1.

1 VC INDUSTRY PROFILE IN INDIA

India currently has more than about 400 Venture capital firms. 4
The Venture Capital industry has shown a exponential upward curve from
investments of
about USD 0.5 billion (56 deals) in 2003 to USD 14 billion (439 deals) in 2007. In the
year 2008, there
was a decline to about USD 11 billion (382 deals).
Unlike before as observed in the early stages of the industrys growth the
investments were inclined
largely towards the IT sector, but within 8 years of success stories now in 2009
Venture cvapital firms
are now interested in nearly all sectors.
With developing Indian entrepreneurship standards, government support , policies
and globalisation
policies there are vast opportunities for private equity investors to capitalize on.
Preferred regions for VC investments are Mumbai, Delhi and NCR, followed by
Bangalore. Although
companies in South India attracted a higher number of investments, in value terms
Western India
did much better. Among cities, Mumbai-based companies retained the top slot with
108 private equity
investments totalling almost US $6 billion in 2007, followed by Delhi/NCR with 63
investments (US
$2.7 billion) and Bangalore with 49 investments aggregating US $700 million.

2.2 INTRODUCTION TO THE VENTURE CAPITAL INDUSTRY

Initiative in India:
Indian tradition of venture capital for industry starts with a history of more than 150
years. Back then
many of the managing agency houses acted as venture capitalists providing both
finance and

management skill to risky projects. It was the managing agency system through
which Tata iron and
Steel and Empress Mills were able to raise equity from the investing public. The
Tatas also initiated a
managing agency system, named Investment Corporation of India in 1937, which by
acting as venture
capitalists, successfully provided hi-tech enterprises such as CEAT tyres, associated
bearings, national
rayon etc. The early form of venture capital enabled the entrepreneurs to raise large
amount of funds and
yet retain management control. After the abolition of managing agency system,
public sector term
lending institutions met a part of venture capital requirements through seed capital
and risk capital for
hi-tech industries which were not able to meet promoters contribution. However all
these institutions
supported only proven and sound technology while technology development
remained largely confident
to government labs and academic institutions.
Many hi-tech industries, thus found it impossible to obtain financial assistance from
banks and other
financial institutions due to unproven technology, conservative attitude, risk
awareness and rigid
security parameters. Venture capitals growth in India passed through various
stages. In 1973, R.S. Bhatt
committee recommended formation of Rs. 100 crore venture capital funds. The
seventh five year plan
emphasized the need for developing a system of funding venture capital. The
Research and
Development Cess Act was enacted in May 1986, which introduced a cess of 5
percent on all payments
made for purchases of technology from abroad. The levy provides the source for the
venture capital

fund. Formalized venture capital took roots when comptroller of capital issues
venture capital guidelines
in Nov 1988.5

2.3 GROWTH OF VENTURE CAPITAL INDUSTRY

Up to 1996: The Early Years:
Funds that were mobilized for venture investment were small in value.
The venture capitalists in those times were mostly from a banking background.
Banks approached the subject of venture funding much likely they approached
debt financing of
a project.
The accent was on the asset-side of the balance sheet. And the focus on
innovation and business
building was low.
Value creation as a focus had not yet been fully discovered, and exit strategies
were being
thought more around the life-term of the fund.
Valuations were low.
No competition between VCs.
Indian entrepreneurs had not yet discovered the venture capital route to funding
and growth and
it reflected in the small amounts that were invested.
There was little or no active participation of venture capitalists in entrepreneurial
activities such
as financial structuring, business strategy.
Business enhancement through networks.
1997 to 2000: The Rock n Roll Years:
The SEBI guidelines of 1996 acted as huge incentive for institutional
acked MNC venture capital companies to focus their attention on India.

 The range of venture capitalists now spanned incubators, ingents, classic venture
capitalists and
even private equity players. And the lines between them had begun to blur.
Venture capitalists were instrumental in introducing risk taking too many,
members of the
professional class.
Innovation was the key, and idea flows equaled doer flows at a frantic pace never
before seen.

2001 Onwards: The Reality Years:

The number of people who had got in to venture capital game was truly
impressive.
In addition to the seasoned players, there were finance and noon finance
professionals of
different hues entering the industry and people with little or no experience running
the
companies.
Venture capital community is finally recognizing that the evolution and business is
an on-going
process. This added to the return of the business maturation cycle of five to seven
years, portends
a less frenetic and more sustained pace of venture activity.

2.4 PROBLEMS IN THE VCs IN THE INDIAN CONTEXT:

One can ask why venture funding is so successful in USA but faced a number of
problems in India. The
biggest problem was a mind set change from collateral funding to high risk high
return funding. Most
of the pioneers in the industry were people with credit background and exposure to
manufacturing

industries. Exposure to fast growing intellectual property business and services

sector was almost zero.
All combined to a slow start to the industry. The other issue that led to such a
situation includes:
2.5 LICENSE RAJ AND THE IPO BOOM:
Till early 1990s, under the license raj regime, only commodity centric businesses
thrived in a deficit
situation.
To fund a cement plant, venture capital is not needed. What was needed was ability
to get a license, and
then get the project funded by the banks and DFIs. In most cases, the promoters
were well established
industrial houses, with no apparent need for funds. Most of these entities were
capable of raising funds
from conventional sources, including term loans from institutional and equity
markets.

2.6 SCALABILITY:
The Indian software segment has recorded an impressive growth over the last few
years and earns large
revenues from its export earnings, yet our share in the global market is less than 1
per cent. Within the
software industry the value chain ranges from body shopping at the bottom to
strategic consulting at the
top. Higher value addition and profitability as well as significant market presence
take place at the
higher end of the value chain. If the industry has to grow further and survive the
flux it would only be
through innovation. For any venture idea to succeed there should be a product that
has a growing market
with a scalable business model. The IT industry (which is most suited for venture
funding because of its

ideas nature) in India till recently had a service centric business model. Products
developed for Indian
markets lack scale.
2.7 MINDSETS:
Venture capital as an activity was virtually non existence in India. Most venture
capital companies went
to provide capital on a secured debt basis, to established businesses with profitable
operating histories.
Most of the venture capital units were off-shoots of financial institutions and banks
and the lending
mindset continued. True venture capital is capital that is used to help launch
products and ideas of
tomorrow. Abroad, this problem is solved by the presence of angel investors. They
are typically wealthy
individuals who not only provide venture finance but also help entrepreneurs to
shape their business and
make their venture successful.

2.8 RETURNS, TAXES AND REGULATIONS:

There is a multiplicity of regulators like SEBI and RBI. Domestic venture funds are
set up under the
Indian Trusts Act of 1882 as per SEBI guidelines, while offshore funds routed through
Mauritius follow
RBI guidelines. Abroad, such funds are made under the Limited Partnership Act,
which brings
advantages in the terms of taxation. The government must allow pension funds and
insurance companies
to invest in venture capitals as in USA where corporate contributors to venture
funds are large.
2.9 EXIT:

The exit routes available to the venture capitalists were restricted to the IPO route.
Before deregulation,
pricing was dependent on the erstwhile CCI regulations. In general all issues were
under period. Even
now SEBI guidelines make it difficult for pricing issues for an easy exit. Given the
failure if the OTCEI
and the revised guidelines, small companies could not hope for a BSE / NSE listing.
Given the dull
market for mergers and acquisitions, strategic sale was also not available.
2.10 VALUATION:
The recent phenomenon is valuation mismatches. Thanks to the software boom,
most promoters have
sky high valuation expectations. Given this, it is difficult for deals to reach financial
closure as
promoters do not agree to a valuation. This coupled with the fancy for software
stocks in the bourses
means that most companies are proponing their IPOs. Consequently, the number
and quality of deals
available to the venture funds gets reduced.

2.11 CONTRIBUTORS TO THE VENTURE FUND:

Foreign Institutional Investors.
All India Financial Institutions.
Multilateral Dev Agencies.
Other Banks.
Other Public.
Private Sector.
Public Sector.
Nationalized Banks.

 State Financial Institutions.

Insurance Companies.
Mutual Funds.

3.3 VENTURE CAPITAL WORKING

3.3.1 STAGES OF FINANCING:
Stages of Financing Time(Years) Uses for the Finance

1. Seed - The first stage of venture capital financing. Seed-stage financings are
often comparatively modest amounts of capital provided to inventors or
entrepreneurs to finance the early development of a new product or service.
These early financings may be directed toward product development, market
research, building a management team and developing a business plan.
A genuine seed-stage company has usually not yet established commercial
operations - a cash infusion to fund continued research and product
development is essential. These early companies are typically quite difficult
business opportunities to finance, often requiring capital for pre-startup R&D,
product development and testing, or designing specialized equipment. An
initial seed investment round made by a professional VC firm typically ranges
from $250,000 to $1 million.
Seed-stage VC funds will typically participate in later investment rounds with
other equity players to finance business expansion costs such as sales and

distribution, parts and inventory, hiring, training and marketing.

2. Early Stage - For companies that are able to begin operations but are not
yet at the stage of commercial manufacturing and sales, early stage
financing supports a step-up in capabilities. At this point, new business can
consume vast amounts of cash, while VC firms with a large number of earlystage companies in their portfolios can see costs quickly escalate.

Start-up - Supports product development and initial marketing. Startup financing provides funds to companies for product development and
initial marketing. This type of financing is usually provided to
companies just organized or to those that have been in business just a
short time but have not yet sold their product in the marketplace.
Generally, such firms have already assembled key management,
prepared a business plan and made market studies. At this stage, the
business is seeing its first revenues but has yet to show a profit. This is
often where the enterprise brings in its first "outside" investors.

First Stage - Capital is provided to initiate commercial manufacturing

and sales. Most first-stage companies have been in business less than
three years and have a product or service in testing or pilot production.
In some cases, the product may be commercially available.

3. Formative Stage - Financing includes seed stage and early stage.

4. Later Stage - Capital provided after commercial manufacturing and sales
but before any initial public offering. The product or service is in production
and is commercially available. The company demonstrates significant
revenue growth, but may or may not be showing a profit. It has usually been
in business for more than three years.

Third Stage - Capital provided for major expansion such as physical

plant expansion, product improvement and marketing.

Expansion Stage - Financing refers to the second and third stages.

Mezzanine (bridge) - Finances the step of going public and

represents the bridge between expanding the company and the IPO

5. Balanced-stage financing refers to all the stages, seed through mezzanine.

3.4 ADVANTAGES OF VENTURE CAPITAL

It injects long term equity finance which provides a solid capital base for future
growth.
The venture capitalist is a business partner, sharing both the risks and rewards.
Venture
capitalists are rewarded by business success and the capital gain.
The venture capitalist is able to provide practical advice and assistance to the
company
based on past experience with other companies which were in similar situations.
The venture capitalist also has a network of contacts in many areas that can add
value to
the company, such as in recruiting key personnel, providing contacts in international
markets, introductions to strategic partners, and if needed co-investments with
other
venture capital firms when additional rounds of financing are required.
The venture capitalist may be capable of providing additional rounds of funding
should it
be required to finance growth.
3.5 DISADVANTAGES OF GOING TO VENTURE CAPITAL FINANCE
The agreement of funding is passed on a contract which could be partial
ownership or other
profit sharing which if not properly negotiated by the entrepreneur he might lose
ownership
of his whole business or idea and future to them.
Intrusion and control : the VC gets the right to drive the firm thereby can take
strategic

decision or can drive them to his advantage if the deal is not guided properly.

3.6 VENTURE CAPITALISTS GENERALLY:

_ Finance new and rapidly growing companies.
_ Purchase equity securities.
_ Assist in the development of new products or services.
_ Add value to the company through active participation.
_ Take higher risks with the expectation of higher rewards.
_ Have a long term orientation.

CONCLUSION
Before you approach a VC for funding, examine your goals. How much capital do you
need? Do you want passive or active investors? Are you looking to ramp up your
marketing efforts? Grow your management team? Does your Board of Directors need
more seasoned expertise? Answering these questions for yourself will help you decide
whom to approach for investment capital, whether that be a VC, angel investor, strategic
investor, or other.
If you choose the VC path, make your best effort to get an entre into your target VCs
through a trusted referral. And always do your homework, both on the VCs youre
targeting and on your own business needs. Do the math, come to the table prepared,
and keep your presentation brief and to the point. Know your ultimate business
objectives, and be honest about those goals with your prospective investors.