A Project Submitted for a

“STUDY OF VENTURE CAPITAL IN INDIA”

PROJECT
SUBMITTED TO

ANNAMALAI UNIVERSITY

SUBMITTED BY

PRASHANT S. JADHAV
Enrollment no: - 4740800052

PROJECT GUIDE

PROF. AMIT GOEL

MBA (FINANCE), CA.

Masters of Business Administration

(Applied Management)
(Second Year)

NIS ACADEMY
Sakinaka, Andheri (E).
Mumbai.400072
2009 – 2010
Study Of Venture Capital In India Page No: 1
Study Of Venture Capital In India Page No: 2
 PROJECT TITLE:-

“STUDY OF
VENTURE CAPITAL
IN INDIA”

Study Of Venture Capital In India Page No: 3

  DECLARATION

I, the undersigned, student of NIS ACADEMY of Masters of Business

Administration (Applied Management) Second year hereby declare

that I have completed this Project of “Study of Venture Capital in

India” in the academic year 2009-2010.

The information submitted in this project is true and original to the best

of my knowledge.

Mr. Prashant Jadhav

Study Of Venture Capital In India Page No: 4

 CERTIFICATE

This is to certify that Mr. Prashant S. Jadhav has successfully

completed the project work as partial fulfillments of the requirement
for The Masters of Business Administration (Applied Management)
in the academic year 2009-2010.

Signature of Project Guide Signature of Location Head

Mr. Amit Goel Mrs.Rita Balachandran

Date: Date:

College Seal

Study Of Venture Capital In India Page No: 5

  ACKNOWLEDGEMENT

One of the pleasant aspects of preparing a project report is the

opportunity to thank to those who have contributed to make the project
completion possible.

I am extremely thankful to Mr. Amit Goel & Mrs. Rita

Balachandran. Whose active interest in the project and insights helped
us formulate, redefine and implement our approach towards the
project.

We are also thankful to all those seen and unseen hands & heads,
which have been of direct or indirect, help in the completion of this
project.

Study Of Venture Capital In India Page No: 6

  PREFACE
In India, a revolution is ushering in a new economy, wherein major investment
are being made in the knowledge based industry with substantially low
investments in land, building, plant and machinery. The asset/ collateral- backed
lending instruments adopted for the hard for the hard core manufacturing
industries, are proving to be inadequate for the knowledge- based industries that
often start with just idea.

The only way to finance such industries is through Venture Capital. Venture
Capital is instrumental in bringing about industrial development, for it exploits
the vast and untapped potentialities and promotes the growth of the knowledge-
based industries worldwide.

In India too, it has become popular in different parts of the country. Thus, the role
of venture capitalist is very crucial, different, and distinguishable to the role of
traditional finance as it deals with others’ money. In view of the globalization;
venture Capital has turned out to be a boon to both business and industry.

This report, which contains in-depth study of Venture Capital Industry in India, is
made with an intension to get through all the aspects related to the topic and to
become able to make some suggestion at the industry. This report deals with the
concept of Venture Capital, with particular reference to India. The report includes
all facts, rules and regulations regarding Venture Capital.

Study Of Venture Capital In India Page No: 7

  EXECUTIVE SUMMARY

Venture capital is a growing business of recent origin in the area of industrial

financing in India. The various financial institution set-ups in India to promote
industries have done commendable work. However, these institutions do not
come up to benefit risky ventures when they are undertaken by new or relatively
unknown entrepreneurs. They contend to give debt finance, mostly in the form of
term loans to the promoters and their functioning has been more akin to that of
commercial banks.

Starting and growing a business always require capital. There are a number of
alternative methods to fund growth. These include the owner or proprietor’s own
capital, arranging debt finance, or seeking an equity partner, as is the case with
private equity and venture capital.

Venture capital is a means of equity financing for rapidly-growing private

companies. Finance may be required for the start-up, development/expansion or
purchase of a company. Venture Capital firms invest funds on a professional
basis, often focusing on a limited sector of specialization (eg. IT, Infrastructure,
Health/Life Sciences, Clean Technology, etc.).

Indian Venture capital and Private Equity Association(IVCA) is a member based

national organization that represents venture capital and private equity firms,
promotes the industry within India and throughout the world and encourages
investment in high growth companies.

IVCA member comprise venture capital firms, institutional investors, banks,

incubators, angel groups, corporate advisors, accountants, lawyers, government
bodies, academic institutions and other service providers to the venture capital
and private equity industry.

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Members represent most of the active venture capital providers and private equity
firms in India. These firms provide capital for seed ventures, early stage
companies, later stage expansion, and growth finance for management
buyouts/buy-ins of established companies.

Venture capitalists have been catalytic in bringing forth technological innovation

in USA. A similar act can also be performed in India. As venture capital has good
scope in India for three reasons:

First: The abundance of talent is available in the country. The low cost high
quality Indian workforce that has helped the computer users worldwide in Y2K
project is demonstrated asset.

Second: A good number of successful Indian entrepreneurs in Silicon Valley

should have a demonstration effect for venture capitalists to invest in Indian
talent at home.

Third: The opening up of Indian economy and its integration with the world
economy is providing a wide variety of niche market for Indian entrepreneurs to
grow and prove themselves.

Study Of Venture Capital In India Page No: 9

 Table of contents
Sr. No. Particular Page No.

Approval Latter -
Declaration 4
Certification 5
Acknowledgment 6
Preface 7
Executive Summary 8
1. Introduction To Project (Synopsis) 12-17
 Objective Of The Study 13

 Statement Of Problems 14

 Limitation Of Project 16

 Scope Of The Project 16

 Research Design And Instruments 17

2. Conceptual Framework 18-57

 Concept Of Venture Capital 19

 Features Of Venture Capital 21

 Venture Capital Spectrum/Stages 23

 Venture Capital Investment Process 36

 Methods Of Venture Financing 43

Study Of Venture Capital In India Page No: 10

  Difference Between Venture Capital And Other 45
Funds(Private Equity)
47
 Venture Capital & Alternative Financing Comparison

54
 Players Venture Capital Industry

3. Global Scenario Of Venture Capital Industry 58-95

 Overview 59

 History & Evolution 59

 Current Industry Trends 64

 Growth Of Venture Capital In Global 67

 2009 Global Venture Capital Industry Survey 69

 China, India And Israel Will Be Most Attractive Growth Of 89

Venture Capital
 Primary Reasons For Venture Capital Investors Expanding 92
Globally
 Investing Globally By Investing Locally 94

 Impediments To Global Investing 95

4. Venture Capital In India 96-142

 Evolution Of Venture Capital Industry In India 97

 Objective And Vision For Venture Capital In India 100

 Venture Capital Industry Life Cycle In India 101

 Growth Of Venture Capital In India 105

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  2009 Venture Capital Investment In India 108

 Need For Growth Of Venture Capital In India 109

 Regulatory And Legal Framework 111

 Major Regulatory Framework For Venture Capital Industry 112

 Regulation Of The Business Of Venture Capital In India 117

 Key Success Factor For Venture Capital Industry In India 120

 Industrial Attractiveness 123

 Domestic Economic Factors 124

 Guidelines For Overseas Venture Capital Investment In India 130

 Challenges Ahead For Venture Capital Financing In India 132

 Problems Of Venture Capital Financing In India 133

 Opportunities And Threats 134

5. Recommendations 142
6. Conclusion 150
7. Bibliography & Webliography 152

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INTRODUCTION

TO PROJECT

(SYNOPSIS)

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  OBJECTIVES OF THE STUDY

 Understand the concept of venture capital. Venture Capital funding is

different from traditional sources of financing. Venture capitalists finance
innovation and ideas which have potential for high growth but with
inherent uncertainties. This makes it a high-risk, high return investment.

 Study venture capital industry in India. Scientific, technology 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.

 Study venture capital industry in global scenario. Venture capital has

played a very important role in U.K., Australia and Hong Kong also in
development of technology growth of exports and employment.

 Study the evaluation & need of venture capital industry in India. 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 next stage. This is very crucial for
sustainable growth and for maintaining India’s competitive edge

 Understand the legal framework formulated by SEBI to encourage

venture capital activity in Indian economy. Promoting sound public
policy on issues related to tax, regulation and securities through
representation to the Securities and Exchange Board of India (SEBI),
Ministry of Finance (MoF), Reserve Bank of India (RBI) and other
Government departments

 Find out opportunities that encourage & threats those hinder venture
capital industry in India.

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  To know the impact of political & economical factors on venture
capital investment.

 STATEMENT OF PROBLEMS

Venture capital is in its nascent stages in India. The emerging scenario of global
competitiveness has put an immense pressure on the industrial sector to improve
the quality level with minimization of cost of products by making use of latest
technological skills. The financing firms expect a sound, experienced, mature and
capable management team of the company being financed. Since the innovative
project involves a higher risk, there is an expectation of higher returns from the
project. The payback period is also generally high (5 - 7 years).

The various problems/ queries can be outlined as follows:

 Problems regarding the infrastructure details of production like plant

location, accessibility, relationship with the suppliers and creditors,
transportation facilities, labor availability etc.

 The limited infrastructure, low foreign investment and other transitional

problems, because of above three reasons availability of fund is very low
in market.

 Uncertainty regarding the success of the product in the market.

 As there is requirement of an experienced management team, Due to

unavailability of experienced and skilled people it is difficult to analyze the
future growth of the product in the market.

Study Of Venture Capital In India Page No: 15

  Government has taken all the Initiatives in formulating policies to
encourage investors and entrepreneurs. A government policy has many
rules and regulation that can create problems in allocating the fund to the
Organizations.

 Initiatives of the SEBI to develop a strong and vibrant capital market

giving the adequate liquidity and flexibility for investors for entry and exit.
Due to many rules and regulations from SEBI organization face lots of
difficulties at the time of entering in the market.

 Problem regarding requirement of an above average rate of return on

investment, also longer payback period. The returns on investment are high
but the probability of fund return is depending on the product success in
future.

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  LIMITATION OF PROJECT

A study of this type cannot be without limitations. It has been observed those
venture capitals are very secretive about their investments. This attitude is a
major hindrance for data collection. However venture capital funds/companies
that are members of Indian venture capital association are to be included in the
study.

 SCOPE OF THE PROJECT

The scope of the research includes all types of venture capital firms set up as a
company & funds irrespective of the fact that they are registered with SEBI of
India or not part of this study

Study Of Venture Capital In India Page No: 17

  RESEARCH DESIGN AND INSTRUMENTS

In India neither venture capital theory has been developed nor are there many
comprehensive books on the subject. Even the number of research papers
available is very limited. The research design used is descriptive in nature. (The
attempt has been made to collect maximum facts and figures available on the
availability of venture capital in India, nature of assistance granted, future
projected demand for this financing, analysis of the problems faced by the
entrepreneurs in getting venture capital, analysis of the venture capitalists and
social and environmental impact on the existing framework.)

The research is based on secondary data collected from the published material.
The data was also collected from the publications and press releases of venture
capital associations in India.

Scanning the business papers filled the gaps in information. The Economic times,
Financial Express and Business Standards were scanned for any article or news
item related to venture capital. Sufficient amount of data about the venture capital
has been derived from this project.

Study Of Venture Capital In India Page No: 18

 CONCEPTUAL
FRAMEWORK

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  CONCEPT OF VENTURE CAPITAL

The term venture capital comprises of two words that is, “Venture” and “capital”.
“Venture” is a course of processing the outcome of which is uncertain but to
which is attended the risk or danger of “Loss”. “Capital” means recourses to start
an enterprise. To connote the risk and adventure of such a fund, the generic name
Venture Capital was coined.

Venture capital is considered as financing of high and new technology based

enterprises. It is said that Venture capital involves investment in new or relatively
untried technology, initiated by relatively new and professionally or technically
qualified entrepreneurs with inadequate funds. The conventional financiers,
unlike Venture capitals mainly finance proven technologies and established
markets. However, high technology need not be prerequisite for venture capital.

Venture capital has also been described as ‘unsecured risk financing’. The
relatively high risk of venture capital is compensated by the possibility of high
return usually through substantial capital gains in term. Venture capital in broader
sense is not solely an injection of funds into a new firm, it is also an input of
skills needed to set up the firm, design its marketing strategy, organize and
manage it. Thus it is a long term association with successive stages of company’s
development under highly risky investment condition with distinctive type of
financing appropriate to each stage of development. Investors join the
entrepreneurs as co-partners and support the project with finance and business
skill to exploit the market opportunities.

Venture capital is not a passive finance. It may be at any stage of business/

production cycle, that is startup, expansion or to improve a product or process,
which are associated with both risk and reward. The Venture capital gains

Study Of Venture Capital In India Page No: 20

through appreciation in the value of such investment when the new technology
succeeds. Thus the primary return sought by the investor is essentially capital
gain rather than steady interest income or dividend yield.

The most flexible Definition of Venture Capital is:-

“The support by investors of entrepreneurial talent with finance and

business skills to exploit market opportunities and thus obtain capital gains.”

Venture capital commonly describes not only the provision of start up finance or
‘seed corn’ capital but also development capital for later stages of business. A
long term commitment of funds is involved in the form of equity investments,
with the aim of eventual capital gains rather than income and active involvement
in the management of customer’s business.

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  FEATURES OF VENTURE CAPITAL

 High Risk
 High Tech
 Equity Participation & Capital Gains
 Participation In Management
 Length Of Investment
 Illiquid Investment

 High Risk

By definition the Venture capital financing is highly risky and chances of failure
are high as it provides long term start up capital to high risk- high reward
ventures. Ventures capital assumes four type of risks, these are:

o Management risk -Inability of management teams to work together.

o Market risk -Product may fail in the market.
o Product risk -Product may not be commercially viable.
o Operation risk -Operation may not be cost effective resulting in
increased cost decreased gross margin.

 High Tech

As opportunities in the low technology area tend to be few of lower order, and hi-
tech projects generally offer higher returns than projects in more traditional area,
venture capital investments are made in high tech. areas using new technologies
or producing innovative goods by using new technology. Not just high
technology, any high risk ventures where the entrepreneur has conviction but

Study Of Venture Capital In India Page No: 22

little capital gets venture finance. Venture capital is available for expansion of
existing business or diversification to a high risk area. Thus technology financing
had never been the primary objective but incidental to venture capital.

 Equity Participation & Capital Gains

Investments are generally in equity and quasi equity participation through direct
purchase of share, options, convertible debentures where the debt holder has the
option to convert the loan instruments into stock of the borrower or a debt with
warrants to equity investment. The funds in the form of equity help to raise term
loans that are cheaper source of funds. In the early stage of business, because
dividends can be delayed, equity investment implies that investors bear the risk
of venture and would earn a return commensurate with success in the form of
capital gains.

 Participation In management

Venture capital provides value addition by managerial support, monitoring and

follow up assistance. It monitors physical and financial progress as well as
market development initiative. It helps by identifying key resource person. They
want one seat on the company’s board of directors and involvement, for better or
worse, in the major decision affecting the direction of company. This is a unique
philosophy of “hand on management” where Venture capitalist acts as
complementary to the entrepreneurs. Based upon the experience other companies,
a venture capitalist advice the promoters on project planning, monitoring,
financial management, including working capital and public issue. Venture
capital investor cannot interfere in day today management of the enterprise but
keeps a close contact with the promoters or entrepreneurs to protect his
investment.

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  Length of Investment

Venture capitalist help companies grow, but they eventually seek to exit the
investment in three to seven years. An early stage investment may take seven to
ten years to mature, while most of the later stage investment takes only a few
years. The process of having significant returns takes several years and calls on
the capacity and talent of venture capitalist and entrepreneurs to reach fruition.

 Illiquid Investment

Venture capital investments are illiquid, that is not subject to repayment on

demand or following a repayment schedule. Investors seek return ultimately by
means of capital gain when the investment is sold at market place. The
investment is realized only on enlistment of security or it is lost if enterprise is
liquidated for unsuccessful working. It may take several years before the first
investment starts too locked for seven to ten years. Venture capitalist understands
this illiquidity and factors this in his investment decision.

 THE VENTURE CAPITAL SPECTRUM/STAGES

The growth of an enterprise follows a life cycle as shown in the diagram below.
The requirements of funds vary with the life cycle stage of the enterprise. Even
before a business plan is prepared the entrepreneur invests his time and resources
in surveying the market, finding and understanding the target customers and their
needs. At the seed stage the entrepreneur continue to fund the venture with his
own fund or family funds. At this stage the fund are needed to solicit the
consultant’s services in formulation of business plans, meeting potential
customers and technology partners. Next the funds would be required for
development of the product/process and producing prototypes, hiring key people
and building up the managerial team. This is followed by funds for assembling

Study Of Venture Capital In India Page No: 24

the manufacturing and marketing facilities in that order. Finally the funds are
needed to expand the business and attaint the critical mass for profit generation.
Venture capitalists cater to the needs of the entrepreneurs at different stages of
their enterprises. Depending upon the stage they finance, venture capitalists are
called angel investors, venture capitalist or private equity supplier/investor.

Venture capital was started as early stage financing of relatively small but rapidly
growing companies. However various reasons forced venture capitalists to be
more and more involved in expansion financing to support the development of
existing portfolio companies. With increasing demand of capital from newer
business, venture capitalists began to operate across a broader spectrum of
investment interest. This diversity of opportunities enabled venture capitalists to
balance their activities in term of time involvement, risk acceptance and reward
potential, while providing ongoing assistance to developing business.

Introduction stage

Growth
Stage
Later Stage

Seed Capital Early Stage

Second

Startup Capital

Venture Capital Spectrum/Stage

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 Different Venture capital firms have different attributes and aptitudes for
different types of Venture capital investments. Hence there are different stages of
entry for different venture capitalists and they can identify and differentiate
between types of venture capital investments, each appropriate for the given stage
of the investee company, these are:-

1. Early stage Finance

 Seed capital
 Start up Capital
 Early/First Stage Capital
 Later/Third Stage capital

2. Later Stage Finance

 Expansion/Development Stage Capital

 Replacement Finance
 Management Buy Out and Buy Ins
 Turnarounds
 Mezzanine/Bridge Finance

Not all business firms pass through each of these stages in sequential manner. For
instance seed capital is normally not required by service based ventures. It
applies largely to manufacturing or research based activities. Similarly second
round finance does not always follow early stage finance. If the business grows
successfully it is likely to develop sufficient cash to fund its own growth, so does
not require venture capital for growth.

Study Of Venture Capital In India Page No: 26

The table below shows risk perception and time orientation for different stages of
venture capital financing.

Financing Stage Period (funds Risk Activity to be financed

locked in years) perception

Early stage finance 7-10 Extreme For supporting a concept

or idea or R & D for
product development
Start up 5-9 Very high Initializing operations or
developing prototypes
First stage 3-7 High Start commercial
production and marketing
Second stage 3-5 Sufficiently Expand market & growing
high working capital need
Later stage finance 1-3 Medium Market expansion,
acquisition & product
development for profit
making company
Buy out-in 1-3 Medium Acquisition financing
Turnaround 1-3 Medium to high Turning around a sick
company
Mezzanine 1-3 Low Facilitating public issue

Venture Capital- Financing Stages

 Seed Capital

It is an idea or concept as opposed to a business. European venture capital

association defines seed capital as “The financing of the initial product
development or capital provided to an entrepreneur to prove the feasibility of a
project and to qualify for start up capital.”

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The characteristics of the seed capital may be enumerated as follows:

o Absence of ready product market

o Absence of complete management team
o Product/process still in R & D stage
o Initial period/licensing stage of technology transfer

Broadly speaking seed capital investment may take 7 to 10 year to achieve

realization. It is the earliest and therefore riskiest stage of Venture capital
investment. The new technology and innovations being attempted have equal
chance of success and failure. Such projects, particularly hi-tech, projects sink a
lot of cash and need a strong financial support for their adaptation,
commencement and eventual success. However, while the earliest stage of
financing is fraught with risk, it also provides greater potential for realizing
significant gains in long term. Typically seed enterprises lack asset base or track
record to obtain finance from conventional sources and are largely dependent
upon entrepreneur’s personal resources. Seed capital is provided after being
satisfied that the entrepreneur has used up his own resources and carried out his
idea to a stage of acceptance and has initiated research. The asset underlying the
seed capital is often technology or an idea as opposed to human assets (a good
management taem0 so often sought by venture capitalists.

Volume of Investment Activity

It has been observed that Venture capitalist seldom make seed capital investment
and these are relatively small by comparison to other forms of Venture finance.
The absence of interest in providing a significant amount of seed capital can be
attributed to the following three factors:-

Study Of Venture Capital In India Page No: 28

 a) Seed capital projects by their very nature require a relatively small amount
of capital. The success or failure of an individual seed capital investment
will have little impact on the performance of all but the smallest venture
capital investments. This is because the small investments are seen to be
cost inefficient in terms of time required to analyze structure manage them.
b) The time horizon to realization for most seed capital investment is
typically 7-10 years which is longer than all but most long-term oriented
investors will desire.
c) The risk of product and technology obsolescence increases as the time to
realization I extended. These types of obsolescence are particularly likely
to occur with high technology investments particularly in the fields related
to Information Technology.

 Start Up Capital

It is stage second in the venture capital cycle and is distinguishable from seed
capital investments. An entrepreneur often needs finance when the business is
just starting. The start up stage involves starting a new business. Here in the
entrepreneur has moved closer towards establishment of a going concern. Here in
the business concept has been fully investigated and the business risk now
becomes that of turning the concept into product.

Start up capital is defined as; “Capital needed to finance the product

development, initial marketing and establishment of product facility.”

The characteristics of start-up capital are:-

a) Establishment of company or business: the company is either being

organized or is established recently. New business activity could be based

on experts, experience or a spin-off from R & D.

Study Of Venture Capital In India Page No: 29

 b) Establishment of most but not all the members of the team: the skills

and fitness to the job and situation of the entrepreneur’s team is an

important factor for start up finance.
c) Development of business plan or idea: the business plan should be fully

developed yet the acceptability of the product by the market is uncertain.

The company has not yet started trading.

In the start up preposition Venture capitalists’ investment criteria shifts from idea
to people involved in the venture and the market opportunity. Before committing
any finance at this stage, venture capitalist however, assesses the managerial
ability and the capacity of the entrepreneur, besides the skills, suitability and
competence of the managerial team are also evaluated. If required they supply
managerial skill and supervision for implementation. The time horizon for start
up capital will be typically 6 or 8 years. Failure rate for start up is 2 out of 3. Start
up needs funds by way of both first round investment and subsequent follow-up
investments. The risk tends to be lower relative to seed capital situation. The risk
is controlled by initially investing a smaller amount of capital in start-ups. The
decision on additional financing is based upon the successful performance of the
company. However, the term to realization of a start up investment remains
longer than the term of finance normally provided by the majority of financial
institutions. Longer time scale for using exit route demands continued watch on
start up projects.

Volume of Investment Activity

Despite potential for secular returns most venture firms avoid investing in start-
ups. One reason for the paucity of start up financing may be high discount rate
that venture capitalist applies to venture proposals at this level of risk and
maturity. They often prefer to spread their risk by sharing the financing. Thus
syndicates of investor’s often participate in start up finance.

Study Of Venture Capital In India Page No: 30

  Early Stage Finance

It is also called first stage capital is provided to entrepreneur who has a proven
product, to start commercial production and marketing, not covering market
expansion, de-risking and acquisition costs.

At this stage the company passed into early success stage of its life cycle. A
proven management team is put into this stage, a product is established and an
identifiable market is being targeted.

British Venture capital Association has vividly defined early stage finance as:
“Finance provided to companies that have completed the product development
stage and require further funds to initiate commercial manufacturing and sales
but may not be generating profits.”

The characteristics of early stage finance may be:-

 Little or no sales revenue.

 Cash flow and profit still negative.
 A small but enthusiastic management team which consists of people with
technical and specialist background and with little experience in the
management of growing business.
 Short term prospective for dramatic growth in revenue and profits.

The early stage finance usually takes 4 to 6 years time horizon to realization.
Early stage finance is the earliest in which two of the fundamentals of business

Study Of Venture Capital In India Page No: 31

are in place i.e. fully assembled management team and a marketable product. A
company needs this round of finance because of any of the following reasons:-

 Project overruns on product development.

 Initial loss after start up phase.

The firm needs additional equity funds, which are not available from other
sources thus prompting venture capitalist that, have financed the start up stage to
provide further financing. The management risk is shifted from factors internal to
the firm (lack of management, lack of product etc.) to factor external to the firm
(competitive pressures, in sufficient will of financial institutions to provide
adequate capital, risk of product obsolescence etc.)

At this stage, capital needs, both fixed and working capital needs are greatest.
Further, since firms do not have foundation of a trading record, finance will be
difficult to obtain and so venture capital particularly equity investment without
associated debt burden is key to survival of the business.

The following risks are normally associated to firms at this stage:-

a) The early stage firms may have drawn the attention of and incurred the
challenge of a larger competition.
b) There is a risk of product obsolescence. This is more so when the firm is
involved in high-tech business like computer, information technology etc.

 Second stage Finance

It is the capital provided for marketing and meeting the growing working capital
needs of an enterprise that has commenced the production but does not have
positive cash flows sufficient to take care of its growing needs. Second stage
finance, the second trench of Early Stage Finance is also referred to as follow on

Study Of Venture Capital In India Page No: 32

finance and can be defined as the provision of capital to the firm which has
previously been in receipt of external capital but whose financial needs have
subsequently exploded. This may be second or even third injection of capital.

The characteristics of a second stage finance are:

 A developed product on the market

 A full management team in place

 Sales revenue being generated from one or more products

 There are losses in the firm or at best there may be a breakeven but the
surplus generated is insufficient to meet the firm’s needs.

Second round financing typically comes in after start up and early stage funding
and so have shorter time to maturity, generally ranging from 3 to 7 years. This
stage of financing has both positive and negative reasons.

Negative reasons include:

 Cost overruns in market development

 Failure of new product to live up to sales forecast.
 Need to re-position products through a new marketing campaign
 Need to re-define the product in the market place once the product
deficiency is revealed.

Positive reasons include:

 Sales appear to be exceeding forecasts and the enterprise needs to acquire

assets to gear up for production volumes greater than forecasts.
 High growth enterprises expand faster than their working capital permit,
thus needing additional finance. Aim is to provide working capital for
Study Of Venture Capital In India Page No: 33
 initial expansion of an enterprise to meet needs of increasing stocks and
receivables.

It is additional injection of funds and is an acceptable part of venture capital.

Often provision for such additional finance can be included in the original
financing packages as an option, subject to certain management performance
targets.

 Later Stage Finance

It is called third stage capital is provided to an enterprise that has established

commercial production and basic marketing set-up, typically for market
expansion, acquisition product development etc. it is provided for market
expansion of the enterprise.

The enterprises eligible for this round of finance have following characteristics:

 Established business, having already passed the risky early stage.

 Expanding high yield, capital growth and good profitability.
 Reputed market position and an established formal organization
structure.

“Funds are utilized for further plant expansion, marketing, working capital or
development of improved products.” Third stage financing is a mix of equity
with debt or subordinate debt. As it is half way between equity and debt in US it
is called “mezzanine” finance. It is also called last round of finance in run up to
the trade sale or public offer.

Venture capitalists prefer later stage investment vis a Vis early stage investments,
as the rate of failure in later stage financing is low. It is because firms at this
stage have a past performance data, track record of management, established

Study Of Venture Capital In India Page No: 34

procedures of financial control. The time horizon for realization is shorter,
ranging from 3 to 5 years. This helps the venture capitalists to balance their own
portfolio of investment as it provides a running yield to venture capitalists.
Further the loan component in third stage finance provides tax advantage and
superior return to the investors.

There are four sub divisions of later stage finance:

 Expansion/Development Finance
 Replacement Finance
 Buyout Financing

 Turnaround Finance

Expansion/ Development finance

An enterprise established in a given market increases its profit exponentially by

achieving the economies of scale. This expansion can be achieved either through
an organic growth, that is by expanding production capacity and setting up proper
distribution system or by way of acquisitions. Anyhow, expansion needs finance
and venture capitalists support both organic growth as well as acquisitions for
expansion.

At this stage the real market feedback is used to analyze competition. It may be
found that the entrepreneur needs to develop his managerial team for handling
growth and managing a larger business.

Realization horizon for expansion/development investment is one to three years.

It is favored by venture capitalist as it offers higher rewards in shorter period with
lower risk. Funds are needed for new or larger factories and warehouses,
production capacities, developing improved or new products, developing new

Study Of Venture Capital In India Page No: 35

markets or entering exports by enterprise with established business that has
already achieved break even and has started making profits.

Replacement Finance

It means substituting one shareholder for another, rather than raising new capital
resulting in the change of ownership pattern. Venture capitalist purchase share
from the entrepreneurs and their associates enabling them to reduce their
shareholding in unlisted companies. They also buy dividend coupon. Later, on
sale of the company or its listing on stock exchange, these are re-converted to
ordinary shares. Thus Venture capitalist makes a capital gain in a period of 1 to 5
years

Buy-out / Buy-in Financing

It is a resent development and a new form of investment by venture capitalist.

The funds provided to the current operating management to acquire or purchase a
significant share holding in the business they manage are called management
buyout.

Management Buy-in refers to the funds provided to enable a manager or a group

of managers from outside the company to buy into it.

It is the most popular form of venture capital amongst stage financing. It is less
risky as venture capitalist in invests in solid, ongoing and more mature business.
The funds are provided for acquiring and revitalizing an existing product line or
division of a major business. MBO (Management buyout) has low risk as
enterprise to be bought have existed for some time besides having positive cash
flow to provide regular returns to the venture capitalist, who structure their
investment by judicious combination of debt and equity. Of late there has been a

Study Of Venture Capital In India Page No: 36

gradual shift away from start up and early finance towards MBO opportunities.
This shift is because of lower risk than start up investments.

Turnaround Finance

It is rare form later stage finance which most of the venture capitalist avoid
because of higher degree of risk. When an established enterprise becomes sick, it
needs finance as well as management assistance for a major restructuring to
revitalize growth of profits. Unquoted company at an early stage of development
often has higher debt than equity; its cash flows are slowing down due to lack of
managerial skill and inability to exploit the market potential. The sick companies
at the later stages of development do not normally have high debt burden but lack
competent staff at various levels. Such enterprises are compelled to relinquish
control to new management. The venture capitalist has to carry out the recovery
process using hands on management in 2 to 5 years. The risk profile and
anticipated rewards are akin to early stage investment.

Bridge Finance

It is the pre-public offering or pre-merger/acquisition finance to a company. It is

the last round of financing before the planned exit. Venture capitalist help in
building a stable and experienced management team that will help the company
in its initial public offer. Most of the time bridge finance helps improves the
valuation of the company. Bridge finance often has a realization period of 6
months to one year and hence the risk involved is low. The bridge finance is paid
back from the proceeds of the public issue.

 VENTURE CAPITAL INVESTMENT PROCESS

Venture capital investment process is different from normal project financing. In

order to understand the investment process a review of the available literature on

Study Of Venture Capital In India Page No: 37

venture capital finance is carried out. Tyebjee and Bruno in 1984 gave model of
venture capital investment activity with some variations is commonly used
presently. As per this model this activity is a five step process as follows:

1. Deal Organization
2. Screening
3. Evaluation or due Diligence
4. Deal Structuring
5. Post Investment Activity and Exit

Investors

Screening

VC MGT Fund
Selection

Investment
process

Structuring
Prospective
Investee

Monitoring

Exit
Study Of Venture Capital In India Page No: 38

Venture Capital Investment Process

  Deal Origination:

In generating a deal flow, the VC investor creates a pipeline of deals or

investment opportunities that he would consider for investing in. deal may
originate in various ways. Referral system, active search system, and
intermediaries. Referral system is an important source of deals. Deals may be
referred to VCFs by their parent organizations, trade partners, industry
associations, friends etc. Another deal flow is active search through networks,
trade fairs, conferences, seminars, foreign visits etc. intermediaries is used by
venture capitalists in developed countries like USA, is certain intermediaries who
match VCFs and the potential entrepreneurs.

 Screening:

VCFs, before going for an in-depth analysis, carry out initial screening of all
projects on the basic of some broad criteria. For example, the screening process
may limit projects to areas in which the venture capitalist is familiar in terms of
technology, or product, or market scope. The size of investment, geographical
location and stage of financing could also be used as the broad screening criteria.

 Due Diligence:

Study Of Venture Capital In India Page No: 39

Due diligence is the industry jargon for all the activities that are associated with
evaluating an investment proposal. The Venture capitalists evaluate the quality of
entrepreneur before appraising the characteristics of the product, market or
technology. Most venture capitalists ask for a business plan to make an
assessment of the possible risk and return on the venture. Business plan contains
detailed information about the proposed venture. The evaluation of ventures by
VCFs in Indian includes; Preliminary evaluation: the applicant required to
provide a brief profile of the proposed venture to establish prima facie eligibility.

Detailed evaluation: once the preliminary evaluation is over, the proposal is

evaluated in greater detail. VCFs in India expect the entrepreneur to have: -
integrity, long-term vision, urge to grow, managerial skills, commercial
orientation.

VCFs in India also make the risk analysis of the proposed projects which
includes: product risk, market risk, technological risk and entrepreneurial risk.
The final decision is taken in terms of the expected risk-return trade-off as shown
in figure.

 Deal Structuring:

In this process, the venture capitalist and the venture company negotiate the
terms of the deals, that are the amount form and price of the investment. This
process is termed as deal structuring. The agreement also include the venture
capitalists right to control the venture company and to change its management if
needed, buyback arrangement specify the entrepreneurs equity share and the
objectives share and the objectives to be achieved.

 Post Investment Activities:

Study Of Venture Capital In India Page No: 40

Once the deal has been structured and agreement finalized, the venture capitalist
generally assumes the role of a partner and collaborator. He also gets involved in
shaping of the direction of the venture. The degree of the venture capitalists
involvement depends on his policy. It may not, however be desirable for a
venture capitalist to get involved in the day-to-day operation of the venture. If a
financial or managerial crisis occurs, the venture capitalist may intervene, and
even install a new management team.

 Exit:

Venture capitalists generally want to cash-out their gains in five to ten years after
the initial investment. They play a positive role in directing the company towards
particular exit routes. A venture may exist in one of the following ways:

There are four ways for a venture capitalist to exit its investment:

 Initial Public Offer (IPO)

 Acquisition by another company
 Re-purchase of venture capitalists share by the investee company
 Purchase of venture capitalists share by a third party

Promoters Buy-back

The most popular disinvestment route in India is promoters buy-back. This route
is suited to Indian conditions because it keeps the ownership and control of the
promoter intact. The obvious limitation, however, is that in a majority of cases
the market value of the shares of the venture firm would have appreciated so

Study Of Venture Capital In India Page No: 41

much after some years that the promoter would to be in a financial position to
buy them back.

In India, the promoters are invariably given the first option to buy back equity of
their enterprise. For example, RCTO participates in the assisted firm’s equity
with suitable agreement for the promoter to repurchase it. Similarly, Confina-
VCF offers an opportunity to the promoters to buy back the shares of the assisted
firm within an agreed period at a predetermined price. If the promoter fails to buy
back the shares within the stipulated period, Confine-VCF would have the
discretion to divest them in any manner it deemed appropriate. SBI capital
Markets ensures through examining the personal assets of the promoters and their
associates, which buy back, would be a feasible option. GV would make
disinvestment, in consultation with the promoter, usually after the project has
settled down, to a profitable level and the entrepreneur is in a position to avail of
finance under conventional schemes of assistance from banks or other financial
institutions.

Initial Public Offers (IPOs)

The benefits of disinvestments via the public issue route are improved
marketability and liquidity, better prospects for capital gains and widely known
status of the venture as well as market control through public share participation.
This option has certain limitations in the Indian context. The promotion of the
public issue would be difficult and expensive since the first generation
entrepreneurs are not known in the capital markets. Further, difficulties will be
caused if the entrepreneurs business is perceived to be an unattractive investment
proposition by investors. Also, the emphasis by the Indian investors on short-
term profits and dividends may tend to make the market price unattractive. Yet
another difficulty in India until recently was that the Controller of Capital Issues
(CCI) guidelines for determining the premium on shares took into account the

Study Of Venture Capital In India Page No: 42

book value and the cumulative average EPS till the date of the new issue. This
formula failed to give due weight age to the expected stream of earning of the
venture firm. Thus, the formula would underestimate the premium. The
government has now abolished the Capital Issues Control Act, 1947 and
consequently, the office of the controller of Capital Issues. The existing
companies are now free to fix the premium on their shares. The initial public
issue for disinvestments of VCFs holding can involve high transaction costs
because of the inefficiency of the secondary market in a country like India. Also,
this option has become far less feasible for small ventures on account of the
higher listing requirement of the stock exchanges. In February 1989, the
Government of India raised the minimum capital for listing on the stock
exchanges from Rs 10 million to Rs 30 million and the minimum public offer
from Rs 6 million to Rs 18 million.

Sale on the OTC Market

An active secondary capital market provides the necessary impetus to the success
of the venture capital. VCFs should be able to sell their holdings, and investors
should be able to trade shares conveniently and freely. In the USA, there exist
well-developed OTC markets where dealers trade in share on telephone/terminal
and not on an exchange floor. This mechanism enables new, small companies
which are not otherwise eligible to be listed on the stock exchange, to enlist on
the OTC markets and provides liquidity to investors. The National Association of
Securities dealers Automated Quotation System (NASDAQ) in the USA daily
quotes over 8000 stock prices of companies backed by venture capital.

The OTC Exchange in India was established in June 1992. The Government of
India had approved the creation for the Exchange under the Securities Contracts
(Regulations) Act in 1989. It has been promoted jointly by UTI, ICICI, SBI
Capital Markets, Can Bank Financial Services, GIC, LIC and IDBI. Since this list

Study Of Venture Capital In India Page No: 43

of market-makers (who will decide daily prices and appoint dealers for trading)
includes most of the public sector venture financiers, it should pick up fast, and it
should be possible for investors to trade in the securities of new small and
medium size enterprise.

The other disinvestment mechanisms such as the management buy outs or sale to
other venture funds are not considered to be appropriate by VCFs in India.

The growth of an enterprise follows a life cycle as shown in the diagram below.
The requirements of funds vary with the life cycle stage of the enterprise. Even
before a business plan is prepared the entrepreneur invests his time and resources
in surveying the market, finding and understanding the target customers and their
needs. At the seed stage the entrepreneur continue to fund the venture with his
own fund or family funds. At this stage the funds are needed to solicit the
consultant’s services in formulation of business plans, meeting potential
customers and technology partners. Next the funds would be required for
development of the product/process and producing prototypes, hiring key people
and building up the managerial team. This is followed by funds for assembling
the manufacturing and marketing facilities in that order. Finally the funds are
needed to expand the business and attaint the critical mass for profit generation.
Venture capitalists cater to the needs of the entrepreneurs at different stages of
their enterprises. Depending upon the stage they finance, venture capitalists are
called angel investors, Venture capitalist or private equity supplier/investor.

 METHODS OF VENTURE FINANCING

Venture Capital is typically available in three forms in India, they are:

 Equity: All VCFs in India provide equity but generally their contribution
does not exceed 49% of the total equity capital. Thus, the effective control

Study Of Venture Capital In India Page No: 44

 and majority ownership of the firm remains with the entrepreneur. They
buy shares of an enterprise with an intention to ultimately sell them off to
make capital gains.
 Conditional Loan: it is repayable in the form of a royalty after the venture
is able to generate sales. No interest is paid on such loans. In India, VCFs
change royalty ranging between 2% to 15%; actual rate depends on other
factors of the venture such as gestation period, cost flow patterns, riskiness
and other factors of the enterprise.
 Income Note: it is a hybrid security which combines the features of both
conventional loan and conditional loan. The entrepreneur has to pay both
interest and royalty on sales, but at substantially low rates.
 Participating Debenture: such security carries charges in 3 phases. In the
start up phase, before the venture attains operations to a minimum level, no
interest is charged, after this, low rate of interest is charged, up to a
particular level of operation. Once the venture is commercial, a high rate of
interest is required to be paid.
 Quasi Equity: quasi equity instruments are converted into equity at a later
date. Convertible instruments are normally converted into equity at the
book value or at certain multiple of EPS, i.e. at a premium to par value at a
later date. The premium automatically rewards the promoter for their
initiative and hand work. Since it is performance related, it motivates the
promoter to work harder so as to minimize dilution of their control on the
company. The different quasi equity instruments are follows:

o Cumulative convertible preference shares.

o Partially convertible debentures.
o Fully convertible debentures.

Study Of Venture Capital In India Page No: 45

  Other Financing methods: a few venture capitalists, particularly in the
private sector, have started introducing innovative financial securities like
participating debentures, introduced by TCFC is an example.

 DIFFERENCE BETWEEN VENTURE CAPITAL

AND OTHER FUNDS (PRIVATE EQUITY)

 Venture Capital Vs Development Funds

Venture capital differs from development funds as latter means putting up of

industries without much consideration of use of new technology or new
entrepreneurial venture but having a focus on underdeveloped areas (locations).
In majority cases it is in the form of loan capital and proportion of equity is very
thin. Development finance is security oriented and liquidity prone. The criteria
for investment are proven track record of company and its promoters, and
sufficient cash generation to provide for returns (principal and interest). The
development bank safeguards its interest through collateral.

They have no say in working of the enterprise except safeguarding their interest
by having a nominee director. They do not play any active role in the enterprise
except ensuring flow of information and proper management information system,
regular board meetings, adherence to statutory requirements for effective
management information system, regular board meetings, adherence to statutory
requirements for effective management control where as Venture capitalist
remain interested if the overall management of the project account of high risk
involved I the project till its completion, entering into production and making
available proper exit route for liquidation of the investment. As against this fixed
payments in the form of installment of principal and interest are to be made to
development.

Study Of Venture Capital In India Page No: 46

  Venture Capital Vs Seed Capital & Risk Capital

It is difficult to make a distinction between venture capital, seed capital, and risk
capital as the latter two form part of broader meaning of Venture capital.
Difference between them arises on account of application of funds and terms and
conditions applicable. The seed capital and risk funds in India are being provided
basically to arrange promoter’s contribution to the project. The objective is to
provide finance and encourage professionals to become promoters of industrial
projects. The seed capital is provided to conventional projects on the
consideration of low risk and security and use conventional techniques for
appraisal. Seed capital is normally in the form low interest deferred loan as
against equity investment by Venture capital. Unlike Venture capital, Seed
capital providers neither provide any value addition nor participate in the
management of the project. Unlike Venture capital Seed capital provider is
satisfied with low-normal returns and lacks any flexibility in its approach.

Risk capital is also provided to established companies for adapting for new
technologies. Herein the approach is not business oriented but developmental. As
a result on one hand the success rate of units assisted by seed capital/risk.

Finance has been lower than those provided with venture capital. On the other
hand the return to the seed/risk capital financier had been very low as compared
to venture capitalist.

Seed Capital Scheme Venture Capital Scheme

Basic Income or aid Commercial viability
Beneficiaries Very small entrepreneurs Medium and large
entrepreneurs are also covered
Size of assistance Rs. 15 lac(Max) Up to 40 percent of promoters’
equity

Study Of Venture Capital In India Page No: 47

Appraisal process Normal Skilled and Specialized
Estimates returns 20 percent 30 percent plus
Flexibility Nil Highly flexible
Value addition Nil Multiple ways
Exit option Sell back to promoters Several, including public offer
Funding sources Owner funds Outside contribution allowed
Syndication Not done Possible
Tax concession Nil Exempted
Success rate Not good Very satisfactory

Difference between Seed Capital Scheme and Venture Capital Scheme

 Venture Capital Vs Bought Out Deals

The important difference between the venture capital and bought out deals is that
bought outs are not based upon high risk- high reward principal. Further unlike
venture capital they do not provide equity finance at different stages of the
enterprise. However both have a common expectation of capital gains yet their
objectives and intents are totally different.

 VENTURE CAPITAL & ALTERNATIVE

FINANCING COMPARISON

Study Of Venture Capital In India Page No: 48

 Venture capital & alternative financing comparison

If we are struggling to find success in our quest for venture capital, maybe we are
looking in the wrong place. Venture capital is not for everybody. For starters,
venture capitalists tend to be very picky about where they invest. They are
looking for something to dump a lot of money into 9usually no less than $1
million) that will pour even more money right back at them in a short amount of
time (typically 3-7 years). We may be planning for a steady growth rate as
opposed to the booming, overnight success that venture capitalists tend to
gravitate toward. We may not be able to turn around as large of a profit as they
are looking for in quick enough time. We may not need the amount of money that
they offer or our business may simply not be big enough.

Simply put, venture capital is not the right fit for our business and there are
plenty of other options available when it comes to finding capital.

 Substitute in Early stage

Study Of Venture Capital In India Page No: 49

 o Angels

Most venture capital funds will not consider investing in anything under $1
million to $2 million. Angels, however, are wealthy individuals who will provide
capital for a startup business. These investors have usually earned their money as
entrepreneurs and business managers and can serve as a prime resource for
advice on top of capital. On the other hand, due to typically limited resources,
angels usually have a shorter investment horizon than venture capitalists and tend
to have less tolerance for losses.

o Private Placement

An investment bank or agent may be able to raise equity for our company by
placing our unregistered securities with accredited investors. However, you
should be aware that the fees and expenses associated with this practice are
generally higher than those that come with venture and angel investors. We will
likely receive little or no business counsel from private investors who also tend to
have little tolerance for losses and under-performance.

o Initial Public Offering

If we are somehow able to gain access to public equity markets than an initial
public offering (IPO) can be an effective way to raise capital. Keep in mind that,
while the public market’s high valuations, abundant capital and liquidity
characteristics make it attractive, the transaction costs are high and there are
ongoing legal expenses associated with public disclosure requirements.

 Later Stage Financing

o Bootstrap Financing

Study Of Venture Capital In India Page No: 50

This method is intended to develop a foundation for your business from scratch.
Financial management is essential to make this work. With bootstrap financing
you’re building a business from nothing, which means there is little to no margin
for error in the finance department. Keep a rigid account of all transactions and
don’t stray from your budget.

A few different methods of bootstrapping include:

Factoring, this generates cash flow through the sale of your accounts receivable
to a “factor” at discounted price for’s cash.

Trade Credit is an option if you are able to find a vendor or supplier that will
allow you to order goods on net 30, 60 or 90 day terms. If you can sell the goods
before the bill comes due then you have generated cash flow without spending
any money. Customers can pay you up front our services.

Leasing, your equipment instead of purchasing it outright.

o Fund from Operations

Look for ways to tweak your business in order to reduce the cash flowing out and
increase the cash flowing in. Funding found in business operations come free of
finance charges, can reduce future financing charges and can increase the value
of your business. Month-by-month operating and cash projections will show how
well we have planned, how you can optimize the elements of your business that
generate cash and allow you to plan for new investments and contingencies.

o Licensing

Study Of Venture Capital In India Page No: 51

Sell licenses to technology that is non-essential to our company or grant limited
licensing to essential technology that can be shared. Throughout licensing we can
generate revenue from up-front fees, access fees, royalties or milestone
payments.

o Vendor Financing

Similar to the trade credit related to bootstrap financing, vendors can play a big
role in financing your new business. Establish vendor relationships through our
trade association and strike deals to offer their product and pay for it at a date in
the near future. Selling the product in time is up to us. In hopes of keeping you as
a customer, vendors may also be willing to work out an arrangement if we need
to finance equipment or supplies. Just make sure to look for stability when you
research a vendor’s credentials and reputation before you sign any kind of
agreement. And keep in mind that many major suppliers (GE Small Business
Solutions, IBM Global Financing) own financial companies that can help you.

o Self Funding

Search between the couch cushions and in old jacket pockets for whatever extra
money you might have lying around and invest it into your business. Obviously
loose change will not be enough for extra business funding, but take a look at
your savings, investment portfolio, retirement funds and employee buyout
options from your previous employer. You won’t have to deal with any creditors
or interest and the return on your investment could be much higher.

However, make sure that you consider the risks involved with using your own
resources. How competitive is the market that you are about to enter into? How
long will it take to pay you back? Will you be able to pay yourself back? Can you
afford to lose everything that you are investing if your business were to fail? It’s

Study Of Venture Capital In India Page No: 52

important that your projected returns are more than enough to cover the risk that
you will be taking.

o SBIR and STTR Programs

Coordinated by the SBA, SBIR (Small Business Innovation Research) and STTR
(Small business Technology Transfer) programs offer competitive federal
funding awards to stimulate technological innovation and provide opportunities
for small businesses. You can learn more about these programs at
SBIRworld.com.

o State Funding

If you’re not having any luck finding funding from the federal government take a
look at what your state has to offer. There is a list of links to state development
agencies that offer an array of grants and financial assistance for small
businessessonsAbout.com..

o Community Banks

These smaller banks may have fewer products than their financial institution
counterparts but they offer a great opportunity to build banking relationships and
are generally more flexible with payment plans and interest rates.

o Microloans

These types of loans can range from hundreds of dollars to low six-figure
amounts. Although some lenders regard microloans to be a waste of time because
the amount is so low, these can be a real boon for a startup business or one that
just needs to add some extra cash flow.

o Finance Debt

Study Of Venture Capital In India Page No: 53

It may be more expensive in the long run than purchasing, but financing your
equipment, facilities and receivables can free up cash in the short term or reduce
the amount of money that you need to raise.

o Friends

Ask your friends if they have any extra money that they would like to invest.
Assure them that you will pay them back with interest or offer those stock
options or a share of the profits in return.

o Family

Maybe you have a rich uncle or a wealthy cousin that would be willing to lend
you some money get your business running or send it to the next level. Again,
make it worth their while by offering interest, stocks or a share of the profits.

o Form a Strategic Alliance

Aligning your business with a corporation can produce funding from upfront or
access fees to your service, milestone payments and royalties. In addition,
corporate partners may be able to provide research funding, loans and equity
investments.

o Sell Some Assets

Find an interested party to buy some of your assets (computers, equipment, real
estate, etc…) and then lease them back to you. This provides an instant source of
cash and you will still be able to use whatever assets you need.

o Business Lines of Credit

Study Of Venture Capital In India Page No: 54

 If your business has positive cash flow and has proven that it will cover its debts
then you may be eligible for a business line of credit. This type of financing is a
common service offered by most business banks and serves as business capital,
up to an agreed upon amount, that you can access at any time.

o Personal Credit Cards

Using personal credit cards to finance a business can be risky but, if you take the
right approach, they can also give your business a lift. You should only consider
using this type of financing for acquiring assets and working capital. Never
consider this to be a long-term option. Once your company breaks even or moves
into the black, ditch the credit cards and move toward traditional bank financing
or lease agreements.

o Business Credit Cards

Business credit cards carry similar risks as personal credit cards but tend to be a
safer alternative. While the activity on this card goes toward your credit report, a
business credit card can help you to build business credit, keep your business
expenses separate from your personal expenses and can make tax season easier to
manage.

 PLAYERS IN VENTURE CAPITAL INDUSTRY

Idea Established the Expansion Troubleshooting

company

Study
Business Small Capital
Of Venture Break In IndiaInvesting In IPO Page
Medium No: 55
Turnaround
concept Venture
Even-point Corporate venture
technology
Fund investors funds
Angle Big Venture Funds + Financial Funds
 Players in Venture Capital Industry

There are following group of players:

 Angels and angel clubs

 Venture capital funds
o Small
o Medium
o Large
 Corporate Venture funds
 Financial service venture groups

 Angels and angel clubs

Angels are wealthy individuals who invest directly into companies. They can
form angel clubs to coordinate and bundle their activities. Beside the money,
angels often provide their personal knowledge, experience and contacts to
support their investees. With average deals sizes from USD100, 000 to USD

Study Of Venture Capital In India Page No: 56

500,000 they finance companies in their early stages. Examples for angel clubs
are –Media Club, Dinner Club, and Angel’s forum

 Small and Upstart Capital Funds

These are smaller Venture Capital Companies that mostly provide seed and
startup capital. The so called “Boutique firms” are often specialized in certain
industries or market segments. Their capitalization is about USD 20 to USD 50
million (is this deals size or total money under management or money under
management per fund?). As for small and medium Venture capital funds strong
competition will clear the market place. There will be mergers and acquisitions
leading to a concentration of capital. Funds specialized in different business areas
will form strategic partnerships. Only the more successful funds will be able to
attract new money. Examples are:

o Artemis Comaford
o Abbell Venture Fund
o Acacia Venture Partners

 Medium Venture Funds

The medium venture funds finance all stages after seed and operate in all
business segments. They provide money for deals up to USD 250 million. Single
funds have up to USD 5 billion under management. An example is Accel Partners

 Large Venture Funds

As the medium funds, large funds operate in all business sectors and provide all
types of capital for companies after seed stage. They often operate internationally
and finance deals up to USD 500 million the large funds will try to improve their
position by mergers and acquisitions with other funds to improve size, reputation

Study Of Venture Capital In India Page No: 57

and their financial muscle. In addition they will to diversify. Possible areas to
enter are other financial services by means of M&As with financial services
corporations and the consulting business. For the latter one the funds have a rich
resource of expertise and contacts in house. In a declining market for their core
activity and with lots of tumbling companies out there is no reason why Venture
Capital funds should offer advice and consulting only to their investees.

Examples are:

o AIG American International Group

o Cap Vest man
o 3i

 Corporate Venture Funds

These Venture Capital funds are set up and owned by technology companies.
Their aim is to widen the parent company’s technology base in an win-win-
situation for both, the investor and the investee. In general, corporate funds invest
in growing or maturing companies, often when the investee wishes to make
additional investments in technology or product development. The average deals
size is between USD 2 million and USD 5 million. The large funds will try to
improve their position by mergers and acquisitions with other funds to improve
size, reputation and their financial muscle. In addition they will to diversify.
Possible areas to enter are other financial services by means of M&As with
financial services corporations and the consulting business. For the latter one the
funds have a rich resource of expertise and contents in house. In a declining
market for their core activity and with lots of tumbling companies out there is no
reason why Venture Capital funds should offer advice and consulting only to
their investees. Examples are:

Study Of Venture Capital In India Page No: 58

 o Oracle
o Adobe
o Dell
o Kyocera

As an example, Adobe systems launched a $40m venture fund in 1994 to invest

in companies strategic to its core business, such as Cascade Systems Inc and
lantana research Corporation-has been successfully boosting demand for its core
products, so that Adobe recently launched a second $40m fund.

 Financial Funds:

A solution for financial funds could be a shift to a higher securisation of Venture

Capital activities. That means that the parent companies shift the risk to their
customers by creating new products such as stakes in a Venture Capital fund.
However, the success of such products will depend on the overall climate and
expectations in the economy. As long as the sown turn continues without any
sign of recovery customers might prefer less risky alternatives.

Study Of Venture Capital In India Page No: 59

GLOBAL SCENARIO

OF VENTURE

CAPITAL INDUSTRY

Study Of Venture Capital In India Page No: 60

  OVERVIEW

The global economic downturn has many venture capitalists altering strategies,
including reducing investment levels in the short term, according to the 2009
Global Venture Capital Survey by Deloitte Touche Tohmatsu and the National
Venture Capital Association. Fifty-one percent of the survey respondents are
decreasing the number of companies in which they plan to invest and just 13
percent are increasing this activity.

The 2009 Global Venture Capital survey, which measured the opinions of more
than 750 venture capitalists worldwide, also shines headlights into the post-
recession landscape. The cleantech sector is poised to become the leading
investment category and the globalization of the venture capital industry will
intensify the latter posing significant competitive questions for the United States
and opportunities for emerging markets such as China.

“While the recession has slowed the pace of venture investing in the short term, it
may very well have expedited the global evolution of the industry in the long
run,” said Mark Jensen, national managing partner of Deloitte LLP’s Venture
Capital Services. “In recent years, many entrepreneurs who have been educated
in the United States have returned home to start companies in their home
countries. The playing field continues to level out in terms of new innovation hot
spots, broader access to capital and growing regional ecosystems that foster risk
taking and capital formation.”

 HISTORY & EVOLUTION

Prior to World War Two, the source of capital for entrepreneurs everywhere was
either the government, government-sponsored institutions meant to invest in such

Study Of Venture Capital In India Page No: 61

ventures, or informal investors (today, termed “angels’) that usually had some
prior relationship to the entrepreneur. In general, throughout history private
banks, quite reasonably, have been unwilling to lend money to a newly
established firm because of the high risk and lack of collateral. After World War
two, in the U.S. a set of intermediaries emerged who specialized in investing in
fledgling firms having the potential for extremely rapid growth.

Form its earliest beginnings on the U.S. East Coast, venture capital gradually
expanded and became an increasingly professionalized institution. During this
period, the locus of the venture capital industry shifted from New York and
Boston on the east Coast to Silicon Valley on the west coast. By the mid 1980s,
the ideal-typical venture capital firm was based in Silicon Valley and invested
largely in electronics with lesser sums devoted to biomedical technologies. Until
the present, in addition to Silicon Valley, the two other major concentrations have
been Boston and New York City.

In both Europe and Asia, there are significant concentrations of venture capital in
London, Israel, Hong Kong, Taiwan, and Tokyo. In the U.S., the government has
played a role in the development of venture capital, though, for the most part, it
was indirect. The indirect role, i.e., the general policies that also benefited the
development of the venture capital industry, was probably the most significant.
Some of the most important of these were;

 The U.S. government generally practiced sound monetary and fiscal

policies ensuring relatively low inflation with a stable financial
environment and currency.
 U.S. tax policy, though it evolved, has been favorable to capital gains,
and a number of decreases in capital gains taxes may have had some
positive effect on the availability of venture capital.

Study Of Venture Capital In India Page No: 62

  With the exception of a short period in the 1970s, U.S. pension funds
have been allowed to invest prudent amounts in venture capital funds.
 The NASDAQ stock market, which has been the exit strategy of choice
for venture capitalists, was strictly regulated and characterized by
increasing openness thus limiting investor’s fears of fraud and
deception.

This created a general macroeconomic environment of transparency and

predictability, reducing risk for investors. Put differently, environmental risks
stemming from government action were minimized- a shop contrast to most
developing nations.

Another important policy has been a willingness to invest heavily and

continuously in university research. This investment funded generations of
graduate students in the sciences and engineering. From this research has come
trained personal and innovations; U.S. universities particularly, MIT, Stanford,
and UC Berkeley played a particular salient role.

The most important direct U.S. government involvement in encouraging the

growth of venture capital was the passage of the small Business Investment Act
of 1958 authorizing the formation of Small Business Investment Corporations
(SBICs). This legislation created a vehicle for funding small firms of all types.
The legislation was complicated, but for the development of venture capital the
following features were most significant:

 It permitted individuals to from SBICs with private funds as paid-in capital

and then they could borrow money on a 2:1 ratio initially up to $300,000,
i.e., they could use up to $300,000 of SBA-guaranteed money for their
investment of $150,000 in private capital.

Study Of Venture Capital In India Page No: 63

  There were also tax and other benefits, such as income and a capital gains
pass through and the allowance of a carried interest as compensation.

The SBIC program becomes one that many other nations either learned from or
emulated. The SBIC program also provided a vehicle for banks to circumvent the
Depression-era laws prohibiting commercial allowed them to acquire equity in
small firms. This made even more capital available to fledgling firms, and was a
significant source of capital in the 1960s and 1970s. The final investment format
permitted SBICs to raise money in the public market. For the most part, these
public SBICs failed and/or were liquidate by the mid 1970s. After the mid 1970s,
with the exception of the bank SBICs, the SBIC program was no longer
significant for the venture capital industry.

The SBIC program experienced serious problems from its inception. One
problem was that as a government agency it was very bureaucratic having many
rules and regulations that were constantly changing. Despite the corruption,
something valuable also occurred. Namely, and especially, in Silicon Valley, a
number of individuals used their SBICs to leverage their personal capital, and
some were so successful that were able to reimburse the program and raise
institutional money to become formal venture capitalists. The SBIC program
accelerated their capital accumulation, and as important, government regulations
made these new venture capitalists professionalize their investment activity,
which had been informal prior to entering the program. Now-illustrious firms
such as Sutter hill ventures, Institutional Venture Partners, Bank of America
Ventures, and Menlo Ventures began as SBICs.

The historical record also indicates that government action can harm venture
capital. The most salient example came in 1973 when the U.S. Congress, in
response to widespread corruption in pension funds, changed Federal pension
fund regulations. In their haste to prohibit pension fund abuses, Congress passed

Study Of Venture Capital In India Page No: 64

the employment Retirement Income Security Act (ERISA) making pension fund
managers criminally liable for losses incurred in High-risk investments. This was
interpreted to include venture capital funds; as a result pension managers shunned
venture capital nearly destroying the entire industry.

This was only reversed after active lobbying by newly created National Venture
Capital Association (NVCA). In 1977, it succeeded in starting a gradual
loosening process that was completed in 1982. The new interpretation of these
pension fund guidelines contributed to first a trickle then a flood of new money
into venture capital funds. The most successful case of the export of Silicon
Valley- style venture capital practice is Israel where the government played an
impotent role in encouraging the growth of venture capital.

The government has a relatively good economic record; there is a minimum of

corruption, massive investment in military, particularly electronics research and
the excellent higher educational system. The importance of the relationships
between Israelis and Jewish individuals in U.S. high-technology industry and the
creation of the Israeli venture capital system should not be underestimated.

For example, the well-known U.S. venture capitalist, Fred Adler, began investing
in Israeli startups in the early 1970s, was involved in forming the first Israeli
venture capital fund. Still the creation of Israeli venture capital industry would
wait until the 1990s, when the government funded an organization Yozma, to
encourage venture capital in Israel.

Yozma received $100 million from the Israeli government. I invested $8 million
in ten funds that were required to raise another $12 million each from “a
significant foreign partner”, presumably an overseas venture capital firm. Yozma
also retained $20 million to invest itself. These “sibling” funds were the
backbone of a now vibrant community that invests in excess of $1 billion in

Study Of Venture Capital In India Page No: 65

Israel in 1999 (Pricewaterhouse 2000). In the U.S., venture capital emerged
through an organic trial-and-error process, and the role of the government was
limited and contradictory. In Israel the government played a vital role in a
supportive environment in which private-sector venture capital had already
emerged.

The role of government differs. In the U.S. the most important role of the
government in was indirect, in Israel it was largely positive in assisting the
growth of venture capital, in India the role of the government has had to be
proactive in removing barriers (Dossani and Kenney 2001).

In every nation, the state has played some role in the development of venture
capital. Venture capital is a very sensitive institutional from due to the high-risk
nature of its investments, so the state must be careful to ensure its policies do not
adversely affect its venture capitalists. Put differently, capricious governmental
action injects extra risk into the investment equation. However, judicious, well
planned government policies to create incentives for private sector involvement
have in the appropriate lead to the establishment of what becomes an independent
self-sustaining venture capital industry.

 CURRENT INDUSTRY TRENDS

 Round Class Distribution

The distribution of financing rounds by round class in mature markets is typically

30-40% in the early stage rounds, 20-25% in second round, and 35-40% in later
rounds. In emerging market like China, the round distribution is very different as
68% in early stage and 25% in second round. In mature countries, the
investments are made at early start up or product development phase.

Study Of Venture Capital In India Page No: 66

  Industry Shifts

It is perhaps no surprise that contraction is mostly concentrated in information

technology and the business, consumer and retail industries, give the huge
number of companies financed in the technology and Internet boom of 1999-
2000, and the subsequent down turn. The healthcare pool, driven by investment
in biopharmaceuticals and medical devices, has actually grown to some degree in
the different geographies. In United States, the healthcare pool has grown
consistently over the last several years, both in terms of number of companies
and cumulative dollars invested.

Key observations on the pool of private companies by industry:-

o The information and technology pool has declined by just 6% since 2002;
particularly due to increasing Interest in WEB 2.0 innovations.

o Since 2003, the cumulative investment has declined in similar amounts.

o The business, consumer and retail category has faced the steepest declines

across the board. In US the number had fallen 54% since 2002 and 54% in
Europe since 2003. In Israel; it dropped 67% since 2004.

o The number of healthcare companies has grown in U.S. since 2002 by 27%
and the capital risen 30% in last five years. Capital investment to the pool
of healthcare of companies dropped by 95 in Europe since 2003 and 9% in
Israel since 2004.

o Clean technology is a small but increasing element of the pool. There were
262 clean technology companies with a cumulative invested venture
capital of U.S. $38 billion in 2007.

Study Of Venture Capital In India Page No: 67

  Mega Trends

Several global mega trends will likely have an impact on venture capital in the
next decade:-

o Beyond the BRICs: - A new wave of fast growing economies is joining

the global growth leaders like Brazil, China, India And Russia. The
beginning of venture capital activity has been seen in others countries
such as Indonesia, Korea, Turkey and Vietnam.
o The new multinationals: - A new breed of global company is emerging

from developing countries and redefining industries through low-cost

advantage, modern infrastructure, and vast customer databases in their
home countries. These companies are potential acquirers of developed
market companies at all stages of growth.
o Globalization of capital: - Changes in economic and financial landscape

are creating significant regional shifts in IPO activity. These changes

have also sparked global consolidation alliances among stock
exchanges.
o Transformation of the CFO’s role and function: - With the globalization

and increasingly complex regulatory environment, CFOs have a wider

range of responsibilities and finance function has been transformed to
face broader mandates.
o Clean Technology: - Clean technology is poised to become the first

break through sector of 21st century. Encompassing energy, air and

water treatment, industrial efficiency improvements, new material and
waste management etc. are playing very vital role globally because of
which VC investors are enjoying rewards.

Study Of Venture Capital In India Page No: 68

  GROWTH OF VENTURE CAPITAL IN GLOBAL

Growth of venture capital in global

Clean technology venture investments in North America, Europe, China and

India totaled US$5.6 billion in 557 deals. However, as these figures are
preliminary, the firms expect the final figures could be up by as much as 10%.

"Utilities continue to bring their capital and access to credit to the cleantech
sector and are playing a key role in getting more projects off the ground. In 2009
we saw a surge in utility Power Purchase Agreement (PPA) announcements with
Solar Thermal and Solar PV accounting for 80% of the total PPAs, while Wind
saw increased capacity announcements in the second half of the year aided by the
Study Of Venture Capital In India Page No: 69
extension of the production tax credit," said Scott Smith, U.S. Clean Tech leader
for Deloitte. "Additional project financing came from large corporations whose
direct investments in cleantech increased by 14% in the second half of 2009
compared to the same period in 2008. Leading global utilities and non-utilities
are likely to continue to see cleantech projects as an attractive investment from an
economical and regulatory perspective."

Venture investment was down 33% in 2009, compared to US$8.5 billion in 2008,
yet investment in cleantech declined less than other sectors, despite the economic
recession.

The largest deal in all sectors was Solyndra’s US$198 million to expand its CIGS
thin film production. The company has since filed for an IPO.

 2009 GLOBAL VENTURE CAPITAL INDUSTRY

SURVEY

The 2009 Global Venture Capital Survey was sponsored by the Global Deloitte
Telecom, Media & Technology (DTT TMT) industry group, in conjunction with
the following venture capital associations throughout the world:
• Brazilian Association of Private Equity & Venture Capital (ABVCAP)
• British Private Equity & Venture Capital Association (BVCA)
• Canada’s Venture Capital & Private Equity Association (CVCA)
• European Private Equity & Venture Capital Association (EVCA)
• Emerging Markets Private Equity Association (EMPEA)
• Indian Venture Capital Association (IVCA)
• Israel Venture Association (IVA)
• Latin American Venture Capital Association (LAVCA)
• Malaysian Venture Capital and Private Equity Association (MVCA)

Study Of Venture Capital In India Page No: 70

 • National Venture Capital Association (NVCA)
• Singapore Venture Capital & Private Equity Association (SVCA)
• Taiwan Private Equity & Venture Capital Association (TVCA)
• Zero2IPO

The survey conducted with venture capitalists (VCs) in the Americas, Asia
pacific (AP), Europe and Israel. There were 725 responses from general partners
of venture capital firm with assets under management ranging from less than
$100 million to greater than $1 billion.

Multiple responses from the same firm were allowed, as the survey was a general
measurement of the state of global investing from all general partners, not
attitudes of specific firm. If respondents did not answer a question, the count for
the question was adjusted accordingly.

The highest number of respondents—35 percent—claimed assets under

management totaling between $100 million and $499 million. Another 34 percent
had managed assets that were less than $100 million, 17 percent had managed
assets greater than $1 billion, and 14 percent had between $500 million and $1
billion in assets under management.

Study Of Venture Capital In India Page No: 71

 40%

35%
35% Assets under Management
30%

25%

20% 18% 17%

16%
14%
15%

10%

5%

0%
$1-$49 million $50-$99 million $100-$499 million $500-$1 billion >$1 billion

Geographically, the breakdown of responses continues to be fairly representative of

both the size and location of firms in the venture capital industry around the world.
Forty-four percent of the respondents were from the United States, 21 percent from
European countries (excluding the UK), 16 percent from Asia Pacific countries, 10
percent from the Americas (excluding the U.S.), 7 percent from the UK, and 2 percent
from Israel.

Location of respondents
7%
16%
AP
Europe
Israel
21% The Americas
44%
U.S.
UK
10% 2%

Study Of Venture Capital In India Page No: 72

 Firm type
28%

Venture Capitl

Private Equity and

Venture Capital

72%

Seventy-two percent of the respondents had a primary investment focus on venture

capital while 28 percent were primarily focused on private equity and venture capital.
And, this year, 52 percent of venture capitalists noted that they are investing outside of
their home country.

Given the severity of the current global recession, this year's survey focused on issues
surrounding its impact on venture capitalists. The survey questions asked how the
global recession is affecting strategy; how future investments are being planned, both
by sector and region; what the anticipated size of the next fund will be and who VCs
think their limited partners will be. We also wanted to know what countries they
believe have the most to gain and lose in this new economy, as well as what they feel
the role of government should be in fostering innovation.

This year's report looks broadly at the results in a global context, but an appendix is
included that breaks out survey responses by geographic regions—the U.S., the
Americas (excluding the U.S.) Europe (excluding the UK), UK, AP and Israel. If you
are interested in responses of investors in a specific region, we encourage you to check
the appendix for those charts.

Study Of Venture Capital In India Page No: 73

  CURRENT STRATEGIES FOR NEW GLOBAL
ECONOMIC

"The perfect storm" has become the cliché of choice to sum up the global economic
recession of 2008-2009. Certainly, today's economic environment is dramatically
different than the venture capitalists were operating in five years ago when the first
Global Venture Capital Survey was launched. Five years ago, the venture capital
community was recovering from the tech bubble bursting and was just beginning to
see significant move towards the globalization of the venture capital industry.

Today, the economy is in a far different place. But, there are still signs of optimism.
VCs are more attuned to the global economy and we're seeing the maturation of some
sectors—specifically semiconductors and telecom—while other sectors—clean
technologies and life sciences—are emerging as areas with great growth potential.
With this shake up in the economy, we are seeing venture capitalists make adjustments
to their investment strategy in order to weather this storm and establish the foundation
to thrive in the future.

"It's been a difficult recession, but the industry is coping and making adjustments," said
Mark Jensen, U.S. national managing partner of Deloitte and Touche LLP's Venture
Capital Services. "They're moving forward and not sitting on their hands waiting for
something to happen."

In general, VCs are decreasing their overall investing dollars, focusing on their best
companies and increasing their alloca- tion to later-stage investments. "We have not
altered our fundamental strategic focus on early-stage health care investing in response
to the recession," explained Kevin Lalande, managing director of Sante Ventures. "That
said, new market realities and lingering uncertainty have factored prominently in our
decisions about which specific opportunities to pursue of those consistent with our
strategy. In the current environment, we are opting for fewer, more capital efficient

Study Of Venture Capital In India Page No: 74

deals in which the existing venture syndicate has enough reserve capacity to fund a
company, if necessary, all the way to cash flow independence."

Adjusting to a New Reality

In short, the tourists have left, explained Mark Heesen, president of the NVCA. "Young
entrepreneurs who thought they could get rich quickly with just a good idea are now
gone and those now left standing recognize the challenges and tenacity needed to
establish and build a sustainable business," he said. "Those out on the dustings trying to
get funded are much more astute about the globalization of the economy and
worldwide competition. They understand that the value of their company today is not
what it will be six months from now and that if they want to be funded, it will likely
be at a lower valuation than in the past."

Lower valuations could present opportunities for VCs looking for a good deal. But are
they spending? In fact, we see the larger firms eying a bigger slowdown than the
smaller firms. Just more than half of respondents from firms managing $500 million or
more are decreasing their level of investment, compared to about one in three of those
managing $99 million or less.

Study Of Venture Capital In India Page No: 75

 120%

100%
12% 13%
17% 21% 18%

80%

37% 36%
60% 42%
49%
47%

40%

51% 51%
20% 40%
34% 32%

0%
$1-$49 million $50-$99 million $100-$499 million $500-$1 Billion >$1 billion

increasinglevel of investment same level of investment Decreasin level of investment

Impact of the global recession on investment strategies-level of investment in

terms of capital (by asset under management)

However, the vast majority of firms are maintaining the same strategy when it comes to
industry sector. At least seven out of 10 VCs—and the percentage increases with the
size of the firm—plan to maintain the same strategy in terms of industry sector.

Study Of Venture Capital In India Page No: 76

 120%

100%
18% 18% 17%
27% 26%
80%

60%

40% 82% 82% 83%

73% 74%

20%

0%
$1-$49 MILLION $50-$99 MILLION $100-$499 MILLION $500-$1 BILLION >$1 BILLION

Changing strategy in terms of industry sector Column1

Impact of the global recession on investment strategies-industry sector (by assets

under management)

"Our firm is interested primarily in potentially great companies that already have some
revenue traction," said Patrick Sheehan, a partner with Environmental Technologies
Fund. "We're trying to find situations where we understand customer need, and it's
easier to do when there are existing customers. Our investing style hasn't changed with
the recession; it's become more appropriate."

What VCs are re-evaluating is the stage in which they're investing. Very few are
shifting to early-stage investing. Instead, about half are maintaining their current
strategy and a significant percentage are shifting their focus to later-stage and existing
portfolio companies. No doubt this is due to both the strain on the capital markets and
the fact that it's now taking longer for companies to be acquired and rare for them to go
public. Investing in later-stage companies shortens the VC's gestation period and
allows them to exit sooner.

Study Of Venture Capital In India Page No: 77

"In this environment, it pays to be either a very early-stage investor or a very late-stage
investor," said Steve Fredrick, general partner of Grotech Ventures. "The classic Series B
round, where a business is still finding its legs and remaining capital requirements are at
best an estimate, carries more risk given higher burn rates and the climate's uncertainty
around future financings. So, we're seeing reduced investment levels as firms either
invest smaller sums in very early-stage companies, or invest traditional sums in fewer
and much later-stage companies. The middle ground has been largely vacated."

Impact of the global recession on investment strategies-stage (by assets under

120%

100% 2%
5% 7% 4%
8%

80%

54%
57%
58% 65% 58%
60%

40%

20% 44%
39%
34% 35%
30%

0%
$1-$49 million $50-$99 million $100-$499 million $500-$1 Billion >$1 billion

Shifting Focus to later-stage companies and existing portfolio companies

Maintaining current strategy in term of stage
Shifting focus to early-stage companies

management)

Five years ago, when the first Global Venture Capital Survey was conducted, the

Study Of Venture Capital In India Page No: 78

results indicated some interest in clean technologies and the life sciences. This year,
regardless of fund size, we see tremendous interest from VCs in both of these sectors,
especially clean technologies, where more than six out of 10 respondents anticipate
their investment levels to increase and another three out of 10 will hold their
investments at the same level.

Telecommunication 15% 56% 29%

Semiconductors, Including electronics 6% 44% 50%

Software 22% 60% 18%

New media/social networking 26% 49% 25%

Biopharmaceuticals 24% 48% 28%

Medical device and equipment 37% 51% 12%

Clean technologies 63% 32% 6%

Consumer business 24% 51% 25%

0% 20% 40% 60% 80% 100% 120%

Increase Remain the same Decraese

In terms of total capital invested, anticipated level of investment change in select sectors, over
the next three years

Among U.S., UK and Israeli investors, about half expect to increase their investments
in cleantech, while about seven out of 10 AP respondents and European respondents
expect their cleantech investments to increase. Two-thirds of respond- dents from the
Americas plan to increase their cleantech investments. This interest could be because
we're seeing an increase in government/political support for cleantech and VCs are
looking more to government participation in both investments and incentives.

Study Of Venture Capital In India Page No: 79

 AP 73% 24% 3%

Europe 71% 24% 5%

Israel 50% 50%

the Americas 66% 28% 7%

US 55% 38% 7%

UK 50% 43% 7%

0% 20% 40% 60% 80% 100% 120%

Increase Remain the same Decrease

In term of total capital Investment, anticipated level of investment in clean

technologies, over the next three year (by location)

"Governments around the world are very supportive of creating a cleantech industry
with tax credits and incentives," said Heesen. "In the U.S., it's now seen as an energy
independence issue, a security issue and a jobs issue. And the public is more supportive
of cleantech activities as more people are cognizant of the threat of global warming."

But while this finding is significant, it's also important to note that with a couple of
exceptions where the sectors have significantly matured—semiconductors and
telecommunications—VCs expect their level of investment in other industries to
remain the same or increase.

Study Of Venture Capital In India Page No: 80

Eastern Exposure

Another trend that hasn't changed in the last five years is venture capitalists' interest in
China and India. Regardless of the size of the firm, investors are intrigued by the
investment possibilities of these two countries.

"We are lucky to be sitting at the hub of what we believe will be the most exciting
venture market in the coming years China," said Gavin Ni, founder, president and CEO
of Zero2IPO. "If you take a look at the short-term, you see China will be the first to
emerge out of the worldwide downturn. China is projecting 7 percent-plus GDP
growth in 2009—the highest in the world. Then, looking beyond, you see a swelling
middle class—but still a minority of the population—with money in their pockets to
spend. That does not even scratch the surface of the eventual buying power of the
largest population in the world—1.3 billion potential consumers."

Half of all respondents expect their investment levels to increase in Asia (excluding
India), while 43 percent expect to increase their investments in India over the next
three years. In 2007, 41 percent of respondents indicated an interest in expanding their
investment focus in Asia Pacific. About one-third expect to increase their investment
levels in South America. Only 17 percent expect to increase their investments in North
America, the same as 2007.

Compared to North America, the numbers were only slightly better for Europe and the
UK (25 percent) and Israel (19 percent). More than half of the respondents do intend to
maintain their investment levels in Europe, while 21 percent expect those levels to
decrease. This investment strategy is a change from 2007, when one-third of
respondents indicated that they were interested in expanding their investment focus in
Europe.

Study Of Venture Capital In India Page No: 81

 Asia(excl. India) 50% 38% 12%

Europe and the UK 25% 54% 21%

India 43% 47% 11% Increse

Israel 19% 62% 19% Remain the

same

Nortgh America 17% 60% 22%

Decrease

South America 36% 45% 19%

0% 20% 40% 60% 80% 100% 120%

In terms of total capital invested, anticipated level of investment change in select

regions, over the next three year

When it comes to interest in Asia and India, UK respondents are the most enthusiastic,
planning either to increase investment levels (67 percent and 58 percent, respectively)
or keep them at the same levels (33 percent and 42 percent, respectively). But, about
nine out of 10 U.S. VCs are also increasing or maintaining their investments in Asia
and India and about the same number of respondents from Asia Pacific have similar
plans.

Study Of Venture Capital In India Page No: 82

 AP 61% 29% 11%

Europe 52% 28% 20%

Israel 67% 33%

the Americas 46% 38% 15%

U.S 40% 50% 11%

UK 67% 33%

0% 20% 40% 60% 80% 100% 120%

Increase Remain the same Decrease

In terms of total capital invested anticipated level of investment change in Asia

Pacific (excl. India). Over the next three years (by location)

AP 57% 36% 7%

Europe(excl.UK) 38% 48% 14%

Israel 83% 17%

The Americas(excl.U.S) 46% 31% 23%

U.S 34% 55% 12%

UK 58% 42%

0% 20% 40% 60% 80% 100% 120%

Increase Remain the same Decrease

In terms of total capital invested, anticipated level of investment change in India,

over the next three year (by location)

In other words, noted Jensen, "Firms are now looking at the whole world in terms of
their investing priorities. The world has gone global in venture capital and the firms are
adapting their strategies accordingly."

David Chao, co-founder and general partner of DCM, agrees. "The lines between

Study Of Venture Capital In India Page No: 83

whether a company is American, Asian or European are blurring because by necessity
many start-ups today have multiple offices. Entrepreneurs can start companies
anywhere they want in the world and pick locations where conditions are favorable
and talent pools are available at reasonable prices."

That perspective is reinforced when you see that investment interest in North America
seems to be decreasing. Only 29 percent of VCs in the Americas (excluding the U.S.)
plan to increase their investments in North American countries while 37 percent expect
them to remain the same. Twenty-two percent of Israeli investors plan to increase their
North American investments while 33 percent expect investment levels to remain the
same. European investors (excluding the UK) are looking at a 16 percent increase and
half expect their investments to remain the same. Only 15 percent of Asia Pacific VCs
expect to increase their investment in North American countries while 40 percent
expect it to remain the same. In the UK, a mere 14 percent plan on increasing their
investments but 48 percent plan on keeping their levels the same. Even among U.S.
VCs, only 16 percent plan to increase their North American investing levels while 71
percent expect their investment levels to stay as they are.

AP 15% 40% 45%

Europe(excl.UK) 16% 50% 34%

Israel 22% 33% 44%

the Americas(excl.U.S) 29% 37% 33%

U.S 16% 71% 13%

UK 14% 48% 38%

0% 20% 40% 60% 80% 100% 120%

Increase Remain the same Decrease

In term of total capital Invested, anticipated level of investment change in North

America, over the three year (by location)

Study Of Venture Capital In India Page No: 84

Why is there so much interest in China and India? China and India are emerging
markets compared to North America, and the U.S. specifically, with great growth
potential. Also, the strained exit markets in the U.S. and the impact of recent
government policies appear to be discouraging investors from increasing their risk
exposure in North America.

AP 9% 29% 63%

Europe(excl.UK) 26% 64% 10%

Israel 57% 43%

the Americas (excl.U.S) 43% 14% 43%

U.S 28% 52% 20%

UK 22% 57% 20%

0% 20% 40% 60% 80% 100% 120%

Increase Remain the same Decrease

Venture capitalists anticipated level of investment in Europe and the UK, over
the next three years (by location)

At least a quarter of global VCs intend to increase their investments levels in Europe
and the UK. This is mainly driven by VCs in the Americas (excluding the U.S.), among
which 43 percent plan to invest more into Europe and the UK. However, another 43
percent of the VCs in that same area intend to reduce their investments in Europe and
the UK. The most positive forecast comes from U.S. players, among which 28% expect
to increase investments, while only 20% foresee a decrease. Israeli and Asia-Pacific
VCs show the least interest in Europe and the UK...

Fund Raising

Despite the fact that the world is struggling with a recession, VCs are remarkably
optimistic about their future funds. Most VCs believe that their next fund will be either
Study Of Venture Capital In India Page No: 85
larger than their existing fund or will be approximately the same size. And, that's
across the board, regardless of the size of the venture firm or where they're located.

Among those managing more than $1 billion, 24 percent project that their next fund
size will increase while almost half expect it to remain the same. Less than a third
anticipates a decrease. Those numbers are very close when it comes to those firms
managing $500 million to $1 billion. As the size of the firm grows smaller, the firms
grow more optimistic about the size of their next fund levels, with 60 percent of the
smallest—those managing $1 million to $49 million— anticipating their fund levels
will grow and another 28 percent stating that they'll remain the same.

120%

100%
12% 13% 19% 22% 28%
80%
28% 29%
33%
60%
51%
48%
40%
60% 58%
49%
20%
27% 24%
0%
$1-$49 million $50-$99 million $100-$499 million $500-$1 billion >$1 billion

Increase Remain the Same Decrease

Projected fund size compared to current fund (by assets under management)

The numbers are far more consistent when you look at this question regionally. Very
little decrease in fund size is projected across the board. And, those projecting increases
or stasis range from the Americas (excluding the U.S.) at 73 percent to the UK at 87
percent. The region anticipating the greatest increase in their next fund is Europe
(excluding the UK) at 55 percent. Europe (excluding the UK) (15 percent) and the UK
(13 percent) are the regions with the lowest expectations of decreased fund size in the

Study Of Venture Capital In India Page No: 86

future.

120%
100%
21% 15% 21% 18% 13%
27%
80%
30% 44%
60% 30% 23% 43%
43%
40%
49% 55% 50%
20% 36% 38% 43%
0%
AP Europe(excl.UK) Israel the Americas U.S UK
(excl.U.S)

Increase Remain the Same Decrease

Projected fund size compared to current fund (by location)

Where around the world is this money coming from? Over the next five years, the vast
number of respondents expects that the number of their limited partner investors
located outside their home country or region will remain the same or increase, again
regardless of the size of the firm or their home country. UK investors, at 97 percent,
appear to be the most eager to engage investors outside of their home country, but
even 92 percent of those VCs responding from Europe (excluding the UK) project
that the number of their limited partners located outside of their region will remain the
same or increase.

120%
100% 8% 9% 5% 4%
15% 14%
80% 32% 30% 43% 43%
31%
60%
64%
40%
54% 60% 61% 52% 54%
20%
21%
0%
AP Europe(excl.UK) Israel the Americas U.S UK
(excl.U.S)

Increase Remain the Same Decrease

Study Of Venture Capital In India Page No: 87

 Anticipated number of investors (limited partners) located outside the venture
capitalists home country /region, over the next five years (by location)

There is, however, a disconnection between the optimism these respondents expressed
and where the investment funds will actually come from. We asked venture capitalists
how the current economic crisis will affect the various types of limited partners'
willingness to invest over the next three years, and while they plan to increase the size
of their funds and level of investing, they nevertheless see their traditional investor base
—commercial banks, investment banks, corporate operating funds, insurance
companies and public pension funds—to be drying up.

"Limited partners were cutting their venture allocations and number of managers before
this economic period began. Like all good investors, they are tracking results and
culling their herd. While they may have taken more risks in years past to increase their
dollars or number of investments, no doubt the jury is starting to come in," explained
Ray Rothrock, managing general partner at Venrock. "However, venture is still
popular for LPs, if they can find the right groups. I would think they, like VCs seeking
great entrepreneurs everywhere, are seeking great VCs everywhere. It makes perfect
sense."

Among all respondents, 88 percent see commercial bank investors' willingness to invest
in venture capital over the next three years decreasing. Another 87 percent were just as
pessimistic over investment banks. About six out of 10 were not sanguine about
corporate operating funds, insurance companies, corporate venture capital, and
endowments decreasing as limited partners.

Intriguingly, venture capitalists are looking to governments as their financial partners.

More than half of VCs see an increase in governments as willing investment partners
with another fourth looking at an increase by family offices.

Study Of Venture Capital In India Page No: 88

 Commercial banks 4% 8% 88%

Investment banks 4% 8% 87%

Corporate operating funds 15% 22% 63%

Corporate venture capital 23% 29% 48%

Endowments 9% 32% 59%

Family offices 23% 31% 47%

Foundations 14% 30% 56%

Fund of funds 22% 38% 40%

governments 54% 21% 24%

Individuals and families 19% 24% 57%

Insurance companies 9% 26% 65%

Private pension funds 16% 33% 51%

Public pension funds 15% 30% 55%

0% 20% 40% 60% 80% 100% 120%

Increase Remain the Same Decrease

The current economic crisis will affect the following types of limited partners'
willingness to invest in the venture capital asset class, over the next three years

22% by corporate venture capital, followed by fund of funds. This is significant, given
a tradition of reliance on private capital in the United States. Six out of ten Asia Pacific
respondents also believe there will be an increase in activity on the part of
government. Among Israeli respondents, that number is almost half of respondents,
while two-thirds of those in the Americas (excluding the U.S.), Europe (excluding the
UK) and the UK see government investment increasing.

Of course, these questions were being answered at a very negative point in time
(February-March 2009), and with the financial challenges traditional investors are
facing, it's clear that the VC community is increasingly looking to the government for
assistance. But even so, it's unclear how they can assert that their funds will increase or

Study Of Venture Capital In India Page No: 89

remain the same when there are fewer limited partners and there's less capital available.

Winner is…

Apparently, among venture capitalists, there's China and there's everyone else. That was
clearly demonstrated in response to earlier questions about where VCs plan to increase
their investments.

It was further validated when VCs were asked directly which country has the most to
gain in overall stature over the next three years. Most respondents from around the
globe chose China either first or second on their lists.

"A question I frequently get is whether China's recent growth in venture investing is
sustainable. I would say, 'of course,'" said Zero2IPO president and CEO, Gavin Ni, "I
interact with China's entrepreneurs every day. There is a real drive to win, and there's no
stopping until the game is won. Others see the victory and want to win, too. And, the
rules of the game from China's government continue to drive strong business growth."

China was a clear favorite among U.S. investors with 42 percent of respondents
believing that the country has the most to gain. Only 24 percent held that conviction
for the U.S., followed by 12 percent for India, 5 percent for Brazil and 2 percent for
Russia. Among VC respondents from the Americas (excluding the U.S.), 35 percent
look to Brazil while 18 percent see China being a clear winner, followed by Canada at
16 percent, India at 14 percent and the U.S. trailing at 12 percent. Israeli respondents
selected the U.S. with 36 percent, followed by China (29 percent), Brazil and Israel (14
percent) and India (7 percent). More than half of Asia Pacific respondents were
enthusiastic about China, while 20 percent looked at India as having the most gain,
followed by Japan (6 percent), the U.S. (5 percent) and Afghanistan (4 percent).

Almost three out of 10 respondents from Europe (excluding the UK) see China as
having the most to gain. Sixteen percent saw that potential from India and the U.S.,

Study Of Venture Capital In India Page No: 90

followed by Brazil (7 percent) and France (6 percent). Finally, 35 percent of UK
respondents eyed China as the clear winner, with India following at 24 percent, the
U.S. at 9 percent and the United Arab Emirates at 6 percent.

China 42%

U.S 24%

India 12%

Brazil 5%

Russia 2%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Top five locations viewed as having the most to gain in terms of overall
economic stature, over the next three years (U.S. respondents)

Brazil 35%

China 18%

Canda 16%

India 14%

U.S 12%

0% 5% 10% 15% 20% 25% 30% 35% 40%

Top five locations viewed as having the most to gain in terms of overall
economic stature, over the next three years (the Americas (excl. U.S)
respondents)

On the opposite end of the spectrum, across the board the U.S. consistently was
perceived as having the most to lose in economic stature—even by more than half of

Study Of Venture Capital In India Page No: 91

U.S. respondents. This shouldn't be surprising, given that having created venture
capital; the U.S. has long had preeminent status. With the rest of the world looking at
the future of the industry and where people will be investing, there's no question among
any respondents that the U.S.'s elevated status cannot continue to be taken for granted,
particularly given this new economic environment and the entrepreneurial ecosystems
that are emerging around the world.

 CHINA, INDIA AND ISRAEL WILL BE MOST

ATTRACTIVE GROWTH OF VENTURE CAPITAL

While overall investment levels are expected to be lower, the KPMG survey
found that 2009 funding will be targeted toward key geographic regions and
industry segments. In addition, the KPMG survey found that venture investors do
not see the IPO market improving for at least a year, and only a small portion of
portfolios are poised for exit in 2009.

While overall investment levels are expected to be lower, the KPMG survey
found that 2009 funding will be targeted toward key geographic regions and
industry segments. Respondents indicated that China, India and Israel will be the
most attractive regions for venture capital, while cleantech, life sciences, mobile
and digital entertainment will remain the hot industries.

‘While overall funding will decrease, venture capitalists will continue to invest in
those areas they feel will provide the best return on investment,’ said Brian
Hughes, KPMG partner based in Philadelphia and co-leader of its venture capital
practice. ‘Not surprisingly, they continue to be bullish on emerging markets and
industry sectors, such as cleantech, that project near term growth.’

In polling 270 venture capitalists, corporate buyers and entrepreneurs, KPMG

found that 73 per cent of respondents expect their firm’s revenue to stay the same

Study Of Venture Capital In India Page No: 92

or increase in 2009. In fact, 52 per cent expect revenue growth to increase,
including 37 percent who predict revenue growth in excess of 10 percent. Only
26 per cent see declining revenues in the year ahead.

The outlook on sustained revenue growth is the silver lining to a tough year that
has seen the fewest venture capital portfolio companies go public since 1977. In
fact, the KPMG survey found that venture capitalists expect the negative IPO
trend to continue in 2009, with 88 per cent of respondents expecting IPO activity
to stay the same or to decline further. Additionally, 82 per cent of venture
capitalists surveyed indicated that they do not anticipate recovery in the IPO
market for at least 12 months. The outlook on IPO activity has clearly impacted
venture capital exit opportunities, and 80 per cent of respondents said less than
20 per cent of their portfolio is poised for exit in 2009.

The decline in IPO opportunities coupled with the expected, continued regression
in valuations of venture-backed companies, may influence the venture capital
community to see acquisitions as liquidity and exit opportunities. When asked
about valuation of venture backed companies, 84 per cent of respondents
predicted decreasing valuations, while only six percent see an increase. With
valuations declining, 58 percent of respondents see M&A increasing next year.

‘There is no question that economic and market conditions have made the current
environment difficult for venture capitalists,’ said Packy Kelly, KPMG partner
based in Silicon Valley and co-leader of its venture capital practice. ‘These
conditions may lead investment firms to focus on the health of existing portfolio
companies and slow the pace of investment. But the commercialization of
products in the clean tech sector probably contributes to a large degree to the
expected growth in revenue of emerging companies.

Study Of Venture Capital In India Page No: 93

According to the KPMG survey, the outlook on investment levels and deal
volume for 2009 mirrors the views on IPO activity. In fact, 74 per cent of
respondents expect overall venture investment to decrease and 82 per cent see a
decline in deal volume. While it is uncertain when venture investment will trend
back up, 50 per cent of venture capitalists surveyed do not expect that up-tick to
occur until the second half of 2009, while 32 per cent predict it will not happen
until 2010 or beyond. Only 18 per cent predict the turnaround in venture funding
will start in the first two quarters of 2009.

While overall investment levels are expected to be lower, the KPMG survey
found that 2009 funding will be targeted toward key geographic regions and
industry segments. Respondents indicated that China, India and Israel will be the
most attractive regions for venture capital, while clean tech, life sciences, mobile
and digital entertainment will remain the hot industries. ‘While overall funding
will decrease, venture capitalists will continue to invest in those areas they feel
will provide the best return on investment,’ said Brian Hughes, KPMG partner
based in Philadelphia and co-leader of its venture capital practice. ‘Not
surprisingly, they continue to be bullish on emerging markets and industry
sectors, such as cleantech, that project near term growth.”

Another indication of the current market conditions’ negative impact on the

venture community can be seen in attitudes toward start-up investing. Ninety-
seven per cent of venture capitalists surveyed said the credit crisis will have an
adverse effect on the availability of venture financing to start-up companies, and
73 per cent said it will be harder to get debt or lease financing.

Study Of Venture Capital In India Page No: 94

  PRIMARY REASONS FOR VENTURE CAPITAL
INVESTORS EXPANDING GLOBALLY

Among the primary reasons VCs around the world are interested in investing
globally is to take advantage of higher quality deal flow- particularly in the
United States, China, parts of Europe, and Israel. This is especially true for non-
U.S. firms. A second reason is the emergence of an entrepreneurial environment,
again and notably in China, but also India. Among U.S. firms, this latter rationale
is the most significant motivation for investing globally. Other motivators include
access to quality entrepreneurs, diversification of industry and geographic risk
and access to foreign markets.

40
34 global US non US
35
31
30 28

25 22
19
20 17
16 16
14 14
15 12 12 12 12
11
9
10
5 5 6
5 2 3

Primary reasons why investors expanding globally venture

Study Of Venture Capital In India Page No: 95

Above chart reveals that 19% U.S. respondents are expand globally for
generating high quality deal flow. And 31% believe that expand globally for
getting benefit of emergence of entrepreneurial environment. Whit 17%
respondents of non U.S are expanding globally for diversification of industry and
geographic risk. All respondents are least concerned about low cost of locations.

 INVESTING GLOBALLY BY INVESTING

LOCALLY

One way to build a comfort zone for global investing and to take advantage of
opportunities abroad is to invest locally in companies with operations outside their
home country, as opposed to investing directly in foreign countries. This year, there
was a significant increase in the number of respondents who indicated that a sizeable
number of their portfolio companies have a considerable amount of operations outside
the country in which they are headquartered.

A significant number, 88 percent of U.S. respondents and 82 percent of non-U.S.

respondents, indicated that at least some portion of their portfolio has significant
operations outside of the country of headquarters. Again, moderation is evident as
more than half of those indicated that less than 25 percent of their portfolio had
significant foreign operations. Nonetheless, these numbers have increased significantly
from prior years and reflect an increased trend in this method of investment.

Study Of Venture Capital In India Page No: 96

 35
32 32 32
30
30
25
25
21
20 18 18
17
15 15
15
12 12
9
10
5
5 3
2 2

0
0% 1-10% 11-25% 26-50% 51-75% 76-100%

Global U.S. Non- U.S.

Percentage of venture capital firms portfolio companies that give significant

operation outside the country

Globally and among U.S. respondents, China has become the primary choice for
relocating manufacturing operations, while India is the primary choice For R&D
operations. Engineering operations tend to land in India as well, but China is also a
popular location. For back office activities, again the choice is India. However, for
non-U.S. respondents, the United States is the primary choice for R&D and
engineering while European respondents preferred Central and Eastern Europe for
manufacturing R&D and Engineering.

One reason why this approach is taking off is that investors are concerned about
intellectual property and liquidity events and in general they feel a need to be closer to
top management. This also reflects a new reality from day one companies that reflect a
larger global entrepreneurial sector. This strategy allows the portfolio companies (and
investors) to take advantage of cost saving and access o talent in foreign markets while
protecting intellectual property. There are however concerns that such a trend could
result in the U.S. losing its R&D edge.

Study Of Venture Capital In India Page No: 97

  IMPEDIMENTS TO GLOBAL INVESTING

For all the benefits of overseas investing, VC firms encounter a variety of risks and
challenges abroad. Both U.S. firms and non-U.S. firms perceive the U.S as the country
where the cost of complying with regulation is too high. In fact, the percentage of non-
U.S. respondents who indicated this as a concern leaped from 28% last year to 41%
this year. Globally, 4% more, 44% saw this issue as a concern. 46% of U.S.
respondents believe the cost of complying with corporate governance is too high.

Top markets where the cost of complying with corporate governance regulation
too high

From the above chart we can see that most of the respondents believe that U.S. has
high cost of complying with Corporate Governance regulation and China, India, Israel
and Canada cost of complying with corporate governance regulation too high.

Study Of Venture Capital In India Page No: 98

 VENTURE
CAPITAL IN
INDIA

Study Of Venture Capital In India Page No: 99

  EVOLUTION OF VENTURE CAPITAL INDUSTRY
IN INDIA

The first major analysis on risk capital for India was reported in 1983. It
indicated that new companies often confront serious barriers to entry into capital
market for raising equity finance which undermines their future prospects of
expansion and diversification. It also indicated that on the whole there is a need
to review the equity cult among the masses by ensuring competitive return on
equity investment. This brought out the institutional inadequacies with respect to
the evolution of venture capital.

In India, the Industrial Finance Corporation of India (IFCO) initiated the idea of
Venture Capital when it established the Risk Capital Foundation in 1975 to
provide seed capital to small and risky projects. However the concept of venture
capital financing got statutory recognition for the first time in the fiscal budget
for the year 1986-87.

The venture Capital companies operating at present can be divided into four
groups:

 Promoted by All-India Development Financial Institutions

 Promoted by State Level Financial Institutions
 Promoted by Commercial Banks
 Private Venture Capitalists.

 Promoted by all India Development Financial Institutions

Study Of Venture Capital In India Page No: 100

The IDBI started a Venture Capital in 1976 as per the long term fiscal policy of
government of India, with an initial of Rs. 10 Cr. which raised by imposing a
chess of 5% on all payment made for the import of technology know-how
projects requiring funds from Rs.5 Lacks to Rs.2.5Cr. Were considered for
financing. Promoter’s contribution ranged from this fund was available at a
concessional interest rate of 9% (during gestation period) which could be
increased at later stages.

The ICICI provided the required impetus to Venture Capital activities in India,
1986 it started providing venture Capital finance in 1998 it promoted, along with
the Unit trust of India (UTI) Technology Development and information Company
of India (TDICI) as first venture Capital company registered under the companies
act, 1956. The TDICI may provide financial assistance to venture capital
undertaking which are set up by technocrat entrepreneurs, or technology
information and guidance services.

The risk capital foundation established by the industrial finance corporation of

India (IFCI) in 1975, was converted in 1988 into the Risk Capital and
Technology Finance Company (RCTC) as a subsidiary company of the IFCI the
rate provides assistance in the form of conventional loans, interest free
conditional loans on profit and risk sharing basis or equity participation in
extends financial support to high technology projects for technological up
gradations. The RCTC has been renamed as IFCI Venture Capital Funds Ltd.
(IVCF)

 Promoted by State Level Financial Institutions

In India, the State Level Financial Institutions in some states such as Madhya
Pradesh, Gujarat, Uttar prades, etc., have done an excellent job and have
provided venture capital to a small scale enterprise. Several successful

Study Of Venture Capital In India Page No: 101

entrepreneurs have been the beneficiaries of the liberal funding environment. In
1990, the Gujarat Industrial Investment Corporation, promoted the Gujarat
Venture Financial Ltd (GVFL) along with other promoters such as the IDBI, the
World Bank, etc., the GVFL provides financial assistance to business in the form
of equity, conditional loans or income notes for technologies development and
innovative products. It also provides finance assistance to entrepreneurs.

The government of Andhra Pradesh has also promoted the Andhra Pradesh
Industrial Development Corporation (APIDC) venture capital ltd. to provide
venture capital financing in Andhra Pradesh.

 Promoted by Commercial Banks

Canbank Venture Capital Fund, State bank Venture Capital Fund and Grindlays
bank Venture Capital Fund have been set up the respective commercial banks to
undertake venture capital activities.

The State bank Venture Capital funds provides financial assistance for bought out
deal as well as new companies in the form of equity which it disinvests after the
commercialization of the project.

Canbank Venture Capital Funds provides financial assistance for proven but yet
to be commercially exploited technologies. It provides assistance both in the form
of equity and conditional loans.

 Private venture Capital Funds

Several private sector venture capital funds have been established in India such as
the 20th Centure Venture Capital Company, Indus venture capital Funds,
Infrastructure Leasing and financial Services Ltd.

Some of the companies that have received funding through this route include:

Study Of Venture Capital In India Page No: 102

 o Mastek, one of the oldest software house in India

o Ruskan software, Pune based software consultancy

o SQL Star, Hyderabad based training and software development
consultancy
o Satyam Infoway, the first private ISP in India
o Hinditrom, makers of embedded software
o Selectia, provider of interaction software selectior
o Yantra, ITL Infosy’s US subsidiary, solution for supply chain management
o Rediff on the Net, India website featuring electronic shopping, news, chat
etc.

 OBJECTIVE AND VISION FOR VENTURE

CAPITAL IN INDIA

Venture capitalists finance innovation and ideas which have 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 financial as well as human 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 and
allows venture capitalists to 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 hand holding of
entrepreneurs by venture capitalists creates an environment particularly suitable
for knowledge and technology based enterprises.

Study Of Venture Capital In India Page No: 103

Scientific, technology 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 United States, is recognized for its globally competitive
high technology and human capital. India has the second largest English speaking
scientific and technical manpower in the world.

The Indian software sector crossed the Rs 100 billion mark turnover during 1998.
The sector grew 58% on a year to year basis and exports accounted for Rs 65.3
billion while the domestic market accounted for Rs 35.1 billion. Exports grew by
67% in rupee terms and 55% in US dollar terms. The strength of software
professionals grew by 14% in 1997 and has crossed 1, 60000. The global
software sector is expected to grow at 12% to 15% per annum for the next 5 to 7
years.

Recently, there has also been greater visibility of Indian companies in the US.

Given such vast potential not only in IT and software but also in the field of
service industries, biotechnology, telecommunications, media and entertainment,
medical and health services and other technology based manufacturing and
product development, venture capital industry can play a catalytic role to put
India on the world map as a success story.

 VENTURE CAPITAL INDUSTRY LIFE CYCLE IN

INDIA

Study Of Venture Capital In India Page No: 104

From the industry life cycle we can know in which stage venture capital are
standing. On the basis of this management can make future strategies of their
business.

Introduction Growth

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

The growth of venture capital in India has four separate phases:

 Phase I- formation of TDICI in 80’s and regional funds as GVFL &

APIDC in early 90s.

The first origin of modern venture capital in India can be traced to the setting up
of a technology Development Funds in the year 1987-88, though the levy of
access on all technology import payment. Technology development fund was
stated to provide financial support to innovative and high risk technological
programmers through the Industrial development bank of India.

The first phase was the initial phase in which the concept of venture capital got
wider acceptance. The first period did not really experience any substantial
growth of venture capitals. The 1980’s were marked by an increasing
disillusionment with the trajectory of the economic system and a belief that
liberalization was needed. The liberalization process started in 1985 in a limited

Study Of Venture Capital In India Page No: 105

way. The concept of venture capital received official recognition in 1988 with the
announcement of the venture capital guidelines.

During 1988 to 1992 about 9 venture capital institutions came up in India.

Though the venture capital funds should operate as open entities, Government of
India controlled them rigidly. One of the major forces that induced Government
of India to start venture funding was the World Bank. The initial funding has
been provided by World Bank. The most important feature of the 1988 rules was
that venture capital funds received the benefit of a relatively low capital gains tax
rate which was lower than the corporate rate. The 1988 guidelines stipulated
venture capital funding firms should meet the following criteria:

o Technology involved should be new, relatively untried, very closely held,

in the process of being taken from pilot to commercial stage or
incorporate some significant improvement over the existing ones in India.
o Promoters/entrepreneurs using the technology should be relatively new,
professionally or technically qualified, with inadequate resources to
finance the project.

Between 1988 and 1994 about 11venture capital funds became operational either
through reorganizing the business or through new entities.

All these followed the Government of India guidelines for venture capital
activities and have primarily supported technology oriented innovative business
started by first generation entrepreneurs. Most of these were operated more like a
financing operation. The main feature of this phase was that the concept got
accepted. Venture capitals become operational in India before the liberalization
process started. The context was not fully ripe for growth of venture capitals. Till
1995 the venture capital operated like any bank but provided funds without
collateral. The first stage of the venture capital industry in India was plagued by

Study Of Venture Capital In India Page No: 106

in experienced management, mandates to invest in certain states and sectors and
general regulatory problems. Many public issue by small and medium companies
have shown that the Indian investor is becoming increasingly wary of investing in
the projects of new and unknown promoters.

The liberation of the economy and toning up of the capital market changed the
economic landscape. The decisions relating to issue of stocks and shares was
handled by an office namely: Controller of capital issues (CCI). According to
1988 venture capital guideline, any organization requiring starting venture funds
have to forward an application to CCI. Subsequent to the liberalization of the
economy in 1991, the office of CCI was abolished in May 1992 and the powers
were vested in Securities and Exchange Board of India (SEBI). The Securities
and Exchange Board of India Act, 1992 empower SEBI under section 11(2)
thereof to register and regulate the working of venture capital funds. This was
done in 1996, through a government notification. The power to control venture
funds has been given to SEBI only in 1995 and the notification came out in 1996.
Till this time venture funds were dominated by Indian firms. The new regulations
became the harbinger of the second phase of the venture capital growth.

 Phase II- Entry of Foreign Venture Capital Funds (VCF) between 1995-
1999

The second phase of venture capital growth attracted many foreign institutional
investors. During this period overseas and private domestic venture capitalists
began investing in VCF. The new regulations in 1996 helped in this. Though the
changes proposed in 1996 had a salutary effect, the development of venture
capital continued to be inhibited because of the regulatory regime and restricted
the FDI environment. To facilitate the growth of venture funds, SEBI appointed a
committee to recommend the changes needed in the venture capital funding
context. This coincided with the IT boom as well as the success of Silicon Valley

Study Of Venture Capital In India Page No: 107

startups. In other words, venture capital growth and IT growth co-evolved in
India.

 Phase III-(2000 onwards)- Venture capital becomes risk averse and

activity declines:

Not surprisingly, the investing in India came “crashing down” when NASDAQ
lost 60% of its value during the second quarter of 2000 and public markets
(including those in India) also declined substantially. Consequently, during 2001-
2003, the venture capitals started investing less money and in money and in more
mature companies in an effort to minimize the risks. This decline broadly
continued until 2003.

 Phase IV- (2004 onward)- Global venture capitals firms actively investing
in India

Since India’s economy has been growing at 7%-8% a year, and since some
sectors, including the services sector and the high end manufacturing sector, have
been growing at 12%-14% a year investors renewed their interest and started
investing again in 2004 the number of deals and the total dollars invested in India
has been increasing substantially.

 GROWTH OF VENTURE CAPITAL IN INDIA

Study Of Venture Capital In India Page No: 108

 Growth of Venture Capital in India

The venture capital is growing 43% CAGR. However, in spite of the venture
capital scenario improving, several specific Venture Capital funds are setting up
shop in India, with the year 2007 having been a landmark year for venture capital
in India. The no of deals are increasing year by year. The no of deal in 2003 only
56 and now in 2007 it touch the 387 deals. The introduction stage of venture
capital industry in India is completed in 2003 after that growing stage of India
venture capital industry is starrted.

Tere are 160 venture capital firms/funds in India. In 2006 it is only but in 2007
the number of venture capital firms are 146. The reason is good position of
capital market. But in 2008 no of venture capital firms increase by only 14 the
reason is crashdown of capital market by 51%. The no of venture capital funds
are increasing year by year

2000 2001 2002 2003 2004 2005 2006 2007 2008

81 77 78 81 86 89 105 146 160

Study Of Venture Capital In India Page No: 109

 NO. OF VC FIRMS IN INDIA

180
160
160 146
S 140
M
IR 120 105
F
C 100 86 89
V 81 81
F 77 78
O 80
.
O 60
N
40
20
0
2000 2001 2002 2003 2004 2005 2006 2007 2008

YEARS

Venture capital growth and industrial clustering have a strong positive

correlation. Foreign diect investment, starting of R&D centres, availability of
venture capital and growth of entreneurial firms are getting concentrated into five
clusters. The cost of mnitoring and the cost of skill acquisition are lower in
clusters, especially for innovation. Entry costs are also lower in clusters. Cerating
enetrepreneursship and stimulating innovation in clusters have to become a major
concern of public policy makers. This is essential becouse only when the cultural
context is conductive for risk management venture capital will take-of. Clusters
support innovation and facilitates risk bearing. Venture capital prefer clusters
because the information costs are lower. Policies for promoting dispersion of
industries are becoming redundant after the economic liberalization.

The venture capital firm invest their money in most developning sectors like
health care, IT-ITes, Telecom, Bio-technology, Media & Entretainment, shipping
& ligistics etc.

Study Of Venture Capital In India Page No: 110

 Total investment

1284 988
685

1101
3979

1628

478
1638
615
1839

IT & ITES BFSI Healtcare & Lifesciences

Media& Entertinment Telecom Manufacturing
Eng & constrution Energy Shipping & Logistics
Others

Total sector wise venture capital investment

Now venture capital is nascent stage in India. Now due to growth of sector, the
venture capital industry is also growing. The top most players in the industries
are ICICI venture capital fund, IT&FS venture capital fund, Canbank.

 2009 VENTURE CAPITAL INVESTMENT IN INDIA

Venture Capital firms invested $475 million in 92 deals during 2009, down from
the $836 million invested across 153 deals in the previous year, according to a
study by Venture Intelligence and Global-India Venture Capital Association.

Venture capital firms, however, began to increase the pace of their investments in
Indian companies in the October-December quarter, making 42 investments

Study Of Venture Capital In India Page No: 111

worth $265 million, compared to 23 investments worth $102 million in the
comparative period a year earlier, the study said.

"The strong recovery in investment activity in the last quarter of 2009, as well the
rising interest among global investors towards emerging markets like India, is
quite encouraging for the growth of the sector," Sudhir Sethi, director of the
Global-India Venture Capital Association, said in a statement.

"During 2010, we expect significant follow-on investments into companies that

raised Series a round (first round) in the past two to three years as well as a rise in
exit activity as the global economic recovery gathers pace," he added.

The information technology and IT-enabled services industry retained its status
as the favorite among venture capital investors during 2009, but the industry's
share declined to about 43% of total investments from about 55% in 2008. Other
industries that attracted significant investor attention during the period included
financial services, healthcare and life sciences, and alternative energy. Within IT
and IT-enabled services, online services companies retained their status as the
favorite sector, accounting for about 39% of the investments during 2009.

Investmentin Area

10%
15%
50%

25%

South India (47%in the total value) Western India (29%in the total value)
North India (12% in the total value) East India (12%in the total value)

Study Of Venture Capital In India Page No: 112

Companies based in south India accounted for 50% of all venture capital
investments (47% by value) during 2009. Their peers in western India accounted
for 25% of the pie (29% by value) while companies in north India accounted for
15% of the investments (12% by value).

Among cities, companies headquartered in Bangalore and Mumbai were the

favorites among venture capital investors during 2009, with the former attracting
29 investments and the latter 15. The Delhi National Capital Region accounted
for 11 investments, followed by Hyderabad with 9 investments.

 NEED FOR GROWTH OF VENTURE CAPITAL IN

INDIA

People in developing countries are poor in part because they have far less capital
than people in industrial countries. Because of this shortage, workers have little
in the way of specialized machinery and equipment, and firms lack money to
obtain more equipment. As a result, productivity of workers in developing
countries is low compared with that of workers in industrial countries. Financial-
resource flows from industrial to developing countries are an obvious means to
overcome this inequality. But financial resources are not enough. Some
developing countries have natural resources such as oil or minerals that, when
sold on world markets, have provided large amounts of money. In many cases the
money has failed to stimulate sustained economic growth or increased
productivity and income for the average person. In part, failure to use capital
productively results from the way these resources flow. In some countries the
government gets the money, which it uses to perpetuate itself through military
spending or through increased consumption spending. In other cases, resources
flow to wealthy individuals who use them to maintain high levels of conspicuous
consumption.

Study Of Venture Capital In India Page No: 113

India is still developing country. In India, a revolution is ushering in a new
economy, wherein entrepreneurs mind set is taking a shift from risk adverse
business to investment in new ideas which involve high risk. The conventional
industrial finance in India is not of much help to these new emerging enterprises.
Therefore there is a need of financing mechanism that will fit with the
requirement of entrepreneurs and thus it needs venture capital industry to grow in
India.

Few reasons for which active Venture Capital Industry is important for India
include:

 Innovation: Needs risk capital in a largely regulated, conservation, legacy

financial system
 Job Creation: large pool of skilled graduates in the first and second tier
cities
 Patient capital: Not flighty, unlike FIIs
 Creating new Industry Clusters: Media, Retail, Call Centers and back
office processing, trickling down to organized effort of support services like
Office services, Catering, Transportation.

 REGULATORY AND LEGAL FRAMEWORK

At present, the Venture Capital activity in India comes under the purview of
different sets of regulations namely:

 The SEBI (Venture Capital Funds) Regulation, 1996[Regulations] lays

down the overall regulatory framework for registration and operations
of venture capital funds in India.
 The Indian Trust Act, 1882 or the company Act, 1956 depending on
whether the fund is set up as a trust or a company.

Study Of Venture Capital In India Page No: 114

  The foreign investment Promotion Board (FIPB) and the 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 proceed from VC funding activity. The
long term capital gain tax is at around 10% in India and the relevant
clauses to VC may be found in Section 10(sub section 23)
 Overseas venture capital investments are subject to the Government of
India Guidelines for Overseas Venture Capital Investment in India
dated September 20, 1995.
 For tax exemptions purposes venture capital funds also needs to comply
with the Income Tax Rules made under Section 10(23FA) of the
Income Tax Act.

 MAJOR REGULATORY FRAMEWORKS FOR

VENTURE CAPITAL INDUSTRY

VC & FVCI

SEBI RBI FIPB TAX

Study Of Venture Capital In India Page No: 115

 • SEBI (VCF) Reg. • FEMA, • FDI • IT Act, 1961
1996 1999 policy • DTAA
• SEBI(FVCI) • Transfer or issue • Investme  Singapore
Reg.2000 of security by a nt approvals  Mauritius
• SCR Act.1956 person resident • Press  Others
• SEBI(SAST) outside India Notes
Reg.1997 regulation 2000
• SEBI(DIP)Guidelines
,2000
• SEBI Act,1992

Major Regulatory frameworks for venture capital industry

In addition to the above, offshore funds also require FIPB/RBI approval for
investment in domestic funds as well as in Venture Capital Undertakings (VCU).
Domestic funds with offshore contributions also require RBI approval for the
pricing of securities to be purchased in VCU likewise, at the time of
disinvestment, RBI approval is required for the pricing of the securities.

Definition of venture capital fund: The Venture Capital Fund is now defined s
a fund established in the form of a Trust, a company including a body corporate
and registered with SEBI which:

 Has a dedicated pool of capital;

 Raised in the manner specified under the regulations; and
 To invest in venture capital undertaking in accordance with the regulation.

Definition of Venture Capital Undertaking: Venture Capital Undertaking

means a domestic company:-

 Whose share are not listed on a recognized stock exchange in India

 Which is engaged in business including such activities or sectors which are
specified in the negative list by the Board with the approval of the Central

Study Of Venture Capital In India Page No: 116

 Government by notification in the Official Gazette in this behalf? The
negative list includes real estate, non-banking financial services, gold
financing, activities not permitted under the Industrial Policy of the
Government of India.

Minimum contribution and fund size: the minimum investment in a Venture

Capital Fund from any investor will not be less than Rs.5 lacks and the minimum
corpus of the fund before the fund can start activities shall be at least Rs.5 corers.

Investment Criteria: The earlier investment criterion has been substituted by

new investment criteria which has the following requirements:

 Disclosure of investment strategy;

 Maximum investment in single venture capital undertaking not to exceed
25% of the corpus of the fund;
 Investment in the associated companies not permitted;
 At least 75% of the investible funds to be invested in unlisted equity shares
or equity linked instruments;
 Not more than 25% of the investible funds may be invested by way of;
o Subscription to initial public offer of a venture capital undertaking
whose shares are proposed to be listed subject to lack in period of
one year;
o Debt or debt instrument of a venture capital undertaking in which
the venture capital funds has already made an investment by way of
equity.

It has also been provided that Venture Capital Fund seeking to avail benefit under
the relevant provisions of the Income Tax Act will be required to divest from the
investment within a period of one year from the listing of the Venture Capital
Undertaking.

Study Of Venture Capital In India Page No: 117

Disclosure and Information to Investors: in order to simplify and expedite the
process of fund raising, the requirement of filing the Placement memorandum
with SEBI is dispensed with and instead the fund will be required to submit a
copy of Placement Memorandum/ copy of contribution agreement entered to with
the investors along with the details of the fund raiser for information to SEBI.
Further, the contents of the Placement Memorandum are strengthened to provide
adequate disclosure and information to investors. SEBI will also prescribe
suitable reporting requirement from the fund on their investment activity.

QIB status for Venture Capital funds: the venture capital funds will be eligible
to participate in the IPO through book building route as qualified Institutional
Buyer subject to compliance with the SEBI (Venture Capital Fund) Regulations.

Relaxation in Takeover Code: the acquisition of share by the company or any

of the promoters from the Venture Capital Funds under the terms of agreement
shall be treated on the same footing as that of acquisition of shares by
promoters/companies from the state level financial institutions and shall be
exempt from making an open offer to other shareholders.

Investment by Mutual Funds in Venture capital Funds: in order to increase

the resources for domestic venture capital funds, Mutual Funds are permitted to
invest up to 5% of its corpus in the case of open ended schemes and up to 10% of
its corpus in the case of close ended schemes. A part from raising the resources
for Venture Capital Funds this would provide an opportunity to small investors to
participate in venture capital activities through Mutual funds.

Government of India Guidelines: the Government of India (MOF) Guidelines

for Overseas Venture Capital Investment in India dated September20, 1995 will
be repealed by the MOF on notification of SEBI Venture Capital Fund
Regulations.

Study Of Venture Capital In India Page No: 118

The following will be the salient features of SEBI (foreign Venture Capital
Investors) Regulations, 2000:

Definition of Foreign Venture capital Investor: any entity incorporated and

established outside India and proposes to make investment in Venture Capital
Fund or Venture Capital Undertaking and registered with SEBI.

Eligibility Criteria: entity incorporated and established outside India in the form
of Investment Company, Trust, Partnership, Pension Fund, Mutual Fund,
University Fund, Endowment Fund, Asset Management Company, Investment
Manager, Investment Management Company or other Investment Vehicle
Incorporated outside India would be eligible for seeking registration from SEBI.
SEBI for the purpose of registration shall consider whether the applicant is
regulated by an appropriate foreign regulatory authority; or is income tax payer;
or submits a certificate from its banker of its or its promoters, track record where
the applicant is neither a regulated entity nor an income tax payer.

Investment Criteria:

 Disclosure of investment strategy;

 Maximum investment in single venture capital undertaking not to exceed
25% of the funds committed for investment to India however it can
invest its total fund committed in one venture capital fund;
 Atleast 75% of the investible funds to be invested in unlisted equity shares

or equity linked instruments.

 Not more than 25%of the investible funds may be invested by way of:
Study Of Venture Capital In India Page No: 119
 o Subscription to initial offer of a venture capital undertaking whose
shares are proposed to be listed subject to lock in period of one
year;
o Debt or debt instrument of a venture capital undertaking in which
the venture capital funds has already made an investment by way
of equity.

Hassle Free Entry and Exit: the Foreign Venture Capital Investors proposing to
make venture capital investment under the Regulations would be granted
registration by SEBI. SEBI Registered Foreign Venture Capital Investors shall be
permitted to make investment on an automatic route within the overall sectoral
ceiling of foreign investment under Annexure III of statement of Industrial Policy
without any approval from FIPB. Further, SEBI registered FVCIs shall be
granted a general permission from the exchange control angle for inflow and
outflow of funds and no prior approval of RBI would be required for pricing,
however, there would be export reporting requirement for the amount transacted.

Trading in Unlisted Equity: the board also approved the proposal to permit
OTCEI to develop a trading window for unlisted securities where Qualified
Institutional Buyers (QIB) would be permitted to participate.

 REGULATION OF THE BUSINESS OF VENTURE

CAPITAL FUND IN INDIA

 Eligibility conditions for grant of license to a venture capital fund.-

(1) A venture capital fund shall not be granted license unless it fulfills the
following conditions, namely:-

a) It is incorporated as a company under the Companies Ordinance, 1984

(XLVII of 1984);
Study Of Venture Capital In India Page No: 120
 b) It is not engaged in any business other than that of investment in venture
projects;
c) It has a minimum paid-up capital of fifty million rupees raised through
private placement; and
d) For the purpose of managing its entire business, it has entered into a
contract, in writing, with a venture capital company and a copy of which
has been filed with the Commission.

(2) The board of venture capital fund shall not have a director, who is on the
board of any venture project being financed by the fund.

 Condition for grant of license.-

(1) No venture capital fund shall commence business unless a license is granted
under these rules.

(2) For obtaining a license a venture capital fund shall

a. Make an application to the Commission on Form V providing

information as sought in Annex therein, along with all the relevant
documents;
b. Submit a bank draft payable to the Commission evidencing the
payment of non-refundable application processing fee amounting to
fifty thousand rupees; and
c. Submit an undertaking that no change in the memorandum and
articles of association and in the directors shall be made without
prior written authorization of the Commission and that all conditions
for grant of license shall be complied with.

Study Of Venture Capital In India Page No: 121

(3) On being satisfied that a venture capital fund is eligible for the grant of a
license and that it would be in the public interest so to do, the Commission may
grant a license in form VI.

(4) Without prejudice to any other conditions under these rules, the Commission
may while granting license imposes any conditions, as it may deem necessary.

 Terms and conditions of operation. - Unless granted a general or

specific waiver by the Commission, a venture capital fund shall

a. Not expose more than forty per cent of its equity to any single group
of companies; Explanation. - For the purposes of this rule group of
companies shall mean companies managed by the members of one
family including spouse, dependent lineal ascendants and
descendants and dependent brothers and sisters.
b. Disclose in its accounts all investments in companies and group of
companies exceeding ten per cent of paid-up capital of venture
capital fund;
c. ensure that the maximum exposure of the venture capital fund to its
directors, affiliated companies and companies in which any of the
directors and their family members including spouse, dependent
lineal ascendants and descendants and dependent brothers and sisters
hold controlling interest shall not exceed ten per cent of the overall
portfolio of venture capital; and
d. Not accept any investment from any investor, which is less than one
million rupees.

 Renewal of license. –

Study Of Venture Capital In India Page No: 122

(1) The license granted to the fund under rule 10 shall be valid for one year and
shall be renewable annually on payment of a fee of twenty thousand rupees on an
application being made on Form VII.

(2) The Commission may, after making such inquiry and after obtaining such
further information as it may consider necessary, renew the license of such fund,
one year on Form VIII on such conditions as it may deem necessary.

 Private placement.-

A venture capital fund shall raise and receive monies for investment in venture
projects through private placement of such securities as may be notified by the
Commission, from time to time.

 Placement memorandum.-

A venture capital fund shall, before soliciting placement of its securities, file with
the Commission a placement memorandum which shall inter alia give details of
the terms subject to which monies are proposed to be raised from such
placements.

 KEY SUCCESS FACTOR FOR VENTURE

CAPITAL INDUSTRY IN INDIA

Knowledge becomes the key factor for a competitive advantage for company.
Venture Capital firms need more expert knowledge in various fields. The various
key success factors for venture capital industry are as follow:

Study Of Venture Capital In India Page No: 123

  Knowledge about Govt. changing policies:

Investment, management and exit should provide flexibility to suit the business
requirements and should also be driven by global trends. Venture capital
investments have typically come from high net worth individuals who have risk
taking capacity. Since high risk is involved in venture financing, venture
investors globally seek investment and exit on very flexible terms which provides
them with certain levels of protection. Such exit should be possible through IPOs
and mergers/acquisitions on a global basis and not just within India. In this
context the judgment of the judiciary raising doubts on treatment of tax on capital
gains made by firms registered in Mauritius gains significance - changing
policies with a retrospective effect is undoubtedly acting as a dampener to fresh
fund raising by Venture capital firms.

 Quick Response time :

The companies have flat organization structure results in quicker decision

making. The entrepreneur is relieved of the trauma that one normally goes
through in an interface with a funding institution or a development agency. They
follow a clearly defined decision making process that works with clock like
precision, which means that if they agree on a funding schedule entrepreneur can
count on them to stick it.

 Knowledge about Global Environment

With increasing global integration and mobility of capital it is important that

Indian venture capital firms as well as venture financed enterprises be able to
have opportunities for investment abroad. This would not only enhance their

Study Of Venture Capital In India Page No: 124

ability to generate better returns but also add to their experience and expertise to
function successfully in a global environment.

 Good Human Resource :

Venture capital should become an institutionalized industry financed and

managed by successful entrepreneurs, professional and sophisticated investors.
Globally, venture capitalist are not merely finance providers but are also closely
involved with the investee enterprises and provide expertise by way of
management and marketing support. This industry has developed its own ethos
and culture. Venture capital has only one common aspect that cuts across
geography i.e. it is risk capital invested by experts in the field. It is important that
venture capital in India be allowed to develop via professional and institutional
management.

 Balance between three factors

Venture Capital backed companies can provide high returns. However, despite of
success stories like Apple, FedEx of Microsoft, a lot of these deals fail. It is said
that only one out of ten companies succeed. That's why every deal has an element
of potential profit and an element of risk, depending on the deals size. To be
successful, a Venture Capital Company must manage the balance between these
three factors.

Financial markets and

the industries to invest in

Study Of Venture Capital In India Page No: 125

Knowled
ge
Risk management skills Possible investees and
and contacts to investors external expertise

Frame work for key success factor

Knowledge is key, to get the balance in this "Magic Triangle". With knowledge
we mean knowledge about the financial markets and the industries to invest in,
risk management skills and contacts to investors, possible investees and external
expertise. High profits, achievable by larger deals, are not only important for the
financial performance of the Venture Capital Company. As a good track record
they are also a vital argument to attract funds which are the basis for larger deals.
However, larger deals imply higher risks of losses. Many Venture Capital
companies try to share and limit their risks. Solutions could be alliances and
careful portfolio management. There are Venture Capital firms that refuse to
invest in e-start-up because they perceive it as too risky to follow today's type.

 INDUSTRIAL ATTRACTIVENESS

Study Of Venture Capital In India Page No: 126

  Market growth rate

CAGROFVC
VALUE OF DEALS

16000 14234
14000
12000
10000
8000 43%
6000
4000
2000 1160
0
2000 2007

CAGR of venture capital industry

From the above graph we can say that Venture capital industry is growing at the
CAGR of 43%. And the value of deals in 2000 was 1160 which increased to
14234 in the year of 2007. This shows substantial increase in the number of
deals. This attracts the new entrepreneur to enter in the industry.

 Intensity of competition:
NO. OF VC FIRMS IN INDIA

180 160
160 146
140
120 105
100 86 89
81 77 78 81
80
60
40
M
O
IR
.N
S
FC
V

20
0
2000 2001 2002 2003 2004 2005 2006 2007 2008
YEARS

Number of venture capital firms in India

Here the number of venture capital firms is increasing year by year. In 2001 it is
only 77 now it has been increased to 160 in the year of 2008. The reason behind

Study Of Venture Capital In India Page No: 127

that is there is over all growth in the GDP and also substantial growth position in
sectors like biotechnology, IT-ES, retailing, telecom etc. due to this more players
are eager to establish their foothold in the industry.

 Regulatory policy

Minimum contribution and fund size: the minimum investment in a Venture

Capital Fund from any investor will not be less than Rs. 5 lacs and the minimum
corpus of the fund before the fund can start activities shall be at least Rs. 5 crores.
And the foreign players can easily enter in the venture capital industry of India.
An offshore venture capital company may contribute 100% of the capital of
domestic venture capital fund. There are other hurdles to enter in the industry so
there is favorable condition for them to enter in to venture capital industry in
India.

 DOMESTIC ECONOMIC FACTORS:

 GDP growth rate

GDP GROWTH RATE(%)

VC GROWTH RATE(%)

GDPV/SVCGROWTHRATE

12 300
251.06 9.4 9.6
10 8.5 240.91 250
7.5
8 200

6 150
4 89.79 100
2 33.33 50
0 0
2004 2005 2006 2007

GDPGROWTHRATE VCGROWTHRATE

GDP V/S VC Growth rate

In above chart there was a positive relationship there was between GDP growth
rates. But in 2007 the growth of Venture Capital was decline to 89.79% from

Study Of Venture Capital In India Page No: 128

240.91% in 2006 but here the value of deal was increasing. In 2008 the growth
rate is 9% and project the next year GDP 8% to 9%. So here we can conclude that
there is good growth prospect for the venture capital players to enter in the
horizon of India.

INFLATIONv/sVCGROWTHRATE

VC GROWTH RATE
INFLATION RATE

8 7.4 300

7
251.06 250
5.8
6 240.91
200
5 4.5

4 150
3.2
3
100
89.79
2
50
1 33.33
0 0
2004 2005 2006 2007

INFLATIONRATE VCGROWTHRATE

Inflation V/S Venture capital growth rate

In above chart the inflation rate is decreased to 4.5 in 2005 from 7.4 in 2004. At
same time the growth of Venture Capital is also declining to 33.33% in 2005
from 251.06% in 2004. From the above chart we can conclude that inflation and
Venture Capital has positive relationship. Now in June 2008 the inflation rate
was 11.9 and the NO. Of deal in first two quarter in 2008 was 170 and value of
deal was 6390 US$mn and in third quarter of 2008 there was only four deals.
And in October the inflation touch the 13.01%. Due to increase in inflation rate
the people will go to spend more. Thus, their savings will decrease. So more
money will come into the market and demand of the products will increase
continuously. Now due to growth of any sector will attract new entrepreneur to
enter in the industry. For that they must need funds. So there is a great
opportunity for venture capital industry to attract this new entrepreneur.

SMALL SCALE INDUSTRIES

Study Of Venture Capital In India Page No: 129
 SMALL SCALE ENTERPRIZE

130
125 128.44
120 123.42
115 118.59
110 113.95
109.49
105
h
k
(la
) n
its N
.fu
o

100
2002-2003 2003-2004 2004-2005 2005-2006 2006-2007

Growth of small and medium scale industries

Venture Capital, to be able to contribute to developing entrepreneurship in India,

needs to concentrate its investment in small and medium enterprises. A “Package
for Promotion of Micro and Small Enterprises” was announced in February 2007.
This includes measures addressing concerns of credit, fiscal support, cluster-
based development, infrastructure, technology, and marketing. Capacity building
of MSME Associations and support to women entrepreneurs are the other
important features of this package. SMEs have been allowed to manage their
direct/indirect exposure to foreign exchange risk by booking/canceling/rollover
of forward contracts without prior permission of RBI.

To boost the micro and small enterprise sector, the bank has decided to refinance
an amount of 7000 crore to the Small Industries Development Bank of India,
which will be available up to March 31, 2010. The Central Bank said that it is
also working on a similar refinance facility for the National Housing Bank
(NHB) of an amount of Rs 4, 000 crore.

 EXPORT AND IMPORT

Study Of Venture Capital In India Page No: 130

 VALUE OF EXPORT AND IMPORT
US dollars in billions

200 185.7 185.7

180
149.2 155.5
160
140 126.4
120 111.5
103.1
100 83.6
78.1
80 61.4 63.8
52.7
60
40
20
0
2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

EXPORT IMPORT

Value of export import

The value of Import and export are increasing year by year. In 2002-03 the value
of import and export are 52.7 and 61.4 US $bn respectively and in 2007-08 the
value of import and export are 155.7 and 185.7 US $bn. It means industry needs
more money for import and export. So it is an opportunity for venture capital. On
the other side when company going to export the company must have good
contact with other country’s company. So for that venture capital industry is
useful because they have good contact and affiliation network with other
country’s company.

Industry Profitability:

The venture capital firms invest their money in most emerging sectors like
biotechnology, IT-ES, retailing, infrastructure which gives higher return but also
they all involved risk in substantial amount.

Possible result of venture capital investments

No. of companies out of 10 Annual rate of

Study Of Venture Capital In India Page No: 131

 investments return
Failure 4 0%
Viable 3 15%
Solid 2 50%
Superstars 1 100%
Blended average 24.5

Success ratio of venture capital deals

From the above table we can see the success ratio of the venture capital
investment. 40% of the investments are getting failure and only 10% of them are
able to give 100% return. And the average return by the venture capitalists is only
24.5% which is not extra ordinary. This type of returns can be found in many
other investment options. So there isn’t any special reason to invest in venture
capital.

 Product innovation:

Venture capital firms are coming with new ideas of investment to attract the
buyers to their firms. For this purpose they are introducing new types of funds
and schemes.

For example, IFCI Venture Capital Funds Limited (IVCF) has launched three
new funds in emerging sectors of the economy namely:

i) India Automotive Component Manufacturers Private Equity Fund –1-Domestic

(IACM-1-D) with a target corpus of Euro 60 million equivalent to Rs.396 crores.
This Fund will be dedicated for investment mainly in Indian Automotive
Component companies and in other related/ emerging sectors.

ii) India Enterprise Development Fund (IEDF), a Venture Capital fund set up
with target corpus of Rs.250 crores to invest in knowledge based projects in key
sectors of Indian economy with outstanding growth prospects.

Study Of Venture Capital In India Page No: 132

iii) Green India Venture Fund (GIVF), a Venture Capital fund setup with a target
corpus of Euro 50 million (approx. Rs.330 crores) with the objective to invest in
commercially viable Clean Development Mechanism (CDM), energy efficient
and other commercially viable projects with an aim to reduce negative ecological
impact, efficient usage of resources such as energy, power etc and other related
sectors/projects. The summary of the Funds:

Launching of new funds by IFCI

Funds IACM –1 GIVF IEDF

Objective To invest in Indian The objective of To invest in
companies engaged GIVF would be to knowledge based
in, amongst others, theinvest in companies projects with
automotive parts and setting up Clean relatively high entry
components Development barriers, critical
manufacturing sector Mechanism (CDM) applications,
in order to generate projects and other prospects for high
high returns for its commercially viable growth and global
investors. projects/ business. scalability in
diversified and/ or
emerging sectors.
Size Euro 60 million (INR Euro 50 million INR 250 Cr
396 Cr) (INR 330 Cr) with
green shoe option
Nature of Fund PE Fund VC Fund VC Fund
Tenure 8 yrs. With two 10 years with two 10 years with two
prolongation option of prolongation options prolongation options
1 year each of 1 year each of 1 year each.
Expected returns 20% p.a. 20% p.a. 20% p.a.
Size of Rs. 6 to 40 Cr Rs. 2 to 30 Cr Rs. 2 to 25 Cr
investment
Management fee 2% of the total 2% of the total 2% of the total

Study Of Venture Capital In India Page No: 133

 subscription amount subscription amount subscription amount
Launching of new funds by IFCI

The SICOM venture capital firm introduce SME opportunity fund for small scale
industries.

 GUIDELINES FOR OVERSEAS VENTURE CAPITAL

INVESTMENT IN INDIA

In recognition of growing importance of Venture Capital as one of the sources of

finance for Indian industry, particularly for the smaller unlisted companies, the
Government has announced a policy governing the establishment of domestic
Venture Capital Funds/Companies. An amendment has also been carried out in
the SEBI Act empowering the Securities and Exchange Board of India (SEBI) to
register and regulate Venture Capital Funds (VCFs) and Venture Capital
Companies (VCCs) through specific regulations.

With a view to augment the availability of Venture Capital, the Government has
decided to allow overseas venture capital investments in India subject to suitable
guidelines as outlined below:

 Offshore investment may invest in approved domestic Venture Capital

Funds/Companies set up under the new policy after obtaining FIPB approval
for the investment. There is no limit to the extent of foreign contribution to a
domestic venture capital company/ fund. An offshore venture capital company
may contribute 100% of the capital of domestic venture capital fund, and may
also set up a domestic asset management company to manage the Fund.
 Establishment of an asset management company with foreign investment to
manage such funds would require FIPB approval and would be subject to the
existing norms for foreign investment in non-bank financial services
companies.
Study Of Venture Capital In India Page No: 134
 Once the initial FIPB approval has been obtained, the subsequent investment
b y the domestic venture capital company/fund in Indian companies will not
require FIPB approval. Such investments will be limited only by the general
restriction applicable to venture capital companies viz.-

o A minimum lock-in period of three years will apply to all such

investments.

o VCFs and VCCs shall invest only in unlisted companies and their
investment shall be limited to 40% of the paid up capital of the
company. The ceiling will be subject to relevant equity investment
limits that may be in force from time to time in relation to areas
reserved for the Small Scale Sector.
o Investment in any single company by a VCF/VCC shall not exceed
20% of the paid-up corpus of the domestic VCF/VCC.

 The tax exemption available to domestic VCFs and VCCs under Section
10(23F) of the Income Tax Act, 1961, will also be extended to domestic VCFs
and VCCs which attract overseas venture capital investments provided these
VCFs/VCCs conform to the guidelines applicable for domestic VCFs/VCCs.
However, if the VCF/VCC is willing to forego the tax exemptions available
under Section 10(23F) of the Income Tax Act, it would be within its rights to
invest in any sector.
 Income paid to offshore investors from Indian VCFs/VCCs will be subject to
tax as per the normal rates applicable to foreign investors.
 Offshore investors may also invest directly in the equity of unlisted Indian
companies without going through the route of a domestic VCF/VCC.
However, in such cases each investment will be treated as a separate act of
foreign investment and will require separate approval as required under the
general policy for foreign investment proposals.

Study Of Venture Capital In India Page No: 135

  CHALLENGES AHEAD FOR VENTURE CAPITAL
FINANCING IN INDIA

Venture Capital is money provided by professionals who invest and manage

young rapidly growing companies that have the potential to develop into
significant economic contributors. According to SEBI regulations, venture capital
fund means a fund established in the form of a company or trust, which raises
money through loans, donations, issue of securities or units and makes or
proposes, to make investments in accordance with these regulations. The funds so
collected are available for investment in potentially highly profitable enterprises
at a high risk of loss. A Venture Capitalist is an individual or a company who
provides. Investment Capital, Management Expertise, Networking & marketing
support while funding and running highly innovative & prospective areas of
products as well as services.

Thus, the investment made by Venture Capitalists generally involves –

o Financing new and rapidly growing companies.

o Purchasing equity securities.
o Taking higher risk in expectation of higher rewards.
o Having a long frame of time period, generally of more than 5 - 6 years.
o Actively working with the company's management to devise strategies
pertaining to the overall functioning of the project.
o Networking and marketing of the product /service being offered.

In an attempt to bring together highly influential Indians living across the United
States, a networking society named IND US Entrepreneurs or TiE was set up in

Study Of Venture Capital In India Page No: 136

1992. The aim was to get the Indian community together and to foster
entrepreneurs for wealth creation. A core group of 10 - 15 individuals worked
hard to establish the organization. The group (TiE) has now over 600 members
with 20 offices spread across the United States. Some of the famous personalities
belonging to this group are Vinod Dham (father of the Pentium Chip), Prabhu
Goel, and K.B. Chandrashekhar (Head of $ 200 mn. Exodus Communications, a
fibre optic network carrying 30% of all Internet content traffic hosting websites
like Yahoo, Hotmail and Amazon.)

 PROBLEMS OF VENTURE CAPITAL FINANCING

IN INDIA:

VCF is in its nascent stages in India. The emerging scenario of global

competitiveness has put an immense pressure on the industrial sector to improve
the quality level with minimization of cost of products by making use of latest
technological skills. The implication is to obtain adequate financing along with
the necessary hi-tech equipments to produce an innovative product which can
succeed and grow in the present market condition. Unfortunately, our country
lacks on both fronts. The necessary capital can be obtained from the venture
capital firms who expect an above average rate of return on the investment. The
financing firms expect a sound, experienced, mature and capable management
team of the company being financed. Since the innovative project involves a
higher risk, there is an expectation of higher returns from the project. The
payback period is also generally high (5 - 7 years). The various problems/ queries
can be outlined as follows:

o Requirement of an experienced management team.

o Requirement of an above average rate of return on investment.
o Longer payback period.

Study Of Venture Capital In India Page No: 137

 o Uncertainty regarding the success of the product in the market.
o Questions regarding the infrastructure details of production like plant
location, accessibility, relationship with the suppliers and creditors,
transportation facilities, labor availability etc.
o The category of potential customers and hence the packaging and pricing
details of the product.
o The size of the market.
o Major competitors and their market share.
o Skills and Training required and the cost of training.
o Financial considerations like return on capital employed (ROCE), cost of
the project, the Internal Rate of Return (IRR) of the project, total amount
of funds required, ratio of owners investment (personnel funds of the
entrepreneur), borrowed capital, mortgage loans etc. in the capital
employed.

 OPPORTUNITIES AND THREATS

 OPPORTUNITIES:

Initiatives taken by the Government in formulating policies to encourage

investors and entrepreneurs

The emerging scenario of global competitiveness has put an immense pressure on

the industrial sector to improve the quality level with minimization of cost of
products by making use of latest technological skills. The implication is to obtain
adequate financing along with the necessary hi-tech equipments to produce an
innovative product which can succeed and grow in the present market condition.
Unfortunately, our country lacks on both fronts. The necessary capital can be

Study Of Venture Capital In India Page No: 138

obtained from the venture capital firms who expect an above average rate of
return on the investment. Government of India understands this.

Also, The Government of India in an attempt to bring the nation at par and above
the developed nations has been promoting venture capital financing to new,
innovative concepts & ideas, liberalizing taxation norms providing tax incentives
to venture firms, giving an opportunity for the creation of local pools of capital
and holding training sessions for the emerging VC investors.

In the year 2000, the finance ministry announced the liberalization of tax
treatment for venture capital funds to promote them & to increase job creation.
This is expected to give a strong boost to the non resident Indians located in the
Silicon Valley and elsewhere to invest some of their capital, knowledge and
enterprise in these ventures.

o SME GROWTH

No. deals V/S No. of SMEs

450 128.44 130

400 387
123.42 125
350
299
300 120
118.59
250
115
200 113.95
146
150 109.49 110
100 71
56 105
50
0 100
2003 2004 2005 2006 2007

No. of deals No. of SMEs

VC, to be able to contribute to developing entrepreneurship in India, needs to

concentrate its investment in small and medium enterprises. A “Package for
Promotion of Micro and Small Enterprises” was announced in February 2007.

Study Of Venture Capital In India Page No: 139

This includes measures addressing concerns of credit, fiscal support, cluster-
based development, infrastructure, technology, and marketing. Capacity building
of MSME Associations and support to women entrepreneurs are the other
important features of this package. SMEs have been allowed to manage their
direct/indirect exposure to foreign exchange risk by booking/canceling/rollover
of forward contracts without prior permission of RBI.

To boost the micro and small enterprise sector, the bank has decided to refinance
an amount of 7000 crore to the Small Industries Development Bank of India,
which will be available up to March 31, 2010. The Central Bank said that it is
also working on a similar refinance facility for the National Housing Bank
(NHB) of an amount of Rs 4, 000 crore.

The Indian economy is growing at 8-9% so the there is a development of all

sector like manufacturing, services sector. So there is a great opportunities for
Venture Capital firms. Because mostly invest their money in this sectors.

India amongst leading entrepreneurial Hotbeds globally

City competencies emerging

o Bangalore

 All IP-led companies; IT and IT-enabled services

o Delhi (NCR)

 Software services, IT enabled services, Telecom

o Mumbai

 Software services, IT enabled services, Media, Computer Graphics,

Animation, Banking
Study Of Venture Capital In India Page No: 140
 o Other emerging Centers

 Chennai, Hyderabad, and Pune

Emerging sectors for investments

As the venture industry continues to accelerate, a number of trends that cross

geographies can be seen. The industry is becoming even more globalized .As a
result, innovation in clean tech, IT, and healthcare, pharmaceutical are having a
global impact. This changing landscape is driving new approaches in how large
corporations are interacting with the venture community.

Clean technology

Global climate changes, high oil prices, accelerated growth in emerging markets,
energy security concerns and the finite nature of resources are some of the key
drivers of the growing global demand for clean technologies in energy and water.
In addition ,the increased willingness of consumers and governments to pay for
and use green technologies ,combined with the positive exit environment of the
last years ,has provided venture capitalists with the confidence to invest in
emerging companies around the globe.

According to the research from Dow Jones Venture One and Ernst &Young .US
$1.28 billion was invested in 140financing rounds in 2006 in China , Europe
Israel and United States that compares to US $ 664.1 million invested in 103
financing rounds in 2005,showing the capital investment in the field has nearly
doubled over the past year. It is expected that investment in clean technologies
will continue to increase not only in developed markets but also in the developing
markets, mainly in India and China.

Study Of Venture Capital In India Page No: 141

Biotechnology

Over last few years ,the story of the US biotech industry has been one of the
remarkable success .There are signs that this success story is now repeated in
other parts of world ,with maturing pipelines, record breaking financing totals,
strong deal activity and impressive financial results. Industry is grew 31% for
second year in raw in 2007.

Pharmaceutical

The industry's growth rate is likely to touch 19 per cent from the current 13 per
cent, according to a projection released by the Confederation of Indian Industries
(CII), on September 1, 2008.

According to a McKinsey study, the Indian pharmaceutical industry is projected

to grow to US$ 25 billion by 2010 whereas the domestic market is likely to more
than triple to US$ 20 billion by 2015 from the current US$ 6 billion to become
one of the leading pharmaceutical markets in the next decade.

The Indian pharmaceutical industry has shown robust growth in terms of

infrastructure development, technology base creation and a wide range of
products with a determination to flourish in the rapidly changing environment,
thereby establishing its global presence. The Indian pharmaceutical industry has
increased its competitive intensity owing to pricing pressures and striving
consistently to innovate. ICICI Venture-controlled Ranbaxy Fine Chemicals
(RFCL) has acquired the US-based specialty chemicals major Mallinckrodt
Baker in a deal estimated at US$ 340 million.

Study Of Venture Capital In India Page No: 142

So there is great opportunity for venture capital industry to invest their money in
this sector. Nowadays, India will become a global pharmacy hub exporting by
exporting domestically produced generic products.

IT/IT-ES Industry

The Department of Information Technology is setting up Nano Electronic

Centers at the Indian Institute of Technology, Mumbai and the Indian Institute of
Science, Bangalore. With an outlay of about Rs. 100 crore to carry out R&D
activities in nano-electronics devices and materials.

In 2006-07, the performance of the Information Technology Enabled Services–

Business Process Outsourcing (ITES-BPO) industry was marked by double-digit
revenue growth, steady expansion into newer service lines and increased
geographic penetration and an unprecedented rise in investments by multinational
corporations (MNCs).

The Special Incentive Package Scheme (SIPS) to encourage investments for

setting up semiconductor fabrication and other micro- and nano-technology
manufacturing industries was announced in March2007. The incentives
admissible would be 20 per cent of the capital expenditure during the first 10
years for units located in Special Economic Zones (SEZs) and 25 per cent for
units located outside SEZs.

Electronic Industry

There is a high growth of software and solutions related to the consumer Internet,
software as a service (SAAS), open source, software-cum-services and
telecommunications (both wireless and wire-line) products and related services.
There is a great opportunity for venture capital industry to invest in this
electronic production industry.

Study Of Venture Capital In India Page No: 143

  Threats:

Venture Capital Market in India Getting Overheated

The Venture Capital market in India seems to be getting as hot as the country’s
famous summers. However, this potential over-exuberance may lead to some
stormy days ahead, based on sobering research compiled by global research and
analytics services firm, Evalueserve. Evalueserve research shows an interesting
phenomenon is beginning to emerge:

Over 44 US-based Venture capital firms are now seeking to invest heavily in
start-ups and early-stage companies in India. These firms have raised, or are in
the process of raising, an average of US $100 million each. Indeed, if these 40-
plus firms are successful in raising money, they would garner approximately $4.4
billion to be invested during the next 4 to 5 years. Taking Indian Purchasing
Power Parity (PPP) into consideration, this would be equivalent to $22 billion
worth of investment in the US. Since about $1.75 billion (or approximately 40%
of $4.4 billion) has been already raised, even if only $2.2 billion is raised by
December 2006, Evalueserve cautions that there will be a glut of Venture Capital
money for early stage investments in India. This will be especially true if the VCs
continue to invest only in currently favorite sectors such as IT, BPO, software
and hardware products, telecom, and consumer Internet. Given that a typical
start-up in India would require $9 million during the first three years (i.e., $3
million per year) and even assuming that the start-up survives for three years,
investing $2.2 billion during 2007-2010 would imply investing in 150 to 180

Study Of Venture Capital In India Page No: 144

start-ups every year during this period, which simply does not seem practical if
the VCs continue to focus only on their current favorite sectors.

Unproductive workforce:

A global survey by McKinsey & Company revealed that Indian business leaders
are much more optimistic about the future than their international peers. So
Indian employees are tardy in their job so it will effect reversely on the economic
condition of the country. Because they are unproductive to the economy of the
country.

Exit route barriers:

Due to crash down of market by 51% from January to November 2008. It creates
a problem for venture capital firms. Because nobody is trying to come up with
IPO and IPO is the exits route door Venture Capital.

Taxes on emerging sector:

As per Union Budget 2007 and its broad guidelines, Government proposed to
limit pass-through status to venture capital funds (VCFs) making investment in
nine areas. These nine areas are biotechnology, information technology,
nanotechnology, seed research and development, R&D for pharmacy sectors,
dairy industry, poultry industry and production of bio-fuels. Pass-through status
means that the incomes earned by funds are taxable now.

Study Of Venture Capital In India Page No: 145

 RECOMMENDATIONS:
 Multiplicity of regulations – need for harmonization
and nodal Regulator:

Presently there are three set of Regulations dealing with venture capital activity
i.e. SEBI (Venture Capital Regulations) 1996, Guidelines for Overseas Venture
Capital Investments issued by Department of Economic Affairs in the MOF in
the year 1995 and CBDT Guidelines for Venture Capital Companies in 1995
which was modified in 1999. The need is to consolidate and substitute all these
with one single regulation of SEBI to provide for uniformity, hassle free single
window clearance. There is already a pattern available in this regard; the mutual
funds have only one set of regulations and once a mutual fund is registered with
SEBI, the tax exemption by CBDT and inflow of funds from abroad is available
automatically. Similarly, in the case of FIIs, tax benefits and foreign
inflows/outflows are automatically available once these entities are registered
with SEBI. Therefore, SEBI should be the nodal regulator for VCFs to provide
uniform, hassle free, single window regulatory framework. On the pattern of FIIs,
Foreign Venture Capital Investors (FVCIs) also need to be registered with SEBI.

Study Of Venture Capital In India Page No: 146

Tax passes through for Venture Capital Funds:

VCFs are a dedicated pool of capital and therefore operate in fiscal neutrality and
are treated as pass through vehicles. In any case, the investors of VCFs are
subjected to tax. Similarly, the investee companies pay taxes on their earnings.
There is a well established successful precedent in the case of Mutual Funds
which once registered with SEBI are automatically entitled to tax exemption at
pool level. It is an established principle that taxation should be only at one level
and therefore taxation at the level of VCFs as well as investors amount to double
taxation. Since like mutual funds VCF is also a pool of capital of investors, it
needs to be treated as a tax pass through. Once registered with SEBI, it should be
entitled to automatic tax pass through at the pool level while maintaining taxation
at the investor level without any other requirement under Income Tax Act.

 Mobilization of Global and Domestic resources:

 Foreign Venture Capital Investors (FVCIs):

Presently, FIIs registered with SEBI can freely invest and disinvest without
taking FIPB/RBI approvals. This has brought positive investments of more than
US $10 billion. At present, foreign venture capital investors can make direct
investment in venture capital undertakings or through a domestic venture capital
fund by taking FIPB / RBI approvals. This investment being long term and in
the nature of risk finance for start-up enterprises, needs to be encouraged.
Therefore, at least on par with FIIs, FVCIs should be registered with SEBI and
having once registered, they should have the same facility of hassle free
investments and disinvestments without any requirement for approval from
FIPB / RBI. This is in line with the present policy of automatic approvals
followed by the Government. Further, generally foreign investors invest through
the Mauritius-route and do not pay tax in India under a tax treaty. FVCIs

Study Of Venture Capital In India Page No: 147

therefore should be provided tax exemption. This provision will put all FVCIs,
whether investing through the Mauritius route or not, on the same footing. This
will help the development of a vibrant India-based venture capital industry with
the advantage of best international practices, thus enabling a jump-starting of the
process of innovation. The hassle free entry of such FVCIs on the pattern of FIIs
is even more necessary because of the following factors:

o Venture capital is a high risk area. In out of 10 projects, 8 either fail or

yield negligible returns. It is therefore in the interest of the country that
FVCIs bear such a risk.
o For venture capital activity, high capitalization of venture capital
companies is essential to withstand the losses in 80% of the projects. In
India, we do not have such strong companies.
o The FVCIs are also more experienced in providing the needed managerial
expertise and other supports.

 Augmenting the Domestic Pool of Resources:

The present pool of funds available for venture capital is very limited and is
predominantly contributed by foreign funds to the extent of 80 percent. The pool
of domestic venture capital needs to be augmented by increasing the list of
sophisticated institutional investors permitted to invest in venture capital funds.
This should include banks, mutual funds and insurance companies’ up to
prudential limits. Later, as expertise grows and the venture capital industry
matures, other institutional investors, such as pension funds, should also be
permitted. The venture capital funding is high-risk investment and should be
restricted to sophisticated investors. However, investing in venture capital funds
can be a valuable return-enhancing tool for such investors while the increase in

Study Of Venture Capital In India Page No: 148

risk at the portfolio level would be minimal. Internationally, over 50% of
venture capital comes from pension funds, banks, mutual funds, insurance funds
and charitable institutions.

 Flexibility in Investment and Exit:

 Allowing multiple flexible structures:

Eligibility for registration as venture capital funds should be neutral to firm

structure. The government should consider creating new structures, such as
limited partnerships, limited liability partnerships and limited liability
corporations. At present, venture capital funds can be structured as trusts or
companies in order to be eligible for registration with SEBI. Internationally,
limited partnerships, Limited Liability Partnership and limited liability
corporations have provided the necessary flexibility in risk-sharing,
compensation arrangements amongst investors and tax pass through. Therefore,
these structures are commonly used and widely accepted globally specially in
USA. Hence, it is necessary to provide for alternative eligible structures.

 Flexibility in the matter of investment ceiling and sectoral restrictions:

70% of a venture capital fund’s investible funds must be invested in unlisted

equity or equity-linked instruments, while the rest may be invested in other
instruments. Though sectoral restrictions for investment by VCFs are not
consistent with the very concept of venture funding, certain restrictions could be
put by specifying a negative list which could include areas such as finance
Study Of Venture Capital In India Page No: 149
companies, real estate, gold-finance, activities not legally permitted and any other
sectors which could be notified by SEBI in consultation with the Government.
Investments by VCFs in associated companies should also not be permitted.
Further, not more than 25% of a fund’s corpus may be invested in a single firm.
The investment ceiling has been recommended in order to increase focus on
equity or equity-linked instruments of unlisted startup companies. As the
venture capital industry matures, investors in venture capital funds will set their
own prudential restrictions.

 Changes in buy back requirements for unlisted securities:

A venture capital fund incorporated as a company/ venture capital undertaking

should be allowed to buy back up to 100% of its paid up capital out of the sale
proceeds of investments and assets and not necessarily out of its free reserves and
share premium account or proceeds of fresh issue. Such purchases will be exempt
from the SEBI takeover code. A venture-financed undertaking will be allowed
to make an issue of capital within 6 months of buying back its own shares instead
of 24 months as at present. Further, negotiated deals may be permitted in unlisted
securities where one of the parties to the transaction is VCF.

 Relaxation in IPO norms:

The IPO norms of 3 year track record or the project being funded by the banks or
financial institutions should be relaxed to include the companies funded by the
registered VCFs also. The issuer company may float IPO without having three
years track record if the project cost to the extent of 10% is funded by the
registered VCF. Venture capital holding however shall be subject to lock in
period of one year. Further, when shares are acquired by VCF in a preferential
allotment after listing or as part of firm allotment in an IPO, the same shall be
subject to lock in for a period of one year. Those companies which are funded by

Study Of Venture Capital In India Page No: 150

Venture capitalists and their securities are listed on the stock exchanges outside
the country; these companies should be permitted to list their shares on the Indian
stock exchanges.

Relaxation in Takeover Code:

The venture capital fund while exercising its call or put option as per the terms of
agreement should be exempt from applicability of takeover code and 1969
circular under section 16 of SC(R) A issued by the Government of India.

Issue of Shares with Differential Right with regard to voting and dividend:

In order to facilitate investment by VCF in new enterprises, the Companies Act

may be amended so as to permit issue of shares by unlisted public companies
with a differential right in regard to voting and dividend. Such flexibility already
exists under the Indian Companies Act in the case of private companies which
are not subsidiaries of public limited companies.

QIB Market for unlisted securities:

A market for trading in unlisted securities by QIBs is developed.

NOC Requirement:

In the case of transfer of securities by FVCI to any other person, the RBI
requirement of obtaining NOC from joint venture partner or other shareholders
should be dispensed with.

RBI Pricing Norms:

At present, investment/disinvestment by FVCI is subject to approval of pricing

by RBI which curtails operational flexibility and needs to be dispensed with.

Study Of Venture Capital In India Page No: 151

  Global integration and opportunities:

 Incentives for Employees:

The limits for overseas investment by Indian Resident Employees under the
Employee Stock Option Scheme in a foreign company should be raised from
present ceilings of US$10,000 over 5 years, and US$50,000 over 5 years for
employees of software companies in their ADRs/GDRs, to a common ceiling of
US$100,000 over 5 years. Foreign employees of an Indian company may invest
in the Indian company to a ceiling of US$100,000 over 5 years.

 Incentives for Shareholders:

The shareholders of an Indian company that has venture capital funding and is
desirous of swapping its shares with that of a foreign company should be
permitted to do so. Similarly, if an Indian company having venture funding and
is desirous of issuing an ADR/GDR, venture capital shareholders (holding
saleable stock) of the domestic company and desirous of disinvesting their shares
through the ADR/GDR should be permitted to do so. Internationally, 70% of
successful startups are acquired through a stock-swap transaction rather than
being purchased for cash or going public through an IPO. Such flexibility
should be available for Indian startups as well. Similarly, shareholders can take
advantage of the higher valuations in overseas markets while divesting their
holdings.

 Global investment opportunity for Domestic Venture Capital Funds

(DVCF):

DVCFs should be permitted to invest higher of 25% of the fund’s corpus or US

$10 million or to the extent of foreign contribution in the fund’s corpus in
unlisted equity or equity-linked investments of a foreign company. Such

Study Of Venture Capital In India Page No: 152

investments will fall within the overall ceiling of 70% of the fund’s corpus. This
will allow DVCFs to invest in synergistic startups offshore and also provide them
with global management exposure.

 Infrastructure and R&D :

Infrastructure development needs to be prioritized using government support and

private management of capital through programmers similar to the Small
Business Investment Companies in the United States, promoting incubators and
increasing university and research laboratory linkages with venture-financed
startup firms. This would spur technological innovation and faster conversion of
research into commercial products.

 Self Regulatory Organization (SRO):

A strong SRO should be encouraged for evolution of standard practices, code of

conduct, creating awareness by dissemination of information about the industry.
Implementation of these recommendations would lead to creation of an enabling
regulatory and institutional environment to facilitate faster growth of venture
capital industry in the country. Apart from increasing the domestic pool of
venture capital, around US$ 10 billion are expected to be brought in by offshore
investors over 3/5 years on conservative estimates. This would in turn lead to
increase in the value of products and services adding up to US$100 billion to
GDP by 2005. Venture supported enterprises would convert into quality IPOs
providing over all benefit and protection to the investors. Additionally, judging
from the global experience, this will result into substantial and sustainable
employment generation of around 3 million jobs in skilled sector alone over next
five years. Spin off effect of such activity would create other support services and
further employment. This can put India on a path of rapid economic growth and
a position of strength in global economy.

Study Of Venture Capital In India Page No: 153

Study Of Venture Capital In India Page No: 154
 CONCLUSION
The study provides that the maturity if the still nascent Indian Venture Capital
market is imminent.

Venture Capitalists in Indian have notice of newer avenues and regions to

expand. VCs have moved beyond IT service but are cautious in exploring the
right business model, for finding opportunities that generate better returns for
their investors.

In terms of impediments to expansion, few concerning factors to VCs include;

unfavorable political and regulatory environment compared to other countries,
difficulty in achieving successful exists and administrative delays in
documentation and approval.

In spite of few non attracting factors, Indian opportunities are no doubt promising
which is evident by the large number of new entrants in past years as well in
coming days. Nonetheless the market is challenging for successful investment.

Therefore Venture capitalists responses are upbeat about the attractiveness of the
India as a place to do the business.

Study Of Venture Capital In India Page No: 155

Study Of Venture Capital In India Page No: 156
 BIBLIOGRAPHY

 BOOKS:

 Taneja Satish, “Venture Capital in India”.

 Chary T Satyanarayana, “Venture Capital – Concepts & Applications ”

 MAGAZINE:

 Sharma Kapil, an Analysis of Venture Capital Industry in India.

 REPORT:

 Trends of Venture Capital in India, survey Report by Deloitte, 2009.

Study Of Venture Capital In India Page No: 157

  Global Trends of Venture Capital, survey report by Deloitte, 2009.
 Economic survey 2008-09,

 WEBSITE:

 www.ivca.org
 www.indiavca.org.
 www.vcindia.com
 www.ventureintelligence.in
 www.nvca.org
 www.economictimes.indiatimes.com
 www.100ventures.com
 www.google.com
 www.deloitte.com

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