Venture Capital Financing

 

INTRODUCTION - Loans Review

This is a new type of financial intermediary, which emerged during the 1970s in the United States. It emerged in the early 1980s in the U.K., in the mid-1980s in Japan and Canada, and around 1987 in India. People now talk of "venture capital industry" or "venture capital market" comprising a large number of Venture Capital Funds (VCFs). The term "venture capital" is evocative and suggestive but vague. It suggests taking risk in supplying capital. However, supply of risk capital may not be the prime function in certain cases. The emphasis will be on supporting technocrats in setting up projects, or on portfolio management. Moreover, every supply of capital involves taking risk.

The term "Venture Capital Funds" is used to represent mutual funds or institutional investors that provide equity finance to unregistered, highly risky, and small private businesses in technology-oriented and knowledge-intensive industries having long development cycles and which do not have access to conventional sources of capital because of the absence of suitable collateral and the presence of high risk. The VCFs play an important role in supplying management and marketing expertise to such units. The list of assisted industries may vary. Electronics, chemicals, plastics, biotechnology, medical care, etc. are the examples. In a nutshell, Venture Capital Funds revolves around high risk, high profitability, high and new technology, and small entrepreneurs.

The question that remains unanswered is whether the VCFs supply any capital/services to existing companies. It would appear that it is so in the U.K. a distinction is made there between venture capital and development capital, the latter being an investment in mature businesses. In the U.S., such distinction is not always made. The VCFs supplies seed capital and development capital for new enterprises, and development capital to established enterprises. Broadly speaking, the scope of activities of VCFs includes provision of

(a) Seed capital for industrial set-ups

(b) Additional capital to new businesses at various stages of their growth

(c) Bridge finance

(d) Equity financing to management groups for taking over other companies

(e) Capital to new entrepreneurs in foreign operations

(f) Capital to mature enterprises for expansion, diversification, and restructuring

The form of investments of VCFs varies from company to company, but they are characterized by substantial control over management decisions, some protection against downside risk, and a share in capital appreciation. VCFs contain a seat on the company’s board of directors. They want to attain high capital gains, by selling the equity invested in the venture, at a later stage. The corporate venture capitalists also aim at other benefits such as access to new technologies and markets.

Though VCFs offer equity capital, the popular vehicle of their investments will be convertible preference share capital. In general, they are less likely to provide debt capital. However, if they provide debt capital, it would be combined with the features of equity such as warrant, convertibility, voting rights, and so on.

Venture capital is a high risk-high return business. The high risk is due to the fact that projects are untested and are undertaken by novices. The targeted long-term returns from venture capital investment are naturally high. It is said that while financing start-ups, common profit targets are "triple the money in three years" or "multiple money seven times in five years" or "earn an annual rate of return of 48 percent"; in second stage of financing, the rate of return of 35 to 40 percent is expected annually, while in third stage financing, the expected rate is 25 percent per annum. Venture capital investment is necessarily a long-term investment. The funds are expected to be tied up for three to ten years.

The suppliers of venture capital fall in these categories:

(a)Subsidiaries of large financial corporations and banks

(b)Private independent specialized firms

(c)Publicly funded small business investment corporations

(d)Subsidiaries or divisions of large manufacturing corporations

Venture Capital Funds business is very new to India. A majority of them belong to financial institutions and banks in the public sector. There are only one or two venture capital funds in the private sector. Some of the important VCFs and their schemes are as follows:

VCF of IDBI

It was started with an initial capital of Rs. 10 crores and is a part of the technology department of the Industrial Development Bank of India. It is meant to aid projects, which promote commercial use of developed technology, or which adapt imported technology for wider applications. It supports high technology, and projects with a maximum cost or Rs. 2.5 crores. Such projects must employ technology that is new and untested in Indian companies. Financial assistance is provided right from the pilot stage and covers upto 90 percent of the total cost, mostly in the form of equity and/or conditional loans, where the return is in the form of royalty on sales, after commercial success. In specific terms, the assistance to the project may vary between Rs. 5 lakhs and Rs. 250 lakhs. It will cover both capital and operating expenditures.

VCFs of UTI

In 1988-89, the Unit Trust of India set up a VCF of Rs. 20 crores in collaboration with the ICICI for fostering industrial development. Technology Development and Information Company of India Ltd. (TDICI) established by the UTI jointly with the ICICI acts as an adviser and manager of the Fund. The UTI launched Venture Capital Unit Scheme to raise resources for this fund. It set up a Second Venture Capital Fund in March 1990 with a capital of Rs. 100 crores, with the objective of financing Greenfield ventures and steering industrial development.

Technology Development and Information Company (TDICI)

It provides support to industries both directly and through venture funds. The TDICI manages two venture capital funds of the UTI. The UTI, ICICI, multi-lateral institutions, Indian banks, and the corporate sector were encouraged to subscribe to the fund.

Risk Capital and Technology Finance Corporation Ltd. (RCTFC)

The IFCI sponsored the Risk Capital Foundation (RCF) in 1985 to give positive encouragement to new entrepreneurs. The RCF was converted into RCTFC on 12 January 1988. It provides both risk capital and technology finance under one roof to innovative entrepreneurs and technocrats for their technology-oriented ventures. Most of the projects it assisted were based on new technology, or new usages of existing technology.

They included manufacture of antibiotic drugs, radio paging systems, pay phones, calcium silicate bricks, polymer concrete, granite and marble processing machinery, and so on.

VCFs of Commercial Banks

Standard Chartered Bank established India's first private sector venture capital fund, namely India Investment Fund with an initial capital of Rs. 10 crores subscribed by NRIs. The Fund provides start-up share capital to new ventures, and to their promoters. It also invests in fresh issues of established companies with a good performance record. The object of the fund is to accomplish huge capital growth for its investors by participating in fast growing companies or high technology companies with potential for high growth.

Amongst the Indian banks, the subsidiaries of SBI and Canara bank provide venture capital funds. They provide equity capital or conditional loans. The projects assisted by them belong to industries such as watches, seamless metal, cement, and ceramics.

Credit Capital Venture Fund (India) Ltd. (CCVF)

It was launched in 1989 and it is the second VCF in the private sector in India. It is a joint venture between Credit Capital Finance Corporation, Asian Development Bank, and Commonwealth Development Corporation of the U.K. Its thrust areas are small export-oriented units and ancillary units. Apart from capital, it provides "hang-on" management support to the projects.

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