Venture Capital in Developing Countries: Challenges Nidhi Baijal HPFGD/AP14/2204 Welingker Institute of Management & Research

Venture Capital Venture capital means funds made available for start-up firms and small businesses with exceptional growth potential Venture capital is money provided by professionals who alongside management invest in young rapidly growing companies that have the potential to develop into significant economic contributors

Features of Venture Capital Long time horizon Lack of liquidity High risk High tech Equity participation and capital gains Participation in management

Advantages of Venture Capital They can provide large sum of equity finance Able to bring wealth and expertise to your company Easier to secure future funding from other sources The business is not obligated to repay the money

Disadvantages of Venture Capital Lengthy and complex process (needs detailed business plan, financial projection and Etc.) In the deal negotiation stage, you will have to pay for legal and accounting fees Investors become part owner of your business – founder loss of autonomy or control

Stages and Risk of Financing Financial Stage Period (funds locked in years0 Risk Perception Activity to be financed Seed Money 7-10 Extreme For supporting a concept or idea or R&D for product development Start Up 5-9 Very High Initializing operations or developing prototypes First Stage 3-7 High Start commercial production and Marketing

Stages and Risk of Financing Financial Stage Period (funds locked in years) Risk Perception Activity to be financed Second Stage 3-5 Sufficiently High Expand market and growing capital need Third Stage 1-3 Medium Market expansion, acquisition and product development for profit making company Fourth Stage Low Facilitating public issue

VC Investment Process Exit Plan Post Investment Activity Deal structuring Due Diligence (Evaluation) Screening Deal Origination

Methods of Venture Financing The financing pattern of the deal is most important element. Following are the various methods of venture financing: Equity Conditional loan Income note Participating debentures Quasi equity

Exit Route Initial public offers Trade sale Promoter buy back Acquisition by another company

VC in Developing countries : Challenges Inadequate deal flow for venture capital Shrinking risk appetite of investors and fund managers Lack of global awareness about local start-ups Start-up founders’ mind-set Lack of local success stories and big hits Bureaucratic barriers to entry for foreign investment Inadequate structure/precedence for structuring venture investments Lack of support from government to encourage venture capital Lack of trust in local judicial process for dispute resolution

Comparison of Developed countries and Developing countries Venture Capital firms Activity Developing Countries VC Firms Developed Countries VC Firms Fund Structure Corporation & Limited Partnership Limited Partnership Capital Sources Pension Funds, Corporations, Insurance Companies, High Net Worth Individuals, Government & Non Governmental Organizations Worth Individuals Types of investments: Traditionally Privatizations, Corporate Restructuring, Strategic Alliances, Infrastructure Funds High-technology, Early-stage, High growth firms Types of investments: Recently Indigenous Technology in Developing Countries Trend towards Late-stage

Comparison of Developed countries and Developing countries Venture Capital firms Activity Developing Countries VC Firms Developed Countries VC Firms Deal Origination Low number of attractive investments, Focus on quality of management, Problems of country risk, Corruption, Exchange rate risk Focus on quality of management Deal Structuring Common stock and debt Common stock, several classes of preferred stock, debt and convertible preferred stock Pricing the Deal Difficulty in assessing the value of an investee company – lack of transparency Higher level of transparency Exit Strategy Sale to third parties, co-investors, investee firm’s management Initial public offering (IPO)

Venture Capital Funding in India Promoted by All India Financial Institutions State level Financial Institutions Commercial Banks Private Sector Institutions

Venture Capital Funds in India VCFs in India can be categorized into following five groups Those promoted by the central Government controlled development finance institutions. For example: ICICI Venture funds Ltd. IFCI Venture Capital Funds Ltd. SIDBI Venture Capital Ltd.

2). Those promoted by State Government Controlled Development Financial Institutions. For Example: Punjab InfoTech Venture Fund Gujrat Venture Finance Ltd. 3). Those Promoted by Public Banks SBI Capital Market Ltd.

4). Those Promoted by Private Sector Companies For Example: IL&FS Trust Company Ltd. Infinity Venture India Fund 5). Those established as an Overseas Venture Capital Fund HSBC Private Equity Walden International Investment Group

Rules by SEBI VCFs are regulated by the SEBI (Venture Capital Fund) Regulations, 1996. The following are the various provisions. A venture capital fund may set up by a company or a trust, after a certificate of registration is granted by SEBI on an application made to it. On receipt of the certificate of registration, it shall be binding on the venture capital fund to abide by the provisions of SEBI Act, 1992. A VCF may raise money from any investor Indian, Non-Resident Indian or foreign, provided the money accepted from any investor is not less than Rs. 5 Lakhs. The VCF shall not issue any document or advertising inviting offers from the public for subscription of it’s security or units.

Rules by SEBI SEBI regulations permit investment by venture capital funds in equity or equity related investments of unlisted companies and also in financially week and sick industries whose shares are listed or unlisted At least 80% of the funds should be invested in venture capital companies and no other limits are prescribed SEBI Regulations don’t provide for any sectorial restrictions for investment except investment in companies engaged in financial services.

Challenges of VC in India

Challenges of VC in India Lack of Scientific and Technical Research Inadequate Technology advancement Attraction limited to top cities (Mumbai, Chennai, Pune, Delhi, Hyderabad and Bangalore) Fiduciary duty owed by the directors Capital market related issues Longer Pay back period Uncertainty regarding success of the product in the market The size of the market Major Competitors and their Market Share