PROJECT REPORT

ON

VENTURE CAPITAL INDUSTRY IN

INDIA

FOR

SUBMISSION IN THE PARTIAL FULFILLMENT OF THE

REQUIREMENT OF FULL TIME MBA PROGRAMME
2002-04

Submitted by: Submitted to:

Name: Amrita – Hazra Ms Ankita Chopra

Roll No.: 19/MBA/RDIAS/02 Project Guide

RUKMINI DEVI INSTITUTE OF ADVANCED STUDIES (Affiliated to

GGSIPU, Delhi) Madhuban Chowk, Rohini, Delhi-85.

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 Acknowledgement

I am deeply indebted to my Project Coordinator Ms Ankita Chopra. for her

valuable suggestion, able guidance and constant encouragement throughout the
Project.

I would also like to thank all others who helped me directly and indirectly
during this project.

Amrita Hazra

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 CERTIFICATE

This is to certify that Ms. AMRITA HAZRA of M.B.A (FT)-4th Semester,

Batch 2002-2004, Roll No 19/RDMB/2002, has undertaken a project on
“VENTURE CAPITAL INDUSTRY IN INDIA” and completed the work
under my supervision. I am satisfied with the project submitted.

ANKITA CHOPRA

Faculty-RDIAS

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 EXECUTIVE SUMMARY

The project covers various aspects of the Indian Venture Capital Industry, such as what is
venture capital , the investment philosophy , what are its process, the various modes to access
the venture capital, options to finance a venture which includes both equity and debt, a brief
history of the venture capital industry and its overview. It also includes the current Indian
scenario with a brief profile of the major players in this industry such as State Finance
Corporations, Small Industrial Development Bank of India (SIDBI), Unit Trust of India
(UTI) etc.
The theoretical foundations cover the stages in the investment cycle of Venture capital
process such as, making a deal, Due diligence, Investment valuation, Pricing and structuring
the deal, Value Addition and monitoring and the exit routes.
This project also includes the various contributors to this industry and their industry wise
investments such as those of Public sector, Private Sector, Nationalized Banks, Mutual Funds
etc. And the categorization venture capital funds such as incubators, angel investors, private
equity players and venture capitalists.
Various factors on which the success of venture capital firms depends such as abandoning the
losers, manage portfolios, as well as focus on industry specific niches are also discussed in
the project.
It also includes a brief summary on the Committee on Development of Small and Medium
Entrepreneurs under the chairmanship of R.S. Bhatt which first highlighted venture capital
financing in India in 1972. And the first origin of modern day Venture Capital in India which
can be traced to the setting up of a Technology Development Fund (TDF) in the year 1987-
88, through the levy of a cess on all technology import payments.
Several companies were financed with this mode of funding which included SQL Star of
Hyderabad, Satyam Infoway to name a few.

However there are several problems faced by the Venture Capitalists in India which include:

 Venture Capital Financing is still not regarded as commercial activity.

 Investors feel that they would like to retain control and also to ensure that the business
must pass onto their family.

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 Returns, Taxes and Regulations

 Limitations on structuring of Venture Capital Funds(VCFs)

 Problem in raising of funds, etc.

The various regulatory issues for Venture Capital The Indian Trust Act 1882, The Central
Board of Direct Taxation (CBDT), Securities and Exchange Board of India,The Foreign
Investment Promotion Board (FIPB) and the Reserve Bank of India (RBI).

However there are several measure which have been provided:

 Social Awareness

 Deregulated Economic Environment

 Fiscal Incentives

 Encouragement to Entrepreneurship and Innovation

 A vigorous marketing thrust, promotional efforts and development strategy employing

new concepts such as venture fairs, venture clubs venture networks, business incubators
etc.

 A Statutory Co-ordination Body

 Encouragement and funding of R&D by private and public sector companies and the
government for ensuring technological competitiveness.

 Training and Development of Venture Capital Managers

 Broad Knowledge Base

Hence the project report analyses and throws a spotlight over the current scenario regarding
the Venture Capital Funds in India and regulations of “Securities Exchange Board of India”
providing the guidelines for such ventures in India.

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 VENTURE CAPITAL INDUSTRY IN INDIA

CHAPTER SCHEME:

I INTRODUCTION

 WHAT IS VENTURE CAPITAL

 INVESTMENT PHILOSOPHY
 OBJECTIVE OF THE STUDY
 DATA SOURCES
 LIMITATIONS
 OVERVIEW OF THE STUDY

II BRIEF HISTORY OF VENTURE CAPITAL INDUSTRY

III THEORETICAL FOUNDATIONS OF VENTURE CAPITAL

 VENTURE CAPITAL PROCESS

 ACCESSING THE VENTURE CAPITAL
 CATEGORIZATION OF VENTURE CAPITALISTS
 ANGEL INVESTORS
 HOW VENTURE CAPITAL IS DIFFERENT FROM COMMERCIAL
LENDING FOR A PROJECT

IV INDIAN SCENARIO

 OVERVIEW OF INDIAN VENTURE CAPITAL INDUSTRY

• OBJECTIVE AND VISION FOR VENTURE CAPITAL IN INDIA.

• EXPERIENCE OF US MARKET
• INDIA IS ATTRACTIVE FOR RISK CAPITAL
• VENTURE CAPITAL AT A TAKE-OFF STAGE IN INDIA
• THE INDIAN GOVERNMENT SETS UP A VENTURE CAPITAL FUND

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  INDIAN SCENARIO
• OPTIONS TO FINANCE A VENTURE
 STRUCTURE OF VENTURE CAPITAL INDUSTRY
 BRIEF PROFILE OF MAJOR PLAYERS
 CONTRIBUTIONS TO VENTURE CAPITAL FUNDS
• CONTRIBUTORS TO VENTURE CAPITAL FUNDS
• INVESTMENT BY INDUSTRY

 FACTORS FOR THE SUCCESS OF VENTURE CAPITAL FIRMS

 PROBLEMS WITH VENTURE CAPITAL IN INDIA
 REGULATORY ISSUES

V CONCLUSIONS

VI BIBLIOGRAPHY

APPENDIX

1. SEBI GUIDELINES FOR VENTURE CAPITAL

 PRELIMINARY
 REGISTRATION OF VENTURE CAPITAL FUND
 INVESTMENT CONDITIONS AND RESTRICTIONS
 GENERAL OBLIGATIONS AND RESPONSIBILITIES
 INSPECTION AND INVESTIGATION
 PROCEDURE FOR ACTION IN CASE OF DEFAULT

2. LIST OF VENTURE CAPITAL COMPANIES IN INDIA

3. INTERVIEW OF PRAMOD HAQUE

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8
VENTURE CAPITAL

INTRODUCTION
Venture capital, a financial innovation of the twentieth century, is a long-term liquid
investment, which can be in the form of equity, quasi-equity and some times debt in new
and high-risk ventures. Venture capital became better known after the famous legend of
Apple Computers, which started out in the US in 1977 with the capital firm, Arthur Rock &
Co. Apple Computers then made it to the Fortune 500 and Arthur Rock & Co. attained height
in Venture capital industry. However the success of Venture Capital in USA stimulated
world countries to practice on Venture capital.
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.

This growing trend can be attributed to rapid advances in technology in the last decade.
Knowledge driven industries like infotech, health-care, entertainment and services have
become the cynosure of bourses worldwide. In these sectors, it is innovation and technical
capability that are big business-drivers. This is a paradigm shift from the earlier physical
production and ‘economies 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 a clear
understanding of the market are among the sought after qualities of a promoter. However,
there are other factors, which lie beyond the control of the entrepreneur. Prominent among
these is the timely infusion of funds. This is where the venture capitalist comes in, with
money, business sense and a lot more.

WHAT IS VENTURE CAPITAL????

Venture Capital is money provided by professionals who invest alongside management in

rapidly growing companies; viz.: Sun, Intel, Microsoft, Mastek, Satyam Infoway, Rediff,
Pizza Corner….

Venture Capital derives its value from the brand equity, professional image, constructive
criticism, domain knowledge, industry contacts, they bring to table at a significantly lower
management agency cost.

Professionally managed venture capital firms generally are private partnerships or closely-
held corporations funded by private and public pension funds, endowment funds,

9
foundations, corporations, wealthy individuals, foreign investors, and the venture capitalists
themselves.

A Venture Capitalists strives to provide entrepreneurs with the support they need to create
up-scalable business with sustainable growth, while providing their contributors with
outstanding returns on investment, for the higher risks they assume.

Venture Capitalists generally:

 Finance new and rapidly growing companies

 Typically knowledge-based, sustainable, up scaleable companies

 Purchase equity / quasi-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.

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INVESTMENT PHILOSOPHY

The basic principal underlying venture capital – invest in high-risk projects with the
anticipation of high returns. These funds are then invested in several fledging enterprises,
which require funding, but are unable to access it through the conventional sources such as
banks and financial institutions. Typically first generation entrepreneurs start such
enterprises. Such enterprises generally do not have any major collateral to offer as security,
hence banks and financial institutions are averse to funding them. Venture capital funding
may be by way of investment in the equity of the new enterprise or a combination of
debt and equity, though equity is the most preferred route.

Since most of the ventures financed through this route are in new areas (worldwide venture
capital follows "hot industries" like infotech, electronics and biotechnology), the probability
of success is very low. All projects financed do not give a high return. Some projects fail and
some give moderate returns. The investment, however, is a long-term risk capital as such
projects normally take 3 to 7 years to generate substantial returns. Venture capitalists offer
"more than money" to the venture and seek to add value to the investee unit by active
participation in its management. They monitor and evaluate the project on a continuous basis.

The venture capitalist is however not worried about failure of an investee company, because
the deal which succeeds, nets a very high return on his investments – high enough to make up
for the losses sustained in unsuccessful projects. The returns generally come in the form of
selling the stocks when they get listed on the stock exchange or by a timely sale of his stake
in the company to a strategic buyer. The idea is to cash in on an increased appreciation of the
share value of the company at the time of disinvestment in the investee company. If the
venture fails, the entire amount gets written off. Probably, that is one reason why venture
capitalists assess several projects and invest only in a handful after careful scrutiny of the
management and marketability of the project.

To conclude, a venture financier is one who funds a start up company, in most cases
promoted by a first generation technocrat promoter with equity. A venture capitalist is not a
lender, but an equity partner. He cannot survive on minimalism. He is driven by
maximization: wealth maximization. Venture capitalists are sources of expertise for the
companies they finance. Exit is preferably through listing on stock exchanges. This method
has been extremely successful in USA, and venture funds have been credited with the
success of technology companies in Silicon Valley. The entire technology industry thrives on
it.

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 OBJECTIVE OF THE STUDY

Objective of the study has been to analyze the:

1. Trends in the Indian Venture Capital Industry.

2. To study the current Indian scenario.
3. To find out the different contributors to the Indian Venture Capital Industry and their
investment industry wise.
4. To identify the major players in the Indian Venture capital Industry.
5. To identify the problems faced by the Indian venture Capitalists.
6. To study the various guidelines of the regulatory body “SEBI”.

LIMITATIONS OF THE PROJECT

Major limitation of the project has been the unavailability of current data, of the contributors
to the Indian Venture Capital Industry (source of data being the year 1998) and no
comparative analysis has been undertaken of the Venture Capital Industry in India with those
of the developed nations like USA, UK due to lack of adequate data.

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 SOURCES OF DATA

The sources of for this project is secondary in nature but predominantly being the internet,
newspapers and magazines. Websites which have contributed to the information for this
project are :

• www.indiainfoline.com
• www.economictimes.com
• www.namesthenri.com
• www.altaassets.com
• www.domain-b.com
• www.google.com

Newspapers and magazines being “THE ECONOMIC TIMES”,“THE TIMES OF INDIA”,

BUSINESS TODAY, BUSINESS WORLD etc.

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 OVERVIEW OF THE STUDY

The project covers various aspects of the Indian Venture Capital Industry, such as what is
venture capital , what is its process, modes to access the venture capital, a brief history of the
venture capital industry and its overview. The current Indian scenario, a brief profile of the
major players in this industry, contributors to this industry and their industry wise
investments. The project also includes the various factors for the success of venture capital
firms, problems faced by them and the measures that should be adopted to tackle such
problems. Other aspects that are covered are the SEBI guidelines that govern the venture
capital firms and how venture capital financing is different from commercial lending for a
project. Lastly what the top venture capitalist of this world sees this industry to be as in the
future.

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 CHAPTER –II

BRIEF HISTORY OF THE VENTURE

CAPITAL INDUSTRY.

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BRIEF HISTORY

The story of venture capital in the history of mankind.

In the fifteenth century, Christopher Columbus sought to travel westwards instead of

eastwards from Europe, 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 for his venture. And thus evolved the concept of Venture Capital.

The modern venture capital industry began taking shape in the post–World War II.

The earliest members of the organized venture capital industry had several role models,
including these three:

American Research and Development Corporation, formed in 1946, whose biggest

success was Digital Equipment. The founder of ARD was General Georges Doroit, a French-
born military man who is considered "the father of venture capital." In the 1950s, he taught at
the Harvard Business School. His lectures on the importance of risk capital were considered
quirky by the rest of the faculty, who concentrated on conventional corporate management.

J.H. Whitney & Co, also formed in 1946, one of whose early hits was Minute Maid juice.
Jock Whitney is considered one of the industry’s founders.

The Rockefeller Family, and in particular, L S Rockefeller, one of whose earliest

investments was in Eastern Airlines, which is now defunct but was one of the earliest
commercial airlines.

The Second World War produced an abundance of technological innovation, primarily with
military applications. They include, for example, some of the earliest work on micro
circuitry. Indeed, J.H. Whitney’s investment in Minute Maid was intended to commercialize
an orange juice concentrate that had been developed to provide nourishment for troops in the
field.

In the mid-1950s, the U.S. federal government wanted to speed the development of advanced
technologies. In 1957, the Federal Reserve System conducted a study that concluded that a
shortage of entrepreneurial financing was a chief obstacle to the development of what it
called "entrepreneurial businesses." As a response this a number of Small Business
Investment Companies (SBIC) were established to "leverage" their private capital by
borrowing from the federal government at below-market interest rates. Soon commercial
banks were allowed to form SBICs and within four years, nearly 600 SBICs were in
operation.

At the same time a number of venture capital firms were forming private partnerships outside
the SBIC format. These partnerships added to the venture capitalist’s toolkit, by offering a

degree of flexibility that SBICs lack. Within a decade, private venture capital partnerships
passed SBICs in total capital under management.

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The 1960s saw a tremendous bull IPO market that allowed venture capital firms to
demonstrate their ability to create companies and produce huge investment returns. For
example, when Digital Equipment went public in 1968 it provided ARD with 101%
annualized Return on Investment (ROI). The US$70,000 Digital invested to start the
company in 1959 had a market value of US$37mn. As a result, venture capital became a hot
market, particularly for wealthy individuals and families. However, it was still considered too
risky for institutional investors.

In the 1970s, though, venture capital suffered a double-whammy. First, a red-hot IPO market
brought over 1,000 venture-backed companies to market in 1968, the public markets went
into a seven-year slump. There were a lot of disappointed stock market investors and a lot of
disappointed venture capital investors too. Then in 1974, after Congress legislation against
the abuse of pension fund money, all high-risk investment of these funds was halted. As a
result of poor public market and the pension fund legislation, venture capital fund raising hit
rock bottom in 1975.

In 1978, there were a number of high-profile IPOs by venture-backed companies. These

included Federal Express in 1978, and Apple Computer and Genetech Inc in 1981. This
rekindled interest in venture capital on the part of wealthy families and institutional investors.
Indeed, in the 1980s, the venture capital industry began its greatest period of growth. In
1980, venture firms raised and invested less than US$600 million. That number soared to
nearly US$4bn by 1987. The decade also marked the explosion in the buy-out business.

The late 1980s marked the transition of the primary source of venture capital funds from
wealthy individuals and families to endowment, pension and other institutional funds. The
surge in capital in the 1980s had predictable results. Returns on venture capital investments
plunged. Many investors went into the funds anticipating returns of 30% or higher. That was
probably an unrealistic expectation to begin with. The consensus today is that private equity
investments generally should give the investor an internal rate of return something to the
order of 15% to 25%, depending upon the degree of risk the firm is taking.

However, by 1990, the average long-term return on venture capital funds fell below 8%,
leading to yet another downturn in venture funding. Disappointed families and institutions
withdrew from venture investing in droves in the 1989-91 period. The economic recovery
and the IPO boom of 1991-94 have gone a long way towards reversing the trend in both
private equity investment performance and partnership commitments.

In 1998, the venture capital industry in the United States continued its seventh straight year
of growth. It raised US$25bn in committed capital for investments by venture firms, who
invested over US$16bn into domestic growth companies in all sectors, but primarily focused
on information technology.

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 CHAPTER- III

THEORETICAL FOUNDATIONS OF
VENTURE CAPITAL

18
VENTURE CAPITAL PROCESS

Obtaining capital for a project through this route is very difficult. It involves many steps
which a prospective entrepreneur has to adopt when he approaches a investor (Venture
Capitalists). They are:
A strong business plan that outlines the management team, product, marketing plan, capital
costs and means of financing and profitability projection of the company. The investment
process is industry specific and may vary with time and region. The typical stages in the
investment cycle are given below.

1. Making a deal
2. Due diligence
3. Investment valuation
4. Pricing and structuring the deal
5. Value Addition and monitoring
6. Exit

Making A Deal
In generating a deal flow, the venture capital investor creates a pipeline of ‘deals’ or
investment opportunities that he would consider for investing in. This is achieved primarily
through plugging into an appropriate network.

Due Diligence
Due Diligence refers to evaluating an investment proposal. It includes carrying checks on the
proposal related to aspects concerning management team, products, technology and the
market. Screening can be sometimes elaborate and rigorous and sometimes specific and brief.

New Financing
Sometimes, companies may have experienced operational problems during their early stages
of growth or due to bad management. These could result in losses or cash flow drains on the
company. Sometimes financing from venture capital may end up being used to finance these
losses. They avoid this through due diligence and scrutiny of the business plan. Financing a
new venture should be done after carefully evaluation of the project.

Investment valuation
Typically in countries where free pricing regimes exist, the valuation process goes through
the following steps:

 Evaluate future revenue and profitability

 Forecast likely future value of the firm based on experienced market

capitalization or expected acquisition proceeds depending upon the anticipated
exit from the investment.

 Target an ownership position in the investee firm so as to achieve desired

appreciation on the proposed investment. The appreciation desired should yield a
hurdle rate of return on a Discounted Cash Flow basis.

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Structuring of deal

It refers to negotiation between entrepreneurs and venture capitalists for closing the deal. The
structure should take into consideration various commercial issues (i.e what the entrepreneur
wants and what the venture capital would require to protect the investment). The instruments
to be used in structuring deals are many and varied. The objective in selecting the instrument
would be to maximize venture capital’s returns/protection and yet satisfy the entrepreneur’s
requirements. The instruments could be as follows:

Instrument Issues

1. Loan- clean vs secured

Interest bearing vs non interest bearing

convertible vs one with features (warrants)
1st Charge, 2nd Charge,
loan vs loan stock
Maturity

2. Preference shares- redeemable (conditions under Company Act)

participating
par value
nominal shares

3. Warrants- exercise price, expiry period

4. Common shares- new or vendor shares

par value
partially-paid shares

5. Options- exercise price, expiry period, call, put

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Exit strategy
Exit is one of the most important issue from both the sides (venture capitalists and
entrepreneur). The actual return from the for venture capitalists come at the time of exit.
There are several exit routes, buy-back by promoters, sale to another company or sale at the
time of Initial Public Offer (IPO). In the present context there is no proper means of exit,
appropriate changes have to made to the existing systems in order for the venture capitalists
to realise their returns after holding on to them for a certain period of time. This factor is
critical to smaller and mid sized companies, which are unable to get listed on any stock
exchange, because of stringent listing requirements. In order to take the full advantage of the
Venture Capital the Government should consider the proposals to bring down certain
hindrances that come in the way for the exit of the venture capitalists

ACCESSING THE VENTURE CAPITAL

Venture capital has been in India for quite sometime. The rejection ratio is very high, out of a
100 proposals received only 1 gets funded. The standard parameters used by venture
capitalists are very similar to any investment decision. The only difference being exit. If one
buys a listed security, one can exit at a price but with an unlisted security, exit becomes
difficult. The key factors which they look for in

1. The Management
2. The Idea
3. Valuation
4. Exit

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CATEGORIZATION

The "venture funds" available could be from:

 INCUBATORS

An incubator is a hardcore technocrat who works with an entrepreneur to develop a business

idea, and prepares a Company for subsequent rounds of growth & funding. eVentures,
Infinity are examples of incubators in India.

 ANGEL INVESTORS

An angel is an experienced industry-bred individual with high net worth. Typically, an angel
investor would:

 invest only his chosen field of technology

 take active participation in day-to-day running of the Company
 invest small sums in the range of USD 1 - 3 million
 not insist on detailed business plans
 sanction the investment in up to a month
 help company for "second round" of funding

The IndUS Entrepreneurs (TiE) is a classic group of angels like: Vinod Dham, Sailesh
Mehta, Kanwal Rekhi, Prabhu Goel, Suhas Patil, Prakash Agarwal, K.B. Chandrashekhar. In
India there is a lack of home grown angels except a few like Saurabh Srivastava & Atul
Choksey (ex-Asian Paints).

 VENTURE CAPITALISTS (VCS)

VCs are organizations raising funds from numerous investors & hiring experienced
professional mangers to deploy the same. They typically:

 invest at “second” stage

 invest over a spectrum over industry/ies
 have hand-holding “mentor” approach
 insist on detailed business plans
 invest into proven ideas/businesses
 provide “brand” value to investee
 invest between USD 2 – 5 million

 PRIVATE EQUITY PLAYERS

They are established investment bankers. Typically:

 invest into proven/established businesses

 have “financial partners” approach
 invest between USD 5 –100 million

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 ANGEL INVESTORS

Angels are important links in the entire process of venture capital funding. This is because
they support a fledging enterprise at a very early stage – sometime even before
commercialization of the product or service offering. Typically, an angel is an experienced
industry-bred individual with high net worth.

Angels provide funding by "first round" financing for risky investments – risky because they
are a young /start-up company or because their financial track record is unstable. This
venture capital financing is typically used to prepare the company for "second round"
financing in the form of an initial public offering (IPO). Example – A company may need
"first round" financing to develop a new product line, (viz a new drug which would require
significant research & development funding) or make a strategic acquisition to achieve
certain levels of growth & stability.

It is important to choose the right Angel because they will sit on your Board of Directors,
often for the duration of their investment and will assist in getting "second round" financing.
When choosing an 'Angel', it is imperative to consider their experience in a relevant industry,
reputation, qualifications and track record.

Angels are people with less money orientation, but
early-stage company work. They are people with
experts in their fields. They understand the field
entrepreneur needs this kind of expertise. He also
Angels bring both to the table of an entrepreneur.
who play an active role in making an
enough hands-on experience and are
from an operational perspective. An
needs money to make things happen.

There are a number of professionally qualified people, especially from IITs who had
migrated to USA. Some of them have made their millions riding the IT boom in Silicon
Valley. Having witnessed the maturity of the Silicon Valley into the global tech hotspot and
thrived in the environment there, these individuals are rich in terms of financial resources and
experience. They are the latest angels in the Indian industry.

The IndUS Entrepreneurs (TiE), a networking society that brings together highly influential
Indians across the US was set up in 1992. The aim of the organization is to get the
community together and to foster entrepreneurs and wealth creation. The idea was sparked
off in 1992, when a group of Silicon Valley entrepreneurs with roots in the Indian sub-
continent met by chance for a meeting with a visiting dignitary from India. A delayed flight
kept the group waiting, and provided an opportunity for people to get to know one another. It
turned out that most of the assembled invitees to the meeting had achieved varying degrees
of entrepreneurial success. The group saw value in getting together on a regular basis to
network with one another. Thus, the idea of TiE was born as a mechanism for high
achievement-oriented IndUS entrepreneurs to network.

Over the years, a core group of about 10-15 individuals worked hard to establish the
organization. Meeting at least once a month, successful veteran entrepreneurs, contributed as
speakers, participants and mentors. Gradually, the group started attracting greater
participation, and the TiE concept started gaining momentum. TiE membership has now

23
grown to over 600 members, and chapters in Boston, Austin and Los Angeles. TiE is also
supported by over 20 institutions that include leading Silicon Valley venture capital
investors, law firms, accounting firms and banks.

Fifty percent of business plans submitted to venture capitalists in the Valley and outside is
now from Indians and TiE can take the lion's share of the credit for this. What's more? About
30 per cent of the projects that are funded, are headed by Indians. As of 1998, over two
dozen start-up companies have benefited from TiE, and two have already made successful
IPOs.

TiE isn't about venture capitalist funding. It's about angel investing. The issue here is to
identify a good idea that hasn't attracted any money, and then fund it the money coming from
the member's own pockets. The environment is traditional in the sense of it following a
gurukul environment of sorts, where the gurus transfer knowledge on business plans,
management strategies and survival kits to new TiE members.

Some of the famous names include

• Vinod Dham, father of the Pentium chip and now the CEO of the Silicon Spice, one
of the most closely watched start-ups in the Silicon Valley today.
• Sailesh Mehta, CEO & President of the US$15bn Providian Financial and the man
who is using technology to re-order consumer finance.
• Kanwal Rekhi, one of the first Indians to become a big name in the valley; founder
of Excelan, past CTO and member of Novell's board, now invests in a number of new
ventures. He is the current chairman of the TiE.
• Prabhu Goel, ‘serial entrepreneur’, who has started three hi-tech companies so far
and is on the board of five other companies as a private investor.
• Suhas Patil, who founded the semiconductor company Cirrus Logic in 1984.
• Prakash Agarwal, whose NeoMagic integrates memory and logic on a single chip.
The six year old company already has a market share of 50%.
• K.B. Chandrashekhar, heads the US$200mn Exodus Communications, whose fiber
optic network carries 30% of all Internet content traffic and whose servers host such
popular websites such as Yahoo, Hotmail and Amazon.

24
How is Extending Venture Capital for an Endeavour is Different from Extending Term
Loan for a Conventional Commercial Project?

A commercial project is undertaken by an entrepreneur for a productive activity, which has

already been recognised and similar projects of the same type executed by others. Everything
about the project is well-known. Financing such a project involves moderate or normal risks.
The applicant seeking finance may be a new entrepreneur or an established businessman. The
project can be assessed with relative ease through well-established yardsticks and risk areas
identified. Taking a decision on financing based on the feasibility and viability of the project
is comparatively an easier process. The financier assesses the cost of the project against the
return it is anticipated to generate to satisfy that the return generated over a period of time
would fully liquidate the loan given with interest.

In contrast an applicant for venture capital primarily possesses expert knowledge, which if
translated into activity promises to provide rich dividends, however with inherent
uncertainties. The project is innovative and has not been set up earlier. Venture capital
financing involves higher risk than conventional loans to industry and business. While in a
conventional term loan 90 to 95% of the projects may come through, a few with time and
cost escalation, in financing start-up or innovative ventures, the rate of failures may at times
be more than that of success. Pricing of venture capital financing must take this factor into
consideration. Projects indicating higher risks, but with the potential for very large return,
when successful alone can be covered under venture financing. Venture capital firms may
generally provide soft loans (equity participation) and may charge the payment of royalty on
the turnover of the recipient company over a specified period of time.

Conventional Project financing is like journeying in a familiar territory, while venture capital
financing is like surveying in an unknown region.

An applicant for venture capital possesses superior knowledge-capital or knowledge-assets,

and he seeks to enter entrepreneurship. The Wright Brothers at the dawn of the 20th Century,
prepared the blue print for a machine that could fly. One that would come forward to finance
the project for execution of the blue-print to produce a flying machine is a provider of
venture capital, and resources extended to Wright brothers for the purpose is Venture Capital.

Similarly Christopher Columbus in the Nineties of the 15th Century prepared a plan to
discover a route to India by sailing from Spain in the western direction, though India it was
known was located towards the east of Spain. The plan to be executed needed resources,
ships, sailors and other material needed for the long voyage. Resource so provided is eligible
to be called Venture Capital. "His (Columbus') 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.

25
 CHAPTER –IV

INDIAN SCENARIO

26
 OVERVIEW OF INDIAN VENTURE CAPITAL (1)

Indian venture capital is at a take-off stage in India, according to this report from
NASSCOM. Changes to the regulatory environment look set to encourage the flow of
investment to the Indian high-tech sector.

In the absence of an organised venture capital industry until almost 1998 in India,
individual investors and development financial institutions have played the role of
venture capitalists. Entrepreneurs have largely depended upon private placements, public
offerings and lending by financial institutions.

In 1973, a committee on the development of small and medium-sized enterprises highlighted

the need to foster venture capital as a source of funding for new entrepreneurs and
technology. Thereafter, some public sector funds were established but the activity of venture
capital did not gather momentum as the thrust was on high-technology projects funded on a
purely financial rather than a holistic basis. Later, a study was undertaken by the World Bank
to examine the possibility of developing venture capital in the private sector, based on which
the Indian government took a policy initiative and announced guidelines for venture capital
funds (VCFs) in 1988. However, these guidelines restricted the setting up of VCFs to the
banks or the financial institutions only. Internationally, the trend favoured venture capital
being supplied by smaller-scale, entrepreneurial venture financiers willing to take a high risk
in the expectation of high returns, a trend that has continued in this decade.

In September 1995 the Indian government issued guidelines for overseas investments in
venture capital in India. For tax exemption purposes, the Central Board of Direct Taxes
(CBDT)issued guidelines. The flow of investments and foreign currency in and out of India
has been governed by the Reserve Bank of India's (RBI) requirements. Furthermore, as part
of its mandate to regulate and to develop the Indian capital markets, the Securities and
Exchange Board of India (SEBI) framed the SEBI (Venture Capital Funds) Regulations,
1996.

Pursuant to this regulatory framework some domestic VCFs were registered with SEBI.
Some overseas investment 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'
(Venture Capital Cycle, Gompers and Lerner, 1999) - is still in a nascent stage in India.
Figures from the Indian Venture Capital Association (IVCA) show that until 1998, around
Rs30bn had been committed by domestic VCFs and off-shore funds, which are members of
IVCA. Figures available from private sources indicate that the overall funds committed are
around US$1.3bn.

27
The funds available for investment are less than 50 per cent of the committed funds and
actual investments are lower still. At the same time, due to economic liberalisation and an
increasingly global outlook in India, there is an increased awareness and interest of domestic
as well as foreign investors in venture capital. While only eight domestic VCFs were
registered with SEBI during 1996-1998, 14 funds have already been registered in 1999-2000.
Institutional interest is growing and foreign venture investments are also on the rise. Given
the proper environment and policy support, there is undoubtedly a tremendous potential for
venture capital activity in India.

In his 2000 budget speech, India's finance minister announced that a key ingredient for future
success lay in venture capital finance. Young Indian entrepreneurs, whether in Silicon
Valley, Bangalore or Hyderabad have shown how ideas, knowledge, entrepreneurship and
technology can combine to yield unprecedented growth of incomes, employment and wealth.
To promote this flowering of knowledge-based enterprise and job creation, he announced a
major liberalisation of the tax treatment for venture capital funds. SEBI was granted the
responsibility for the registration and regulation of both domestic and overseas venture
capital funds. This liberalisation and simplification of procedures is expected to encourage
non-resident Indians (NRIs) in Silicon Valley and elsewhere to invest some of their capital,
knowledge and
enterprise in Indian ventures.

Objective and vision for venture capital in India

Venture capital is very different from traditional sources of financing. Venture capitalists
finance innovation and ideas, which have a potential for high growth but with inherent
uncertainties. This makes it a high-risk, high-return investment. Apart from finance, venture
capitalists provide networking, management and marketing support as well. In the broadest
sense, therefore, venture capital connotes human as well as financial capital. In the global
venture capital industry, investors and investee firms work together closely in an enabling
environment that allows entrepreneurs to focus on value creating ideas. Venture capitalists,
meanwhile, drive the industry through ownership of the levers of control in return for the
provision of capital, skills, information and complementary resources. This very blend of risk
financing and handholding of entrepreneurs by venture capitalists creates an environment
particularly suitable for knowledge and technology-based enterprises.
Scientific, technological and knowledge-based ideas - properly supported by venture capital -
can be propelled into a powerful engine of economic growth and wealth creation in a
sustainable manner. In various developed and developing economies, venture capital has
played a significant developmental role. India, along with Israel, Taiwan and the US, is
recognised for its globally competitive high technology and human capital. India's recent
success story in software and IT is almost a fairy tale when considering obstacles such as
inadequate infrastructure, expensive hardware, restricted access to foreign skills and capital,
and limited domestic demand. It also indicates the potential India has in terms of knowledge
and technology-based industry.

28
India has the second largest English speaking scientific and technical manpower in the world.
Some of its management (IIMs) and technology institutes (IITs) are known globally as
centres of excellence. Every year, over 115,000 engineers graduate from government-run and
private engineering colleges. Many also graduate with diploma courses in computers and
other technical areas. Management institutes produce 40,000 management graduates
annually. All of these candidates are potential entrepreneurs.

It is also important to recognise that while India is doing very well in IT and software, it is
still behind in terms of product and packaged development. Many experts believe that just as
the US did in the semiconductor industry in the eighties, it is time for India to move to a
higher level in the value chain.

This is not expected to happen automatically. The sequence of steps in the high technology
value chain is information, knowledge, ideas, innovation, product development and
marketing. Basically, India is still at the level of ‘knowledge'. Given the limited
infrastructure, low foreign investment and other transitional problems, it certainly needs
policy support to move to the third stage - ie, ideas - and beyond, towards innovation and
product development. This is crucial for sustainable growth and for maintaining India's
competitive edge. This will take capital and other support, which can be provided by venture
capitalists.

India also has a vast pool of existing and on-going scientific and technical research carried
out by a large number of research laboratories, including defence laboratories as well as
universities and technical institutes. A suitable venture capital environment - which includes
incubation facilities - can help a great deal in identifying and actualising some of this
research into commercial production.

The development of a proper venture capital industry, particularly in the Indian context, is
needed if high quality public offerings (IPOs) are to be achieved. In the present situation, an
individual investor becomes a venture capitalist of a sort by financing new enterprises and
undertaking unknown risks. Investors also get enticed into public offerings of unproven and
at times dubious quality. This situation can be corrected by venture-backed successful
enterprises accessing the capital market. This will also protect smaller investors.

Experience of US market

The potential of venture capital is tremendous when looking at the experience of other
countries. A study of the US market between 1972 and 1992 showed that venture-backed
IPOs earned 44.6 per cent over a typical five year post-listing holding period, compared with
22.5 per cent for non-venture backed IPOs. The success of venture capital is only partly
reflected by these numbers, since 80 per cent of the firms that receive venture capital are sold
to other companies rather than achieving an IPO. In such cases, the return multiple vis-à-vis
non-venture funded companies is much higher.

29
This potential can also be seen in the growth of sales figures for the US. From 1992 to 1998,
venture-backed companies saw their sales grow, on average, by 66.5 per cent per annum as
against five per cent for Fortune 500 firms. The export growth by venture-funded companies
was 165 per cent. The top ten US sectors, measured by asset and sales growth, were
technology-related.

Thus, venture capital is valuable not just because it makes risk capital available in the early
stages of a project, but also because a venture capitalist brings expertise that leads to superior
product development. The big focus of venture capital worldwide is, of course, technology.
Thus, in 1999, of $30bn of venture capital invested in the US, technology firms received
approximately 80 per cent. Additional to this huge supply of venture funds from formally
organised venture capital firms, is an even larger pool of angel or seed/start-up funds
provided by private investors. In 1999, according to estimates, approximately US$90bn of
angel investment was available, thus making the total ‘at-risk' investment in high-technology
ventures in a single year worth around US$120bn. By contrast, in India, cumulative
disbursements to date are less than US$500m, of which technology firms have received only
36 per cent.

India is attractive for risk capital

India certainly needs a large pool of risk capital both from home and abroad. Examples of the
US, Taiwan and Israel clearly show that this can happen. But this is dependent on the right
regulatory, legal, tax and institutional environment; the risk-taking capacities among the
budding entrepreneurs; start-up access to R&D flowing out of national and state level
laboratories; support from universities; and infrastructure support, such as telecoms,
technologyparks,etc.

Steps are being taken at governmental level to improve infrastructure and R&D. Certain NRI
organisations are taking initiatives to create a corpus of US$150m to strengthen the
infrastructure of IITs. More focused attempts will be required in all these directions.
Recent phenomena, partly ignited by success stories of Indians in the US and other places
abroad, provide the indications of a growing number of young, technically-qualified
entrepreneurs in India. Already there are success stories in India. At the same time, an
increasing number of savvy, senior management personnel have been leaving established
multinationals and Indian companies to start new ventures. The quality of enterprise in
human capital in India is on an ascending curve.

The environment is ripe for creating the right regulatory and policy environment for
sustaining the momentum for high-technology entrepreneurship. Indians abroad have
leapfrogged the value chain of technology to reach higher levels. At home in India, this is
still to happen. By bringing venture capital and other supporting infrastructure, this can
certainly become a reality in India as well.

India is rightly poised for a big leap. What is needed is a vibrant venture capital sector, which
can leverage innovation, promote technology and harness the ongoing knowledge explosion.

30
This can happen by creating the right environment and the mindset needed to understand
global forces. When that happens we would have created not ‘Silicon Valley' but the ‘Ind
Valley' - a phenomenon for the world to watch and reckon with.

Venture capital at a take-off stage in India

Lately, in India, the demand for software and dot.com-driven IT stocks on the stock
exchanges has been growing steadily. Most of the companies have recorded substantial
increases in their market capitalisation during the last year. On 2 May 2000, the info-tech
industry's market capitalisation reached in excess of US$59bn, showing the highest increase
in absolute valuation compared to any other industry during the last year.

The IPOs achieved by software companies in India in 1999 have attracted record investor
subscriptions. The demand for Indian IT stocks is very high, even on Nasdaq, as is evident
from the listing of ADRs of Infosys Technologies and Satyam Infoway. Investors have
lapped up the offerings of these two companies and their shares have appreciated
tremendously since their IPOs on Nasdaq.

A similar investor preference for start-up IT companies is being seen, though not of the same
magnitude. Yet, it is apparent that investors are willing to take higher risks for a potentially
higher reward by investing in start-up companies.

Until 1998, the venture creation phenomenon for the IT sector in India had been quite
unsatisfactory. Some experts believe that India lacks strong anchor companies like HP and
Fairchild, which funded the start-ups of early Silicon Valley entrepreneurs. Others believe
that Indian entrepreneurs are not yet globally connected and are often unwilling to share
equity with a quality risk capital investor. There was also a perception that start-ups in India
do not typically attract the right managerial talent to enable rapid growth. Finally, exit
options were considered to be few, with the general feeling that entrepreneurs were unwilling
to sell their start-ups even if it was feasible. As a result, much of the risk capital available
was not quickly deployed. However, since March 1999, things have been changing
dramatically for the better.

The venture capital phenomenon has now reached a take-off stage in India. Risk capital in all
forms is becoming available more freely. As against the earlier trend, where it was easy to
raise only growth capital, even financing of ideas or seed capital is available now. The
number of players offering growth capital and the number of investors is rising rapidly. The
successful IPOs of entrepreneur-driven Indian IT companies have had a very positive effect
in attracting investors. The Indian government initiatives in formulating policies regarding
sweat equity, stock options, tax breaks for venture capital along with overseas listings have
all contributed to the enthusiasm among investors and entrepreneurs, as has the creation of
the dot.com phenomenon.

In India, the venture capital creation process has started taking off. All the four stages -
including idea generation, start-up, growth ramp-up and exit processes - are being
encouraged. However, much needs to be done in all of these areas, especially on the exit side.

31
The Indian government sets up a venture capital fund

The Indian government has reiterated its commitment to the Indian software-driven IT
industry by creating a National Venture Capital Fund for the Software and IT Industry
(NFSIT). NFSIT, set up in association with various financial institutions and the industry,
operates under the umbrella of the Small Industries Development Bank of India (SIDBI). The
objective of the fund is to encourage entrepreneurship in the areas of software, services,
dot.com and other IT related sectors in which India has inherent as well as acquired
competency. The fund was launched by prime minister Atal Behari Vajpayee, who has
emerged as a strong proponent of India's software-driven IT industry. The fund is expected to
be a key component in addressing the rapidly growing demand for venture capital in India.
The fund will be looking at supporting entrepreneurship in high growth sectors.

Many state governments have already set up venture capital funds for the IT sector in
partnership with local state financial institutions and SIDBI. These include Andhra Pradesh,
Karnataka, Delhi, Kerala and Tamil Nadu.

(1)
Source of the article is from NASSCOM’s website.

32
 INDIAN SCENARIO

The Committee on Development of Small and Medium Entrepreneurs under the

chairmanship of R.S. Bhatt first highlighted venture capital financing in India in 1972.

It drew attention to the problems of new entrepreneurs and technologists in setting up

industries. In 1975, venture capital financing was introduced in India by the all India
Financial Institutions with the inauguration of Risk Capital Foundation (RCF) sponsored by
IFCI, with a view to encourage the technologist and the professionals to promote new
industries. In 1976, the seed capital scheme was introduced by IDBI. Till 1984, venture
capital took the form of risk capital and seed capital. In 1986, ICICI launched a venture
capital scheme to encourage new technocrats in the private sector in emerging fields of high
-risk technology.
Consequently, Government of India felt the need of venture capital funds in India in the
context of structural development and growth of small-scale business enterprises, since
small-scale industries form the major constituents and the backbone of Indian Economy.
Economic prosperity and development of the state is impossible without adequate economic
support to the small-scale industrial sector. The period 1986-87, is regarded an eventful year
for the venture capital industry in the country. A 5percent was levied on all know-how
payments to create a venture capital fund by IDBI. ICICI also started to become a partner of
the venture capital industry in the same year.

The first origin of modern day Venture Capital in India can be traced to the setting up of a
Technology Development Fund (TDF) in the year 1987-88, through the levy of a cess on all
technology import payments.

In 1988, TDICI (now ICICI Ventures) and Gujarat Venture Finance Ltd. (GVFL) were
formed.

In 1996, SEBI came out with guidelines for venture capital funds, which paved the way for
entry of foreign venture funds into India.

Today, the total pool of Indian Venture Capital today, stands over Rs. 50bn.

Some of the companies that have received funding through this route include:

 SQL Star, Hyderabad based training and software development company

 Satyam Infoway, the first private ISP in India

 Rediff on the Net, Indian website featuring electronic shopping, news, chat, etc

33
  Planetasia.com, Microland’s subsidiary, one of India’s leading portals

 Torrent Networking, pioneer of Gigabit-scaled IP routers for inter/intra nets

 Selectica, provider of interactive software selection

 Yantra, ITLInfosys’ US subsidiary, solutions for supply chain management

The infotech companies are the most favored by venture capitalists, companies from other
sectors also feature equally in their portfolios. The other sectors such as pharmaceutical,
medical appliances and biotechnology industries also get much preference. However, recent
developments have shown that India is maturing into a more developed marketplace,
unconventional investments in a gamut of industries have sprung up all over the country.

OPTIONS TO FINANCE A VENTURE

Projects can be financed both through equity and debt instruments. The rapid growth in the
financial markets, has brought about further development and improvement in venture capital
financing. Banks and development financial institutions like ICICI, IDBI and IFCI were
providers of term loans for funding projects.

At present, several venture capital firms are incorporated in India and they are promoted
either by all India Financial Institutions like IDBI, ICICI, IFCI, State level financial
institutions, Public Sector Banks or promoted by Foreign Banks/ Private sector or financial
institutions like Indus Venture Capital Fund, Credit Capital Venture Fund etc.

34
 STRUCTURE OF VENTURE CAPITAL INDUSTRY

The Venture capital firms in India can be categorized into the following four groups:

 All India Developmental Financial Institutions sponsored Venture Capital Funds

promoted by the all-India development financial institutions such as Technology
Development and Information Company of India Limited(TDICI) by ICICI, Risk Capital
Technology Financial Corporation Limited (RCTCF) by IFCI and Risk Capital Fund by
IDBI.

 State Finance Corporations sponsored Venture Capital Funds promoted by the state-
level developmental financial institutions such as Gujarat Venture Capital Limited
(GVCL) and Andhra Pradesh Industrial Development Corporation’s, Venture Capital
Limited (APIDC-VCL).

 Bank-sponsored Venture Capital Funds promoted by public sector banks such as Can
finance and SBI Caps.

 Private Venture Capital Funds promoted by the foreign banks/private sector companies
and financial institutions such as Indus Venture Capital Funds, Credit Capital Venture
Funds and Grindlay’s India Development Fund.

Objectives of VCFs in India

The objective of Indian venture Capital Funds are:

 financing and development of high technology businesses,

 to provide financial assistance for attaining commercial application of indigenous

technology or adapting imported technology for wider domestic application,

to provide risk capital to first generation entrepreneurs for setting up industrial projects and
to accelerate the pace and quality of technological innovations for products having
application in industry, agriculture, health, energy and other areas beneficial to the
development process in India.

35
BRIEF PROFILE OF MAJOR PLAYERS

 IDBI Venture Capital Fund

This was established in1986 with the objective to finance projects whose requirements range
between Rs. 5 lakhs to 2.5 crores. The promoters’ stake should be at least 10percent for the
ventures below Rs. 50 lakhs and 15percent for those above 50 lakhs. Financial assistance is
extended in the form of unsecured loans involving minimum legal formalities. Interest at
concessional rate of 9percent is charged during technology development and trial run of
production stage and it will be 17percent once the product is commercially traded in the
market by the financially assisted firm. IDBI venture capital funds extends its financial
assistance to the ventures likely to be engaged in the fields of chemicals, computer software,
electronics, bio-technology, non-conventional energy, food products, refractories and
medical equipments.

 Technology Development and Information Company of India Limited (TDICI)

This venture Capital fund was jointly floated by Industrial Credit & Investment Corporation
of India (ICICI) and Unit Trust of India (UTI) to finance the projects of professional
technocrats who take initiative in designing and developing indigenous technology in the
country. Technology Development and Information Company of India Limited (TDICI) was
launched with an authorized capital base of Rs. 20 crores and the same was targeted to be
increased to Rs. 40 to 50 crores. TDICI favours the firms seeking financial assistance for
developing information technology, management consultancy, pharmaceutical, veterinary
biological, environmental, engineering, non-conventional sources of energy and other
innovative services in the country.

 Unit Trust of India (UTI)

In 1988-99 UTI set-up a venture capital fund of Rs. 20 crores in collaboration with ICICI for
fostering industrial development. TDICI established by UTI jointly with ICICI acts as an
advisor and manager of the fund. UTI launched venture capital unit scheme (VECAUS-I) to
raise resources for this fund. It has set up a second venture capital fund in March 1990 with a
capital of Rs. 100 crores with the objective of financing green field ventures and steering
industrial development.

 Risk Capital and Technology Finance Corporation Ltd. (RCTFC)

IFCI had sponsored in 1985, Risk Capital Foundation (RCF) to give positive encouragement
to the new entrepreneurs. RCF was converted into RCTFC on 12th January, 1988. It provides
both risk capital and technology finance and roof to innovative entrepreneurs and technocrats
for their technology oriented ventures.

36
 Small Industrial Development Bank of India (SIDBI)

Small Industrial Development Bank of India (SIDBI)has decided to set-up a venture capital
fund in July 1993, exclusively for support to entrepreneurs in the small sector. Initially a
corpus has been created by setting apart Rs. 10 crores. The fund would be augmented in
future, depending upon requirements.

 Andhra Pradesh Industrial Development Corporation (APIDC)

APIDC Venture Capital Ltd. (APIDC-VCL) was promoted by APIDC with an authorized
capital of Rs.2 million on 29th August 1989. Its main objective is to encourage technology-
based ventures particularly those started by first generation technocrat entrepreneurs and
ventures involving high risk in the state of Andhra Pradesh.

 Gujarat Venture Finance Limited(GVFL)

GVFL has been promoted by the Gujarat Industrial Investment Corporation Limited (GIIC)
in 1990, to provide financial support to the ventures whose requirements range between 25
lakhs and 2 crores. Total corpus of Rs. 24 crores of the referred venture capital fund was co-
financed by GIIC, state financial corporation, some private corporates and World Bank. The
firms engaged in biotechnology, surgical instruments, conservation of energy and food
processing industries are financed by GVFL.

 Commercial Banks Sponsored Venture Capital Funds

State Bank of India, Canara Bank, Grindlays Bank and many other banks have participated in
the venture capital fund building Industry in order to provide financial assistance to the
projects associated with high risks. SBI venture capital is monitored through SBI capital
markets. Canbanks venture capital functions through Canbank. Financial services and India
Investment Fund represents the venture capital launched by Grindlays Bank.

37
 Private Sector Venture Capital Funds

i) Hindus Venture Capital Funds: Hindus venture capital fund is one of the noteworthy
private venture capital companies. It has been promoted with an initial corpus of Rs.21
crores contributed by several Indian and international institutions/ companies. Hindus
venture management limited, a separate company has been entrusted to manage the funds
of Hindus venture capital fund. It extends financial support to the firms operating in the
area of healthcare products, electronics and computer technology. Investment strategy of
the fund is not to invest more than 10percent of its corpus in one project and equity stake
in a company upto 50 percent.
ii) 20th Century Venture Capital Fund: 20th century venture capital fund has been
established with a corpus of Rs. 20 crores promoted by 20th century finance company
limited. The fund envisages focus on sick industries and first generation entrepreneurs.
iii) Credit Capital Venture Fund (CCVF): CCVF(India) Limited has been formed as a
subsidiary of credit capital finance corporation limited in April1989. This fund has been
promoted by nearly 15 major industrial houses in the country with the objectives of
reviving sick units. It is the first private managed venture fund with a subscribed capital
of Rs.10 crore contributed to the extent of Rs.6.5 crore by international financial agencies
and the remaining raised through public subscription.

 Pool of Venture Capital Funds in India

There has been an increase in the pool of funds available for Venture capital activity to
Rs.29, 884.04 million in 1998 from Rs. 25,595.17 million 1997. Investments have gone up to
Rs. 12,59.85 million in 728 projects from Rs. 10,000.46 million in 691 projects in 1997.
Average investment per project has increased to Rs. 17.25 million in 1998 from Rs. 14.47
million 1997. There has been an average increase of almost 20 percent in the project size
from the previous year.

38
 VENTURE CAPITAL FUNDS IN INDIA

CONTRIBUTION TO "Venture Capital Funds" (1)

Contributors 1998

Rs. Million %

Foreign Institutional Investors 15,178.05 50.79

All Indian Financial Institute 7,727.47 25.86

Multilateral Dev. Agencies 2,298.63 7.69

Other Banks 1,709.76 5.72

Other Public 725.32 2.43

Private Sector 623.61 2.09

Public Sector 442.14 1.48

Nationalized Banks 433.67 1.45

Non-Residents Indians 313.39 1.05

Insurance Companies 62.50 0.21

Mutual Funds 4.50 0.01

Total 29,884.04 100.00

Investment by Industry

As in the previous year, the maximum investment has been made in industrial products and
machinery followed by investment in computer software and service. There is an interesting
change here compared to the previous year. In 1998 the total of the investments in computer
software and hardware put together exceeds investments in industrial products and
machinery. In the previous year, the total investment in industrial products and machinery
exceeded that in the computer industry. This is a clear indication that investment in the IT
industry, as a whole is attracting greater attention, compared to other industries. This is in
keeping with global trends.

39
 Contributors 1998
Rs. Million %
Industrial Products and Machinery 2,956.67 219

Computer Software Service 2,508,87 100

Consumer Related 1,381.49 52

Medical 817.48 47

Computer Hardware System 735.41 30

Food and Food Processing 718.56 50

Tel. and Data Communication 417.89 18

Biotechnology 448.77 27

Other Electronics 426.06 40

Energy Related 229.56 18

Others 1,865.09 127

Total 12,559.85 728

Investment by Stages of Financing

A sum of Rs.5, 146.40 million, which is almost 41 percent of the total venture capital
investment of Rs. 12,559.85 million, has been invested in start-up projects, followed by Rs.
4,478.60 million in later stage projects, Rs. 2,208.39 million in other early stage projects, Rs.
643.51 million in seed stage projects and only Rs. 82.95 million in turnaround projects.

Industry wise Investment

Investment Stages 1998
Rs. Million %
Start-up Stage 5,146.40 355
Later Stage 4,478.60 166
Other Early Stage 2,203.39 118
Seed Stage 643.51 80
Turnaround Financing 82.95 9
Total 12,559.85 728

40
The average amount of investments per project makes an interesting study. It is Rs. 8.04
million per project in the seed stage, Rs. 9.21 million per project in the turnaround stage Rs.
14.50 million per project in the start-up stage, Rs. 18.72 million per project in the other early
stage and Rs. 26.98 million per project in the later stage. This shows that the average
investment per project is the maximum in the later stage. This is as expected, since later stage
projects generally require larger amounts of finance. Seed stage investments generally
require smaller investments per projects. These averages also show that not only are the
number of investments in turnaround projects minimal, the amounts of investments in such
projects are also very little, further supporting the theory that venture capitalists are generally
not keen to fund turnaround projects.

But alas, Indian venture capital industry is still at the take-off stage and not achieved the
objectives so as to provide financial assistance for attaining commercial application of
indigenous technology or adapting imported technology for wider domestic application, to
provide risk capital to first generation entrepreneurs for setting up industrial projects and to
accelerate the pace and quality of technological innovations for products having application
in industry, agriculture, health, energy and other areas beneficial to the development process
in India. This is because, of the challenges and issues with regard to its development.

(1)
source of data being www.indiainfoline.com, venture capital

41
FACTORS FOR THE SUCCESS OF VENTURE CAPITAL FIRMS

The success of venture capital firms rest on the following characteristics:

1. Although corporate managers have a clear focus in their business, they run into ambiguity
with venture programs. Their biggest challenge is to establish clear, prioritized objectives.
Simply making a good financial return is not sufficient.

2. Focus on specific industry niches.

3. Manage portfolios ruthlessly, abandon losers, whereas abandoning ventures has never been
easy for large corporations, whose projects are underpinned by personal relationships,
political concerns.

But there are several challenges faced by the Venture Capital Industry:
 Venture Capital Financing is still not regarded as commercial activity.

 Investors feel that they would like to retain control and also to ensure that the business
must pass onto their family.

 Restricted scope of Venture Capital in India to hi-tech projects and for turning Research
and Development into Commercial Production

 Entrepreneurs sensitiveness to the mode of divestment and

 Ambiguous government policy towards inter-corporate investment and issue of shares to

the entrepreneurs at below per value or in the form of a “ guest equity”.

But the question is how relevant is corporate venturing in the India?

The firms, which launched the successful corporate ventures had created new products in the
market operating at the higher end of the value chain and had attained a certain size in the
market. Most Indian companies are yet to move up the value chain and consolidate their
position as players in the global market. Corporate venturing models would probably benefit
Indian companies who are large players in the Indian market in another five to 10 years by
enabling them to diversify and at the same time help start up companies. Multinationals led
by Intel are the best examples of corporate venturing in an Indian context.

However there are several problems associated with the

Venture Capital Funds in India!!!

42
PROBLEMS WITH VENTURE CAPITAL IN INDIA

One can ask why venture funding is so successful in USA and faced a number of problems in
India. The biggest problem was a mindset change from "collateral funding" to high risk high
return funding. Most of the pioneers in the industry were people with credit background and
exposure to manufacturing industries. Exposure to fast growing intellectual property business
and services sector was almost zero. All these combined to a slow start to the industry. The
other issues that led to such a situation include:

 License Raj And The IPO Boom

Till early 90s, under the license raj regime, only commodity centric businesses thrived in a
deficit situation. To fund a cement plant, venture capital is not needed. What was needed was
ability to get a license and then get the project funded by the banks and DFIs. In most cases,
the promoters were well-established industrial houses, with no apparent need for funds. Most
of these entities were capable of raising funds from conventional sources, including term
loans from institutions and equity markets.

 Scalability

The Indian software segment has recorded an impressive growth over the last few years and
earns large revenues from its export earnings, yet our share in the global market is less than 1
per cent. Within the software industry, the value chain ranges from body shopping at the
bottom to strategic consulting at the top. Higher value addition and profitability as well as
significant market presence take place at the higher end of the value chain. If the industry has
to grow further and survive the flux it would only be through innovation. For any venture
idea to succeed there should be a product that has a growing market with a scalable business
model. The IT industry (which is most suited for venture funding because of its "ideas"
nature) in India till recently had a service centric business model. Products developed for
Indian markets lack scale.

 Mindsets

Venture capital as an activity was virtually non-existent in India. Most venture capital
companies want to provide capital on a secured debt basis, to established businesses with
profitable operating histories. Most of the venture capital units were offshoots of financial
institutions and banks and the lending mindset continued. True venture capital is capital that
is used to help launch products and ideas of tomorrow. Abroad, this problem is solved by the
presence of `angel investors’. They are typically wealthy individuals who not only provide
venture finance but also help entrepreneurs to shape their business and make their venture
successful.

43
  Returns, Taxes and Regulations

There is a multiplicity of regulators like SEBI and RBI. Domestic venture funds are set up
under the Indian Trusts Act of 1882 as per SEBI guidelines, while offshore funds routed
through Mauritius follow RBI guidelines. Abroad, such funds are made under the Limited
Partnership Act, which brings advantages in terms of taxation. The government must allow
pension funds and insurance companies to invest in venture capitals as in USA where
corporate contributions to venture funds are large.

 Exit

The exit routes available to the venture capitalists were restricted to the IPO route. Before
deregulation, pricing was dependent on the erstwhile CCI regulations. In general, all issues
were under priced. Even now SEBI guidelines make it difficult for pricing issues for an easy
exit. Given the failure of the OTCEI and the revised guidelines, small companies could not
hope for a BSE/ NSE listing. Given the dull market for mergers and acquisitions, strategic
sale was also not available.

 Valuation

The recent phenomenon is valuation mismatches. Thanks to the software boom, most
promoters have sky high valuation expectations. Given this, it is difficult for deals to reach
financial closure as promoters do not agree to a valuation. This coupled with the fancy for
software stocks in the bourses means that most companies are preponing their IPOs.
Consequently, the number and quality of deals available to the venture funds gets reduced.

 Limitations on structuring of Venture Capital Funds(VCFs)

VCFs in India are structured in the form of a company or trust fund and are required to
follow a three-tier mechanism-investors, trustee company and AMC. A proper tax-efficient
vehicle in the form of ‘Limited Liability Partnership Act’ which is popular in USA, is not
made applicable for structuring of VCFs in India. In this form of structuring, investors’
liability towards the fund is limited to the extent of his contribution in the fund and also
formalities in structuring of fund are simpler.

 Problem in raising of funds

In USA primary sources of funds are insurance companies, pensions funds, corporate bodies
etc; while in Indian domestic financial institutions, multilateral agencies and state
government undertakings are the main sources of funds for VCFs. Allowing pension funds,
insurance companies to invest in the VCFs would enlarge the possibility of setting up of
domestic VCFs. Further, if mutual funds are allowed to invest upto 5 percent of their corpus
in VCFs by SEBI, it may lead to increased availability of fund for VCFs.

44
  Lack of Inventive to Investors

Presently, high net worth individuals and corporates are not provided with any investments in
VCFs. The problem of raising funds from these sources further gets aggravated with the
differential tax treatment applicable to VCFs and mutual funds. While the income of the
Mutual Funds is totally tax exempted under Section 10(23D) of the Income Tax Act income
of domestic VCFs which provide assistance to small and medium enterprise is not totally
exempted from tax. In absence of any inventive, it is extremely difficult for domestic VCFs
to raise money from this investor group that has a good potential.

 Absence of ‘angel investors’

In Silicon Valley, which is a nurturing ground for venture funds financed IT companies,
initial/seed stage financing is provided by the angel investors till the company becomes
eligible for venture funding. There after, Venture capitalist through financial support and
value-added inputs enables the company to achieve better growth rate and facilitate its listing
on stock exchanges. Private equity investors typically invest at expansion/ later stages of
growth of the company with large investments. In contrast to this phenomenon, Indian
industry is marked by an absence of angel investors.

 Limitations of investment instruments

As per the section 10(23FA) of the Income Tax Act, income from investments only in equity
instruments of venture capital undertakings is eligible for tax exemption; whereas SEBI
regulations allow investments in the form of equity shares or equity related securities issued
by company whose shares are not listed on stock exchange. As VCFs normally structure the
investments in venture capital undertakings by way of equity and convertible instruments
such as Optionally/ Fully Convertible Debentures, Redeemable Preference shares etc., they
need tax breaks on the income from equity linked instruments.
Harmonization of SEBI regulations and income tax rules of CBDT would provide much
required flexibility to VBCFs in structuring the investment instruments and also availing of
the tax breaks. Thus investments by VCFs by instruments other than equity can also be
qualified for Tax exemption.

 Domestic VCFs vis-à-vis Offshore Funds

The domestic VCFs operations in the country are governed by the regulations as prescribed
by SEBI and investment restrictions as placed by CBDT for availing of the tax benefits. They
pay maximum marginal tax 35percent in respect of non exempt income such as interest
through Debentures etc., while off-shore Funds which are structured in tax havens such as
Mauritius are able to overcome the investment restriction of SEBI and also get exemption
from Income Tax under Tax Avoidance Treaties. This denies a level playing field for the
domestic investors for carrying out the similar activity in the country.

45
 Limitations on industry segments

In sharp contrast to other countries where telecom, services and software bag the largest
share of venture capital investments, in India other conventional sectors dominate venture
finance. Opening up of restrictions, in recent time, on investing in the services sectors such as
telecommunication and related services, project consultancy, design and testing services,
tourism etc, would increase the domain and growth possibilities of venture capital.

 Anomaly between SEBI regulations and CBDT rules

CBDT tax rules recognize investment in financially weak companies only in case of unlisted
companies as venture investment whereas SEBI regulations recognize investment in
financially weak companies which offers an attractive opportunity to VCFs. The same may
be allowed by CBDT for availing of tax exemption on capital gains at a later stage. Also
SEBI regulations do not restrict size of an investment in a company. However, as per Income
tax rules, maximum investment in a company is restricted to less than 20 per cent of the
raised corpus of VCF and paid up share capital in case of Venture Capital Company. Further,
investment in company is also restricted upto 40 per cent of equity of investee company.
VCFs may place the investment restriction for VCFs by way of maximum equity stake in the
company, which could be upto 49 per cent of equity of the Investee Company.

 Limitation on application of sweet equity and ESOP

In the US, an entrepreneur can declare that he has nothing much to contribute except for
‘intellectual’ capital and still he finds venture capitalists backing his idea with their money.
And when they come together, there is a way to structure the investment deal in such a
manner that the entrepreneur can still ensure a controlling stake in the venture. In the US, the
concept of par value of shares does not exist that allows the different par value shares.
Absence of such mechanism puts limitations in structuring the deals.
Further, as per present tax structure in India, sweet equity and ESOP issued to
entrepreneur and employees gets taxed twice at the time of acquisition and divestment. Tax
incidence at two points involving undue hassles to allottees of sweat equity of individual, as a
perquisite in its income, to the extent of 33 per cent defeats the entire purpose of its issue.

 Legal framework

Lack of requisite legal framework resulting in inadequate penalties in case of suppression of

facts by the promoters-results in low returns even from performing companies. This has
bearing on equity investments particularly in unlisted companies.

46
 REGULATORY ISSUES

There are a number of rules and regulation for venture capital and these would broadly come
under either of the following heads:

 The Indian Trust Act, 1882 or the Company Act, 1956 depending on whether the
fund is set up as a trust or a company. (In the US, a venture capital firm is normally
set up as a limited liability partnership)

 The Foreign Investment Promotion Board (FIPB) and the Reserve Bank of India
(RBI) in case of an offshore fund. These funds have to secure the permission of the
FIPB while setting up in India and need a clearance from the RBI for any repatriation
of income.

 The Central Board of Direct Taxation (CBDT) governs the issues pertaining to
income tax on the proceeds from venture capital funding activity. The long term
capital gains tax is at around 10% in India and the relevant clauses to venture capital
may be found in Section 10 (subsection 23).

 The Securities and Exchange Board of India has come out with a set of guidelines
attached in the annexure.

In addition to the above there are a number of arms of the Government of India – Ministry of
Finance that may have to be approached in certain situations. Also intervention allied
agencies like the Department of Electronics, the National Association of Software and
Computers (NASSCOM) and various taskforces and standing committees is not uncommon.

Probably this explains why most of the funds prefer to take the easy way out by listing as
offshore funds operating out of tax havens like Mauritius (where the Avoidance of Double
Taxation Treaty, incomes may be freely repatriated).

47
CHAPTER- V

CONCLUSION

48
After analyzing the various problems being faced by the Venture Capitalists in India certain
issues need to be dealt with very seriously regarding the growth and success of such ventures.
Hence certain remedial measures should be provided, such as:

MEASURES TO BE PROVIDED

From the experience of Venture Capital activities in the developed countries and detailed
case study of venture capital in India we can derive that the following measures needs to be
provided to boost Venture Capital industry in India.

 Social Awareness
Lack of social awareness of the existence of venture capital industry has been observed.
Hardly few know about the principal objectives and functions of the existing venture capital
funds in the country and thus banking of the media is required to bridge the gulf between the
society and the existing venture capital funds.

 Deregulated Economic Environment

A less regulated and controlled business and economic environment where an attractive
customer opportunity exists or could be created for high-tech and quality products.

 Fiscal Incentives
Though Venture Capital funds like Mutual funds are exempted from paying tax on dividend
income and long-term capital gains, from equity investment, unlike Mutual funds there are
pre-conditions attached to the tax shelter. So it is imperative that the Government streamlines
its guidelines on tax exemption for Venture Capital Funds.

 Enterpreneurship And Innovation

A broad-based (and less family based) entrepreneurial traditions and societal and
governmental encouragement for innovation creativity and enterprise.

 Marketing Thrust
A vigorous marketing thrust, promotional efforts and development strategy employing new
concepts such as venture fairs, venture clubs venture networks, business incubators etc., for
the growth of venture capital.

49
 A Statutory Co-ordination Body
A harmonious co-ordination needs to be maintained among the technology institutes,
professional institutes and universities who are the producers of future venture capital
managers. The coordinating organ so formed is expected to ventilate an outline of the latest
requirements of the venture capital funds management. Central Government should come
forward to promote the referred coordination organ in the form of a statutory body. The
coordination organ would not only maintain link with the domestic professional institutions,
technology institutes and universities but also with the global venture capital funds in order
to exchange the novel ideas that can help in standardizing Indian practice on venture capital
funds.

 Technological Competitiveness:
Encouragement and funding of R&D by private and public sector companies and the
government for ensuring technological competitiveness.

 Training and Development of Venture Capital Managers

For the success of venture capital fund, be it privately owned or public sector financial
institutions, strategies need to be found to promote entrepreneurship. For this, venture capital
funds need professionals with initiative, drive and vision to identify such entrepreneurs who
have sound & ideas and innovative vision. Unfortunately, such professionals are not easily
available particularly in developing countries like India. Therefore management schools need
to develop social training programs to train venture capital mangers in which risk taking and
entrepreneurial attitude needs to be incubated.

 Broad Knowledge Base

A more general, business and entrepreneurship oriented education system where scientist and
engineers have knowledge of accounting, finance and economics and accountants understand
engineering or the physical sciences.

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 Exit Routes
For venture capital funds, exits are crucial; going public is one way for the investors to be
paid back. Current rules of companies going public in India insist on sustained track record
of profits. For entrepreneur driven companies where value creation is through intellectual
property patents, methodologies and processes, such norms are archaic. Venture capitalists
earn through value creation leading to exits and not through dividends. Venture funds would
prefer the company to invest back dividends into the business. As such the question of stream
of dividends pay outs prior to IPO over three years as is required in India is a hindrance.

Another exit route can be repurchases of shares by promoters but it is an expensive

way of assuring investors an exit bank roll. Inter accruals alone may not be adequate to
backroll the repurchases and institutional funding for such buyouts is rarely forthcoming.
Though there is no legal bar on such funding, but the risk of extending against the shares of
newly established company have kept away most of the bank and financial institutions.
Creative financial engineering can find a way around this problem. To provide the
lenders with an additional degree of security, a special purpose vehicle (SPV) can be created
which would hold the shares bought back from the venture capital firms in trust until the firm
achieves a certain rate of return. Meanwhile, a certain proportion of the firms sales proceeds
can be funneled directly to the SPV to amortize debt.

All these measures such as a broad knowledge base, exit routes etc should be adopted, to
ensure effective growth and success of Venture Capital Funds in India such that a potential
investor develops the confidence to invest in the Indian markets.

51
 BIBLIOGRAPHY

 R P Rustogi: Incorporating the Emerging Trends in the Indian Capital Market,

Galgotia Publication Company, 2 nd Edition, 2002.

 James C. Van Horne and John M. Wachowicz, Jr: Fundamentals of Financial

Management, Prentice Hall, 9 th Edition, 1996.

 H R Machiraju: Indian Financial System, Vikas Publishing House, 2 nd Edition,

2002.

 Prasanna Chandra: Financial Management, Theory and Practice, Tata Mc Graw Hill
Publishing Company Limited, 5th Edition, 2001.

 L M Bhole: Financial Institutions and Markets, 2 nd Edition, 1992.

 M Y Khan: Indian Financial System, Tata Mc Graw Hill Publishing Company

Limited, 2th Edition, 2000.

Newspapers:
 Times of India
 Economic Times
 Hindustan Times

52
APPENDIX

53
 APPENDIX- 1

SEBI GUIDELINES FOR VENTURE CAPITAL

PRELIMINARY

Short title and commencement

(1) These regulations may be called the Securities and Exchange Board of India (Venture
Capital Funds) Regulations, 1996.

(2) They shall come into force on the date of their publication in the Official Gazette.

Definitions

In these regulations, unless the context otherwise requires, -

(a) "Act" means the Securities and Exchange Board of India Act, 1992 ;
(b) "certificate" means a certificate of registration granted by the Board ;
(c) "company" means a company incorporated under the Companies Act, 1956 ;
(d) "economic offence" means an offence to which the Economic Offences Act, 1974
applies for the time being;
(e) "enquiry officer" means an enquiry officer appointed by the Board,
(f) "Form" means any of the forms set out in the First Schedule;
(g) "Government of India Guidelines" means the guidelines dated September 20, 1995
issued by the Government of India for Overseas Venture Capital Investments in India
as amended from time to time;
(h) "inspecting officer" means an inspecting officer appointed by the Board ;
(i) "Schedule" means a schedule annexed to these regulations;
(j) "sick industrial company" has the same meaning as is assigned to Sick Industrial
Companies Act, 1985;
(k) "trust" means a trust established under the Indian Trusts Act, 1882
(l) "units" means the interest of the investors in a scheme of a venture capital fund set up
as a trust, which consist of each unit representing one undivided share in the assets of
the scheme;

54
(m) "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.

55
 REGISTRATION OF VENTURE CAPITAL FUND

Application for grant of certificate proposing

(1) Any company or trust to carry on any activity as a venture capital fund on or after the
commencement of these regulations shall make an application to the Board for grant of a
certificate.

(2) Any company or trust, who on the date of commencement of these regulations is carrying
any activity as a venture capital fund without a certificate shall make an application to the
Board for grant of a certificate within a period of three months from the date of such
commencement:

Provided that the Board, in special cases, may extend the said period upto a maximum of six
months from the date of such commencement.

(3) An application for grant of certificate under sub-regulation (1) or sub-regulation (2) shall
be made to the Board in Form A and shall be accompanied by a non-refundable application
fee as specified in Part A of the Second Schedule to be paid in the manner specified in Part B
thereof.

(4) Any company or trust referred to in sub-regulation (2) who fails to make an application
for grant of a certificate within the period specified therein shall cease to carry on any
activity as a venture capital fund.

(5) The Board may in the interest of the investors issue directions with regard to the transfer
of records, documents or securities or disposal of investments relating to its activities as a
venture capital fund.

(6) The Board may in order to protect the interests of investors appoint any person to take
charge of records, documents, securities and for this purpose also determine 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 have to fulfil in
particular the following conditions, namely:-

(a) if the application is made by a company, -

(i) memorandum of association has as its main objective, the carrying on of the activity of a
venture capital fund;

(ii) it is prohibited by its memorandum and articles of association from making an invitation
to the public to subscribe to its securities;

56
(iii) its director or principal officer or employee is not involved in any litigation connected
with the securities market which may have an adverse bearing on the business of the
applicant;

(iv) its director, principal officer or employee has not at any time been convicted of 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 registered under the
provisions of the Indian Registration Act, 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 in any litigation
connected with the securities market which may have an adverse bearing 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.

The applicant is permitted to carry on the activities of a venture capital fund.

The applicant is a fit and proper person.

The directors or the trustees, as the case may be, of such body corporate, if any, is not
involved in any litigation connected with the securities market which may have an adverse
bearing on the business of the applicant.

(d) the company or trust has not been refused a certificate by the Board or its certificate
has been suspended under regulation 30 or cancelled under regulation 31.

Furnishing of information, clarification

The Board may require the applicant to furnish such further information as it may consider
necessary.

57
Consideration of application

An application which is not complete in all respects shall be rejected by the Board:

Provided that, before rejecting any such application, the applicant shall be given an
opportunity to remove, within thirty days of the date of receipt of communication, the
objections indicated by the Board.

Provided further that the Board may, on being satisfied that it is necessary to extend the
period specified in the first proviso, extend such period by such further time not exceeding
ninety days.

Procedure for grant of certificate

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

(2) On receipt of intimation, the applicant shall pay to the Board, the registration fee
specified in Part A of the Second Schedule in the manner specified in Part B thereof.

(3) The Board shall on receipt of the registration fee grant a certificate of registration in Form
B.

Conditions of certificate

The certificate granted under regulation 7 shall be inter-alia, subject to the following
conditions, namely:-

(a) the venture capital fund shall abide by the provisions of the Act, the Government of India
Guidelines and these regulations;
(b) the venture capital fund shall not carry on any other activity other than that of a venture
capital fund;
(c) the venture capital fund shall forthwith inform the Board in writing if any information or
particulars previously submitted to the Board are found to be false or misleading in any
material particular or if there is any change in the information already submitted.

Procedure where certificate is not granted

(1) After considering an application made under regulation 3, if the Board is of the opinion
that a certificate should not be granted, it may reject the application after giving the applicant
a reasonable opportunity of being heard.

(2) The decision of the Board to reject the application shall be communicated to the applicant
within thirty days.

58
Effect of refusal to grant certificate

(1) Any applicant whose application has been rejected under regulation 9 shall not carry on
any activity as a venture capital fund.

(2) Any company or trust referred to in sub-regulation, whose application for grant of
certificate has been rejected under regulation 9 by the Board shall, on and from the date of
the receipt of the communication under regulation 9, cease to carry on any activity as a
venture capital fund.

(3) The Board may in the interest of the investors issue directions with regard to the transfer
of records, documents or securities or disposal of investments relating to its activities as a
venture capital fund.

(4) The Board may in order to protect the interests of the investors appoint any person to take
charge of records, documents, securities and for this purpose also determine the terms and
conditions of such an appointment.

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 INVESTMENT CONDITIONS AND RESTRICTIONS

Minimum investment in a venture capital fund

(1) A venture capital fund may raise monies from any investor whether Indian, foreign or
non-resident Indian.

(2) No venture capital fund set up as a company or any scheme of a venture capital fund set
up as a trust shall accept any investment from any investor which is less than five lakh
rupees:

Provided that nothing contained in sub-regulation (2) shall apply to investors who are,-
(a) employees or the principal officer or directors of the venture capital fund, or directors of
the trustee company or trustees where the venture capital fund has been established as a
trust; or
(b) non resident Indians; or
(c) persons or institutions of foreign origin.

Restrictions on investment by a venture capital fund

All investments made or to be made by a venture capital fund shall be subject to the
following restrictions:

(a) the venture capital fund shall not invest in the equity shares of any company or institution
providing financial services;
(b) at least 80 percent of funds raised by a venture capital fund shall be invested in:-

(i) the equity shares or equity related securities issued by a company whose securities are
not listed on any recognised stock exchange:

Provided that a venture capital fund may invest in equity shares or equity related securities of
a company whose securities are to be listed or are listed where the venture capital fund has
made these investments through private placements prior to the listing of the securities.

(ii) the equity shares or equity related securities of a financially weak company or a sick
industrial company, whose securities may or may not be listed on any recognised
stock-exchange. Explanation: For the purposes of this regulation, a "financially weak
company" means a company, which has at the end of the previous financial year
accumulated losses, which has resulted in erosion of more than 50% but less than
100% of its networth as at the beginning of the previous financial year.

(iii) providing financial assistance in any other manner to companies in whose equity
shares the venture capital fund has invested under sub-clause (i) or sub-clause (ii), as
the case may be. Explanation: For the purposes of this regulation, "funds raised"
means the actual monies raised from investors for subscribing to the securities of the
venture capital fund and includes monies raised from the author of the trust in case

60
 the venture capital fund has been established as a trust but shall not include the paid
up capital of the trustee company, if any.

Prohibition on listing

No venture capital fund shall be entitled to get its securities or units, as the case may be,
listed on any recognised stock exchange till the expiry of three years from the date of the
issuance of securities or units, as the case may be, by the venture capital fund.

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 GENERAL OBLIGATIONS AND RESPONSIBILITIES

Prohibition on inviting subscription from the public

No venture capital fund shall issue any document or advertisement inviting offers from the
public for the subscription or purchase of any of its securities or units.

Private placement

A venture capital fund may receive monies for investment in the venture capital fund through
private placement of its securities or units.

Placement memorandum

(1) The venture capital fund established as a trust shall, before issuing any units file with the
Board a placement memorandum which shall give details of the terms subject to which
monies are proposed to be raised from investors.

(2) A venture capital fund established as a company shall, before making an offer inviting
any subscription to its securities, file with the Board a placement memorandum which shall
give details of the terms subject to which monies are proposed to be raised from the
investors.

Contents of placement memorandum

(1) The placement memorandum referred to in regulation 16 shall contain the following,
namely:-

(a) details of the trustees or trustee company of the venture capital fund;
(b) details of entitlement on the units of the trust for which subscription is being sought;
(c) details of investments that are proposed to be made;
(d) tax implications that are likely to apply to investors;
(e) manner of subscription to the units of the trust;
(f) the period of maturity, if any, of the scheme;
(g) the manner, if any, in which the scheme is to be wound up;
(h) manner in which the benefits accruing to investors in the units of the trust are to be
distributed;
(i) details of the asset management company, if any, and of fees to be paid to such a
company.

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(2) The placement memorandum referred to regulation 16 shall contain the following,
namely:-

(a) details of the securities that are being offered;

(b) details of investments that are proposed to be made;
(c) details of directors of the company;
(d) tax implications that are likely to apply to investors;
(e) manner of subscription to the securities that are to be issued;
(f) manner in which the benefits accruing to investors in the securities are to be distributed;
and
(g) details of the asset management company, if any, and of fees to be paid to such a
company.

Circulation of placement memorandum

The placement memorandum referred to in regulation 16 may be issued for private

circulation only after the expiry of twenty one days of its submission to the Board:

Provided that if, within twenty one days of submission of the placement memorandum, the
Board communicates any amendments to the placement memorandum, the venture capital
fund shall carry out such amendments in the placement memorandum before such
memorandum is circulated to the investors.

Changes in the placement memorandum to be intimated to the Board

Amendments or changes to any placement memorandum already filed with the Board can be
made only if,-

(a) a copy of the placement memorandum indicating the changes is filed with the Board; and
(b) within twenty one days of such filing, the Board has not communicated any objections or
observations on the said amendments or changes.

Maintenance of books and records

(1) Every venture capital fund shall maintain for a period of ten years books of accounts,
records and documents which shall give a true and fair picture of the state of affairs of the
venture capital fund.

(2) Every venture capital fund shall intimate the Board, in writing, the place where the books,
records and documents referred to in sub-regulation (1) are being maintained.

63
Power to call for information

(1) 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.

(2) Where any information is called for under sub-regulation (1) it shall be furnished to the
Board within fifteen days.

Submissions of reports to the Board

The Board may at any time call upon the venture capital fund to file such reports as the
Board may desire with regard to the activities carried on by the venture capital fund.

Winding up

(1) A scheme of a venture capital fund set up as a trust shall be wound up,

(a) when the period of the scheme, if any, mentioned in the placement memorandum is over;
(b) 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;
(c) if seventy five percent of the investors in the scheme pass a resolution at a meeting of
unit holders that the scheme be wound up; or
(d) if the Board so directs in the interests of investors.

(2) A venture capital fund set up as a company shall be wound up in accordance with the
provisions of the Companies Act, 1956

(3) The trustees or trustee company of the venture capital fund set up as a trust shall intimate
the Board and investors of the circumstances leading to the winding up of the scheme under
sub-regulation (1).

Effect of winding up

(1) On and from the date of intimation under regulation 23, no further investments
shall be made on behalf of the scheme so wound up.
(2) Within three months from the date of intimation under sub-regulation.
(3) of regulation 23, the assets of the scheme shall be liquidated, and the proceeds
accruing to investors in the scheme distributed to them after satisfying all
liabilities.

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 INSPECTION AND INVESTIGATION

Board's right to inspect or investigate

(1) The Board may appoint one or more persons as inspecting or investigating officer to
undertake inspection or investigation of the books of accounts, records and documents
relating to a venture capital fund for any of the following reasons, namely:-

(a) to ensure that the books of account, records and documents are being maintained by the
venture capital fund in the manner specified in these regulations;
(b) to inspect or investigate into complaints received from investors, clients or any other
person, on any matter having a bearing on the activities of the venture capital fund;
(c) to ascertain whether the provisions of the Act and these regulations are being complied
with by the venture capital fund; and
(d) to inspect or investigate suo motu into the affairs of a venture capital fund, in the interest
of the securities market or in the interest of investors.

Notice before inspection or investigation

(1) Before ordering an inspection or investigation under regulation 25, the Board shall give
not less than ten days notice to the venture capital fund.

(2) Notwithstanding anything contained in sub-regulation (1), where the Board is satisfied
that in the interest of the investors no such notice should be given, it may by an order in
writing direct that the inspection or investigation of the affairs of the venture capital fund be
taken up without such notice.

(3) During the course of an inspection or investigation, the venture capital fund against
whom the inspection or investigation is being carried out shall be bound to discharge its
obligations as provided in regulation 27.

Obligations of venture capital fund on inspection or investigation by the Board

(1) It shall be the duty of the venture capital fund whose affairs are being inspected or
investigated, and of every director, officer and employee thereof, of its asset management
company, if any, and of its trustees or directors or the directors of the trustee company, if
any, to produce before the inspecting or investigating officer such books, securities, accounts,
records and other documents in its custody or control and furnish him with such statements
and information relating to the venture capital fund, as the inspecting or investigating officer
may require, within such reasonable period as the inspecting officer may specify.

65
(2) The venture capital fund shall allow the inspecting or investigating officer to have
reasonable access to the premises occupied by such venture capital fund or by any other
person on his behalf and also extend reasonable facility for examining any books, records,
documents and computer data in the possession of the venture capital fund or such other
person and also provide copies of documents or other materials which, in the opinion of the
inspecting or investigating officer are relevant for the purposes of the inspection or
investigation, as the case may be.

(3) The inspecting or investigating officer, in the course of inspection or investigation shall
be entitled to examine or to record the statements of any director, officer or employee of the
venture capital fund.

(4) It shall be the duty of every director, officer or employee, trustee or director of the trustee
company of the venture capital fund to give to the inspecting or investigating officer all
assistance in connection with the inspection or investigation, which the inspecting or
investigating officer may reasonably require.

Submission of Report to the Board

The inspecting or investigating officer shall, as soon as possible, on completion of the

inspection or investigation submit an inspection or investigation report to the Board:

Provided that if directed to do so by the Board, he may submit an interim report.

Communication of findings etc. to the venture capital fund

(1) The Board shall, after consideration of the inspection or investigation report or the
interim report referred to in regulation 28, communicate the findings of the inspection officer
to the venture capital fund and give him an opportunity of being heard.

(2) On receipt of the reply if any, from the venture capital fund, the Board may call upon the
venture capital fund to take such measures as the Board may deem fit in the interest of the
securities market and for due compliance with the provisions of the Act and these
regulations.

66
 PROCEDURE FOR ACTION IN CASE OF DEFAULT

Suspension of certificate

The Board may suspend the certificate granted to a venture capital fund where the venture
capital fund:

(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 any material
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 by the
Board;
(f) fails to resolve the complaints of investors or fails to give a satisfactory reply to the
Board in this behalf.

Cancellation of certificate

The Board may cancel the certificate granted to a venture capital fund:-

(a) when the venture capital fund is guilty of fraud or has been convicted of an offence
involving moral turpitude;
(b) the venture capital fund has been guilty of repeated defaults of the nature specified in
regulation 30; or
(c) contravenes any of the provisions of the Act or these regulations.

Manner of making order of cancellation or suspension

No order of suspension or cancellation of certificate shall be made by the Board, except after
holding an enquiry in accordance with the procedure specified in regulation 33.

Manner of holding enquiry before suspension or cancellation

(1) For the purpose of holding an enquiry under regulation 32, the Board may appoint one or
more enquiry officers.

67
(2) The enquiry officer shall issue to the venture capital fund, at its registered office or its
principal place of business, a notice setting out the grounds on which action is proposed to be
taken against it and calling upon it to show cause against such action within a period of
fourteen days from the date of receipt of the notice.

(3) The venture capital fund may, within fourteen days from the date of receipt of such
notice, furnish to the enquiry officer a written reply, together with copies of documentary or
other evidence relied on by it or sought by the Board from the venture capital fund.

(4) The enquiry officer shall give a reasonable opportunity of hearing to the venture capital
fund to enable him to make submissions in support of its reply made under sub-regulation
(3).

(5) Before the enquiry officer, the venture capital fund may appear through any person duly
authorised by the venture capital fund:

Provided that no lawyer or advocate shall be permitted to represent the venture capital fund
at the enquiry:

Provided further that where a lawyer or an advocate has been appointed by the Board as a
presenting officer under sub-regulation (6), it shall be lawful for the venture capital fund to
present its case through a lawyer or advocate.

(6) The enquiry officer may, if he considers it necessary, ask the Board to appoint a
presenting officer to present its case.

(7) The enquiry officer shall, after taking into account all relevant facts and submissions
made by the venture capital fund, submit a report to the Board and recommend the penal
action, if any, to be taken against the venture capital fund as also the grounds on which the
proposed action is justified.

Show-cause notice and order

(1) On receipt of the report from the enquiry officer, the Board shall consider the same and
may issue to the venture capital fund a show-cause notice as to why the penal action as
proposed by the enquiry officer should not be taken against it.

(2) The venture capital fund shall, within fourteen days of the date of the receipt of the show-
cause notice, send a reply to the Board.

(3) The Board, after considering the reply, if any, of the venture capital fund, shall, as soon as
possible pass such order as it deems fit.

Effect of suspension and cancellation of certificate

(1) On and from the date of the suspension of the certificate, the venture capital fund shall
cease to carry on any activity as a venture capital fund during the period of suspension, and

68
shall be subject to such directions of the Board with regard to any records, documents or
securities that may be in its custody or control, relating to its activities as venture capital
fund, as the Board may specify.

(2) On and from the date of cancellation of the certificate, the venture capital fund shall, with
immediate effect, cease to carry on any activity as a venture capital fund, and shall be subject
to such directions of the Board with regard to the transfer of records, documents or securities
that may be in its custody or control, relating to its activities as venture capital fund, as the
Board may specify.

Publication of order of suspension or cancellation

The order of suspension or cancellation of certificate passed under regulation 35 may be

published by the Board in two newspapers.

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 APPENDIX-2
List of Venture Capital Companies in India
1. 20th Century Finance Corporation Limited
Centre Point
Dr.Ambedkar Road
Parel
Mumbai - 400012

2. AIG Investment Corporation (Asia) Limited

India - Representative Office
2634 Oberoi Towers
Nariman Point
Mumbai - 400021

3. Acuity Strategic Financials Private Limited

14 Santosh, 2nd floor
242 Lady Jamshedji Road
Mumbai - 400028

4. AIA Capital India Private Limited

9B Hansalaya
Barakhamba Road
New Delhi - 110001
5. Alliance DLJ Private Equity Fund
404 / 405 Prestige Centre Point
7 Edward Road
Bangalore - 560052

6. Alliance Venture Capital Advisors Limited

607 Raheja Chambers
Free Press Journal Road, Nariman Point
Mumbai - 400021

7. APIDC Venture Capital Limited

1102 Block A, 11th floor
Babukhan Estate, Basheerbagh
Hyderabad - 500001

8. Canbank Venture Capital Fund Limited

2/F Kareem Towers, 11th floor
19/5 -19/6 Cunningham Road
Bangalore - 560052

9. Draper International (India) Private Limited

V203 Prestige Meridian -1
M.G. Road
Bangalore - 560001

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10 eVentures India
. (Consultair Investments Private Limited)
Khetan Bhavan
8 Jameshedji Tata Road
Churchgate
Mumbai - 400020

11 GE Capital Services India Limited

. AIFACS Building
1 Rafi Marg
New Delhi - 110001

12 Gujarat Venture Finance Limited

. Premchand House Annexe, 1st floor
Behind Popular House
Ashram Road
Ahmedabad - 380009

13 HSBC Private Equity Management Mauritius Limited

. Ashoka Estate, 3rd floor
24 Barakhamba Road
New Delhi - 110001

14 ICICI Securities and Finance Company Limited

. 41/44 Strand Palace
M.Desai Marg
Colaba
Mumbai - 400005

15 ICICI Venture Funds Management

. Company Limited (formerly TDICI)
Raheja Plaza, 4th floor
17 Commissariat Road
D'Souza Circle
Bangalore - 560025

16 IFB Venture Capital Finance Limited

. 8/1 Middletown Row
Calcutta - 700071

17 Industrial Development Bank of India

. IDBI Tower Cuffe Parade
Mumbai - 400005

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18 Small Industries Development Bank of India (SIDBI)
. SIDBI Venture Capital Limited
Nariman Bhavan
227 Vinay K. Shah Marg
Nariman Point
Mumbai - 400021

19 Tata Investment Corporation Limited

. Ewart House, 3rd floor
Homi Modi Street Fort
Mumbai - 400001

20 Templeton India Private Equity Fund

. 125 Free Press House
Nariman Point
Mumbai - 400021

21 Vista Ventures
. DBS Corporate Club
26 Cunningham Road
Bangalore - 560052

22 Walden-Nikko India Management Company Limited

. One Silverstone
294 Linking Road
Khar (West)
Mumbai - 400052

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 APPENDIX-3

What the leader speaks!!!!

www.ibef.org

Pramod Haque

Managing Partner, Norwest Venture Partners

Forbes' number one venture capitalist Pramod Haque roots for outsourcing.

Forbes' number one venture capitalist in the world, Pramod Haque says outsourcing to
India is very crucial for start-ups. He says rarely does his company finance a start-up
which does all its work in the US, since their breakeven formula does not work for such
companies.

Q: How many ideas do you hear a day?

A: I don't have the exact number but we hear a lot of ideas. We have a team of about eight
investment personnel and we have been in business for forty-three years. So a lot of people
know about us and approach us with ideas. Probably less than 1-2% of the ideas we hear get
funded.

Q: Is it because they are not good or is it because those are not in the areas of your
interest?

A: It's a combination of both. We are very selective and we maintain a very high standard.
Also we are focused exclusively on the information technology space. And many ideas we
hear are outside that space. So for those two reasons, our focus and then our standards, we
fund very few ideas that we hear.

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Q: It is very rare that we get two Indians on the top any financial list like this. What is
it that makes Indians at Silicon Valley great venture capitalists?

A: There are lot of Indians who participate in Silicon Valley endeavours. There was a time
when I heard some statistics, haven't been able to verify them, that 40% of the companies that
get started in the Valley, are started by Indians. There is a very high percentage of Indian
professionals that work in the valley. Both our firms - Norwest Venture Partners and Kleiner
Perkins - have had a long history of funding some very good companies. So success breeds
success, we see the best of the best and therefore we are fortunate enough to have been
affiliated with leading companies.

Q: Is their success rate better than the rest?

A: I really don't have numbers. But I think lot of successful companies in the Valley have
been started by Indians.

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Q: Forbes says that venture capitalists are taking second look at funding?

A: I think what they were referring to is that - there were lot of good companies that were
funded in the 2001-02 - and some of these good companies were unable to get enough
traction in the market place. Not because the product ideas were not good but because the
economy was in recession and the entire hi-tech industry was in the dumps. So I think one of
the things that is happening that VC have gone back and tried to differentiate between
companies that were not having traction because the idea was poor and the companies that
were not having traction because the market wasn't buying. So you pick the best out of those.

Q: Any idea about failed companies?

A: I think a lot of companies failed. I can give you rough numbers. There was a time when
people were following this very closely. There were somewhere around 10,000 companies
that got started in the 1998-2001 and I would say that at this stage, there are probably only
about 3000 of them still there. So 70% of them have either been shutdown or they have been
consolidated where they have been merged with each other or with other larger companies.

Q: When Forbes talks about people like you, are you looking at that 7000 that were
shutdown, or are you looking at the 3000?

A: I think they are probably referring to some of the 3000 that are left or were successful
enough. Even among those, we are very selective.

Q: Is there any particular characteristic that distinguishes these?

A: These are all in hi-tech sector. They are all in IT sector. I think the key thing to spot in
those companies is that they are highly differentiated and that have not been leapfrogged by
someone else and therefore are worthy of continuing investments.

Q: VC is after all early investment in slightly risky proposition...

A: In some sense. Some of them might work because some of these companies have little or
not sales traction. And in some sense they would qualify as later stage investments because
they do have a product in place. But I don't think there is a lot of that is happening.
Predominantly the companies that are getting funded today in the Silicon Valley are brand
new start-ups. And of the 3000-odd companies we spoke of, there is a later stage investing is
going on in some of these companies that we have just talked about 3000 companies.

Q: What do you think of valuations?

A: I think it is very fair to say that valuations in the private equity market and in the VC
market, have all been rolled back in the last year or so and to some extent they reflect the

75
valuation of the public market. So the public market itself has come down substantially in
valuations and therefore private companies have also come back in their valuations.

Q: What kind of opportunities do you take into account when you consider a proposal?

A: Our view is that really, when we fund new companies or even existing companies, what
we tell the entrepreneurs that are involved in these companies, that the market is really gone
back to the early nineties. So it's almost that the clock has been rolled back ten years. To give
you an example, one of the companies that, we had funded and had a very successful
acquisition. That was a company called Cerent Corporation, that Cisco paid $7 billion for.
You are not going to see those kinds of acquisition prices in a long-time, especially for early
stage companies.

Over the last year we have exited about three companies, where we have had acquisitions and
I would say that the average acquisition price is more than the $175 million range.

Q: Outsourcing has become a big issue. What’s your take on it?

A: As a US venture capitalist, I am very bullish on outsourcing and from my perspective

there are really two broad categories of that. Larger established companies who have seen
their revenues declined during the recession and had to perform as far as earnings are
concerned, have really taken a look at their cost structure and decided that they need to
reduce their cost structure. So we have several companies, who have come to companies
here, to outsource. These are large established companies and they are outsourcing some of
the IT functions or maintenance functions. So that is one type of outsourcing.

But I think outsourcing is also very essential for smaller start-ups, which is where I have
spent lot of my time and there is a very fundamental reason for that. As we said earlier, the
exit valuations have dropped in the market place and innovation, if it is going to happen has
to be successful for investors as well as entrepreneurs and I have often said that innovation as
a business model, which means that investors and entrepreneurs, when they spend time and
money, at the end of the day see a return on their investment.

Now because exit valuation have dropped to, what I call the pre - 1995 levels, The rough rule
of thumb we have is that a software company should be able to get cash-flow breakeven in 3-
4 years with about $20 million of equity capital and a hardware company, system company
or a semiconductor company, needs to get cash-flow breakeven with about $40-45 million
dollars of investment over four years.

Now it is very difficult to achieve those kinds of numbers if you do all the development work
in India. And so rarely do we start a company today in the US where we do not ask the
entrepreneurs to fund or to outsource some of their development work to India.

Q: Are we seeing the trend happening?

A: I think it's a trend that will accelerate. I believe in spite of all the noise that you hear from
political figures at this time. It's election time and there is some real pain undoubtedly. There

76
are lot of people who are not finding jobs but my belief is that the short-term pain will
eventually lead to long-term gain.

Q: So you are saying hope for VC, it doesn't make sense to invest in a company that is
only going to work in America, it has to be outsourcing?

A: If that is going to be successful within the parameter that I described, it has to figure out a
way, to reduce its cost structure and the only way that I know is to say, we are going to take a
substantial fees of our development work and to move in countries like India and China.

Q: What kind of work..

A: India is very well known for its software development expertise. I think at this stage, it is
fair to say that countries like Taiwan and China have very good advantage when it comes to
manufacturing of hardware that goes into some of these electronic systems, as well as semi-
conductors.

Q: Will you keep investing?

A: Actually we have invested in few of these companies and our model is that we will find
companies here in India that have core technology and what we will do then is, we would set
up that company and organise it in the US and we would hire a CEO there and the sales in
the BPO marketing because we need to close to the actual customers, the early adopters of
those technologies. But we would then continue to fund the development work here in India.

Q: You are saying that there is work for everybody?

A: Not necessarily in the outsourcing arena. These are product companies. These are
companies that are actually building real products that we can sell into core markets in
America and in Europe and in India as well. But the early markets are still in the US and in
Europe.

Q: What kinds of products?

A: For example we have just funded a company in Bangalore, which has a business process
improvement software product. A product was developed in Bangalore and now we have set-
up the company in the US, sales and marketing is there and lot of the initial customers in the
US.

Q: How do you see future?

A: I think IT is not going to go away. IT spending is continuing to increase as a percentage

in GDP. In the 2000-01 timeframe, because we were in the middle of recession, we saw IT
spending plunge. But IT spending is coming back. Not only IT spending is coming back, but
also innovation has started again. We see more and more CIOs now, whose core priority in
the 2001-02 timeframe was cost reduction and therefore they were not buying any new

77
technologies. Now in 2004 their core priorities are starting to shift and they are looking at
increasing their revenues and they are looking at ways of doing that and technology is a very
big factor.

Q: But what about margins?

A: Yes, that is another reason for outsourcing. A lot of these companies have to outsource
some of their development and even customers support to countries like India and China so
that they can maintain the same margins.

Q: How do you view VC funding to companies in China?

A: Speaking from a small company perspective, that is funding smaller companies, I think
one of the challenge is and the concern that we have about the Chinese market is the lack of
intellectual property protection. And that is still a mystery, the intellectual property laws are
not well defined and I think till such time as those laws get better defined, for example, we
as Norwest Venture Partners has some reticence in terms of going out and investing in start-
ups in that arena.

Q: Are you happy with the intellectual property laws, the recent example is Ten Sports
and Doordarshan controversy...

A: I think the Indian market intellectual property laws need to get beefed up even more. But I
think this country has a running start and I think our heritage with the British system of
justice provides the groundwork for the right kind of intellectual property laws to be laid.
There is more room for improvement there and I think in general as you look at this whole
issue of outsourcing, our Secretary of State, Colin Powell has pointed out that as long as
India opens up its markets, so that there can be mutual trading, so that US companies can sell
products here as well as Indian companies bidding for outsourcing contracts. So I think there
is need to be fair amount of give and take and if that happens I think we will see tremendous
growth in the trading between these two countries in the hi-tech sector.

Q: If India remains closed but American companies see advantage in outsourcing work
in India, how much of a spoiler can the government of America be?

A: It is hard to say. As I said earlier a lot of the rhetoric that we hear today is primarily
because this is election year. The pains are real. There are lots of people in the market place
that are not finding jobs but at the end of the day I am a firm believer that outsourcing
actually helps create new jobs in US. I can point to several new companies that we have
funded, that have created new jobs in the US, which we would not have funded unless we
were convinced that these companies can get to cash-flow breakeven to a $20 million worth
of capital in the software industry and the only way we can do that is to outsource some of
those jobs. So some of these jobs are getting created in US and some of these jobs are getting
created in India.

Q: How easy it is to remain on the top of the list?

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A: I don't think it is the priority. The thing that we focus on is, how do we build successful
companies. Other people also create successful company. We have gone out and invested in
large companies. In the past we have done deals with the Kleiner Perkins, we have done
deals with Mayfield and we do deals with lot of various venture capitalists also.

79