CASE STUDY: VENTURE CAPITAL

INTRODUCTION

Starting and growing a business always require capital. There are a number of alternative
methods to fund growth. These include the owner or proprietor’s own capital, arranging debt
finance, or seeking an equity partner, as is the case with private equity and venture capital.

Private equity is a broad term that refers to any type of non-public ownership equity securities
that are not listed on a public exchange. Private equity encompasses both early stage (venture
capital) and later stage (buy-out, expansion) investing. In the broadest sense, it can also include
mezzanine, fund of funds and secondary investing.

Venture capital is a means of equity financing for rapidly-growing private companies. Finance
may be required for the start-up, development/expansion or purchase of a company. Venture
Capital firms invest funds on a professional basis, often focusing on a limited sector of
specialization (eg. IT, infrastructure, health/life sciences, clean technology, etc.).

The goal of venture capital is to build companies so that the shares become liquid (through IPO
or acquisition) and provide a rate of return to the investors (in the form of cash or shares) that is
consistent with the level of risk taken.

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With venture capital financing, the venture capitalist acquires an agreed proportion of the equity
of the company in return for the funding. Equity finance offers the significant advantage of
having no interest charges. It is "patient" capital that seeks a return through long-term capital
gain rather than immediate and regular interest payments, as in the case of debt financing. Given
the nature of equity financing, venture capital investors are therefore exposed to the risk of the
company failing. As a result the venture capitalist must look to invest in companies which have
the ability to grow very successfully and provide higher than average returns to compensate for
the risk.

When venture capitalists invest in a business they typically require a seat on the company's board
of directors. They tend to take a minority share in the company and usually do not take day-to-
day control. Rather, professional venture capitalists act as mentors and aim to provide support
and advice on a range of management, sales and technical issues to assist the company to
develop its full potential.

Venture capital has a number of advantages over other forms of finance, such as:

1) It injects long term equity finance which provides a solid capital base for future growth.
2) The venture capitalist is a business partner, sharing both the risks and rewards. Venture
capitalists are rewarded by business success and the capital gain.
3) The venture capitalist is able to provide practical advice and assistance to the company based
on past experience with other companies which were in similar situations.
4) The venture capitalist also has a network of contacts in many areas that can add value to the
company, such as in recruiting key personnel, providing contacts in international markets,
introductions to strategic partners, and if needed co-investments with other venture capital firms
when additional rounds of financing are required.
5) The venture capitalist may be capable of providing additional rounds of funding should it be
required to finance growth.

DEFINITION:

According to the Bank of England Quarterly Bulletin of 1984, “Venture Capital

Investment is defined as an activity by which investors support entrepreneurial talent with
finance and business skills to exploit market opportunities and thus obtain long term capital
gains.”

HISTORY:

With few exceptions, private equity in the first half of the 20th century was the domain of
wealthy individuals and families. The Vanderbilts, Whitneys, Rockefellers, and Warburgs were
notable investors in private companies in the first half of the century. In 1938, Laurance S.
Rockefeller helped finance the creation of both Eastern Air Lines and Douglas Aircraft and the

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Rockefeller family had vast holdings in a variety of companies. Eric M. Warburg founded E.M.
Warburg & Co. in 1938, which would ultimately become Warburg Pincus, with investments in
both leveraged buyouts and venture capital.

Origins of modern private equity:

Before World War II, money orders (originally known as "development capital") were primarily
the domain of wealthy individuals and families. It was not until after World War II that what is
considered today to be true private equity investments began to emerge marked by the founding
of the first two venture capital firms in 1946: American Research and Development Corporation.
(ARDC) and J.H. Whitney & Company.

ARDC was founded by Georges Doriot, the "father of venture capitalism" (former dean of
Harvard Business School and founder of INSEAD), with Ralph Flanders and Karl Compton
(former president of MIT), to encourage private sector investments in businesses run by soldiers
who were returning from World War II. ARDC's significance was primarily that it was the first
institutional private equity investment firm that raised capital from sources other than wealthy
families although it had several notable investment successes as well. ARDC is credited with the
first trick when its 1957 investment of $70,000 in Digital Equipment Corporation (DEC) would
be valued at over $355 million after the company's initial public offering in 1968 (representing a
return of over 1200 times on its investment and an annualized rate of return of 101%).

Former employees of ARDC went on and established several prominent venture capital firms
including Greylock Partners (founded in 1965 by Charlie Waite and Bill Elfers) and Morgan,
Holland Ventures, the predecessor of Flagship Ventures (founded in 1982 by James Morgan).
ARDC continued investing until 1971 with the retirement of Doriot. In 1972, Doriot merged
ARDC with Textron after having invested in over 150 companies.

J.H. Whitney & Company was founded by John Hay Whitney and his partner Benno Schmidt.
Whitney had been investing since the 1930s, founding Pioneer Pictures in 1933 and acquiring a
15% interest in Technicolor Corporation with his cousin Cornelius Vanderbilt Whitney. By far
Whitney's most famous investment was in Florida Foods Corporation. The company developed
an innovative method for delivering nutrition to American soldiers, which later came to be
known as Minute Maid orange juice and was sold to The Coca-Cola Company in 1960. J.H.
Whitney & Company continues to make investments in leveraged buyout transactions and raised
$750 million for its sixth institutional private equity fund in 2005.

Early venture capital and the growth of Silicon Valley:

Sand Hill Road in Menlo Park, California, where many Bay Area venture capital firms are
basedOne of the first steps toward a professionally-managed venture capital industry was the
passage of the Small Business Investment Act of 1958. The 1958 Act officially allowed the U.S.
Small Business Administration (SBA) to license private "Small Business Investment
Companies" (SBICs) to help the financing and management of the small entrepreneurial
businesses in the United States.

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During the 1960s and 1970s, venture capital firms focused their investment activity primarily on
starting and expanding companies. More often than not, these companies were exploiting
breakthroughs in electronic, medical, or data-processing technology. As a result, venture capital
came to be almost synonymous with technology finance. An early West Coast venture capital
company was Draper and Johnson Investment Company, formed in 1962 by William Henry
Draper III and Franklin P. Johnson, Jr. In 1964 Bill Draper and Paul Wythes founded Sutter Hill
Ventures, and Pitch Johnson formed Asset Management Company.

It is commonly noted that the first venture-backed startup is Fairchild Semiconductor (which
produced the first commercially practical integrated circuit), funded in 1959 by what would later
become Venrock Associates. Venrock was founded in 1969 by Laurance S. Rockefeller, the
fourth of John D. Rockefeller's six children as a way to allow other Rockefeller children to
develop exposure to venture capital investments.

It was also in the 1960s that the common form of private equity fund, still in use today, emerged.
Private equity firms organized limited partnerships to hold investments in which the investment
professionals served as general partner and the investors, who were passive limited partners, put
up the capital. The compensation structure, still in use today, also emerged with limited partners
paying an annual management fee of 1-2.5% and a carried interest typically representing up to
20% of the profits of the partnership.

The growth of the venture capital industry was fueled by the emergence of the independent
investment firms on Sand Hill Road, beginning with Kleiner, Perkins, Caufield & Byers and
Sequoia Capital in 1972. Located, in Menlo Park, CA, Kleiner Perkins, Sequoia and later venture
capital firms would have access to the many semiconductor companies based in the Santa Clara
Valley as well as early computer firms using their devices and programming and service
companies.

Throughout the 1970s, a group of private equity firms, focused primarily on venture capital
investments, would be founded that would become the model for later leveraged buyout and
venture capital investment firms. In 1973, with the number of new venture capital firms
increasing, leading venture capitalists formed the National Venture Capital Association (NVCA).
The NVCA was to serve as the industry trade group for the venture capital industry. Venture
capital firms suffered a temporary downturn in 1974, when the stock market crashed and
investors were naturally wary of this new kind of investment fund.

It was not until 1978 that venture capital experienced its first major fundraising year, as the
industry raised approximately $750 million. With the passage of the Employee Retirement
Income Security Act (ERISA) in 1974, corporate pension funds were prohibited from holding
certain risky investments including many investments in privately held companies. In 1978, the
US Labor Department relaxed certain of the ERISA restrictions, under the "prudent man rule,"
thus allowing corporate pension funds to invest in the asset class and providing a major source of
capital available to venture capitalists.

1980s:

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The public successes of the venture capital industry in the 1970s and early 1980s (e.g., Digital
Equipment Corporation, Apple Inc., Genentech) gave rise to a major proliferation of venture
capital investment firms. From just a few dozen firms at the start of the decade, there were over
650 firms by the end of the 1980s, each searching for the next major "home run". While the
number of firms multiplied, the capital managed by these firms increased by only 11% from $28
billion to $31 billion over the course of the decade.

The growth of the industry was hampered by sharply declining returns and certain venture firms
began posting losses for the first time. In addition to the increased competition among firms,
several other factors impacted returns. The market for initial public offerings cooled in the mid-
1980s before collapsing after the stock market crash in 1987 and foreign corporations,
particularly from Japan and Korea, flooded early stage companies with capital.

In response to the changing conditions, corporations that had sponsored in-house venture
investment arms, including General Electric and Paine Webber either sold off or closed these
venture capital units. Additionally, venture capital units within Chemical Bank and Continental
Illinois National Bank, among others, began shifting their focus from funding early stage
companies toward investments in more mature companies. Even industry founders J.H. Whitney
& Company and Warburg Pincus began to transition toward leveraged buyouts and growth
capital investments.

The venture capital boom and the Internet Bubble (1995 to 2000):

By the end of the 1980s, venture capital returns were relatively low, particularly in comparison
with their emerging leveraged buyout cousins, due in part to the competition for hot startups,
excess supply of IPOs and the inexperience of many venture capital fund managers. Growth in
the venture capital industry remained limited throughout the 1980s and the first half of the 1990s
increasing from $3 billion in 1983 to just over $4 billion more than a decade later in 1994.

After a shakeout of venture capital managers, the more successful firms retrenched, focusing
increasingly on improving operations at their portfolio companies rather than continuously
making new investments. Results would begin to turn very attractive, successful and would
ultimately generate the venture capital boom of the 1990s. Former Wharton Professor Andrew
Metrick refers to these first 15 years of the modern venture capital industry beginning in 1980 as
the "pre-boom period" in anticipation of the boom that would begin in 1995 and last through the
bursting of the Internet bubble in 2000.

The late 1990s were a boom time for venture capital, as firms on Sand Hill Road in Menlo Park
and Silicon Valley benefited from a huge surge of interest in the nascent Internet and other
computer technologies. Initial public offerings of stock for technology and other growth
companies were in abundance and venture firms were reaping large returns.

VENTURE CAPITAL FIRMS AND FUNDS:

Venture capitalists

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A venture capitalist (also known as a VC) is a person or investment firm that makes venture
investments, and these venture capitalists are expected to bring managerial and technical
expertise as well as capital to their investments. A venture capital fund refers to a pooled
investment vehicle (often an LP or LLC) that primarily invests the financial capital of third-party
investors in enterprises that are too risky for the standard capital markets or bank loans. Venture
capital firms typically comprise small teams with technology backgrounds (scientists,
researchers) or those with business training or deep industry experience.

A core skill within VC is the ability to identify novel technologies that have the potential to
generate high commercial returns at an early stage. By definition, VCs also take a role in
managing entrepreneurial companies at an early stage, thus adding skills as well as capital
(thereby differentiating VC from buy-out private equity, which typically invest in companies
with ,proven revenue), and thereby potentially realizing much higher rates of returns. Inherent in
realizing abnormally high rates of returns is the risk of losing all of one's investment in a given
startup company. As a consequence, most venture capital investments are done in a pool format,
where several investors combine their investments into one large fund that invests in many
different startup companies. By investing in the pool format, the investors are spreading out their
risk to many different investments versus taking the chance of putting all of their money in one
start up firm.

Structure

Venture capital firms are typically structured as partnerships, the general partners of which serve
as the managers of the firm and will serve as investment advisors to the venture capital funds
raised. Venture capital firms in the United States may also be structured as limited liability
companies, in which case the firm's managers are known as managing members. Investors in
venture capital funds are known as limited partners. This constituency comprises both high net
worth individuals and institutions with large amounts of available capital, such as state and
private pension funds, university financial endowments, foundations, insurance companies, and
poopled investment vehicles, called fund of fund.

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RATIONALE:

The rationale for venture capital arises on account of the fact that there is a high
expectation for large gains for an entrepreneur which acts as the motivation behind taking up
risky investments that carry high return profiles. Venture capital investment is made with the
objective of obtaining equity ownership in such enterprises initially, and to take part in the
growing prospects in the form of capital appreciation subsequently.

FEATURES:

New Ventures: Venture capital investment is generally made in new enterprises that use new
technology to produce new products, in expectation of high gains or sometimes, spectacular
returns.

Continuous Involvement: Venture capitalists continuously involve themselves with the client’s
investments, either by providing loans or managerial skills or any other support.

Mode of Investment: Venture capital is basically an equity financing method, the investment
being made in relatively new companies when it is too early to go to the capital market to raise
funds. In addition, financing also takes the form of loan finance/convertible debt to ensure a
running yield on the portfolio of the venture capitalists.

Objective: The basic objective of a venture capitalist is to make a capital gain on equity
investment at the time of exit and regular return on debt financing. It is a long-term investment in

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growth oriented small/medium firms. It is long term capital that is injected to enable the business
to grow at a rapid pace, mostly from the start-up stage.

Hands-on Approach: Venture capital institutions take an active part in providing value added
services such as providing business skills, etc. to investee firms. They do not interfere in the
management of the firms nor do they acquire a majority /controlling interest in the investee
firms. The rationale for the extension of hands-on management is that venture capital
investments tend to be highly non-liquid.

High Risk-return Ventures: Venture capitalists finance high risk-return ventures. Some of the
ventures yield very high return in order to compensate for the heavy risks related to the ventures.
Venture capitalists usually make huge capital gains at the time of exit.

Nature of Firms: Venture capitalists usually finance small & medium sized firms during the
early stages of their development, until they are established and are able to raise finance from the
conventional industrial finance market. Many of these firms are new, high-technology oriented
companies.

Liquidity: Liquidity of venture capital investment depends on the success or otherwise of the
new venture or product. Accordingly there will be higher liquidity where the new ventures are
highly successful.

ORIGIN & GROWTH OF VENTURE CAPITAL IN INDIA:

Venture capital that originated in India very late is still in its infancy. It was the Bhatt Committee
(Committee on Development of Small & Medium Entrepreneurs) in the year 1972, which
recommended the creation of venture capital. The committee urged the need for providing such
capital to help new entrepreneurs and technologists in setting up industries.

A brief description of some of the venture capital funds in India is as follows:

1. Risk Capital foundation: The Industrial Finance Corporation of India (IFCI) launched the
first venture capital fund in the year 1975. The fund, ‘Risk Capital Foundation’ (RCF) aimed at
supplementing ‘promoter’s equity’ with a view to encouraging technologists and professionals to
promote new industries.

2. Seed capital scheme: This venture capital fund was launched by IDBI in 1976, with the same
objective in mind.

3. Venture capital scheme: Venture capital funding obtained official patronage with the
announcement by the Central Government of the ‘Technology Policy Statement’ in 1983. It
prescribed guidelines for achieving technological self-reliance through commercialization and
exploitation of technologies. The ICICI, an all India financial institution in the private sector set
up a Venture capital scheme in 1986, to encourage new technocrats in the private sector to enter
new fields of high technology with inherent high risk. The scheme aimed at allocating funds for

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providing assistance in the form of venture capital to economic activities having risk, but also
high profit potential.

4. PACT: The ICICI undertook the administration of Program for Application of Commercial
Technology (PACT), aided by U.S.AID with an initial grant of USD 10 million. The program
aims at financing specific needs of the corporate sector industrial units along the lines of venture
capital funding.

5. Government fund: IDBI, as nodal agency, administers the venture capital fund created by the
Central Government with effect from 1st April, 1986. The government started imposing a
Research & Development (R & D) levy on all payments made for the purchase of technology
from abroad, including royalty payments, lump sum payments for foreign collaboration and
payment for designs and drawings under the R&D Cess Act, 1986. The levy was used as a
source of funding the venture capital fund.

6. TDICI: In 1988, an ICICI sponsored company, viz. Technology Development and

Information Company of India ltd. (TDICI) was founded, and venture capital operations of
ICICI were taken over by it with effect from July 1, 1988.

7. RCTFC: The Risk Capital Foundation (RCF) sponsored by IFCI was converted into Risk
Capital and Technology Finance Corporation Ltd. (RCTFC) in the year 1988. It took over the
activities of RCF, in addition to the management of other financing technology development
schemes and venture capital fund.

8. VECAUS: VECAUS-I, the UTI sponsored “Venture Capital Unit Scheme” was launched in
the year 1989. Technology Development and Information Company of India Ltd. (TDICI) was
appointed as its managers. In the year 1990, the corporation was also entrusted with the
responsibility of managing another UTI sponsored venture fund entitled ‘VECAUS-II’. In
1991, UTI launched VECAUS-III and RCTC was appointed as fund manager.

VENTURE CAPITAL & OTHER FUNDS:

Venture capital funds are different from other capital funds in many respects as shown below:

Venture capital & Development capital: Venture capital is advanced for ventures using new
technology or new innovation. In this type of financing the venture capital company remains
interested in the overall management of the project due to the high risk involved in the venture.
Funds are made available throughout the project, commencing from commercial production to
the successful marketing of products, to ensure continuous revenue earnings, enhanced worth of
the investments, and finally making available a proper exit route for liquidating the investments.
Development capital, on the other hand, is generally granted in the form of loans for setting
industrial units, and also for expansion and modernization. The lender takes special care in
ensuring the end use of the credit and requires prompt payment of interest and repayment of the
loan amount.

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Venture capital, Seed capital & Risk capital: There are no tangible differences between
venture capital, seed capital & risk capital. Both seed capital & risk capital are components of
venture capital. Seed capital and risk capital are provided by all- India financial institutions in the
form of promoter’s contribution to the project, with the emphasis on providing interest free
finance to encourage professionals to become promoters of industrial projects.

Venture capital & National equity fund for small entrepreneur: The National equity fund,
administered by SIDBI, was established in 1987, with the object of providing seed capital
assistance to small entrepreneurs, in the rural as well as urban areas, with a population below 5
Lakhs.

STAGES OF VENTURE CAPITAL FINANCING

Setting up a new venture

↓
Seed Capital
↓
Early stage financing
↓
Follow on financing
↓
Expansion financing
↓
Replacement financing
↓
Turnaround financing
↓
Exit
↓

IPO M&A Company/Promoters Buy Back

Seed capital:
This is the early stage of financing. This stage involves primarily R & D financing .The
European venture capital financing defines seed capital as “the financing of the initial product
development or capital provided to an entrepreneur to prove the feasibility of a project for start
up capital. This stage involves serious risk, as there is no guarantee for the success of the
concept, idea & process pertaining to high technology or innovation. This stage requires constant
infusion of funds in order to sustain the R & D work & establish the process of successful
adaptation, going into the commencement of commercial production & marketing. Venture
financing constitutes financing of ideas developed by R & D wings of companies or at university
centers. Chances of success in hi–tech projects are meager.

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The venture capital fund considers the following points to safeguard its own interests.
1. Successful performance record, entrepreneur’s previous experience in similar products,
technology & market.
2. Qualities of business management & technical innovation in the enterprise, realistic business
plan with the clear future projects for which seed capital is required.

Start up financing:
The European venture capital association defines start up financing as “the capital needed to
finance the product development, initial marketing & establishment of product facilities “. This
too falls under the category of early stage financing .the term ‘start up’ refers where a new
activity is launched .the activity may be one emanating from R & DS stage, or arising from
transfer of technology from overseas–based business. Venture capital finance is provided to the
projects, which have been selected for commercial production. The activity chosen for funding
has the potential for fulfilling effective demand. Venture capitalists provide finance with the
view to take advantage of the capital gain arising from equity appreciation on completion of such
projects & marketing of its product. The venture capitalists on their part take into consideration
such factors as the managerial ability, capacity, experience, competence etc of the entrepreneur
before making investments.

The entrepreneur should furnish the following details to the venture capitalists:
1. Brief history of business or project.
2. A synoptic note on career history of entrepreneur & key managers.
3. Description of product / service to be manufactured.
4. Description of product /service with existing /future state of competition, growth prospects in
the share market etc.
5. Description of technical process involved & technology to be followed in the manufacturing
process.
6. Degree of technological obsolesces in technical process.
7. Finance history & forward projections of turnover profits, cash flows & borrowings over at
least a two year period.
8. Proposed deal structure for the funding being sought.

Venture capitalists appraise projects by taking the following key factors into consideration with
the basic objective of assessing the risk involved in financing, & then judge the realistic
expectation of gains:

1. Track record: The track record of the promoter / entrepreneur /management team / skilled staff
resource is analyzed to evaluate the management performance record, ability, capacity of the
entrepreneur to handle the proposed business plan successfully.

2. Performance assumptions: the technical performance assumptions about the

product/process/service, the technical strength of the proposed process service with reference to
product life cycle are also analyzed.

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3. Market potential: Market potential, relating to market size, growth & penetration are
analyzed .in addition, evaluation state of domestic competition & international competition is
also carried out.

4. Cost Structure: An analysis in order to evaluate profitability projections on realistic cost

assumptions & competitive price setting is under taken, as part of venture financing.

5. Time Schedule: overall completion time is ascertained by evaluating the time schedule given
by client for completion of the plan on a realistic basis & the experience gained by the venture
capitalist/merchant bankers from other projects.

Early stage financing:

The European venture capital Association defines early stage finance as “finance provided to
companies that have completed development stage & require further funds to initiate commercial
manufacturing & sales. They will not be generating profit”. This is the kind of financing required
fro completing the project. It is required immediately after the start up stage of a project. The
need for additional funds arises when the project encounters cost & time over – runs or when the
completed projects starts making losses, thus necessitating the infusion of equity type funding.
This type of funding may also be required when the start up has been successful, & the business
is growing.

Follow–on financing:
The European venture capital association defines follow on financing or second round finance as
“the provision of capital to a firm which has been in receipt of external capital but whose
financial needs have subsequent expanded “. Later stage, in a project at this stage promises to be
a attractive in terms of earning potential, it is considered to be the most attractive stage for
venture capital financing. Financing, at this point in the project, is preferred by venture
capitalists around the world, particularly in U.K & U.S.A.

Expansion Financing:
The European Venture capital Association defines expansion capital as “the finance provided to
fund the expansion or growth of a company which is breaking even or trading at small profit “.
Expansion or growth of a company will be used to finance increased production capacity, market
or product development to provide additional working capital. This is one of the later stage
financing methods, whereby finance is provided by the venture capitalists for adding production
capacity, once it has successfully gained a market share, & faces increased demand for the
product. Financing is also made available for acquisition or takeover.

Replacement Financing:
A later stage financing method, also know as ‘money – out deal’, whereby venture capitalists
extend financing for the purchase of the existing shares from an entrepreneur or their associates
in order to reduce their holdings in the unlisted company, is know as ‘replacement financing ‘.
This sale of shares may be by persons other than entrepreneurs or their associate’s .The venture
capitalists may buy ordinary shares from vendors and may convert them into preference shares
bearing a fixed dividend coupon. Such shares may be converted back into ordinary shares if the
company is listed & can thereafter be sold.

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Turnaround Financing:
This type of financing provided by the venture capitalists in the event of an enterprise becoming
unprofitable after the launch of commercial production. This is provided in the form of a relief
package from the existing the exiting venture capital investors & the enterprise is provided with
specialist skills to recover. This form of financing is popular in the U.S finance is made available
to a unlisted & non profitable venture in need of equity funds to allow for turn around .The
finance may also be provided to sustain the current operations of the enterprise.

Exit Options:

Exit Options are one of the most discussed aspects of a venture capital fund-raising process. The
promoters and the investors make money if and only if the company is able to provide a decent
exit to the investors. Exit Options are important for all concerned parties (promoters, investors)
as a good return on investment consummates the hard work, efforts put in by the promoters and
the risk taken by the investors.

When it comes to exiting from the company (i.e. selling the common shares) the equity holders
mostly exercise one of the following three options-

1. Initial Public Offering (IPO)

2. Mergers and Acquisition (M&A)
3. Company/Promoters Buy Back

Initial Public Offering (IPO): IPO is the process to selling the company’s shares to public.
After the IPO, the shares are traded in a stock exchange and people can buy and sell shares by
paying a small brokerage. This is one exit option that all investors love. IPO provides the
investors time, price and quantity flexibility. Investors can choose to sell any quantity at
anytime and at any price once the company’s shares are listed on a stock exchange.

Mergers and Acquisition (M&A): M&A is the process of selling the company’s shares,
partially or completely, to another company. This is the second preferred option by the investor
as it does not provide them the flexibility to exit at their chosen time and they have to sell all
their shares in one go. In most cases of an M&A, the pricing, timing and quanta is specified
simultaneously and investors do not have the flexibility in their exit.

Company/Promoters Buy Back: This is the least preferred option by the investor. In
company/promoters buyback arrangement, the company or the promoters agree to buy the
investors’ shares at a certain price if company is not able to provide any other exit either through
the IPO or M&A. This option is least preferred because here investors’ returns are capped and
there is no upside beyond that. However, investors like to put this in the shareholders’ agreement
so that at least their capital and minimum returns are protected even if company does not do as
well as projected.

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ROLES:

Within the venture capital industry, the general partners and other investment professionals of
the venture capital firm are often referred to as "venture capitalists" or "VCs". Typical career
backgrounds vary, but broadly speaking venture capitalists come from either an operational or a
finance background. Venture capitalists with an operational background tend to be former
founders or executives of companies similar to those which the partnership finances or will have
served as management consultants. Venture capitalists with finance backgrounds tend to have
investment banking or other corporate finance experience.

Although the titles are not entirely uniform from firm to firm, other positions at venture capital
firms include:

• Venture partners – Venture partners are expected to source potential investment

opportunities ("bring in deals") and typically are compensated only for those deals with
which they are involved.

• Principal – This is a mid-level investment professional position, and often considered a

"partner-track" position. Principals will have been promoted from a senior associate
position or who have commensurate experience in another field such as investment
banking or management consulting.

• Associate – This is typically the most junior apprentice position within a venture capital
firm. After a few successful years, an associate may move up to the "senior associate"
position and potentially principal and beyond. Associates will often have worked for 1–2
years in another field such as investment banking or management consulting.

• Entrepreneur-in-residence (EIR) – EIRs are experts in a particular domain and perform

due diligence on potential deals. EIRs are engaged by venture capital firms temporarily
(six to 18 months) and are expected to develop and pitch startup ideas to their host firm
(although neither party is bound to work with each other). Some EIR's move on to
executive positions within a portfolio company.

STRUCTURE OF THE FUNDS:

Most venture capital funds have a fixed life of 10 years, with the possibility of a few years of
extensions to allow for private companies still seeking liquidity. The investing cycle for most
funds is generally three to five years, after which the focus is managing and making follow-on
investments in an existing portfolio. This model was pioneered by successful funds in Silicon
Valley through the 1980s to invest in technological trends broadly but only during their period of

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ascendance, and to cut exposure to management and marketing risks of any individual firm or its
product.

In such a fund, the investors have a fixed commitment to the fund that is initially unfunded and
subsequently "called down" by the venture capital fund over time as the fund makes its
investments. There are substantial penalties for a Limited Partner (or investor) that fails to
participate in a capital call.

It can take anywhere from a month or so to several years for venture capitalists to raise money
from limited partners for their fund. At the time when all of the money has been raised, the fund
is said to be closed and the 10 year lifetime begins. Some funds have partial closes when one half
(or some other amount) of the fund has been raised. "Vintage year" generally refers to the year in
which the fund was closed and may serve as a means to stratify VC funds for comparison. This
free database of venture capital funds shows the difference between a venture capital fund
management company and the venture capital funds managed by them.

GEOGRAPHICAL DIFFERENCES:

Venture capital, as an industry, originated in the United States and American firms have
traditionally been the largest participants in venture deals and the bulk of venture capital has
been deployed in American companies. However, increasingly, non-US venture investment is
growing and the number and size of non-US venture capitalists have been expanding.

Venture capital has been used as a tool for economic development in a variety of developing
regions. In many of these regions, with less developed financial sectors, venture capital plays a
role in facilitating access to finance for small and medium enterprises (SMEs), which in most
cases would not qualify for receiving bank loans.

In the year of 2008, while the Venture Capital fundings are still majorly dominated by U.S.
(USD 28.8 B invested in over 2550 deals in 2008), compared to International fund investments
(USD 13.4 B invested in everywhere else), there have been an average 5% growth in the Venture
capital deals outside of the U.S- mainly in China, Europe and Israel. Geographical differences
can be significant. For instance, in the U.K., 4% of British investment goes to venture capital,
compared to about 33% in the U.S.

United States:

Venture capitalists invested some $6.6 billion in 797 deals in U.S. during the third quarter of
2006, according to the MoneyTree Report by PricewaterhouseCoopers and the National Venture
Capital Association based on data by Thomson Financial. A National Venture Capital
Association survey found that a majority (69%) of venture capitalists predicted that venture
investments in the U.S. would have leveled between $20–29 billion in 2007.

Canada:

15
Canadian technology companies have attracted interest from the global venture capital
community as a result, in part, of generous tax incentive through the Scientific Research and
Experimental Development (SR&ED) investment tax credit program. The basic incentive
available to any Canadian corporation performing R&D is a refundable tax credit that is equal to
20% of "qualifying" R&D expenditures (labour, material, R&D contracts, and R&D equipment).
An enhanced 35% refundable tax credit of available to certain (i.e. small) Canadian-controlled
private corporations (CCPCs). Because the CCPC rules require a minimum of 50% Canadian
ownership in the company performing R&D, foreign investors who would like to benefit from
the larger 35% tax credit must accept minority position in the company - which might not be
desirable. The SR&ED program does not restrict the export of any technology or intellectual
property that may have been developed with the benefit of SR&ED tax incentives.

Canada also has a fairly unique form of venture capital generation in its Labour Sponsored
Venture Capital Corporations (LSVCC). These funds, also known as Retail Venture Capital or
Labour Sponsored Investment Funds (LSIF), are generally sponsored by labor unions and offer
tax breaks from government to encourage retail investors to purchase the funds. Generally, these
Retail Venture Capital funds only invest in companies where the majority of employees are in
Canada. However, innovative structures have been developed to permit LSVCCs to direct in
Canadian subsidiaries of corporations incorporated in jurisdictions outside of Canada.

Europe:

Europe has a large and growing number of active venture firms. Capital raised in the region in
2005, including buy-out funds, exceeded €60bn, of which €12.6bn was specifically for venture
investment. The European Venture Capital Association includes a list of active firms and other
statistics. In 2006 the top three countries receiving the most venture capital investments were the
United Kingdom (515 minority stakes sold for €1.78bn), France (195 deals worth €875m), and
Germany (207 deals worth €428m) according to data gathered by Library House.

European venture capital investment in the second quarter of 2007 rose 5% to 1.14 billion Euros
from the first quarter. However, due to bigger sized deals in early stage investments, the number
of deals was down 20% to 213. The second quarter venture capital investment results were
significant in terms of early-round investment, where as much as 600 million Euros (about
42.8% of the total capital) were invested in 126 early round deals (which comprised more than
half of the total number of deals). Private equity in Italy was 4.2 billion Euros in 2007.

Israel:

Israel’s venture capital industry has rapidly developed from the early 1990s, and has about 70
active venture capital funds, of which 14 are international VCs with Israeli offices. Israel's
thriving venture capital and Business incubator industry played an important role in the booming
high-tech sector. In 2008, venture capital investment in Israel rose 19 percent to $1.9 billion.

Asia:

16
 • India is fast catching up with the West in the field of venture capital and a number of
venture capital funds have a presence in the country (IVCA). In 2006, the total amount of
private equity and venture capital in India reached US$7.5 billion across 299 deals.

• China is also starting to develop a venture capital industry (CVCA).

• Vietnam is experiencing its first foreign venture capitals, including IDG Venture Vietnam
($100 million) and DFJ Vinacapital ($35 million)

Middle East and North Africa:

The Middle East and North Africa (MENA) venture capital industry is an early stage of
development, but growing. The MENA Private Equity Association Guide to Venture Capital for
entrepreneurs lists VC firms in the region, and other resources available in the MENA VC
ecosystem.

BACKGROUND

A Brief Introduction:

The venture capital industry in India is still at a nascent stage. With a view to promote
innovation, enterprise and conversion of scientific technology and knowledge based ideas into

17
commercial production, it is very important to promote venture capital activity in India. India’s
recent success story in the area of information technology has shown that there is a tremendous
potential for growth of knowledge based industries. This potential is not only confined to
information technology but is equally relevant in several areas such as bio-technology,
pharmaceuticals and drugs, agriculture, food processing, telecommunications, services, etc.
Given the inherent strength by way of its skilled and cost competitive manpower, technology,
research and entrepreneurship, with proper environment and policy support, India can achieve
rapid economic growth and competitive global strength in a sustainable manner.

A flourishing venture capital industry in India will fill the gap between the capital requirements
of technology and knowledge based startup enterprises and funding available from traditional
institutional lenders such as banks. The gap exists because such startups are necessarily based
on intangible assets such as human capital and on a technology-enabled mission, often with the
hope of changing the world. Very often, they use technology developed in university and
government research laboratories that would otherwise not be converted to commercial use.
However, from the viewpoint of a traditional banker, they have neither physical assets nor a low-
risk business plan. Not surprisingly, companies such as Apple, Exodus, Hotmail and Yahoo, to
mention a few of the many successful multinational venture-capital funded companies, initially
failed to get capital as startups when they approached traditional lenders. However, they were
able to obtain finance from independently managed venture capital funds that focus on equity or
equity-linked investments in privately held, high-growth companies. Along with this finance
came smart advice, hand-on management support and other skills that helped the entrepreneurial
vision to be converted to marketable products.

Critical factors for success of venture capital industry:

Some of the factors critical for the success of the VC industry in India are:

(1) The regulatory, tax and legal environment should play an enabling role. Internationally,
venture funds have evolved in an atmosphere of structural flexibility, fiscal neutrality and
operational adaptability.
(2) Resource raising, investment, management and exit should be as simple and flexible as
needed and driven by global trends.
(3) Venture capital should become an institutionalized industry that protects investors and
investee firms, operating in an environment suitable for raising the large amounts of risk
capital needed and for spurring innovation through startup firms in a wide range of high
growth areas.
(4) In view of increasing global integration and mobility of capital it is important that Indian
venture capital funds as well as venture finance enterprises are able to have global
exposure and investment opportunities.
(5) Infrastructure in the form of incubators and R&D need to be promoted using Government
support and private management as has successfully been done by countries such as the
US, Israel and Taiwan. This is necessary for faster conversion of R & D and
technological innovation into commercial products.

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Problem:

Objective of the Study:

Objective of the study is to study venture capital Industry in India. Scientific, technology 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.

Problem:
This report is basically a study of venture capital in India and an effort to find answers to the
following queries:
1) How do venture capitalists structure deals in India?

2) How do venture capitalists find the cost of venture capital in India?

3) How do venture capitalists protect their ownership rights in India?

4) How do venture capitalists make valuations in India?

The research is based on secondary data collected from the published material and various
websites.

METHODOLOGY

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REVIEW OF THE LITERATURE:

Technology and knowledge based ideas will drive the global economy in the 21 st century. India’s
recent success story in the area of information technology has shown that there is a tremendous
potential for the growth of knowledge based industries. This potential is not only confined to
information technology but is equally relevant in several areas such as bio-technology,
pharmaceuticals, media and entertainment, agriculture and food processing, telecommunication
and other services. Given the inherent strength by way of its human capital, technical skills, cost
competitive manpower, research and entrepreneurship, India can unleash a revolution of wealth
creation leading to employment generation and rapid economic growth in a sustainable manner.
What is needed is risk finance and venture capital environment which can leverage innovation,
promote technology and harness knowledge based ideas.

In the absence of an organised venture capital industry, individual investors and development
financial institutions have hitherto played the role of venture capitalists in India. Entrepreneurs
have largely depended upon private placements, public offerings and lending by the financial
institutions. In 1973 a committee on Development of Small and Medium Enterprises highlighted
the need to foster venture capital as a source of funding new entrepreneurs and technology.
Thereafter some public sector funds were set-up 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 Government of India took a
policy initiative and announced guidelines for venture capital funds (VCFs) in India in 1988.
However, these guidelines restricted setting up of VCFs by the banks or the financial institutions
only. Internationally, the trend favoured venture capital being supplied by smaller-scale,
entrepreneurial venture financiers willing to take high risk in the expectation of high returns, a
trend that has continued in this decade.

Thereafter, the Government of India issued guidelines in September 1995 for overseas venture
capital investment in India. For tax-exemption purposes, guidelines were issued by the Central
Board of Direct Taxes (CBDT) and the investments and flow of foreign currency into and out of
India is governed by the Reserve Bank of India (RBI). Further, as a part of its mandate to
regulate and to develop the Indian capital markets, Securities and Exchange Board of India
(SEBI) framed SEBI (Venture Capital Funds) Regulations, 1996.

Pursuant to the regulatory framework mentioned above, some domestic VCFs were
registered with SEBI. Some overseas investment has also come 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” (“The Venture Capital Cycle”, Gompers and Lerner, 1999) is relatively in a nascent
stage in India. Figures from the Indian Venture Capital Association (IVCA) show that, till 1998,
around Rs.30 billion had been committed by domestic VCFs and offshore funds which are
members of IVCA [Not all overseas venture investors and domestic funds are members of the
IVCA.] Figures available from private sources indicate that overall funds committed are around
US$ 1.3 billion. Investible funds are less than 50% of the committed funds and actual

20
investments are lower still. At the same time, due to economic liberalization and increasing
global outlook in India, there is increased awareness and interest of domestic as well as foreign
investors in venture capital. While only 8 domestic VCFs were registered with SEBI during
1996-1998, an additional 13 funds have already been registered in 1999. Institutional interest is
growing and foreign venture investments are also on the increase. Given the proper environment
and policy support, there is tremendous potential for venture capital activity in India.

Industry
VC alleges that the information they breed and the services they provide are as important as
funds infused. Hence monitoring they provide is valuable, which is also associated with some
predictions about the firm. Thus, VCs operate in environments where their relative efficiency in
selecting and monitoring investments gives them a comparative advantage over other investors.
This suggests strong industry effects in venture capital investments (Amit, James and Zott
1998).Venture capitalists should be prominent in industries where informational concerns are
important, such as biotechnology, computer software, etc., rather than in “routine “start-ups such
as restaurants, retail outlets, etc. The latter are risky and require close monitoring. But, VCs still
prefer projects where monitoring and selection costs are relatively low or where the costs of
informational asymmetry are less severe (Amit, James and Zott 1998).

Syndication
Syndication adds value to the portfolio companies (Bygrave, 1987; Brander et al., 1999),
spreading financial value at risk (Sahlman, 1990; Lerner, 1994; Lockett and Wright, 2001),
improved investment decision making (Wilson, 1968; Lerner, 1994), information sharing on
new, potential deals (Bygrave,1987), social structural reasons such as establishment of status
(Podolny, 2001), and window dressing (Lerner, 1994). Chemmanur and Tian (2009) develop a
theoretical rationale for the formation of syndicates in venture capital (VC) financing and
analyze the dynamics of VC interaction subsequent to syndicate formation. They found that
complex projects are likely to get financed by VC syndicates, syndication in various rounds lead
to more successful exits compared to those which switched to single VCs in later rounds.
Additionally VCs forming a part of syndicate backing a successful firm’s are more likely to form
a syndicate backing future projects. Wilson (1968) find that engaging several parties in
investment decision-making may lead to increase in agency cost that tends to make the process
of arriving at the final decision much slower and more cumbersome than if the firm acted on its
own, even though joint decision-making may lead to better investment decisions .

Investment Duration
Cumming and Macintosh 2001, used sample data from US and Canada to confirm the statistical
significance of stage of firm at first investment, capital available to the venture capital industry
on investment duration. Cumming and Johan (2010) formulate a theory of VC investment
duration based on the idea that venture capitalists exit when the expected marginal cost of
maintaining the investment is greater than the expected marginal benefit, and thereby relate VC
investment duration to entrepreneurial firm characteristics, investor characteristics, deal
characteristics, and institutional and market conditions.

Staging

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Sahlman (1990) analyzes the staging decision, how the EF receives each round of financing from
VC firms. Venture capital firms can stage their financing to mitigate information asymmetry and
agency problems (e.g. Neher, 1999; Wang and Zhou, 2004). Gompers 1995 concludes venture
capitalists need to monitor entrepreneurs closely and invest frequently, to learn about the effort
of entrepreneurs and to reduce the agency costs of inefficient continuation. Li (2007) analyzes
the staging decision through real options perspective as a choice between holding the current
option to invest and investing now to obtain the option to invest subsequently. The study
concluded that market uncertainty encourages venture capital firms to delay investing at each
round of financing, whereas competition, project-specific uncertainty and agency concerns
prompt venture capital firms to invest sooner.

Exits
Wang and Sim (2001) conducted an empirical study in Singapore using survey data for the
period 1990- 1998.The study concluded that family owned ,high technology industries tends to
exit via IPO. Moreover IPO exit route is positively related to total amount of venture financing
and total sales while being independent of frequency of finance rounds. These results reveal
immaturity of Asia’s capital market in comparison to west. Giot and Schwienbacher (2007)
examined the time to ‘IPO’, ’Trade sale’ and ’liquidation’ for 6000 VC backed firms covering
more than 20,000 investment rounds. They concluded that as time flows, likelihood of firm
exiting via IPO increases with the time. However after reaching a plateau, non-exited
Investments have fewer possibilities of IPO exits as time increases. This sharply contrasts with
trade-sale exits. The results also indicated that proximity of at least one VC fund makes trade
sales more likely. According to Bienz and leite (2008) ,highly profitable company that need few
insights will go public ,while less profitable company that require more control will be sold in
trade-sale. This is consistent with empirical evidence that IPOs have higher rate of return than
trade sales. Schwienbacher (2001) introduces product characteristics into the analysis with the
aim to identify their effect on the optimal exit decision on the financial market. Going public can
be more profitable than a trade-sale when the product is sufficiently innovative. Cumming and
Johan (2008) investigated a sample of 223 entrepreneurial investee firms financed by 35 venture
capital funds in 11 continental European countries. The results indicates pre-planned acquisition
exits are associated with stronger investor veto and control rights, a greater probability that
convertible securities will be used, and a lower probability that common equity will be used; the
converse is observed for pre-planned IPOs.
According to Arif and Abdulkhadir, firm’s with low investment duration exit through IPO route.
Additionally IPO exit route is positively related to total amount of venture financing, total rounds
and total funds participating.

Dot-com Effect
M B Green (2004) made comparisons between pre-bubble, bubble and post-bubble investment
patterns by state for location, stage and industry of investment. States with large levels of
investment show well-balanced investments across industries, while states with smaller totals do
not. The bubble period was quiet different from pre-dotcom and post-dotcom and had
experienced larger absolute flows of capital, more and larger deals. Brent, David, Michael (2005)
concluded that the survival rate of dot-com start-ups, is 48% and the number of dot-com start-
ups, is approximately 50,000 and Dot-Com Era was a legitimate response to a technology shock.
Indian VC-PE industry

22
I.M. Pandey (1998) investigates the process of developing venture capital in India through
TDICI. In the initial years they face a lot of problems, like in raising funds and evaluating
prospective business. Initially they focused on high-tech industry but later on they shifted to
profitable industry. Later on the firms get flourished and took initiatives to develop VC industry
in India. Rajan (2010) introduced a VC/PE data sample in India for the period 2004-2008 .The
results indicates large proportions are round 1 investment with dramatic decrease in subsequent
rounds. Most of the investment are late stage and characterize by short duration. These factors
don’t favour long-term growth of VC industry in India.

PROBLEM UNDER STUDY:

How do venture capitalists structure deals in India:

Indian Venture Capital and Private Equity Industry

Among developing countries, India has a big role in VC industry. The VC industry started here
in 1964 though it is formally recognized in developed market like the US since 1940s.Pre-
globalization, India was witnessing a very slow growth. But post 1991, India experienced
tremendous growth in the number of deal, total investment, deal size etc. According to Price
Waterhouse Coopers (PWC) Global private Equity report 2008, India was the recipient of
highest PE-VC report investments in Asia –Pacific Region and only behind US and UK
worldwide in 2007.India had moved from 14th rank with a share of only 1.5% in 2004 to 3rd
rank with a share of 7% in total PE-VC investment worldwide in 2007.Inspite of this appealing
action in PE-VC investment arena in India, there are very few studies done in India VC-PE
investments.
From the table below, it can be determined that industry doesn’t have significant influence on all
investment variables except burn rate and round duration. Hence it reflects the immatureness of
Indian VC/PE industry.

Industry Influence and Investment Patterns across Different Exit Strategies

23
Investment Patterns across Exit Strategies

From above table it can be determine that, Exit strategy has a significant influence on investment
duration, time to exit and round duration. Investment duration is significantly higher for M&A
than IPO and IPO firms’ are getting early exit. But the round duration is lower in IPO firm,
which means they are involved with more uncertainty and are raising more and more funds
quickly.
The above sample data consists of Indian data from Venture Intelligence for a period of 2004-
2008.

The above graph shows the growth of private equity and venture capital in India. This data has
been collected from Indian Venture Capital Association.

24
The above graph shows the growth of investments by sector of venture capital in India. This data
has been collected from Indian Venture Capital Association. Among all the sectors IT industry
has seen the most venture capital investments.
As per the trends in 2006, US$7.5bn was invested across 299 deals. IT & ITES retained its status
as the favorite industry among PE investors, followed by manufacturing and real estate. Largest
PE deal was $900M LBO of Flextronics by Kohlberg Kravis Roberts (KKR). M&A and IPO
activity continued to remain strong.

25
As per the above graph, most of investments were made at the late stage.

26
27
Syndication:
Syndication is the process whereby a group of venture capitalists will each put in a portion of the
amount of money needed to finance a small business.

Venture cap firms use deal syndication, a VC jargon for joint investment, as a risk mitigation
strategy while investing in early stage startups. Getting another VC firm to invest in early stage
idea provides a strong second validation.

A snap shot of the top 81 deals made in 2005 show, 18 of them were through syndication
. While this shows that syndication is not new to the Indian sub-continent, a
Venture Capitalists remarked
‘Syndication is still too large a term to use in the Indian context, as growth capital usually is
done independently’ While there are insufficient statistics (as not all deal are announced) to plot
syndication activity, there are adequate deals to provide us insight into the factors that influence
firms to syndicate.

Motives for Syndication In India:

Finance Based Motives:

Lockett & Wright (2001) have found the dominant motive to syndicate between UK firms is
finance based. The same is true of Indian firms. Irrespective of the stage in which they invest, the
finance motive proves to be an important reason to syndicate.
Large firms that invested in late stage reason that the large size of deal in proportion to available
size of funds is an important criterion as is the need to disperse financial risk. Early stage

28
ventures found the need to diversify risk as well as access to additional rounds of financing g as
important. In contrast a large early stage investor did not find additional rounds of financing a
reason to syndicate, owing to size of funds he had access to. An investor who focused on
multilateral investment, but whose funds size is smaller claimed ‘I don’t mind looking at co-
investors if the deal size is too huge’.
This reflects that firms in later stages also look at syndication to access funds over and above the
diversification of risk. This would be in consonance with Lockett & Wright’s (2001) result
where only firms that focused on MBO/MBI investments did not find the deal size pertinent
enough to prompt syndication.

Resource Based Motives

According to Jungwirth and Moog (1994) generalists VCs seek to syndicate in order to gain
resources while specialist funds syndicate to enhance deal flow. In the Indian scenario, VCs who
invest in all stages/ or generalists do want to encash on the resources of other syndicate partners.
While these firms have sufficient managerial expertise they wanted to syndicate with firms that
have technical capabilities. As quoted by an officer in a late stage VC firm ‘Managerial skills…
not as important as the technical expertise’.
Contrary to Jungwirth and Moog (1994) findings, the need for managerial resources or access to
specific skills in order to manage the investment is more important than increase deal flow for
the specialist funds investing in early stage. Firms lay more emphasis on the need for resources
they lacked than increasing deal flow to seek a syndicate partner.

Deal Flow
While the importance of deal flow and the benefits of having a steady flow of business is
acknowledged, venture capitalists do not considered it to be more important than resource based
motive or finance based motive to syndicate deals. The importance of deal flow as a motive can
be understood by the reaction of a venture capitalists ‘Deal per se is not an issue’.
While the research of Lockett &Wright (2001) on the UK venture capital market show that deal-
based motive was more important than the resource-based motive for syndicated out deals, and
the same was found by Manigart et al in (2002a) for France in turns out that in the Indian context
it is not so. This is because of the number of deals available to venture capitalists. A venture
capitalist elaborated this point by highlighting ‘As far as deal flow is concerned there is enough
for all, occasionally we do cross arms’.
Deal-flow takes relevance when competition levels are high (Lockett & Wright, 1999). Given
there are sufficient deals for the firms operating in India currently; the need for deal flow does
not take precedence over resource-based view for syndication. The emerging market is
characterized by an increase in commercially oriented firms there by supplying a string of private
equity opportunities (Wright et al, 2004).

Local & Foreign Firms

The factors that are important for local/domestic firms to syndicate with other local firms and
foreign firms are different. The reason venture capitalists want to syndicate with foreign firms is
for both finance and resource based motives. Co-investment between two or more domestic firms
on the other hand is purely for financial motives. To quote venture capitalists reasons for
choosing a local firm vis-à-vis a foreign firm:
‘Local partner…. it would be purely financial, risk sharing and deal size’.

29
Some venture capital funds are in ‘Rupees’ and some in ‘Dollars’. This also influences the
choice of syndicating out deals to foreign VCs. Foreign firms choose to invest in firms whose
offices are incorporated in the US and have back offices in India. With value driven in the US a
venture capital firm with rupee funding, investing in the back office operations in India would
not prove to be profitable. As a local venture capitalists explained ‘…. Well I can’t invest with
foreign firms it will leave me with bread crumps’.
While most domestic firms in India have foreign currency or mixed currency funds, this problem
is with the smaller venture capital and government affiliated firms. However, the smaller venture
capitalists do not fall under the radar of foreign firms.
The late stage investments in India are dominated with foreign players along with a few strong
domestic players. Foreign firms prove to be ideal syndicate partners for both financial and
resource based reasons. Local firms investing in all stages considered syndicating on the basis of
technical expertise that foreign firms provided over and above the financial reasons.While early
stage ventures considered resources in relation to deal being outside their specialized industry or
outside the stage of investment.
The need to seek secondary approval of either a foreign or domestic player to invest in a deal
was not considered highly important by most venture capitalists.
Access to networks to enhance deal flow were a low motivator when syndicating with domestic
firms was concerned. A venture capitalist reacted by saying ‘I don’t need to look at a domestic
for networking, they are no different from me. Foreign partners have access to people in the US,
which I would typically not have’.
Also the need to syndicate with a foreign player to boost the entrepreneurs business and a need to
access foreign markets were high.

Analysis of Syndication in India:

An analysis of the syndication practices in India reveals that the current economic condition
and internationalisation play a vital role.
A major distinguishing factor between a developed economy and an emerging market economy
on syndication practices, which can be made, is the importance of deal flow as a motivator.
Opportunities for investment are influence by economic cycles. UK data show that syndication
levels increased with the onset of recession (Lockett & Wright, 1999). Deal flow is crucial in
competitive environment as good deals are hard to come by. In the Indian context, as the
environment is not yet highly competitive and given the high level of economic activity, there
are sufficient deals. Therefore, the need to syndicate for the purpose of deal flow is not as
important as it is in the developed countries.
Furthermore, there is difference from earlier findings when the domestic firms are analyzed as
a subgroup of specialists and generalists. While specialist / early stage want to syndicate to
encash on resources like managerial talent, generalists / late stage firms also want to syndicate
on the basis of resources like technical know how. The late stage/ generalist funds according to
Jungwirth and Moog (2004), show that firms want to syndicate for increasing deal flow, which is
not so in the Indian context.
There is no literature on the syndication practices between foreign and local firms in emerging
markets. However, in the case of alliances between foreign firms and local firms in emerging
markets the foreign partner is expected to contribute with finance and technological resources
while a domestic partner contributes to the alliance with local knowledge and networking (De
Mattos et al, 2002). Although, this reflects a pattern in alliances of firms the same pattern is seen

30
in the Indian venture capital industry. Domestic firms find the motives to syndicate with foreign
firms for financial and resource based reasons. But, while syndicating with domestic firms the
reasons are predominantly to disperse risk, as the resources that a local firm would bring, like
networking and geographical knowledge would be a duplication of their current resources.
Internationalization acts as a conduit for transfer of skill sets, it also is a window for domestic
firms to access foreign markets. Given, the high concentration of IT and ITES industry in India,
with an export market aboard, the need to enter foreign markets to enhance value for the
entrepreneur is key. A Venture capitalist accentuated the point by saying ‘He [foreign company]
will help the company scale up fast, if he has a sizable export market, the foreign partner will add
more value than me alone’.
The findings of the non-lead participation in a syndicate are also different from those of
developed market. Non-lead syndicate members in the UK (Lockett & Wright, 1999) tend to
syndicate in such a role for the most part when they have expertise in a particular geography,
sector or stage rather than the lack of it. While the sub-group of foreign and domestic firms exist
in the Indian scenario, the results are also different. The non-lead choose to syndicate with
foreign partners with an intention of gaining exposure to resources as well as their having of
resource. Conversely, to join an Indian syndicate in a non-lead role domestic partners choose to
do so, as there already had expertise in specific areas.
There were similarities in the motives for syndication between developed and emerging markets.
Local companies stressed on the importance of reputation and credibility in the case of partner
selection and there was no relevant difference in the choice between a foreign or domestic
partner. Monitoring of investees in a lead role by either a foreign or domestic firm again did not
bring out any difference.
Some of the reasons that local firms found as a deterrent to syndicate with foreign partners was
their having rupee denominated funds and the existence of centralize control in decision making
for foreign funds. As a venture capitalist said ‘Their approval and consent tends to be centralized
abroad and take too much time in decision making, that we think is a drawback’.
Currently syndication in India is still in a nascent stage. But as the industry develops and the
competitive environment intensifies, there is bound to be an increase in co-invested deals.

31