Venture Capital

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Chapter – 1

INTRODUCTION TO VENTURE CAPITAL FUNDS

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INT

INTRODU

RODUCTIO

CTION

N to

to Vent

Venture

ure Capit

Capital

al

1.1 VENTURE CAPITAL

Sm

Smalall l busbusininessesses es nevnever er seeseem m to to havhave e enoenough ugh momoneyney. . BaBankenkers rs and and SuSupplpplieiers,rs, naturally, are important in financing small business growth through loans and credit, naturally, are important in financing small business growth through loans and credit, but

but an an equally equally important important source source of of long long term.term.Growth CapitalGrowth Capital is the venture capitalis the venture capital firm. Venture Capital financing may have an extra bonus, for if a small firm has an firm. Venture Capital financing may have an extra bonus, for if a small firm has an adequate equity base; banks are more willing to extend credit.

adequate equity base; banks are more willing to extend credit.

Ventu

Venture re capicapitaltal is is momoneney y prprovovidided ed by by prprofofesessisiononalals s whwho o ininvevest st alalonongsgsididee management in young, rapidly growing companies that have the potential to develop management in young, rapidly growing companies that have the potential to develop into

into signsignificificant ant econeconomiomic c contcontribuributortors. s. VentVenture ure capicapital tal is is an an impimportaortant nt soursource ce of of equity for start-up companies.

equity for start-up companies.

Venture capital is capital typically provided by outside investors for financing of new, Venture capital is capital typically provided by outside investors for financing of new, growing or struggling businesses. Venture capital investments generally are high growing or struggling businesses. Venture capital investments generally are high risk risk investments but offer the potential for above average returns and/or a percentage of investments but offer the potential for above average returns and/or a percentage of owne

ownershirship p of the of the comcompanypany. . A A ventventure capitaure capitalist (VC) is list (VC) is a a persperson who on who makemakes s suchsuch in

inveveststmementnts. s. A A veventnturure e cacapipitatal l fufund nd is is a a popoololed ed ininveveststmement nt vevehihiclcle e (o(oftften en aa partnership)

partnership) that that primarily primarily invests invests the the financial financial capital capital of of third-party third-party investors investors inin enterprises that are too risky for the standard capital markets or bank loans.

enterprises that are too risky for the standard capital markets or bank loans.

The term ‘Venture Capital’ is understood in many ways. In a narrow sense, it refers The term ‘Venture Capital’ is understood in many ways. In a narrow sense, it refers to, investment in new and tried enterprises that are lacking a stable record of growth. to, investment in new and tried enterprises that are lacking a stable record of growth. In a broader sense,

In a broader sense,ventureventure capitalcapitalrefers to the commitment of refers to the commitment of capitalcapitalasas

shareholding, for the formulation and setting up of small firms specializing in new shareholding, for the formulation and setting up of small firms specializing in new ideas or new technologies. It is not merely an injection of

ideas or new technologies. It is not merely an injection of fundsfundsinto a new firm, it isinto a new firm, it is a simultaneous input of skill needed to set up the firm, design its marketing strategy a simultaneous input of skill needed to set up the firm, design its marketing strategy and organize and manage it. It is an association with successive stages of firm’s and organize and manage it. It is an association with successive stages of firm’s development with distinctive types of financing appropriate to each stage of development with distinctive types of financing appropriate to each stage of development.

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According to International Finance Corporation (IFC), venture capital is equity or According to International Finance Corporation (IFC), venture capital is equity or equ

equitity y feafeatutured red cacapipital tal seeseekiking ng invinvestestmement nt in in new new idideaseas, , new new comcompanpanieies, s, newnew production,

production, new new process process or or new new services services that that offer offer the the potential potential of of high high returns returns onon investments.

investments. As

As defidefined ned in in RegRegulatulation ion 2(m2(m)of )of SEBSEBI I (Ve(Venturnture e CapCapitaital l FunFunds) ds) RegRegulatulation ion , , 19961996 "venture capital fund means a fund established in the form of a company or trust "venture capital fund means a fund established in the form of a company or trust which raises monies through loans, donations issue of securities or units as the case which raises monies through loans, donations issue of securities or units as the case ma

may y be, be, anand d mamakekes s or or prpropooposes ses to to mamake ke invinvestestmementnts s in in acaccorcordandance ce wiwith th ththeseese regulations.

regulations.

Thus venture capital is the capital invested in young, rapidly growing or changing Thus venture capital is the capital invested in young, rapidly growing or changing companies that have the potential for high growth. The VC may also invest in a firm companies that have the potential for high growth. The VC may also invest in a firm that is unable to raise finance through the conventional means.

that is unable to raise finance through the conventional means.

Professionally managed venture capital firms generally are private partnerships or Professionally managed venture capital firms generally are private partnerships or closely-held corporations funded by private and public pension funds, endowment closely-held corporations funded by private and public pension funds, endowment fund

funds, s, founfoundatdationsions, , corcorporaporatiotions, ns, wealwealthy thy indiindividuviduals, als, foreforeign ign inveinvestorstors, s, and and thethe venture capitalists themselves.

venture capitalists themselves. Venture capitalists generally: Venture capitalists generally:

•

• Finance new and rapidly growing companies;Finance new and rapidly growing companies; •

• Purchase equity securities;Purchase equity securities; •

• Assist in the development of new products or services;Assist in the development of new products or services; •

• Add value to the company through active participation;Add value to the company through active participation; •

• Take higher risks with the expectation of higher rewards;Take higher risks with the expectation of higher rewards; •

• Have a long-term orientationHave a long-term orientation

When considering an investment, venture capitalists carefully screen the technical and When considering an investment, venture capitalists carefully screen the technical and business

business merits merits of of the the proposed proposed company. company. Venture Venture capitalists capitalists only only invest invest in in a a smallsmall percentage

percentage of of the the businesses businesses they they review review and and have have a a long-term long-term perspective. perspective. GoingGoing forward, they actively work with the company's management by contributing their forward, they actively work with the company's management by contributing their experience and business savvy gained from helping other companies with similar experience and business savvy gained from helping other companies with similar growth challenges.

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Venture capitali

Venture capitalists mitigate the risk sts mitigate the risk of venture investing by of venture investing by developideveloping a ng a portfoliportfolio of o of young companies in a

young companies in a single venture fund. Many times they will co-invest with other single venture fund. Many times they will co-invest with other professional

professional venture venture capital capital firms. In firms. In addition, addition, many vmany venture parenture partnership tnership will managewill manage multiple funds simultaneously. For decades, venture capitalists have nurtured the multiple funds simultaneously. For decades, venture capitalists have nurtured the growth of America's high technology and entrepreneurial communities resulting in growth of America's high technology and entrepreneurial communities resulting in sig

signinifificancant t job job crecreatationion, , ececonoonomimic c grogrowtwth h and and intinterernatnatioional nal cocompmpetietititivenvenesess.s. Companies such as Digital Equipment Corporation, Apple, Federal Express, Compaq, Companies such as Digital Equipment Corporation, Apple, Federal Express, Compaq, Sun

Sun MiMicrcrosyosyststemems, s, IntIntelel, , MiMicrcrosoosoftft, , YaYahoohoo, , AiAirtrtel el and and GenGenententecech h arare e fafamomousus examples of companies that received venture capital early in their development.

examples of companies that received venture capital early in their development.

Venture Capital is the business of establishing an investment fund in the form of Venture Capital is the business of establishing an investment fund in the form of equ

equitity y fifinannancincing g vivia a ininvesvestmtmentents s in in ththe e cocommmmon on stostockscks, , prprefeeferrerred d stostockcks s andand convertible debentures of various companies. These companies are seen to have a convertible debentures of various companies. These companies are seen to have a high growth potential and are able to be listed on the stock exchange in order to gain high growth potential and are able to be listed on the stock exchange in order to gain the highest returns in dividends and capital gain.

the highest returns in dividends and capital gain.

1.2 The Origin of Venture Capital

In the 1920's & 30's, the wealthy families of and individuals investors provided the In the 1920's & 30's, the wealthy families of and individuals investors provided the start up money for companies that would later become famous. Eastern Airlines and start up money for companies that would later become famous. Eastern Airlines and Xerox are the more famous ventures they financed. Among the early VC funds set up Xerox are the more famous ventures they financed. Among the early VC funds set up was the one

was the one by the Rockfeller Family which started a special fund called VENROCK by the Rockfeller Family which started a special fund called VENROCK in 1950, to finance new technology companies.

in 1950, to finance new technology companies. USA is the birth place of

USA is the birth place of Venture CapitVenture Capital Industry as we al Industry as we know it today. During mostknow it today. During most its historical evolution, the market for arranging such financing was fairly informal, its historical evolution, the market for arranging such financing was fairly informal, relying primarily on the resources of wealthy families.

relying primarily on the resources of wealthy families.

In 1946, American Research and Development Corporation (ARD), a publicly traded, In 1946, American Research and Development Corporation (ARD), a publicly traded, closed-end investment company was formed. ARD's best known investment was the closed-end investment company was formed. ARD's best known investment was the start-up financing it provided in 1958 for computer maker Digital Equipment Corp. start-up financing it provided in 1958 for computer maker Digital Equipment Corp. ARD was eventually profitable, providing its original investors with a 15.8 percent ARD was eventually profitable, providing its original investors with a 15.8 percent annual rate of return over its twenty-five years as an independent firm. General annual rate of return over its twenty-five years as an independent firm. General Doriot, a professor at Harvard Business School, set up the ARD, the first firm, as Doriot, a professor at Harvard Business School, set up the ARD, the first firm, as oppo

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advanced technology developed in the US Universities. ARD's approach was a classic advanced technology developed in the US Universities. ARD's approach was a classic VC in the sense that it used only equity, invested for long term, and was prepared to VC in the sense that it used only equity, invested for long term, and was prepared to live with

live with losers. ARD's investmlosers. ARD's investment in ent in DigitaDigital l EquipmEquipment Corporation (DEC) in ent Corporation (DEC) in 19571957 was a watershed in the history of VC financing.

was a watershed in the history of VC financing.

The number of such specialized investment firms, eventually to be called venture The number of such specialized investment firms, eventually to be called venture capital firms, began to boom in the late 1950s.The growth was aided in large part by capital firms, began to boom in the late 1950s.The growth was aided in large part by the creation in 1958 of the federal Small Business Investment Company program. the creation in 1958 of the federal Small Business Investment Company program. Hundreds of SBICs were formed in the 1960s, and many remain in operation today. Hundreds of SBICs were formed in the 1960s, and many remain in operation today.

Slow Growth in 1960s & early 1970s, and the First Boom Year in 1978 Slow Growth in 1960s & early 1970s, and the First Boom Year in 1978

During the 1960s and 1970s, venture capital firms focused their investment activity During the 1960s and 1970s, venture capital firms focused their investment activity primarily on

primarily on starting and starting and expanding cexpanding companies. More ompanies. More often than often than not, these conot, these companiesmpanies were exploiting breakthroughs in electronic, medical or data-processing technology. were exploiting breakthroughs in electronic, medical or data-processing technology. As a result, venture capital came to be almost synonymous with technology finance. As a result, venture capital came to be almost synonymous with technology finance. Venture capital firms suffered a temporary downturn in 1974, when the

Venture capital firms suffered a temporary downturn in 1974, when the stock marketstock market crashed and investors were naturally wary of this new kind of investment fund. 1978 crashed and investors were naturally wary of this new kind of investment fund. 1978 was the first big year for venture capital. The industry raised approximately $750 was the first big year for venture capital. The industry raised approximately $750 million in 1978.

million in 1978.

Highs & Lows of the 1980s Highs & Lows of the 1980s

In 1980, legislation made it possible for pension funds to invest in alternative assets In 1980, legislation made it possible for pension funds to invest in alternative assets classes such as venture capital firms. 1983 was the boom year - the stock market went classes such as venture capital firms. 1983 was the boom year - the stock market went through the roof and there were over 100 initial public offerings for the first time in through the roof and there were over 100 initial public offerings for the first time in U.S. history. That year was also the year that many of today's largest and most U.S. history. That year was also the year that many of today's largest and most prominent firms were fou

prominent firms were founded.nded. Due to

Due to the excethe excess ss of of IPIPOs Os and and the inexthe inexperperieience nce of of mamany ny veventunture re cacapitpital al fufundnd ma

managnagersers, , VC VC rereturturns ns wewere re ververy y low low thrthrougough h the the 1981980s. 0s. VC VC fifirmrms s retretrerenchnched,ed, working hard to make their portfolio companies successful. The work paid off and working hard to make their portfolio companies successful. The work paid off and returns began climbing back up.

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Boom Times in the 1990s Boom Times in the 1990s

The 1990s have been, by far the best years for the Venture Capital Industry. The The 1990s have been, by far the best years for the Venture Capital Industry. The engine for growth has been the favourable economic climate in the US coupled with engine for growth has been the favourable economic climate in the US coupled with the advent of the Internet boom. During this decade, the interest rates were low and the advent of the Internet boom. During this decade, the interest rates were low and the P/Es were very high compared to historical averages. Finally, the rate of M&A the P/Es were very high compared to historical averages. Finally, the rate of M&A acti

activity vity has has incrincreaseeased d dramdramatiaticallcally y in in the the 19901990s, s, creacreatinting g mormore e oppoopportunrtunitiities es for for small, venture-backed companies to exit (cash out) at high prices.

small, venture-backed companies to exit (cash out) at high prices. Th

The e adadvevent nt of of ththe e InInteternrnet et as as a a nenew w memedidium um fofor r boboth th pepersrsononal al anand d bubusisinenessss communications and commerce created an avalanche of opportunities for venture communications and commerce created an avalanche of opportunities for venture cap

capititalialists sts in in the the mimid d and and lalate te 1991990s. 0s. As As a a resresulult, t, the the inindusdustrtry y has has expexperieriencenceded extraordinary growth in the past few years, both in the number of firms, and in the extraordinary growth in the past few years, both in the number of firms, and in the amount of capital they have raised.

amount of capital they have raised.

1.3

The Background

In

In SeptSeptembember er 19951995, , GoveGovernmrnment ent of of IndiIndia a issuissued ed guidguidelielines nes for for overoverseas seas ventventureure capital investment in India whereas the Central Board of Direct Taxes (CBDT) issued capital investment in India whereas the Central Board of Direct Taxes (CBDT) issued guidelines for tax exemption purposes. (The Reserve Bank of India governs the guidelines for tax exemption purposes. (The Reserve Bank of India governs the investme

investment and flow nt and flow of foreign currency in and out of of foreign currency in and out of India.) As a part of India.) As a part of its mandateits mandate to regulate and to

to regulate and to develop the Indian capital markets, Securidevelop the Indian capital markets, Securities and Exchange Boardties and Exchange Board of India (SEBI) framed the SEBI (Venture Capital Funds) Regulations, 1996.

of India (SEBI) framed the SEBI (Venture Capital Funds) Regulations, 1996.

Pursuant to the regulatory framework, some domestic VCFs were registered with Pursuant to the regulatory framework, some domestic VCFs were registered with SEBI. Some overseas investments also came through the Mauritius route. However, SEBI. Some overseas investments also came through the Mauritius route. However, the

the venventuture re cacapitpital al indindustustry, ry, undunderserstotood od gloglobalbally ly as as 'in'indepdependendenentltly y mamanagnageded,, ded

dedicicatated ed poopools ls of of cacapitpital al thathat t focfocus us on on equequitity y or or equequitity y lilinkenked d invinvestestmementnts s inin privately

privately held, held, high high growth growth companies' companies' (The (The Venture Venture Capital Capital Cycle, Cycle, Gompers Gompers andand Lerner, 1999) is still relatively in a nascent stage in India. Figures from the Indian Lerner, 1999) is still relatively in a nascent stage in India. Figures from the Indian Vent

Venture ure CapiCapital tal AssoAssociatciation ion (IV(IVCA) reveal CA) reveal thathat, t, tiltill l 20002000, , arouaround nd Rs. Rs. 2,202,200 0 crorcroree (US$ 500 million) had been committed by the domestic VCFs and offshore funds (US$ 500 million) had been committed by the domestic VCFs and offshore funds

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which are members of IVCA. Figures available from private sources indicate that which are members of IVCA. Figures available from private sources indicate that overall funds committed are around US$ 1.3 billion.

overall funds committed are around US$ 1.3 billion.

Funds that can be invested were less than 50 percent of the committed funds and Funds that can be invested were less than 50 percent of the committed funds and actual investments were lower still. At the same time, due to economic liberalisation actual investments were lower still. At the same time, due to economic liberalisation and

and inincrecreasiasing ng glglobaobal l outoutloolook k in in InIndiadia, , an an inincrecreaseased d awawarareneeness ss and and ininteteresrest t of of domestic as well as foreign investors in venture capital was observed. While only 8 domestic as well as foreign investors in venture capital was observed. While only 8 domestic VCFs were registered with SEBI during 1996-98, more than 30 additional domestic VCFs were registered with SEBI during 1996-98, more than 30 additional funds have already been registered in 2000-01.

funds have already been registered in 2000-01.

Institutional interest is growing and foreign venture investments are also on the Institutional interest is growing and foreign venture investments are also on the increase. Given the proper environment and policy support, there is a tremendous increase. Given the proper environment and policy support, there is a tremendous potential for vent

potential for venture capital activity ure capital activity in India.in India.

The Finance Minister, in the Budget 2000

The Finance Minister, in the Budget 2000 speech announced, "For boosting high techspeech announced, "For boosting high tech sectors and supporting first generation entrepreneu

sectors and supporting first generation entrepreneurs, there is rs, there is an acute need an acute need for higher for higher investments in venture capital activities." He also said that the guidelines for the investments in venture capital activities." He also said that the guidelines for the registration of venture capital activity with the Central Board of Direct Taxes would registration of venture capital activity with the Central Board of Direct Taxes would be

be harmonized harmonized with thwith those ose for for registration registration with thwith the e Securities Securities and and Exchange Exchange Board Board of of India.

India.

SEBI decided to set up a committee on venture capital to identify the impediments SEBI decided to set up a committee on venture capital to identify the impediments and suggest suitable measures to facilitate the growth of venture capital activity in and suggest suitable measures to facilitate the growth of venture capital activity in India. Keeping in view the need for global perspective, it was decided to associate India. Keeping in view the need for global perspective, it was decided to associate Indian entrepreneur from Silicon Valley in the committee. The setting up of this Indian entrepreneur from Silicon Valley in the committee. The setting up of this committ

committee was primarily motivated by the need ee was primarily motivated by the need to play a to play a facilitafacilitating role in ting role in tune withtune with the mandate of SEBI, to regulate as well as develop the market. The committee the mandate of SEBI, to regulate as well as develop the market. The committee headed by

headed by K. B. K. B. ChandrasChandrasekhar, Chairman, Exodus Communicaekhar, Chairman, Exodus Communications Inc., tions Inc., submittsubmitteded its report on 8 January 2000.

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1.4

(a)

(a)Mea

Meaning

ning of

of Vent

Venture

ure Cap

Capital

ital

Venture

Venture capitalcapital is long-term risk is long-term risk capitalcapital to finance high technology projects whichto finance high technology projects which involve risk but at the same time has strong potential for growth.

involve risk but at the same time has strong potential for growth.VentureVenture capitalistcapitalist pools

pools their their resources resources including including managerial managerial abilities abilities to to assist assist new new entrepreneur entrepreneur in in thethe early years of the

early years of the projectproject. Once the. Once theprojectproject reaches the stage of profitability, they sellreaches the stage of profitability, they sell their equity holdings at high premium.

their equity holdings at high premium.

(b) Definit

(b) Definition

ion of

of the

the Ven

Ventur

ture

e Capi

Capital

tal Comp

Company

any

A

A ventureventure capitalcapital company is defined as “a financing institutions which joints ancompany is defined as “a financing institutions which joints an entrepreneur as a co-promoter in a

entrepreneur as a co-promoter in a projectproject and shares the risks and rewards of theand shares the risks and rewards of the enterprise.”

enterprise.”

1.5 Characteristics of Venture Capital

Th

The e ththree ree priprimamary ry chcharaaractcterieriststics ics of of ventureventure capitalcapital fundsfunds whwhicich h mamay y ththemem eminently suitable as a source of risk finance are:

eminently suitable as a source of risk finance are: (1) that it is equity or quasi equity investments; (1) that it is equity or quasi equity investments; (2) it is long-term investment; and

(2) it is long-term investment; and (3) it is an active from of investment. (3) it is an active from of investment.

First,

First, ventureventure capitalcapital is equity or quasi equity because the investor assumes risk.is equity or quasi equity because the investor assumes risk. There is no

There is no security for his investment.security for his investment.VentureVenture capitalcapital fundsfundsby participating in theby participating in the equity

equity capitalcapital institutionalize the process of risk taking which promotes successfulinstitutionalize the process of risk taking which promotes successful domestic technology development.

domestic technology development.

Investors of

Investors of ventureventure capitalcapital have no liquidity for a period of time.have no liquidity for a period of time.VentureVenturecapitalistcapitalist or

or fundsfunds hope that the company they are backing will thrive and after five to sevenhope that the company they are backing will thrive and after five to seven years from making the investment it will be large and profitable enough to sell its years from making the investment it will be large and profitable enough to sell its shares in the stock market. But a reward is thee for liquidity and waiting. The

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capitalists hope to sell their share for many times what they paid for. If the unit fails capitalists hope to sell their share for many times what they paid for. If the unit fails the

the ventureventure capitalists losses everything. The probability distribution of expectedcapitalists losses everything. The probability distribution of expected returns for most

returns for mostventureventure capitalcapitalinvestment is highly skewed to the right. The successinvestment is highly skewed to the right. The success rate is 10-20 percent.

rate is 10-20 percent.

Secondly,

Secondly, ventureventure capitalcapitalis long-term investment involving both money and time.is long-term investment involving both money and time. Finally,

Finally, ventureventure capitalcapital investment involves participation in the management of theinvestment involves participation in the management of the company.

company. VentureVenturecapitalist participates in the Board and guides the firm on strategiccapitalist participates in the Board and guides the firm on strategic and policy matters. The features of

and policy matters. The features of ventureventure capitalcapital generally are, generally are, financing new andfinancing new and rapidly growing companies; purchase of equity shares; assist in transformation of rapidly growing companies; purchase of equity shares; assist in transformation of innovative technology based ideas into products and services; and value to company innovative technology based ideas into products and services; and value to company by active participat

by active participation; assume risks in ion; assume risks in the expectation of largthe expectation of large rewards; and possee rewards; and possess ass a long-term perspecti

long-term perspective. These ve. These features of features of ventureventure capitalcapital render it render it eminenteminently ly suitablsuitablee as a source of risk

as a source of risk capitalcapitalfor domestically developed technologies.for domestically developed technologies. New

New ventureventure prpropooposalsals s in in hihigh gh tetechnchnolology ogy arearea a arare e atattrtractactive ive bebecaucause se of of thethe perceived

perceived possibility possibility of of substantial substantial growth growth andand capitalcapital gains. Althoughgains. Although ventureventure capital

capital evoevolvelved d as as a a memethothod d of of earearly ly sagsage e finfinancancining g it it ininclucludes des devdevelelopmopmenent,t, expansion and buyout financing for units which are unable to raise

expansion and buyout financing for units which are unable to raise fundsfunds throughthrough normal financing channels. Units in developing countries need

normal financing channels. Units in developing countries need fundsfunds for financingfor financing various stages of development. Such a broad approach would help

various stages of development. Such a broad approach would help ventureventure fundsfunds toto diversify their investment and spread risks.

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1.6 1.6 Types of

Types of Venture Cap

Venture Capital F

ital Firms

irms

Ve

Ventnturure e CaCapipitatal l cacan n be be didivivideded d ininto to mamany ny didiffffererenent t tytypepes s acaccocordrdining g to to ththee characte

characteristics of the ristics of the shareholshareholders and ders and sources of investment -- such sources of investment -- such as private equityas private equity firms, banks, financial institutions, private corporations, the government or

firms, banks, financial institutions, private corporations, the government or insuranceinsurance companies.

companies.

Generally there are three types of organized or institutional venture capital funds: Generally there are three types of organized or institutional venture capital funds: venture capital funds set up by angel investors, that is, high net worth individual venture capital funds set up by angel investors, that is, high net worth individual inve

investorstors; s; ventventure ure capicapital tal subssubsidiidiariearies s of of corpcorporatorations ions and and privprivate ate ventventure ure capicapitaltal firm

firms/ s/ fundfunds. s. VenVenture ture capcapital ital subssubsidiidiariearies s are are estestabliablished shed by by majmajor or corpcorporatorationsions,, commercial bank holding companies and other financial institutions.

commercial bank holding companies and other financial institutions.

Venture funds in India can be classified on the basis of the type of promoters. Venture funds in India can be classified on the basis of the type of promoters.

•

• Financial institutions led by ICICI ventures, ILFS, etc. Private venture fundsFinancial institutions led by ICICI ventures, ILFS, etc. Private venture funds

like Indus, etc. like Indus, etc.

•

• Regional funds: Warburg Pincus, JF Electra (mostly operating out of HongRegional funds: Warburg Pincus, JF Electra (mostly operating out of Hong

Kong). Kong).

•

• Regional funds dedicated to India: Draper, Walden, etc.Regional funds dedicated to India: Draper, Walden, etc. •

• Offshore funds: Offshore funds: Barings, TCWBarings, TCW, HSB, HSBC, C, etc.etc. •

• Corporate ventures: venture capital subsidiaries of corporations.Corporate ventures: venture capital subsidiaries of corporations. •

• Angels: high net worth individual investors.Angels: high net worth individual investors. •

• Merchant bankers and NBFCs who specialize in "bought out" deals also Merchant bankers and NBFCs who specialize in "bought out" deals also fundfund

companies. companies.

On the basis of geographical focus On the basis of geographical focus

•

• RegionalRegional •

• GlobalGlobal

On the basis of industry specialty On the basis of industry specialty

•

• IT and IT-enabled servicesIT and IT-enabled services •

• Software Products (Mainly Enterprise-focused)Software Products (Mainly Enterprise-focused) •

• Wireless/Telecom/Semiconductor Wireless/Telecom/Semiconductor •

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•

• Media/EntertainmentMedia/Entertainment •

• Bio Technology/Bio InformaticsBio Technology/Bio Informatics •

• PharmaceuticalsPharmaceuticals •

• Contract ManufacturingContract Manufacturing •

• RetailRetail

On the basis of funding stage: On the basis of funding stage:

• • Seed/earlySeed/early • • Late/mboLate/mbo • • PipePipe

The Venture Capital firms in India can be categorized into the following four groups: The Venture Capital firms in India can be categorized into the following four groups: 1.

1. All-IndiAll-India a DFI-spoDFI-sponsored VCFs such nsored VCFs such as Technology as Technology DevelopmDevelopment ent and Informationand Information Company of India Ltd. (TDICI) by ICICI, Risk Capital and Technology Finance Company of India Ltd. (TDICI) by ICICI, Risk Capital and Technology Finance Corporation Ltd. (RCTFC) by IFCI and Risk Capital Fund by IDBI

Corporation Ltd. (RCTFC) by IFCI and Risk Capital Fund by IDBI 2.

2. SFC-spSFC-sponsored VCFs such as onsored VCFs such as Gujarat Venture Capital Ltd. (GVCL) by GIIC Gujarat Venture Capital Ltd. (GVCL) by GIIC andand Andhra Pradesh Venture Capital Ltd. (APVCL) by APSFC

Andhra Pradesh Venture Capital Ltd. (APVCL) by APSFC 3.

3. Bank-sponsored VCFs such as Canfina and SBI CapsBank-sponsored VCFs such as Canfina and SBI Caps 4.

4. Private VCFs supported by private sector companies such as Indus VenturePrivate VCFs supported by private sector companies such as Indus Venture Capital Fund, Credit Capital Venture Fund.

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Chapter – 2

Development of VCF in International Arena and

Development of VCF in International Arena and INDIA

INDIA

2.1 VCF in International Arena

2.2 Venture Capital in India

2.3 Future of Venture Capital in India

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Development of Venture Capital

2.1 The International arena

The modern venture capital industry began taking shape in the post – World War II The modern venture capital industry began taking shape in the post – World War II years. It is often said that people decide to become entrepreneurs because they see years. It is often said that people decide to become entrepreneurs because they see role models in other people who have become successful entrepreneurs. Much the role models in other people who have become successful entrepreneurs. Much the same thing can be said about venture capitalists.

same thing can be said about venture capitalists.

USA

The history of the venture capital in US traces back to the period after World War II The history of the venture capital in US traces back to the period after World War II when a few wealthy family groups like Rockefeller, Andrew Carnegie and others took when a few wealthy family groups like Rockefeller, Andrew Carnegie and others took the

the iniinititiatiativeve. . ThThe e venventurture e capcapitital al indindustustry ry wawas s ststartarted ed by by GeGeorgorge e DeDetrtroit oit whwhoo collaborated in establishing Corporation at Boston. From 1965 to 1972 nearly 40 collaborated in establishing Corporation at Boston. From 1965 to 1972 nearly 40 venture capital companies were formed with committed assets of $500 million. It is venture capital companies were formed with committed assets of $500 million. It is noted that in

noted that in the US, the venture capital industry has the US, the venture capital industry has been associated with technologybeen associated with technology development. In the 1980s, the US venture industry began to establish its business development. In the 1980s, the US venture industry began to establish its business overseas at large.

overseas at large.

UK

In the UK, the development of venture capital owes to the professionally managed In the UK, the development of venture capital owes to the professionally managed specialist fund – Charter House – set up in 1980 for providing risk equity finance for specialist fund – Charter House – set up in 1980 for providing risk equity finance for young and

young and growing small business. In 1983, growing small business. In 1983, British Venture Capital AssociatBritish Venture Capital Association wasion was established with a membership of 33 funds, which rose to 115 in 1992.

established with a membership of 33 funds, which rose to 115 in 1992.

JAPAN

In 1963, 3 Government assisted companies were established in Tokyo, Osaka and In 1963, 3 Government assisted companies were established in Tokyo, Osaka and Nagoya,

Nagoya, to to provide provide venture venture capital capital t t small small and and medium medium industries. industries. Leading Leading financialfinancial institutions in Japan started venture capital companies for financing high technology institutions in Japan started venture capital companies for financing high technology ind

industustririal al uniunits. The ts. The raprapid id grogrowtwth h of of inindusdustrtry y in in JapJapan an is is crcrediediteted d to to ththe e eaeasysy availability of venture capital.

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2.2 VENTURE CAPITAL IN INDIA

This activity in

This activity in the past the past was possibly done by was possibly done by the developmental financithe developmental financial institutionsal institutions like

like IDBIDBI, I, ICIICICI CI and and StaState te FinFinanciancial al CorCorporaporatiotions. ns. TheThese se instinstitutitutions ions prompromoteotedd entities in the private sector with debt as an instrument of funding.

entities in the private sector with debt as an instrument of funding.

For a long time funds raised from public were used as a source of VC. This source For a long time funds raised from public were used as a source of VC. This source however depended a lot on the market vagaries. And with the minimum paid up however depended a lot on the market vagaries. And with the minimum paid up capital requirements being raised for listing at the stock exchanges, it became difficult capital requirements being raised for listing at the stock exchanges, it became difficult for smaller firms with viable projects to raise funds from public.

for smaller firms with viable projects to raise funds from public.

In India, the need for VC was recognised in the 7th five year plan and long term fiscal In India, the need for VC was recognised in the 7th five year plan and long term fiscal policy of GOI. In 19

policy of GOI. In 1973 a committee on Develop73 a committee on Development of small and medium ment of small and medium enterprisesenterprises highlighted the need to faster VC as a source of funding new entrepreneurs and highlighted the need to faster VC as a source of funding new entrepreneurs and tec

technohnologlogy. y. VC VC fifinannancincing g rereallally y stastartrted ed in in IndIndia ia in in 1981988 8 wiwith th ththe e foformrmatation ion of of Te

Technchnoloology gy DeDevelvelopmopment ent and and InfInformormatatioion n CoCompmpany any of of IndIndia ia LtLtd. d. (T(TDICDICI) I) -- promoted by ICICI and UTI.

promoted by ICICI and UTI.

The first private VC fund was sponsored by Credit Capital Finance Corporation The first private VC fund was sponsored by Credit Capital Finance Corporation (CFC) and promoted by Bank of India, Asian Development Bank and the

(CFC) and promoted by Bank of India, Asian Development Bank and the

Commonwealth Development Corporation viz. Credit Capital Venture Fund. At the Commonwealth Development Corporation viz. Credit Capital Venture Fund. At the same time Gujarat Venture Finance Ltd. and APIDC Venture Capital Ltd. were same time Gujarat Venture Finance Ltd. and APIDC Venture Capital Ltd. were started by state level financial institutions. Sources of these funds were the financial started by state level financial institutions. Sources of these funds were the financial institutions, foreign institutional investors or pension funds and high net-worth institutions, foreign institutional investors or pension funds and high net-worth

individuals. Though an attempt was also made to raise funds from the public and fund individuals. Though an attempt was also made to raise funds from the public and fund new ventures, the venture capitalists had hardly any impact on the economic scenario new ventures, the venture capitalists had hardly any impact on the economic scenario for the next eight years

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GROWTH OF FIRMS IN INDIA GROWTH OF FIRMS IN INDIA

Y

Yeeaarr NNoo. . oof f FFuunnddss YYeeaarr NNoo. . oof f FFuunnddss

1 1999955 44 22000011 1122 1 1999966 77 22000022 66 1 1999977 1100 22000033 22 1 1999988 66 22000044 33 1 1999999 55 22000055 11 2 2000000 4477 22000066 22 Source: AVCJ/IVCA Source: AVCJ/IVCA

India is prime target for venture capital and private equity today, owing to various India is prime target for venture capital and private equity today, owing to various fact

factors ors such such as as fast fast growgrowing ing knowknowledledge ge basebased d induindustristries, es, favofavouraburable le inveinvestmstmentent opportunities, cost competitive workforce, booming stock markets and supportive opportunities, cost competitive workforce, booming stock markets and supportive regulator

regulatory environment among others. The y environment among others. The sectors where the country sectors where the country attractattracts s ventureventure ca

capipitatal l arare e IT IT anand d ITITESES, , sosoftftwaware re prprododucuctsts, , babanknkining, g, PSPSU U didisisinvnvesestmtmenentsts,, entertainment and media, biotechnology, pharmaceuticals, contract manufacturing and entertainment and media, biotechnology, pharmaceuticals, contract manufacturing and retail. An offshore venture capital company may contribute upto 100 percent of the retail. An offshore venture capital company may contribute upto 100 percent of the capital of a domestic venture capital fund and may also set up a domestic asset capital of a domestic venture capital fund and may also set up a domestic asset management company to manage the fund. Venture capital funds (VCFs) and venture management company to manage the fund. Venture capital funds (VCFs) and venture capital companies (VCC) are permitted upto 40 percent of the paid up corpus of the capital companies (VCC) are permitted upto 40 percent of the paid up corpus of the dom

domestestic ic unlunlististed ed comcompanpanieies. s. ThThis is ceceililing ing wowould uld be be susubjbject ect to to rerelevlevant ant equequitityy investment limit in force in relation to areas reserved for SSI. Investment in a single investment limit in force in relation to areas reserved for SSI. Investment in a single company by a VCF/VCC shall not exceed 5 percent of the paid up corpus of a company by a VCF/VCC shall not exceed 5 percent of the paid up corpus of a domestic VCF/VCC. The automatic route is not available.

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2.3Future of Venture Capital in India

Ra

Rapidpidly ly chachanginging ng ecoeconomnomic ic envenviroironmnment ent acaccelcelererateated d by by ththe e hihigh gh tetechnchnoloologygy explosion, emerging needs of new generation of entrepreneurs in the process and explosion, emerging needs of new generation of entrepreneurs in the process and inad

inadequaequacy cy of of the the exisexistintingg venture capitalventure capital fundfunds/scs/schemhemes es are are indiindicaticative ve of of thethe tremendous scope for

tremendous scope for ventureventure capitalcapital in India and pointers to the need for thein India and pointers to the need for the creation of a sound and broad-based

creation of a sound and broad-basedventureventure capitalcapitalmovement India.movement India. There are many entrepreneurs in India with a good

There are many entrepreneurs in India with a good projectproject idea but no previousidea but no previous entrepreneurial track record to leverage their firms, handle customers and bankers. entrepreneurial track record to leverage their firms, handle customers and bankers.

Venture

Venture capitalcapital can open a new window for such entrepreneurs and help them tocan open a new window for such entrepreneurs and help them to launch their projects successfully.

launch their projects successfully.

With rapid international march of technology, demand for newer technology and With rapid international march of technology, demand for newer technology and products

products in in India India has has gone gone up up tremendously. tremendously. the the pace pace of of development development of of new new andand indigenous technology in the country has been slack in view of the fact that several indigenous technology in the country has been slack in view of the fact that several process d

process developed in eveloped in laboratories laboratories are not are not commercialized beccommercialized because of ause of unwillingness unwillingness of of people

people to take to take entrepreneurial entrepreneurial risks, i.e. risks, i.e. risk thrisk their eir fundsfunds as also undergo the ordeal of as also undergo the ordeal of marketing the products and process. In such a situation,

marketing the products and process. In such a situation, ventureventure financing assumesfinancing assumes more significance. It can act not only act as a financial catalyst but also provide strong more significance. It can act not only act as a financial catalyst but also provide strong imp

impetus etus for for ententreprrepreneueneurs rs to to devedevelop lop prodproductucts s invoinvolvinlving g newenewer r tectechnolhnologieogies s andand commercialize them. This will give a boost to the development of new technology and commercialize them. This will give a boost to the development of new technology and would go a long way in broadening the industrial base, creation of jobs, provide a would go a long way in broadening the industrial base, creation of jobs, provide a thrust to exports and help in the overall enrichment of the economy.

thrust to exports and help in the overall enrichment of the economy.

Another type of situation commonly found in our country is where the local group and Another type of situation commonly found in our country is where the local group and a multi-national company may be ready to enter into a joint

a multi-national company may be ready to enter into a joint ventureventure but the former but the former does not have sufficient

does not have sufficient fundsfunds to put up its share of the equity and the latter isto put up its share of the equity and the latter is restrict

restricted to ed to a certain percentage. For the a certain percentage. For the personal reasons or because of personal reasons or because of competicompetition,tion, the local group may not be

the local group may not be keen to invite any one keen to invite any one in its industry or any major privatein its industry or any major private investor to contribute equity and may prefer a

investor to contribute equity and may prefer a ventureventure capitalcapital company, as a lesscompany, as a less intimately involved and temporary shareholder.

intimately involved and temporary shareholder.VentureVenturecapitalists can also lend their capitalists can also lend their expertise and standing to the entrepreneurs.

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In service sector, which has immense growth prospects in India,

In service sector, which has immense growth prospects in India, ventureventure capitalistscapitalists can play significant role in tapping its potentiality to the full. For instance,

can play significant role in tapping its potentiality to the full. For instance, ventureventure

capi

capitalitalists sts can can provprovideide capitalcapital and and exexperpertitise se to to orgorgananizaizatiotions ns selselliling ng anantitiqueque,, remodeled jewellery, builders of resort hotels, baby and health care market, retirement remodeled jewellery, builders of resort hotels, baby and health care market, retirement homes and small houses.

homes and small houses.

In view of the above, it will be desirable to establish a separate national

In view of the above, it will be desirable to establish a separate national ventureventure capital

capital fund tow which the financial institutions and banks can contribute. In scopefund tow which the financial institutions and banks can contribute. In scope and content such a national

and content such a nationalventureventure capitalcapitalfund should cover:fund should cover: (i) all the aspects of

(i) all the aspects of ventureventure capitalcapital financing in all the three stages of conceptual,financing in all the three stages of conceptual, deve

developmlopmentaental l an an explexploitaoitation tion phasphases es in in the the procprocess ess of of comcommermerciacializalization of tion of thethe technological innovation and

technological innovation and

(ii) as may of the risk stages-development, manufacturing, marketing, management (ii) as may of the risk stages-development, manufacturing, marketing, management an

and d grgrowowth th as as popossssibible le unundeder r InIndidian an CConondidititionons. s. ThThe e fufund nd shshouould ld ofoffefer r aa comprehensive package of technical, commercial, managerial and financial assistance comprehensive package of technical, commercial, managerial and financial assistance and services to building entrepreneurs and be a position to offer innovative solutions and services to building entrepreneurs and be a position to offer innovative solutions to the

to the varied problems faced by them in varied problems faced by them in business promotibusiness promotion, transfer and innovation.on, transfer and innovation. To this end, the proposed national

To this end, the proposed national ventureventure capitalcapital fund should have at its commandfund should have at its command multi-disciplinary technical expertise. The major thrust of this fund should be on the multi-disciplinary technical expertise. The major thrust of this fund should be on the promotion

promotion of of viable viable new new business business in in India India to to take take advantage advantage of of the the on on coming coming highhigh technology revolution and setting up of high growth industries so as to take the Indian technology revolution and setting up of high growth industries so as to take the Indian economy to commanding heights.

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Chapter – 3

Venture Capital Investment Process

3 3..1

1 IIn

nv

veessttm

meen

nt

t P

Prro

occeed

du

urree

3.2

3.2 Investment

Investment in

in VC

VC by

by Banks

Banks

3.3 Angle

3.4

3.4 Corporate

Corporate Venturing

Venturing

3.5

3.5 Consortium

Consortium Financing

Financing

3.6

3.6 Favourites

Favourites of

of the

the Investors

Investors

3.7

3.7 Promotion

Promotion Strategies

Strategies

3.8 Incentives

3.9 Initiatives

3.10

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Venture Capital Investment Process

3.1 3.1 Investment Procedure

Investment Procedure

In generating a deal flow, the venture capital investor creates a pipeline of ‘deals’ or In generating a deal flow, the venture capital investor creates a pipeline of ‘deals’ or inv

investestmement nt oppopportortuniunitities es thathat t he he wouwould ld conconsisider der ininvesvestiting ng in. in. ThThis is is is achachieievedved primarily

primarily through through plugging plugging into into an an appropriate appropriate network. network. The The most most popular popular network network obviously is the network of venture capital funds/investors. It is also common for obviously is the network of venture capital funds/investors. It is also common for venture capitals to develop working relationships with R&D institutions, academia, venture capitals to develop working relationships with R&D institutions, academia, etc,

etc, whicwhich h coulcould d potepotentintially ally lealead d to to busibusiness ness oppoopportunrtunitiities. es. UndeUnderstarstandabndably ly thethe composition of the network would depend on the investment focus of the venture composition of the network would depend on the investment focus of the venture capital funds/company. Thus venture capital funds focusing on early stage technology capital funds/company. Thus venture capital funds focusing on early stage technology based

based deals deals would would develop develop a a network network of of R&D R&D centers centers working working in in those those areas. areas. TheThe network is crucial to the success of the venture capital investor. It is almost imperative network is crucial to the success of the venture capital investor. It is almost imperative for the venture capital investor to receive a large number of investment proposals for the venture capital investor to receive a large number of investment proposals from which he can select a few good investment candidates finally.

from which he can select a few good investment candidates finally. Be

Beforfore e mamakiking ng anany y invinvestestmementnt, , the the goagoal l as as veventunture re capcapititalialists sts is is to to undundererstastandnd virtually every aspect of the target company: the experience and capabilities of the virtually every aspect of the target company: the experience and capabilities of the management team, the business plan, the nature of its operations, its products and/or management team, the business plan, the nature of its operations, its products and/or services, the methods by which sales are made, the market for the products and/or services, the methods by which sales are made, the market for the products and/or services, the competitive landscape, and other factors that may affect the outcome of services, the competitive landscape, and other factors that may affect the outcome of the investment. While due diligence investigations are viewed by many as mundane the investment. While due diligence investigations are viewed by many as mundane and irritating tasks, the process enables venture capitalists to address areas of concern, and irritating tasks, the process enables venture capitalists to address areas of concern, is an important tool in determining a fair pre-investment valuation, and may help to is an important tool in determining a fair pre-investment valuation, and may help to avoid significant and otherwise unexpected liability following the investment.

avoid significant and otherwise unexpected liability following the investment.

The venture capitalists view the due diligence process as a means of identifying and The venture capitalists view the due diligence process as a means of identifying and becoming

becoming comfortable comfortable with with the the risks risks to to which which their their capital capital will will be be exposed. exposed. The The duedue di

dililigegencnce e prprococesess s ininvovolvlves es an an asassesessssmement nt of of boboth th ththe e mimicrcroeoecocononomimic c anandd macroeconomic factors that can affect the earnings growth of the target company. The macroeconomic factors that can affect the earnings growth of the target company. The due diligence process also includes a review of the corporate and legal records, due diligence process also includes a review of the corporate and legal records, including the documentation supporting any previous issuances of the company's including the documentation supporting any previous issuances of the company's securities.

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Only

Only one or two business plans in 100 result in successful financingone or two business plans in 100 result in successful financing. And of every. And of every 10 investments made, only one or two are successful. But this is enough to recover 10 investments made, only one or two are successful. But this is enough to recover investments made by the venture capital (VC) in all 10 start-ups in addition to an investments made by the venture capital (VC) in all 10 start-ups in addition to an average 40-50% return! Securing an investment from an institutional venture capital average 40-50% return! Securing an investment from an institutional venture capital fund is extremely difficult. It is estimated that only five business plans in 100 are fund is extremely difficult. It is estimated that only five business plans in 100 are viable investment opportunities and only three in 100 results in successful financing. viable investment opportunities and only three in 100 results in successful financing. In fact, the odds could be as low as one in 100. More than half of the proposals to In fact, the odds could be as low as one in 100. More than half of the proposals to venture capitali

venture capitalists are sts are usually rejecteusually rejected after a d after a 20-30 minute scanning, and 25 per 20-30 minute scanning, and 25 per centcent are discarded after a lengthier review. The remaining 15 per cent are looked at in are discarded after a lengthier review. The remaining 15 per cent are looked at in more detail, but at least 10 per cent

more detail, but at least 10 per cent of these are dismissed due to irreconcilablof these are dismissed due to irreconcilable flawse flaws in the management team or the business plan.

in the management team or the business plan.

A Venture Capitalist looks at various aspects before investing in any venture. First, A Venture Capitalist looks at various aspects before investing in any venture. First, you need to work out a business plan. The business plan is a document that outlines you need to work out a business plan. The business plan is a document that outlines the management team, product, marketing plan, capital costs and means of financing the management team, product, marketing plan, capital costs and means of financing and profitability statements.

and profitability statements. 1.

1. Initial EvaluInitial Evaluation: This involves the initial process of assessing the feasibiation: This involves the initial process of assessing the feasibility of lity of the project.

the project. 2.

2. Due dilDue diligeigencence: : In this stagIn this stage e an in-dan in-deptepth h ststudy is udy is cocondunductcted to ed to ananalalyse theyse the feasibility of the project.

feasibility of the project. 3.

3. DeDeal al strstructucturiuring ng anand d negnegotiotiatiation: on: HaHavinving g estestabablislished hed the the fefeasiasibilbilitity, y, ththee instruments that give the required return are structured.

instruments that give the required return are structured. 4.

4. Investment valuation: Investment valuation: In In this stage, this stage, final amfinal amount for ount for deal deal is is decided.decided. 5.

5. DocumeDocumentation: Tntation: This is the his is the process of process of creaticreating and execung and executing legating legal documenl documents tots to protect the interes

protect the interest of the venture.t of the venture. 6.

6. MoMonitnitorioring and Valng and Value addue addititioion: In this stn: In this stageage, the proj, the projecect is t is momonitnitorored byed by executives from the venture fund and undesirable variations from the business plan executives from the venture fund and undesirable variations from the business plan are dealt with.

are dealt with. 7.

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1.

1. Initial Evaluation:

Initial

Evaluation:

Before any in depth

Before any in depth analysis is done on analysis is done on a project, an initial screening is carried out toa project, an initial screening is carried out to satisfy the venture capitalist of certain aspects of the project. These include

satisfy the venture capitalist of certain aspects of the project. These include

•

• Competitive aspects of the product or serviceCompetitive aspects of the product or service •

• Outlook of the target market and their perception of the new productOutlook of the target market and their perception of the new product •

• Abilities of the management teamAbilities of the management team •

• Availability of other sources of fundingAvailability of other sources of funding •

• Expected returnsExpected returns •

• Time and resources required from the venture capital firmTime and resources required from the venture capital firm

Through this screening the venture firm builds an initial overview about the Through this screening the venture firm builds an initial overview about the

•

• Technical skills, experience, business sense, temperament and ethics of theTechnical skills, experience, business sense, temperament and ethics of the

promoters promoters

•

• The stage of the technology being used, the drivers of the technology and theThe stage of the technology being used, the drivers of the technology and the

direction in which it is moving direction in which it is moving

•

• Location and size of market and market development costs, driving forces of Location and size of market and market development costs, driving forces of

the market, competitors and share, distribution channels and other market the market, competitors and share, distribution channels and other market related issues

related issues

•

• Financial facts of the dealFinancial facts of the deal •

• CoCompmpetietititive ve edgedge e avaavaililablable e to to ththe e ththe e comcompanpany y and and fafactoctors rs afaffecfectiting ng itit

significantly significantly

•

• Advantages from the deal for the venture capitalistAdvantages from the deal for the venture capitalist •

• Exit options availableExit options available

2. Due diligence

Due diligence is term used that includes all the activities that are associated with Due diligence is term used that includes all the activities that are associated with investigating an investment proposal to assess feasibility. It includes carrying out investigating an investment proposal to assess feasibility. It includes carrying out in-depth reference checks on the proposal related aspects such as management team, depth reference checks on the proposal related aspects such as management team, products,

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data are done during this stage. The important feature to note is that venture capital data are done during this stage. The important feature to note is that venture capital due diligence focuses on the qualitative aspects of an investment opportunity.

due diligence focuses on the qualitative aspects of an investment opportunity. Areas of due diligence would include

Areas of due diligence would include

•

• General assessmentGeneral assessment 

 business plan analysisbusiness plan analysis 

 contract detailscontract details 

 collaboratorscollaborators 

 corporate objectivescorporate objectives 

 SWOT analysisSWOT analysis 

 Time scale of implementationTime scale of implementation •

• PeoplePeople 

 Managerial abilities, past performance and credibility of promotersManagerial abilities, past performance and credibility of promoters 

 FinanciaFinancial background and l background and feedback about promoters from bankers feedback about promoters from bankers and previousand previous

lenders lenders



 Details of Board of Directors and their role in the activitiesDetails of Board of Directors and their role in the activities 

 Availability of skilled labour Availability of skilled labour 

 Recruitment processRecruitment process •

• Products/services, technology and processProducts/services, technology and process

In this category the type of questions asked will depend on the nature of the industry In this category the type of questions asked will depend on the nature of the industry into which the company is planning to enter. Some of the areas generally considered into which the company is planning to enter. Some of the areas generally considered are

are



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

 Competing technologies and comparisonsCompeting technologies and comparisons 

 Raw materials to be used, their availability and major suppliers, reliability of Raw materials to be used, their availability and major suppliers, reliability of

these suppliers these suppliers



 Machinery to be used and its availabilityMachinery to be used and its availability 

 Details of various tests conducted regarding the new productDetails of various tests conducted regarding the new product 

 Product life-cycleProduct life-cycle 

 Environment and pollution related issuesEnvironment and pollution related issues 

 Secondary data collection on the product and technology, if so availableSecondary data collection on the product and technology, if so available •

• MarketMarket

The questions asked under this head also vary depending on the type of product. The questions asked under this head also vary depending on the type of product. Some of the main questions asked are

Some of the main questions asked are



 main customersmain customers 

 future demand for the productfuture demand for the product 

 competitors in the market for the same product category and their strategycompetitors in the market for the same product category and their strategy 

 pricing strategypricing strategy 

 supplier and buyer bargaining power supplier and buyer bargaining power 

 channels of distributionchannels of distribution 

 marketing plan to be followedmarketing plan to be followed 

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Market survey could be conducted to gather further more accurate and relevant data. Market survey could be conducted to gather further more accurate and relevant data.

•

• FinanceFinance 

 Financial forecasts for the next 3-5 yearsFinancial forecasts for the next 3-5 years 

 Analysis of financial reports and balance sheets of firms already promoted or runAnalysis of financial reports and balance sheets of firms already promoted or run

by the promoters of the

by the promoters of the new venturenew venture



 Cost of productionCost of production 

 Wage structure detailsWage structure details 

 Accounting process to be usedAccounting process to be used 

 Financial report of critical suppliersFinancial report of critical suppliers 

 Returns for the next 3-5 years and thereby the returns to the venture fundReturns for the next 3-5 years and thereby the returns to the venture fund 

 Budgeting methods to be adopted and budgetary control systemsBudgeting methods to be adopted and budgetary control systems 

 External financial audit if requiredExternal financial audit if required

Sometimes, companies may have experienced operational problems during their early Sometimes, companies may have experienced operational problems during their early stages of growth or due

stages of growth or due to bad management. These could result in losses or cash flowto bad management. These could result in losses or cash flow drains on the company. Sometimes financing from venture capital may end up being drains on the company. Sometimes financing from venture capital may end up being used to finance these losses. They avoid this through due diligence and scrutiny of the used to finance these losses. They avoid this through due diligence and scrutiny of the business plan.

business plan.

3. 3. Structuring

Structuring a

a deal

deal

Structur

Structuring refers to ing refers to putting together the financial aspects of putting together the financial aspects of the deal and the deal and negotiatnegotiatinging with the entrepreneurs to accept a venture capital’s proposal and finally closing the with the entrepreneurs to accept a venture capital’s proposal and finally closing the deal. Also the structure should take into consideration the various commercial issues deal. Also the structure should take into consideration the various commercial issues (ie what the entrepreneur wants and what the

(ie what the entrepreneur wants and what the venture capital would require to protectventure capital would require to protect the investment).