative and risky where the traditional banks and the financial institutions, being basically risk- averse investors, may not come forward to finance it. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Venture capital investors step in and finance the projects, participate in the management, sail through with the entrepreneur and finally exit when they find that the project is successful. Share the returns when the project turns success and bear the risks in case of failure. A venture capital firm is a financial partner of an entrepreneur in his project who sees him through its implementation and commercial operation. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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European Venture Capital Association (EVCA)
‘Providing seed, start-up and first stage financing and also funding the expansion of companies that have already demonstrated their business potential but do not yet have access to the public securities market or to credit oriented institutional funding sources’ Jane Koloski Morris ‘Risk finance forentrepreneurial,growth oriented companies’ European Venture Capital Association (EVCA) Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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‘Equity or equity featured capital seeking investment in new ideas, new companies, new products, new processes or new services that offer the potential of high returns on investment’ International Finance Corporation (IFC) Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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It reflects the old saying, ‘nothing ventured, nothing gained’.
Venture capital means to risk capital because the success or failure of the entrepreneur affects the returns of the venture capital investor. The term ‘venture’ in the generic name ‘venture capital’, might probably signify the adventuristic element of investing. It reflects the old saying, ‘nothing ventured, nothing gained’. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Difference between Venture capital and Private equity:
Ventue capital is a subset of private equity funding. The term ‘private equity’ is more broad based and it includes venture capital, buyouts and mezzanine financing. Venture capital concentrates on young companies whereas buyouts and mezzanine financing focuses on investing in mature companies. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Difference between Venture capital and Angel investing:
An angel investor does the same functions as that of a venture capitalist. However, they invest their own capital rather than that of institutional or other individual investors. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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The National Venture capital Association (NVCA) of the US points out that the angel investment community is an informal network of investors who invest in companies for their own interests. Further, the NVCA states that the angel investors invest less than $1 million in any particular company, whereas venture capitalists usually invest more than $1 million per company “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Characteristics of venture capital
1. Risky projects Venture Capital finances new projects that are untried and which a. Possess higher than average risk levels. b. Difficult to quantify the risk through the conventional risk measurement tools. c. May be a new product, a new technology or a new process that results in cost savings for the companies. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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A few sectors of venture capital investments. Telecommunications
d. Mostly, the investments are made in emerging industries which are technology driven. A few sectors of venture capital investments. Telecommunications Biopharmaceuticals Medical devices Software Semiconductors including electronics Clean energy technologies Contd…
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2. Early stage financing Every project has a life cycle and this consists of two stages – early stages and later stages. Finances the products or services which are at the early stages of their life cycle. Helps the entrepreneur from the concept stage to the start of commercial operations. The term venture capital, in a broader perspective, includes seed stage financing, early stage financing and later stage financing. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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3. Entrepreneur centric Supports the business idea of the entrepreneur. Emphasize on business plan Idea might have been evolved out of research and development by the entrepreneur. Background of the entrepreneur, in terms of education, and the experience in the product development are weighed heavily in the venture capital process. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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4. Partnering A venture capital financing firm is seen as a partner in the business. Brings in his own experience of implementing a project and works for the success of the project. Serves in the Board of Directors and contributes to the efficient management of the project. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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5. Form of finance Venture capital assistance is mostly in the form of participation in the equity capital of the company. In some cases, it could be in the quasi-equity instruments like convertible preference shares. In India, venture capital is extended in the form of conditional loans also. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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6. Turnaround investments
Apart from green field investments which have been untreaded so far, venture capital also includes investment in turnaround cases. The term venture capital is so inclusive now that it includes a whole range of financing from seed capital to buyouts. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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7. Long term Venture capital investors invest in companies for a longer term to realise the gains on their investments. Investments remain illiquid until the exit time. The projects take a longer time to be commercially successful and until that time Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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8. Prospects If the companies that seek venture capital finance are successful in their projects, the returns from the investments will be above average. The very project itself will be of such a nature that it has the possibility of earning above average returns once it is commercially successful. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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“Financial Services” by R Shanmugham
Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Venture Capital Terminology
Finance provided to high-risk, high return projects that may be in the start-up phase or in a turnaround situation. 2. Venture capitalist Financier or the venture investor who provides financing either as equity or loan to the firm that requires venture capital. Also called as Venture Capital Fund (VCF), venture financier, venture capitalists, venture capital company and venture investors Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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3. Investee companies/portfolio companies
Firms or promoters who seek venture capital finance beneficiaries of the venture finance Requires necessary documentation such as the business plan, application form, etc. to obtain venture capital assistance Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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4. Seed financing Capital provided to facilitate commercialisation of new product concepts, often from laboratories, research and development centres or entrepreneurs. Involves relatively a small amount of capital provided to the entrepreneur to prove a concept. If this process is successful, seed financing may result in a start-up. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Start-up financing 6. Mezzanine financing
Covers the financing provided to establish a legal company structure around a marketable product concept. 6. Mezzanine financing Generally, mezzanine financing arises at the later stages of venture. Final round of financing prior to an IPO by the client firm. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Bridge financing 8. Follow-on financing
Capital provided on a short-term basis to a company prior to its ‘going public’ or its next major private equity transaction. 8. Follow-on financing Venture capital-assisted firms could go for follow- on financing at a stage when they need funds for further growth. Follow-on financing is a supplementary round of financing in an existing venture capital-funded company. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Turnaround financing Finance provided to an established firm that is in financial distress but perceived to be a commercially viable enterprise. This means that a potentially viable company which is facing financial difficulties could be a candidate for venture capital investment. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Evolution of venture capital finance
1946 Venture capital is an American phenomenon that beginned with the formation of the American Research and Development Corporation (ARD) 1957 ARD’s investment in Digital Equipment Corporation (DEC), an important milestone. 1960 An era of developments in the field of electronics, medical technology and computers. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Growth of the semiconductor companies and the computer firms.
1970 Growth of the semiconductor companies and the computer firms. The rise of biotechnology firms during the 70s was discernible with the assistance of venture capital firms. 1972 The venture capital industry leader, Kleiner Perkin Caufield & Byers and another firm, Sequoia Capital started their operations. 1980 An era of development of supercomputers 1990 Growth of firms specialising in internet-based applications. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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In each of these technology cycles, venture capital firms played a key role in the US economy.
Venture capital market in the US consisted of three types of investors as follows: a. Venture capital partnerships (limited liability partnerships). b. Investment institutions such as pension funds, endowments, etc. c. Individuals. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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VENTURE CAPITAL NVESTMENT PROCESS
DEAL ORIGINATION SCREENING DUE DILIGENCE VALUATION STRUCTURING THE DEAL VALUE ADDITION EXIT “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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1. Deal origination A venture capitalist has to scout for the investment opportunities or the deals for investment. Sources of deals - referrals, intermediaries such as investment bankers, industry associations, friends, active search through networks, trade fairs, seminars and conferences etc. Brings potential entrepreneurs and venture capital firms together. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Deal origination - Example
Deal Sourcing by ICICI Ventures ICICI Ventures’ investment process starts with the sourcing of deals. Being the premier private equity player in India, ICICI Ventures’ reputation and brand equity has been attracting investment proposals and deals from entrepreneurs, management teams, promoters and intermediaries. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Deals are also directly sourced from industry contacts of the management team. Besides, ICICI Ventures also leverages its network with investment banks, fund investors, and also draws upon its access to the ICICI Bank Limited’s network with its large corporate clientele. Note :*ICICI Ventures is the subsidiary of ICICI Bank and it is a venture capital and private equity firm. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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2. Screening Limit the projects to the areas in which the
Venture capitalist is familiar with, in terms of technology, product. Initial screening-examination of the business plan of the applicant to determine whether or not the proposal fits in with the expertise of the venture capitalist. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Fig. Business plan funnel
Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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3. Due diligence Activities concerning the assessment of the business and financial viability of the target investment. Focuses on the qualitative aspect of the investment opportunity. Includes activities such as reference checks, evaluation of management team, product, technology and market. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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4. Valuation Venture investment is mostly in the form of participation in equity. Apart from the original investment, there may be subsequent rounds of financing or follow-on financing at different stages. As the investment is made in equity capital, valuation becomes essential. A complex process and it is generally aimed at finding an acceptable price for the deal. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Models for the process of valuation
Net present value method :Estimating the likely future value of the firm, given the target ownership position in the investee firm, and the desired appreciation in investment being sought. First Chicago method: Estimates the expected rate of return through probability weighting for three scenarios – success, sideways survival and failure. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Factors affecting valuation of the firm
Economic conditions Demand–supply position of venture capital. Firm specific factors such Track record of the promoter Unique Selling Proposition (USP) of the product Size of the market, etc. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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5. Structuring the deal Deal structuring – Negotiation between the venture capitalist about the form and the price of the investment. Both have their own wish list. For instance, the venture capitalist ensures adequate reward to the risk which he undertakes and pay attention to the issues such as management participation, and future liquidity for the investment, etc. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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The entrepreneur ensures whether finance to realise the business goals, and control of the business firm is adequate. The ultimate result is a structure that it is mutually beneficial to both the parties. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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6. Value addition Hand Holding approach: In the post- investment scenario, the venture capitalists take an active part in the management of the company by becoming a member of the Board. The managerial input given by the professional team of the venture capitalists is a useful value addition to the project. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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More appropriate for start-up firms that are at the early stages of development. The investee company becomes the portfolio company for the venture capitalists. A close monitoring of the portfolio company is done by the venture capitalists by their presence in the Board meetings, review sessions and periodical reports. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Value addition-example
Post-Investment Process at ICICI Ventures The Investment team works with management teams to identify opportunities for enhancing value through cost reduction and internal rationalisation. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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They also work together to implement growth strategies based on market definitions, customer segmentation, price management, focused marketing and sales plans, strategic capital investments and/or the introduction of proven technologies. The Investment teams also help in further strengthening the management teams. ICICI Ventures works actively with management teams to identify and execute acquisitions. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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7. Exit The venture capitalist holds on to his investments for a longer period, say, 5–7 years and at the end would like to realise the gains by exiting the investee company. It has several exit options: IPO: The familiar route is an IPO by which the venture capitalist can off load his holding and book the returns. Acquisitions: the company gets acquired by another corporate at a higher value. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Purchase by promoter: The promoter– entrepreneur may buy the shares of the venture capitalists at an agreed price. Purchase by outsider: Venture capitalist’s share can also be purchased by an outsider also. The above figure reflects the exit route of the venture capital firms in the US. Out of 11,686 companies assisted by venture capitalists, 33% were acquired by other companies; 14% have adopted the IPO route and 18% firms failed. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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FIG. EXIT ROUTE OF THE VENTURE CAPITAL FIRMS IN THE US
Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Example-Exit Strategies of ICICI Ventures
ICICI Ventures seeks to achieve a timely and appropriate exit to return cash and profits for its investors. Such exit strategies may include: a. Selling off the stake to strategic investors. b. Initial Public Offering in India or overseas. c. Sale to any other private equity fund or venture capital fund. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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d. Secondary sale on stock markets.
e. Merger with an existing listed company. f. Management/company buy-backs. The holding period of each investment is generally between 3 and 5 years, which depends upon the stage of investment and the performance of the sector and the company. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Advantages of Venture Capital
The entrepreneur concentrates on the project leaving aside the pressures of bringing in capital for the purpose of growth. Emphasis is placed on the track record of performance, venture capital focuses on the person and the innovativeness of the project. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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1. Long-term finance 2. Business partner
Venture capital is usually in the form of participation in the equity of the company. Interested in the capital gain from the sale of their stake after a long period. Not interested in quick returns in a short period. 2. Business partner Venture capitalists are business partners of the entrepreneur. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Risk and rewards are shared by him.
Provides advice and shares the experience gathered from similar companies that they have assisted. Have a network of contacts which helps to add value to the business of the company. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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4. Favourable impact on the economy
3. Additional funding Venture capital firms do not stop with the initial funding but provide additional rounds of financing is done at different stages if needed. 4. Favourable impact on the economy Venture capitalist catalyses innovations and the spirit of entrepreneurship in the economy. It leads commercialisation of technology in many sectors. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Forms of Venture Capital Assistance
1. Participation in equity capital Common form of venture capital The venture capitalists subscribe to the equity of the company with the intention of holding them for some period and ultimately sell them to realise the returns. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Buy-back options are also provided to the promoters.
The subscription to equity normally does not exceed 49% of the total equity capital. The control and management lie with the promoter–entrepreneur. Indian VCFs prefer to have minority positions in the companies and they exit through disinvestment. Buy-back options are also provided to the promoters. At present, equity is the popular form of venture financing in all the financial markets. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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2. Conditional loans. Common in Indian venture capital industry.
A royalty amount which ranges from 2% to 15% of the sales turnover is payable to the VCF for the purpose of repayment. In this form, servicing of the loan is linked to the project’s performance, unlike a the normal loan with an interest payment and principal repayment at specified dates Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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3. Income notes Hybrid securities which possess the characteristics of both the conventional loans and the conditional loans. The entrepreneur or the company has to pay interest as well as royalty on sales which will be at a lower rate. Instances of conditional loans and income notes are very few. Prevalent at the early stages of venture capital growth. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Venture Capital in the US and Europe
The European venture capital industry is yet another mature market for venture funds. Investments by the European private equity and venture capital firms amounted to €73.8 billion in 2007, and approximately European companies received private equity investments. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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About 85% of these companies have fewer than 500 employees
About 85% of these companies have fewer than 500 employees. According to the EVCA, between 2000 and 2004, the European private equity and venture capital-financed companies created 1 million new jobs, which translate to compound annual growth rate of 5.4% per year. Between 1997 and 2004, the average employment growth in buyout-financed companies was 2.4%, compared to 30.5% for venture-backed companies. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Sweden has private equity investment to the extent of 1. 2% of its GDP
Sweden has private equity investment to the extent of 1.2% of its GDP. Countries such as the Netherlands and the UK have slightly more than 1% of their GDP in the form of private equity. All other European countries had an investment in private equity at a level below 1% of their GDP. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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In the European venture capital industry, the term ‘private equity’ is often used in conjunction with venture capital. The term is treated as a generic name which includes venture capital, growth capital, buyout financing and turnaround financing. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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According to the EVCA, the venture capital financing was to the tune of €15.4 billion during the years 2003–2007; growth capital during the same period was €45.1 billion and buyout financing was to the extent of € billion. Banks, pension funds, fund-of-funds and insurance companies emerged as the major investors in private equity and venture capital market. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Highest over the six year period.
Table. Venture Capital Trends in US “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Venture Capital in India
The evolution of venture capital industry dates back to the 1970s. Individual investors and development financial institutions played the role of venture capitalists at the initial stage. Entrepreneurs depended upon private placements, public offerings and lending by the financial institutions. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Development of Small and Medium Enterprises (RS Bhatt Committee) committee was set up in 1973 to highlight the importance of venture capital. Based on a study undertaken by the World bank, the formal introduction of venture capital industry was done in the 1988 budget of the Government of India. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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A cess of 5% was collected on all payments for import of technology or technical know-how resulting in a fund that was to be administered by the IDBI. Risk Capital and Technology Finance Corporation (RCTFC) was setup in 1988 to assist entrepreneurs through conventional loans and conditional loans on a profit sharing basis. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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The Technology Development and Information Company of India (TDICI) which is an initiative of ICICI and the UTI, came into existence in is a pioneer of the venture capital industry in India. This outfit was later on transformed into ICICI Venture Management (ICICI Ventures), the private equity and venture capital arm of ICICI Bank. The Government of India issued guidelines in September 1995 for overseas venture capital investment in India. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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For tax-exemption purposes, guidelines were issued by the Central Board of Direct Taxes (CBDT), and the investments and flow of foreign currency into and out of India is governed by the RBI. SEBI framed SEBI (Venture Capital Funds) Regulations 1996 to regulate and to develop the Indian capital market. As per the regulations, some domestic VCFs were registered with SEBI. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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However, the venture capital industry as understood globally is still in a nascent stage in India.
The KB Chandrasekhar Committee on Venture Capital (2000) observed that India’s recent success story in the area of IT has shown that there is a tremendous potential for growth of knowledge-based industries. This potential is confined to several areas such as biotechnology, pharmaceuticals and drugs, agriculture, food processing, telecommunications services, etc. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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The venture capital industry was thus evolving into a mature segment when more number of players entered the sector. The structure of the industry currently looks as follows: VCFs promoted by the development finance institutions such as ICICI, IDBI, etc. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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VCFs promoted by public sector banks.
VCFs promoted by the State government- controlled financial institutions (examples: Gujarat Venture Finance Ltd and Andhra Pradesh Venture capital Ltd) VCFs promoted by public sector banks. VCFs promoted by the foreign banks, foreign VCFs, private companies and financial institutions (examples: Indus Venture Fund, Lazard India, etc.) Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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According to the Year book 2001 of the Indian Venture Capital Association (IVCA), India is ranked third most active venture capital market in Asia-Pacific region (except Japan) for the year 2001. In 2001, 65.4% of the companies that raised venture capital were in IT and communications. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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In total, 19 exits were achieved during the year 2001 with no IPOs.
Early stage financing saw an increase from $124.4 million in 2000 to $294.3 million in Expansion stage financing accounted for 60% of disbursements in 2001 compared to 44.3% in 2000. In total, 19 exits were achieved during the year 2001 with no IPOs. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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The entry of foreign venture capital investors into the Indian market is one of the outstanding features of development of the industry in India. These funds have come through their holding companies registered in countries such as Mauritius, Cyprus, etc. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Major beneficiary sector
Table. Industry-wise Cumulative Investment Details of SEBI Registered Venture Capital Funds and Foreign Venture Capital Investors (FVCI) (as of 31 December 2008) Major beneficiary sector “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Figure 8.3 Growth of Venture Capital and Private Equity in India.
“Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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According to Venture Intelligence, a research service firm, on venture capital and private equity, the amount of venture investments during 2008 was about $740 million across 125 investments as against $876 million invested over 144 deals during 2007. Industry experts attribute a major portion of the fall to the last quadrant of 2008, when economies world over started feeling the burden of the credit-induced economic crisis that originated in the US. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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The venture capital space in India is dominated by non-India funds that have strong linkages to the US and the Europe. Also, in the current environment, VCFs thrust is on value addition in existing portfolio companies rather than making fresh investments. Valuations, which are at lower levels and the lack of entrepreneurial activity are cited as the other reasons for the fall in investments. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Prof. G Sabarinathan in his ‘Venture capital: Time to Reflect
Prof. G Sabarinathan in his ‘Venture capital: Time to Reflect?’ in Business Line points out four issues faced by the venture capital industry in India. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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1. Mismatch Mismatch between the kind of venture capital available and what the market demands. VCFs are mostly targeting IT firms, pharmaceutical firms or certain service industries that require expansion financing of Rs 15 crores or more. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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The market consists of a large number of aspiring entrepreneurs, start-ups and old economy firms that are in need of funds but are unable to attract venture capital funds. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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2. Dependence on foreign investors
Most VCFs in India are a division of the global investment institutions, and international funds which represent more than 95% of the venture capital invested in India. Their functioning is dictated by the policies of the parent company and often the local market needs are ignored. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Currency risk also affects their performance.
Many nations have understood the importance of developing the local venture capital industry than depending on the foreign funds Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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3. Poor quality corporate governance
In the event of any failure of partners on their contractual obligations, there is no sound legal redressal of grievances of partners involved in the process. As a result, the aggrieved parties in India often agree to settlements that are unfair to them. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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4. Lack of strong trade association
The venture capital industry in India lacks a broad-based and effective trade association. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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SEBI and Venture Capital Funds
SEBI is the regulator of the venture capital funds in India. VCFs have to register themselves with SEBI in accordance with the following two regulations: a. SEBI(Venture Capital Funds) Regulations Concerned with the Indian VCFs registered with SEBI which lists 132 funds under this category. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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SEBI (Foreign Venture Capital Investors) Regulations 2000
It governs those funds from outside India but which operate in India. There are 129 such funds registered with SEBI. The venture capital funds are subject to the inspection and investigative powers of the regulator. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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The necessary forms to be used and the fees to be paid are indicated in the schedules to the regulations. A brief overview of the regulations beginning from the definition of the terms. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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1. Venture Capital Fund (VCF)
It means a fund established in the form of a trust under the Indian Trust Act, 1882, as a company or a body corporate that has a dedicated pool of capital that is raised in a prescribed manner and invested in accordance with the regulations. The SEBI regulations prescribe the way in which the money for the VCF should be raised as well as the way in which it should be invested. The VCF may be organised as trust or as a company. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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2. Venture Capital Undertaking (VCU)
It is the company or the entrepreneur seeking the venture finance from the VCF. The SEBI regulations define the VCU as a domestic company whose shares are not listed in a recognised stock exchange and it is not engaged in manufacturing a product or offering a service mentioned in the ‘negative list’ in the schedule of the regulations. The negative list specifies NBFCs and gold financing as some of the businesses. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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3. Raising of resources The corpus fund of the VCF can be raised by the issue of units to the investors who may be Indian investors, foreign investors or the NRI investors. The units can be placed only through the private placement route. No public issue is possible by a VCF to raise capital. A minimum corpus fund of Rs 5 crores have to be collected before the start of operations of the VCF. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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4. Investment conditions and restrictions
VCF cannot invest more than 25% of the corpus fund in a VCU. The regulations also indicate the form of investments. A minimum of 66.67% has to be invested in unlisted equity shares or equity-linked instruments such as share warrants, convertible preference shares and convertible debentures. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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The VCFs can invest not more than 33.33% in the following:
a. Subscription to the IPOs of a VCU whose shares are proposed to be listed. b. Debt instruments of a VCU in which the VCF has equity shares. c. Preferential allotment of a listed company, subject to lock-in of 1-year period. d. Equity or equity-linked instruments of a financially weak company or sick industrial company whose shares are listed. e. SPV created by the VCF for the purpose of facilitating and or promoting investment Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Investment options are wider and it does not stop with unlisted companies alone.
Facility is extended sick companies and companies in financial trouble. This is what is described in the other developed countries as ‘bailout’ financing. A subscription to the IPOs of a company implies the last stage financing by the VCF. Similarly, investments can be made in potentially dilutive instruments such as convertible preference shares, convertible debentures and share warrants. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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5. Foreign Venture Capital Investors (FVCI)
Second set of regulations issued in the year 2000. FVCI is defined as an investor incorporated, or established outside India, and is registered under the SEBI regulations. Another route for foreign investments to flow into India similar to the Foreign Direct Investments (FDI). Has to get the ‘no objection certificate’ from the SEBI and clearance from the RBI for bringing the capital. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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In the recent years, the flows of capital into sectors such as real estate through the FVCI route vis-à-vis the FDI route, seem to have attracted the attention of the regulators, especially, the RBI. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Relatively speaking, the FVCI route results in a regulatory arbitrage, meaning that there are some advantages, such as tax benefits and no lock-in, etc., which makes the FVCI a preferable route. This issue has been seized up by the regulators and appropriate policy changes have been initiated. One of the measures in this direction is limiting the tax benefits to selected sectors. The government has now proposed to limit the tax benefits to investments made by venture funds in nine selected sectors from 1 April 2007. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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A venture capital undertaking is being redefined as an unlisted company engaged in the business of biotechnology, IT relating to software and hardware development, nanotechnology, seed research and development (R&D), R&D of new chemical entities in the pharma sector, dairy industry, poultry industry, production of biofuels and hotel-cum-convention centres with a capacity of at least 3000 This implies that any investment in sectors such as real estate will attract tax. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Conclusion Venture capital fills the gaps left by the traditional forms of financing. It catalyses the entrepreneurial spirit by assisting the entrepreneur even at the concept stage or seed stage itself. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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High-technology, high-risk projects are undertaken through venture financing. Initially, the venture capital funds were focusing the IT firms, but over the technology cycles other sectors too were financed by the venture funds. The venture investment process involves detailed study of the project and its commercial viability. Valuation and pricing the deal is a crucial step in the venture investment process. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Indian venture capital industry had its modest beginnings in 1988 and the growth has been rather slow because of the risk-averse nature of financial institutions. However, the flow of capital from the foreign venture capital investors has been very steady and a wider spectrum of companies from various industries has been benefited by the venture capital funds. “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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APPENDIX I Case Study: Gujarat Venture Finance Ltd. (GVFL) and Icenet.net Ltd. Icenet.net Limited is an Ahmedabad based company promoted by Chirag Mehta, Hemal Patel and Nipam Shah having technical backgrounds. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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The company is a GVFL assisted company.
The company is an internet service provider and offers a wider range of services which include dial-up access, server co-location, web hosting, internet telephony, leased line services, and enterprise business solutions. The company is a GVFL assisted company. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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GVFL added value by providing strategic support through exploring tie-ups and identifying merger and acquisition opportunities. It enforced strict corporate governance practices with enhanced transparency towards stake holders. Icenet.net could achieve a 30 percent market share and it is the market leader in Gujarat. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Source: http://www.gvfl .com/ss-icenet.htm
It was the ‘first’ company in several aspects – first in internet telephony in India, first in launching digital ISP, first in setting up international satellite gateway, and first in using the Ethernet technology. The company has acquired a slot in the top 20 ISPs in India. GVFL was with the company for 6 years and divested in the year 2007. Source: .com/ss-icenet.htm “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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APPENDIX II Case Study: Blue Run Partners
Blue Run is a venture capital arm of Nokia Venture Partners. It has been around in India for some time and has made a couple of investments like Nevis, which is in the business of security software and Deeya, which is developing a cost saving battery and Ugenie that makes online shopping engines that makes price comparisons. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Blue Run focuses on cost effective innovations
Blue Run focuses on cost effective innovations. The markets in India such as telecom or financial services are exploding in size but do not have enough revenues to support the high cost equipment or do not have enough revenues to support the high cost of software that was developed in the West Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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What Blue Run will back is innovation that lowers the cost
What Blue Run will back is innovation that lowers the cost. For example, Deeya Technologies has a battery technology that can actually bring down the power bill of telecom equipments. ‘This ends up lowering the cost and boosts margins for the operator’, says Mr Sujit Banerjee, partner in BlueRun Partners. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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The big challenge will be, having served the Indian market, whether they manage to operate in global markets. ‘We believe that we can give out inputs and help them make that transition after they have captured the markets here’, says Banerjee. This approach is in contrast to a few years ago when VCs refused to bankroll local market ideas by saying, ‘I want to see global ideas’. Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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Source: Based on inputs from The Economic Times dt.7.08. 2007.
‘I can see some merit in that because you have to be close to the market. But India is a big market now. And besides many of the VCs who said that they were actually investment bankers rather than people with any experience of building companies’, says Mr Sasha Mirchandani, another partner of Blue Run. Source: Based on inputs from The Economic Times dt “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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APPENDIX III ICICI Ventures (Select Portfolio Companies)
Sl no. Name of the Portfolio Companies 1. Arch Pharmalabs 2. Avesthagen 3. Biocon 4. Deccan Aviation 5. Electrotherm India 6. Gateway Distriparks Contd… “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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7. Infomedia 8. I-Venpharma 9. Medicorp 10. Naukri. com 11
7. Infomedia 8. I-Venpharma 9. Medicorp 10. Naukri.com 11. Shoppers’ Stop 12. TV Today “Financial Services” by R Shanmugham Copyright 2009 Wiley India Pvt. Ltd. All rights reserved.
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