You are on page 1of 37

CHAPTER I

INTRODUCTION AND DESIGN OF THE STUDY

1.1

INTRODUCTION

Technological change and development, being important ingredients of


economic growth, should be induced through an appropriate strategy. The
encouragement of the birth and progress of high-technology small firms is a major
factor on which the survival of any economy may depend. Both economists and
third world governments realized quite early the key role of new high-technology
industries in determining national economics success, and took measures to
encourage the rate of formation of new firms and their growth. In this case
whether in relation to new or existing companies, venture capital plays a
significant role.

Venture Capital is the capital committed, as shareholdings, for the


formation and setting up of firms specializing in new ideas, or new technologies,
with a large element of risk for the shareholders, but with a potential for rapid
development. A venture capital firm serves as an intermediary between investors
looking for high returns for their money and entrepreneurs in search of needed
capital for their start-ups.

Venture capital is a post-war phenomenon in the business world. It


originated and got popularized in the USA in the sixties. In the late 1960s, a new
breed of professional investors called venture capitalists emerged in the US whose
specialty was to combine risk capital with entrepreneurial management and to use
advanced technology to launch new products and companies in the market place.
Undoubtedly it was the venture capitalists astute ability to assess and manage
enormous risks and export from them tremendous returns that changed the face of
America.

This surge in enthusiasm for venture capital gathered pace and it has been
developing spectacularly world-wide since the second half of the seventies. Many
governments are experimenting with this US inspired investment discipline as a
means to stimulate the fledgling enterprises, which they see as vital to their
nations economic growth. The United Kingdom occupies the second place after
the US in terms of investment in venture capital. Several Organisation of
Economic Co-operation and Development (OECD) countries also have designed
and implemented measures to promote venture capitalism. The growth of venture
capital in the USA, the UK and other developing countries is primarily due to the
rapidly developing potential and commercialization of science and technology.
The emergence of unlisted securities market in these countries has further
enhanced the scope of venture capital. These opportunities lured the venture
capital institutions to invest in high-tech projects under conditions of extreme

uncertainty, as those projects were otherwise neglected by the traditional


financing institutions.

The impressive returns achieved by the U.S. venture capitalists attracted


investors from around the world. In some cases, these funds were routed through
venture capital firms based in the U.S. and managed by foreign professionals or
corporate

venture

capital

investment

operations,

operated

by

foreign

multinationals. More frequently, European and Asian funds were invested in the
U.S. funds and invested in the U.S. startups. Despite these investments, non-U.S.
capital has only played a minor role in financing the U.S. venture capital.

Arrival of venture capital in Indian capital market, though belated, is a


welcome development. The concept was adopted in India, after realizing the
difficulties faced by new entrepreneurs with viable projects, to raise funds from
the capital market. India, Asias fourth largest economy, is a new market in which
everyone is learning. With steady growth between five per cent and seven per cent
in the past several years, a pace that would likely continue, India offers
tremendous opportunities for financial services even as it transforms itself slowly
from a planned economy to a free-market one. It has already witnessed the
emergence of several innovative financial instruments and services, and venture
capital is the latest entrant in this field.

The development of venture capital is a recent phenomenon in India. It is


still in the infancy stage and requires proper framework and promotional efforts
for its fast growth. Unlike the USA, where it is normal for an entrepreneur to set
up a company or introduce a new product in the market by obtaining finance from
the venture capital funds with willingness to share the risk in returns of future
gains, in India risk financing is yet to pick up in a significant way. It can be said
that the conventional industrial finance in India is not of much help to the new
emerging enterprises. There is a need of finance for the entire duration to enable
the companies to recover from the negative cash flows in the early years. In other
words, finance is required to enable them to move from the start-up phase to the
expansion phase. Venture capital is the financing mechanism that fits with the
requirement of the new enterprise, which introduces a new product having greater
risks in returns and financial performances.

In broad terms, venture capital is the investment of long-term equity


finance where the venture capitalist earns primarily in the form of capital gain.
The underlying assumption is that the entrepreneur and the venture capitalist
would act as partners. True venture capital does not remain confined to hi-tech;
any risky idea could be financed by the venture capitalist. Venture capital can
prove to be a powerful mechanism to institutionalize innovative entrepreneurship.
A venture capitalists management approach differs significantly from that of a

conventional banker, lender or a stock market investor. In fact, a venture capitalist


combines the qualities of banker, stock-market investor and entrepreneur in one.

1.2

STATEMENT OF THE PROBLEM

Venture Capital (VC) is a significant financial innovation in the twentieth


century. It is a form of financing, designed for funding high technology with high
risk and with perceived high rewards. It usually refers to financing provided by
venture capitalists, who invest, alongside innovative entrepreneurs, in relatively
new, high growth companies that have a reasonable, though not assured, potential
to develop into highly profitable ventures. Such investments may exhibit high-risk
(of failure) or high return (in terms of large appreciation in the capital invested)
characteristics.

Traditionally, the role of venture capital is an extension of the development


financial institutions (PARA BANKING). The origin of modern Venture Capital
in India can be traced to the setting up of a Technology Development Fund (TDF)
in the year 1987-88, through the levy of access on all technology import payment.
TDF was meant to provide financial assistance to innovative and high-risk
technological programs through the Industrial Development Banks of India. This
measure was followed up in November 1988, by the issue of guidelines by the
(then) Controller of Capital Issues (CCI). These stipulated the framework for the

establishment and operation of funds companies that could avail of the fiscal
benefits extended to them.

Venture Capital has been a new type of financing for the past three decades
in India, they have been contributing to the development of economy by financing
the entrepreneurial capital requirements. The researcher wishes to study the
opportunities and prospects of the venture capital companies in India, by studying,
how far they have been contributing capital to the entrepreneurs, what is the
method of project evaluation, criteria for selecting the projects, types of industries
in which they have invested, state-wise investment and performance evaluation of
the venture capital companies, for this study ICICI Venture Fund Management
Company Limited and IFCI Indian Venture Funds Limited have been taken up for
the study.
Significance of the study:
Venture capital funds have been instrumental for the most amazing success
stories in the Silicon Valley in the USA, where the concept of venture capital was
born. There have been examples of companies backed by venture capitalists
growing to large corporation abroad. Some of the notable names are Microsoft,
Federal express, Intel, SanMicrosystems etc., However in India the venture capital
companies are yet to make their presence felt. The venture capital industry in
Tamil Nadu is still at a nascent stage but with the untapped potential, is expected
to grow rapidly in the future. There is a dire need to make a swot analysis of

venture capital undertakings and identify the problems faced by them for their
development which will make Tamil Nadu a manufacturing hub. There lies the
need for the study.

1.3

REVIEW OF LITERATURE
A review of previous studies on Venture Capital Financing is essential to

understand its concept and characteristics and also to identify the areas already
investigated so that new areas hitherto unexplored may be studied in depth. A
number of articles have been written and research work have been done on the
subject both in India and abroad and these are reviewed in this section.

Capital market plays a very significant role in the development of any


economy. Most of the countries in the Indo-Asian region are developing and are
in a continuous process of political and economic reforms. The entire South Asian
region has great economic potential which is yet to be fully exploited. Besides its
vast population, this region is also rich in natural resources. Till recently, most
countries in this region had a closed economy. At the beginning of this decade,
some countries like India, Pakistan and Bangladesh started liberalizing their
economies. The liberilisation facilitates export opportunities for the domestic
companies and access to advanced technology from the developed countries.

In the earlier years, individual investors and development financial


institutions played the role of venture capitalists in India and entrepreneurs largely
depended upon private placements, public offerings and the finance lent by
financial institutions. In the early seventies, the need to foster venture capital as a
source of funding new entrepreneurs and technology was highlighted by the
Committee on Development of Small and Medium Enterprises. In spite of some
public sector funds being set up, the venture capital activity did not gather
momentum. 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
Government of India took a policy initiative and announced guidelines for venture
capital funds in India in 1988. However, these guidelines recommended the
setting up of venture capital funds restricted only to the banks or the financial
institutions. Internationally, however, entrepreneurs, willing to take higher risk, in
anticipation of higher returns, usually set up venture capital funds. This is in
contrast to banks and financial institutions, which are more averse to risk.

In September 1995, the Government of India issued guidelines for overseas


venture capital investment in India whereas the Central Board of Direct Taxes
(CBDT) issued guidelines to venture capital companies for tax exemption
purposes. In 1996, SEBI came out with guidelines for venture capital funds,
which paved the way for entry of foreign venture funds into India. The Finance
Minister, in the budget 1999-2000 speech announced, For boosting high tech

sectors and supporting first generation entrepreneurs, there is an acute need for
higher investments in venture capital activities. Recognizing the acute need for
higher investment in venture capital activities to promote technology and
knowledge- based enterprises, SEBI appointed a committee headed by K.B.
Chandrasekhar to identify the impediments in the growth of the venture capital
industry in India and to suggest suitable measures. The committee submitted its
report on January 8, 2000 and the Finance Minister in his budget proposals 20002001, announced a new regime for venture capital funds, and proclaimed SEBI as
the single-point nodal agency for registration and regulation of both domestic and
overseas venture capital funds. The new regime stipulated that no approval of
venture capital funds by tax authorities would be required and that the principle of
pass through would be applied in tax treatment of venture capital funds. The
recommendation of the Chandrasekhar Committee remains a land mark in this
regard.
One of the first articles in India on the subject was by Prasanna Chandra.1
In this article Prasanna Chandra states that the term Venture Capital, is used to
describe investments in very young companies or start-up situations which are
characterized by a high risk reward ratio. Prasanna Chandra also summaries the
salient features of venture capital financing.

Prasanna Chandra, Venture Capital, Paper prepared for Programme on Frontiers


of Financial Management, Bangalore, November 6-10, 1989.
9

I.M. Pandey2 in his article Venture Capital in India published in


Chartered Financial Analyst, July August 1989, says that in general Venture
Capital is considered a synonym of high risk capital, that is long term funds
invested in new enterprises. In broad terms Pandey describes Venture Capital as
the investment of long-term risk equity finance where the primary reward for the
venture capitalists is an eventual capital gain. More often than not this would be a
commitment of capital or shareholdings for the formation and setting up of small
companies specializing in new ideas and new technologies.
According to Kaura and Chandra3 Venture Capital is a form of financing,
designed for funding high technology, high risk and perceived high reward
projects. While a conventional financier seeks to back projects with proven
technologies and established markets, a venture capitalist provides funds to
entrepreneurs and enterprises pursuing new and unexplored avenues. Venture
capitalist helps the promoter to actualize the project and attain commercialization.
Financial support is extended not only as a conventional loan but also with fixed
intentions of sharing the reward as well as the risk with the sponsors of the
projects. In addition to providing finance, a venture capital financier provides

I.M. Pandey, Venture Capital in India, Chartered Financial Analyst, JulyAugust, 1989.
3

Mohinder N. Kaura and Sharat G. Chandra, Venture Capital as a Medium for


Financing Hi-Tech Projects, ASCI Journal of Management, September-December,
1991.
10

management support to establish the venture successfully. According to him


venture capital is a medium for translating the entrepreneurial ideas from a
research laboratory stage to the production line and further on to get the product to
the market.
A report in the Economic Times of Venture Capital4 describes the working
of venture capital finance as follows: A promoter comes forward either with a
new but as yet untried product or process and needs a financial backer to help him
to set up his plant or to buyout a part of an existing enterprise. He may not be able
to go to the regular banks for one of two reasons; the product may be untried and
there may be further teething trouble to overcome in its design and marketing.
Alternatively, the promoter may have no previous track record as an investor. In
such cases, the financier may come forward and lend his money on the
understanding that, if the enterprise succeeds it will go public, that is float shares
on the stock exchange. The more successful the venture, higher will be the profits
earned by both promoter and the financier through the sale of shares.
S.V. Kumars5 the Economic Comment on Venture Capital Lessons in
the Business World, April 12-25, 1989 describes venture capital as neither
philanthropy nor gambling.
4

Venture Capital - Lack of Incentives Hinder Growth, Economic Times, March


20, 1992.
5
S.V. Kumars, Economic Comment on Venture Capital Lessons, Business
World, April 12-25, 1989.
11

Roger L. Cottrell6 says that there are not private sector insurance
companies or pension funds gathering regular premium income and virtually no
private banks willing to devote a small portion of their resources to the venture
capital niche. It is unlikely that such enterprises will be created in the foreseeable
future to mobilize private savings for investments.
Sanjeev Sharma7 states that anomalous and ambiguous government
guidelines seriously hamper the development of venture capital financing in India.
Guidelines according to Sharma are full of lacunae and unless they are rectified
healthy venture capital development cannot be ensured. Another deterrent to large
private participation is the risk involved in funding relatively new projects with no
proven record in market acceptability. Also the harsh and inconsistent tax policies
of the government have proved to be the industrys bane. Prof. Rupal J. Jagirdar8
feels that though Guidelines provide for a concessional rate of capital gains tax,
the move can hardly be deemed as concession in view of the enormous risks
involved in the activity.
Jagirdar estimates that in developing countries like India, the success ratio
of venture capitalism is 1:7, that is, for every one company that succeeds, seven

Roger L. Cottrell, Venture Capital Myths and Realities, Fortune India,


December 1-15, 1989.
7

Sanjeev Sharma, Venture Capital Key Source of Industrial Finance, Financial


Express, June 21, 1992.
8
Rupal J. Jagirdar, Venture Capital A Capital Error?, Fortune India,
December 1-15, 1989, pp.15-19.
12

might fail. Typically, the supernormal profits made on a single investment should
compensate for the numerous losses spread over the other seven. For example,
Venrock Association, a premier venture capital company in the USA the financed
the start up costs of Apple computers for $ 5 million and subsequently recovered $
83 million on disinvestments to the public. However in India if one makes such
supernormal profit one has to reckon with the high rate of tax incidence which is
why some sort of preferential tax treatment is necessitated if venture capital is to
be a feasible proposition.

Sidney Pinto, a veteran merchant banker and a director of Credit Capital


Finance Corporation, in an interview with Dipankar Mitra9 says that the tax
exemption on capital gains for corporations is discouraging.

Economic Times has summed up the problem as Lack of Incentives


Hinder Growth.10 According to this report, at present there are too many hurdles
for a new entrepreneur, in India:

The author feels that in view of the current process of technological upgradation in the Indian industry and the emergence of high technology industries,
there is a considerable scope for technology related risk finance.
Institutionalisation of finance for such opportunities in the form of venture capital
9

Dipankar Mitra, Adventure at Last, Business India, June 12-25, 1989,


pp.93-96.
10

Lack of Incentives Hinder Growth, Economic Times, March 20, 1992.


13

would, therefore, go a long way in accelerating this process. The resources exist,
but the fiscal incentives to make venture capital investment a commercial risk
worth taking must be created or, if they already exist, highlighted and improved.
Basudev Dass11 attributed the reasons for slow take off of venture capital in
India to the fact that the entire Indian business ethos is corroded by black money.
Most entrepreneurs including first generation entrepreneurs are driven by income
tax, excise and wealth-tax laws into taking out large portions of a companys real
income in black. The result is that any partner in a new venture, providing the
capital, is deprived of a full and fair return.
Nitish K. Sengupta12 feels that for promoting venture capital companies, it
is necessary to provide adequate fiscal incentives and tax concessions to venture
capital companies both for raising resources from the public and for earning an
attractive return from the investment made in promoted ventures. A liberal fiscal
incentive regime conducive to the growth of venture capital industry is absolutely
necessary in order to offset the large percentage of failures and the very small
percentage of success stories which alone contribute to the ultimate overall
profitability of venture capital.

11

Basudev Dass, New Options: Venture Capital, Business India, January 22


February 4, 1990, pp.50-56.
12
Nitish K. Sengupta, Unshackling of Indian Industry, Vision Books, New
Delhi, 1992.
14

M. Narasimham, chairman of Credit Capital Venture Fund (India) Limited,


in his speech at the companys Annual General Meeting on September 11, 1992,
pointed out that Guidelines need to combine effective regulations with autonomy
and operational flexibility while at the same time ensure equality of treatment in
tax and other matters as between venture capital companies promoted in public,
joint or private sector.
Bagchi13 summarizes the reasons espoused for the tardy state of affairs in
the Indian venture capital industry as: as lack of tax concessions, strict guidelines,
including definition of high-risk technology and total project size, no concept of
equity below par, lack of research and manpower skills which do not equip them
for early stage investment, and attitude of entrepreneurs.
Asim K. Mishra,14 in his article Venture Capital Financing Evaluation
studies and Follow-up Action published in the Chartered Accountant presents a
comprehensive policy framework for venture capital in India. The article also
deals with various issues like the institutional support and disinvestments policy
for the successful functioning of the venture capital financing. The author
concludes by suggesting that the tax incentives and legislative support play an
active role in nurturing the growth of venture capital financing.
13

Pradipta Bagchi, The Rear to Venture Out, Economic Times, March 18,

1993.
14

Asim K. Mishra, Venture Capital Financing Evaluation Studies and Follow-up


Action, The Chartered Accountant, November 1993, pp. 361-367.
15

S.P. Srivastava,15 emphasizes the role of various financial institutions in the


promotion of venture capital in India. He specifically deals with the role of IFCI,
IDBI, and ICICI. He concludes by saying that the changing economic
environment and high technology explosion are clear indication of the vast scope
for venture capital in India.

A succinct overview of the concept of venture capital and venture capital


financing in India is presented by I.M. Pandey16 in his article, Venture Capital
the Adventure. He feels the urgent necessity for strengthening the linkages
between government policies and the policies of venture capital funds and other
financial institutions in the field of science and technology.
T. Satyanarayana Chary,17 in his article, Venture capital finance A case
study of APIDC-Venture capital Limited attempts to study the emergence of
venture capital in India and specifically the working of APIDC-Venture capital
limited. He strongly suggests that the Indian venture capital companies should
change their attitude as active partners in the venture rather than as owners by
themselves to get the complete satisfaction of investee companies.

15

S.P. Srivastava, Venture Capital An Emerging Dimension of Institutional


Financing, Southern Economist, August 15, 1992, pp. 29-30.
16
I.M. Pandey, Venture Capital The Adventure, Chartered Financial
Analyst, July 1994, pp.90-91.
17

T. Satyanarayana Chary, Venture Capital Finance: A Case Study of APIDC


Venture Capital Limited, Abhigyan, January-March, 2004, pp.13-22.
16

Sandhya Prakash18 emphasizes the need for considerable fine-tuning for


venture capital industry to make a suitable impact on Indian business especially in
the small sector.
Shalin J. Parikh19 in his article focuses on the venture capital as anew type
of financial intermediary. He lists the concepts of venture capital and its evolution
and the various regulatory framework within which it operates.
Bob Zider20 who is the president of Beta Group, a firm that develops and
commercialises new technology with funding, in his article, How Venture
Capital Works underlines the mechanics of the venture capital industry with due
stress on the perception of both the players and the beneficiaries.
Managing Venture Capital Productivity An Emerging Issue21 is an
article written by Umasankar Saha wherein the discusses the economics of per
capital venture capital productivity from the view-point of the enterprise as well
as the society. He focuses the emerging issue of managing per capita venture
capital productivity efficiently to steer entrepreneurship development.
18

Sandhya Prakash, Venture Capital Comes of Age, Indian Management,


April 2000, pp.15-21.
19

Shalin J. Parikh, Venture Capital Funds are not Non-Banking Financial


Intermediaries, The Chartered Accountant, December 2002, pp.620-624.
20

Bob Zider, How Venture Capital Works, Harvard Business Review,


November-December, 1998, pp.131-139.
21

Umasankar Saba, Managing Venture Capital Productivity An Emerging


Issue, The Management Accountant, December 1999, pp.908-916.
17

A. Vinay Kumar,22 in his article, focuses on the requirements of venture


capital firms in India for selecting ventures. Venture capitalists view ventures
from the lens of these basic preferences. According to him, for seed stage funding
Indian venture capital firms look for one most important preference that is the
percentage of ownership that they can buy in the idea.
Sudhir Sethi23 in his article, Indian Venture Capital ReformsRecommendations for 2001 suggests to initiate some important reforms to
revitalize the Indian venture capital industry.
Sabarinathan,24 in his article, discusses how the Indian venture capitalists
react to the boom and bust of IT business scenario. The trend of the venture
capital investments in IT business in India is elaborated in detail in this article.
Deshpande25 in his article, Venture Capital Industry in India makes an
evaluation regarding the venture capital financing in the developed countries like
the USA and Europe and the developing countries. He highlights how the Indian
22

V. Vinay Kumar, Venture Stage Investment Preferences of Indian Venture


Capitalists: An Exploratory Analysis of Principal Components, The ICFAI Journal of
Applied Finance, Vol.8, No.3, May 2002, pp.40-51.
23

Sudhir Sethi, Indian Venture Capital Reforms Recommendations for 2001,


Chartered Financial Analyst, January 2001, p.13.
24

G. Sabarinathan, Venture Capital Investment Trends in IT Businesses in


India, IIMB Management Review, March 2002, pp.79-95.
25
C.S. Deshpande, The Venture Capital Industry in India, Saket Industrial
Digest, January, 2001, pp.44-50.
18

venture capital system is different from that of the system developed in the US
and Europe.

Venture capital that fuelled the revolution of American start-up companies


especially in the info-tech industry is still to become a significant phenomenon in
India. Laments A.K. Mishra,26 in his article Venture Capital A Long Way to
Go.
Garry Sharp27 in his book, The Insiders Guide to Raising Venture
Capital, presents a comprehensive and unbiased coverage of venture capital
financing in a modern economy. Starting with brief introduction of venture capital
financing and various commonly used terms the book explores the need for
venture capital finance with an outline of its development, scope and the types of
investments. The book also focuses upon the management of venture capital
funding and investigates in detail its applications at various levels.
Charis Bovaird,28 in his book, Introduction to Venture Capital Finance,
defines the classical concepts of venture capital financing. The first part of the
book devotes attention to a working knowledge of the subject. The second part
focuses on the key strategy and management issues involved in venture capital

26

A.K. Mishra, Venture Capital A Long Way to Go, Indian Management,


April, 1998, pp.57-59.
27

Garry Sharp, The Insiders Guide to Raising Venture Capital, Kongan Page,
London, 1991.
28
Chris Bovaird, Introduction to Venture Capital Finance, Pitman Publishing,
London, 1990.
19

investments. The book mainly deals with a survey conducted by the author on
ninety-three venture capital backed companies in the UK to attain a better
understanding of the demands of entrepreneurs and the needs of those firms. The
book provides the reader with a knowledge and understanding of the advice and
assistance that entrepreneurial firms expect their venture capital firms to provide.
Rod B. McNaughton,29 in the book, Venture Capital International
Comparisons presents a spatially disaggregate evaluation of the organization and
functioning of the venture capital markets.
I.M. Pandey,30 in his book, Venture Capital The Indian Experience,
provides a review of the development of venture capital with focus on venture
capital in Asia. Subsequently, the next explains the context of venture capital in
India and its role in technology development. The book also examines the
practices and policies followed by the venture capital firms in India. Finally the
book reviews the policy initiatives necessary for the growth of venture capital in
India.

29

Rod B. McNaughton, in Milford B. Green (ed.), Venture Capital International


Comparison, London and New York, Routledge, 1991.
30

I.M. Pandey, Venture Capital The Indian Experience, Prentice-Hall of India,


New Delhi, 1999.
20

Venture Capital Financing in India a book written by J.C. Verma,31


caters to a variety of needs including those of the providers and users of venture
capital and includes an analysis of the various practices and procedures in venture
capital financing. It also profiles the venture capitalists operating in India at the
time.
M.Y. Khan,32 in his book, Financial Services makes an attempt to
provide a judicious mix of theory and practice of contemporary Indian financial
services sector. It covers in detail the theoretical and regulatory aspects of venture
capital financing. He discusses the theoretical framework of venture capital
financing and the salient features of such financing currently in operation in India.
Ramesh and Gupta33 in their book, Venture Capital and the Indian
Financial Sector, deals with various aspects involved in the valuation of venture
capital firms own portfolio. The book also examines the structural and legal
aspects which are of considerable importance to the venture capital industry. On
similar lines, Vasant Desai,34 L.M. Bhole,35 H.R. Machiraju36 and V.K. Bhalla37 in
their books Management of Indian financial Institutions, Financial Institutions
31

J.C. Verma, Venture Capital Financing in India, Response Books, New Delhi,

1997.
32

M.Y. Khan, Financial Services, Tata McGraw Hill Publishing Company Ltd.,
New Delhi, 1997.
33

S. Ramesh and Arun Gupta, Venture Capital and the Indian Financial Sector,
Oxford University Press, New Delhi, 1995.

21

and Markets Structure- Growth and Innovations, Indian Financial System and
Management of Financial Services deal with venture capital financing,
respectively.
The articles, Finding Exit Routes38 and Exit Policy39 answer relevant
questions regarding the exit routes of the Indian venture capital companies.
In his article Venture Capitalists Tango with SEBI,40 Sengupta and
Prasad deal with the registration formalities of Indian venture capital companies
with the SEBI. The article analyses various reasons for the registration and the
subsequent benefits available to Indian and Foreign venture capital companies
operating in India.

34

Vasant Desai, Management of Indian Financial Institutions, Himalaya


Publishing House, Mumbai, 1996.
35

L.M. Bhole, Financial Institutions and Markets Structure Growth and


Innovations, Tata McGraw Hill Publishing Company Ltd., New Delhi, 1997.
36

H.R. Machiraju, Indian Financial System, Vikas Publishing House Private


Ltd., New Delhi, 1999.
37

V.K. Bhalla, Management of Financial Services, Anmol Publications Pvt.


Ltd., New Delhi, 2002.
38

Snigdha Sengupta, Finding Exit Routes, Business World, 29 December 2003,

39

Shishir Prasad, Exit Policy, Business World, 29 December, 2003, p.30.

p.9.

40

Snigdha Sengupta and Shishir Prasad, Venture Capitalists Tango with SEBI,
Business World, 6 October, 2003, p.18.
22

The article, New Targets for Venture Funds,41 focuses on the need for
improving business models for venture capital to explore new markets in India.

The article Venture Capital Distributions: Short-run and Long-run


reactions42

examines the distribution of venture capital investments to the

investors in venture capital funds by the funds general partners.


The articles Venture Capital: Its Concept and performance in India43 and
Venture capital financing: The emerging trends in India,44 focus on the stages
and forms of venture financing in India.
The article Advantage start-ups45 points out that the venture capital
industry in India seems ready for a relaunch, with the government offering
attractive tax breaks and promise of a better return on investment looking brighter
than ever before.

41

Shishir Prasad, New Targets for Venture Funds, Business World, 3 June
2002, pp.38-40.
42

Paul Compers and Josh Lerner, Venture Capital Distributions: Short-run and
Long-run Relations, The Journal of Finance, Vol.LIII, No.6, December, 1998,
pp.2161-2183.
43
Shiv Prasad and Hanuman Prasad, Venture Capital: Its Concept and
Performance in India, Udyog Pragati, Vol.25, No.1, January-March, 2001, pp.33-41.
44

M. Murugesan, Venture Capital Financing: The Emerging Trends in India,


Banking Finance, January 2002, pp.3-8.
45
Tushar Pania, Advantage Start-Ups, Business India, September 11-24, 1995,
pp.85-89.
23

Satish Taneja46 in his article Venture Capital- How to Source it presents


the factors influencing venture capitalists choice of investments and on analysis of
venture. He also deals with the characteristics of entrepreneurs and how to choose
the entrepreneur and a right venture capitalist.
The article Venture capital: The Need of the Hour47 deals with the
importance of venture capital financing in India as a part of its industrial
development programme.
Hareram Hajara,48 in his article, explains the origin, growth, and regulatory
framework of venture capital financing in India. Shedde49 portrays the investment
criteria of the venture capitalists and their supports to the organization.

The ICRA Information Services, in its publication, on Venture Capital in


India50 details the history, growth and pattern of venture capital investments in
India. Taori, K.J.51 in his article Venture Capital Funding elaborately
discusses the various aspects of venture capital financing like its history, stages,

46

Satish Teneja, Venture Capital How to Source It, Abhigyan, Vol.XX, No.3,
October-December, 2002, pp.1-7.
47

V. Mallik, Venture Capital:


Accountant, November, 1995, pp.31-33.

The Need of the Hour, The Chartered

48

Hareram Hajra, Venture Capital Fund A Boon to the New Breed


Entrepreneurs, The Management Accountant, April 2002, pp.265-270.
49
P.D. Shedde, Venture Capital, Touchdown India, May 1999, pp.5-7.
50

ICRA Information Services, Venture Capital in India, October, 2001, pp.3-7.

24

forms of assistance and the exists. The article also deals with the SBIs approach
to financing software activities.
The article Waiting to take-off52 presents the obstacles which restricted
the growth of venture capital industry in India.
Mishra53. in his article Venture Capital: Issues, Options and Strategies,
presents the overview of venture capital in India, stages of venture capital
financing, policy framework and various issues. Similarly, Sabarinathan54 in his
article also speaks about the vital issues relating to venture capital and IT firms in
India. The writers worth-mentioning, who elaborately discussed the legal and
operational problems in venture capital financing include: Singhvi, L.K.,55
Sadhak, H.,56 Govil Anju,57 Sudha Nagaraj,58 Hema Ramakrishnan and
Muralidhar, S.,59 and Subhash Agrawal.60
51

K.J. Taori, Venture Capital Funding, The Journal of the Indian Institute of
Bankers, Vol.72, No.2, April-June 2001, pp.13-19.
52

Lancelot Joseph and Roy Pinto, Waiting to Take-off, Business India,


February 7-20, 2000, pp.85-88.
53

A.K. Mishra, Venture Capital: Issues, Options and Strategies, Productivity,


Vol.39, No.3, October-December, 1998, pp.414-422.
54

G. Sabarinathan, Venture Capital and IT Firms in India Vital Issues, IIMB


Management Review, March 2002, pp.73-78.
55

L.K. Singhvi, Venture Capital Industry in India An Agenda for Growth,


Productivity, Vol.40, No.1, October-November, 1999.
56

H. Sadhak, Venture Capital in India, Yojana, Vol.83(24), 1st January 1990,


pp.21-23.

25

Julia Hanna (2006) stated that the venture capital firms often consider
investments in companies located far away or in unfamiliar industries. How do
they spot these opportunities and also reduce risk? It's the power of networks,
says Harvard Business School professor Toby Stuartand understanding how
they work in VC is just now starting to be understood. Key concepts include:
Networks are important in all industries, but especially so in VC where
investment opportunities can be located far away from the centers of venture
capital. "Spanning ties" enable investors with fixed locations and industry
expertise to learn of opportunities outside their geographic and industry domains,
while also reducing risk. Ties are more likely to form between VC firms in the
context of bandwagons, such as a "hot" IPO market, that create a rush of
excitement around particular types of companies.61

Carmen Nobel (2010) stated that the clean-tech start-ups depend on


patience and public policy to thrivethe Internet models for VC funding don't

57

Govil Anju, Venture Capital Favour Low Risk Funds, Economic Times, July
31, Bombay, 1995.
58

Sudha Nagaraj, Venture Capital, Computers Today, 1-15 April, 2000,


pp.30-37.
59

Hema Ramakrishnan and S. Muralidhar, Venture Capital: Negative List to


Cover More Turf, Business Line, March 17, New Delhi, 2000,.
60

Subhash Agrawal, Venture Capital in India, Financial Express, March 11,


Chennai, 2004.
61
Julia Hanna, The Money ConnectionUnderstanding VC Networks,
Harvard Business School, December 4, 2006.
26

apply. That's why Harvard Business School professor Joseph Lassiter is making
an unusual recommendation to his entrepreneurship students: Spend a few years
serving time in a government job. Key concepts include: MBA students and
young venture capitalists often assume that all promising start-ups can grow and
exit as fast as Internet start-ups, but they're mistaken.

Clean-tech start-ups are

often stymied by a "valley of death"that precarious stage between researching


and developing a product and going to market.

The success of clean-tech

companies often is dependent on public policy, so it behooves budding VCs and


entrepreneurs to spend a few years learning the ropes in a government or
corporate job.62

A very few research works deal with venture capital financing in India. The
present study evaluates the concepts, procedures, legal and operational problems
in venture capital financing, the volume of investments made by the venture
capitalists and the perception of the investee companies of the venture capital
financing in India.

62

Carmen Nobel, Venture Capital's Disconnect with Clean Tech, Harvard

Business School, October 18, 2010.


27

1.4

OBJECTIVES OF THE STUDY


The specific objectives are:
1. To study the conceptual and legal framework of venture capital
investment in India.
2. To Examine the Evolution and growth of venture capital in India and
abroad.
3. To analyze the profile of the selected venture capital fund Companies.
4. To identify the factors influencing venture capital undertakings in
Tamil Nadu.
5. To make a SWOT analysis of venture capital undertakings in Tamil
Nadu.
6. To make concrete suggestions based on the analysis.

1.5

RESEARCH METHODOLOGY
This part of the study describes the methodology which includes collection

of data, sampling design, period of study, operational definition of concept,


construction of questionnaire, tools of analysis, data processing and framework of
analysis.

28

Data Collection
Primary Data

The present study is an empirical one based on the survey method. The first
hand data were collected from the investee companies in India through a
questionnaire and personal observation. The data relating to various problems
encountered by the investee companies in TamilNadu and their perception of the
venture capitalists were gathered through the questionnaire.

A number of discussions were held with knowledgeable persons such as


academicians, officials of the venture capital companies, entrepreneurs, and the
office bearers of IVCA for designing the questionnaire.

Secondary Data

The study mainly depends on the published and unpublished secondary


data available with Indian Venture Capital Association (IVCA), New Delhi, the
countrys umbrella association of venture capital. The IVCA has been pivotal in
persuading the government to create a framework of policies and procedures,
conducive to the creation of venture capital firms and flow of capital to India. The
data required for the study were collected from the internal records, official
circulars, business development and research files, pamphlets, and from the
internal accounting records of the IVCA. The various reports, records, and

29

booklets issued and maintained by the ICICI have also been used in the study. The
information was also gathered by having informal discussions with the company
secretary and senior vice-presidents of the investee companies.

Construction of the Questionnaire

The variables to be studied were identified from the various reports and
booklets published by the financial institutions, published articles, preliminary
discussions with some selected officials of the ICICI and IFCI Venture Capital
companies. The questionnaire so drafted was circulated among a few research
scholars, and field experts for a critical review with regard to wordings, format,
sequence and the like. It was drafted in the light of their comments and a pilot
study was conducted with 15 venture capital undertakings for necessary
modifications. The questionnaire, accordingly prepared was an undisguised,
structural data-gathering instrument, suitable for a mailed questionnaire.
Period of study:
The primary data for the study was collected during 2010-2012.
1.6

SAMPLING TECHNIQUE

This research study covers venture capital undertakings assisted by ICICI


and IFCI.

The venture capital companies were asked to give a list of their

beneficiary units. There were 404 beneficiary units as on December 31, 2011.The
questionnaire was administered only to 150 investee companies each 75 from

30

ICICI and IFCI, Judgment Sampling Method was adopted giving due
representation to micro, small, medium and big/large industries. Thus the study
covers 150 venture capital investee undertakings.
Statistical tools applied:
The following statistical tools were applied for analyses of the study.
Percentage analysis, Mean deviation, Standard deviation, Karl Pearson Skewness,
Correlation variance, chi-square test, t-test, SWOT analysis etc.
Operational Concepts
The venture capital industry has created its own vocabulary to describe
financing methods it employs. Some of the terms and jargons commonly used in
the venture capital financing are explained below:

1. Angel

Wealthy individual who invests in entrepreneurial firms. Although angels


perform many of the same functions as venture capitalists, they invest their own
capital rather than that of institutional or other individual investors.

2. Bridge Financing
Financing a company expecting to go public within six to twelve months. It
includes pre-merger/acquisition finance provided to a company. It is the last round
of financing before the planned exit.

31

3. Business Plan
A detailed feasibility report of a business venture.

4. Deal Structuring
The exact terms of the investment as negotiated between the venture
capitalist and investee company. The term includes the amount, form and price of
the investment.
5. Due Diligence
Detailed analysis and appraisal of the background of the entrepreneur and
his business plan.
6. Exit
The disinvestments by a venture capital fund/ company of the equity held
in an investee company.
7. Exit Routes
The means by which a venture capitalist disinvests his stock in an assisted
company. Usual exit routes are buy-back, an IPO or trade sale.
8. Fund of Funds
A fund that invests primarily in other venture capital funds rather than
portfolio firms, often organized by an investment adviser or investment bank.

32

9. Hands-on
Management style where venture capitalists participate in day-to-day
operations of the business.

10. IPO (Initial Public Offering)


A companys first offering of shares to public. IPO, flotation, float, going
public, and listing are just some of the terms used when a company obtains a
quotation on a stock market.
11. LBO (Leverage Buy-Out)
A buy-out or acquisition of a business using mostly debt and a small
amount of equity. Buy-out financed by another venture capitalist is known as
leveraged buy-out.

12. Management Buy-in (MBI)


The purchase of a business by one or more outside managers with the help
of a group of financial backers.
13. Management Buy-out (MBO)
The purchase of a business by its exiting managers (not owners) with the
help of a group of financial backers.

33

14. Mezzanine Financing


A later stage venture capital investment with low risk. It is a mix of debt
and equity financing.
15. Private Equity
Private equity includes organizations devoted to venture capital, leveraged
buyouts, consolidations, mezzanine and distressed debt investments, and a variety
of hybrids such as venture leasing and venture factoring.
16. Venture Capitalist
A general partner or associate at a venture capital company.
17. Venture Capital Undertaking/Investee Company

A company where in a venture capitalist has made an investment. It is the


company financed by a venture capitalist.
18. Venture Capital Company (VCC)
A company which has made investments by way of acquiring equity shares
of venture capital undertakings in accordance with the prescribed guidelines.
9. Venture Capital Fund (VCF)
A fund, operating under a trust deed registered under the provisions of the
Registration Act, 1908, established to raise monies by trustees for investments
mainly by way of acquiring equity shares of a venture capital undertaking in
accordance with the prescribed guidelines.

34

1.7

LIMITATIONS OF THE STUDY

Every research study suffers from errors and limitations. Some of these are
inherent in the research design, while some others become part of the study during
various stages of operations. The present study is subject to the following
constraints and limitations.
.a. The questionnaires used for this study despite pretesting, may contain a
few errors, some variables would have been left out. But efforts have been made
to minimize such errors.
b. The investee companies categorically refused to provide any financial
data particularly relating to the amount and stages of investment. Hence, the
researcher could gather only qualitative opinion from the investee companies.
Since such financial data were not made available by the respondents, they are
excluded from the study.

1.8

CHAPTER SCHEME

The present study PROBLEMS AND PROSPECTS OF VENTURE


CAPITAL UNDERTAKINGS IN TAMIL NADU , has been organized into
seven chapters.

35

Chapter I Introduction and Research Design introduces the subject


and deals with a review of related literature, statement of the problem,
significance of the study, objectives of the study, research design of the study,
source of data, period of study, operational concepts, limitations and the chapter
organization.
Chapter II Conceptual and Legal Framework of Venture Capital
Investment describes the concepts of venture capital and legal framework.
Chapter III An Overview of Venture Capital in India and Abroad
presents the origin, growth and development of venture capital financing in India,
the various phases of development and the major players of the Indian venture
capital industries. Further, it highlights the performance of venture capitalists
globally.
Chapter IV Profile of the Selected Venture Capital Financing
Companies describes the profile of the venture capital companies namely ICICI
Venture Fund Management Company Limited and IFCI India Venture Funds
Limited.
Chapter V
analyses

Factors Influencing Venture Capital Undertakings

socio-economic profile of venture capital entrepreneurs and factors

influencing venture capital undertakings.

36

Chapter VI SWOT Analysis of Venture Capital undertakings


examines the strengths, weaknesses ,opportunities and threats of venture capital
undertakings and the problems faced by them.
Chapter VII Summary of Findings, Suggestions and Conclusion
presents the summary of findings, suggestions and conclusion and the scope for
further research.

37

You might also like