VENTURE CAPITAL

VENTURE CAPITAL FUND (VCF) DEFINED

• A FUND

• ESTABLISHED IN THE FORM OF A COMPANY OR TRUST

• WHICH RAISES MONEY

• THROUGH LOANS, DONATIONS, ISSUE OF SECURITIES OR UNITS AS THE CASE MAY BE

• AND MAKES OR PROPOSES TO MAKE INVESTMENTS

• IN ACCORDANCE WITH REGULATIONS

[SEBI – (VCP) REGULATIONS 1996]

VENTURE CAPITAL DEFINED

• AN EQUITY OR EQUITY FEATURED CAPITAL

• SEEKING INVESTMENT IN

• NEW IDEAS, NEW COMPANIES, NEW PRODUCTION, NEW PROCESS OR NEW SERVICES

• THAT OFFER THE POTENTIAL OF

• HIGH RETURNS ON INVESTMENTS

(INTERNATIONAL FINANCIACE CORP. – IFC)

MEANING

• SOURCE OF LONG TERM FINANCE

• PROVIDED TO SMALL OR MEDIUM SIZED BUSINESS

• PROMOTED BY INDIVIDUALS OR FIRMS

• INVOLVING NEW TECHNOLOGY OR PRODUCTS

• INVESTMENT BY MEANS OF EQUITY FINANCE ON PROJECTS

VENTURE CAPITAL IMPLIES, CAPITAL COMMITTED AS SHAREHOLDINGS FOR THE FORMATION AND SETTING UP OF FIRMS SPECIALISING IN NEW IDEAS OR NEW

TECHNOLOGIES WITH AN ELEMENT OF RISK FOR THE OWNHERS OR SHAREHOLDERS BUT WITH A

POTENTIAL FOR RAPID GROWTH

WHAT ELSE DO VCs PROVIDE?

IN ADDITION TO RISK CAPITAL, VENTURE CAPITALISTS PROVIDE MANAGERIAL, COMMERCIAL, TECHNICAL, FINANCIAL AND ENTREPRENEURIAL SERVICES TO THE FIRM TO ACHIEVE OPTIMUM PERFORMANCE

VENTURE CAPITALISTS INVESTING KNOWLEDGE AND OPERATING EXPERIENCE ARE AS VALUABLE AS THEIR CAPITAL.

ACT AS AN ENGINE OF ECONOMIC GROWTH

CHARACTERISTICS OF VENTURE CAPITAL INVESTMENT

• EQUITY INVESTMENT

• SUBSTANTIAL / MINORITY EQUITY SHARES

• NOT TO “TAKE-OVER MANAGEMENT” BUT TO “SUPPORT THE COMPANY”.

• BOARD POSITION DESIRED BUT NOT MANDATORY

• PASSIVE/ACTIVE INVESTOR

• EXIT IS VERY IMPORTANT – USUALLY 3-5 YEARS

• EARLY STAGE/EXPANSION STAGE/LATER STAGE

IDEAL VENTURE CAPITAL INVESTOR

• EX-INDUSTRY-KNOWLEDGE OF INDUSTRY, OF DEAL STRUCTURING AND OF EXISTS

• INDUSTRY AND VENTURE CAPITAL NETWORK

• ABILITY TO STAY OVER 2 TO 3 ROUNDS

• ASSISTANCE WITH BUSINESS STRATEGY, RECRUITMENT, FUND RAISING, PARTNERING,CUSTOMER CONTACTS AND EXISTS (IPO, M & A) / ACTIVE BOARD PARTICIPATION

VC CONCEPTS: VENTURE CAPITAL VS. DEBT FINANCE

VENTURE FINANCE DEBT FINANCE

OBJECTIVE MAXIMIZE RETURN INTEREST PAYMENT

HOLDING PERIOD 2 – 5 YEARS SHORT/LONG TERM

INSTRUMENTS COMMON SHARES, CONVERTIBLE BONDS, OPTIONS, WARRANTS

LOAN, FACTORING, LEASING

PRICING PRICE EARNINGS RATIO, NET TANGIBLE ASSETS

INTEREST SPREAD

COLLATERAL VERY RARE YES

OWNERSHIP YES NO

CONTROL MINORITY SHAREHOLDERS, RIGHTS PROTECTION, BOARD MEMBERS

COVENANTS

IMPACT ON B/S OF FINANCED

REDUCED LEVERAGE INCREASED LEVERAGE

EXIT MECHANISM PUBLIC OFFERING, SALE TO THIRD PARTY, SALE TO ENTREPRENEUR

LOAN REPAYMENT

VC CONCEPTS: VENTURE CAPITALISTS VS. BANKER

• BANKER IS A MANAGER OF PUBLIC MONEY WHILE THE VENTURE CAPITALIST IS BASICALLY AN INVESTOR

• VENTURE CAPITALIST GENERALLY INVESTS IN NEW VENTURES STARTED BY TECHNOCRATS WHO GENERALLY ARE IN NEED OF ENTREPRENEURIAL AID AND FUNDS.

• VENTURE CAPITALISTS GENERALLY INVEST IN COMPANIES THAT ARE NOT LISTED ON ANY STOCK EXCHANGES. THEY MAKE PROFITS ONLY AFTER THE COMPANY OBTAINS LISTING.

VC CONCEPTS: VENTURE CAPITALISTS VS. BANKER

• THE MOST IMPORTANT DIFFERENCE BETWEEN A VENTURE CAPITALIST AND CONVENTIONAL INVESTORS AND MUTUAL FUNDS IS THAT HE IS A SPECIALIST AND LENDS MANAGEMENT SUPPORT AND ALSO

• FINANCIAL AND STRATEGIC PLANNING

• RECRUITMENT OF KEY PERSONNEL

• OBTAIN BANK AND OTHER DEBT FINANCING

• ACCESS TO INTERNATIONAL MARKETS AND TECHNOLOGY

• INTRODUCTION TO STRATEGIC PARTNERS AND ACQUISITION TARGETS IN THE REGION

• REGIONAL EXPANSION OF MANUFACTURING AND MARKETING OPERATIONS

• OBTAIN A PUBLIC LISTING

WHERE DOES A COMPANY LOOK FOR FUNDS?

• FRIENDS, RELATIVES, ASSOCIATES FAITH MONEY

EQUITY /DEBT NO VALUE-ADD

• ANGELS: EX-ENTREPRENEUR

EQUITY, OPERATIONAL KNOWLEDGE, SEED STAGE

• VENTURE CAPITAL

EQUITY, OPERATIONAL KNOWLEDGE (NOT COMPULSORY), VALUE-ADD, EARLY EXPANSION STAGE

• PRIVATE EQUITY

EQUITY, LARGE AMOUNTS, LATER STAGE/PRE-IPO, NO INDUSTRY VALUE ADD

• BANKS

ASSET BACKED, HIGH FIXED COSTS

VENTURE CAPITAL: STAGES OF FINANCING

SEED MONEY STAGE: SMALL AMOUNT OF FINANCING NEEDED TO PROVE A CONCEPT OR DEVELOP A

PRODUCT. MARKETING IS NOT INCLUDED IN THIS STAGE

START-UP: FINANCING FOR A FIRM THAT STARTED UP IN THE PAST ONE

YEAR. FUNDS ARE LIKELY TO PAY FOR MARKETING AND PRODUCT

DEVELOPMENT

SECOND-ROUND FINANCING: FUNDS EARMARKED FOR WORKING

CAPITAL FOR A FIRM THAT IS SELLING ITS PRODUCT, BUT IS STILL

LOSING MONEY

FIRST-ROUND FINANCING: ADDITIONAL MONEY TO BEGIN SALES AND MANUFACTURING AFTER A FIRM HAS SPENT ITS

START-UP CAPITAL

THIRD-ROUND FINANCING: FINANCING FOR A FIRM THAT IS

BREAKING EVEN AND IS CONTEMPLATING AN EXPANSION

PROJECT

FOURTH-ROUND FINANCING: MONEY PROVIDED FOR FIRMS

THAT ARE LIKELY TO GO PUBLIC SOON. ALSO KNOWN AS BRIDGE

FINANCING

KEY WORDS: PRE-MONEY POST-MONEY SHARE PRICE

VENTURE CAPITAL DEAL

PRE-MONEY

STATE OF AFFAIRS IMMEDIATELY PRIOR TO THE TRANSACTIONPOST-MONEY

STATE OF AFFAIRS IMMEDIATELY AFTER THE TRANSACTION

PRE-MONEY VALUATION = SHARE PRICE*PRE-MONEY SHARES

INVESTMENT = SHARE PRICE*SHARES ISSUED

POST-MONEY SHARES = PRE-MONEY SHARES+SHARES ISSUEDPOST-MONEY VALUATION = PRE-MONEY VALUATION+INVESTMENT FRACTION OWNED = INVESTMENT/POST-MONEY VALUATION = INVESTMENT/PRE-MONEY VALUATION

+ INVESTMENT

VENTURE CAPITAL DEAL EXAMPLE

SAY AN INVESTMENT OF INR 20 CRORE AT INR 30 CRORE “PRE-MONEY VALUATION, MEANS INVESTOR WILL OWN 40 PERCENT OF THE COMPANY AFTER INVESTMENT

FRACTION OWNED = 20/30+20 = 2/5 = 40%

LET’S ASSUME COMPANY HAS 15 LAC SHARES OUTSTANDING PRIOR TO INVESTMENT

THEREFORE, THE PRICE PER SHARE:

SHARE PRICE = PRE-MONEY VALUATION / PRE-MONEY SHARES (IN LACS)

= 3000 / 15 = INR 200.

SHARE ISSUED = INVESTMENT / SHARE PRICE = 2000/200 = 10 LACS

VENTURE CAPITAL

MAJOR POINTS TO REMEMBER IN A VENTURE CAPITAL NEGOTIATION ARE

• IT’S ONLY MONEY

• ONCE THE TERMS ARE AGREED UPON, KEEP YOUR SENSE OF HUMOUR, A DEAL WILL CLOSE

• HIRE A DEAL -MAKING LAWYER OR A CONSULTANT

• LET HIM DO HIS JOB

• SHOW UP AT CLOSING TO COLLECT YOUR CHEQUE (UNLESS FUNDS ARE WIRE TRANSFERRED)

• CASH THE CHEQUE

VENTURE CAPITAL

THINGS TO AVOID THAT COULD KILL THE DEAL

• TURNING THE NEGOTIATION INTO THE PERSONAL COMPETITION WITH THE VENTURE CAPITALISTS (THE EGO FAULT)

• FORGETTING THAT PRICE IS NOT EVERYTHING

• PITTING THE VENTURE CAPITALISTS AGAINST EACH OTHER

• HAVING YOUR BROTHER-IN-LAW, DIVORCE LAWYER, CLOSE THE DEAL

• SHOOTING YOURSELF IN THE FOOT AT A FINAL SHOWDOWN

VENTURE CAPITALIST’S INVESTMENT PHILOSOPHY

INVESTMENT PHILOSOPHY OF FEW SELECTED VENTURE CAPITALISTS

ANDY RACHLEFF OF BENCHMARK CAPITAL

“ WE ARE FOCUSED ON ONE, AND ONLY ONE MISSION: TO HELP TALENTED ENTREPRENEURS BUILD GREAT TECHNOLOGY COMPANIES. THAT’S WHAT DRIVES US AND EVERYTHING WE DO – FROM HOW WE ORGANISE OUR FIRM TO OUR INVESTMENT STARATEGY”.

JOHN DOERR OF KPCB

“ INVEST IN INNOVATIVE COMPANIES WITH A COMPELLING VISION, THAT ARE LIKELY TO BE BIG WINNERS”.

JEFF MOORE OF MOHR DAVIDOW (MDV)

“ INVEST IN COMPANIES CAREFULLY, SELECTING THOSE THAT MATCH UP WELL WITH OUR PARTNER’S OWN KNOWLEDGE AND EXPERIENCES”.

JEFF MOORE OF MOHR DAVIDOW (MDV)

“WE LIMIT THE NUMBER OF COMPANIES THAT WE WILL INVEST IN AS MUCH AS WE ARE COMMITTED TO ADDING VALUE TO EACH AND EVERYONE OF OUR PORTFOLIO COMPANIES PROVIDING THEM THE ATTENTION THEY NEED.

Business plan

• A plan which explains the nature of the proposed venture’s business, what it wants to achieve and how it is going to do it. The plan should include;

• Background of the venture• The details of product/service• Market analysis• Business operations• The management team

Contd.

• Marketing arrangements

• Financial projections

• Sources and uses of financial requirements

• The exit route/opportunities

VC financing - process

• Deal origination- referral system, active search, intermediaries

• Screening- initial investigation• Due diligence- detailed evaluation basically

focusing on techno-economic evaluation, evaluation of the entrepreneur in terms of integrity, long term vision, urge to grow, managerial skills and commercial orientation

VC financing process

• Risk analysis- product risk, market risk, technological risk, entrepreneurial risk, other related risks

• Deal structuring- terms and conditions of the deal, amount, price, protective rights to control, exit route etc.

• Post investment activities- extent of involvement by the VCF

• Exit plan- IPO, Acquisition by other co. purchase by promoter, management buy out etc.

Methods of financing

• Equity- not more than 49%• Conditional loan- no interest on such loans. Repayment in

the form of royalty i.e. certain percentage of sales after generation of sales.

• Income note- it is a combination of conventional and conditional loan. Interest and royalty both are paid at a lower rate.

• Other methods- debentures, convertible loan stock, special ord. shares (voting right without commitment of dividend

•

Pvt. Equity vs. Venture capital

• Risk• Higher hurdle rate• Investment in ongoing business/new

venture• Burden of repayment• Stake/ownership• Pvt. Equity is a broad term which includes

venture capital also.

Role of Angel in VC

• Angels are individuals who are interested in providing finance at the initial stage. They either have the related experience and expertise or the knowledge about the product.

• They actively guide and support the entrepreneurs at different levels.

• The cost of funding is comparatively higher