Venture capital financing

vc financing

1. Venture Capital Financing

2. Venture capital It is defined as equity investment in a growth oriented small/medium business to enable investees to accomplish corporate objectives, in return for minority shareholding in the business or the irrevocable right to acquire it. Venture capital institution/fund- Intermediary between investors looking for returns and entrepreneurs who need institutional capital as they are yet not ready to go to the public.

3. Venture capital Features - Primarily equity finance - Long term investment - Substantial degree of active involvement - High risk return spectrum - Not only technology finance

4. Selection of investment Business plan feasability study track record of owner etc Stages of financing Early stage – Seed capital , Start up , Second round financing Later stage – Mezzanine capital, Bridge/Expansion, Buyouts, Turnaround

5. Selection of investment(stages) Early stage Seed capital /pre start up Applied research phase Entrepreneurial skills match with the market opportunity High risk Marketing related risk

6. Selection of investment(stages) Start up Includes new projects based on technology, knowledge new projects by established companies or a new company Indication about potential market High risk Second round financing Product launched but not profitable large funds Debt and some income

7. Selection of investment(stages) 2. Later stage financing Mezzanine /development capital Require additional finance but cannot resort to public issue Expansion , penetration ,new management etc Bridge/expansion Low risk Acquisition of other firms

8. Selection of investment(stages) Buyout - Management buyout - Management buyins Turnaround - Buying the control of sick company

9. Selection of investment (FA) Financial analysis Various methods include I Conventional Venture Capitalist Valuation Method II The First Chicago Method III The Revenue Multiplier Method

10. Selection of investment (FA) I Conventional Venture Capitalist Valuation Method Two points of time- starting time and exit time Steps Compute the annual revenue at the time of liquidation Compute the expected earnings level Compute the future market valuation of VCU Obtain the PV of VCU PV= Rs 50 lakhs , Fund= Rs 20 lakhs , Ownership= 40%

11. Selection of investment (FA) II The First Chicago Method Considers the entire earning stream Steps Scenarios- Success , Sideway survival, Failure and their probability Find discounted present value under three scenarios PV * Prob Assume PV= Rs 5 cr , Fund= Rs 2.5 cr , Ownership=50%

12. Selection of investment (FA) III The Revenue Multiplier Method M t = (1 +r) n ap (1+d) n V= PV R = annual revenue r= expected growth rate n=expected no of years a= expected profit margin at the time of exit p= expected P/E ratio d= discount rate

13. Selection of investment ( Structuring) Structuring the deal / Financial Instruments Refers to financial instruments through which investment is made. Types Equity Ordinary Non voting Deferred Preferred Equity warrants Preference shares Cumulative convertible pref shares Participating pref shares Cumulative convertible participatory preferred ordinary Convertible cumulative redeemable preference shares

14. Selection of investment ( Structuring) 2. Debt Conditional loan Conventional loan Income notes Non convertible debentures Partly convertible debentures Zero interest bonds Secured Premium notes Deep discount bonds

15. Selection of investment (Aftercare) Investment Nurturing/Aftercare The enduring relationship between VCI and VCU and the active relationship played by the former in the management of latter. Styles Hands on Hands off Hand holding

16. Selection of investment (Aftercare) Hands on Continuous and constant involvement Representation on the board Generally in early stage financing Need experts 2. Hands off Passive role Rarely have nominee directors Business running smoothly

17. Selection of investment (Aftercare) 3. Hands holding Reactive approach Right to nominate Actively participates Objectives Proper utilisation of assistance Implement the project Finding additional finance

18. Selection of investment (Aftercare) Provide strategic inputs Anticipates problem No default Evaluate the perfomance Use the feedback

19. Selection of investment (Aftercare) Techniques Personal discussion Plant visits Feedback through nominee directors Periodic reports Commissioned studies

20. Valuation of Portfolio Two instruments Equity Debt Equity investments Cost method Market value based method

21. Valuation of Portfolio I. Cost method At the historical cost Simple and objective Two values at different times II. Market value based method Quoted MV method - based on market quotations - large holdings

22. Valuation of Portfolio Fair market value method – assets are worth what they can earn - based on risk and future earnings Stages of investment Unquoted venture investments - immature companies - at cost

23. Valuation of Portfolio -written up : third party, better operating results - written down : long term problems , need finance 2. Unquoted development investments - mature companies - based on P/E ratio and dis rate 3. Quoted investments - companies with IPO - restriction on sale of shares

24. Valuation of Portfolio 2. Debt instruments i. Convertible debt Market value method moving averages/weighted average is a better approach MV + fluctuations Underestimation

25. Valuation of Portfolio Fair value method Price in open market Biased ii. Non convertible debt Fixed interest non convertible debt Relate nominal yield to current yield Maturity date, date of valuation ,safety etc

26. Valuation of Portfolio Non interest non convertible debt Discount rate acc to solvency Highly leveraged investments At cost

27. Structural aspects Objectives Limited liability Simple operation Tax transparency Tax exemption for managers Tax benefits for investors

28. Structural aspects Alternative forms Limited partnership Investment company Investment trust Off shore funds Small business investment company

29. Structural aspects Limited partnership - Evolved in USA - General and limited partners - General partners : business identification investment appraisal Negotiation Investment monitoring Exit deals Others

30. Structural aspects Mode of Compensation: annual mgt fee and carried interest Advantages taxed for partners only carried interest Disadvantage: unlimited liability

31. Structural aspects 2 Investment company Limited liability Double taxation 3. Investment trust -no tax on dividend - conditions Income from investment in shares / security Not more than 15% Shares are listed Distribute income

32. Structural aspects 4. Offshore investment company 5. Offshore unit trust 6. Small business investment company - not more than 20% of capital n reserves - No controlling interest - loans for five yrs or so

33. Exit /Disinvestment Depends on number of factors Equity / quasi equity investments Going public Sale to entrepreneurs Trade sale Selling to new investor Liquidation

34. Exit /Disinvestment Going public Advantage : liquidity , higher price, better image Limitations: reporting requirements, disclosures , cost , stock exchange regulations OTCEI route could be opted

35. Exit /Disinvestment 2. Sale to entrepreneur Directly or through employees Exit by put or call option BV method P/E ratio % of Sales method Multiple cash flow method Independent valuation Agreed price

36. Exit /Disinvestment 3. Trade sales Management buyins / buyout alternatives : cash sales of equity shares issue of notes secured by assets in consideration 4. Sales to new investor 5. Liquidation

37. Exit /Disinvestment Debt instruments Normal loan Conditional loan

38. Disadvantages of VC financing Forced management changes Loss of equity stake Decision making ability Delays in funding Entrepreneur will be the last to be paid

39. Venture capital Vs Debt finance Basis Venture Capital Debt Financing Objective Realise 'market' investment returns Regular interest & principal payments Holding Period Long term Short/medium term Instruments Common & preference shares, convertible warrants, options Loans, factoring, installment plans Collateral No Yes

40. Venture capital Vs Debt finance Basis Venture Capital Debt Financing Pricing Earnings multiple Interest spread Impact on Balance Sheet Reduce leverage Increase leverage Impact on Cash-Flow Cash sourced from the market Cash sourced from the borrower Exit Mechanism Listing, buy-back, sale to 3rd parties Loan repayments

41. Angel Investors, VCs and PE Firms Three forms of funding available Angel Investor Retired entrepreneurs Motivated beyond pure money Make bigger and better investment Software ,media, healthcare etc Seed stage

42. Angel Investors, VCs and PE Firms Venture Capitalists Comes after seed funding Highly risk ventures Diverse mix of enterprises and small businesses Capable of turning into $100million company 1-3-6 out of 10 Interest in high tech co.s

43. Angel Investors, VCs and PE Firms PE Firms Raise funds from HNI and institutional investors Few investments but larger in value Support companies for expansion Big firms engage in leveraged buyouts

44. Indian scenario Initiative More than 150 yrs ago – Managing agency houses acted as VC Tata Iron and Steels and Empress Mills were created Investment Corporation of India was formed Abolished managing agency system and Public sector term lending institutions came in

45. Indian scenario 1973- R.S. Bhatt Committee 1986- Research and Development Act 1987- UNDP examined the possibility of developing VC 1988- CCI issued guidelines

46. Indian scenario Guidelines Public Sector FI, SBI and banks to set up VC with min fund of Rs 10 crore : Promoters- Min 40% Foreign equity- upto 25% NRI – upto 74% , 25-40% VCC/ VCF can be set up as a joint venture Managed by professionals Cannot do trading, broking etc

47. Indian scenario Listing according to prescribed conditions A person acting as President, VP etc cannot hold same position VC assistance – Upto 10 crore , new technology ,new promoters ,employing professionals Share pricing at the time of disinvestment

48. Indian scenario Methods of venture financing Equity Conventional loan Conditional loan Income notes At present several VCC are incorporated and they are promoted by All India level institutions or state level financial institutions

49. Indian scenario All India FIs VC division of IDBI Risk Capital and Technology Finance Corporation (RCTC) (Subs of IFCI) State FI Gujarat Venture Finance Ltd. (Promoted by GUC) AP Industrial Development Corporation Venture Capital Ltd

50. Indian scenario Banks Canbank Venture Capital Fund ( Canfina and Canara Bank) SBI Venture Capital Fund Indian Investment Fund ( Grindlays Bank) Private Sector Indus Venture Capital Fund ( Mafatlals and HUL) Credit Capital VF (India) Ltd

51. Indian scenario Present Position 1993-94: 20 VCCs ,350 projects , Rs 250 crore 1996 Set up 17 funds 61% equity investment , 21% convertible instruments and 6% debt Industrial products and machinery > Consumer products > Food processing > Software and aservice sector

52. Indian scenario Year 2000- 13 more VCF Year 2009 – $117 million in six months Year No of VC funds 2002 78 2003 81 2004 86 2005 105 2006 146 2008 160 2011 184

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