Lesson 9. Venture Capital: Origin and Evolution
Origin and Evolution
For the Indian industries, venture capital is quite a new concept. As the name indicates, it deals with providing financial support and stability to new entrepreneurs to initiate and capitalize their business. General Doritos set up the American Research and Development Fund (AR and D) at Massachusetts Institute of Technology in 1946 to finance the commercial utilization of innovative technologies developed in universities in USA and that’s where the origin of venture capital lies. This organization provided finance to 100 companies nearly for 11 long years and made its investment 35 times. Noticing the grand success of the AR and D, big companies in the USA like Xerox, 3m and General Electric also jumped into the field of venture capital. This trend was suddenly followed by Japanese. The early 1950s noticed the growth in number of companies undergoing venture capital. In UK it was seen during the 19th century when European Merchant Bankers supported the growth of industry in their dominions like South Africa, India and USA. Ultimately in India also some companies showed interest in venture capital. The TATA Group’s Investment Corporation of India successfully developed a number of companies like Associated Bearings, CEAT Tires during the period of Independence. Afterwards, venture capital financing was first started by IFCI which sponsored The Risk Capital Foundation In 1975.
9.2. CONCEPT OF VENTURE CAPITAL
Venture capital is a kind of equity financing specifically for providing fund to high risk projects. It is based upon the partnership formed between the entrepreneur and the venture capitalist and thus, represents an effort to new entrepreneurship which goes further for the conventional projects. Venture capital is an investment in such types of enterprise where the uncertainties are yet to be reduced to minimum risks. It is generally provided to the entrepreneurs with good business thoughts as well as sound knowledge of the particular business but lacking financial resources to execute them. Venture capital can open doors for such new entrepreneurs.
Thus, venture capital can be considered as equity support to finance new concepts that involve a high risk and at the same time, have high development and profitability. Venture capital is important enough to facilitate the small and medium entrepreneurs to initiate innovative enterprises. It is very much linked with inventiveness, novelty, high development and high profit. It is regarded as the launching platform to innovative entrepreneurship.
9.3. AIMS OF VENTURE CAPITAL:
a) It satisfies the ambition of entrepreneurs.
b) It gives life to potential business enterprise.
c) It provides proper direction to guide new entrepreneurs.
d) It helps in building enterprise.
9.4. FEATURES OF VENTURE CAPITAL:
a) It assumes a high level of risks in the anticipation of earning a high profit.
b) It finances high-risk projects.
c) It actively guides the innovative enterprise.
d) It takes generally 4 to 5 years to attain the desired level of profit.
e) It is fundamentally a long-standing venture and the incomes are in the form of capital gains.
f) Venture capitalists normally discontinue their investment in the assisted company when it reaches a definite juncture of profitability.
g) It carries a royalty related to sales generated by the company after commercialization.
9.5. VENTURE CAPITAL: FINANCING STEPS
Once the company decides to opt for the venture capital funding route, it becomes essential to follow proper system and procedure. In India, the typical venture capital fund raising process involves the following steps:
1. Identifying the accurate investment financier – The Company should prefer to work with an Investment Banking firm (IB) that offers the following skill set:
a. Very good perception and vision of venture capital business
b. Good understanding of company’s trade and production
c. aptitude to tell a good and factual story about the company
d. knowledge of dealing with the Venture capital
e. Good set of connections in the Venture Capital community
2. Preparation of Investment Memorandum and Financial Model:
After the finalization of the investment banking firm, the company should work to prepare the Investment Memorandum (IM) and a Financial Model (FM) in coordination with the investment bank. A good IM is very important for the company’s business as it addresses most of the investor’s key questions and queries and helps the investor to make up his mind for the company. A Financial Model includes various business variables like revenue drivers; cost drivers, capital expenses etc. in a Microsoft Excel file and projects the company revenues, profitability, cash flows and finance necessities for next 5 to 7 years.
3. Short listing and approaching the venture capital funds:
The next step is to list out the investors whom the investment banker will approach on behalf of the company. While short-listing the investors, it should be kept in mind that the short listed investors should be comfortable with the company’s production, stage of business (seed stage, early stage, growth stage, pre-IPO etc.) and the company’s finance necessities.
4. Meeting the Venture Capital Funds:
The investment banker approaches the venture capital finances and starts making presentation to them. The purpose of these presentations is to arrange the first meeting between the promoters of the company and the investors. In the follow-up meetings, the company tries to convince the investors about the investment. Once the investors are convinced, they issue a Term Sheet.
5. Signing the Term Sheet:
A Term Sheet (TS) generally covers all the key terms and conditions of the investment. The valuation of the company and the transaction structure are the most important terms in the TS. There are a number of other important terms related to investor’s exit, board memberships etc, which are also covered in the Term Sheet. Once there is an agreement on all the terms, a non-binding Term Sheet is signed between the company and the investors.
6. Due Diligence by the Investors:
After the Term Sheet, investors conduct a due diligence process on the company. Generally investor’s due diligence process focuses on the following aspects of the company and its expansion plans:
7. Signing the shareholder’s agreements and funds transfer
Once the investors are pleased with the outcome of the due diligence process, they issue a Shareholder’s Agreement (SHA). SHA covers all the terms of the Term Sheet and other important terms and conditions regarding dispute resolution, non-compete, lock-in, share transfer process etc. Generally lawyers from the company’s side and the investor’s side are also involved in this process. Once there is an agreement, all the shareholders of the company and the investors sign the SHA and investor transfers funds to the company.
9.6. SOURCES OF VENTURE CAPITAL
The important sources of venture capital in our country are as follows:
1. Programme for Advancement of Commercial Technology (PACT): It was the first venture capital funding in India, started in 1995 to finance Indian firms in commercializing the innovative technologies. It was started by Indo-US joint ventures known as Programme for Advancement of Commercial Technology.
2. Technology Development and Investment Corporation of India (TDICI):
Technology Development and Investment Corporation of India (TDICI) was the first venture capital company of India and it was promoted by ICICI in 1986.
3. Risk Capital and Technology Finance Corporation (RCTFC): It is an autonomous body launched by Industrial Finance Corporation of India (IFCI). It promotes and supports the entrepreneurs especially engaged in technological development.
4. Venture capital scheme of IDBI: This scheme of IDBI is emerging as one of the major sources of venture-capital funding. It is meant specifically to support projects which promote innovative and experimental technologies in Indian conditions.
Following is the list of some of the players engaged in the venture capital finance in the India:
a) ANZ Grindlays Bank
b) Credit Capital Venture Fund (India) Ltd
c) 20th Century Venture Capital Corporation
d) APIDC Venture Capital Ltd
e) Canbank Venture Capital Fund
f) Gujarat Venture Finance Ltd
g) Industrial Development Bank of India
h) IL and FS Venture Corporation
i) SBI Capital Venture Fund
j) Pardeshiya Industrial and Investment Corporation of Uttar Pradesh Ltd (PICUP)
9.7. CRITERIA ADOPTED BY VENTURE CAPITALISTS TO PROVIDE VENTURE
The following criteria are taken into consideration by the venture capitalists while going for investment decisions:
a) The reliability, business insight and the entrepreneurial spirit of the management team are considered as the most essential factors.
b) The background of the entrepreneur and his administration team
c) The technical practicability and commercial feasibility of the project, procedure or service
d) Huge and speedily developing market opportunity
e) Advantage in terms of price or cost
f) Guts for satisfactory profitability over a period of four to seven years.
9.8. MERITS OF VENTURE CAPITAL:
(a) Venture capital helps in promotion of industrialization in the country.
(b) It helps in developing and promoting innovative technologies.
(c) It helps the new entrepreneurs to convert their thoughts into reality.
(d) It enhances employment opportunities.
(e) It develops entrepreneurship in the country.
Reference: Khanka, S.S. 1. 999. Entrepreneurial Development, S. Chand and Co., New Delhi.