Project on Venture Capitalists

8/14/2019 Project on Venture Capitalists

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PROJECT ON VENTURE CAPITALISTSSemester-III, PGeMBA 2006-08, METs AMDC

Prepared by:1. Krunal Shah 61562. Gautam Foria 60453. Ishita Kohli 60834. Niral Chandarana 60235. Pratik Parekh 61226. Sneha Lalwani 60877. Vivek Jain 60648. Brinda Jogani 6069


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DECLARATION

We the members of Group No. 3 students of Mumbai Educational Trust,

PGeMBA Finance, Sem-3 hereby declare that we have completed the project on VENTURE CAPITAL in academic year 2007-08. The information submitted is

free from any errors to the best of our knowledge.

CERTIFICATE

We the members of Group No. 3 students of Mumbai Educational Trust, PG-

eMBA Finance, Sem-3 hereby declare that with respect to the subject on


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Financial Management - II, we have completed the project on Venture Capital in

academic year 06-07.under the control and guidance of our college Prof.Vijay

Paradkar.

DATE OF SUBMISSION:

ACKNOWLEDGEMENT

During the perseverance of this project we were supported by different people,

whose names if not mentioned would be inconsiderate on our part.

We would like to thank with affection and appreciation and acknowledge our

indebt ness to Prof. Vijay Paradkar, visiting faculty of Mumbai Educational Trust,

Bandra who initiated us in the preparation of a Project on Venture Capital. The

learning and knowledge that we have gained in the process of preparation of this


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project has been tremendous and we would like to thank Prof. Vijay Paradkar for

providing us with the opportunity to work on this project.

We owe sincere gratitude towards each and everyone who have given a helping

hand in the completion of this project.

INDEX

Sr. No. TOPICS

I. Executive Summary

II. Indian Financial SectorIII. Concept Of VC

IV. Venture Capital FlowV. Features of A VC

VI. VC The History

VII. Private Equity

VIII. Types of VCsIX. SEBI Regulations For VCs

X. SEBI Regulations ForForeign VCs


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XI. Valuation Methods UsedBy VCs

XII. Financial Instruments Used

By VCsXIII. Stages Of VC Investment

XIV. Documentation

XV. Difference Between A VC &A Banker/Money Manager

XVI. An Exercise: Launching &

Managing A VCFXVII. Bibliography

I. EXECUTIVE SUMMARYA number of technocrats are seeking to set up shop on their own and capitalizeon opportunities. In the highly dynamic economic climate that surrounds ustoday, few traditional business models may survive. Countries across the globeare realizing that it is not the conglomerates and the gigantic corporations thatfuel economic growth any more. The essence of any economy today, is the small

and medium enterprises. In the year 2006, venture money invested in India was$3 bn and is expected to reach $6.5 bn by the end of this year.

This growing trend can be attributed to rapid advances in technology in the lastdecade. Knowledge driven industries like InfoTech, health-care, manufacturing,entertainment and services have become the cynosure of bourses worldwide. Inthese sectors, it is innovation and technical capability that are big business-drivers. This is a paradigm shift from the earlier physical production andeconomies of scale model.

However, starting an enterprise is never easy. There are a number of parameters

that contribute to its success or downfall. Experience, integrity, prudence and aclear understanding of the market are among the sought after qualities of apromoter. However, there are other factors, which lie beyond the control of theentrepreneur. Prominent among these is the timely infusion of funds. This iswhere the venture capitalist comes in, with money, business sense and a lotmore.


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II. INDIAN FINANCIAL SECTORThe financial sector in India is characterized by liberal and progressive policies,vibrant equity and debt markets and prudent banking norms. Indias financialsector has been one of the fastest growing sectors in the economy. India has afinancial system that is regulated by independent regulators in the sectors ofbanking, insurance, capital markets etc.

2.1. Size Total banking assets stood at around $ 600 billion

Assets owned by Indias mutual funds crossed the Rs 4 trillion-mark

Indias entire stock of financial assets--equity, corporate and government debtand bank deposits--is valued at US$ 1.1 trillion

More than 80 venture capital and private equity funds operate in India.

2.2. Structure Public Sector (Government owned) banks account for 75% of the banking

assets; however, Indian private banks and foreign banks are growing at arapid pace.

Standard Chartered Bank, Citibank and HSBC are the top three foreign banksin India accounting for more than 65% of the total assets of foreign banks

Most of the global players in banking & financial services Morgan Stanley,Merrill Lynch, JP Morgan, Deutsche Bank, UBS, ABN Amro, Barclays, Calyonetc. - have presence in India


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The Mutual Funds industry has both domestic and foreign players like - UTIMutual Fund, Prudential ICICI, HDFC, Franklin Templeton, Birla and TataFunds.

2.3. Banking SystemThe Indian Banking sector has greatly benefited from the structural reforms overthe last decade. This coupled with recent treasury gains & improved quality ofcredit portfolios has made balance sheets of majority of banks appear to be in afar healthier state than they have historically been. Apart from the improvementin underlying business fundamentals, the sectors prospects have been boostedby an upturn in the economy and increased demand from both the corporate andthe retail clientele. In todays scenario banking has assumed a technologyintensive and customer-friendly face with focus on the ease and speed ofoperations.

An array of services is provided today from retail banking to corporate banking

and industrial lending to investment banking.

The Reserve Bank of India (RBI) controls and supervises the banking industry. Italso prescribes broad parameters of banking operations within which thecountrys banking and financial system functions.

2.4. Insurance SectorThe Insurance sector in India has been traditionally dominated by state ownedLife Insurance Corporation and General Insurance Corporation and its foursubsidiaries. Government of India has now allowed FDI in insurance sector up to26%, which has seen a number of new joint venture private companies entering

the life and general insurance sectors, and their market share is rising at a rapidpace. Insurance Development and Regulatory Authority (IRDA) is the regulatoryauthority in the insurance sector developed under the provisions of the InsuranceDevelopment and Regulatory Authority Act, 1999.

2.5. Capital MarketIndia has a transparent; highly technology enabled and well regulated stock /capital market. A vibrant, well-developed capital market facilitates investment andeconomic growth. The capital market transactions today involve lots of checksand balances with efficient electronic trading and settlement systems. Today the

stock markets are buoyant and have a range of players including mutual funds,FIIs, hedge funds, corporate and other institutions. Securities and ExchangeBoard of India regulate the Indian capital markets. Indias capital marketcomprises of 23 stock exchanges with over 9000 listed companies. BombayStock Exchange (BSE) is one of the oldest exchanges in Asia. National StockExchange (NSE) is third largest exchange in the world in terms of number oftrades. These exchanges constitute an organized market for securities issued bythe Central and State Governments, public sector companies and public limited


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companies. The average daily turnover of BSE is around 4,000 crores and that ofNSE is 9,000 crores. The stock exchanges provide an efficient and transparentmarket for trading in equity, debt instruments and derivatives. The stockexchanges are demutualised, and have been converted into companies now, inwhich brokers only hold minority share holding. In addition to the SEBI Act, the

Securities Contracts (Regulation) Act, 1956 regulates the stock markets.

2.6. Mutual FundsThe Indian mutual fund industry is one of the fastest growing sectors in the Indiancapital and financial markets. The mutual fund industry in India has seendramatic improvements in quantity as well as quality of product and serviceofferings in recent years.The industry has grown in size and the total assets under management (AUM)stood at Rs 4, 02,035.88 crores in May 2007(equivalent to US$ 100 billion).Almost all varieties of schemes are offered today. The Mutual fund industryoperates in a strict regulatory environment and conforms to the best international

standards. Association of Mutual Funds in India (AMFI) is a trade body of all themutual funds in India. It is a non-profit organisation set-up to promote and protectthe interests of mutual funds and their unit holders. SEBI is the regulator of themutual fund industry in India.

2.7. Non Banking Finance CompaniesNon Banking Financial Companies (NBFCs) have played a crucial role inbroadening the access to financial services, enhancing competition and in thediversification of the financial sector. NBFCs are increasingly being recognizedcomplementary to the banking system, capable of spreading risks at times of

financial distress. NBFCs are recognized as an integral part of the financialsystem with an impetus to improve the credibility of the entire sector. Today,NBFCs are present in the competing fields of vehicle financing, hire purchase,lease, personal loans, working capital loans, consumer loans, housing loans,loans against shares, investments, distribution of financial products, etc. The totalnumber of NBFCs registered with the RBI in India in 2006 stood at 13,014.

2.8. Credit Rating AgenciesIndias credit rating agencies are world reckoned. The credit rating agencies ratecorporate debt and equity securities such as debentures, shares and commercialpaper. Today, credit ratings have become necessary because it has become

mandatory for companies to obtain a credit rating before issuing convertible andnon-convertible debentures. The four important credit rating agencies in India areCredit Rating Information Services of India Limited (CRISIL) InvestmentInformation and Credit Rating Agency of India (ICRA), Credit Analysis andResearch Ltd. (CARE) Today the rating agencies have diversified and forayedinto a variety of services such as risk management, strategy, corporate advisory,IT, across various sectors. The credit rating agencies are regulated by SEBIthrough separate regulations.


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2.9. Venture FundsVenture capital can be used as a financial tool for development, within the rangeof SME finance, by playing a key role in business start-ups, existing small andmedium enterprises (SME) and overall growth in developing economies. Venture

capital acts most directly by being a source of job creation, facilitating access tofinance for small and growing companies which otherwise would not qualify forreceiving loans in a bank, and improving the corporate governance andaccounting standards of the companies.

India is a prime target for venture capital and private equity today, owing tovarious factors such as fast growing knowledge based industries, favorableinvestment opportunities, cost competitive workforce, booming stock markets andsupportive regulatory environment among others. The sunrise sectors thatattract venture funds are healthcare, education, financial services,hospitality, media & entertainment, ITES and InfoTech. Indian venture Capital

Association is the apex association of VC funds in the country. India has morethan 80 venture Funds registered with SEBI.

III. CONCEPT OF VC

Venture capital is a growing business of recent origin in the area of industrialfinancing in India. The various financial institutions set-up in India to promoteindustries have done commendable work. However, these institutions do notcome up to the benefit of risky ventures when new or relatively unknown

entrepreneurs undertake them. They contend to give debt finance, mostly in theform of term loan to the promoters and their functioning has been more akin tothat of commercial banks. The financial institutions have devised schemes suchas seed capital scheme, Risk capital Fund etc., to help new entrepreneurs.However, to evaluate the projects and extend financial assistance they follow thecriteria such as safety, security, liquidity and profitability and not potentially. Thecapital market with its conventional financial instruments/ schemes does notcome much to the benefit or risky venture. New institutions such as mutual funds,leasing and hire purchase Companys have been established as another leasingand hire purchase Companys have been established as another source offinance to industries. These institutions also do not mitigate the problems of new

entrepreneurs who undertake risky and innovative ventures.

The term Venture Capital comprises of two words that is Venture and Capital.Venture is defined as a course of processing, the outcome of which is uncertainbut to which is attended the risk or danger ofLOSS. Capital means resources tostart an enterprise. To connote the risk and adventure of such a fund, the genericname Venture Capital was coined.


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Venturecapital is long-term risk capital to finance high technology projects, whichinvolve risk, but at the same time has strong potential for growth. Venturecapitalists pool their resources including managerial abilities to assist newentrepreneur in the early years of the project. Once the project reaches the stageof profitability, they sell their equity holdings at high premium.

Venture capital refers to organize private or institutional financing that canprovide substantial amounts of capital mostly through equity purchases andoccasionally through debts offerings to help growth oriented firms to develop andsucceed.

The term venture capital denotes institutional investors that provide equityfinancing to young businesses and play an active role advising theirmanagements.

Broadly the Venture Capital finance includes a variety of investment vehicles. A

much wider range of activities than purely start up situations are undertaken byVenture capital.

What is Venture Capital?

Venture capital is a type of private equity capital typically provided byprofessional, outside investors to new, growth businesses. Generally made ascash in exchange for shares in the investee company, venture capitalinvestments are usually high risk, but offer the potential for above-averagereturns.

The term Venture Capital is understood in many ways. In a narrow sense, itrefers to, investment in new and tried enterprises that are lacking a stable recordof growth.

In a broader sense, venture capital refers to the commitment of capital asshareholding, for the formulation and setting up of small firms specializing in newideas or new technologies. It is not merely an injection of funds into a new firm, itis a simultaneous input of skill needed to set up the firm, design its marketingstrategy and organize and manage it. It is an association with successive stagesof firms development with distinctive types of financing appropriate to each stageof development.

It is the investment of long term risk finance in new and untried enterprises thatare lacking in a stable record of growth. It means an investment in thosebusiness ventures where uncertainties are yet to be reduced to the risk that issubject to rational criteria of security analysis.

Venture capital can also include managerial and technical expertise. Mostventure capital comes from a group of wealthy investors, investment banks andother financial institutions that pool such investments or partnerships. This form


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of raising capital is popular among new companies, or ventures, with limitedoperating history, which cannot raise funds through a debt issue. The downsidefor entrepreneurs is that venture capitalists usually get a say in companydecisions, in addition to a portion of the equity.

Contrary to popular perception, venture capital plays only a minor role in fundingbasic innovation. Where venture money plays an important role is the next stageof innovation life cycle-the period in a companys life when it begins tocommercialize its innovation. It is estimated that more than 80% of the moneyinvested by VC goes into building the infrastructure required to grow the businessin expense investments (manufacturing, sales, and manufacturing) and thebalance sheet (providing fixed asset and working capital).

Venture money is not long term money. The idea is to invest in a companysbalance sheet and infrastructure until it reaches a sufficient size and credibility sothat it can be sold to a corporation or so that an institutional public equity markets

can step in and provide liquidity. In essence VC buys a stake in anentrepreneurs idea, nurtures it for a short period of time, and then exits with ahelp of Investment Banker.

Venture capitals niche exists because of the structure and rule of capital markets.Someone with a new idea or technology often has no other institution to turn to.Usury law, limits the interest banks can charge on loans-and the risk inherent instart ups justify the higher rates so charged by the banks. This limits a bank toinvest in those projects that secure the debt with hard assets. And in todaysinformation based economy, many start ups have few hard assets. Public Equityand Investment Bank are both constrained by regulations and operating practicesto protect the public investor. Venture Capital fills the gap between innovationand traditional lower cost sources of capital available for ongoing concerns.Filling that void successfully requires the venture capital industry to provide asufficient return on capital to attract private equity funds, attractive returns for itsown participants, and sufficient upside potential entrepreneurs to attract highquality ideas that will generate high returns.


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IV. VENTURE CAPITAL FLOW


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One myth is that VC invests in good people and good ideas. Thereality is that they invest in good industries that arecompetitively forgoing the market.

In effect VC focuses on the middle part of classic industry S-Curve. They avoid

both the early stages, when technologies are uncertain and market stages areunknown and the later stage when competitive shakeouts and consolidations areinevitable and growth rates slow dramatically.

Growing within high growth segments is a lot easier than doing so in low, no ornegative growth ones as every businessman knows. In other words regardless ofthe talent or charisma an individual entrepreneur may posses they rarely receivebacking from VC if they are in low growth industry. During this adolescent periodof high and accelerating growth, it can be extremely hard to distinguish the finalwinners from the losers because their financial performance and growth ratelooks strikingly similar. At this stage, all companies are struggling to deliver

products to this product-starved market. Thus the critical challenge for the VC isto identify competent management that can execute-that is, supply the growingdemand.

This need for high returns makes venture funding an expensive capital source forcompanies, and most suitable for businesses having large up-front capitalrequirements which cannot be financed by cheaper alternatives such as debt.That is most commonly the case for intangible assets such as software, andother intellectual property, whose value is unproven. In turn this explains whyventure capital is most prevalent in the fast-growing technology and life sciencesor biotechnology fields.

Picking the wrong industry or betting on a technology risk is an unproven marketsegment is something VCs avoid. By investing in areas with high growth rates,VC primarily consign their risk to the ability of the companys management toexecute.

Because of the strict requirements venture capitalists have for potentialinvestments, many entrepreneurs seek initial funding from angel investors, whomay be more willing to invest in highly speculative opportunities, or may have aprior relationship with the entrepreneur. Furthermore, many venture capital firmswill only seriously evaluate an investment in a start-up otherwise unknown tothem if the company can prove at least some of its claims about the technology

and/or market potential for its product or services. To achieve this, or even just toavoid the dilutive effects of receiving funding before such claims are proven,many start-ups seek to self-finance until they reach a point where they cancredibly approach outside capital providers such as VCs or angels. This practiceis called "bootstrapping".

VC investing in high growth segments is likely to have exit opportunities becauseinvestment bankers are to 8% money raised through an IPO.


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As long as VC are able to exit the company and industry before it tops out, theycan reap extra ordinary returns at relatively low risk.

4.2. Venture Capital Fund

A venture capital fund (VCF) is a pooled investment vehicle (often a limitedpartnership) that primarily invests the financial capital of third-party investors inenterprises that are too risky for the standard capital markets or bank loans.

Venture Capital Fund shall make investment in the venture capital undertaking asenumerated below:

At least 75% of the investible funds shall be invested in unlisted equityshares or equity linked instruments.

Not more than 25% of the investible funds may be invested by way of:

Subscription to initial public offer of a venture capital undertaking whoseshares are proposed to be listed subject to lock-in period of one year.

Debt or debt instrument of a venture capital undertaking in which theventure capital fund has already made an investment by way of equity.

The venture capital fund shall issue a placement memorandum, which shallcontain details of the terms, and conditions subject to which monies areproposed to be raised from investors.

The Venture Capital Fund shall file with the Board for information, the copy of theplacement memorandum or the copy of the contribution or subscriptionagreement entered with the investors along with a report of money actuallycollected from the investor.

VCF promotes growth in the companies they invest in and managing theassociated risk to protect and enhance their investors' capital.

VCF typically source most of their funding from large investment institutions.

VCF Invest the amount in companies with high growth potential or in companies,which have the ability to quickly, repay.

VCF Exit through the company listing on the stock exchange, selling to a tradebuyer or through a management buyout.


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Most venture capital funds have a fixed life of 10 years, with the possibility of afew years of extensions to allow for private companies still seeking liquidity. Theinvesting cycle for most funds is generally three to five years, after which thefocus is managing and making follow-on investments in an existing portfolio.

In a typical venture capital fund, the general partners receive an annualmanagement fee equal to 2% of the committed capital to the fund and 20% of thenet profits (also known as "carried interest") of the fund; a so-called "two and 20"arrangement, comparable to the compensation arrangements for many hedgefunds. Strong Limited Partner interest in top-tier venture firms has led to ageneral trend toward terms more favorable to the venture partnership, and manygroups now have carried interest of 25-30% on their funds. Because a fund mayrun out of capital prior to the end of its life, larger VCs usually have severaloverlapping funds at the same time; this lets the larger firm keep specialists in allstages of the development of firms almost constantly engaged. Smaller firmstend to thrive or fail with their initial industry contacts; by the time the fund cashes

out, an entirely-new generation of technologies and people is ascending, whomthe general partners may not know well, and so it is prudent to reassess and shiftindustries or personnel rather than attempt to simply invest more in the industryor people the partners already know.

4.3. Venture Capital Company

A venture capital company is defined as a financing institution which joins anentrepreneur as a co-promoter in a project and shares the risks and rewards ofthe enterprise.

Venture capital general partners (also known in this case as "venture capitalists"or "VCs") are the executives in the firm, in other words the investmentprofessionals. Typical career backgrounds vary, but many are former chiefexecutives at firms similar to those which the partnership finances and othersenior executives in technology companies.

Investors in venture capital funds are known as limited partners. Thisconstituency comprises both high net worth individuals and institutions with largeamounts of available capital, such as state and private pension funds, universityfinancial endowments, foundations, insurance companies, and pooled investmentvehicles, called fund of funds.

Other positions at venture capital firms include venture partners andentrepreneur-in-residence (EIR). Venture partners "bring in deals" and receiveincome only on deals they work on (as opposed to general partners who receiveincome on all deals). EIRs are experts in a particular domain and perform duediligence on potential deals. EIRs are engaged by VC firms temporarily (six to 18months) and are expected to develop and pitch startup ideas to their host firm


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(although neither party is bound to work with each other). Some EIRs move on toroles such as Chief Technology Officer (CTO) at a portfolio company.

4.4. Nature and ScopeMerchant bankers can assist venture proposals of technocrats, with hightechnology that are new and high risk, to seek assistance from venture capitalfunds for technology based industries which contribute significantly to growthprocess. Public issues are not available on such Greenfield ventures.

Venture capital refers to organize private or institutional financing that canprovide substantial amounts of capital mostly through equity purchases andoccasionally through debts offerings to help growth oriented firms to develop andsucceed. The term venture capital denotes institutional investors that provide

equity financing to young businesses and play an active role advising theirmanagements.

Venture capital thrives best where it is not restrictively defined. Both in theU.S.A., the cradle of modern venture capital industry and U.K. where it isrelatively advance venture capital as n activity has not been defined. Layingdown parameters relating to size of investment, nature of technology andpromoters background do not really help in promoting venture proposals.Venture capital enables entrepreneurs to actualize scientific ideals and enablesinventions. It can contribute as well as benefit from securities marketdevelopment. Venture capital is a potential source for augmenting the supply of

good securities with track record of performance to the stock market that facesshortage of good securities to absorb the savings of the investors. Venturecapital in turn benefits from the rise in market valuation that results from an activesecondary market.


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V. FEATURES OF VCThe key terms found in most definition of Venture capital are: high technologyand high risk, equity investment and capital gains, value addition through

participation in management.

5.1. High Risk

By definition the Venture capital financing is highly risky and chances of failureare high as it provides long term start up capital to high risk-high rewardventures. Venture capital assumes four types of risks:

Management Risk-inability of the management teams to work together.

Market Risk- product may fail in the market.

Product Risk-product may not be commercially viable Operation Risk-operations may not be cost effective resulting in increasedcost and decreased gross margins.

Normally three out of every ten units financed by Venture capital succeed.

5.2. High Technology

As opportunities in the low technology area tend to be few and of lower order,and hi-tech projects generally offer higher returns than projects in moretraditional areas, Venture capital investments are made in high technology areas

using new technology. Not just high technology, any high-risk ventures where theentrepreneur has conviction but little capital gets venture finance. Venture capitalis available for expansion of existing business or diversification to a high-riskarea. Thus technology financing had never been primary objective but incidentalto Venture capital.

5.3 Equity Participation and Capital Gains

Investments are generally in equity and quasi equity participation through directpurchase of shares, options, convertible debentures where the debt holder hasthe option to convert the loan instruments into stock of the borrower or a debtwith warrants to equity investment. The funds in the form of equity help to raiseterm loans that are cheaper source of funds. In the early stages of business,because dividends can be delayed, Equity investment implies that investors bearthe risk of venture and would earn a return commensurate with the success inthe form of capital gains.


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5.4. Participation in Management

Venture capital provides value addition by managerial support, monitoring andfollow up assistance. It monitors physical and financial progress as well asmarket development initiative. It helps by identifying key resource persons. They

want one seat on the companys board of directors and involvement, for better orworse, in the major decisions affecting the direction of the company. This is aunique philosophy of hands on management where Venture capitalist acts ascomplementary to the entrepreneurs. Based upon the experience with othercompanies, a venture capitalist advises the promoters on project planning,monitoring, financial management, including working capital and public issue.Venture capital investor cannot interfere in day today management of theenterprise but keeps close contact with the promoters or entrepreneurs to protecthis investment.

5.5. Length of Investment

Venture capitalists help companies grow, but they eventually seek to exit theinvestment in three to seven years. An early stage investment may take seven toten years to mature, while most of the later stage investments take only a fewyears. The process of having significant returns takes several years and calls onthe capacity and talent of venture capitalist and entrepreneurs to reach fruition.

5.6. Illiquid Investment

Venture capital investments are illiquid that is, not subject to repayment on

demand or following a repayment schedule. Investors seek return ultimately bymeans of capital gains when the investment is sold at market place. Theinvestment is realized only on enlistment of security or it is lost if enterprise isliquidated for unsuccessful working. It may take several years before the firstinvestment starts to return proceeds. In some cases the investment may belocked for seven to ten years. VC understands this illiquidity and factors in hisinvestment decisions.


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on American banks in the 1930s there was no private merchant banking industryin the United States, a situation that was quite unique in developed nations.

As late as the 1980s Lester Thurow, a noted economist, decried the inability ofthe USA's financial regulation framework to support any merchant bank other

than one that is run by the United States Congress in the form of federally fundedprojects. These, he argued, were massive in scale, but also politically motivated,too focused on defense, housing and such specialized technologies as spaceexploration, agriculture, and aerospace. US investment banks were confined tohandling large M&A transactions, the issue of equity and debt securities, and,often, the breakup of industrial concerns to access their pension fund surplus orsell off infrastructural capital for big gains.

Not only was the lax regulation of this situation very heavily criticized at the time,this industrial policy differed from that of other industrialized rivalsnotablyGermany and Japanwhich at that time were gaining ground in automotive and

consumer electronics markets globally. However, those nations were alsobecoming somewhat more dependent on central bank and elite academicjudgment, rather than the more diffuse way that priorities were set by governmentand private investors in the United States.

Actually venture capitalist developers venture situations in which to invest. Forhis trouble, venture capitalist receive 20 to 25 percent of the ultimate profits ofthe partnership know as carried interest. He also collects an annual fee of 2percent (of capital lent or invested in equity) to cover costs. Apart fromindividuals, investors include institutions such as pension funds, life insurancecompanies and even universities. The institutional investors invest about 10

percent of their portfolio in the venture proposals. Specialist venture capital fundsin USA have about $30 billions on an annual basis to seek-out promising start-ups and take in them. In Japan there are about 55 active venture firms with fundsamounting to $ 7 billions (1993). Venture capital funds are also extant in U.K.,France and Korea.


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6.2. VentureCapitalIn India

The developmental financial institutions like IDBI, ICICI and State FinancialCorporations possibly did this activity in the past. These institutions promoted

entities in the private sector with debt as an instrument of funding.

For a long time funds raised from public were used as a source of VC. Thissource however depended a lot on the market vagaries. And with the minimumpaid up capital requirements being raised for listing at the stock exchanges, itbecame difficult for smaller firms with viable projects to raise funds from public.

In India, the need for VC was recognised in the 7th five-year plan and long termfiscal policy of GOI. In 1973 a committee on Development of small and mediumenterprises highlighted the need to faster VC as a source of funding newentrepreneurs and technology. VC financing really started in India in 1988 with

the formation of Technology Development and Information Company of India Ltd.(TDICI) - promoted by ICICI and UTI.

The first private VC fund was sponsored by Credit Capital Finance Corporation(CFC) and promoted by Bank of India, Asian Development Bank and theCommonwealth Development Corporation viz. Credit Capital Venture Fund. Atthe same time state level financial institutions started Gujarat Venture FinanceLtd. and APIDC VENTURE CAPITAL LTD. Sources of these funds were thefinancial institutions, foreign institutional investors or pension funds and high net-worth individuals. Though an attempt was also made to raise funds from thepublic and fund new ventures, the venture capitalists had hardly any impact on

the economic scenario for the next eight years.

India is prime target for venture capital and private equity today, owing to variousfactors such as fast growing knowledge based industries, favorable investmentopportunities, cost competitive workforce, booming stock markets and supportiveregulatory environment among others.

The sectors where the country attracts venture capital are IT and ITES, softwareproducts, banking, PSU disinvestments, entertainment and media,biotechnology, pharmaceuticals, contract manufacturing and retail. An offshoreventure capital company may contribute up to 100 percent of the capital of a

domestic venture capital fund and may also set up a domestic assetmanagement company to manage the fund. Venture capital funds (VCF) andventure capital companies (VCC) are permitted up to 40 percent of the paid upcorpus of the domestic unlisted companies. This ceiling would be subject torelevant equity investment limit in force in relation to areas reserved for SSI.Investment in a single company by a VCF/VCC shall not exceed 5 percent of thepaid up corpus of a domestic VCF/VCC. The automatic route is not available.


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Indian companies received almost no Private Equity (PE) or Venture Capital (VC)funding a decade ago. This scenario began to change in the late 1990s with thegrowth of Indias Information Technology (IT) companies and with thesimultaneous dot-com boom in India. VCs started making large investments inthese sectors, however the bust that followed led to huge losses for the PE and

VC community, especially for those who had invested heavily in start-ups andearly stage companies. After almost three years of downturn in 2001-2003, thePE market began to recover towards the end of 2004. PE investors beganinvesting in India again, except this time they began investing in other sectors aswell (although the IT and BPO sectors still continued to receive a significantportion of these investments) and most investments were in late-stagecompanies. Early-stage investments have been dwindling or have, at best,remained stagnant right through mid-2006.

6.3.The PE and VC Investment Boom in 2000 and Its Aftermath

1996-1997 - Beginning of PE/VC activity in India:

The Indian private equity (PE) and venture capital (VC) market roughly started in1996-1997 and it scaled new heights in 2000 primarily because of the successdemonstrated by India in assisting with Y2K related issues as well as the overallboom in the Information Technology (IT), Telecom and the Internet sectors,which allowed global business interactions to become much easier. In fact, thetotal value of such deals done in India in 2000 was $1.16 billion and the averagedeal size was approximately US $4.14 million.

2001-2003 - VC/PE becomes risk averse and activity declines:

Not surprisingly, the investing in India came crashing down when NASDAQ lost60% of its value during the second quarter of 2000 and other public markets(including those in India) also declined substantially. Consequently, during 2001-2003, the VCs and PEs started investing less money and in more maturecompanies in an effort to minimize the risks. For example:(a) The average deal size more than doubled from $4.14 million in 2000 to $8.52million in 2001(b) The number of early-stage deals fell sharply from 142 in 2000 to 36 in 2001(c) Late-stage deals and Private Investments in Public Equity (PIPEs) declined

from 138 in 2000 to 74 in 2001, and(d) Investments in Internet-related companies fell from $576 million in 2000 to$49 million in 2001. This decline broadly continued until 2003.

2004 onwards - Renewed investor interest and activity:

Since Indias economy has been growing at 7%-8% a year, and since somesectors, including the services sector and the high-end manufacturing sector,


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have been growing at 12%-14% a year, investors renewed their interest andstarted investing again in 2004. As Figure 1 shows, the number of deals and thetotal dollars invested in India has been increasing substantially. For example, US$1.65 billion in investments were made in 2004 surpassing the $1.16 billion in2000 by almost 42%. These investments reached US $2.2 billion in 2005, and

during the first half of 2006, VCs and PE firms had already invested $3.48 billion(excluding debt financing). The total investments in 2006 are likely to be $6.3billion, a number that is more than five times the amount invested in 2000.

PE investment expands beyond IT and ITES:

A very important feature of the resurgence in the PE activity in India since 2004has been that the PEs are no longer focusing only on the IT and the ITES (ITEnabled Services, commonly known as Business Process Outsourcing or BPO)sectors. This is partly because the growth in the Indian economy is no longerlimited to the IT sector but is now spreading more evenly to sectors such as bio-technology and pharmaceuticals; healthcare and medical tourism; auto-components; travel and tourism; retail; textiles; real estate and infrastructure;entertainment and media; and gems and jewellery. Figure 2 shows the divisionacross various sectors with respect to the number of deals in India in 2000, 2003and the first half of 2006.


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Early Stage VC Investments during 2000-2006:

Since the Purchase Power Parity (PPP) in India is approximately a factor of 5 (asin, a factor of 5 is used to normalize the GDPs of US & India on a PPP basis),analysis shows that early stage VC investments in India should include those thatare $8 million or less. In fact, we can classify early stage investments further intoSeed, Series A and Series B investments depending upon their value.

Figure below highlights an approximate comparison of the typical range of Seed,Series A, and Series B funding in India versus that in the US (actual dollaramounts; not adjusted in terms of PPP).

Figure given below provides a break-up of the total value of investments into

early-stage investments (primarily by VCs) and late-stage investments and

PIPEs (primarily by PEs). Even within early-stage investments, seed investments

declined the most during 2000-2003 and have essentially remained negligible

during 2004-2006.


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Figure below shows the break-up of early-stage investments by Seed and SeriesA and B investments. In a nuance, perhaps unique to India, since the Indianupper middle class has become quite affluent during the last 7-10 years, theentrepreneurs are relying more and more on family and friends for seed funding,

and since emerging entrepreneurs come from this upper middle class, the needfor seed funding from VCs could remain low for many years to come.

In the year 2006 Venture money invested in India was $3bn andis expected to reach $6.5bn by the end of the year.


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VII. PRIVATE EQUITY

Private equity is a broad term that commonly refers to any type of non-public

Ownership Equity securities that are not listed on a public exchange. Since theyare not listed on a public exchange, any investor wishing to sell private equitysecurities must find a buyer in the absence of a public marketplace. There aremany transfer restrictions on private securities. Investors in private securitiesgenerally receive their return through one of three ways: an initial public offering,a sale or merger, or a recapitalization.Private equity firms generally receive a return on their investment through one ofthree ways: an IPO, a sale or merger of the company they control, or arecapitalization. Unlisted securities may be sold directly to investors by thecompany (called a private offering) or to a private equity fund, which poolscontributions from smaller investors to create a capital pool.

Considerations for investing in private equity funds relative to other forms ofinvestment include:

Substantial entry costs, with most private equity funds requiring significantinitial investment (usually upwards of $100,000) plus further investment forthe first few years of the fund called a 'drawdown'.

Investments in limited partnership interests (which are the dominant legalform of private equity investments) are referred to as "illiquid" investmentsthat should earn a premium over traditional securities, such as stocks andbonds. Once invested, it is very difficult to gain access to your money, as it is

locked-up in long-term investments that can last for as long as twelve years.Distributions are made only as investments are converted to cash; limitedpartners typically have no right to demand that sales be made.

If the private equity firm can't find good investment opportunities, they will notdraw on our commitment. Given the risks associated with private equityinvestments, you can lose all your money if the private-equity fund invests infailing companies. The risk of loss of capital is typically higher in venturecapital funds, which back young companies in the earliest phases of theirdevelopment, and lower, in mezzanine capital funds, which provide interiminvestments to companies which have already proven their viability but have

yet to raise money from public markets.

Consistent with the risks outlined above, private equity can provide highreturns, with the best private equity managers significantly outperforming thepublic markets.

For the above-mentioned reasons, private equity fund investment is for thosewho can afford to have their capital locked in for long periods of time and who are


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able to risk losing significant amounts of money. This is balanced by the potentialbenefits of annual returns, which range up to 30% for successful funds. Mostprivate equity funds are offered only to institutional investors and individuals ofsubstantial net worth. The law often requires this as well, since private equityfunds are generally less regulated than ordinary mutual funds.


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VIII.TYPES OF VCS

8.1. Incubators

Incubator is a company or facility designed to foster entrepreneurship and helpstartup companies usually technology-related, to grow through the use of sharedresources, management expertise and intellectual capital.Kanwal Rekhi School of Information Technology (KReSIT) is a businessincubators at IIT Mumbai is the best example of business incubators in India.

8.2. Angle InvestorsAn angel investor(known as a "business angel" in Europe, or simply an "angel")is an affluent individual who provides capital for a business start-up, usually inexchange for ownership equity. Angels typically invest their own funds, unlikeventure capitalists, who manage the pooled money of others in a professionally-

managed fund. However, a small but increasing number of angel investors areorganizing themselves into angel networks orangel groups to share researchand pool theirinvestment capital.Angel investments bear extremely high risk, and thus require a very highreturn on investment. Because a large percentage of angel investments arelost completely when early stage companies fail, professional angel investorsseek investments that have the potential to return at least 10 or more times theiroriginal investment within 5 years, through a defined exit strategy, such as plansfor an initial public offering or an acquisition.Angel investors are often retired entrepreneurs or executives, who may beinterested in angel investing for other reasons in addition to pure monetary

return. These include wanting to keep abreast of current developments in aparticular business arena, mentoring another generation of entrepreneurs, andmaking use of their experience and networks on a less-than-full-time basis. Thus,in addition to funds, angel investors can often provide valuable managementadvice and important contacts.

8.3. Venture CapitalistVenture capitalists are organizations which pooled in money from variousinvestors in a professionally managed fund. VCs are inclined toward theturnaround ventures that entail some investment risk but offer the potential forabove average future profits.Sources of venture capital includes wealthy individual investors; subsidiaries ofbanks and other corporations organized as small business investmentcompanies (SBICs); groups of investment banks and other financing sourceswho pool investments in venture capital funds or Venture Capital LimitedPartnerships.
http://topic/startup-companyhttp://topic/ownership-equityhttp://topic/venture-capitalhttp://topic/fundinghttp://topic/fundinghttp://topic/investmenthttp://topic/riskhttp://topic/rate-of-return-1http://topic/exit-strategyhttp://topic/initial-public-offeringhttp://topic/mergers-and-acquisitionshttp://topic/mergers-and-acquisitionshttp://topic/ownership-equityhttp://topic/venture-capitalhttp://topic/fundinghttp://topic/investmenthttp://topic/riskhttp://topic/rate-of-return-1http://topic/exit-strategyhttp://topic/initial-public-offeringhttp://topic/mergers-and-acquisitionshttp://topic/startup-company


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8.4. Private Equity playersEquity capital that is made available to companies or investors but not quoted on

a stock market. The funds raised through private equity can be used to develop

new products and technologies, to expand working capital, to make acquisitions,

or to strengthen a company's balance sheet. KKR (Kohlberg Kravis Roberts),Blackstone and Vestar Capital Venture and ICICI venture are examples of private

equity players.

Private equity funds typically control management of the companies in which they

invest, and often bring in new management teams that focus on making the

company more valuable.

8.5. Types of Venture Capital firmsThere is quite a variety of types of venture capital firms. They include:

1. Traditional partnerships: which are often established by wealthy familiesto aggressively manage a portion of their funds by investing in small

companies. These funds are typically established as partnerships that invest

the money of their institutional limited partners. The partners typically include

corporate pension funds, government pension funds, private individuals,

foreign investors, corporations and insurance companies. These include

venture capital funds that are focused on investing in minority businesses or

minority markets.

2. Investment banking firms: which usually trade in more established

securities, but occasionally form investor syndicates for venture proposals.

3. Manufacturing companies: which have sometimes looked upon

investing in smaller companies as a means of supplementing their R & D

programs (Some "Fortune 500" corporations have venture capital operations

to help keep them abreast of technological innovations).

4. Small Business Investment Corporations (SBICs): which are licensed

by the Small Business Administration (SBA) and which may provide

management assistance as well as venture capital.

In addition to these venture capital firms there are individual private investors andfinders. Finders, which can be firms or individuals, often know the capital industryand may be able to help the small company seeking capital to locate it, thoughthey are generally not sources of capital themselves. Care should be exercisedso that a small business owner deals with reputable, professional finders whosefees are in line with industry practice. Further, it should be noted that venture


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capitalists generally prefer working directly with principals in making investments,though finders may provide useful introductions.

8.6. Parties involved1. Entrepreneurs

The word entrepreneur derived from the French verb enterprendre, which meansto undertake. It is very difficult to define entrepreneur but Peter Drucker andFrancies Walker explain their views on entrepreneur.It is the qualities of the entrepreneur that define entrepreneur. Innovative, risktaking ability, passionate, visionary, change agent and many more qualities thatmakes entrepreneur apart from others and define what he is.Entrepreneurs has various types but broadly classified according to: the type ofbusiness, the use of technology, the motivation, the growth, the stages ofdevelopment, area, gender and age, the sale of operation and others.In the flow entrepreneur creates an idea which creates the entire flow.Entrepreneur has to sell its idea to the Venture Capitalist. In turn entrepreneur

receives the fund (money) to implement his idea into reality.

2. Venture CapitalistsHe is the one who supports the idea of the entrepreneur and in turn makes fundavailable to the entrepreneur. Venture capitalist posses a good experience of hisarea and provide expertise to the entrepreneur. Venture capitalist makes moneyfor themselves by making market for entrepreneurs, investors and bankersVenture capitalist will raise money from the investors who expect high returns.Venture capitalist takes the help of bankers to issues IPOs and in turn receivedthe initial outflow.

3. InvestorsThese are the private investors who expect high return as they invest in thebusiness which is full of risk. They invest in from of money and received return inform of money as well. Venture capitalists raise money from these investors toinvest in entrepreneurs idea.

4. BankersAn investment banker helps the venture capitalist to float the IPOs in the market.They are the one who help the venture capitalist to exit from the VC.


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8.7. How funds flow between the parties


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IX. SEBI REGULATIONS FOR VCs

9.1. DEFINITIONS:Venture capital fund means a fund established in the form of a trust or a

company including a body corporate and registered under these regulationswhich(i) Has a dedicated pool of capital;(ii) Raised in a manner specified in the regulations; and(iii) Investsin accordance with the regulations;

Venture capital undertaking means a domestic company(i)Whose shares are not listed on a recognized stock exchange in India.(ii) Which is engaged in the business for providing services, production ormanufacture of article or things or does not include such activities or sectorswhich are specified in the negative list by the Board with the approval of the

Central Government by notification in the Official Gazette in this behalf.

9.2. REGISTRATION OF VENTURE CAPITAL FUNDSApplication for Grant of Certificate:(a) Any company or trust or a body corporate proposing to carry on any activityas a venture capital fund on or after the commencement of these regulationsshall make an application to the Board for grant of a certificate.(b)Any company or trust or a body corporate, which on the date ofcommencement is carrying any activity as a venture capital fund without acertificate shall make an application to the Board for grant of a certificate within aperiod of three months (maximum of six months in special cases) from the dateof such commencement.(c) An application for grant of certificate shall be accompanied by anonrefundable application fee.(d) Any company or trust or a body corporate who fails to make an application forgrant of a certificate within the period specified therein shall cease to carry onany activity as a venture capital fund.(e) The Board may in order to protect the interests of investors appoint anyperson to take charge of records, documents, securities and for this purpose alsodetermine the terms and conditions of such an appointment.

Eligibility Criteria:

For the purpose of the grant of a certificate by the Board the applicant shall haveto fulfill in particular the following conditions, namely:

(a) if the application is made by a company :(i)Memorandum of association as has its main objective, the carrying on of theactivity of a venture capital fund;(ii)It is prohibited by its memorandum and articles of association from making aninvitation to the public to subscribe to its securities;


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(iii) Its director or principal officer or employee is not involved in any litigationconnected with the securities market which may have an adverse bearing on thebusiness of the applicant;(iv)Its director, principal officer or employee has not at any time been convictedof any offence involving moral turpitude or any economic offence;

(v) It is a fit and proper person

(b) If the application is made by a trust(i)The instrument of trust is in the form of a deed and has been duly registeredunder the provisions of the Indian Registration Act, 1908 (16 of 1908);(ii)The main object of the trust is to carry on the activity of a venture capital fund;(iii)The directors of its trustee company, if any or any trustee is not involved inany litigation connected with the securities market which may have an adversebearing on the business of the applicant;(iv)The directors of its trustee company, if any, or a trustee has not at any time,been convicted of any offence involving moral turpitude or of any economic

offence;(v) The applicant is a fit and proper person;

(c) If the application is made by a body corporate(i)It is set up or established under the laws of the Central or State Legislature,(ii)The applicant is permitted to carry on the activities of a venture capital fund,(iii)The applicant is a fit and proper person,(iv)The directors or the trustees, as the case may be, of such body corporatehave not been convicted of any offence involving moral turpitude or of anyeconomic offence,(v)The directors or the trustees, as the case may be, of such body corporate, ifany, are not involved in any litigation connected with the securities market whichmay have an adverse bearing on the business of the applicant;

(d) The applicant has not been refused a certificate by the Board or its certificatehas not been suspended or cancelled under regulation.

Furnishing of information, clarification:The Board may require the applicant to furnish such further information as it mayconsider necessary.

Consideration of application:An application which is not complete in all respects shall be rejected by theBoard:Provided that, before rejecting any such application, the applicant shall be givenan opportunity to remove, within thirty days further on being satisfied that it isnecessary to extend the period by such further time not exceeding ninety days.

Procedure for grant of certificate:(a) If the Board is satisfied that the applicant is eligible for the grant of certificate,it shall send intimation to the applicant.


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(b) On receipt of intimation, the applicant shall pay to the Board; the registrationfee.(c) The Board shall on receipt of the registration fee grant a certificate ofregistration.

Procedure where certificate is not granted:(a) After considering an application made under regulation , if the Board is of theopinion that a certificate should not be granted, it may reject the application aftergiving the applicant a reasonable opportunity of being heard.(b) The decision of the Board to reject the application shall be communicated tothe applicant within thirty days.

9.3. INVESTMENT CONDITIONS AND RESTRICTIONSMinimum investment in a Venture Capital Fund:(a) A venture capital fund may raise monies from any investor whether Indian,Foreign or non-resident Indian by way of issue of units.

(b) No venture capital fund set up as a company or any scheme of a venturecapital fund set up as a trust shall accept any investment from any investor whichis less than five lakh rupees:Provided that nothing contained in sub-regulation (2) shall apply to investorswho are,(i)Employees or the principal officer or directors of the venture capital fund, ordirectors of the trustee company or trustees where the venture capital fund hasbeen established as a trust;(ii) The employees of the fund manager or asset Management Company;(c) Each scheme launched or fund set up by a venture capital fund shall havefirm commitment from the investors for contribution of an amount of at least

rupees five crores before the start of operations by the venture capital fund.

Investment conditions and restrictions:All investment made or to be made by a venture capital fund shall be subject tothe following conditions, namely:(a) Venture capital fund shall disclose the investment strategy at the time ofapplication for registration;(b) Venture capital fund shall not invest more than 25% corpus of the fund in oneventure capital undertaking;(i) Venture capital fund may invest in securities of foreign companies subject tosuch conditions or guidelines that may be stipulated or issued by the ReserveBank of India and the Board from time to time.(c) Shall not invest in the associated companies; and(d) Venture capital fund shall make investment as enumerated below:(i) At least 66.67% of the investible funds shall be invested in unlisted equityshares or equity linked instruments of venture capital undertaking.(ii) Not more than 33.33%of the investible funds may be invested by way of:(ii.a) Subscription to initial public offer of a venture capital undertaking whoseshares are proposed to be listed


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(ii.b) Debt or debt instrument of a venture capital undertaking in which theventure capital fund has already made an investment by way of equity.(ii.c) Preferential allotment of equity shares of a listed company subject to lock inperiod of one year;(ii.d) The equity shares or equity linked instruments of a financially weak

company or a sick industrial company (a company, which has at the end of theprevious financial year accumulated losses, which has resulted in erosion ofmore than 50% but less than 100% of its net-worth as at the beginning of theprevious financial year) whose shares are listed.(ii.e) Special Purpose Vehicles which are created by a venture capital fund forthe purpose of facilitating or promoting investment in accordance with theseRegulations.(e) Venture capital fund shall disclose the duration of life cycle of the fund.

Prohibition on listing:No venture capital fund shall be entitled to get its units listed on any recognized

stock exchange till the expiry of three years from the date of the issuance of unitsby the venture capital fund.

9.4. GENERAL OBLIGATIONS AND RESPONSIBILITIESProhibition on inviting subscription from the public:No venture capital fund shall issue any document or advertisement inviting offersfrom the public for the subscription or purchase of any of its units.

Private placement:A venture capital fund may receive monies for investment in the venture capitalfund only through private placement of its units.

Placement memorandum or subscription agreement:(a) The venture capital fund shall(i) Issue a placement memorandum which shall contain details of the terms andconditions subject to which monies are proposed to be raised from investors; or(ii) Enter into contribution or subscription agreement with the investors whichshall specify the terms and conditions subject to which monies are proposed tobe raised.(b) The Venture Capital Fund shall file with the Board for information, the copy ofthe placement memorandum or the copy of the contribution or subscriptionagreement entered with the investors along with a report of money actually

collected from the investor.

Contents of placement memorandum:The placement memorandum or the subscription agreement with investors shallcontain the following, namely:-(a) Details of the trustees or Trustee Company and the directors or chiefexecutives of the venture capital fund;


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(b) (i) The proposed corpus of the fund and the minimum amount to be raised forthe fund to be operational;(ii) The minimum amount to be raised for each scheme and the provision forrefund of monies to investor in the event of non-receipt of minimum amount;(c) Details of entitlements on the units of venture capital fund for which

subscription is being sought;(d) Tax implications that are likely to apply to investors;(e) Manner of subscription to the units of the venture capital fund;(f) The period of maturity, if any, of the fund;(g) The manner, if any, in which the fund shall be wound up;(h) The manner in which the benefits accruing to investors in the units of the trustare to be distributed;(i) Details of the fund manager or asset Management Company if any, and thefees to be paid to such manager;(j) The details about performance of the fund, if any, managed by the FundManager;

(k) Investment strategy of the fund;(l) Any other information specified by the Board.

Maintenance of books and records:(a) Every venture capital fund shall maintain for a period ofeight years books ofaccount, records and documents which shall give a true and fair picture of thestate of affairs of the venture capital fund.(b) Every venture capital fund shall intimate the Board, in writing, the place wherethe books, records and documents are being maintained.

Power to call for information:

(a)The Board may at any time call for any information from a venture capital fund

with respect to any matter relating to its activity as a venture capital fund.(b) Where any information is called for shall be furnished within the time specifiedby the Board.

Submission of reports to the Board:The Board may at any time call upon the venture capital fund to file such reportsas theBoard may desire with regard to the activities carried on by the venture capitalfund.

Winding-up:

(a) A scheme of a venture capital fund set up as a trust shall be wound up,(i) When the period of the scheme, if any, mentioned in the placementmemorandum is over;(ii)If it is the opinion of the trustees or the trustee company, as the case may be,that the scheme shall be wound up in the interests of investors in the units;(iii)Ifseventy-five per cent of the investors in the scheme pass a resolution at ameeting of unit-holders that the scheme be wound up; or(iv)If the Board so directs in the interests of investors.


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(b) A venture capital fund set up as a company shall be wound up in accordancewith the provisions of the Companies Act, 1956.(c) The trustees or trustee company of the venture capital fund set up as a trustor the Board of Directors in the case of the venture capital fund is set up as acompany (including body corporate) shall intimate the Board and investors of the

circumstances leading to the winding up of the Fund or Scheme.

Effect of winding-up:(a) On and from the date of intimation, no further investments shall be made onbehalf of the scheme so wound up.(b) Within three months from the date of intimation, the assets of the schemeshall be liquidated, and the proceeds accruing to investors in the schemedistributed to them after satisfying all liabilities.(c) Notwithstanding anything as asset and subject to the conditions, if any,contained in the placement memorandum or contribution agreement orsubscription agreement, as the case may be, in specie distribution of assets of

the scheme, shall be made by the venture capital fund at any time, including onwinding up of the scheme, as per the preference of investors, after obtainingapproval of at least 75% of the investors of the scheme.

9.5. INSPECTION AND INVESTIGATIONBoards right to inspect or investigate.The Board may suo motu or upon receipt of information or complaint appointsone or more persons as inspecting or investigating officer to undertake inspectionor investigation of the books of account, records and documents relating to aventure capital fund.

Notice before inspection or investigation.Before ordering an inspection or investigation, the Board shall give not less thanten days notice to the venture capital fund.

9.6. CASE OF DEFAULTLiability for action in case of default:Without prejudice to the issue of directions or measure under regulation 29, aventure capital fund which(a)contravenes any of the provisions of the Act or these regulations;(b)Fails to furnish any information relating to its activity as a venture capital fund

as required by the Board;(c) Furnishes to the Board information which is false or misleading in anymaterial particular;(d)Does not submit periodic returns or reports as required by the Board;(e)Does not co-operate in any enquiry, inspection or investigation conducted bythe Board;(f)Fails to resolve the complaints of investors or fails to give a satisfactory replyto the Board in this behalf;


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Shall be dealt with in the manner provided in the Securities and Exchange Boardof India(Procedure for Holding Enquiry by Enquiry Officer and Imposing Penalty)Regulations,2002.

9.6. AMOUNT TO BE PAID AS FEESApplication fee Rs. 1, 00,000Registration fee Rs. 10, 00,000

9.7. NEGATIVE LIST(a) Non-banking financial services excluding that NBFC which are registered withRBI and have been categorized as Equipment Leasing or Hire PurchaseCompanies.

(b) Gold financing excluding those Companies which are engaged in goldfinancing for jewellery.(c) Activities not permitted under industrial policy of Government of India.(d) Any other activity which may be specified by the Board in consultation withGovernment of India from time to time.


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X. SEBI REGULATIONS FORFOREIGN VCs

10.1. DEFINITIONS:Designated bank" means any bank in India which has been permitted by theReserve Bank of India to act as banker to the Foreign Venture Capital Investor.

"Domestic custodian" means a person registered under the Securities andExchange Board of India (Custodian of Securities) Regulations, 1996.

Equity linked instruments" includes instruments convertible into equity shareor share warrants, preference shares, debentures compulsorily; or optionallyconvertible into equity.

"Foreign venture capital investor" means an investor incorporated andestablished outside India, is registered under these Regulations and proposes tomake investment in accordance with these Regulations.

"Investible funds" means the fund committed for investments in India net ofexpenditure for administration and management of the fund.

"Venture Capital Fund" means a Fund established in the form of a Trust, acompany including a body corporate and registered under Securities andExchange Board of India (Venture Capital Fund) Regulations, 1996, which(i) Has a dedicated pool of capital;

(ii) Raised in the manner specified under the Regulations; and(iii) Invests; in accordance with the Regulations.

"Venture capital undertaking" means a domestic company:-(i) Whose shares are not listed in a recognized stock exchange in India;(ii) Which is engaged in the business of providing services, production ormanufacture of articles or things, but does not include such activities or sectorswhich are specified in the negative list by the Board, with approval of CentralGovernment, by notification in the Official Gazette in this behalf."

10.2. REGISTRATION OF FOREIGN VENTURE CAPITALINVESTORS

Application for grant of certificate: For the purposes of seeking registrationunder these regulations, the applicant shall make an application to the Board withthe application fee as specified


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Eligibility Criteria:For the purpose of the grant of a certificate to an applicant as a Foreign VentureCapital Investor, the Board shall consider the following conditions for eligibility,namely: -

(a) The applicants track record, professional competence, financial soundness,experience, general reputation of fairness and integrity.(b) Whether the applicant has been granted necessary approval by the ReserveBank of India for making investments in India;(c) Whether the applicant is an investment company, investment trust,investment partnership, pension fund, mutual fund, endowment fund, universityfund, charitable institution or any other entity incorporated outside India; or(d) Whether the applicant is an asset management company, investmentmanager or investment Management Company or any other investment vehicleincorporated outside India;(e) Whether the applicant is authorized to invest in venture capital fund or carry

on activity as foreign venture capital investors;(f) Whether the applicant is regulated by an appropriate foreign regulatoryauthority or is an income tax payer; or submits a certificate from its banker of itsor its promoters track record where the applicant is neither a regulated entity noran income tax payer.(g) The applicant has not been refused a certificate by the Board.(h) Whether the applicant is a fit and proper person.

Furnishing of information, clarificationThe Board may require the applicant to furnish such further information as it mayconsider necessary.

Consideration of applicationAn application which is not complete in all respects shall be rejected by theBoard:Provided that, before rejecting any such application, the applicant shall be givenan opportunity to remove, within thirty days of the date of receipt ofcommunication, the objections indicated by the Board.Provided further that the Board may, on being satisfied that it is necessary toextend the period specified above may extend such period not beyond ninetydays.

Procedure for grant of certificate(a) If the Board is satisfied that the applicant is eligible for the grant of certificate,it shall send intimation to the applicant.(b) On receipt of intimation, the applicant shall pay to the Board; the registrationfee.(c) The Board shall on receipt of the registration fee grant a certificate ofregistration.


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Procedure where certificate is not granted(a) On considering an application made if the Board is of the opinion that acertificate should not be granted, it may reject the application after giving theapplicant a reasonable opportunity of being heard.(b) The decision of the Board to reject the application shall be communicated to

the applicant.

10.3. INVESTMENT CONDITIONS AND RESTRICTIONSInvestment Criteria for a Foreign Venture Capital InvestorAll investments to be made by a foreign venture capital investors shall be subjectto the following conditions: -(a) It shall disclose to the Board its investment strategy.(b) It can invest its total funds committed in one venture capital fund.(c) It shall make investments as enumerated below:(i) At least 66.67% of the investible funds shall be invested in unlisted equityshares or equity linked instruments of Venture Capital Undertaking.

(ii) Not more than 33.33% of the investible funds may be invested by way of:(ii.a) Subscription to initial public offer of a venture capital undertaking whoseshares are proposed to be listed.(ii.b) Debt or debt instrument of a venture capital undertaking in which the foreignventure capital investor has already made an investment by way of equity.(ii.c) Preferential allotment of equity shares of a listed company subject to lock inperiod of one year.(ii.d) The equity shares or equity linked instruments of a financially weakcompany or a sick industrial company (a company, which has at the end of theprevious financial year accumulated losses, which has resulted in erosion ormore than 50% but less than 100% of its net worth as at the beginning of the

previous financial year) whose shares are listed.(ii.e) Special Purpose Vehicles which are created for the purpose of facilitating orpromoting investment in accordance with these Regulations.(d) It shall disclose the duration of life cycle of the fund.

10.4. GENERAL OBLIGATIONS AND RESPONSIBILITIESMaintenance of books and records(a) Every Foreign Venture Capital Investor shall maintain for a period of eightyears, books of accounts, records and documents which shall give a true and fairpicture of the state of affairs of the Foreign Venture Capital Investor.(b) Every Foreign Venture Capital Investor shall intimate to the Board, in writing,the place where the books, records and documents are being maintained.

Power to call for information(a) The Board may at any time call for any information from a Foreign VentureCapital Investor with respect to any matter relating to its activity as a ForeignVenture Capital Investor.


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(b) Where any information is called for it shall be furnished within the timespecified by the Board.General Obligations and Responsibilities(a) Foreign Venture Capital Investor or a global custodian acting on behalf of theforeign venture capital investor shall enter into an agreement with the domestic

custodian to act as a custodian of securities for Foreign Venture Capital Investor.(b) Foreign Venture Capital Investor shall ensure that domestic custodian takessteps for,-(i) Monitoring of investment of Foreign Venture Capital Investors in India(ii) Furnishing of periodic reports to the Board(iii) Furnishing such information as may be called for by the Board.Appointment of designated bankForeign Venture Capital Investor shall appoint a branch of a bank approved byReserve Bank of India as designated bank for opening of foreign currencydenominated accounts or special non-resident rupee account.

10.5. INSPECTION AND INVESTIGATIONSBoard's right to inspect or investigateThe Board may, suo-moto or upon receipt of information or complaint, cause aninspection or investigation to be made in respect of conduct and affairs of anyforeign venture capital investor by an Officer whom the Board considers fit for.Notice before inspection or investigationBefore ordering an inspection or investigation, the Board shall give not less thanten days notice to the venture capital fund.

10.6. IN CASE OF DEFAULTBoard's right to suspend or cancel certificate of registration

Without prejudice to the appropriate directions or measures board may afterconsideration of the investigation report, initiate action for suspension orcancellation of the registration of such Foreign Venture Capital Investor:Provided that no such certificate of registration shall be suspended or cancelledunless the procedure specified is complied with.Suspension of certificateThe Board may suspend the certificate where the Foreign Venture CapitalInvestor:(a) Contravenes any of the provisions of the Act or these regulations;(b) Fails to furnish any information relating to its activity as a Foreign Venture

Capital Investor as required by the Board;(c) Furnishes to the Board information which is false or misleading in anymaterial particular;(d) Does not submit periodic returns or reports as required by the Board;(e) Does not co-operate in any enquiry or inspection conducted by the Board;


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Cancellation of certificateThe Board may cancel the certificate granted to a Foreign Venture CapitalInvestor: -(a) When the Foreign Venture Capital Investor is guilty of fraud or has beenconvicted of an offence involving moral turpitude;

Explanation: The expression "fraud" has the same meaning as is assigned to it insection 17 of the Indian Contract Act, 1872. (9 of 1872)(b) The Foreign Venture Capital Investor has been guilty of repeated defaults. or(c) Foreign Venture Capital Investor does not continue to meet the eligibilitycriteria laid down in these regulations;(d) Contravenes any of the provisions of the Act or these regulations.

Action against intermediaryThe Board may initiate action for suspension or cancellation of registration of anintermediary holding a certificate of registration under section 12 of the Act whofails to exercise due diligence in the performance of its functions or fails to

comply with its obligations under these regulations.Provided that no such certificate of registration shall be suspended or cancelledunless the procedure specified in the regulations applicable to such intermediaryis complied with.

Appeal to Securities Appellate TribunalAny person aggrieved by an order of the Board under these regulations mayprefer an appeal to the Securities Appellate Tribunal in accordance with section15T of the Act.

Amount to be paid as fees

Application fee (US$) 5, 000Registration fee shall be payable at the time of registrationfor grant of certificate (US $) 20, 000

10.6. NEGATIVE LIST

(a) Non-banking financial services excluding those Non Banking Financialcompanies which are registered with Reserve Bank of India and have beencategorized as Equipment Leasing or Hire Purchase companies.(b) Gold financing excluding those companies which are engaged in gold

financing for jewellery.(c) Activities not permitted under the Industrial Policy of Government of India(d) Any other activity wshich may be specified by the Board in consultation withthe Government of India from time to time.


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TAXATIONIn 2002, Under new rules in India, the entire income of registered VC funds,whether foreign or domestic, is exempt from Indian income tax, subject to

certain conditions. But to take advantage of this tax-exempt status, fundsmust register with the regulator, the Securities and Exchange Board ofIndia.

In late 2000, Sebi issued the Foreign Venture Capital Investor Regulations, 2000.They apply to foreign venture capital investors (FVCI) incorporated andestablished outside India and which propose to invest in India. Until recently,FVCIs avoided registering themselves with Sebi due to the extremely confusingregulatory and tax position. FVCIs preferred to operate from overseas, usuallythrough a liaison office in India. However, this was no longer the case followingthe enactment of the Regulations, and also amendment to the Indian Income Tax

Act, 1961 (IT Act).

The clear advantages of registration notwithstanding, there were an argumentthat it is mandatory anyway. This view was based on Section 12(1B) of the SebiAct, 1992, which provides that no person may sponsor or carry on any venturecapital fund without a certificate of registration from Sebi, in accordance with theRegulations. Failure to register may amount to a contravention of the provisionsof Section 12(1B) of the Sebi Act, 1992, which can lead to heavy fines.

This view proceeds on the assumption that a distinction must be made betweena non-resident making a foreign direct investment (FDI) and an FVCI. This

distinction is established from the nature of the agreements entered into by aforeign investor with the Indian investee companies and its promoters, and alsowhether the foreign investor otherwise carries on the business of being a venturecapital fund outside India.

This contention was reinforced when India's central bank, the Reserve Bank ofIndia (RBI), amended the Foreign Exchange Management (Transfer or Issue ofSecurity by a Person Resident outside India) Regulations, 2000, to specificallybring within its fold investments by a Sebi-registered FVCI in a domestic, Sebi-registered venture capital fund or an unlisted Indian company. The effect of theamendment is that such an investment will no longer be regarded as FDI, but as

a separate category of investment. The advantage of such treatment is thatshares issued by unlisted Indian companies to an FVCI will not be subject tocompliance with the usual price guidelines and the FVCI may acquire orpurchase the shares issued by unlisted Indian companies at a price that ismutually agreed between the buyer and the seller or issuer.


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Advantages of Regisration

The obvious advantage of registration is that, under the IT Act, its income is taxfree. But another advantage is that under the normal FDI rules, all FDI investorsrequire the central government's prior permission to invest in a similar field to any

of its previous investments or tie ups. In other words, automatic approval is notallowed and a no-objection certificate of the Indian investee company (with whomthere is an existing tie up) is required. However, Sebi-registered FVCIs areexempted from this requirement.

There is no minimum capitalization requirement for being registered as an FVCI.It can invest either in a domestic fund or in a domestic company whose sharesare not listed on a recognized stock exchange in India (it does not matter if itsshares are listed on a stock exchange outside India, such as the NASDAQ orNYSE) and is not engaged in any activity except real estate, non-bankingfinancial services or gold financing (a venture capital undertaking). While granting

registration, Sebi will take into account the FVCI's track record, reputation of thegroup and financial soundness. While it can invest its total funds even in onedomestic fund, it cannot invest more than 25 per cent of its committed funds inany one venture capital undertaking (and at least 75 per cent of suchinvestments must be in equity).

The Regulations require an FVCI to appoint a domestic custodian as well asopen a non-resident rupee or foreign currency account with a designated bank.Banks are allowed to offer forward cover (for hedging against forex risk) to FVCIsto the extent of their inward remittance. Registration fees payable to Sebi areabout $11,000.

Taxation of FVCI

Under Section 90(2) of the IT Act, a non-resident assessee based in a countrywith which India has a double taxation avoidance agreement (DTAA), may opt tobe taxed either under the IT Act or the DTAA, whichever is more beneficial?

Under Section 10(23FB) of the IT Act, any income of a registered FVCI is exemptfrom income tax. The FVCI can carry on business in India through a permanent

establishment in India, and yet its entire income would be tax free. On the otherhand, if the FVCI opts to be taxed under the DTAA and it has a permanentestablishment in India, its Indian income will not be tax free.

The tax exemption under section 10(23FB) has to be read with section 115U ofthe IT Act, which confers a pass-through status on Sebi-registered venture funds.Investors in such funds would be liable to tax in respect of the income receivedby them from the FVCI in the same manner as it would have been, had the


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investors invested directly in the venture capital undertaking. In other words,income earned by an FVCI by way of dividend, interest or capital gains, upondistribution, would continue to retain the same character in the hands of itsinvestors.

This brings us to a question as to what is the nature of the income derived by anFVCI from its Indian investments. While dividend declared by an Indian companyis tax free in the hands of any recipient, including an FVCI, the gains, an FVCIwould make upon exit from an Indian investment, was so far regarded as capitalgains. However, the Authority for Advance Ruling on March 7 2001 held thatprofits made by a private equity fund or venture capital fund should be taxed asbusiness profits and not as capital gains.

Are no

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