Venture Capital[1]

8/6/2019 Venture Capital[1]

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Venture Capital


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Introduction

An entrepreneur New and unknown technocrat, Possesses innovative

ideas to develop a new product

To turn his ideas into a successful commercial venture Funds

required

Finance required for such purpose is more risky in nature, because the

innovative ideas of the entrepreneur have not been tried on acommercial scale

if the venture proves successful, it has potential for high returns

Venture Capital

long-term investment in business

has potential for significant growth and financial returns

provided in the form of equity apart from conditional loans and conventional

loans

High risk high expected returns


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Classification of Venture Capital Funds

Classified based on the activities

Incubators

Angel Investors

Venture Capitalists

Private Equity Players


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Incubators

An incubator is a hard core technocrat who works with an entrepreneur to

develop a business idea and prepares a company for subsequent rounds of

growth and funding

E.g. E-Ventures, Infinity, ICICI Winfra (JV of ICICI & West Bengal

Infrastructure Development Corporation) setting up an IT incubation center.

Angel Investors

An experienced industry-bred individual with high net worth.

Invests in his chosen field of technology and take active participation in day-to

day running of the company

An important link in the entire process of venture capital financing

Provide funding by first round financing for risky investment like a young/start-up company

Bring expertise as well as money

IndUS Entrepreneurs, Vinod Dham, Sailesh Mehta, Kanwal Rekhi, Prabhu

Goel, Atul Choksi, Suhas Patil etc.


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Venture Capitalists

Organisations that raise funds from numerous investors and hire experienced

professionals to deploy the same

Invest at a second stage investment

Sow the capital, nurture it and when grown sell, take the profit and get out of

the business

Private Equity

Established investment bankers

Invest into proven/established businesses have financial partner approach

Invest between USD 5 100 million

Threat to venture capital financing

E.g. ICICI Ventures with USD 2 billion fund to manage

Major portfolio pf ICICI Ventures Air Deccan, Dr. Reddys, Biocon,

Centurian Bank of Punjab, Naukari.com, Pentaloon Retail, Reliance

Petroleum etc.


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Ventures Capital Financing Process

Getting capital through this route is very difficult and involves many

steps Making a deal (Deal origination)

Due diligence (Evaluation)

Investment valuation

Deal Structuring

Exit

Making a deal

A continuous flow of deals is essential for a venture capital business

Deals may originate in many ways

Referral system through parent organization, trade partners, industryassociations, friends etc.

Business plan competitions To source a new and innovative idea andshort listed projects are provided necessary expertise

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


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Due Diligence/Evaluation

After screening due diligence

Subjective but comprehensive evaluation of quality of entrepreneur andbusiness plan

Research parameters Integrity, Urge to grow, Long-term vision,

Commercial orientation, Critical competence vis--vis ventures, Ability to

evaluate and react to risk, Well thought strategy to remain ahead of

competition, High market growth rate, Expected returns >25% in fiveyears, Managerial skills and Marketing skills.

Investment Evaluation

To ascertain the expected price for the deal

Steps followed are

Projections on future revenues and profitability

Expected market capitalization

Deciding on the ownership stake based on the return expected on the

proposed investment


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Deal Structuring

To decide the amount and form of investment with protective covenants

Various instruments to structure the deal equity shares, preference

shares, loans, warrants, participatory notes etc.

Post InvestmentActivities and Exit

Once the investment is finalized and the deal is structured, VC assumesthe role of a partner, collaborator or mentor

The degree of involvement depends on their policy

In case of crisis VC takes charge and some times even changes themanagement team

Typically aim at making medium to long-term capital gain generally wantcash-out gains in five-ten years after the initial investment

Exit routes

Initial Public Offering Acquisition by another VC company

Repurchase of the VCs shares by the promoters

Purchase of VCs share by a third party

Self liquidating process in case of debt financing


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The Business Plan

Executive Summary Brief description of each item

Business Background Product / Service

Market Analysis

Sales and Marketing Strategy

Production and operations

Management Risk Factors

Funds Requested

Return on Investment and Exit

Use of Proceeds

Financial Summaries Appendices

Resume of key management and employees

Detailed financial forecasts and assumptions

Market research report

Company literature, brochure and picture of the product


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STAGES OF VENTURE CAPITAL FINANCING

Venture capital fund provides finance to the venture capital

undertaking at different stages of its life cycle according to

requirements.

Stages classified into two

Early stage financing

Seed Capital Stage

Start-up Stage

Second Round Financing

Later stage financing

Expansion Finance

Replacement Finance

Turn Around Finance

Buoyant Deals


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Seed Capital Stage

Primary stage associated with research and development

Concept, idea, process pertaining to high technology or innovation

are tested on a laboratory scale.

Based on laboratory trial, a prototype product development is carried

out and possibilities of commercial production of the product is

explored.

Risk perception of investment quite high, a few venture capital

funds invest in the seed capital stage of product development.

Early Stage Financing


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Start-up Stage

Venture capital finance available at the start-up stage of the

projects which have been selected for commercial production. Start-up - Launching or beginning a new activity, but the product

must have effective demand and command potential market in

the country.

The entrepreneurs who lack financial resources for undertaking

production, approach the venture capital funds for extending

funds through equity.

Before making such investments, venture capital fund companies

assess the managerial ability, capacity and the commitment of

entrepreneur to make the project idea as success.

If necessary, the venture capital funds lend managerial skills,

experience, competence and supervise the implementation to

achieve successful operation. High degree of risk is involved in

start-up financing.


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Second Round Financing

After the product has been launched in the market, further funds are needed

because the business has not yet become profitable and hence new investors

are difficult to attract.

Investor has invested his own funds but further infusion of funds is needed

Venture capital funds provide finance at such stage, which is comparatively

less risky than the first two stages.

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

regular income.


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Later Stage Financing

Even when the business is established requires additional finance

Cannot be take by offering shares (public issue)

Venture capital funds prefer later stage financing as they anticipate income

at a shorter duration and capital gains subsequently.

Types of Later stage financing

Mezzanine/Development Capital

Finance for purchase of new equipment, refinancing of existing debt,

penetration into new region etc.

Expansion finance

Finance to expand business by way of acquisition of other firms, last

round of financing before a planned exit


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Buyouts

Transfer of management control

Management buy-outs VCs provide funds to enable the current

operating management/investors to acquire existing product line or

business

Can acquire a sick company and turn it around need money and

management to turnaround

Management buy-ins

Funds provided to enable an outside group to buy an ongoing company

Target are weaker or underperforming companies


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Merits of Venture Capital Financing

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

to business

Successfully attracting a VC can help the business to find easier and

secure funding from other sources

VC can take part in promoting an innovative ideas which otherwise

would have buried due to paucity of funds

Encouragement to new breed of entrepreneurs to take up risk

For VC benefit from the growing economy


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Demerits of Venture Capital Financing

Securing a deal with VC is a long and complex process

To draw up a detailed business plan, entrepreneur requires professional

help

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

and accounting fees

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

entrepreneur

Partnering the profit with the VC


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SEBIGuidelines for Foreign Venture Capital Funds

Registration

A foreign venture capital investor (FVCI) must be registered with SEBI afterfulfilling the following eligibility conditions and on payment of application fee

of US $1000:

Its track record, professional competence, financial soundness, experience,

reputation of fairness and integrity

RBI has granted approval of investing in India

It is an investment company, trust, partnership, pension or mutual or

endowment fund, charitable institution or any other entity incorporated outside

India.

It is an asset/investment management company, investment manager or any

other investment vehicle incorporated outside India.

It is authorised to invest in Venture Capital Fund or to carry on activity asVenture Capital Fund.

It is regulated by an appropriate foreign regulatory authority or is an income

tax payer. Otherwise, it submits a certificate from its bankers about its

promoters track record.

It is a fit and proper person.


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SEBI will grant the Certificate ofRegistration on receipt of the

registration fee ofUS $10,000 on the following conditions:

it would appoint a domestic custodian for the custody of securities.

to enter into an agreement with any bank to act as its banker for operating a

special non-resident rupee/foreign currency account.

Investment Criteria

Foreign VC Investors must disclose their investment strategy to SEBI. They

are permitted to invest their total funds committed in one venture capital

funds, but for investing in venture capital undertakings they have to follow the

norms as prescribed by SEBI domestic VCFs.

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

Power to conduct inspection/investigation in respect of conduct and affairs ofFVCls.

Power to issue directions in the interest of the capital market and investors.

Power to suspend or cancel registration.

Power to call for any information.


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Venture Capital Funds in India is promoted by

All India Financial Institutions

State level Financial Institutions

Commercial Banks

Private Sector Institutions

Indian

IFCI Venture Capital Funds Ltd.

IDBI Venture Capital Fund

ICICI Venture Funds Management Company Ltd.

SIDBI Venture Capital Ltd.

Foreign

Venture Capital[1]

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