Various institutions play a vital role in the financial market, particularly in equity-related issues, in addition to banks, brokerage firms, insurance companies, and so on. India’s start-up and venture capital ecosystems continue to thrive as investors adopt a long-term view based on the country’s strong growth potential. Venture capital is an investment made by affluent investors or businessmen in a start-up firm with strong possibilities of expanding, flourishing, and making a big profit. Venture capitalists are investors who make investments in newly established innovative businesses. In exchange for their investment, venture capitalists receive a significant stake in the start-up firm and positions on the board of directors. The VC process is complete when the company is sold, either through a stock market listing or by being merged into/acquired by another firm, or when the start-up fails to perform as projected. The funds raised through exits are subsequently returned to the relevant fund holders, while the surplus is collected as profit by the VC company and the investment cycle is completed.
History of Venture Capital Funds
Venture capital plays an important role in the establishment and growth of innovative businesses in India. Previously, banking organisations provided venture capital investment. These financial institutions encouraged private-sector corporations to use debt as a source of capital. In 1986, the ICICI, an all-India financial institution in the private sector, established a Venture Capital Scheme to encourage emerging experts in the private sector to explore high-risk domains of advanced technology. The government of India recognised the need for venture capital in its seventh five-year plan and long-term fiscal strategy. The Central Government’s issuance of the “Technology Policy Statement” gave venture capital investment formal backing. It outlined criteria for achieving technical self-sufficiency through technology commercialization and exploitation. The strategy sought to allocate funds for giving support in the form of venture capital to economic enterprises that were both risky and profitable. Credit Capital Finance Corporation (CFC) sponsored the first private venture capital fund, Credit Capital Venture Fund, which was pushed by the Bank of India, the Asian Development Bank, and the Commonwealth Development Corporation. IDBI, as nodal agency, manages the venture capital fund established by the Central Government. Under the Research and Development Cess Act of 1986, the government began imposing a fee on all payments made for the purchase of technology from abroad, including royalty payments, lump sum payments for overseas collaboration, and payment for ideas and drawings. The levy was used as a source of funding the venture capital fund.
Registration of Venture Capital Funds
A venture capital fund can be incorporated as a trust under the Indian Trust Act or as a business under the Companies Act of 1956. The regulations authorized for the registration of a business or trust that was either operating as a venture capital fund prior to the enactment of this act or planned to do so after the enactment of this act. If a business or trust that was operating as a venture capital fund prior to the implementation of these regulations does not apply to SEBI for registration within three months of the implementation of the laws, it will cease to operate as a venture capital fund.
The following steps must be taken to register:
i) An application for grant of certificate to be made to SEBI in Form A along with a fee of Rs 25,000. The fee shall be paid through a draft.
ii) There are certain conditions which must be fulfilled before the certificate of registration is granted by SEBI: In the case of a company, the MOA of the company shall have the main object of venture capital fund as its main object, and invitation to public shall be expressly prohibited by the MOA and AOA; additionally, no officer of the company shall be involved in any litigation related to the security market or shall have been convicted of an economic offence.If the trust is in the form of a deed, it has been legally registered under the Indian registration act. The basic goal of a venture capital fund is to do business. Any trustee of the trust is not involved in a security market dispute and has not been convicted of any economic violation.In case of a body corporate, it should be formed under the laws of central or state legislature and it is permitted to venture in the field of venture capital funds.
iii) The registration application must be comprehensive in every way. If SEBI detects anything in the application that makes it incomplete, it will offer the applicant thirty days to close the loophole, after which the application would be rejected by the board.
iv) If SEBI determines that the application is suitable, it shall notify the applicant; upon receipt of the information, the applicant shall surrender to SEBI the registration fee of Rs 5 lacs, upon receipt of which SEBI shall issue the Certificate of registration.
Advantages of Venture Capital Funds
Company Expansion: Venture capital offers a large funding which a company requires to grow their operations. It allows for firm expansion that would not be achievable with bank financing or other means.
Backing the business with expertise: Venture capitalists bring essential skills, guidance, and industry connections. These professionals have extensive understanding of certain industry norms and may assist you in avoiding many of the pitfalls that are commonly connected with startups.
Value Added Services: Venture Capitalists offer HR Consultants that specialize in hiring the best employees for your company. This helps to prevent hiring the unsuitable candidate. It also provides a variety of additional services such as mentorship, partnerships, and departure assistance.
No Repayment Requirement: There is no repayment obligation to investors, as there would be with a bank loan. Rather, investors bear the investment risk because they trust in the company’s future success.
Superior Management: Being an entrepreneur does not automatically imply being a competent company manager. However, because Venture Capitalists own a portion of the company. They will have a say in the management of the company. This is a huge benefit if one is not skilled at operating a firm.
Investment Criteria and Limitations
The information memorandum or placement memorandum of a VC must include its investment strategy, investment purpose, and investment technique. VC investments are subject to various requirements, which include, among other things, the following: The Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004, as modified from time to time, govern VC’s investment in securities of firms incorporated outside India. The amount invested in an investee firm should not exceed 25% of the corpus. The uninvested corpus might be invested in liquid mutual funds, bank deposits, or other liquid assets. Investment in associates is permitted only if 75 percent of VC investors, measured by the value of their investment in the VC, approve the investment.VC funds may invest in units of another VC; VC shall not borrow funds directly or indirectly or engage in any leverage except for meeting temporary funding requirements for no more than thirty days, four times per year, and not more than ten percent of the corpus; At least two-thirds of the corpus shall be invested in unlisted equity shares or equity linked instruments of a venture capital undertaking or in companies listed or proposed to be listed on a Small and Medium Enterprises (“SME”) list.
Disadvantages of Venture Capital Funds
Ownership and control dilution: Venture capitalists invest large sums of money in start-ups in exchange for an interest in the company’s stock. If the start-up is successful, it can help them make a lot of money. VC’s are frequently appointed to the Board of Directors. They take an active role in business decision-making. Venture capitalists will want to safeguard their investments. Things might become chaotic if the Capitalist and the founder of the start-up disagree on almost anything. Any major decision necessitates the approval of investors.
Venture Capital’s Early Redemption: The venture capitalist may elect to repay the investment within 3 to 5 years. Their major goal is to maximize profits. Venture funding may not be appropriate for an entrepreneur whose company strategy will generate liquidity over a longer period of time.
Approaching a VC may be time-consuming: The VC s are overburdened with unwelcome investment possibilities. As a result, many company pitches go overlooked. One method of approaching the VC is through a mutual link.
Prolonged and Complicated Procedure: The proprietor of a new firm should first produce a thorough business strategy. The VC then thoroughly examines the company strategy. The company strategy is then thoroughly discussed in a one-on-one discussion. If the VC decides to proceed with the money, due diligence is performed to check the specifics. Only the VC will give a term sheet if the due diligence is judged to be sufficient.
Large return on investment could be required: Some venture capitalists expect a significant return on investment within three to five years. If the startup requires longer time to create a high ROI, VC may not be the best option since the expectation of a larger return on investment may induce a high degree of stress.
Startup enterprises are critical to the nation’s growth and economic well-being. Venture capital is essential for every startup’s growth. It guarantees that sufficient equity is available for entrepreneurs. Aside from being a significant role in company development and expansion, venture capital investment can have certain negative consequences for startup health. In the form of equity investment and managerial support, venture capitalists give significant assistance to emerging inventive high-potential enterprises. Their long-term objective is to have the startup generate enough revenue so they can withdraw with profits in the end. With this perspective, venture capitalists will seek a stake in the new firm in proportion to their investment. As a result, startups may have very little say in their own firm at times. One widely held belief is that nothing can be completely good or bad. The same is true for venture capital. Despite various shortcomings in venture capital investment, it is strongly encouraged to have venture capital investments to maintain the country’s economic health.