Venture Capital and Private Equity

Venture Capital
is a form of "risk capital". In other words, capital that is invested in a business where there is a substantial element of risk relating to the future creation of profits and cash flows. Risk capital is invested as shares (equity) rather than as a loan and the investor requires a higher "rate of return" to compensate him for his risk.

Venture Capital provides long-term, committed share capital, to help unquoted companies grow and succeed. If an entrepreneur is looking to start-up, expand, buy-into a business, buy-out a business in which he works, turnaround or revitalize a company, venture capital could help do this. Obtaining venture capital is substantially different from raising debt or a loan from a lender. Lenders have a legal right to interest on a loan and repayment of the capital, irrespective of the success or failure of a business. As a shareholder, the venture capitalist's return is dependent on the growth and profitability of the business. This return is generally earned when the venture capitalist "exits" by selling its shareholding in the business.

Venture Capital in India

History of Venture Capital in India dates back to early 70's when Govt of India appointed a committee laid by Late Shri R.S.Bhatt to find out the ways to meet a void in conventional financing for funding start-up companies based on absolutely new innovative technologies. Such companies either did not get any financial support or the funding was inadequate which resulted into their early mortality. The committee recommended starting of Venture Capital industry in India. In mid 80's three all India financial institutions viz IDBI, ICICI, IFCI started investing into the equity of small technological companies.

In Nov 1988, Govt of India decided to institutionalize Venture Capital Industry and announce guidelines in the parliament. Controller of Capital issues implemented these guidelines known as CCI for VC. These guidelines were very restrictive and following a very narrow definition of VC. They required Venture Capital to be invested in companies based on innovative technologies started by first generation entrepreneur. This made VC investment highly risky and unattractive. Nonetheless many private initiatives were taken. At the same time World Bank selected 6 institutions to start VC investment in India. This included TDICICI (ICICI), GVFL, Canbank Venture Capital Fund, APIDC, RCTC (now known as IFCI Venture Capital Funds Ltd.) and ILF (now known as Pathfinder).

In 1995, Govt of India permitted Foreign Finance companies to make investments in India and many foreign VC private equity firms entered India. In 1996, government announced guidelines to regulate the VC industry. Though there were many shortcomings these guidelines were the starting point.

In 1997, IT boom in India made VC industry more significant. Due to symbiotic relationship between VC and IT industry, VC got more prominence as a major source of funding for the rapidly growing IT industry. Indian VC's which were so far investing in all the sectors changed their focus to IT and telecom industry.

The recession during 1999 - 2001 took the wind out of VC industry. Most of the VC either closed down or wound-up their operations. Almost all of them changed their focus to existing successful firms for their growth and expansion. VC firms also got engaged into funding buyouts, privatisation and restructuring. Currently, just a few firms are taking the risk of investing into the start-up technology based companies.

Difference between VC and private equity:

Private equity refers to equity or quasi-equity investments in high-growth companies and includes buyouts, mezzanine financing, privatization and public as well as private deals. The private equity asset class includes venture capital, buyouts, and mezzanine investment activity. While venture capital focuses on investing in private, young, fast growing companies, private equity players largely provide mezzanine or bridge funding.

What kind of businesses are attractive to venture capitalists:

Venture capitalists prefer to invest in "entrepreneurial businesses". This does not necessarily mean small or new businesses. Rather, it is more about the investment's aspirations and potential for growth, rather by current size. Venture capital investors are interested in companies with high growth prospects, which are managed by experienced and ambitious teams who are capable of turning their business plan into reality.

Process of investment by VC investors

VC funds receive the proposals for investment either directly or through financial intermediaries. The process of investment by a VC funds begins with desk research on a deal. In case the deal evinces interest of VC funds, the Management Team is requested to present the Business model of company, unique aspects of business, future prospects and the investment proposal. During interaction, VC fund assesses the quality & competence of Management team with a view to get perspective on overall business prospects of investment proposal. In case, after discussions with Management team, VC investor finds the deal as investible proposition, a document containing terms of proposed investment known as term sheet, is devised and negotiated with Promoters for their concurrence.

VC funds take up the venture for detailed due-diligence after getting final concurrence of Entrepreneurs on terms of proposed investment negotiated with them. The detailed due diligence of project is carried out by VC funds themselves or assigned to independent Advisors. The detailed due diligence of project is carried out to examine Business, financial and legal aspects of proposed investment. During the process of due diligence, VC funds also assess requirement of funds, stages & quantum of investment and related milestones for investment. The investee company is expected to provide all the cooperation to VC fund/ independent Advisor carrying out due diligence of its venture and explain material transactions undertaken by the company in the past.

On successful completion of due diligence, depending on findings and in process of getting internal approvals for investment, VC funds may modify or stipulate such other conditions as are considered appropriate by them for investment in the company and accordingly negotiate changes/ modifications in the term sheet with the Entrepreneurs (also called Promoters). In case revised terms for investment are agreeable to Entrepreneurs, VC funds issue Letter of Intent for investment and require investee companies to complete formalities for availing investment. These formalities include execution of legal agreements by Promoters/ Investee companies, passing of requisite Board/ Company's resolution, obtaining approval of Govt. & other statutory approvals, etc. for facilitating investment.

Thereafter, on request by companies for release the investment, VC funds, subject to compliance of pre-disbursement conditions and achievement of milestones stipulated for same, undertake investment in the company.

During currency of investment, VC funds regularly monitor functioning of Investee companies, give inputs on strategic plans and guide companies for optimizing their performance. VC funds also pursue the Investee companies to orient their business plans & achieve performance targets to qualify for bringing out Initial Public offers (IPOs) and get listed on stock exchanges for providing exit from investment to VC funds.

The process of investment and level of participation of VC funds in management of venture indicated above is illustrative and may vary depending on merits of a venture or strategy of a VC fund.