Chapter: Business Science - Merchant Banking and Financial Services - Other Fund Based Financial Services

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Venture Capital

It is a long term capital invested in companies which involves high risk. The financing involves high risk but is compensated by high return.

VENTURE CAPITAL

 

1 INTRODUCTION

 

An entrepreneur, with a good technical knowledge, raising of capital in the conventional method will be very difficult. So, by a new technique of financing, long term capital is provided to small and medium sector through an institutional mechanism. So capital assistance against high growth oriented along with managerial assistance was felt necessary. This gave to the birth of Venture Capital Assistance.

 

VENTURE A business enterprise involving considerable risk

 

2 Meaning of Venture Capital:

 

It is a long term capital invested in companies which involves high risk. The financing involves high risk but is compensated by high return.

 

3 FEATURES OF VENTURE CAPITAL The following are the features of venture capital

 

1. It is the financing of capital for new companies.

 

2. This finance can also be loan-based or in convertible debentures

 

3. Providers of venture capital aim at capital gain due to the success achieved by the borrowing concern.

 

4.  Venture capital is always a long-term investment and made in companies which have high growth potential.

 

5.  The venture capital provider take part in the business of borrowing concern simultaneously provides managerial skill.

 

6. Venture capital financing contains risks. But the risk is compensated with a higher return.

 

7.  It involves financing mainly small and medium size firms, which are in their early stages. When the assistance of venture capital, these firms will stabilize and later can go in for traditional finance.

 

4 Objectives of Venture Capital

 

•To finance new companies who find it difficult to go to capital market

 

•To provide long term finance to small and medium scale industries

 

•To provide managerial assistance

 

•To bring in rapid growth in the business

 

5 Financing By Venture Capital Institutions:

 

Before going in for venture capital finance, the venture capital institution will have to assess the potentiality of the borrowing concern by a proper appraisal. This appraisal will be similar to the project appraisal undertaken by commercial banks. There are three stages involved in the venture capital finance.

 

6 Stages/Process

 

1. Seed capital It is the capital provided for testing the product and examining the commercial viability of the product. It enables the venture capital institution to find out the technical skill of the borrowing concern and its market potentially. So, we can say seed capital is more of a

 

product development and all the finance required at this stage is provided by the venture capital

 

institution.

 

2. Start up Start up of the product refers to the tested in the market and after being satisfied with its acceptability by the market, financing will be provided for further development of the product and marketing of the product. The startup may be classified into four categories: 1. A new high technology, introduced by the entrepreneur. 2. A new business started by an entrepreneur who has a thorough working knowledge and experience –normally started by persons who were working in an established firm and having gained sufficient experience. 3. New projects started by existing companies. Example: Retail business started by Hindustan Lever Limited. 4. A new company promoted by existing company. Here, the venture capital institution is keen to have a first-rated management which may have a second rated product. But not vice versa i.e., venture capital will not be provided for a concern having a second-rated management but a first-quality product.

 

3.  Second round finance It is the second round of finance after the initial stage after being commercially successful for want of some more finance.

 

4.  Later stage financing It is the financing after second round finance. The business concern which has borrowed venture capital has now become a well established business. But still, it is not able to go in for public issue of shares. At this stage, the venture capital institution will provide finance.

 

5. Messanine capital This is a stage where the borrowing company is not only well established but has overcome the risks and has started earning profits. But they have to go for some more year before reaching the stage of self sustenance. This finance is used by the borrowing company for purchase of plant and machinery, repayment of past debts, and entering new areas.

 

6. Bridge capital A capital of medium term finance ranging from one to three years and used for extending a business Example: bridge loan for acquiring other firms.

 

7.  Management Buy-outs (MBO) It is the capital used for acquiring all the shares and the voting rights to remove external control. Example : An Indian company’s s purchased by NRIs at the initial stage and after sometime these shares are bought back by the company with the help of profits and finance by venture capital institutions.

 

8. Management buy-in (MBI) Management buy in is the case where the funds are provided for an outside group to buy an ongoing company.

 

9. Turn Around Turn around may be

 

Financial Turnaround: When the company is able to improve its conditions financially, it is called financial turnaround, which is due to the financial assistance by venture capital institution.

 

Management Turn around: similarly, when the management of the company makes a turn around by becoming self dependent and is able to face the challenges of business, it is called management turn around.

 

7 Infrastructure financing Incubators:

 

Incubators are non profit entities providing consultancy services in promoting venture capital. To encourage venture capital industry, it is necessary to develop proper infrastructure for venture capital, as being done in foreign countries. Consultancy may be about office environment, finance and other complimentary resources. Incubators are promoted normally by government or professional organizations interested in developing small companies. The venture capital fund companies also have their own incubators and they provide in-house incubators. The job of incubators will be to provide early support to young entrepreneurs so that the enterprise is converted into a successful commercial venture at the earliest. For this purpose, proper financial support and managerial support are given. There are two successful incubator models. These are:

 

1.  Small Business Investment Company Programme (SBIC), administrated by Small Business Administrator (SBA).

 

2. Bilateral Industrial Research and Development Foundation (BIRD).

 

SBIC, USA provides venture capital to private investment managers who promote small companies. SBIC provides two-third of the capital and the remaining one-third is provided by insurance companies, endowments, foundations, etc. The capital supplied by SBA requires rate of return which is much lower than the market rate. SBIC will also raise capital from the open market. 45% of the total equity is provided by venture capital firms in America for the small enterprises. This method can be adopted in India also. The second model, BIRD is introduced by Israel  – The  Israeli  government  with  International  Corporation  could  mobilize  funds  for providing venture capital fund. The fund provides not merely financial assistance but infrastructure development, assistance for manufacturing and for selling innovative products.

 

 

8 Venture Capital in India

 

 

The venture capital institutions (VCIs) in India can be broadly classified into 5 types. 1. Venture Capital companies promoted by Development Banks 2. State level Venture capital companies 3. Commercial banks promoted Venture capital companies 4. Private sector Venture capital companies 5. Foreign venture Capital funds.

 

1. VC companies promoted by Development banks

 

a)  IDBI –VFC (Venture Fund Company) : IDBI promoted venture fund company in the year 1986. It is promoted by the Technology Development Wing of IDBI.

 

b)  TDICI - Technology Development and Information company of India Ltd. This was started in January 1988 with the support of ICICI and UTI. This is the country‗s first venture  fund (Venture Capital Unit Scheme). It was started with an initial fund of Rs.20 Crores and it has  financed nearly 37 small and medium scale enterprises. At present, it has a total fund of Rs.120  crores. The initial fund has yielded a return of Rs.16 crores.

 

 

c) RCTC –Risk Capital and Technology Finance Corporation Ltd: It is a subsidiary of IFCI, started in January 1988. Its resource base has Rs.30 crores which has contributions from UTI, IFCI and World Bank.

 

2. State level Venture Capital companies There are two state-level venture fund companies in India. They are 1. Gujarat Venture Finance Ltd. 2. Andhra Pradesh Venture Capital Limited (AVCL). Gujarat Venture Finance Ltd: Gujarat Industries Investment Corporation Ltd., along with Gujarat Lease Finance Corporation Ltd., Gujarat Alkalies & Chemicals Ltd., and Gujarat State Fertilizer Ltd., promoted Gujarat Venture finance Ltd. It has a venture fund of Rs.24 crores and was started in 1990. Andhra Pradesh Venture Capital Limited (AVCL): This was promoted by APIDC (Andhra Pradesh Industrial Development Corporation), IDBI, Andhra Bank and Indian Overseas Bank.

3. Venture Capital Companies promoted by Commercial Banks Notable among the venture companies promoted by the commercial banks i. Canara Bank venture Capital Fund (CVCF) : ii. Grind lays Bank has promoted India Investment Fund and Second India Investment Fund. iii. SBI Capital Venture Capital Fund.

 

4. Private sector Venture Capital companies in private sector, we have Larazd Credit Capital Venture Fund and Indus Venture Management Ltd. (IVML).

 

5. Foreign Venture Capital funds The Hong Kong Bank has promoted venture fund. Alliance Capital of U.S.A. has also promoted venture capital fund.

 

Guidelines For Providing Venture Capital:

 

The venture capital companies have been given certain guidelines for providing venture capital. Accordingly, the venture capital companies must obtain a detailed report from the borrowing company. The report should contain the following details: -

 

1. History of the borrowing company

 

2. Available facility for the borrowing company

 

3. Description of the products manufactured by the company

 

4. Market trend of the products

 

5. Cash flow position of the concern

 

6. Operating profit

 

7. Key personnel.

 

It takes about 6 months for a venture capital company to process the application during which period, aspects such as the organizational structure, competition for the company's product, etc., are studied.

 

9Investment Pattern In Venture Capital:

 

The investment plan will consist of 3 stages –

 

a). Basic stage

 

b). Operating stage

c). Exit stage

 

• Basic stage involves the study and evaluation of the project. • Operating stage deals with monitoring the functioning of the management of the borrowing concerns and advice for providing new round of finance. In the course of studying the managerial skill, the following aspects will be taken a) product quality b) Market size c) rate of return d) venture location e) growth potential f) state of entrepreneur

 

• Exit stage – The borrowing company may be sold to a third party or the company may be left  to look after itself. While studying the managerial skill, he following aspects will be taken: a) Product quality b) Market size c) Rate of return d) Venture location e) Growth potential f) State of entrepreneur

 

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