Saturday, September 25, 2010

Venture Capital in India

Historical valuation on the secondary marketImage via Wikipedia

A number of technocrats are seeking to set up shop on their own and capitalize on opportunities. In the highly dynamic economic climate that surrounds us today, few ‘traditional’ business models may survive. Countries across the globe are realizing that it is not the conglomerates and the gigantic corporations that fuel economic growth any more. The essence of any economy, today is the small and medium enterprises. For example, in the US, 50% of the exports, are created by companies with less than 20 employees and only 7% are created by companies with 500 or more employees.

The concept of venture capital is not new. Venture capitalists often relate the story of Christopher Columbus. In the fifteenth century, he sought to travel westwards instead of eastwards from Europe and so planned to reach India. His far-fetched idea did not find favor with the King of Portugal, who refused to finance him. Finally, Queen Isabella of Spain, decided to fund him and the voyages of Christopher Columbus are now empanelled in history.

In the modern times Angel investors, public venture capital, and other funding sources have had a significant impact on the U.S. economy during the 1980s. Venture capital fund organizations are specifically designed to provide risk capital to entrepreneurs.

Venture Capital- is the capital which funds the early, seed or initial stages of potentially high risk business ideas. The investment is usually in the form of shares (stock) or an instrument, which can be converted into shares at a future date. Venture capitalists (VC’s) expect high annual returns (generally varying between 25% and 75%) on their investment. Investment is generally in the range of Rs.10 mn. to Rs.500 mn. in a single proposal.

What Is Venture Capital?

Venture capital is money provided by professionals who invest alongside management in young, rapidly growing companies that have the potential to develop into significant economic contributors. Venture capital is an important source of equity for start-up companies.

Professionally managed venture capital firms generally are private partnerships or closely-held corporations funded by private and public pension funds, endowment funds, foundations, corporations, wealthy individuals, foreign investors, and the venture capitalists themselves.

Venture capitalists generally:

-    Finance new and rapidly growing companies
-    Purchase equity securities
-    Assist in the development of new products or services
-    Add value to the company through active participation
-    Take higher risks with the expectation of higher rewards
-    Have a long-term orientation

When considering an investment, venture capitalists carefully screen the technical and business merits of the proposed company. Venture capitalists only invest in a small percentage of the businesses they review and have a long-term perspective. They also actively work with the company's management, especially with contacts and strategy formulation. Venture capitalists mitigate the risk of investing by developing a portfolio of  young companies in a single venture fund. Many times they co-invest with other professional venture capital firms. In addition, many venture partnerships manage multiple funds simultaneously. For decades, venture capitalists have nurtured the growth of America's high technology and entrepreneurial communities resulting in significant job creation, economic growth and international competitiveness. Companies such as Digital Equipment Corporation, Apple, Federal Express, Compaq, Sun Microsystems, Intel, Microsoft and Genentech are famous examples of companies that received venture capital early in their development

In India, these funds are governed by the Securities and Exchange Board of            India (SEBI) guidelines. According to this, venture capital fund means a fund              established in the form of a company or trust, which raises monies through  loans, donations, issue of securities or units as the case may be, and makes or proposes to make investments in accordance with these regulations
Venture Capital scenario in India

      In the earlier years, individual investors and development financial institutions played the role of venture capitalists in India and entrepreneurs largely depended upon private placements, public offerings and the finance lend by financial institutions. In early seventies, the need to foster venture capital as a source of funding new entrepreneurs and technology was highlighted by the Committee on Development of Small and Medium Enterprises. In spite of some public sector funds being set up, the venture capital activity did not gather momentum. In 1988, the Government of India, based on a study undertaken by the World Bank, announced guidelines for setting up venture capital funds (VCFs). These guidelines were restricted to setting up of VCFs by banks or financial institutions only. Internationally, however, entrepreneurs who are willing to take higher risk, in anticipation of higher returns, usually set up venture capital funds. This is in contrast to banks and financial institutions, which are more averse to risk.
      In September 1995, Government of India issued guidelines for overseas venture capital investment in India whereas the Central Board of Direct Taxes (CBDT) issued guidelines for tax exemption purposes. (The Reserve Bank of India governs the investment and flow of foreign currency in and out of India.) As a part of its mandate to regulate and to develop the Indian capital markets, Securities and Exchange Board of India (SEBI) framed the SEBI (Venture Capital Funds) Regulations, 1996. Pursuant to the regulatory framework, some domestic VCFs were registered with SEBI. Some overseas investments also came through the Mauritius route. However, the venture capital industry, understood globally as independently managed, dedicated pools of capital that focus on equity or equity linked investments in privately held, high growth companies is still relatively in a nascent stage in India. Figures from the Indian Venture Capital Association (IVCA) reveal that, till 2000, around Rs. 2,200 crore (US$ 500 million) had been committed by the domestic VCFs and offshore funds which are members of IVCA. Figures available from private sources indicate that overall funds committed are around US$ 1.3 billion.
Also due to economic liberalisation and increasing global outlook in India, an increased awareness and interest of domestic as well as foreign investors in venture capital was observed. While only 8 domestic VCFs were registered with SEBI during 1996-98, more than 30 additional funds have already been registered in 2000-01.

Institutional interest is growing and foreign venture investments are also on the increase. Given the proper environment and policy support, there is a tremendous potential for venture capital activity in India. The Finance Minister, in the Budget 2000 speech announced, "For boosting high tech sectors and supporting first generation entrepreneurs, there is an acute need for higher investments in venture capital activities." He also said that the guidelines for the registration of venture capital activity with the Central Board of Direct Taxes would be harmonised with those for registration with the Securities and Exchange Board of India. SEBI decided to set up a committee on venture capital to identify the impediments and suggest suitable measures to facilitate the growth of venture capital activity in India. Keeping in view the need for global perspective, it was decided to associate Indian entrepreneur from Silicon Valley in the committee. The setting up of this committee was primarily motivated by the need to play a facilitating role in tune with the mandate of SEBI, to regulate as well as develop the market. The committee headed by K. B. Chandrasekhar, Chairman, Exodus Communications Inc., submitted its report on 8 January 2000. In his Budget Proposals 2000-01, the Finance Minister announced new regime for venture capital funds. And proclaimed SEBI as the single point nodal agency for registration and regulation of both domestic and overseas venture capital funds. The new regime stipulated that no approval of venture capital funds by tax authorities would be required and that the principle of "pass through" would be applied in tax treatment of venture capital funds. Recently, the Government of India has also announced the"exit policy" for venture capitalists.

 India has the second largest English speaking scientific and technical manpower in the world. Given this quality and magnitude of human capital India's potential to create enterprises is unlimited. Given the vast potential, which is, not only confined to IT and software but also in other sectors like biotechnology, telecommunications, media and entertainment, medical and health etc., venture capital industry is playing and shall continue to play a catalyst's role in industrial development.

In the early 1980s, the idea that venture capital might be established in India would have seemed utopian. India's highly bureaucratized economy, avowed pursuit of socialism, still quite conservative social and business worlds, and a risk-averse financial system provided little institutional space for the development of venture capital. With the high level of government involvement, it is not surprising that the first formal venture capital organizations began in the public sector. From its inception the Indian venture capital was linked with exogenous actors, public and private. In India, one of the most autarchic economies in the world, both the development of venture capital and the information technology industry have been intimately linked with the international economy. The earliest discussion of venture capital in India came in 1973, when the government appointed a commission to examine strategies for fostering small and medium-sized enterprises the Indian financial systems' operation made it difficult to raise "risk capital" for new ventures and proposed various measures to liberalize and deregulate the financial market.

The First Stage, 1986–1995

Indian policy toward venture capital has to be seen in the larger picture of the government's interest in encouraging economic growth. The 1980s were marked by an increasing disillusionment with the trajectory of the economic system and a belief that liberalization was needed.
Prior to 1988, the Indian government had no policy toward venture capital; in fact, there was no formal venture capital. In 1988, the Indian government issued its first guidelines to legalize venture capital operations. These regulations really were aimed at allowing state controlled banks to establish venture capital subsidiaries, though it was also possible for other investors to create a venture capital firm. However, there was only minimal interest in the private sector in establishing a venture capital firm.
The government's awakening to the potential of venture capital occurred in conjunction with the
World Bank's interest in encouraging economic liberalization in India. So, in November 1988, the Indian government announced an institutional structure for venture capital. Making the case for supporting the new venture capital guidelines with investments into Indian venture capital funds, the World Bank calculated that demand over the next 2–3 years would be around $67–133 million per annum, and it proposed providing $45 million to four public sector financial institutions for the purpose of permitting them to establish venture capital operations under the November 1988 guidelines issued by the Government of India. The funds were restricted to investing in small amounts per firm (less than 100 million rupees); the recipient firms had to be involved in technology that was “new, relatively untried, very closely held or being taken from pilot to commercial stage, or which incorporated some significant improvement over the existing ones in India.” The government also specified that the recipient firm’s founders should be “relatively new, professionally or technically qualified, and with inadequate resources or backing to finance the project.” There were also other bureaucratic fetters. There was even a list of approved investment areas. Two government-sponsored development banks, ICICI and IDBI, were required to clear every portfolio firm’s application to a venture capital firm to ensure that it fulfilled the right purposes. Also, the Controller of Capital Issues of the Ministry of Finance had to approve every line of business in which a venture capital firm wished to invest. In other words, the venture capitalists were to be kept on a very short leash.
Despite these constraints, the World Bank supported the venture capital project, noting that the
Guidelines reflect a cautious approach designed to maximize the likelihood of venture capital financing for technology-innovation ventures during the initial period of experimentation and thereby demonstrate the viability of venture capital in India.

The Second Stage, 1995–1999

The success of Indian entrepreneurs in Silicon Valley that began in the 1980s became far more visible in the 1990s. This attracted attention and encouraged the notion in the U.S. that India might have more possible entrepreneurs. Very often, NRIs were important investors in these funds. In quantitative terms, it is possible to see a dramatic change in the role of foreign investors. Notice also the comparative decrease in the role of the multilateral development agencies and the Indian government’s financial institutions. The overseas private sector investors became a dominant force in the Indian venture capital industry.
Venture capital should become an institutionalised industry financed and managed by successful entrepreneurs, professional and sophisticated investors. Globally, venture capitalists are not merely finance providers but are also closely involved with the investee enterprises         and provide expertise by way of management and marketing support. This industry has developed its own ethos and culture. Venture capital has only one common aspect that cuts across geography i.e. it is risk capital invested by experts in the field. It is important that venture capital in India be allowed to develop via professional and institutional management..  .

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