Venture Capital

VENTURE CAPITAL

Prof.Biswo Ranjan Mishra

Meaning of Venture Capital

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

• Venture Capitalist pool their resources including managerial abilities to assist new entrepreneurs in the early years of the project.

• Once the project reaches the stage of profitability, they sell their equity holding at high premium.

Features of Venture Capital------

• Venture capital is usually in the form of an equity participation. It may also take the form of convertible debt or long term loan.

• Investment is made only in high risk but high growth potentials.

• Venture capital is available only for commercialization of new ideas or new technologies.

• Venture capitalist joins the entrepreneurs as a co-promoter in projects and share the risks and rewards of the enterprise.

------Features of Venture Capital

• There is continuous involvement in business after making an investment by the investor.

• Once the venture has reached the full potential the venture capitalist disinvests his holding either to the promoters or in the market.

• Venture capital is not just injection of money but also an input needed to set-up the firm, design its marketing strategy and organize and manage it.

• Investment is usually made in small and medium scale enterprises.

Stages Of Venture Capital Financing

• Seed capital: The financing of the initial product development or the capital provided to an entrepreneur to prove the feasibility of a project and to qualify for start-up capital / R&D financing

• Start-up financing: Capital needed to finance the product development, initial marketing and the establishment of product facilities / new activity is launched

---------Stages Of Venture Capital Financing

• Early stage financing: Finance provided to companies that have completed development stage and require further funds to initiate commercial manufacturing and sales /They will not yet generating profits.

• Follow-on financing: the provision of capital to a firm which has previously been in receipt of external capital but whose financial needs have subsequently expanded .The project must proved to be successful.


• Expansion financing: The finance provided to fund the expansion or growth of a company which is breaking even or trading at a small profit .The company must gained market share.

• Replacement financing: A later stage financing whereby finance is provided in lieu of existing equity shares to be sold at a later date when the company goes for listing . This is also known as money out deal.


• Turn-around financing: The finance provided in the event of an enterprise becoming unprofitable after launch of commercial production.

• Mezzanine Finance: The last stage financing which is half way between equity and loan capital, in terms of risk and return.

Analyzing Venture Capital Proposal-------

• Fundamental Analysis– History (History of the company, date of incorporation,

summary of progress)– Management ( Quality, experience, strategy & motivation of

management, directors, shareholders)– Products (Description of company’s product & services)– Markets (Size nature of business, location, potential

competition, USPs)– Manufacturing (Technology used, source of supply,

manufacturing capacity)– Risks (Objective analysis of fundamental risks and

management’s plan to cope with the same )

--------Analyzing Venture Capital Proposal

• Financial Analysis– Earnings growth potential– Sensitivity of earnings to sales and margins– Likely time lag between investment and returns– Likely impact on cash flows – Expected value of the company at the notional

time of divestment– Financial risks and management’s plan to cope

with these


• Portfolio Analysis – Size of investment (Amount of money per

investment)– Stage of development ((Some investment in start up

stage, Some in development stage, Some in maturity stage)

– Geographic location (International diversity should be with a local fund)

– Industry sectors (Diversify portfolio in order to off set problematic or slow growth investments)


• Divestment Analysis– Trade sale (The process of selling the investment to a

company in the trade)– Take-out (The process of selling the investment to

another professional investor, another venture capitalist)

– Earn out (Venture capital investment is realized through the entrepreneur buying back the venture capitalist share with proceeds of the project)

– Flotation ((Issue of securities in stock market)

Investment Nurturing

• The process, by which venture capital companies continue to involve themselves in the operations of concerns assisted by them, is called Investment Nurturing.

• The main elements of nurturing are as follows:1. Provision of continuing guidance and support to optimize

the benefits of investment to both the venture capital companies and the units concerned

2. Building a joint relationship to tackle operational and other problems of business

3. Protection of the investment / interest of the venture capitalist

Objectives of Nurturing• Ensuring proper utilization of assistance provided, any deviation from

the programmed / appraisal should be with prior approval of VCI.• Ensuring the implementation of the project / venture within the time

and cost envisaged• Assisting in finding additional / supplementary finance, in case of time

and cost over-runs beyond controls of the VCU• Providing strategic inputs in technology, production, finance,

marketing, personnel and so on• Anticipating likely problems and advise remedial / preventive

measures• Evaluating performance of the project and suggesting measures for

improvement

Styles of Nurturing/Methods of Nurturing---------

• The extent of participation by the venture capital companies in the affairs of the assisted units constitutes the style of nurturing.

• The style depends upon a variety of factors such as the specialization of the venture capital company, the stage of investment, financing plan, the stage of development of the venture capital industry etc.

• The different styles are:1. Hands-on nurturing2. Hands-off nurturing3. Hands-holding nurturing

Hands-on-Nurturing• Continuous and constant involvement in the operation of

the investee company by way of representation on the board of director is ‘Hands-on-Nurturing’.

• Venture capital company provides guidance on long term business planning, technology development, financial planning, marketing strategy etc.

• This style is essential in early stage of the project.• The nurturing is provided either by in-house-expertise,

or by a core group of external advisor in specific area.

Hands-off Nurturing

• In this style the venture capitalist do not normally actively participate in formulating strategies / policy matters,inspite of the right to do so.

• Here the venture capitalist do not appoint nominee directors.

• This style is appropriate incase of syndicated /Joint/ Consortium venture financing.

• It may be appropriate after the initial plan of the venture is over, and the business is running smoothly.

Hands-Holding Nurturing

• In this style, the venture capital companies take part in the management of the venture only when approached by the units.

• Venture capitalist provide either in-house assistance or arrange assistance, from outside expert.

Nurturing Methods/Techniques of Nurturing--------

• Personal Discussions (If the venture facing operational problem)

• Plant Visits (Ventures which are in implementation stage)

• Feedback (Collect information through nominee directors)

• Periodic Reports (Sent by the units to VC)• Commissioned Studies (Special studies conducted to

identify problem & offer solutions)

Exit Mechanism

• Every venture capital investment is usually liquidated after accomplishment of the purpose of the venture investment.

• The time of exit is decided in advance at the time of financing the venture companies.

• The methods of exit are as follows:1. IPO method2. Sale of shares method3. Puts and Calls method4. Trade sales5. Liquidation

IPO Method-------

• It is also known as going public or flotation method.• It is the most popular exit route.• The major benefit of this method:1. It facilitates liquidity of investment through listing on

stock exchange.2. It commands higher price of securities as compared to

private placement.3. It creates better image & credibility with the

public,managers,customers and financial institution.

----- IPO Method

• The major drawback of this method is: higher issue cost, increased accountability to shareholders, etc.

• Venture capitalists can also approach the OTCEI as a public issue for exiting, whereby bought-out deals are struck with the members of the OTCEI, who would in turn offer the shares thus acquired, to the public at a future date.

Sale of shares method------

• Under this method ,sale of shares is undertaken by the venture capitalists to entrepreneurs who have promoted the ventures.

• The entrepreneurs, through employees, can also acquire shares by forming an employee stock ownership trust.

• The sources of the trust include contribution by the employees/company and borrowings from financial institutions and banks.

Puts and calls method--------

• Under this method, the exit takes place through puts and calls.

• For this purpose, venture capital companies enter in to a formal exit agreement with the entrepreneurs at a price based on a predetermined formula.

• The put option is the right to sell, while the call option is the right of the entrepreneurs to buy.

-----Puts and calls method

• The puts and call values are determined as follows:1. Book value method(Book value of Net Assets)2. P/E Ratio(EPS*P/E Ratio)3. Percentage of sales method(Modified P/E)4. Multiplier cash flow method (Cash flow*Industry

multiplier)5. Independent valuation(Out side expert)6. Agreed Price(Price agreed at the time of financing)

Trade sale----

• Under this method ,the entire investee company is sold to another company at an agreed price.

• This takes place through management buy-in or management buy-out.

• MBOs is the acquisition of a company(or the shares in that company) from the existing owners by a team of existing management /employees.

• Management buy-in involves bringing in a management team comprising of outsiders, who are strangers to the company, as opposed to a buy- out, where they are part of the existing team.

Liquidation-----

• The exit takes place in an involuntary manner.

• This usually happens under circumstances where the assisted unit makes an utter failure to take off due to stiff competition, technology failure/obsolescence of technology, poor management and so on.

SEBI Venture Capital Funds(Amendment )Regulation

2000---• It states that minimum investment in a venture

capital fund from any investor shall not be less than 5lakh and the minimum corpus of the fund before it can start activities shall be Rs 5 crore.

• The investment criteria of the fund shall be:1. Investment strategy shall be disclosed.2. Maximum investment in a single venture capital

undertaking not to exceed 25% of the corpus of the fund.

--------SEBI Venture Capital Funds(Amendment )Regulation 2000

3. Investment in associated companies is not permitted.

4. At least 75% of the investible funds are to be invested in unlisted equity shares or equity linked instruments.

5. Not more than 25% of the investible funds are to be invested by way of subscription to IPO of a venture capital undertaking or debt or debt instrument of a venture capital undertaking.

--------SEBI Venture Capital Funds(Amendment)Regulation 2000• The venture capital funds are now required to

submit a copy of the placement memorandum/copy of contribution agreement entered into with investors along with the details of the fund raised to the SEBI.

• The Venture capital funds have been given (QIB) Qualified institutional buyer status and they can participate in the IPO through the book building route.

--------SEBI Venture Capital Funds(Amendment)Regulation 2000• Mutual funds are permitted to invest up to 5%

of their corpus in the case of an open ended scheme and up to 10% of their corpus in the case of a close ended scheme. This would provide opportunities for small investors to participate in Venture capital activities through mutual fund.

Venture Capital Funds in India-----

Companies Promoted by all India FIs• Venture capital division of IDBI• Risk Capital Technology Finance

Corporation(RCTC) (Subsidiary of IFCI)• Technology Development and Information

Company of India Ltd(TDICI)(Promoted by ICICI & UTI)

------Venture Capital Funds in India

Companies promoted by SFIs:• Gujarat Venture Finance Ltd• Andhra Pradesh Industrial development

corporation Venture capital


Companies Promoted by Banks• Can Bank Venture capital Fund• SBI Venture Capital Fund• Indian Investment Fund(Promoted by

Grindlays Bank)• Infrastructure Leasing Venture Capital

(Promoted by Central Bank of India)


Companies in Private Sector• Indus Venture Capital Fund(Promoted by

Mafatlals & Hindustan Lever)• Credit Capital Venture Fund(India) Ltd.• 20 th Century Venture Capital Corporation

Ltd.• Venture capital Fund promoted by V.B.Desai&

Co.

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