Challenges Ahead for Venture Capital Financing in India

Venture Capital is money provided by professionals who invest and manage young rapidly growing companies that have the potential to develop into significant economic contributors. According to SEBI regulations, venture capital fund means a fund established in the form of a company or trust, which raises money through loans, donations, issue of securities or units and makes or proposes, to make investments in accordance with these regulations. The funds so collected are available for investment in potentially highly profitable enterprises at a high risk of loss. A Venture Capitalist is an individual or a company who provides. Investment Capital, Management Expertise, Networking & marketing support while funding and running highly innovative & prospective areas of products as well as services.

Thus, the investments made by Venture Capitalists generally involves

• Financing new and rapidly growing companies.
• Purchasing equity securities.
• Taking higher risk in expectation of higher rewards.
• Having a long frame of time period, generally of more than 5 – 6 years.
• Actively working with the company’s management to devise strategies pertaining to the overall functioning of the project.
• Networking and marketing of the product /service being offered.

In an attempt to bring together highly influential Indians living across the United States, a networking society named IND US Entrepreneurs or TiE was set up in 1992. The aim was to get the Indian community together and to foster entrepreneurs for wealth creation. A core group of 10 – 15 individuals worked hard to establish the organisation. The group (TiE) has now over 600 members with 20 offices spread across the United States. Some of the famous personalities belonging to this group are Vinod Dham (father of the Pentium Chip), Prabhu Goel, K.B. Chandrashekhar (Head of $ 200 mn. Exodus Communications, a fibre optic network carrying 30% of all Internet content traffic hosting websites like Yahoo, Hotmail and Amazon.)

Venture Capital Financing :

It generally involves start up financing to help technically sound, globally competitive and potential projects to compete in the international markets with the high quality and reasonable cost aspects. The growth of South East Asian economies especially Hongkong, Singapore, South Korea, Malaysia along with India has been due to the large pool of Venture Capital funds from domestic / offshore arenas.

Venture Capitalists draw their investment funds from a pool of money raised from public and private investors. These funds are deployed generally as equity capital (ordinary and preference shares) and some times as subordinated debt which is a semi secured investment in the company (through debenture) ranking below the secured lenders that often requires periodic repayment. Today, a VC deal can involve common equity, convertible preferred equity and subordinated debt in different proportions.

The Venture Capital funding varies across the different stages of growth of a firm. The various stages are :

• Pre seed Stage : Here, a relatively small amount of capital is provided to an entrepreneur to conceive and market a potential idea having good future prospects. The funded work also involves product development to some extent.
• Seed Stage : Financing is provided to complete product development and commence initial marketing formalities.
• Early Stage / First Stage : Finance is provided to companies to initiate commercial manufacturing and sales.
• Second Stage : In the Second Stage of Financing working capital is provided for the expansion of the company in terms of growing accounts receivable and inventory.
•  Third Stage : Funds provided for major expansion of a company having increasing sales volume. This stage is met when the firm crosses the break even point.
• Bridge / Mezzanine Financing or Later Stage Financing : Bridge / Mezzanine Financing or Later Stage Financing is financing a company just before its IPO (Initial Public Offer). Often, bridge finance is structured so that it can be repaid, from the proceeds of a public offering.

There are basically four key elements in financing of ventures which are studied in depth by the venture capitalists. These are :

• Management : The strength, expertise & unity of the key people on the board brings significant credibility to the company. The members are to be mature, experienced possessing working knowledge of business and capable of taking potentially high risks.
• Potential for Capital Gain : An above average rate of return of about 30 – 40% is required by venture capitalists. The rate of return also depends upon the stage of the business cycle where funds are being deployed. Earlier the stage, higher is the risk and hence the return.
• Realistic Financial Requirement and Projections : The venture capitalist requires a realistic view about the present health of the organisation as well as future projections regarding scope, nature and performance of the company in terms of scale of operations, operating profit and further costs related to product development through Research & Development.
•  Owner’s Financial Stake : The financial resources owned & committed by the entrepreneur/ owner in the business including the funds invested by family, friends and relatives, play a very important role in increasing the viability of the business. It is an important avenue where the venture capitalist keeps an open eye.

Problems of Venture Capital Financing :

VCF is in its nascent stages in India. The emerging scenario of global competitiveness has put an immense pressure on the industrial sector to improve the quality level with minimisation of cost of products by making use of latest technological skills. The implication is to obtain adequate financing along with the necessary hi-tech equipments to produce an innovative product which can succeed and grow in the present market condition. Unfortunately, our country lacks on both fronts.

The necessary capital can be obtained from the venture capital firms who expect an above average rate of return on the investment. The financing firms expect a sound, experienced, mature and capable management team of the company being financed. Since the innovative project involves a higher risk, there is an expectation of higher returns from the project. The payback period is also generally high (5 – 7 years).