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Growth Of Venture Capital Financing In India

The purpose of this research paper is to analyse the development and growth of venture capital funds in India. The venture capital industry in India has been in operation in some form since 1973. It is now has successfully emerged for all the business firms that take up risky projects and have high growth prospects. The venture capital investment assist in fostering innovative entrepreneurship in India.

The private organization which does not want to take finance from the society may have their view on venture capital. It has potential to become an important source for financing of small-scale enterprises (SSEs). Venture capital finance is often thought of as 'the early stage financing of new and young enterprises seeking to grow rapidly.

With the increased foreign rivalry, a variety of growth-oriented businesses have venture capital as a solution. Due to the lack of autonomy and lengthy and complex process, venture capital investment is usually made by accredited, high-net worth individuals or other financial institutional investors. This paper focuses on the challenges and opportunities that entrepreneurs face when it comes to venture capital investing.

Introduction
India has emerged as one of the world's fastest developing economies in the 21st century. It is among the most lucrative investment opportunities. India's economic advantage over other emerging countries is due to its large trained people capital and knowledge imprisoned in research laboratories. There should be a type of financing  that connects all available resources for effective exploration and usage.

This relationship is accessible in a variety of forms, including bank loans, private debt, equities, bonds, and so on. However, each has advantages and disadvantages that make them inapplicable in certain situations. Development in a high-growth field needs not just advanced technology and large sums of money, but also the willingness to take significant risks.[1]

It contributes significantly to the life cycle of developing businesses by investing in high-risk, growth-oriented projects. It bridges the gap between high-quality ideas and available funding. Whereas traditional ways of finance, such as bank loans, government subsidies, and so on, are costly and time-consuming for new entrepreneurs, venture capital funds have evolved as a savior, offering required help to cash-strapped creative businesses in return for shares.[2]

"Venture capital funding" can also refer to "initial stage investment by small and emerging enterprises wanting to develop swiftly." It is an investment that will help to encourage creative enterprise in India. It arose as a result of the need to give unconventional, risky financing  to new companies based on creative entrepreneurship.

Venture capital is an investment in new companies promoted by a technically or professionally competent entrepreneur in the form of stock, quasi-equity, and at times debt- direct or conditional. It consists of capital investment, including stock and debt, which entails significant risk and uncertainty.[3]

The venture capital business in India is growing. The slow and arduous evolution of India's integrated venture capital sector has been constrained by resource constraints imposed by the overarching framework of socialistic economic ideologies. While banks and government-owned development finance institutions provided funding for new businesses, it was only available as collateral-based money on a project-financing basis, making it difficult for most new entrepreneurs, particularly those in the technology and services sectors, to raise funds for their ideas and businesses.

Most entrepreneurs had to rely on their own financial capital, as well as that of their family, well-wishers, and private lenders, to accomplish their business dreams. In 1972, the Small and Medium Enterprise Development Commission proposed that venture capital be supported as a form of financing  for emerging entrepreneurs and technology. As a result, during the next decade and a half, various incremental steps will be taken to assist needy technology-based small and medium companies (SMEs) in gaining access to venture capital funding.[4]

Venture Capital Funding

According to section 2(m)[5] of SEBI Venture Capital Funds (VCFs) Regulations, 1996, A Venture Capital Fund means a fund established in the form of a trust/company; including a body corporate, and registered with SEBI which (i) has a dedicated pool of capital raised in a manner specified in the regulations and (ii) invests in venture capital undertakings (VCUs) in accordance with these regulations.

Venture capital funds (VCFs) are investment vehicles that allow individuals to put their money into freshly created start-ups as well as small and medium-sized businesses in exchange for ownership in such businesses. These are investment funds that typically target companies that have the potential to provide significant profits but also carry a high level of risk.[6]

Venture capital is a sort of private equity, which means that investments are not available on the open market.[7] The fund is managed by a venture capital firm, and the investors are usually investment banks, high net worth individuals, and any other financial institutions. [8]

The Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 ("AIF Regulations") govern venture capital funds (VCFs) in India (SEBI). It is a Category I Alternative Investment Fund that operates as a financial intermediary to give finance to small businesses and emerging start-ups with strong development potential. A VCF's investments are largely in unlisted stocks of start-ups or developing or early stage Indian enterprises, limited liability partnerships engaged in new goods, new services, technology, or intellectual property rights-based activities, or a new business model.[9]

Types Of Venture Capital Funding

Venture Capital Funds are classified on the basis of their utilisation at different stages of a business. The 3 main types are early stage financing , expansion financing , and acquisition/buyout financing.[10]
  1. Early Stage financing:
    • Early stage financing has three sub divisions seed financing, start up financing and first stage financing.
    • Seed funding is a small sum of money provided to an individual in order for him or her to be available for a start-up loan.
    • Start up financing is given to companies for the purpose of finishing the development of products and services.
    • Financing for the first stage of a business: who have exhausted all of their initial funds and need funding to continue full-scale operations are the primary beneficiaries of First Stage Financing.
       
  2. Expansion Financing:
    Expansion financing may be categorized into second-stage financing, bridge financing and third stage financing or mezzanine financing.
    • Second-stage financing is provided to companies for the purpose of beginning their expansion. It is also known as mezzanine financing. It is provided for the purpose of assisting a particular company to expand in a major way.
       
    • Bridge financing may be provided as a short-term interest only finance option as well as a form of monetary assistance to companies that employ the Initial Public Offers as a major business strategy.
       
  3. Acquisition or Buyout Financing:
    Acquisition or buyout financing is categorized into acquisition finance and management or leveraged buyout financing. Acquisition financing assists a company to acquire certain parts or an entire company. Management or leveraged buyout financing helps a particular management group to obtain a particular product of another company.[11]

Structure Of Venture Capital Fund

The Structure Of Venture Capital Fund Is As Follows:
Management company:
A management company is a business entity created by a venture firm's general partners (GPs). It's responsible for managing a venture firm's operations across its funds. The management company collects fees and pays expenses. It also typically owns the fund's trademark and brand. Single-member companies, which are most common for new GPs, are treated as "disregarded entities" under U.S. tax code, while multi-member companies are treated as partnerships.[12]

General partner (GP):
The manager of a venture capital fund is called a "general partner" (GP). A GP is responsible for raising money from a network of investors, selecting investments, and overseeing all of the operational, accounting, and legal aspects of the fund. A GP often follows an investment thesis to select investments, targeting a specific segment of the market and/or stage of investment. A general partner has unlimited liability for the partnership.

Limited partners (LPs):
They are passive investors in the fund. Examples of LPs include pension funds, insurance companies, high-net-worth individuals or other financial institutions. The liability of limited partners is capped at the amount of capital the limited partner contributed to the fund. Investors in a venture capital fund are called "limited partners" (LPs).
Portfolio companies. Companies the fund invests in.

Operation Of Venture Capital Fund

Venture capital investments can be classified as early-stage capital, seed capital, or expansion-stage finance based on the maturity of the firm at the time of investment. However, the stage of investment has little bearing on how venture capital firms work.

Funds start with a capital-raising period during which the venture capital company seeks investors for the new fund.[13] Potential investors are provided a prospectus for the fund before committing funds. Following a commitment, the fund's operators contact all possible investors to settle individual investment amounts.

Following that, the venture capital fund seeks private equity investments that have the potential to provide favorable returns for its investors. This procedure entails the fund's manager or managers analyzing hundreds of business plans in search of possibly high-growth enterprises. Fund managers make investment decisions based on the prospectus and the expectations of the investors. Once an investment is placed, the fund will incur an annual management fee of around 2%.

When a venture capital fund's portfolio firm leaves, investors get returns through a merger and acquisition or an IPO. The revenues will subsequently be divided pro rata among the fund's investors. In addition to the yearly management charge, the fund will keep a share of the earnings if the investment is profitable.[14]

Method Of Venture Capital Funding

Funds can be raised from investors in exchange for the following:
  1. Share in equity of the Company:
    In exchange for a share in the equity of the company
     
  2. Participating in Debentures:
    A type of debt instrument that is not backed by any collateral but gives the investor a right to participate in the profit of the company.
     
  3. Conditional Loan:
    These loans do not carry interest and are repayable to the investor in the form of royalty after the company seeking investment starts generating revenue.
     
  4. Income Notes:
    It is a hybrid of both; traditional loans and conditional loans, wherein the entrepreneur will have to pay both royalties and interest at a very minimal rate. [15]

Benefits And Challenges Of Venture Capital Funds

Benefits:
  • Assist in the acquisition of business knowledge:
    One of the key benefits of venture capital is that it assists new entrepreneurs in the acquisition of business skills. Those providing VC have extensive knowledge to assist owners in decision making, particularly in human resource and financial management.
     
  • Business owners are not required to repay:
    Entrepreneurs or business owners are not required to reimburse the invested amount. Even if the business fails, it will not be required to return the loan.
     
  • Assists in the formation of important connections:
    Because of their knowledge and network, VC providers may assist business owners in the formation of valuable connections. This may be really advantageous in terms of marketing and promotion.
     
  • Aids in the raising of additional Capital:
    VC investors strive to inject more capital into a firm in order to increase its valuation. They can do so by bringing in additional investors at a later time. In certain circumstances, the investing company reserves more rounds of money in the future.
     
  • Assists with technology update:
    VC may provide the required capital for small enterprises to upgrade or incorporate new technology, allowing them to remain competitive.[16]

Challenges:
  • Reduction of ownership stake:
    The primary disadvantage of VC is that entrepreneurs give up an ownership stake in their business. Many a time, it may so happen that a company requires additional funding that is higher than the initial estimates. In such situations, the owners may end up losing their majority stake in the company, and with that, the power to make decisions.
     
  • Give rise to a conflict of interest:
    Investors not only hold a controlling stake in a start-up but also a chair among the board members. As a result, conflict of interest may arise between the owners and investors, which can hinder decision making.
     
  • Receiving approval can be time-consuming:
    VC investors will have to conduct due diligence and assess the feasibility of a start-up before going ahead with the investment. This process can be time-consuming as it requires excessive market analysis and financial forecasting, which can delay the funding.
     
  • Availing VC can be challenging:
    Approaching a venture capital firm or investor can be challenging for those who have no network. [17]

Growth Of Venture Capital Financing In India

The present venture capital financing  climate is significantly different. In India, there has been a venture capital business since 1990. It has now effectively developed for all organizations that undertake risky endeavors while yet having tremendous growth possibilities. Bonds, seed capital, and other forms of risk capital are issued as venture capital in India. In 1988, ICICI formed a venture capital fund with the Unit Trust of India. There are already a number of venture capital businesses in India.

Finance institutions, such as ICICI Bank, have entered the industry and established their own venture capital sections. Aside from Indian investors, multinational firms have established themselves in India as a financial institution that invests in huge corporations. International investors are accountable for India's large-scale capital market development. India's economy is thriving, owing to considerable changes in the financial investment structure throughout time.

Previously, India had just commercial banks and a few financial institutes, but with venture capital investment, the country has grown substantially. Businesses are increasingly concentrating on expansion since they can acquire money from venture capital.

The scale and efficiency of business firms in India have grown. With rising overseas competition, venture capital may help a range of growth-oriented enterprises. Businesses in India that deal with computer technology, manufacture products, or provide contemporary facilities are eligible for venture capital investment. While its impact varies by region, the venture capital (VC) business is crucial in encouraging entrepreneurship and innovation.

In India, anybody with a creative company idea with expanding demand, a competent management team, an ambitious business model, and home-run potential can apply for investment capital funding. When they identify a business that satisfies all of the investment requirements, venture capitalists seize the opportunity to fund it in the hopes of generating a significant profit.

Before to the arrival of venture capital, Development Finance Institutions (DFIs) operated similarly to venture capitalists by offering direct equity participation support. The necessity for venture capital became clear in the mid-1980s, when a substantial number of founders burnt their fingers in such enterprises.

The venture capital industry in India originated in the late 1980s, with the Indian government granted legal status to venture capital activities in 1988, and has attracted interest ever since. The first Indian venture capital firm was the Technology Development and Information Company of India Ltd. (TDICI), a 50/50 joint venture between ICICI and UTI.

The funds were managed by TDICI and were registered as the UTI Venture Capital Unit Scheme (VECAUS). After that, the SEBI (Venture Capital Fund) Regulations, 1996, and the SEBI (Foreign Venture Capital Investor) Regulations, 2000, developed the industry's regulatory structure, boosting growth in the business, following the suggestion of the Chandrasekhar committee.

With the passage of time, venture capital has reached to celestial heights. 323 agreements were signed between January and September 2015, bringing $1.4 billion in investment. According to Venture Intelligence, acquisitions in the first nine months of 2015 exceeded the previous year's record high of $1.2 billion (304 agreements). With a host of rules and funding intended for start-ups, the Indian government budget for 2014-15 forecasted the construction of an investor-friendly climate.

Simultaneously, a start-up fund of INR 10,000 crore was established. As a result, everything appeared to be on the upswing, and all of these events appeared to presage a golden period for angel investors and venture capitalists.[18] Currently, in the year 2022, early-stage VC investments in India rose over 28 percent to $1.50 billion from $1.17 billion in 2021.[19]

Examples Of Venture Capital Funding In India

Kohlberg Kravis & Roberts (KKR), one of the world's leading alternative investment asset managers, has agreed to invest USD150 million (Rs 962 crore) in Mumbai-based listed polyester producer JBF Industries Ltd. The company will invest in zero-coupon compulsorily convertible preference shares with 14.5% voting rights in its Singapore-based fully owned subsidiary JBF Global Pte Ltd. KKR money will assist JBF in completing ongoing initiatives. [20]


Pepperfry.com, India's largest furniture e-marketplace has secured USD 100 million in a new round of fundraising spearheaded by Goldman Sachs and Zodius Technology Fund. Pepperfry will utilize the funding to increase its presence in Tier III and Tier IV cities by adding to its increasing fleet of delivery vans. It will also build additional distribution centers and extend its carpentry and assembly service network. This is the greatest volume of investment raised by a sector-focused e-commerce business in India. [21]

Conclusion
Venture capital is a vital source of funding for high-growth startups in India and plays an important role in spurring job creation and economic productivity. It was introduced in India back in 1988, after economic liberalisation. IFC, ICICI, and IDBI were the few organisations that established Venture Capital funds and targeted large corporations. The formalisation of the Indian Venture Capital market started only after 1993.[22]

This paper examines the challenges and opportunities that entrepreneurs face while working with venture capital assets, as well as the importance of venture capital funding in the corporate world. An entrepreneur may benefit from the assistance of a venture capitalist in a number of ways.

The desirability of venture capital funding is largely based on the venture capitalists ability to make managerial contributions to the firm. Long-term funding is not the same as venture capital. A venture capitalist, on the other hand, invests in an entrepreneur's idea, nurtures it for a set period of time, and then exits with the help of an investment banker.

According to the findings, every entrepreneur is ready to approach Venture Capitalists but is unable to complete all of the necessary paperwork. Despite the fact that venture capital is scarce, it is critical to the development of innovative creative ideas.[23] Venture capital financing has become a part of the popular business in India. These Investments are growing at an exponential rate and one who is starting his business can look it as a good option of financing  its venture.

End-Notes:
  1. Komala G., A Paradigim shift in Indian venture capital industry, CORE (Nov. 25, 2022), https://core.ac.uk/download/pdf/72802819.pdf.
  2. Neetika Ahuja & Sweta Sinha, Venture Capital Funds in India, MONDAQ (Nov. 25, 2022), https://www.mondaq.com/india/securities/1079416/venture-capital-funds-in-india.
  3. Akinchan Buddhodev Sinha, Growth and development of Venture Capital financing  in India, ICSI (Nov. 25, 2022), https://www.icsi.edu/media/portals/86/manorama/Venture%20Capital%20SSIM%20BOOK.pdf.
  4. Tapan Kumar Nayak, A Study on the Growth of Venture Capital financing  in India, IGNITED MINDS JOURNALS (Nov. 25, 2022), http://ignited.in/I/a/304322.
  5. SEBI (Venture Capital Funds) Regulations, 1996 () 2(m).
  6. Venture Capital Funds, GROWW (Nov. 25, 2022), https://groww.in/p/venture-capital-funds
  7. What is a Venture Capital Fund ?, ANGELLIST VENTURE (Nov. 25, 2022), https://learn.angellist.com/articles/venture-capital-fund.
  8. Venture Capital Fund, CORPORATE FINANCE INSTITUTE (Nov. 25, 2022), https://corporatefinanceinstitute.com/resources/wealth-management/venture-capital-fund/.
  9. Supra note 2.
  10. Venture Capital Funds , BANKBAZAAR (Nov. 26, 2022), https://www.bankbazaar.com/mutual-fund/venture-capital-funds.html
  11. Venture capital, EDUPRISTINE (Nov. 26, 2022), https://www.edupristine.com/blog/venture-capital.
  12. Supra note 7.
  13. Supra note 8.
  14. Supra note 10.
  15. Diksha Shastri, Understanding various types of venture capital funding, LEGALWIZ (Nov. 26, 2022), https://www.legalwiz.in/blog/understanding-various-types-of-venture-capital-funding.
  16. Supra note 11.
  17. Supra note 6.
  18. Supra note 4.
  19. Amit Pamnani, Early stage startup investment is the new sweet spot for VC investors, LIVEMINT (Nov. 26, 2022), https://www.livemint.com/opinion/online-views/early-stage-startup-investment-is-the-new-sweet-spot-for-vc-investors-11663499652671.html.
  20. Supra note 11.
  21. Id.
  22. Supra note 7.
  23. Supra note 4.

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