Venture Capital Funds Vivek Kumar Pandey Roll No. 174

Project for Corporate Regulation (HONS I): VENTURE CAPITAL FUNDS

Project on:

VENTURE CAPITAL FUNDS

Submitted to: Dr. Y. Papa Rao

On: 7.4.2015

Submitted by: VIVEK KUMAR PANDEY

Section: C

Project for Corporate Regulation

(Hons. I)

Roll No. : 174

Semester: VIII, B.A LLB. (Hons.)

Hidayatullah National Law University,

Raipur, Chhattisgarh.

DECLARATION1


I hereby declare that this project report entitled

“VENTURE CAPITAL FUNDS”

is genuine and written by me, as my Corporate Regulation , (Honors I) project, with my

own effort and that no part has been plagiarized without citations.

2


ACKNOWLEDGEMENTS

I have taken efforts in this project. However, it would not have been possible without the kind

support and help of many individuals. I would like to extend my sincere thanks to all of them. I

am highly indebted to Dr. Y. Papa Rao, Faculty of Corporate Regulation, for putting trust in

me and giving me a project topic as such as this and for having the faith in me to deliver.

It is with his guidance and constant supervision and support in completing the project. I would like

to express my gratitude towards my parents & member of HNLU for their kind co-operation and

encouragement which help me in completion of this project.

My thanks and appreciations also go to my colleagues in developing the project and people who

have willingly helped me out with their abilities.

Vivek Kumar Pandey

Semester: VIII

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TABLE OF CONTENTS

DECLARATION…...…………………………………………………………………………….......2

ACKNOWLEDGEMENTS………………………………………………………………………..……

3

TABLE OF CONTENTS……………………………………………………...…. ………...

………….4

INTRODUCTION………………………………………………………………...……….………….5

OBJECTIVES………………………………………..………………………………..…………......6

RESEARCH METHODS AND DATA BASE…………………………………………………...

………..6

CHAPTER I: INTRODUCTION TO VENTURE CAPITAL FUNDS- MEANING AND

SIGNIFICANC…………………………………………………………………………………...7

CHAPTER II: STRUCTURING VENTURE CAPITAL FUNDS……………………….….10

CHAPTER III OPERATION OF VENTURE CAPITAL FUNDS…………………….……14

CHAPTER IV INDIA IS ATTRACTIVE FOR RISK CAPITAL……………………….….18

CHAPTER V: CRITICAL FACTORS FOR SUCCESS OF VENTURE CAPITAL

INDUSTRY………………………………………………………………………...……………24

CONCLUSION……………………………………………………………………...........................2

5

REFERENCES…………………………………………………………………………….………..25

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INTRODUCTION

Venture capital and private equity funds are becoming increasingly popular routes of foreign

investment into India. Venture capital funds (“VCF”) are professional money managers who

provide risk capital to businesses. They assume various forms; however, they all share the

common trait of making investments in privately held companies at an early stage on the belief

that the investee companies have the potential to provide them a very high rate of return on the

investment made.

Venture capital is money provided by an outside investor to finance a new, growing, or troubled

business. The venture capitalist provides the funding knowing that there’s a significant risk

associated with the company’s future profits and cash flow. Capital is invested in exchange for

an equity stake in the business rather than given as a loan, and the investor hopes the investment

will yield a better-than-average return.

Venture capital is an important source of funding for start-up and other companies that have a

limited operating history and don’t have access to capital markets. A venture capital firm (VC)

typically looks for new and small businesses with a perceived longterm growth potential that will

result in a large payout for investors.

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A venture capitalist is not necessarily just one wealthy financier. Most VCs are limited

partnerships that have a fund of pooled investment capital with which to invest in a number of

companies. They vary in size from firms that manage just a few million dollars worth of

investments to much larger VCs that may have billions of dollars invested in companies all over

the world. VCs may be a small group of investors or an affiliate or subsidiary of a large

commercial bank, investment bank, or insurance company that makes investments on behalf

clients of the parent company or outside investors. In any case, the VC aims to use its business

knowledge, experience and expertise to fund and nurture companies that will yield a substantial

return on the VC’s investment, generally within three to seven years.

Not all VC investments pay off. The failure rate can be quite high, and in fact, anywhere from 20

percent to 90 percent of portfolio companies may fail to return on the VC’s investment. On the

other hand, if a VC does well, a fund can offer returns of 300 to 1,000 percent.

In additional to a portion of the equity, a VC expects to have a say in how its portfolio company

operates. Ideally, the VC fosters growth at the company through its involvement in managerial,

strategic, and planning decisions. To do this, the VC relies on the expertise of its general partners

who may be former CEOs, bankers, or experts in a particular industry. In most cases, one or

more general partners of the VC take Board of Director positions at a portfolio company. They

may also help recruit key executives to the portfolio company.

6


OBJECTIVES

To study about meaning of Venture Capital Funds.

To know about its structure and its operation.

To critically analyze the venture capital funds.

RESEARCH METHODOLOGY

This research project is descriptive and analytic in nature and mainly based on secondary sources

which include books and web pages on this topic. I’ve referred to various books kept in the library.

These methods do not include field work and mainly depend on electronic resources. I owe my chief

source of inspiration to our respected faculty. The data base referred is not copied from any other

source and is purely authentic and genuine.

7


CHAPTERIZATION

CHAPTER I: INTRODUCTION TO VENTURE CAPITAL FUNDS- MEANING AND

SIGNIFICANCE

Venture capital is a specific type of finance well suited to the requirements of new technology

based firms. The combination of research and development, intangible assets, negative earnings,

uncertain prospects and absence of a proven track record, which are characteristic of start-up and

pre-commercial initiatives, leads to an unacceptably high perception of risk for conventional

financial institutions and debt financing. Venture capital addresses the consequent financing gap

through equity participation.

Venture capital was conceived in 1946 in the US, but its growth only accelerated in the late

1970s. In Europe, venture capital only started in the 1980s. In the last two decades venture

capital has grown to become a well-established sector with recognised conventions and practices,

such as:

• Development of venture capital firms managing pools of capital predominantly structured as

“limited partnership” venture capital funds with clear fees and incentives for the fund's

performance;

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• Specialisation of venture capital funds in terms of phase of company development and type of

financing (seed, start-up, second-/third-stage, etc), sectoral and geographical focus, etc;

• Type of venture capital firm: run by private individuals (independent), subsidiary of a financial

institution (captive), corporate entity (corporate venturing) or affiliated to public authority;

• Accepted principles for raising funds, assessing investment proposals (due diligence),

monitoring (growing) the investments (investee companies) and planning the exits (investment 1realisation) from the early stages of an investment. Venture capital can be seen to consist of a

demand and a supply cycle. 2

The former represents the demand for capital for the creation and growth of companies - by

implication SMEs. The cycle starts with the necessity for seed capital, to fund an initial idea or

basic research. It proceeds with the funding requirements of the successive stages of a company's

growth, such as test marketing, product development, full-scale production through to final

market rollout. The cycle closes with the exit, typically a private “trade sale” or “initial public

offering” (IPO) on a stock market, and the reimbursement of the invested capital plus gains.

Each stage is associated with a different level of risk during which the nascent SME requires

sufficient and appropriate funding to sustain growth and avoid liquidity constraints, which may

endanger its ultimate commercial success and access to conventional debt financing. Similarly,

venture capital firms can be viewed as representative of the supply cycle, starting with the

creation of a venture capital fund, typically having a 10-year life span, raising the necessary

funds from capital providers (investors) and marketing and investing the fund in “investee”

initiatives and companies over the first 2-3 years. In subsequent years the fund managers play an

active role in monitoring, advising and growing the value of investees so that in the later years of

the fund's life, investments can be exited from successfully. The cycle renews itself with the

venture capital firm launching a new fund3

Venture Capital Fund Management:

1 see <http://www.iosrjournals.org/iosr-jbm/papers/Vol4-issue2/G0424670.pdf> as accessed on 1st april 2015. 2 http://en.wikipedia.org/wiki/Venture_capital > as acessed on 1st April 2015/ 3 http://www.moneycontrol.com/glossary/mutual-fund/what-is-venture-capital-what-are-venture-capital-funds_1599.html as acessed on 1st Aprill 2015.

9

http://www.moneycontrol.com/glossary/mutual-fund/what-is-venture-capital-what-are-venture-capital-funds_1599.html

http://www.moneycontrol.com/glossary/mutual-fund/what-is-venture-capital-what-are-venture-capital-funds_1599.html

http://www.iosrjournals.org/iosr-jbm/papers/Vol4-issue2/G0424670.pdf


It is thorough due diligence process of investees prior to investment, requiring fund managers to

have specific technology expertise, to ensure a sectorally balanced supply of capital and avoid

any “herding” behaviour where investment decisions mimic market trends rather than add value -

as experienced in the recent past with the “dotcom bubble” to the detriment of biotechnology

investments; o thorough monitoring of investees, requiring fund managers to provide commercial

and managerial support, as well as to supply successive capital infusions adapted to the growth

pattern characteristic of each sector and to the specific type of product or service under

development; o congruence of the exit route and the characteristics of the investee's assets,

including “platform building” to achieve critical mass and accelerate exit.4

The role of venture capital

A person with an idea, discovery or invention – the budding entrepreneur – will first commit his

savings to test his concept. Failing this, or when extra funding is required, he will turn to his

immediate family and friends with a request for financial support. However, funding needs are

likely to rapidly exceed the entrepreneur's own and immediate entourage resources, especially if

his concept proves worthy of further development. This is the phase where seed finance is

required. Seed finance from a venture capital fund or a business angel might typically be in the

range of up to a couple of hundred thousand euros to support the development of an innovation.

The entrepreneur will use the funds to prove and develop his concept, to research the market

potential and to prepare a business plan. If successful, the entrepreneur will also have to start

building a management team, probably with5 the assistance of the capital provider. This is

important because the entrepreneur – possibly a scientist or engineer – is unlikely to have the

marketing, financial and other managerial skills necessary to bridge the forthcoming

“commercialisation gap”. 6

The nascent company will require more capital to prepare for and initiate commercial operations.

By this phase the company will have completed market studies, assembled the key management,

developed a business plan and be ready to do business. However, in the absence of any sales

revenue, let alone profits, the company will be relying upon start-up and early-stage finance to

4 http://business.gov.in/business_financing/venture_capital.php as acessed on 12th March 2015; 5 http://www.sebi.gov.in/cms/sebi_data/commondocs/vcfnew_p.pdf as accessed on 1st April 2015. http://www.investopedia.com/terms/v/vcfund.asp as acessed on 31st March 2015. 6

10

http://www.investopedia.com/terms/v/vcfund.asp

http://www.sebi.gov.in/cms/sebi_data/commondocs/vcfnew_p.pdf

http://business.gov.in/business_financing/venture_capital.php


progress. Start-up and early-stage finance can range up to several million euros. In the absence of

a track record by which to judge the company, the venture capital fund in deciding whether to

provide capital will rely on its perception of the company's ultimate success and, therefore, on

the thoroughness of the business plan and the experience and robustness of the company's

management. The venture capital fund will seek to protect its investment, usually provided in the

form of an equity participation in the company, by imposing certain conditions, such as vetting

or appointing key management and being represented on the company's board. As the company

expands, its needs for capital will commensurately grow.

Capital may be required to increase production capacity, develop products and markets or to

provide additional working capital. By this stage, the company will have sales revenue and

probably will be generating a profit, which, however, may be insufficient to fund its expansion.

It may, therefore, revert to its capital provider for second-/third-stage finance. Depending on the

sector of the company's activity and its phase of development, second-/ third-stage finance may

range well above ten million euros. By now, the company will have a track record to assist the

venture capital fund in deciding whether to provide capital. However, largely the same criteria

and conditions for providing start-up and early-stage finance would apply. Additionally, the

venture capital fund is likely to limit its exposure to a particular company by syndicating its

investment with other funds. 7

Ultimately, a successful company will reach a development phase when it will be ready for an

initial public offering (IPO) on a stock market and become a fully fledged public (quoted)

company. Depending on the sector, IPOs are made before the company is profitable, like in the

biotechnology 5 For a comprehensive analysis of business angels, namely the different behaviour

of business angels and venture capitalists in financing entrepreneurship, see van Osnabrugge and

Robinson (1999a) and European Commission (2000)

CHAPTER II: STRUCTURING VENTURE CAPITAL FUNDS

The three (3) most common types of venture capital funds are as follows:

Domestic Funds8

7 http://www.legalservicesindia.com/article/article/regulatory-aspects-of-venture-capital-in-india-265-1.html as acessed on 1st April 2015. 8 http://www.thebhc.org/sites/default/files/beh/BEHprint/v023n2/p0001-p0026.pdf as accessed on 1st April 2015.

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http://www.thebhc.org/sites/default/files/beh/BEHprint/v023n2/p0001-p0026.pdf

http://www.legalservicesindia.com/article/article/regulatory-aspects-of-venture-capital-in-india-265-1.html


For domestic funds (i.e., where the funds are going to be raised in India), the structure most

commonly used involves the establishment of a domestic investment vehicle which pools funds

from the investors, and also a separate investment advisor for carrying on asset management

activities and identifying possible investee companies. The domestic investment vehicle is either

a trust or company. It is pertinent to note that unlike in the US or the UK, India does not

recognize limited partnerships. Due to operational flexibility, trusts have been the most favoured

option for domestic VCFs.9

Offshore Funds

Here, an investment vehicle in the form of a limited liability company or limited liability

partnership organized in an offshore tax favorable jurisdiction makes portfolio investments into

Indian companies. Mauritius, which has a favorable tax treaty with India, is routinely used to

locate the investment vehicle (see discussion below). Usually, there is an offshore manager to

administer the assets of the fund, and an investment advisor in India for identifying deals and

prospective investment opportunities.

However, in such a structure, the relationship between the Indian advisor, the overseas manager

and the offshore fund must be structured very carefully. This is important so as to avoid a

situation where the offshore fund is deemed to have a permanent establishment (“PE”) in India,

which can have adverse tax implications.10

Unified Funds

This structure is generally used where domestic investors are also expected to participate in the

fund. In this structure, a domestic investment vehicle is established in India preferably as a trust

(alternatively, as a company) in addition to the offshore fund. This domestic trust is registered

with the Securities Exchange Board of India as a venture capital fund. The domestic investors

directly contribute to the domestic trust, whereas overseas investors pool their investments into

9 http://www.smoothridetoventurecapital.com/PVI.A02_Venture.Capital.Industry.in.India.pdf as accessed on 2nd April 2015. 10 http://www.ojasventures.com/ as accessed on 12th March 2015.

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http://www.ojasventures.com/

http://www.smoothridetoventurecapital.com/PVI.A02_Venture.Capital.Industry.in.India.pdf


the offshore fund, which, in turn, invests in the domestic trust. The portfolio investments are

made by the trust, which will generally have a domestic manager or advisor.11

This structure is preferred from a tax perspective as well. As the Indian advisor is not connected

with the offshore fund directly and it draws its compensation from the domestic trust, the

chances of the Indian advisor being considered as the offshore fund’s PE are fairly slim12

CHAPTER III OPERATION OF VENTURE CAPITAL FUNDS

The operation of a venture capital fund can be viewed as a “cycle”8 . The cycle starts with the

“fund raising” process; proceeds through the investment in, monitoring of, and adding value to

firms; and concludes as the management team exits successful deals (see section 2.6) and returns

capital to their investors. The cycle renews itself with the management team raising of a new

fund. The “fund raising” process may take up several months during which the management

team seeks commitments from investors. To do this the management team prepares an

Information Memorandum, which, in addition to the principal terms and conditions outlined

above, will provide information on:

• the fund's investment strategy, focus (stage, sector, geographical region, etc) and rationale;

• the target size of the fund and its minimum size for first closure, with respective closing dates;

• the “market” of potential investee companies and the proposed “marketing” strategy to

generate “deal-flow”; 13– Final version • the management team's experience and capacity to

assess the proposed deals – to perform the required “due diligence”

; • the decision-making process to ensure the fund is soundly invested;

• the expected number, individual size and relative importance to the size of the fund of the

deals;

11 http://articles.economictimes.indiatimes.com/2014-05-26/news/50098927_1_idg-ventures-india-tiger-global-lee-fixel as acessed on 2nd April 2015. 12 http://economictimes.indiatimes.com/definition/venture-capital as accessed on 3rd April 2015. 13 See Gompers and Lerner (1999, 2000) 12 Financing innovative firms through venture capital C. Christofidis/O. Debande – 22/02/01

13

http://economictimes.indiatimes.com/definition/venture-capital

http://articles.economictimes.indiatimes.com/2014-05-26/news/50098927_1_idg-ventures-india-tiger-global-lee-fixel



• the management team's attitude to investee companies (e.g. hands-on management, board

participation, etc) and ability to add value, grow the companies over a period of time and realise

the investments (“exit”);14

• the reporting to investors (annual reports, meetings…) and the envisaged investor relation

committees and advisory board. Already during the fund raising process, the management team

will have started “marketing the fund” to identify and attract investment opportunities.

Established venture capital firms and teams, with funds under management, may regularly be

receiving requests from earlier contacts and require less active marketing. Depending on the

focus and investment strategy of the venture capital firm, the contacts may be oriented towards

academia and R&D foundations (seed and start-up financing). Otherwise, contacts would be in

the area of conventional financial institutions (growth and later stage). In any case, the venture

capital firm will seek to expand continuously its network of contacts, also by relying on the due

diligence of previous and current deals. Of course marketing through contacts will be

supplemented by normal advertising of the fund in the specialist press and by participation and

presentations in conferences and fairs. With the fund closed and marketing under way, deals will

start flowing to the management team for assessment and, depending on the outcome of the “due

diligence”, possible financing.15

venture capital industry in India is still at a nascent stage. With a view to promote innovation,

enterprise and conversion of scientific technology and knowledge based ideas into commercial

production, it is very important to promote venture capital activity in India. India‘s recent

success story in the area of information technology has shown that there is a tremendous

potential for growth of knowledge based industries. This potential is not only confined to

information technology but is equally relevant in several areas such as bio-technology,

pharmaceuticals and drugs, agriculture, food processing, telecommunications, services, etc.

Given the inherent strength by way of its skilled and cost competitive manpower, technology,

research and entrepreneurship, with proper environment and policy support, India can achieve

rapid economic growth and competitive global strength in a sustainable manner.

14 https://hbr.org/2014/08/vc-funding-can-be-bad-for-your-start-up/ as accessed on 3rd April 2015. 15 https://www.mycapital.com/VenetureCapital101_MyCapital.pdf as acessed on 2nd April 2015.

14

https://www.mycapital.com/VenetureCapital101_MyCapital.pdf

https://hbr.org/2014/08/vc-funding-can-be-bad-for-your-start-up/


A flourishing venture capital industry in India will fill the gap between the capital requirements

of Manufacture and Service based startup enterprises and funding available from traditional

institutional lenders such as banks. The gap exists because such startups are necessarily based on

intangible assets such as human capital and on a technology-enabled mission, often with the

hope of changing the world. Very often, they use technology developed in university and

government research laboratories that would otherwise not be converted to commercial use.

However, from the viewpoint of a traditional banker, they have neither physical assets nor a low-

risk business plan.

Not surprisingly, companies such as Apple, Exodus, Hotmail and Yahoo, to mention a few of the

many successful multinational venture-capital funded companies, initially failed to get capital as

startups when they approached traditional lenders. However, they were able to obtain finance

from independently managed venture capital funds that focus on equity or equity-linked

investments in privately held, high-growth companies. Along with this finance came smart

advice, hand-on management support and other skills that helped the entrepreneurial vision to be

converted to marketable products.16

A similar investor preference for start-up IT companies is being seen, though not of the same

magnitude. Yet, it is apparent that investors are willing to take higher risks for a potentially

higher reward by investing in start-up companies. Until 1998, the venture creation phenomenon

for the IT sector in India had been quite unsatisfactory. Some experts believe that India lacks

strong anchor companies like HP and Fairchild, which funded the start-ups of early Silicon

Valley entrepreneurs. Others believe that Indian entrepreneurs are not yet globally connected and

are often unwilling to share equity with a quality risk capital investor. There was also a

perception that startups in India do not typically attract the right managerial talent to enable rapid

growth. Finally, exit options were considered to be few, with the general feeling that

entrepreneurs were unwilling to sell their start-ups even if it was feasible. 17

As a result, much of the risk capital available was not quickly deployed. However, since March

1999, things have been changing dramatically for the better. The venture capital phenomenon

has now reached a take-off stage in India. Risk capital in all forms is becoming available more

16https://www.sec.gov/divisions/investment/guidance/im-guidance-2013-13.pdf as acessed on 4th April 2015. 17 http://www.treasury.gov/resource-center/sb-programs/Documents/VC%20Report.pdf as accessed on 3rd April 2015.

15

http://www.treasury.gov/resource-center/sb-programs/Documents/VC%20Report.pdf

https://www.sec.gov/divisions/investment/guidance/im-guidance-2013-13.pdf


freely. As against the earlier trend, where it was easy to raise only growth capital, even financing

of ideas or seed capital is available now. The number of players offering growth capital and the

number of investors is rising rapidly.

The successful IPOs of entrepreneur-driven Indian IT companies have had a very positive effect

in attracting investors. The Indian government initiatives in formulating policies regarding sweat

equity, stock options, tax breaks for venture capital along with overseas listings have all

contributed to the enthusiasm among investors and entrepreneurs, as has the creation of the

dot.com phenomenon. In India, the venture capital creation process has started taking off.

All the four stages - including idea generation, start-up, growth ramp-up and exit processes - are

being encouraged. However, much needs to be done in all of these areas, especially on the exit

side.

CHAPTER IV INDIA IS ATTRACTIVE FOR RISK CAPITAL:-

India certainly needs a large pool of risk capital both from home and abroad. Examples of the

US, Taiwan and Israel clearly show that this can happen. But this is dependent on the right

regulatory, legal, tax and institutional environment; the risk-taking capacities among the budding

entrepreneurs; start-up access to R&D flowing out of national and state level laboratories;

support from universities; and infrastructure support, such as telecoms, technology parks, etc.

Steps are being taken at governmental level to improve infrastructure and R&D. Certain NRI

organizations are taking initiatives to create a corpus of US$150m to strengthen the

infrastructure of IITs. More focused attempts will be required in all these directions. Recent

phenomena, partly ignited by success stories of Indians in the US and other places abroad,

provide the indications of a growing number of young, technically-qualified entrepreneurs in

India. Already there are success stories in India. At the same time, an increasing number of

savvy, senior management personnel have been leaving established multinationals and Indian

companies to start new ventures. The quality of enterprise in human capital in India is on an

ascending curve. The environment is ripe for creating the right regulatory and policy

environment for sustaining the momentum for high-technology entrepreneurship. Indians abroad

16


have leapfrogged the value chain of Role of Venture technology to reach higher levels. At home

in India, this is still to happen.18

By bringing venture capital and other supporting infrastructure, this can certainly become a

reality in India as well. India is rightly poised for a big leap. What is needed is a vibrant venture

capital sector, which can leverage innovation, promote technology and harness the ongoing

knowledge explosion. This can happen by creating the right environment and the mindset needed

to understand global forces. When that happens we would have created not ‗Silicon Valley' but

the ‗Ind Valley' - a phenomenon for the world to watch and reckon with.

A viable venture capital industry depends upon a continuing flow of investment opportunities

capable of growing sufficiently rapidly to the point at which they can be sold yielding a

significant annual return on investment. If such opportunities do not exist, then the emergence of

venture capital is unlikely. In the U.S. and Israel such opportunities occurred most regularly in

the information technologies.

Moreover, in every country, with the possible exception of the U.S., any serious new opportunity

has to be oriented toward the global market, because few national markets are sufficiently large

to generate the growth capable of producing sufficient capital gains. Since Independence, the

Indian government strove to achieve autarky and the protection of Indian markets and firms from

multinational competition guided nearly every policy – the information technology industries

were no exceptions. 19

The protectionist policy had benefits and costs. The benefit was that it contributed to the creation

of an Indian IT industry; the cost was that the industry was backward despite the excellence of its

personnel. Due to this lack of foreign investment and despite the presence of skilled Indian

personnel, India was a technological backwater even while East Asia progressed rapidly. In

terms of experience, India contrasted favorably with most developing countries, which had

small, inefficient stock markets listing only established firms. However, although these stock

markets provided an exit opportunity, they did not provide the capital for firm establishment. Put

differently, accessible stock markets did not create venture capital for startups; they merely

18 http://www.kauffman.org/~/media/kauffman_org/research%20reports%20and%20covers/2012/05/we%20have%20met%20the%20enemy%20and%20he%20is%20us(1).pdf as accessed on 3rd April 2015. 19 http://faculty.chicagobooth.edu/steven.kaplan/research/kaplanlerner.pdf as acessed on 2nd April 2015.

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http://faculty.chicagobooth.edu/steven.kaplan/research/kaplanlerner.pdf

http://www.kauffman.org/~/media/kauffman_org/research%20reports%20and%20covers/2012/05/we%20have%20met%20the%20enemy%20and%20he%20is%20us(1).pdf



provided an opportunity for raising follow-on capital or an exit opportunity. Other institutional

sources of funds .India has a strong mutual fund sector that began in 1964 with the formation of

the Unit Trust of India (UTI), an open-ended mutual fund, promoted by a group of public sector

financial institutions. Because UTI‘s investment portfolio was to consist of longer-term loans, it

was meant to offer savers a return superior to bank rates. In keeping with the risk-averse Indian

environment, initially UTI invested primarily in long-term corporate debt. 20

However, UTI eventually became the country‘s largest public equity owner as well. This was

because the government controlled interest rates in order to reduce the borrowing costs of the

large manufacturing firms that it owned. These rates were usually set well below market rates,

yet UTI and other institutional lenders were forced to lend at these rates. In response, firms

started issuing debt that was partially convertible into equity in order to attract institutional

funds. The largest single source of funds for U.S. venture capital funds since the 1980s has been

public and private sector pension funds. In India, there are large pension funds but they are

prohibited from investing in either equity or venture capital vehicles, thus closing off this source

of capital. In summation, prior to the late 1980s, though India did have a vibrant stock market,

the rigid and numerous regulations made it nearly impossible for the existing financial

institutions to invest in venture capital firms or in startups.

Nearly all of these institutions were politicized, and the government bureaucrats operating them

were risk-adverse. On the positive side, there was a stock market with investors amenable to

purchasing equity in fairly early-stage companies. It was also possible to bootstrap a firm and/or

secure funds from friends and family – if one was well connected. However, no financial

intermediaries comfortable with backing small technology-based firms existed prior to the mid

1980s. It is safe to say that little capital was available for any entrepreneurial initiatives. An

entrepreneur aiming to create a firm would have to draw upon familial capital or bootstrap their

firm. An Indian venture capital industry is struggling to emerge and given the general global

downturn, the handicaps existing in the Indian environment are threatening. As we have seen,

many of the preconditions do exist, but the obstacles are many.21

20 http://zoo.cs.yale.edu/classes/cs155/fall01/kearns.pdf as acessed on 2nd April 2015. 21 http://www.cemfi.es/~suarez/repullo-suarez.pdf as acessed on 2nd April 2015.

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http://www.cemfi.es/~suarez/repullo-suarez.pdf

http://zoo.cs.yale.edu/classes/cs155/fall01/kearns.pdf


Some of these can be addressed directly without affecting other aspects of the Indian political

economy. Others are more deeply rooted in the legal, political, and economic structure and will

be much more difficult to overcome without having a significant impact on other parts of the

economy. A number of these issues were addressed in a report submitted to SEBI in January

2000 from its Committee on Venture Capital. 22

SEBI then recommended that the Ministry of Finance adopt many of its suggestions. In June

2000, the Ministry of Finance adopted a number of the Committee‘s proposals. For example, it

accepted that only SEBI should regulate and register venture capital firms. The only criterion

was to be the technical qualifications of their promoters, whether domestic or offshore. Such

registration would not impose any capital requirements or legal structure – this is very important,

because it would allow India to develop a legal structure suitable to its environment, while

offering tax pass-through for all firms registered as venture capital firms with SEBI. This was an

important achievement of the Committee‘s report. However, the proposed guidelines continued

to prohibit finance and real estate investments. Whether this type of micromanagement is good

policy seems dubious. Also, registered venture capital funds must invest 70 percent of their paid-

in capital in unlisted equity or equity-related, fully convertible instruments. Similarly, related-

company transactions would Role of Venture Capital in Indian Economy e be prohibited, and not

more than 25 percent of a fund‘s capital could be invested in a single firm. In the U.S. most of

these provisions are not law, but are codified in the limited partnership contracts and accepted as

common sense. Rather than letting the market decide which venture capital firms are operating

responsibly, the Indian government continues to specify a variety of conditions.23

A number of suggestions were not accepted even though they would assist in the growth of

venture capital. Many were related to the much larger general issues of corporate governance.

For example, there was no change in the regulations regarding restrictions on currency no

convertibility, providing employees more flexible stock-option plans, allowing domestic venture

capital firms to hold equity in overseas startups, and regulations allowing greater flexibility in

voting and dividend rights. Reluctance to adopt these measures is understandable, because they

22 https://www.india-financing.com/Venture_Capital_Fund_in_India.pdf as acessed on 2nd April 2015 23http://www.angelcapitalassociation.org/data/Documents/Resources/McKaskill_- _Raising_Angel_and_VC_Finance.pdf as accessed on 2nd April 2015.

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http://www.angelcapitalassociation.org/data/Documents/Resources/McKaskill_-_Raising_Angel_and_VC_Finance.pdf


https://www.india-financing.com/Venture_Capital_Fund_in_India.pdf


would strike at some of the fundamental issues of corporate governance in India. Thus they were

seen as policy decisions that might set in motion a larger chain of events.

At the end of 2001, the Indian venture capital environment contained several unresolved issues.

One important obstacle was the inability to pass through unrealized gains or losses through to the

venture capital fund's investors through a direct distribution of stock or other securities unless the

fund is organized as a trust. In the US, these "in-kind distributions" are the most common method

of compensating investors.24

This method increases the return for socially beneficial tax-exempt organizations such as

foundations and pension funds. Private individuals, of course, pay taxes. Allowing legal

structures, such as limited partnerships, will enable such pass-through and encourage investment

in venture capital funds India has a large, sophisticated financial system including private and

public, formal and informal actors. In addition to formal financial institutions, informal

institutions such as family and moneylenders are important sources of capital. India has

substantial capital resources, but as Table 1 indicates, the bulk of this capital resides in the

banking system.

In the formal financial system, lending is dominated by retail banks rather than the wholesale

banks or the capital markets for debt. The primary method for firms to raise capital is through the

public equity markets, rather than through private placements

CHAPTER V: CRITICAL FACTORS FOR SUCCESS OF VENTURE CAPITAL

INDUSTRY

While making the recommendations the Committee felt that the following factors are critical for

the success of the VC industry in India: (

A) The regulatory, tax and legal environment should play an enabling role. Internationally,

venture funds have evolved in an atmosphere of structural flexibility, fiscal neutrality and

operational adaptability.

(B) Resource raising, investment, management and exit should be as simple and flexible as

needed and driven by global trends

24 http://www.thebhc.org/sites/default/files/beh/BEHprint/v023n2/p0001-p0026.pdf as accessed on 3rd April 2015.

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(C) Venture capital should become an institutionalized industry that protects investors and

investee firms, operating in an environment suitable for raising the large amounts of risk capital

needed and for spurring innovation through startup firms in a wide range of high growth areas.

(D) In view of increasing global integration and mobility of capital it is important that Indian

venture capital funds as well as venture finance enterprises are able to have global exposure and

investment opportunities. 25

(E) Infrastructure in the form of incubators and R&D need to be promoted using Government

support and private management as has successfully been done by countries such as the US,

Israel and Taiwan. This is necessary for faster conversion of R & D and technological innovation

into commercial products. 26

The hassle free entry of such Foreign Venture Capitalists in the pattern of FIIs is even more

necessary because of the following factors:

(i) Venture capital is a high risk area. In out of 10 projects, 8 either fails or yield

negligible returns. It is therefore in the interest of the country that FVCIs bear such a

risk.27

(ii) 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.

(iii) The FVCIs are also more experienced in providing the needed managerial expertise

and other supports.28

Recommendations made by K B Chandrasekhar Committee:

(1) Multiplicity of regulations – need for harmonization and nodal Regulator

(2) Double taxation for Venture Capital Funds need to be avoided

25 http://www.kauffman.org/~/media/kauffman_org/research%20reports%20and%20covers/2012/05/we%20have%20met%20the%20enemy%20and%20he%20is%20us(1).pdf as accessed on 2nd April 2015. 26http://www.majmudarindia.com/pdf/Venture%20capital%20funds-%20a%20legal%20and%20structural %20overview.pdf as accessed on 2nd April 2015. 27 http://www.sebi.gov.in/cms/sebi_data/commondocs/vcfnew_p.pdf as acessed on 12th March 2015. 28 http://www.evca.eu/media/78722/guide-on-private-equity-and-venture-capital-2007.pdf as accessed on 2nd April 2015.

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http://www.majmudarindia.com/pdf/Venture%20capital%20funds-%20a%20legal%20and%20structural%20overview.pdf





(3) Mobilization of Global and Domestic resources

(4) Flexibility in Investment and Exit of Venture Capitalists:

(5) Flexibility in the matter of investment ceiling and sectoral restrictions:

(6)Relaxation in IPO norms:29

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

(8) Global integration and opportunities: (A) Incentives for Employees: (B) Incentives for

Shareholders (C) Global investment opportunity for Domestic Venture Capital Funds (DVCF):

Role of Venture Capital in Indian Economy

(9) Development in Infrastructure and R&D (10)Self Regulatory Organization (SRO)

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. 30

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.

29 http://www.eib.org/attachments/pj/vencap.pdf as accessed on 2nd April 2015. 30 http://madisonparkgrp.com/pdf/gtvc.pdf as acessed on 12th March 2015.

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http://madisonparkgrp.com/pdf/gtvc.pdf

http://www.eib.org/attachments/pj/vencap.pdf


CONCLUSION

Venture capital in the India. is significantly larger and more active than in any other country. The control

mechanisms and tight monitoring of high risk/ high reward projects and the information generating

activities of venture capitalists are clearly valuable. Venture capitalists are a long-run competitive

advantage for the American economy. Present and future world leading finns have been, are, and will

continue to be financed by venture capital. Promoting an efficient venture capital sector should be a goal

of any administration. Will venture capital thrive in the 1990s? The question cannot be easily answered

because many policies the Clinton administration has proposed have yet to be implemented. We do not

know if they will succeed in stimulating small business formation in general and venture capital in

particular. Health care reform could curtail investment in promising areas like biotechnology and

medical-related fields. The experiences of the 1980s and the political debate of the early 1990s have

focused attention on small firms as the engine for economic development in the United States for the next

decade. New initiatives and regulations can aid in the growth of venture capital.

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Journal of Finance 48, 831-880. Kaplan, S., F. Martel, and P. Strömberg, 2007, “How Do

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Kaplan, S., "The Staying Power of Leveraged Buyouts," Journal of Financial

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WEBLIOGRAPHY


http://articles.economictimes.indiatimes.com/2014-05-26/news/50098927_1_idg-

ventures-india-tiger-global-lee-fixel



http://www.majmudarindia.com/pdf/Venture%20capital%20funds-%20a%20legal

%20and%20structural%20overview.pdf





http://www.thebhc.org/sites/default/files/beh/BEHprint/v023n2/p0001-p0026.pdf http://

www.angelcapitalassociation.org/data/Documents/Resources/McKaskill_-

_Raising_Angel_and_VC_Finance.pdf

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