VENTURE CAPITAL

INTRODUCTION

Venture capital, a financial innovation of the twentieth century, is a long-term liquid

investment, which can be in the form of equity, quasi-equity and some times debt in new
and high-risk ventures. Venture capital became better known after the famous legend of
Apple Computers, which started out in the US in 1977 with the capital firm, Arthur Rock &
Co. Apple Computers then made it to the Fortune 500 and Arthur Rock & Co. attained height
in Venture capital industry. However the success of Venture Capital in USA stimulated world
countries to practice on Venture capital.
A number of technocrats are seeking to set up shop on their own and capitalize on
opportunities. In the highly dynamic economic climate that surrounds us today, few
traditional business models may survive. Countries across the globe are realizing that it is
not the conglomerates and the gigantic corporations that fuel economic growth any more.
The essence of any economy, today is the small and medium enterprises.
This growing trend can be attributed to rapid advances in technology in the last decade.
Knowledge driven industries like infotech, health-care, entertainment and services have
become the cynosure of bourses worldwide. In these sectors, it is innovation and technical
capability that are big business-drivers. This is a paradigm shift from the earlier physical
production and economies of scale model.
However, starting an enterprise is never easy. There are a number of parameters that
contribute to its success or downfall. Experience, integrity, prudence and a clear
understanding of the market are among the sought after qualities of a promoter. However,
there are other factors, which lie beyond the control of the entrepreneur. Prominent among
these is the timely infusion of funds. This is where the venture capitalist comes in, with
money, business sense and a lot more.

WHAT IS VENTURE CAPITAL????

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Venture Capital is money provided by professionals who invest alongside management in

rapidly growing companies; viz.: Sun, Intel, Microsoft, Mastek, Satyam Infoway, Rediff,
Pizza Corner.
Venture Capital derives its value from the brand equity, professional image, constructive
criticism, domain knowledge, industry contacts, they bring to table at a significantly lower
management agency cost.
Professionally managed venture capital firms generally are private partnerships or closelyheld corporations funded by private and public pension funds, endowment funds,
foundations, corporations, wealthy individuals, foreign investors, and the venture capitalists
themselves.
A Venture Capitalists strives to provide entrepreneurs with the support they need to create upscalable business with sustainable growth, while providing their contributors with
outstanding returns on investment, for the higher risks they assume.
Venture Capitalists generally:
Finance new and rapidly growing companies
Typically knowledge-based, sustainable, up scaleable companies
Purchase equity / quasi-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
When considering an investment, venture capitalists carefully screen the technical and
business merits of the proposed company. Venture capitalists only invest in a small
percentage of the businesses they review and have a long-term perspective. They also
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actively work with the company's management, especially with contacts and strategy
formulation.
Venture capitalists mitigate the risk of investing by developing a portfolio of young
companies in a single venture fund. Many times they co-invest with other professional
venture capital firms. In addition, many venture partnerships manage multiple funds
simultaneously. For decades, venture capitalists have nurtured the growth of America's high
technology and entrepreneurial communities resulting in significant job creation, economic
growth and international competitiveness. Companies such as Digital Equipment
Corporation, Apple, Federal Express, Compaq, Sun Microsystems, Intel, Microsoft and
Genentech are famous examples of companies that received venture capital early in their
development.
In India, these funds are governed by the Securities and Exchange Board of India (SEBI)
guidelines. According to this, venture capital fund means a fund established in the form of a
company or trust, which raises monies through loans, donations, issue of securities or units as
the case may be, and makes or proposes to make investments in accordance with these
regulations.

INVESTMENT PHILOSOPHY
The basic principal underlying venture capital invest in high-risk projects with the
anticipation of high returns. These funds are then invested in several fledging enterprises,
which require funding, but are unable to access it through the conventional sources such as
banks and financial institutions. Typically first generation entrepreneurs start such
enterprises. Such enterprises generally do not have any major collateral to offer as security,
hence banks and financial institutions are averse to funding them. Venture capital funding
may be by way of investment in the equity of the new enterprise or a combination of debt and
equity, though equity is the most preferred route.
Since most of the ventures financed through this route are in new areas (worldwide venture
capital follows "hot industries" like infotech, electronics and biotechnology), the probability
of success is very low. All projects financed do not give a high return. Some projects fail and
some give moderate returns. The investment, however, is a long-term risk capital as such
projects normally take 3 to 7 years to generate substantial returns. Venture capitalists offer
"more than money" to the venture and seek to add value to the investee unit by active
participation in its management. They monitor and evaluate the project on a continuous basis.
To conclude, a venture financier is one who funds a start up company, in most cases
promoted by a first generation technocrat promoter with equity. A venture capitalist is not a
lender, but an equity partner. He cannot survive on minimalism. He is driven by
maximization: wealth maximization. Venture capitalists are sources of expertise for the
companies they finance. Exit is preferably through listing on stock exchanges. This method
has been extremely successful in USA, and venture funds have been credited with the
success of technology companies in Silicon Valley. The entire technology industry thrives on
it.

OBJECTIVE OF THE STUDY

Objective of the study has been to analyze the:

1. Trends in the Indian Venture Capital Industry.

2. To study the current Indian scenario.
3. To find out the different contributors to the Indian Venture Capital Industry and their
investment industry wise.
4. To identify the major players in the Indian Venture capital Industry.
5. To identify the problems faced by the Indian venture Capitalists.
6. To study the various guidelines of the regulatory body SEBI.

LIMITATIONS OF THE PROJECT

Major limitation of the project has been the unavailability of current data, of the contributors
to the Indian Venture Capital Industry (source of data being the year 1998) and no
comparative analysis has been undertaken of the Venture Capital Industry in India with those
of the developed nations like USA, UK due to lack of adequate data.

BRIEF HISTORY OF THE VENTURE CAPITAL INDUSTRY.

BRIEF HISTORY
The story of venture capital in the history of mankind.
In the fifteenth century, Christopher Columbus sought to travel westwards instead of
eastwards from Europe, to reach India. His far-fetched idea did not find favor with the King
of Portugal, who refused to finance him. Finally, Queen Isabella of Spain, decided to "fund"
him for his venture. And thus evolved the concept of Venture Capital.
The modern venture capital industry began taking shape in the postWorld War II.
The earliest members of the organized venture capital industry had several role models,
including these three:
American Research and Development Corporation, formed in 1946, whose biggest
success was Digital Equipment. The founder of ARD was General Georges Doroit, a Frenchborn military man who is considered "the father of venture capital." In the 1950s, he taught at
the Harvard Business School. His lectures on the importance of risk capital were considered
quirky by the rest of the faculty, who concentrated on conventional corporate management.
J.H. Whitney & Co, also formed in 1946, one of whose early hits was Minute Maid juice.
Jock Whitney is considered one of the industrys founders.
The Rockefeller Family, and in particular, L S Rockefeller, one of whose earliest
investments was in Eastern Airlines, which is now defunct but was one of the earliest
commercial airlines.
The Second World War produced an abundance of technological innovation, primarily with
military applications. They include, for example, some of the earliest work on micro
circuitry. Indeed, J.H. Whitneys investment in Minute Maid was intended to commercialize
an orange juice concentrate that had been developed to provide nourishment for troops in the
field.

In the mid-1950s, the U.S. federal government wanted to speed the development of advanced
technologies. In 1957, the Federal Reserve System conducted a study that concluded that a
shortage of entrepreneurial financing was a chief obstacle to the development of what it
called "entrepreneurial businesses." As a response this a number of Small Business
Investment Companies (SBIC) were established to "leverage" their private capital by
borrowing from the federal government at below-market interest rates. Soon commercial
banks were allowed to form SBICs and within four years, nearly 600 SBICs were in
operation.
At the same time a number of venture capital firms were forming private partnerships outside
the SBIC format. These partnerships added to the venture capitalists toolkit, by offering a
degree of flexibility that SBICs lack. Within a decade, private venture capital partnerships
passed SBICs in total capital under management.

The 1960s saw a tremendous bull IPO market that allowed venture capital firms to
demonstrate their ability to create companies and produce huge investment returns. For
example, when Digital Equipment went public in 1968 it provided ARD with 101%
annualized Return on Investment (ROI). The US$70,000 Digital invested to start the
company in 1959 had a market value of US$37mn. As a result, venture capital became a hot
market, particularly for wealthy individuals and families. However, it was still considered too
risky for institutional investors.
In the 1970s, though, venture capital suffered a double-whammy. First, a red-hot IPO market
brought over 1,000 venture-backed companies to market in 1968, the public markets went
into a seven-year slump. There were a lot of disappointed stock market investors and a lot of
disappointed venture capital investors too. Then in 1974, after Congress legislation against
the abuse of pension fund money, all high-risk investment of these funds was halted. As a
result of poor public market and the pension fund legislation, venture capital fund raising hit
rock bottom in 1975.

In 1978, there were a number of high-profile IPOs by venture-backed companies. These

included Federal Express in 1978, and Apple Computer and Genetech Inc in 1981. This
rekindled interest in venture capital on the part of wealthy families and institutional investors.
Indeed, in the 1980s, the venture capital industry began its greatest period of growth. In
1980, venture firms raised and invested less than US$600 million. That number soared to
nearly US$4bn by 1987. The decade also marked the explosion in the buy-out business.
The late 1980s marked the transition of the primary source of venture capital funds from
wealthy individuals and families to endowment, pension and other institutional funds. The
surge in capital in the 1980s had predictable results. Returns on venture capital investments
plunged. Many investors went into the funds anticipating returns of 30% or higher. That was
probably an unrealistic expectation to begin with. The consensus today is that private equity
investments generally should give the investor an internal rate of return something to the
order of 15% to 25%, depending upon the degree of risk the firm is taking.
However, by 1990, the average long-term return on venture capital funds fell below 8%,
leading to yet another downturn in venture funding. Disappointed families and institutions
withdrew from venture investing in droves in the 1989-91 period. The economic recovery
and the IPO boom of 1991-94 have gone a long way towards reversing the trend in both
private equity investment performance and partnership commitments.
In 1998, the venture capital industry in the United States continued its seventh straight year
of growth. It raised US$25bn in committed capital for investments by venture firms, who
invested over US$16bn into domestic growth companies in all sectors, but primarily focused
on information technology.

THEORETICAL FOUNDATIONS OF VENTURE CAPITAL

VENTURE CAPITAL PROCESS
Obtaining capital for a project through this route is very difficult. It involves many steps
which a prospective entrepreneur has to adopt when he approaches a investor (Venture
Capitalists). They are:
A strong business plan that outlines the management team, product, marketing plan, capital
costs and means of financing and profitability projection of the company. The investment
process is industry specific and may vary with time and region. The typical stages in the
investment cycle are given below.
1.
2.
3.
4.
5.
6.

Making a deal
Due diligence
Investment valuation
Pricing and structuring the deal
Value Addition and monitoring
Exit

Making A Deal
In generating a deal flow, the venture capital investor creates a pipeline of deals or
investment opportunities that he would consider for investing in. This is achieved primarily
through plugging into an appropriate network.
Due Diligence
Due Diligence refers to evaluating an investment proposal. It includes carrying checks on the
proposal related to aspects concerning management team, products, technology and the
market. Screening can be sometimes elaborate and rigorous and sometimes specific and brief.
New Financing
Sometimes, companies may have experienced operational problems during their early stages
of growth or due to bad management. These could result in losses or cash flow drains on the
company. Sometimes financing from venture capital may end up being used to finance these
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losses. They avoid this through due diligence and scrutiny of the business plan. Financing a
new venture should be done after carefully evaluation of the project.
Investment valuation
Typically in countries where free pricing regimes exist, the valuation process goes through
the following steps:
Evaluate future revenue and profitability
Forecast likely future value of the firm based on experienced market
capitalization or expected acquisition proceeds depending upon the anticipated
exit from the investment.
Target an ownership position in the investee firm so as to achieve desired
appreciation on the proposed investment. The appreciation desired should yield a
hurdle rate of return on a Discounted Cash Flow basis.

Structuring of deal
It refers to negotiation between entrepreneurs and venture capitalists for closing the deal. The
structure should take into consideration various commercial issues (i.e what the entrepreneur
wants and what the venture capital would require to protect the investment). The instruments
to be used in structuring deals are many and varied. The objective in selecting the instrument
would be to maximize venture capitals returns/protection and yet satisfy the entrepreneurs
requirements.

Exit strategy
Exit is one of the most important issue from both the sides (venture capitalists and
entrepreneur). The actual return from the for venture capitalists come at the time of exit.
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There are several exit routes, buy-back by promoters, sale to another company or sale at the
time of Initial Public Offer (IPO). In the present context there is no proper means of exit,
appropriate changes have to made to the existing systems in order for the venture capitalists
to realise their returns after holding on to them for a certain period of time. This factor is
critical to smaller and mid sized companies, which are unable to get listed on any stock
exchange, because of stringent listing requirements. In order to take the full advantage of the
Venture Capital the Government should consider the proposals to bring down certain
hindrances that come in the way for the exit of the venture capitalist

ACCESSING THE VENTURE CAPITAL

Venture capital has been in India for quite sometime. The rejection ratio is very high, out of a
100 proposals received only 1 gets funded. The standard parameters used by venture
capitalists are very similar to any investment decision. The only difference being exit. If one
buys a listed security, one can exit at a price but with an unlisted security, exit becomes
difficult. The key factors which they look for in
1.
2.
3.
4.

The Management
The Idea
Valuation
Exit

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CATEGORIZATION
INVESTORS
The classification of investors was done on 2 criteria. The first criterion was based on the
geographic origin of the investor. That is, on the basis whether the investor was registered as
a domestic or a foreign investor. The second classification was based on the nature of
promoters of the VCPE funds. The funds were broadly classified into five categories based
on the promoters of the fund. The five categories along with a short description for each of
them are given below:
Corporate Venture (CORPVEN):
These include VCPE operations set up by non financial companies. Large companies (e.g.,
Intel, Siemens) that have venture capital investment divisions within their organizations
would fall under this category. Usually, in a CORPVEN program, the entire investment funds
would be provided by the parent company. CORPVEN differentiates itself from the PRIV
(see below) categories by the close links between the venture and business operations of the
parent company. The corporations use a venture program to invest in companies that can
have strategic significance to their existing or future operations. Occasionally, CORPVEN
investments are also made in areas that are unrelated to the existing operations of the
corporation, thereby making it a purely financial investment.
Financial Corporations (FINCORP):
VCPE operations that are promoted by financial institutions such as banks, term lending
institutions, etc. would fall in this category. Examples of VCPE firms under this category
include ICICI Venture, IL&FS Investment Managers, and AXIS PE.
Investment Banks (IBANK):

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VCPE operations that are promoted by investment banks fall under this category. Investment
banks are also widely called as merchant bankers in India and they provide a gamut of
services such as underwriting, trading of securities, advisory services, etc. Financial
corporations that do not have significant fund based operations would fall in this category.
Examples of VCPE firms under this category would include the venture operations of JM
Financial, Motilal Oswal, etc.
Government Institutions (GOVT):
VCPE firms and operations that are backed and managed by governments, multilateral
agencies, and development financial institutions would fall in this category. Even if the
venture operations are of the type of FINCORP, if there is a strong government influence on
the investment operations, then it would be classified under the GOVT category. For
example, Gujarat Venture Finance Limited (GVFL) would be classified as a GOVT VCPE
fund.
Private Equity/ Venture Capital Firm (PRIV):
Boutique or specialized VCPE fund management companies would fall under this category.
These are promoted by independent fund managers, who raise capital from various investors
to make investments. Examples in this category would include Nexus Venture Partners, TVS
Capital, etc. In addition to the formal channels of VCPE funds, early stage investment also
occurs from a network of informal channels, called as angel investors. Angel investors are
wealthy individuals who invest their personal capital in start up and entrepreneurial
companies. While this report does not focus on angel investors, Chapter 7 provides a
preliminary analysis of the profile of angel investors in India.
Incubators:
An incubator is a hardcore technocrat who works with an entrepreneur to develop a business
idea, and prepares a Company for subsequent rounds of growth & funding. eVentures,
Infinity are examples of incubators in India.

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 Angel investors
An angel is an experienced industry-bred individual with high net worth. Typically, an angel
investor would:

invest only his chosen field of technology

take active participation in day-to-day running of the Company

invest small sums in the range of USD 1 - 3 million

not insist on detailed business plans

sanction the investment in up to a month

help company for "second round" of funding

The IndUS Entrepreneurs (TiE) is a classic group of angels like: Vinod Dham, Sailesh Mehta,
Kanwal Rekhi, Prabhu Goel, Suhas Patil, Prakash Agarwal, K.B. Chandrashekhar. In India
there is a lack of home grown angels except a few like Saurabh Srivastava & Atul Choksey
(ex-Asian Paints).
Venture capitalists (VCS)
VCs are organizations raising funds from numerous investors & hiring experienced
professional mangers to deploy the same. They typically:

invest at second stage

invest over a spectrum over industry/ies

have hand-holding mentor approach

insist on detailed business plans

invest into proven ideas/businesses

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provide brand value to investee

invest between USD 2 5 million

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How is Extending Venture Capital for an Endeavour is Different from Extending Term
Loan for a Conventional Commercial Project?
A commercial project is undertaken by an entrepreneur for a productive activity, which has
already been recognised and similar projects of the same type executed by others. Everything
about the project is well-known. Financing such a project involves moderate or normal risks.
The applicant seeking finance may be a new entrepreneur or an established businessman. The
project can be assessed with relative ease through well-established yardsticks and risk areas
identified. Taking a decision on financing based on the feasibility and viability of the project
is comparatively an easier process. The financier assesses the cost of the project against the
return it is anticipated to generate to satisfy that the return generated over a period of time
would fully liquidate the loan given with interest.
In contrast an applicant for venture capital primarily possesses expert knowledge, which if
translated into activity promises to provide rich dividends, however with inherent
uncertainties. The project is innovative and has not been set up earlier. Venture capital
financing involves higher risk than conventional loans to industry and business. While in a
conventional term loan 90 to 95% of the projects may come through, a few with time and
cost escalation, in financing start-up or innovative ventures, the rate of failures may at times
be more than that of success. Pricing of venture capital financing must take this factor into
consideration. Projects indicating higher risks, but with the potential for very large return,
when successful alone can be covered under venture financing. Venture capital firms may
generally provide soft loans (equity participation) and may charge the payment of royalty on
the turnover of the recipient company over a specified period of time.
Conventional Project financing is like journeying in a familiar territory, while venture capital
financing is like surveying in an unknown region.
An applicant for venture capital possesses superior knowledge-capital or knowledge-assets,
and he seeks to enter entrepreneurship. The Wright Brothers at the dawn of the 20th Century,
prepared the blue print for a machine that could fly. One that would come forward to finance
the project for execution of the blue-print to produce a flying machine is a provider of
venture capital, and resources extended to Wright brothers for the purpose is Venture Capital.
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Similarly Christopher Columbus in the Nineties of the 15th Century prepared a plan to
discover a route to India by sailing from Spain in the western direction, though India it was
known was located towards the east of Spain. The plan to be executed needed resources,
ships, sailors and other material needed for the long voyage. Resource so provided is eligible
to be called Venture Capital. "His (Columbus') far-fetched idea did not find favor with the
King of Portugal, who refused to finance him. Finally, Queen Isabella of Spain, decided to
fund him and the voyages of Christopher Columbus are now empanelled in history.

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INDIAN SCENARIO
OVERVIEW
Indian venture capital is at a take-off stage in India, according to this report from
NASSCOM. Changes to the regulatory environment look set to encourage the flow of
investment to the Indian high-tech sector.
In the absence of an organised venture capital industry until almost 1998 in India,
individual investors and development financial institutions have played the role of
venture capitalists. Entrepreneurs have largely depended upon private placements, public
offerings and lending by financial institutions.
In 1973, a committee on the development of small and medium-sized enterprises highlighted
the need to foster venture capital as a source of funding for new entrepreneurs and
technology. Thereafter, some public sector funds were established but the activity of venture
capital did not gather momentum as the thrust was on high-technology projects funded on a
purely financial rather than a holistic basis. Later, a study was undertaken by the World Bank
to examine the possibility of developing venture capital in the private sector, based on which
the Indian government took a policy initiative and announced guidelines for venture capital
funds (VCFs) in 1988. However, these guidelines restricted the setting up of VCFs to the
banks or the financial institutions only. Internationally, the trend favoured venture capital
being supplied by smaller-scale, entrepreneurial venture financiers willing to take a high risk
in the expectation of high returns, a trend that has continued in this decade.
In September 1995 the Indian government issued guidelines for overseas investments in
venture capital in India. For tax exemption purposes, the Central Board of Direct Taxes
(CBDT)issued guidelines. The flow of investments and foreign currency in and out of India
has been governed by the Reserve Bank of India's (RBI) requirements. Furthermore, as part
of its mandate to regulate and to develop the Indian capital markets, the Securities and
Exchange Board of India (SEBI) framed the SEBI (Venture Capital Funds) Regulations,
1996.

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Pursuant to this regulatory framework some domestic VCFs were registered with SEBI.
Some overseas investment also came through the Mauritius route. However, the venture
capital industry - understood globally as independently managed, dedicated pools of capital
that focus on equity or equity-linked investments in privately held, high-growth companies'
(Venture Capital Cycle, Gompers and Lerner, 1999) - is still in a nascent stage in India.
Figures from the Indian Venture Capital Association (IVCA) show that until 1998, around
Rs30bn had been committed by domestic VCFs and off-shore funds, which are members of
IVCA. Figures available from private sources indicate that the overall funds committed are
around US$1.3bn.
The funds available for investment are less than 50 per cent of the committed funds and
actual investments are lower still. At the same time, due to economic liberalisation and an
increasingly global outlook in India, there is an increased awareness and interest of domestic
as well as foreign investors in venture capital. While only eight domestic VCFs were
registered with SEBI during 1996-1998, 14 funds have already been registered in 1999-2000.
Institutional interest is growing and foreign venture investments are also on the rise. Given
the proper environment and policy support, there is undoubtedly a tremendous potential for
venture capital activity in India.
In his 2000 budget speech, India's finance minister announced that a key ingredient for future
success lay in venture capital finance. Young Indian entrepreneurs, whether in Silicon Valley,
Bangalore or Hyderabad have shown how ideas, knowledge, entrepreneurship and
technology can combine to yield unprecedented growth of incomes, employment and wealth.
To promote this flowering of knowledge-based enterprise and job creation, he announced a
major liberalisation of the tax treatment for venture capital funds. SEBI was granted the
responsibility for the registration and regulation of both domestic and overseas venture
capital funds. This liberalisation and simplification of procedures is expected to encourage
non-resident Indians (NRIs) in Silicon Valley and elsewhere to invest some of their capital,
knowledge and enterprise in Indian ventures.

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Objective And Vision For Venture Capital In India

Venture capital is very different from traditional sources of financing. Venture capitalists
finance innovation and ideas, which have a potential for high growth but with inherent
uncertainties. This makes it a high-risk, high-return investment. Apart from finance, venture
capitalists provide networking, management and marketing support as well. In the broadest
sense, therefore, venture capital connotes human as well as financial capital. In the global
venture capital industry, investors and investee firms work together closely in an enabling
environment that allows entrepreneurs to focus on value creating ideas. Venture capitalists,
meanwhile, drive the industry through ownership of the levers of control in return for the
provision of capital, skills, information and complementary resources. This very blend of risk
financing and handholding of entrepreneurs by venture capitalists creates an environment
particularly suitable for knowledge and technology-based enterprises.
Scientific, technological and knowledge-based ideas - properly supported by venture capital can be propelled into a powerful engine of economic growth and wealth creation in a
sustainable manner. In various developed and developing economies, venture capital has
played a significant developmental role. India, along with Israel, Taiwan and the US, is
recognised for its globally competitive high technology and human capital. India's recent
success story in software and IT is almost a fairy tale when considering obstacles such as
inadequate infrastructure, expensive hardware, restricted access to foreign skills and capital,
and limited domestic demand. It also indicates the potential India has in terms of knowledge
and technology-based industry.
India has the second largest English speaking scientific and technical manpower in the world.
Some of its management (IIMs) and technology institutes (IITs) are known globally as
centres of excellence. Every year, over 115,000 engineers graduate from government-run and
private engineering colleges. Many also graduate with diploma courses in computers and
other technical areas. Management institutes produce 40,000 management graduates
annually. All of these candidates are potential entrepreneurs.
It is also important to recognise that while India is doing very well in IT and software, it is
still behind in terms of product and packaged development. Many experts believe that just as

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the US did in the semiconductor industry in the eighties, it is time for India to move to a
higher level in the value chain.
This is not expected to happen automatically. The sequence of steps in the high technology
value chain is information, knowledge, ideas, innovation, product development and
marketing. Basically, India is still at the level of knowledge'. Given the limited
infrastructure, low foreign investment and other transitional problems, it certainly needs
policy support to move to the third stage - ie, ideas - and beyond, towards innovation and
product development. This is crucial for sustainable growth and for maintaining India's
competitive edge. This will take capital and other support, which can be provided by venture
capitalists.
India also has a vast pool of existing and on-going scientific and technical research carried
out by a large number of research laboratories, including defence laboratories as well as
universities and technical institutes. A suitable venture capital environment - which includes
incubation facilities - can help a great deal in identifying and actualising some of this
research into commercial production.
The development of a proper venture capital industry, particularly in the Indian context, is
needed if high quality public offerings (IPOs) are to be achieved. In the present situation, an
individual investor becomes a venture capitalist of a sort by financing new enterprises and
undertaking unknown risks. Investors also get enticed into public offerings of unproven and
at times dubious quality. This situation can be corrected by venture-backed successful
enterprises accessing the capital market. This will also protect smaller investors.

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Experience of US market
The potential of venture capital is tremendous when looking at the experience of other
countries. A study of the US market between 1972 and 1992 showed that venture-backed
IPOs earned 44.6 per cent over a typical five year post-listing holding period, compared with
22.5 per cent for non-venture backed IPOs. The success of venture capital is only partly
reflected by these numbers, since 80 per cent of the firms that receive venture capital are sold
to other companies rather than achieving an IPO. In such cases, the return multiple vis--vis
non-venture funded companies is much higher.
This potential can also be seen in the growth of sales figures for the US. From 1992 to 1998,
venture-backed companies saw their sales grow, on average, by 66.5 per cent per annum as
against five per cent for Fortune 500 firms. The export growth by venture-funded companies
was 165 per cent. The top ten US sectors, measured by asset and sales growth, were
technology-related.
Thus, venture capital is valuable not just because it makes risk capital available in the early
stages of a project, but also because a venture capitalist brings expertise that leads to superior
product development. The big focus of venture capital worldwide is, of course, technology.
Thus, in 1999, of $30bn of venture capital invested in the US, technology firms received
approximately 80 per cent. Additional to this huge supply of venture funds from formally
organised venture capital firms, is an even larger pool of angel or seed/start-up funds
provided by private investors. In 1999, according to estimates, approximately US$90bn of
angel investment was available, thus making the total at-risk' investment in high-technology
ventures in a single year worth around US$120bn. By contrast, in India, cumulative
disbursements to date are less than US$500m, of which technology firms have received only
36 per cent.

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India is attractive for risk capital

India certainly needs a large pool of risk capital both from home and abroad. Examples of the
US, Taiwan and Israel clearly show that this can happen. But this is dependent on the right
regulatory, legal, tax and institutional environment; the risk-taking capacities among the
budding entrepreneurs; start-up access to R&D flowing out of national and state level
laboratories; support from universities; and infrastructure support, such as telecoms,
technologyparks,etc.
Steps are being taken at governmental level to improve infrastructure and R&D. Certain NRI
organisations are taking initiatives to create a corpus of US$150m to strengthen the
infrastructure of IITs. More focused attempts will be required in all these directions.
Recent phenomena, partly ignited by success stories of Indians in the US and other places
abroad, provide the indications of a growing number of young, technically-qualified
entrepreneurs in India. Already there are success stories in India. At the same time, an
increasing number of savvy, senior management personnel have been leaving established
multinationals and Indian companies to start new ventures. The quality of enterprise in
human capital in India is on an ascending curve.
The environment is ripe for creating the right regulatory and policy environment for
sustaining the momentum for high-technology entrepreneurship. Indians abroad have
leapfrogged the value chain of technology to reach higher levels. At home in India, this is
still to happen. By bringing venture capital and other supporting infrastructure, this can
certainly become a reality in India as well.
India is rightly poised for a big leap. What is needed is a vibrant venture capital sector, which
can leverage innovation, promote technology and harness the ongoing knowledge explosion.
This can happen by creating the right environment and the mindset needed to understand
global forces. When that happens we would have created not Silicon Valley' but the Ind
Valley' - a phenomenon for the world to watch and reckon with.

24

Venture capital at a take-off stage in India

Lately, in India, the demand for software and dot.com-driven IT stocks on the stock
exchanges has been growing steadily. Most of the companies have recorded substantial
increases in their market capitalisation during the last year. On 2 May 2000, the info-tech
industry's market capitalisation reached in excess of US$59bn, showing the highest increase
in absolute valuation compared to any other industry during the last year.
The IPOs achieved by software companies in India in 1999 have attracted record investor
subscriptions. The demand for Indian IT stocks is very high, even on Nasdaq, as is evident
from the listing of ADRs of Infosys Technologies and Satyam Infoway. Investors have lapped
up the offerings of these two companies and their shares have appreciated tremendously since
their IPOs on Nasdaq.
A similar investor preference for start-up IT companies is being seen, though not of the same
magnitude. Yet, it is apparent that investors are willing to take higher risks for a potentially
higher reward by investing in start-up companies.
Until 1998, the venture creation phenomenon for the IT sector in India had been quite
unsatisfactory. Some experts believe that India lacks strong anchor companies like HP and
Fairchild, which funded the start-ups of early Silicon Valley entrepreneurs. Others believe
that Indian entrepreneurs are not yet globally connected and are often unwilling to share
equity with a quality risk capital investor. There was also a perception that start-ups in India
do not typically attract the right managerial talent to enable rapid growth. Finally, exit
options were considered to be few, with the general feeling that entrepreneurs were unwilling
to sell their start-ups even if it was feasible. As a result, much of the risk capital available was
not quickly deployed. However, since March 1999, things have been changing dramatically
for the better.
The venture capital phenomenon has now reached a take-off stage in India. Risk capital in all
forms is becoming available more freely. As against the earlier trend, where it was easy to
raise only growth capital, even financing of ideas or seed capital is available now. The
25

number of players offering growth capital and the number of investors is rising rapidly. The
successful IPOs of entrepreneur-driven Indian IT companies have had a very positive effect
in attracting investors. The Indian government initiatives in formulating policies regarding
sweat equity, stock options, tax breaks for venture capital along with overseas listings have
all contributed to the enthusiasm among investors and entrepreneurs, as has the creation of
the dot.com phenomenon.
In India, the venture capital creation process has started taking off. All the four stages including idea generation, start-up, growth ramp-up and exit processes - are being
encouraged. However, much needs to be done in all of these areas, especially on the exit side.

The Indian government sets up a venture capital fund

The Indian government has reiterated its commitment to the Indian software-driven IT
industry by creating a National Venture Capital Fund for the Software and IT Industry
(NFSIT). NFSIT, set up in association with various financial institutions and the industry,
operates under the umbrella of the Small Industries Development Bank of India (SIDBI). The
objective of the fund is to encourage entrepreneurship in the areas of software, services,
dot.com and other IT related sectors in which India has inherent as well as acquired
competency. The fund was launched by prime minister Atal Behari Vajpayee, who has
emerged as a strong proponent of India's software-driven IT industry. The fund is expected to
be a key component in addressing the rapidly growing demand for venture capital in India.
The fund will be looking at supporting entrepreneurship in high growth sectors.
Many state governments have already set up venture capital funds for the IT sector in
partnership with local state financial institutions and SIDBI. These include Andhra Pradesh,
Karnataka, Delhi, Kerala and Tamil Nadu.

26

STRUCTURE OF VENTURE CAPITAL INDUSTRY

The Venture capital firms in India can be categorized into the following four groups:

All India Developmental Financial Institutions sponsored Venture Capital Funds

promoted by the all-India development financial institutions such as Technology
Development and Information Company of India Limited(TDICI) by ICICI, Risk Capital
Technology Financial Corporation Limited (RCTCF) by IFCI and Risk Capital Fund by
IDBI.

State Finance Corporations sponsored Venture Capital Funds promoted by the statelevel developmental financial institutions such as Gujarat Venture Capital Limited
(GVCL) and Andhra Pradesh Industrial Development Corporations, Venture Capital
Limited (APIDC-VCL).

Bank-sponsored Venture Capital Funds promoted by public sector banks such as Can
finance and SBI Caps.

Private Venture Capital Funds promoted by the foreign banks/private sector companies
and financial institutions such as Indus Venture Capital Funds, Credit Capital Venture
Funds and Grindlays India Development Fund.

Objectives of VCFs in India

The objective of Indian venture Capital Funds are:

financing and development of high technology businesses,
to provide financial assistance for attaining commercial application of indigenous
technology or adapting imported technology for wider domestic application,
to provide risk capital to first generation entrepreneurs for setting up industrial projects
and to accelerate the pace and quality of technological innovations for products having
27

application in industry, agriculture, health, energy and other areas beneficial to the
development process in India.

BRIEF PROFILE OF MAJOR PLAYERS

IDBI Venture Capital Fund

This was established in1986 with the objective to finance projects whose requirements range
between Rs. 5 lakhs to 2.5 crores. The promoters stake should be at least 10percent for the
ventures below Rs. 50 lakhs and 15percent for those above 50 lakhs. Financial assistance is
extended in the form of unsecured loans involving minimum legal formalities. Interest at
concessional rate of 9percent is charged during technology development and trial run of
production stage and it will be 17percent once the product is commercially traded in the
market by the financially assisted firm. IDBI venture capital funds extends its financial
assistance to the ventures likely to be engaged in the fields of chemicals, computer software,
electronics, bio-technology, non-conventional energy, food products, refractories and medical
equipments.

Technology Development and Information Company of India Limited (TDICI)

This venture Capital fund was jointly floated by Industrial Credit & Investment Corporation
of India (ICICI) and Unit Trust of India (UTI) to finance the projects of professional
technocrats who take initiative in designing and developing indigenous technology in the
country. Technology Development and Information Company of India Limited (TDICI) was
launched with an authorized capital base of Rs. 20 crores and the same was targeted to be
increased to Rs. 40 to 50 crores. TDICI favours the firms seeking financial assistance for
developing information technology, management consultancy, pharmaceutical, veterinary
biological, environmental, engineering, non-conventional sources of energy and other
innovative services in the country.
28

 Unit Trust of India (UTI)

In 1988-99 UTI set-up a venture capital fund of Rs. 20 crores in collaboration with ICICI for
fostering industrial development. TDICI established by UTI jointly with ICICI acts as an
advisor and manager of the fund. UTI launched venture capital unit scheme (VECAUS-I) to
raise resources for this fund. It has set up a second venture capital fund in March 1990 with a
capital of Rs. 100 crores with the objective of financing green field ventures and steering
industrial development.

Risk Capital and Technology Finance Corporation Ltd. (RCTFC)

IFCI had sponsored in 1985, Risk Capital Foundation (RCF) to give positive encouragement
to the new entrepreneurs. RCF was converted into RCTFC on 12th January, 1988. It provides
both risk capital and technology finance and roof to innovative entrepreneurs and technocrats
for their technology oriented ventures.

Small Industrial Development Bank of India (SIDBI)

Small Industrial Development Bank of India (SIDBI)has decided to set-up a venture capital
fund in July 1993, exclusively for support to entrepreneurs in the small sector. Initially a
corpus has been created by setting apart Rs. 10 crores. The fund would be augmented in
future, depending upon requirements.

Andhra Pradesh Industrial Development Corporation (APIDC)

APIDC Venture Capital Ltd. (APIDC-VCL) was promoted by APIDC with an authorized
capital of Rs.2 million on 29th August 1989. Its main objective is to encourage technologybased ventures particularly those started by first generation technocrat entrepreneurs and
ventures involving high risk in the state of Andhra Pradesh.
29

 Gujarat Venture Finance Limited(GVFL)

GVFL has been promoted by the Gujarat Industrial Investment Corporation Limited (GIIC)
in 1990, to provide financial support to the ventures whose requirements range between 25
lakhs and 2 crores. Total corpus of Rs. 24 crores of the referred venture capital fund was cofinanced by GIIC, state financial corporation, some private corporates and World Bank. The
firms engaged in biotechnology, surgical instruments, conservation of energy and food
processing industries are financed by GVFL.

Commercial Banks Sponsored Venture Capital Funds

State Bank of India, Canara Bank, Grindlays Bank and many other banks have participated in
the venture capital fund building Industry in order to provide financial assistance to the
projects associated with high risks. SBI venture capital is monitored through SBI capital
markets. Canbanks venture capital functions through Canbank. Financial services and India
Investment Fund represents the venture capital launched by Grindlays Bank.

Private Sector Venture Capital Funds

i) Hindus Venture Capital Funds: Hindus venture capital fund is one of the noteworthy
private venture capital companies. It has been promoted with an initial corpus of Rs.21
crores contributed by several Indian and international institutions/ companies. Hindus
venture management limited, a separate company has been entrusted to manage the funds
of Hindus venture capital fund. It extends financial support to the firms operating in the
area of healthcare products, electronics and computer technology. Investment strategy of
the fund is not to invest more than 10percent of its corpus in one project and equity stake
in a company upto 50 percent.

30

ii) 20th Century Venture Capital Fund:

20th century venture capital fund has been

established with a corpus of Rs. 20 crores promoted by 20th century finance company
limited. The fund envisages focus on sick industries and first generation entrepreneurs.
iii) Credit Capital Venture Fund (CCVF): CCVF(India) Limited has been formed as a
subsidiary of credit capital finance corporation limited in April1989. This fund has been
promoted by nearly 15 major industrial houses in the country with the objectives of
reviving sick units. It is the first private managed venture fund with a subscribed capital
of Rs.10 crore contributed to the extent of Rs.6.5 crore by international financial agencies
and the remaining raised through public subscription.

Pool of Venture Capital Funds in India

There has been an increase in the pool of funds available for Venture capital activity to Rs.29,
884.04 million in 1998 from Rs. 25,595.17 million 1997. Investments have gone up to Rs.
12,59.85 million in 728 projects from Rs. 10,000.46 million in 691 projects in 1997. Average
investment per project has increased to Rs. 17.25 million in 1998 from Rs. 14.47 million
1997. There has been an average increase of almost 20 percent in the project size from the
previous year.

31

FACTORS FOR THE SUCCESS OF VENTURE CAPITAL FIRMS

Five critical success factors have been identified for the growth of VC in India, namely:
The regulatory, tax and legal environment should play an enabling role as internationally
venture funds have evolved in an atmosphere of structural flexibility, fiscal neutrality and
operational adaptability.
Resource raising, investment, management and exit should be as simple and flexible as
needed and driven by global trends.
Venture capital should become an institutionalized industry that protects investors and
investee firms, operating in an environment suitable for raising the large amounts of risk
capital needed and for spurring innovation through start-up firms in a wide range of high
growth areas.
In view of increasing global integration and mobility of capital it is important that Indian
venture capital funds as well as venture finance enterprises are able to have global exposure
and investment opportunities
Infrastructure in the form of incubators and R&D need to be promoted using government
support and private management as has successfully been done by countries such as the US,
Israel and Taiwan. This is necessary for faster conversion of R&D and technological
innovation into commercial products.
With technology and knowledge based ideas set to drive the global economy in the coming
millennium, and given the inherent strength by way of its human capital, technical skills, cost
competitive workforce, research and entrepreneurship, India can unleash a revolution of
wealth creation and rapid economic growth in a sustainable manner. However, for this to
happen, there is a need for risk finance and venture capital environment which can leverage
innovation, promote technology and harness knowledge based ideas.

32

But there are several challenges faced by the Venture Capital Industry:
Venture Capital Financing is still not regarded as commercial activity.
Investors feel that they would like to retain control and also to ensure that the business
must pass onto their family.
Restricted scope of Venture Capital in India to hi-tech projects and for turning Research
and Development into Commercial Production
Entrepreneurs sensitiveness to the mode of divestment and
Ambiguous government policy towards inter-corporate investment and issue of shares to
the entrepreneurs at below per value or in the form of a guest equity.
But the question is how relevant is corporate venturing in the India?
The firms, which launched the successful corporate ventures had created new products in the
market operating at the higher end of the value chain and had attained a certain size in the
market. Most Indian companies are yet to move up the value chain and consolidate their
position as players in the global market. Corporate venturing models would probably benefit
Indian companies who are large players in the Indian market in another five to 10 years by
enabling them to diversify and at the same time help start up companies. Multinationals led
by Intel are the best examples of corporate venturing in an Indian context.

33

PROBLEMS WITH VENTURE CAPITAL IN INDIA

One can ask why venture funding is so successful in USA and faced a number of problems in
India. The biggest problem was a mindset 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 these combined to a slow start to the industry. The
other issues that led to such a situation include:
License Raj And The IPO Boom
Till early 90s, 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 institutions and equity markets.
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.

34

 Mindsets
Venture capital as an activity was virtually non-existent in India. Most venture capital
companies want to provide capital on a secured debt basis, to established businesses with
profitable operating histories. Most of the venture capital units were offshoots 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.
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 terms of taxation. The government must allow
pension funds and insurance companies to invest in venture capitals as in USA where
corporate contributions to venture funds are large.

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 priced. Even now SEBI guidelines make it difficult for pricing issues for an easy
exit. Given the failure of 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.

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
35

software stocks in the bourses means that most companies are preponing their IPOs.
Consequently, the number and quality of deals available to the venture funds gets reduced.
Limitations on structuring of Venture Capital Funds(VCFs)
VCFs in India are structured in the form of a company or trust fund and are required to
follow a three-tier mechanism-investors, trustee company and AMC. A proper tax-efficient
vehicle in the form of Limited Liability Partnership Act which is popular in USA, is not
made applicable for structuring of VCFs in India. In this form of structuring, investors
liability towards the fund is limited to the extent of his contribution in the fund and also
formalities in structuring of fund are simpler.

Problem in raising of funds

In USA primary sources of funds are insurance companies, pensions funds, corporate bodies
etc; while in Indian domestic financial institutions, multilateral agencies and state
government undertakings are the main sources of funds for VCFs. Allowing pension funds,
insurance companies to invest in the VCFs would enlarge the possibility of setting up of
domestic VCFs. Further, if mutual funds are allowed to invest upto 5 percent of their corpus
in VCFs by SEBI, it may lead to increased availability of fund for VCFs.

Lack of Inventive to Investors

Presently, high net worth individuals and corporates are not provided with any investments in
VCFs. The problem of raising funds from these sources further gets aggravated with the
differential tax treatment applicable to VCFs and mutual funds. While the income of the
Mutual Funds is totally tax exempted under Section 10(23D) of the Income Tax Act income
of domestic VCFs which provide assistance to small and medium enterprise is not totally
exempted from tax. In absence of any inventive, it is extremely difficult for domestic VCFs
to raise money from this investor group that has a good potential.

36

 Absence of angel investors

In Silicon Valley, which is a nurturing ground for venture funds financed IT companies,
initial/seed stage financing is provided by the angel investors till the company becomes
eligible for venture funding. There after, Venture capitalist through financial support and
value-added inputs enables the company to achieve better growth rate and facilitate its listing
on stock exchanges. Private equity investors typically invest at expansion/ later stages of
growth of the company with large investments. In contrast to this phenomenon, Indian
industry is marked by an absence of angel investors.

Limitations of investment instruments

As per the section 10(23FA) of the Income Tax Act, income from investments only in equity
instruments of venture capital undertakings is eligible for tax exemption; whereas SEBI
regulations allow investments in the form of equity shares or equity related securities issued
by company whose shares are not listed on stock exchange. As VCFs normally structure the
investments in venture capital undertakings by way of equity and convertible instruments
such as Optionally/ Fully Convertible Debentures, Redeemable Preference shares etc., they
need tax breaks on the income from equity linked instruments.
Harmonization of SEBI regulations and income tax rules of CBDT would provide much
required flexibility to VBCFs in structuring the investment instruments and also availing of
the tax breaks. Thus investments by VCFs by instruments other than equity can also be
qualified for Tax exemption.

Domestic VCFs vis--vis Offshore Funds

The domestic VCFs operations in the country are governed by the regulations as prescribed
by SEBI and investment restrictions as placed by CBDT for availing of the tax benefits. They
pay maximum marginal tax 35percent in respect of non exempt income such as interest
through Debentures etc., while off-shore Funds which are structured in tax havens such as
37

Mauritius are able to overcome the investment restriction of SEBI and also get exemption
from Income Tax under Tax Avoidance Treaties. This denies a level playing field for the
domestic investors for carrying out the similar activity in the country.

Limitations on industry segments

In sharp contrast to other countries where telecom, services and software bag the largest
share of venture capital investments, in India other conventional sectors dominate venture
finance. Opening up of restrictions, in recent time, on investing in the services sectors such as
telecommunication and related services, project consultancy, design and testing services,
tourism etc, would increase the domain and growth possibilities of venture capital.

Anomaly between SEBI regulations and CBDT rules

CBDT tax rules recognize investment in financially weak companies only in case of unlisted
companies as venture investment whereas SEBI regulations recognize investment in
financially weak companies which offers an attractive opportunity to VCFs. The same may
be allowed by CBDT for availing of tax exemption on capital gains at a later stage. Also
SEBI regulations do not restrict size of an investment in a company. However, as per Income
tax rules, maximum investment in a company is restricted to less than 20 per cent of the
raised corpus of VCF and paid up share capital in case of Venture Capital Company. Further,
investment in company is also restricted upto 40 per cent of equity of investee company.
VCFs may place the investment restriction for VCFs by way of maximum equity stake in the
company, which could be upto 49 per cent of equity of the Investee Company.

Limitation on application of sweet equity and ESOP

In the US, an entrepreneur can declare that he has nothing much to contribute except for
intellectual capital and still he finds venture capitalists backing his idea with their money.
And when they come together, there is a way to structure the investment deal in such a
38

manner that the entrepreneur can still ensure a controlling stake in the venture. In the US, the
concept of par value of shares does not exist that allows the different par value shares.
Absence of such mechanism puts limitations in structuring the deals.
Further, as per present tax structure in India, sweet equity and ESOP issued to
entrepreneur and employees gets taxed twice at the time of acquisition and divestment. Tax
incidence at two points involving undue hassles to allottees of sweat equity of individual, as a
perquisite in its income, to the extent of 33 per cent defeats the entire purpose of its issue.

Legal framework

Lack of requisite legal framework resulting in inadequate penalties in case of suppression of

facts by the promoters-results in low returns even from performing companies. This has
bearing on equity investments particularly in unlisted companies.

39

REGULATORY ISSUES
There are a number of rules and regulation for venture capital and these would broadly come
under either of the following heads:
The Indian Trust Act, 1882 or the Company Act, 1956 depending on whether the
fund is set up as a trust or a company. (In the US, a venture capital firm is normally
set up as a limited liability partnership)
The Foreign Investment Promotion Board (FIPB) and the Reserve Bank of India
(RBI) in case of an offshore fund. These funds have to secure the permission of the
FIPB while setting up in India and need a clearance from the RBI for any repatriation
of income.
The Central Board of Direct Taxation (CBDT) governs the issues pertaining to
income tax on the proceeds from venture capital funding activity. The long term
capital gains tax is at around 10% in India and the relevant clauses to venture capital
may be found in Section 10 (subsection 23).
The Securities and Exchange Board of India has come out with a set of guidelines
attached in the annexure.

SEBI Venture Capital Funds (VCFs) Regulations, 1996

A Venture Capital Fund means a fund established in the form of a trust/company;
including a body corporate, and registered with SEBI which (i) has a dedicated pool
of capital raised in a manner specified in the regulations and (ii) invests in venture
capital undertakings (VCUs) in accordance with these regulations.
A Venture Capital Undertaking means a domestic company (i) whose shares are not
listed on a recognised stock exchange in India and (ii) which is engaged in the
business of providing services/production/manufacture of articles/things but does not
include such activities/sectors as are specified in the negative list by SEBI with
40

government approval-namely, real estate, non-banking financial companies (NBFCs),

gold financing, activities not permitted under the industrial policy of the Government
and any other activity which may be specified by SEBI in consultation with the
Government from time to time.
Registration
All VCFs must be registered with SEBI and pay Rs.25,000 as application fee and Rs.
5,00,000 as registration fee for grant of certificate.
Recommendations of SEBI (Chandrasekhar) Committee, 2000 SEBI appointed
the Chandrasekhar Committee to identify the impediments in the growth of venture
capital industry in the country and suggest suitable measures for its rapid growth. Its
report was submitted in January, 2000. The recommendations pertain to
1. Harmonisation of multiplicity of regulations
2. VCF structures
3. Resource raising
4. Investments
5. Exit
6. SEBI regulations
7. Company law related issues and
8. Other related issues.

41

VENTURE CAPITAL FUNDS IN INDIA

CONTRIBUTION TO "Venture Capital Funds"
This table shows the contribution towards Venture Capital in India. The contribution of
different investors to venture capital.
Contributors

2014
Rs. Million
%

Foreign Institutional
Investors
All Indian Financial
Institute
Multilateral Dev. Agencies
Other Banks
Other Public
Private Sector
Public Sector
Nationalized Banks
Non-Residents Indians
Insurance Companies
Mutual Funds
Total

15,178.05

50.79

7,727.47

25.86

2,298.63
1,709.76
725.32
623.61
442.14
433.67
313.39
62.5
4.5
29,884.04

7.69
5.72
2.43
2.09
1.48
1.45
1.05
0.21
0.01
100

Table
16,000.00
14,000.00
12,000.00
10,000.00
8,000.00
6,000.00
4,000.00
2,000.00
0.00

60
50
40
30
20
10
0

Rs. Million
Percentage

Figure

Investment by Industry
42

As in the previous year, the maximum investment has been made in industrial products and
machinery followed by investment in computer software and service. There is an interesting
change here compared to the previous year. In 1998 the total of the investments in computer
software and hardware put together exceeds investments in industrial products and
machinery. In the previous year, the total investment in industrial products and machinery
exceeded that in the computer industry. This is a clear indication that investment in the IT
industry, as a whole is attracting greater attention, compared to other industries. This is in
keeping with global trends.

Contributors

2014

Industrial Products and

Machinery
Computer Software Service
Consumer Related
Medical
Computer Hardware System
Food and Food Processing
Tel. and Data Communication
Biotechnology
Other Electronics
Energy Related
Others
Total

Rs. Million
%
2,956.67
219
2,508,87
1,381.49
817.48
735.41
718.56
417.89
448.77
426.06
229.56
1,865.09
12,559.85

100
52
47
30
50
18
27
40
18
127
728

Table
3,500.00
3,000.00
2,500.00
2,000.00
1,500.00
1,000.00
500.00
0.00

250
200
150
100
50
0
Rs. Million
Percentage

Figure

43

Investment by Stages of Financing

A sum of Rs.5, 146.40 million, which is almost 41 percent of the total venture capital
investment of Rs. 12,559.85 million, has been invested in start-up projects, followed by Rs.
4,478.60 million in later stage projects, Rs. 2,208.39 million in other early stage projects, Rs.
643.51 million in seed stage projects and only Rs. 82.95 million in turnaround projects.

Investment Stages

Start-up Stage
Later Stage
Other Early Stage
Seed Stage
Turnaround
Financing
Total

2014
Rs. Million Percentag
e
5,146.40
355
4,478.60
166
2,203.39
118
643.51
80
82.95
9
12,559.85

728

Table
6,000.00

400
350
300
250
200
150
100
50
0

5,000.00
4,000.00
3,000.00
2,000.00
1,000.00
0.00

Rs. Million
Percentage

Figure

Observation
The average amount of investments per project makes an interesting study. It is Rs. 8.04
million per project in the seed stage, Rs. 9.21 million per project in the turnaround stage Rs.
14.50 million per project in the start-up stage, Rs. 18.72 million per project in the other early
stage and Rs. 26.98 million per project in the later stage. This shows that the average
44

investment per project is the maximum in the later stage. This is as expected, since later stage
projects generally require larger amounts of finance. Seed stage investments generally
require smaller investments per projects. These averages also show that not only are the
number of investments in turnaround projects minimal, the amounts of investments in such
projects are also very little, further supporting the theory that venture capitalists are generally
not keen to fund turnaround projects.
But alas, Indian venture capital industry is still at the take-off stage and not achieved the
objectives so as to provide financial assistance for attaining commercial application of
indigenous technology or adapting imported technology for wider domestic application, to
provide risk capital to first generation entrepreneurs for setting up industrial projects and to
accelerate the pace and quality of technological innovations for products having application
in industry, agriculture, health, energy and other areas beneficial to the development process
in India. This is because, of the challenges and issues with regard to its development.

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Region wise Distribution of Investors

Investors were classified based on their location to start with. Investors can either have a
presence (physical office) in India or could invest directly from abroad. Within India, the
investors were classified into four regions based on the location of their main office.

Table Region wise distribution of investors

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Figure Growth in the number of investors for different regions

Observation
The figure indicates the growth in the number of investors across different regions in India
over the years. Several observations could be made from the trend. There has been no major
investor presence in the Eastern region, and there is no change in this trend over the years.
Among the remaining three regions, the Western region accounts for a majority of the
investors (about 60%). The Southern region in India has the second highest number of
investors after the West. Like that of the West, the proportion of investors in the South have
more or less remained the same over the years 24% in 2000, slightly increasing to 26% in
2004 and then 24% in 2009.
Regional Distribution Of Investments
Further to the analysis on investors in different locations, we also analyzed the investments
made in different regions. Table indicates the investment pattern observed for both domestic
and foreign investors in the regions.

Table Percentage of investment across different regions

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Investments by Type Of Investor

Table shows year wise investments made by different categories of investors. Panel A
indicates investments by different investors when they are classified on the basis of the type
of promoters. Panel B indicates investments by investors when they are classified on the
basis of their origin.

Table Year wise investments, $million (% of total investments in that year)

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Figure Investment growth

Observation
Figure indicates that the domestic investors were early to sense the economic boom in 2005
and showed a Year-on-Year (growth of investments of 84% over that of 2004 compared to a
flat growth of 8% for foreign VCPE firms. From then on, the growth rate of investments of
foreign investors grew by 416% in 2006 and 141% in 2007. The domestic VCPE investors
were able to respond faster to both the growth and contraction phases as compared
to foreign VCPE investors.

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Distribution Of Investments In Different Sectors For Domestic Investors And Foreign

Investors
Figure indicates the percentage of investments in select 4 industry categories for domestic
and foreign investors respectively. Several broad trends could be noted. Firstly, the
investment trends between domestic and foreign investors do not have much common
ground. While foreign investors have an increasing percentage of investments in the IT &
ITES sector during 2007 09, the same sector accounts for a decreasing percentage of
investments among the domestic investors. Similarly, the share of investments made by
domestic investors in Engineering and Construction sector has grown substantially from
2007, whereas for foreign investors, the investment in this sector has been fluctuating and
shows a decreasing trend in 2009.

Figure Distribution of investments in different sectors for domestic investors

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Figure Distribution of investments in different sectors for foreign investors

Observation
In recent years no single sector seems to dominate the investments made by foreign
investors. Particularly in the years 2008 and 2009, the percentages of investments in each of
the four sectors are quite close. Investments made by domestic investors on the other hand
indicate strong preferences in various years. For example, in 2009, Engineering &
Construction and Media accounted for more than 50% of the investments made by domestic
investors. Similarly, in 2006, Engineering & Construction and BFSI accounted for more than
50% of the investments made in that year.

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Investment Trends for The Small And The Large Investors

Table gives the year wise investments made and the number of investors for two groups of
investors, i.e., those who have made aggregate investments less than $150 million and those
who have aggregate investments more than $1 billion in the six year period 2004 09. A
graphical illustration is given in Figure.

Table Investments is $million (Number of investors) for years 2004-2009

Figure Total investments made by the small and large investors in different years

Observation
The investments made by both the investor groups were more or less comparable in 2005.
However, the investments made by Group C investors grew steeply in 2006 and 2007, but
fell down do the same level as that of Group A investors in 2008 and 2009. This indicates that
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there is a lot of volatility in investments made by Group C investors. For steady growth of
VCPE investments, we need to increase the participation of Group A investors.
The investments made by Group C investors grew 6 fold in 2006 compared to a 3 fold rise in
the investments of Group A investors. The steep fall in investments in 2008 was a result of
the rapid reduction in investments by the Group C investors. Investments by Group C
investors reduced by 77% during the year.

Analysis Of Single Investment Deals

To enable further analysis of the investors who have made only single investments, the year
wise number of investors who have only single investments were identified (Figure 6.3). It
can be seen that the foreign investors account significantly for such investments in each of
the years.

Figure Proportion of investors in various categories who have made only single investments

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Figure Year wise distribution of investors who have single investments

Observation
While it is understandable that foreign investors use their initial investment to test the waters
before deciding on their sustained commitment for investing in the country, it is difficult to
reason why a significant percentage of domestic investors have not made more than one
investment. The domestic investors would have a better understanding of the market as
compared to foreign investors and may not need to make a test investment. The only reason
we could think is that they were probably not successful in getting suitable investment
opportunities in the increasingly competitive market for quality investments.
Seen in a different perspective, the instance of single investment investors can be considered
as a result of the increased competition for investments that exists in the Indian markets
today. Only capable and performing investors are able to make subsequent investments.

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Investment during the Downturn

To analyze whether there has been a flight of investors during the economic downturn 2008
09, we broke down the investors into two categories, those who made investments during
2008 and 2009, and those who made investments only in the years 2004-2007. The results are
given in Table
World over, the VCPE investments were significantly affected during the economic
slowdown. The trend was very similar in India as well. VCPE investments in India fell from
a peak of $21 billion in 2007 to $2.5 billion in 2009. This was an 88% reduction in the
investments made within a span of 2 years.

Table Break down of investments by domestic and foreign Investors

Observation
VCPE investments are sensitive to changes in economic cycles. During the global economic
crisis, there was a drastic reduction in the number and amount of VCPE investments made.
Our analysis indicates that though the investments have decreased, the number of investors
investing in India has increased. Investors seem to believe in the India story even in tough
situations. On the other hand, this also indicates the increasing competition among the VCs in
the marketplace.

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Investments in Different Industries

The investments made by both domestic and foreign investors in the three different deal slabs
in each of the 9 industry categories were tabulated. The results are given in Table

Table Industry wise investment for different categories of deal sizes

Figure Number of investments in deals greater than $40 million

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Observation
In investments of deals than $20 million, foreign investors have 30% of their investments
in IT and ITES in

Contrast to just 12% by domestic investors. In the same deal slab, Manufacturing, and
Engineering & Construction sectors seemed to be one of the favorites for domestic investors.
These sectors received 19.2% and 16.5% of all domestic investments respectively. Our
analysis indicates a strong differentiating factor between domestic and foreign investors.
Domestic investors have a high preference to invest in more core engineering sectors with
tangible assets whereas foreign investors seem to have a preference for investing in
technology led sectors like IT and ITES, which is a major constituent of the services sector. It
needs to be noted that the services sector contributes about 55% of India GDP.

Investment Consistency
Investment consistency has been defined as the regularity in which the investor makes
investments. We have tried to capture the dimension of investment regularity by analyzing
whether the investor has made investments in each of the years, 2004 09. Even if an
investor has made significant number of investments in the six year period, we feel that it is
important that these investments occur regularly rather than in spikes.

Table Investment consistency

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Figure Number of investors and the year in which they made their last investments

Observation
The graph indicates that a total of 117 investors, about 35% of the investors in our sample,
have not made any investments since 2007. The proportion of foreign investors who have not
made any investments since 2007 is marginally higher than that of the proportion of domestic
investors. The proportion of foreign investors who have not made any investment since 2007
is about 36%, whereas the same proportion for domestic investors is about
30%.

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CONCLUSION

In recent years the growth of Venture Capital Business has been drastically decreasing due to
many reasons. The regulator has to liberalize the stringent policies and pave the way to the
venture capital investors to park their funds in most profitable ventures. Though an attempt
was also made to raise funds from the public and fund new ventures, the venture capitalists
had hardly any impact on the economic scenario for the next few years. At present many
investments of venture capitalists in India remain on paper as they do not have any means of
exit. Appropriate changes have to be made to the existing systems in order that venture
capitalists find it easier to realize their investments after holding on to them for a certain
period of time.
After analyzing the various problems being faced by the Venture Capitalists in India certain
issues need to be dealt with very seriously regarding the growth and success of such ventures.
Hence certain remedial measures should be provided, such as:

MEASURES TO BE PROVIDED

From the experience of Venture Capital activities in the developed countries and detailed case
study of venture capital in India we can derive that the following measures needs to be
provided to boost Venture Capital industry in India.

Social Awareness
Lack of social awareness of the existence of venture capital industry has been observed.
Hardly few know about the principal objectives and functions of the existing venture capital
funds in the country and thus banking of the media is required to bridge the gulf between the
society and the existing venture capital funds.

Deregulated Economic Environment

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A less regulated and controlled business and economic environment where an attractive
customer opportunity exists or could be created for high-tech and quality products.

Fiscal Incentives
Though Venture Capital funds like Mutual funds are exempted from paying tax on dividend
income and long-term capital gains, from equity investment, unlike Mutual funds there are
pre-conditions attached to the tax shelter. So it is imperative that the Government streamlines
its guidelines on tax exemption for Venture Capital Funds.

Enterpreneurship And Innovation

A broad-based (and less family based) entrepreneurial traditions and societal and
governmental encouragement for innovation creativity and enterprise.

Marketing Thrust
A vigorous marketing thrust, promotional efforts and development strategy employing new
concepts such as venture fairs, venture clubs venture networks, business incubators etc., for
the growth of venture capital.

A Statutory Co-ordination Body

A harmonious co-ordination needs to be maintained among the technology institutes,
professional institutes and universities who are the producers of future venture capital
managers. The coordinating organ so formed is expected to ventilate an outline of the latest
requirements of the venture capital funds management. Central Government should come
forward to promote the referred coordination organ in the form of a statutory body. The
coordination organ would not only maintain link with the domestic professional institutions,
technology institutes and universities but also with the global venture capital funds in order
to exchange the novel ideas that can help in standardizing Indian practice on venture capital
funds.

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 Technological Competitiveness:
Encouragement and funding of R&D by private and public sector companies and the
government for ensuring technological competitiveness.

Training and Development of Venture Capital Managers

For the success of venture capital fund, be it privately owned or public sector financial
institutions, strategies need to be found to promote entrepreneurship. For this, venture capital
funds need professionals with initiative, drive and vision to identify such entrepreneurs who
have sound & ideas and innovative vision. Unfortunately, such professionals are not easily
available particularly in developing countries like India. Therefore management schools need
to develop social training programs to train venture capital mangers in which risk taking and
entrepreneurial attitude needs to be incubated.

Broad Knowledge Base

A more general, business and entrepreneurship oriented education system where scientist and
engineers have knowledge of accounting, finance and economics and accountants understand
engineering or the physical sciences.

Exit Routes
For venture capital funds, exits are crucial; going public is one way for the investors to be
paid back. Current rules of companies going public in India insist on sustained track record
of profits. For entrepreneur driven companies where value creation is through intellectual
property patents, methodologies and processes, such norms are archaic. Venture capitalists
earn through value creation leading to exits and not through dividends. Venture funds would
prefer the company to invest back dividends into the business. As such the question of stream
of dividends pay outs prior to IPO over three years as is required in India is a hindrance.

All these measures such as a broad knowledge base, exit routes etc should be adopted, to
ensure effective growth and success of Venture Capital Funds in India such that a potential
investor develops the confidence to invest in the Indian markets.
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BIBLIOGRAPHY
Books
R P Rustogi: Incorporating the Emerging Trends in the Indian Capital Market,
Galgotia Publication Company, 2 nd Edition, 2002.
James C. Van Horne and John M. Wachowicz, Jr: Fundamentals of Financial
Management, Prentice Hall, 9 th Edition, 1996.
H R Machiraju: Indian Financial System, Vikas Publishing House, 2 nd Edition,
2002.
Prasanna Chandra: Financial Management, Theory and Practice, Tata Mc Graw Hill
Publishing Company Limited, 5th Edition, 2001.
L M Bhole: Financial Institutions and Markets, 2 nd Edition, 1992.
M Y Khan: Indian Financial System, Tata Mc Graw Hill Publishing Company
Limited, 2th Edition, 2000.
Newspapers:
Times of India
Economic Times
Hindustan Times

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