VENTURE CAPITAL FUNDING

Entrepreneurs as problem solvers The most difficult problems in the world do not have obvious

solutions They require creativity and tenacity

Entrepreneurs have the necessary traits: Vision Determination Resourcefulness Creativity A willingness to change direction when necessary

What is Venture Capital

U.S. – 30 years in existence Fairly new term in Asia (until the last 2-3 years) Earliest venture capital firm in Asia began in 1963 in

Japan Refers to investments in young, rapidly growing

companies (particularly high-tech related) in the U.S. Serves as an intermediary between investors looking for

high returns and entrepreneurs in need of capital Wider meaning in Asia ------- generally refers to equity

investments in growing, unlisted companies. Private Equity Direct Investments

Sources of Funding

What are they? Self Friends & Family Debt Grants, contracts – NIH, SBA, DARPA, etc. Angels Venture funds Crossover funds Strategic (other companies) Public markets

Where does the money comes from?

Fund investors:

Insurance companies Pension funds University endowment funds Family trusts Government Treasury / Agencies Listed corporations / Private companies Wealthy high net worth individuals (>US$1 million)

Nature of Venture Capital

Debt Financing

Public Market

Objective: generation of long term capital gains

Horizon: 2-7 years

Liquidity: low

Risk: High

Instruments: shares, convertible bonds, options, warrants

Critical factor(s): Management team and market potential, rather than collateral

Value-added services/advantages

◈ Financial and strategic planning ◈ Recruitment of key personnel ◈ Access to international markets and technology ◈ Introduction to strategic partners and acquisition targets ◈ Obtain a public listing

Industry Preference/Classifications

◈ Telecom ◈ Construction/Mining

◈ Media ◈ Agriculture/Fisheries

◈ IT ◈ Infrastructure

◈ Leisure/Entertainment ◈ Financial Services

◈ Electronics ◈ BioTech/Life Sciences

◈ Travel/Hospitality ◈ Real Estates

◈ Manufacturing/ Consumer Products

What are VC looking for in return?

Big equity upside from appreciation in the value of the Company.

Return target – normally in the range of IRR 15%-25%

Investment Process· Sourcing/Marketing Exits:

◈ IPOs Sale back◈ ◈ Trade sale to Strategic investors

· Initial evaluation & terms Put Option◈

· Due diligence · Monitoring ◈ viable business plan board seat◈ ◈ proprietary technology financial performance◈ ◈ enforceable legal structure ◈ accounting/financial integrity

· Documentation/Completion/Funding ◈ legal structure ◈ valuation

· Final negotiation/term sheet ◈ Shareholders’ Agreement ◈ Subscription Agreement

Issues with venture capital

No alignment with vision, mission, goals Enter with an intention to get out Demand – supply gap in funds Improper model Loss of control

Exit Strategy

Preferred exit route – IPO Strategic investor Buy back M&As Bigger VC Fund investing etc.

Venture Capital Investment Process

Screening Due diligence Evaluation Deal structuring Post-investment activity Exit

Stages of VC financing

1. Seed stage financing - The venture is still in the idea formation stage and its product or

service is not fully developed. Money may also be spent on marketing research, patent application.

- Capital provided for a business idea; usually supports product development and market research.

CONTD..

2. Early Stage

Start Up:

First Stage:

Second Stage:

CONTD..

3. Mezzanine Stage Also known as Bridge Financing.

- Capital provided for expansion of a profitable company for going public ( IPO).

Traditional Bank Finance vsVenture Capital Focus on entrepreneur, project and growth

prospects rather than security High risk, high return & high failure scenario Instruments – Debt vs Equity In case of failure – returns nil/negligible Time horizon for returns – Long Asset based financing vs Strength of Idea Focus on security vs Growth Prospects

VC in the business lifespan

Initial Idea, Business Formation

Business Growth

Maturing business

Larger sustainable enterprise

•Entrepreneur conceives idea•Often a small proprietorship•Generally micro or sub-micro in size

•Entrepreneur works with team

•Business plan to grow business past micro stage•Requires more infrastructure, addition of new products and services•Increase in headcount

•VC provides financial support•VC provides business building support

•Business growth slows•Focus on profit and efficiency

•VC provides strategic and operational support

•Business enters small stage•Pursues growth opportunities to get to medium and large size

•Other investors join

World Market Conditions

“Fear” is high Global credit

crunch/recession Uncertainty about size

and extent of problem Companies most

affected have bad balance sheets

VSX Volatility Index Sept 2000- Sept 2008

Data courtesy of SV Life Sciences LLP

Effect on Private Companies

Relatively limited impact on Indian companies Reduced access to public markets for exit or

financing Reduced availability of credit and increased

financing costs Potentially longer time period to exit and lower

exit valuations

So…

Financial markets are a mess India is a great place to be in these times Funding is still available, but…

Bar is raised for new investments Valuations are down Each type of funding is affected differently

Impact of the crisis on venture capital

Limited impact in the short term – in 95% of cases, funds will continue Quality VCs raise money from quality, long-term Limited

Partners (LPs) VCs have not typically used debt … fortunately

Potentially dramatic impact in the long term Exits – Definitely delayed significantly

VC investment criteria will be more conservative Early-stage VCs will still invest in early-stage companies but

hurdles will increase More sensitive on capital needs, time to market etc.

Asian Direct Investments: Past Excessive valuations

Plenty of capital available

Tightly - controlled enterprises → family business → allow only passive investments

Limited Government support for foreign investors → legal reforms → → corporate governance (transparency)

Risks associated with currency, political stability and credit

Situation in India• Growth in India has been disproportionately concentrated in industry and services • Rural and semi-urban India is lagging behind the rest of the country

- These regions are afflicted with poor infrastructure, low levels of education, lack of literacy, among other problems

•Private capital is the only source large enough to meet the scale of India’s need

- Social capital markets too small- Government does not understand private business sufficiently and is often compromised by political concerns

VC in India

India - Perhaps no better place to be driving innovation Buyers less affected by acute economic turmoil Insatiable demand Demographics

Lot’s of money still out there … the bar is much higher but great opportunities and great teams will get funded Take a strategic approach to fund raising. Target the best

sources of money given your opportunity and stage of development

Expect to spend a lot of time raising money

Needs of Micro & Small entrepreneurs

Skill / Resource Source

Product / service Idea

Operational capability

Team

Local market knowledge

Flexibility

Capital funding

Strategic support

•Entrepreneur

•Entrepreneur

•Entrepreneur

•Entrepreneur

•Entrepreneur

•Outside source

•Outside source

Role of VCs

•VCs should demonstrate that private capital can be used to support the growth of these enterprises

•Target 32% per investment return while furthering development

• Overall fund return should entice other private sources to enter rural and semi-urban India

SIDBI Venture Capital Ltd. (SVCL)

Wholly Owned Subsidiary of SIDBI Established to carry out business of setting

up, advising and managing Venture Capital funds

Professionally managed AMC Currently managing Rs.600 cr of VC funds

as Investment Manager

National Venture Fund for Software and IT Industry (NFSIT) Set up as a Trust Fund registered with SEBI Inaugurated by the Hon’ble Prime Minister in

December 1999 1st fund with Government contribution Tenure - 10 years (close ended) Corpus - Rs.100 crore Contributors - SIDBI, MCIT (GoI) and IDBI AMC – SIDBI Venture Capital Ltd. Trustee – SIDBI Trustee Company Ltd.

NFSIT Rs.100 cr corpus Dedicated to Software & IT Industry Investment by way of equity/ equity type

instruments Several hundred business plans examined Co-investment with other funds Investments in software services, products,

ITES, Internet initiatives etc.

Role of SVCL

SMEs require high level of handholding Active management participation by SVCL Nominee directors appointed on all investee cos. Quarterly internal audit by outside CA firm, progress

reports and visits Help create systems, provide strategic input for key

functional areas Help in resource mobilisation and fund raising

SIDBI Growth Fund

Structured as a unit scheme of SIDBI SME Venture Fund, registered under Trusts Act and with SEBI

Corpus size Rs.500 crore Initial corpus of Rs.100 crore committed by SIDBI Balance Rs.400 cr contributed by commercial banks. 8-year close-ended fund. Registered with SEBI.

SIDBI Growth Fund

To meet the long term risk capital of SME units and to provide mentoring support

Focus on growth sectors like – Biotech, IT, Pharma, Food processing, Retailing, Service sector projects Light Engineering etc

SIDBI Growth Fund

Proven technology or business model Sound Management Team Sustainable competitive IPR and a well

differentiated market positioning Clear exit plans for VC investors Potential of being market leader