The term venture capital was originally coined in U.S.A. and has been developing world wide. The move spread in India in 1973 when R.S. Bhatt Committee recommended the formation of venture capital fund in the country. The concept of venture capital was evolved to help those persons who have good product ideas, but lack the necessary funds to convert these ideas into production. It is a source of finance for the new and untried enterprises having new ideas and new technologies with high risk, but with a potential for rapid growth. Venture capital is usually structured in the form of equity and debt capital. It is provided by the wealthy investors, firms, institutions and companies for all stages of financing the new venture. Some think that venture capital is the early-stage financing of new start-up ventures. Others think that venture capital is the financing of high and new technology-based enterprises. More accurately, venture capital is an alternative form of equity and debt financing made available to new ventures who have technically qualified entrepreneurs with inadequate funds, having high risk but good growth prospects. A few definitions of Venture Capital are as follows :
International Finance Corporation, Washington (IFCW) defines venture capital as “equity or equity featured capital seaking investment in new ideas, new companies, new products, new processes or new services that offer the potential of high returns on invest. ment. It may also include, investment in turn around situations, ” According to the Bank of England, “Venture capital is an activity by which investors support entrepreneurial talent with finance and•business skills to exploit capital gain.” According to Pratt, Venture capital is thought of as, “the early stage financing of new and young enterprises seeking to grow rapid Thus, venture capital is an alternative form o/ equity financing made available to new ventures and technically qualified entrepreneurs with inadequate funds, high risk and good growth prospects.
Entrepreneurial firms which are high risk units, high return ventures and which face the difficulty of funds get their finances from venture capitalists, This type of capital is provided only for new ventures.
CHARACTERISTICS OR ESSENTIALS OF VENTURE CAPITAL
The venture capital financing is different from traditional or conventional financing in that the traditional financiers invest in proven technologies and low risk ventures, whereas venture capitalists invest in new technologies and high risk ventures. Some of the main distinguishing features of venture capital may be summarised as follows :
(1) High Risk : Venture capitalists provide finance to high risk ‘high-reward ventures. These risks involve technology risk, market risk, liquidity risk or any other type of risk.
(2) Equity-Debt Financing : Venture capitalists manage for both equity and debt finances. They invest in shares to get high returns. They earn capital gains by selling the shares once the enterprise prove profitable. They provide debt financing in the form of debentures.
(3) Long-Term Investment : Venture financing is a long-term investment of funds. Funds are provided för 5 to 10 years. Venture capi!al is not repayable on demand. The investor has to wait for a long time to earn profit.
(4) Participation in Management : As already explained venture capitalist not only invests in the equity shareholding of the entrepreneurs company but also participates in the management affairs and gives his advice from time to time. Venture Capitalist has an active involvement in the business of the entrepreneur after making an investment. Thus we can say that venture capitalists don’t just invest, rather they build companies.
(5) Creative Capital : Venture Capital is termed as a creative capital as it propelled new ideas to major commercial successes. It helps entrepreneurs to launch enterprise with a specific promise.
(6) Professional Entrepreneurs : Usually, the venture capital is provided to those entrepreneurs who are professionally or technically qualified but lack adequate funds to start a new venture. The entrepreneur should have the capability to make an intense effort to do the business. He should also have proper knowledge of his markets, along with risk management quality.
(7) New Technology : Venture capitalists provide finance usually to those entrepreneur who try or employ new technology which may produce uncertain results.
SOURCES OF VENTURE CAPITAL
The concept of venture capital was originated in the U.S.A. Now it has become a worldwide concept in the field of risk financing of industrial projects. The development of venture capital in India is still in infancy, being about a decade old. It is a growing capital market. In fact in India, ‘risk financing is still in an evolutionary state. The funds available to Indian venture capital industry are small. What is the need or relevance of venture capital in India when there are commercial banks and financial institutions to provide funds to industrial enterprises, small or large ? In developed countries, where there is highly progressive industrial environment as well as advanced entrepreneurial culture, it is common for entrepreneurs to set up companies to produce new products by Obtaining funds from venture capitalists. On the other hand, in India and also in other developing countries, ‘risk’ financing of this type is yet in its infant stage. Of course, there are a large number of commercial banks and financial institutions in India, which provide ‘traditional’ (non-risk) financing mainly to those enterprises that use proven or established technologies with minimum level of risk. Such financing is collateral-security oriented and asset-based. It involves uniform repayment of fixed instalment. It is security oriented rather than risk-oriented. Traditional finance has a preference for foreign technology firms, and do not trust the entrepreneurs who adopt new products or new technology involving greater risk. In this background of weaknesses or drawbacks of traditional finance the venture capital assumes an important role to play in providing risk finance to small and medium size entrepreneurs. Sources of Venture Capital in India may be divided into three categories :
(I) All India Level Venture Capital Funds.
(Il) State-Level Venture Capital Funds.
(Ill) Specific Venture Capital Funds.
(1) ALL INDIA LEVEL VENTURE CAPITAL FUNDS :– Many Venture Capital Funds are established at All India level to provide venture capital in India. Some of the important venture capital funds are as follows :
(1) IFCI Venture Capital Fund Limited : IFCI provided venture capital assistance for the first time in 1975 after the establishment of risk capital foundation (RCF). The financial capital assistance under IFCI’s risk foundation scheme has been mainly for the traditional industries like textile, iron and steel and chemical. It provides assistance basically for technologists and professionals. General limit of contribution is up to 50% of promoter’s contribution, subject to a ceilling of Rs. million. Only public limited companies were eligible for this finance. IFCI charge no interest on such loans but a nominal service charge is levied. Mode of repayment was that, repayment will be out of dividends and the period of repayment is fixed according to the facts of each case.
(2) IDBI Venture Capital Fund : IDBI Venture Capital Fund (VCF) was started in 1986 with an initial capital ofRs. 10 crore. This fund provide venture capitåLto low and medium grade ventures. IDBI has started seed capital scheme for venture capital finance Main points of seed capital scheme of IDBI are :
(i) Project cost upto ‘Rs.Æ0 ‘millions’and project should be in small or medium firms.
(ii) Assistance will not exceed Rs. 1.5 per project.
(iii) Debt-equity norm of 2 : 1 is stipulated.
(iv) Free of interest loans and nominal service charge.
(v) Assistance is provided through SIDCs/SFCs.
(vi) Policy of being lender of last resort for financial requirements.
(3) ICICI Venture Management Company Ltd : The Government of India issued Venture Capital Guidelines in Novem- ber, 1988. These guidelines authorised all India Financial Institutions, Commercial Banks and their subsidiaries to launch venture capital companies. ICICI in 1988 formed Technology Development and Investment Corporation of India. (TDICI). This corporation managed various schemes •of venture capital financing on commerciallines. This is also the largest venture capital firm in India. It provides assistance to industries directly or through venture funds which are managed by it for other institutions and venture funds out of its own resources. TDICI accepts and evaluates the promotor’s business plan by knowing his management team, nature of his product, market conditions for his product, competition, his investment requirement etc. TDICI goes through the entrepreneur’s business plan, if it finds the plan to be good, and the promotor is clear about his business he gets, his work is almost done, otherwise his project is dropped.
(4) Canbank Venture Capital Fund Limited (CVCFL) : Canbank Venture Capital Fund Limited was established in 1989. At present Canbank has three subsidiary units which possess Rs. 164 crore, Rs. 10•5 crore and Rs. 30 crore respectively. Up to 30th March 2003 Canbank has provided financial aid of Rs. 3424 crore to 51 institutions. Influenced by the success of these venture funds, Canbank is going to establish a fourth venture fund subsidiary, which will be able to provide assistance of venture capital of Rs. 100 crore.
(11) STATE LEVEL VENTURE CAPITAL FUNDS :- In India various state level venture capital funds have been established by the State Governments after realising the significance and role of venture capital in industrial development. These venture capital funds have been promoted by state government. A few among them are :
(1) Gujarat venture Finance Limited (GVFL) : Under venture capital funds sponsored by state level financial institutions is
(iii) Debt-equity norm of 2 : 1 is stipulated.
(iv) Free of interest loans and nominal service charge.
(v) Assistance is provided through SIDCs/SFCs.
(vi) Policy of being lender of last resort for financial requirements.
(3) ICICI Venture Management Company Ltd : The Government of India issued Venture Capital Guidelines in November, 1988. These guidelines authorised all India Financial Institutions, Commercial Banks and their subsidiaries to launch venture capital companies. ICICI in 1988 formed Technology Development and Investment Corporation of India. (TDICI). This corporation managed various schemes •of venture capital financing on commerciallines. This is also the largest venture capital firm in India. It provides assistance to industries directly or through venture funds which are managed by it for other institutions and venture funds out of its own resources. TDICI accepts and evaluates the promotor’s business plan by knowing his management team, nature of his product, market conditions for his product, competition, his investment requirement etc. TDICI goes through the entrepreneur’s business plan, if it finds the plan to be good, and the promotor is clear about his business he gets, his work is almost done, otherwise his project is dropped.
(4) Canbank Venture Capital Fund Limited (CVCFL): Canbank Venture Capital Fund Limited was established in 1989. At present Canbank has three subsidiary units which possess Rs. 164 crore, Rs. 10.5 crore and Rs. 30 crore respectively. Up to 30th March 2003 Canbank has provided financial aid of Rs. 3424 crore to 51 institutions. Influenced by the success of these venture funds, Canbank is going to establish a fourth venture fund subsi diary, which will be able to provide assistance of venture capital of Rs. 100 crore.
(11) srrATE LEVEL VENTURE CAPITAL FUNDS
In India various state level venture capital funds have been established by the State Governments after realising the significance and role of venture capital in industrial development. These venture capital funds have been promoted by state government. A few among them are :
(1) Gujrat venture Finance Limited (GVFL) : Under venture capital funds sponsored by state level financial institutions is GVFL promoted in July, 1990 to provide venture capital for the commercialisation of new technological developments and innovative products. It shares risk of entrepreneurs by providing financial as. sistance in the form of equity and quasi equity.
(2) Punjab Infotech Venture Fund (PIVF) : PIVF i dedicated to investing in companies in the Information Technology Sector within the State of Punjab. The Fund’s investments in companies will be through the route of equity and quasi equity instruments. The Fund will seek to achieve its returns through dividends and capital gains at the time of divestment through an initial public offering or a negotiated sale ofits holding. The Fund is being managed by Punjab Venture Capital Limited, an asset management company, promoted by the PSIDC acting as the nodal agency ofthe Government of Punjab.
(111) SPECIFIC VENTURE CAPITAL FUNDS Despite of Commercial Banks, Private Sector Banks and Financial institutions are also providing venture capital funds to entrepreneurs. Some ofthese VCFs are :
(i) India Investment Fund which is established by Grindly Bank and afterwards it was taken over by Standard Chartered Bank.
(ii) Credit Capital Venture Fund established by Credit Capital Corporation.
(iii) Technology Development and Information Co. Ltd. At present around 16 private sector funds are registered with SEBI and this number is expected to grow faster.
DIFFERENCE BETWEEN TRADITIONAL AND VENTURE CAPITAL
| Traditional Financing | Venture Capital Financing | |
| Technology | Traditional Financing Provides funds to new or untried technology. | |
| Risk | It involves low risk.
|
It involves high risk. |
| Security | The lender adopts a
policy of ‘playing safe’ and insists on some valuable collateral security for repayment of loan amount. |
This is not necessary to
demand security for venture capital financing. |
| Participation in Management | Investor does not take
any responsibility for management of the borrower’s enterprise. |
The venture capitalist
actively involves himself in the management of borrower’s firm.
|
| Finance Stage | It is provided in the
developmental stage.
|
Basically it is provided
inthe start-up stage, although it is also given for expansion, development or traditional acquisition purpöses |
| Period
|
it is generally a
medium-term finance |
It is a long-term
financing. |
| Amount of Funds
|
Traditional lenders
provide small funds.
|
Venture capitalists
provide huge funds. |
| Relations | They maintain conditional commercial
relations. |
They maintain long-
term business relation- ships with entrepreneurs. |
Explain the Venture Capital Fund.
According to SEBI or Securities and Exchange Board of India, Venture Capital Fund is a Fund registered in the form of a company or corporation or trust according to the guidelines of SEBI and :
(i) Have a sufficient fund of capital;
(ii) Collect the fund according to the prescribed rules of SEBI;
(iii) Invest Funds according to the rules laid down by SEBI.
A venture capital fund can be constituted in the form of a trust or a company. Venture capital fund appoints on asset Management Company to manage the portfolio of the fund. A venture capital fund should have Rs. 5 crore (Rs. 50 million) before it can start venture capital activities. As per guidelines issued by the Central Board of Direct Taxes, a venture capital fund could invest upto 40% of the Paid up capital of investor company or upto 20% of the corpus of the fund in one venture.
Describe in brief the various documents required for venture capital.
Venture capital process is different from normal project financing. Tyebjee and Bruno (1984) have given a model of venture capital investment activity which, with some variations, is conmonthly used at present. According to them the venture capital investment process is a sequential process that involve five steps. Documents required at each stage are as follows :
(1) Deal Orientation : At this stage, a letter of introduction is necessary from the referring party sent to the Venture Capital Company. It should present details about the potential venture, its technical viability and good image of the entrepreneur.
(2) Screening : Screening of proposals is necessary to save the time and money cost. Only proposals which clear screening test are considered for evaluation. At this stage the Venture Capital Company may ask for technology and product profiles as well as venture or investment profile depending on the criteria used in the screening process.
(3) Evaluation or Due Diligence : Evaluation or due diligence means careful and proper detailed analysis, The proposals that have successfully passed through the screening process are then subjected to a detailed evaluation process called due diligence. Most of the venture coming to a venture capitalist are new ventures being set up by first-time promoter, neither the ventures have any track record nor the entrepreneur are have any operating experience. In such cases, the venture capital company uses a subjective but comprehensive evaluation. At this stage the Business Plan is an important document upon which the evaluation is based. Most venture capitalists ask for a business plan to make an assessment of the possible risk and return on the venture. Well prepared plan is the best introduction of the entrepreneur who is going to set up a new venture. A detailed and well-organized business plan is the only way to gain the attention Of the venture capitalist and to obtain the needed funds.
(4) Deal Structuring : If the proposed venture and its business plan are found as viable, then venture capitalist and the entrepreneur negotiate the terms of the deal, such as : the amount Of money to be invested, the form of investment (equity or debt), the price of Investment, exit period, etc. This process is termed as deal structuring. At this stage, a written agreement is prepared between the entrepreneur and the venture capitalist. This contains all the terms and conditions agreed between them. This agreement is written on a stamp paper, signed by both and is registered with the government agency. It is treated as a valid evidence before a court of law in case of a dispute.
Seed Capital
Seed Capital is relatively small amount of capital provided to an entrepreneur, generally to prove a concept or an idea. According to The European Venture Capital Association “Seed Finance is the fianncing of the initial product development or the capital provided to an entrepreneur to prove the feasibility of profitability; seed capital in other words is a start up capital. ” According to Mumford and Dotzler, “seed capital is used to finance initial research and development on the concept, build a prototype, to market research analysis the business plan. ” Seed Finance stage is the most difficult stage to finance because (i) the entrepreneur’s idea is yet to take a definite and commercial shape, (ii) he has no business plan, (iii) his product has recently passed through research and development stage (iv) there is yet no complete management team. When an entrepreneur who does not have adequate funds of his own, approaches the suppliers of seed capital with his proposal. It is the riskiest stage of venture capital because returns from seed capital investments typically don’t start to come through for seven to ten years.
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