What is Venture Capital?

Venture Capital is pool of investment done by wealthy investors to provide finance to the startup
companies and small business that are believed to have long- term growth potential & rewarding
capital gains. Venture capital generally comes from well-off investors, institutional investors and any
other financial institutions. Venture capital financing is funding provided to companies and
entrepreneurs. It can be provided at different stages of their evolution, although it often involves early
and seed round funding.

 Financial Institution- A financial institution (FI) is a company engaged in the business of dealing
with financial and monetary transactions such as deposits, loans, investments, and currency
exchange. The major categories of financial institutions include central banks, retail and
commercial banks, credit unions, savings, and loans associations, investment banks &
companies, brokerage firms, insurance companies, and mortgage companies. Industrial Finance
Corporation of India (IFCI), Small Industries Development Bank of India(SIDBI)
 An institutional investor buys, sells, and manages stocks, bonds, and other investment securities
on behalf of its clients, customers, members, or shareholders. Mutual funds, and insurance
companies, endowment funds, commercial banks, hedge funds, pension funds, and insurance
companies. For eg – Indian mutual Funds, Indian Insurance Companies, local pension funds

Why do startups raise VC money?

For new companies or ventures that have a limited operating history (under two years), venture
capital is increasingly becoming a popular — even essential — source for raising money, especially if
they lack access to capital markets, bank loans, or other debt instruments. Big name companies like
Apple, Amazon, Facebook, and Google were once venture-backed startups. Unlike car dealerships and
airlines – companies with valuable physical assets and more predictable cash flows – startups typically
have little collateral to offer against a traditional loan. Therefore, if an investor were to issue a loan to
a startup, there’s no way to guarantee that the investors could recoup the amount they’ve lent out if
the startup were to fail. By raising venture capital rather than taking out a loan, startups can raise
money that they are under no obligation to repay. However, the potential cost of accepting that
money is higher – while traditional loans have fixed interest rates, startup equity investors are buying
a percentage of the company from the founders. This means that the founders are giving investors
rights to a percentage of the company profits in perpetuity, which could amount to a lot of money if
they are successful.

What are Venture Capital Firms?

Venture Capital Firms are money management organizations that raise money from various
sources & invest this collective capital into startups. The investment Period for VC Firms is
usually between 3-7 years or more.
Who are venture capitalists?
A venture capitalist (VC) is an investor who supports a young company in the process of expanding or
provides the capital needed for a startup venture. A venture capitalist is willing to invest in such
companies because the potential return on investment (ROI) can be significant if the company is
successful.
What are VC Funds?

VC funds are pools of money, collected from a variety of investors, that a fund manager invests into a
collection of startups and makes competitive returns on those investments. A typical VC firm manages
about $207 million in venture capital per year for its investors. On average, a single fund contains
$135 million. This capital is usually spread between 30-80 startups, though some funds are entirely
invested into a single company, and others are spread between hundreds of startups.

Source: FundersClub.

Venture capital is a subset of private equity (PE).

Private Equity - Private Equity It is a medium to long-term finance provided in return for an equity
stake in potentially high-growth unlisted companies. Institutional and retail investors provide the
capital for private equity, and the capital can be utilized to fund new technology, make acquisitions,
expand working capital, and to bolster and solidify a balance sheet. A private equity fund has Limited
Partners (LP), who typically own 99 percent of shares in a fund and have limited liability, and General
Partners (GP), who own 1 percent of shares and have full liability. The latter are also responsible for
executing and operating the investment.

venture capital tends to focus on emerging companies seeking substantial funds for the first time,
while private equity tends to fund larger, more established companies that are seeking an equity
infusion or a chance for company founders to transfer some of their ownership stakes.

Structure of Venture Capital?

So, we have General Partners and Limited partners within the Venture capital Structure.

The Parties that invest their money in VC funds are known as limited partners (LPs). Generally, LPs are
high net worth individuals, institutional investors,

Breakdown of LP Capital Invested in VC Funds:

 Majority institutional: pension funds, endowment funds, etc. Institutional fund managers will
generally invest some of the capital within VC funds, with the goal of achieving a certain
overall percentage of return (say, 15% increase) each year
 Small percentage from high-net worth individuals: individuals with a net worth of over $1
million in liquid assets who invest their personal wealth in startups or VC(Also known as Angel
Investors).

When it comes to the management of the funds, general partners come into the picture.

 VC firms will typically employ one or many fund managers, or general partners (GPs) to run
their funds. GPs are responsible for making smart investment decisions and maximizing
returns for the LPs who invest in the funds they manage. These investment professionals are
called Venture Capitalists.
 GP responsibilities include: - Raising funds from LPs - Sourcing top startups - Performing due
diligence - Investing fund capital in high-promise startups - Delivering returns back to
 investors in the fund (LPs) - Providing value-add to fund portfolio companies beyond just
capital, including introductions, advice, introductions to follow-on investors, etc

History of VC In India?

1. Setting up TDICI & Regional Funds 1987 -1994

The organized venture capital industry didn’t exist in India till almost 1986. The role of venture
capitalists till then was played by individual investors & development financial institutions.
The idea of venture capital gained momentum after it found mention in the budget of 1986-
1987. In India, the call for Venture Capital was acknowledged in the 7th five year plan and long
term fiscal policy of GOI. Venture Capital financing actually originated in India, in 1988, with the
formation of Technology Development and Information Company of India Ltd. (TDICI) -
promoted by ICICI and UTI. The first private venture capital fund was sponsored by Credit
Capital Finance Corporation (CFC) and promoted by Bank of India, Asian Development Bank and
the Commonwealth Development Corporation viz. Credit Capital Venture Fund
Soon many other funds followed with govt owned banks & financial Institutions as the pioneers
of the Indian venture capital Industry.
2. Entry of foreign Venture Capital Funds 1995-1998
The Govt. of India issued guidelines in September 1995 for overseas investment in VC in India.
For tax-exemption purposes, guidelines were also issued by the Central board of Direct
Taxes(CBDT) & the investments and flow of foreign currency into and out of India was
governed by the RBI requirements.
Further as a part of its mandate to regulate & to develop the Indian Capital Markets, the
Securities and Exchange Board of India (SEBI) framed the SEBI (venture Capital Funds)
Regulations 1996.

These guidelines were further amended in April 2000 with the objective of fuelling the growth of
venture capital activities in India.

SEBI VC Regulations Act

 Important definitions
Associate company- means a company in which a director or trustee or sponsor or settler of the
venture capital fund or asset management company holds either individually or collectively,
equity shares in excess of 15 % of the paid-up equity share capital of venture capital
undertaking;]
Trust - “trust” means a trust established under the Indian Trusts Act, 1882
Unit - 2 [“unit” means beneficial interest of the investors in the scheme or fund floated by trust
or 3 [shares] issued by a company including a body corporate
Equity linked Instruments - “equity linked instruments” includes instruments convertible into
equity shares or share warrants, preference shares, debentures compulsorily 3 [or optionally]
convertible into equity;]
Venture Capital Fund - “venture capital fund” means a fund established in the form of a trust or
a company including a body corporate and registered under these regulation which— (i) has a
 dedicated pool of capital; (ii) raised in a manner specified in the regulations, and (iii) invests 4 [*
* *] in accordance with the regulations;]
Foreign Company- “a foreign company” means a foreign company within the meaning of section
591 of the Companies Act, 1956;
Venture Capital Undertaking- venture capital undertaking” means a domestic company— (i)
whose shares are not listed on a recognized stock exchange in India; (ii) which is engaged in the
business for providing services, production or manufacture of article or things or does not
include such activities or sectors which are specified in the negative list by the Board with the
approval of the Central Government
Investible Funds - “investible funds” means corpus of the fund net of expenditure for
administration and management of the fund;]
 Regulatory Framework
 VC basis on types of Promoters
1. Venture Capital Funds promoted by the Central government controlled development financial
institutions such as TDICI, by ICICI, Risk capital and Technology Finance Corporation Limited
(RCTFC) by the Industrial Finance Corporation of India (IFCI) and Risk Capital Fund by IDBI.
2. It is promoted by the state government-controlled development finance institutions such as
Andhra Pradesh Venture Capital Limited (APVCL) by Andhra Pradesh State Finance Corporation
(APSFC) and Gujarat Venture Finance Company Limited (GVCFL) by Gujarat Industrial Investment
Corporation (GIIC)
3. Also, promoted by Public Sector banks such as Canfina and SBI-Cap.
4. Venture Capital Funds promoted by the foreign banks or private sector companies and
financial institutions such as Indus Venture Fund and Grindlay's India Development Fund[12].

 Registration, Eligibility & Minimum Investment Criteria for a VC funds

Registration : Any company or trust [or a body corporate] proposing to carry on any activity as a
venture capital fund on or after the commencement of these regulations shall make an
application to the Board for grant of a certificate within 3 months from the date of such
commencement.
Eligibility : For Venture Capital Funds it is required that Memorandum of Association or Trust
Deed must have main objective to carry on action of Venture Capital Fund including prohibition
by Memorandum of Association & Article of Association for making an invitation to the public to
subscribe to its securities. Further, it is required that Director or Principal Officer or Employee or
Trustee is not caught up in any litigation connected with the securities market and has not at
any time been convicted of any offence involving moral turpitude or any economic offence. Also,
in case of, body corporate, it must have been set up under Central or State legislations and
applicant has not been refused certificate by SEBI[13].
Minimum Investment Criteria –
A Venture Capital Funds may generate investment from any investor (Indian, Foreign or Non-
resident Indian) by means of issue of units and no Venture Capital Fund shall admit any
investment from any investor which is less than five Lakhs. Employees or principal officer or
directors or trustee of the VCF or the employees of the fund manager or Asset Management
Company (AMC) are only exempted. It is also mandatory that VCF shall have firm commitment
of at least five Crores from the Investors before the start of functions by the VCF. Disclosure of
 investment strategy to SEBI before registration, no investment in associated companies and
duration of the life cycle of the fund is compulsorily being done. It shall not invest more than
twenty five percent of the funds in one Venture Capital Undertaking. Also, minimum 66.67% of
the investible funds shall be utilized in unlisted equity shares or equity linked instruments of
Venture Capital Undertaking.
It is also mandatory that not more than 33.33% of the investible funds may be invested by way
of following as stated below:-
· Subscription to initial public offer of a venture capital undertaking, whose shares are proposed
to be listed.
· Debt or debt instrument of a venture capital undertaking in which the foreign venture capital
investor has already made an investment, by way of equity.
· Preferential allotment of equity shares of a listed company, subject to a lock-in period of one
year.
· The equity shares or equity linked instruments of a financially weak or a sick industrial
company (as explained in the SEBI FVCI Regulations) whose shares are listed.
A foreign venture capital investor may invest its total corpus into one venture capital fund
 Tax Exemptions –
Indian Venture Capital Funds are allowed to tax payback under Section 10(23FB) of the Income
Tax Act, 1961. Any income earned by an SEBI registered Venture Capital Fund (established either
in the form of a trust or a company) set up to raise funds for investment in a Venture Capital
Undertaking is exempt from tax[16].
On the other hand, if the Venture Capital Fund is prepared to forego the tax exemptions
available under Section 10(23F) of the Income Tax Act, it would be within its rights to invest in
any sector[17].