The Hindu Business Line : VC funding: Nothing ventured, nothing gained

Since many innovations and inventions cannot be commercialised due to lack of funds, venture capital finance acts as a strong impetus for entrepreneurs to develop products involving newer technologies and to commercialise them.

VENTURE capital, the new-age finance, is gaining importance in the Indian economy as traditional financial institutions and commercial banks are hamstrung by inadequacy of equity capital, focus on low-risk ventures, conservative approach, and delays in project evaluation.

Venture capital is also often described as "the early stage financing of new and young enterprises seeking to grow rapidly".

It is often the only resort for new and innovative business proposals that are high-risk or tentative in nature, though they have something definite to contribute to the economy.

From the perspective of the venture capitalist venture capital is seen as `you've-got-the-idea, we-have-the-money'.

The main features of venture capital are:

Long-time horizon: In general, venture capital undertakings take a longer time — say, 5-10 years at a minimum — to come out commercially successful; one should, thus, be able to wait patiently for the outcome of the venture.

Lack of liquidity: Since the project is expected to run at start-up stage for several years, liquidity may be a greater problem.

High risk: The risk of the project is associated with management, product and operations.

Unlike other projects, the ones that run under the venture finance may be subject to a higher degree of risk, as their result is uncertain or, at best, probable in nature.

High-tech: Venture capital finance caters largely to the needs of first-generation entrepreneurs who are technocrats, with innovative technological business ideas that have not so far been tapped in the industrial field.

However, a venture capitalist looks not only for high-technology but the innovativeness through which the project can succeed.

Equity participation and capital gains: A venture capitalist invests his money in terms of equity or quasi-equity. He does not look for any dividend or other benefits, but when the project commercially succeeds, then he can enjoy the capital gain which is his main benefit. Otherwise, he will be losing his entire investment.

Participation in management: Unlike the traditional financier or banker, the venture capitalist can provide managerial expertise to entrepreneurs besides money.

Since many innovations and inventions cannot be commercialised due to lack of finance, venture capital finance acts as a strong impetus for entrepreneurs to develop products involving newer technologies and to commercialise them.

Venture capital has also gained in importance as a mechanism for the rehabilitation of sick companies. Moreover, venture capitalists also assist smaller units in upgrading their technology.

The key factors for the success of any project under the consideration of a venture capitalist are:

Clear and objective thinking;

Operational experience, especially in a start-up;

Firm grasp of numbers of numbers;

People management skills;

Ability to spot technology and market trends;

Wide network of contacts;

Knowledge of all facets of business — marketing, Finance and HR;

Judgment to evaluate them on the basis of integrity and ability;

Patience to pursue the final goal;

Drive to guide budding entrepreneurs; and

Empathy with entrepreneurs.

Venture capital in India

The Committee on Development of Small and Medium Entrepreneurs, under the chairmanship of Mr R. S. Bhatt, first highlighted venture capital financing in India in 1972.

In 1975, venture capital financing was introduced in India by the financial institutions with the inauguration of Risk Capital Foundation (RCF), sponsored by IFCI with a view to encouraging technologists and professionals to promote new industries.

In 1976 the seed capital scheme was introduced by IDBI. Till 1984 venture capital took the form of risk capital and seed capital.

In 1986 ICICI launched a venture capital scheme to encourage new technocrats in the private sector in emerging fields of high-risk technology.

In 1986-87 the Government levied a 5 per cent cess on all knowhow payments to create a venture capital fund by IDBI.

ICICI also became a partner of the venture capital industry in the same year. Several venture capital firms are incorporated in India and they are promoted either by financial institutions, such as IDBI, ICICI, IFCI, State-level financial institutions and public sector banks, or promoted by foreign banks/private sector financial institutions such as Indus Venture Capital Fund, Credit Capital Venture Fund, and so on. Hence, the total pool of Indian venture capital today stands over Rs 5,000 crore.

Current trends in the sector

The venture capital sector in India is still at the crossroads and striving hard to take off. In the recent past, many changes have been occurred in the industry. They are:

Capital is pouring into private equity funds;

Average ticket size of VC investment is increasing;

First-generation entrepreneurs are finding it easier to raise funds;

Investors are demanding non-financial value addition;

Most States are setting up regional VC funds;

VC firms are getting professionalised;

Incubation of entrepreneurs is increasing;

VC firms are acquiring specific industry focus; and

Competition is stretching valuations.

The industry can well leap into the high growth trajectory if it is given the necessary boost and the Government and the venture capitalists take the proper measures.

Unless the challenges facing the sector are rightly addressed, VC funding cannot meet with the kind of success it has in the developed countries.

The challenges

Venture capital financing is still not regarded as a commercial activity;

Investors feel they would like to retain control and ensure that the business passes on to someone in their family;

Restricted scope of venture capital in hi-tech projects and for turning R&D into commercial production;

Entrepreneurs' sensitiveness to the mode of divestment; and

Ambiguous government policy towards inter-corporate investment and issue of shares to the entrepreneurs at below par value or in the form of "guest equity".

Role of Government

The success of VC funding ultimately depends on the contributions of both the Government and the venture capitalists, as they have to play significant and pervasive roles in motivating industry to achieve its goals.

In this regard, as part of its responsibility the Government has to strive hard to promote a well-developed and well-functioning capital market, establish OTC markets, boost entrepreneurial spirits, de-regulate sectors such as telecom, ensure low tax rates and abolish capital gains tax, and remove the cultural bias towards ownership in Indian promoters

On the other hand, the venture capitalists have to also play a different role, a more proactive one.

They are not expected to just finance a venture but also see the undertaking's pre- and post-operational functioning.

Moreover, a venture capitalist should provide all possible linkages and support to the entrepreneur for the growth of the enterprise.

In India there is no dearth of creativity, though it is little used. Venture capitalists should provide the entrepreneur moral support in forming the company besides financial and technical support.

Finally, they should play the role of a partner and manager rather than just a financier.

In this era of globalisation, where change plays a dominant role in influencing the fate of industry, the success of any country or organisation depends on its strength in creativity and innovations.

Venture capitalists can create the right enabling environment for such innovation and nurture it with care so that it powers change and dramatic growth in industry.

(The author is Assistant Professor, Department of Business Management, Alluri Institute of Management Sciences, Warangal.)

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