CENTRAL UNIVERSITY OF SOUTH BIHAR

SCHOOL OF LAW & GOVERNANCE

Venture Capital: Features, Scope and Importance

UNDER THE SUPERVISION-

Mr. Pradip Kumar Das

Associate Professor

School of Law & Governance

Submitted by-

Arvind Kumar

Enrollment no.-CUSB1813125021

7th semester, B.A.LL.B (Hons.)

1
 CONTENT

S. no. CONTENT PAGE NO.

1 CHAPTER-1 04
INTRODUCTION
2 CHAPTER-2 05-06
CRITICAL FACTORS FOR SUCCESS OF
VENTURE CAPITAL INDUSTRY
3 CHAPTER-3 07-09
FEATURES AND VISION FOR VENTURE CAPITAL
IN INDIA
4 CHAPTER-4 10
MOBILISATION OF GLOBAL AND DOMESTIC
RESOURCE

5 CHAPTER-5 11
FLEXIBILITY IN INVESTMENT AND EXIT

6 CHAPTER-6 12
CONCLUSION
7 CHAPTER – 7 13
BIBLIOGRAPHY
 RESEARCH OBJECTIVES

The term venture capital comprises of two words that is, “Venture” and “capital”. “Venture” is a
course of processing the outcome of which is uncertain but to which is attended the risk or danger of
“Loss”. “Capital” means recourses to start an enterprise. To connote the risk and adventure of such a
fund, the generic name Venture Capital was coined.

RESEARCH QUESTIONS

1) Explain the procedure of establishing venture capital and it is beneficial for an individual?

2) Discuss the necessity and need to focus on establishment of venture capital companies

RESEARCH METHODOLOGY

The research methodology used by me is Doctrinal Research Method. The content is being taken
from books and Internet facilities available for law have been utilized for this project. I have also
followed the steps provided by my subject teacher cum mentor for doing my project work.

RESEARCH HYPOTHESIS

Venture capital is considered as financing of high and new technology based enterprises. It is said
that Venture capital involves investment in new or relatively untried technology, initiated by
relatively new and professionally or technically qualified entrepreneurs with inadequate funds. The
conventional financiers, unlike Venture capitals mainly finance proven technologies and established
markets. However, high technology need not be prerequisite for venture capital.
 CHAPTER-1

INTRODUCTION
The venture capital industry in India is still at a nascent stage. With a view to promote innovation,
enterprise and conversion of scientific technology and knowledge based ideas into commercial
production, it is very important to promote venture capital activity in India. India’s recent success
story in the area of information technology has shown that there is a tremendous potential for growth
of knowledge based industries.1 This potential is not only confined to information technology but is
equally relevant in several areas such as bio-technology, pharmaceuticals and drugs, agriculture,
food processing, telecommunications, services, etc. Given the inherent strength by way of its skilled
and cost competitive manpower, technology, research and entrepreneurship, with proper
environment and policy support, India can achieve rapid economic growth and competitive global
strength in a sustainable manner.

A flourishing venture capital industry in India will fill the gap between the capital requirements of
technology and knowledge based startup enterprises and funding available from traditional
institutional lenders such as banks.2 The gap exists because such startups are necessarily based on
intangible assets such as human capital and on a technology-enabled mission, often with the hope of
changing the world. Very often, they use technology developed in university and government
research laboratories that would otherwise not be converted to commercial use. However, from the
viewpoint of a traditional banker, they have neither physical assets nor a low-risk business plan.
Not surprisingly, companies such as Apple, Exodus, Hotmail and Yahoo, to mention a few of the
many successful multinational venture-capital funded companies, initially failed to get capital as
startups when they approached traditional lenders. However, they were able to obtain finance from
independently managed venture capital funds that focus on equity or equity-linked investments in
privately held, high-growth companies. Along with this finance came smart advice, hand-on
management support and other skills that helped the entrepreneurial vision to be converted to
marketable products.

1
Commissioner of Income Tax vs. Achaldas Dhanraj and Sanklecha Brothers MANU/RH/0106/1995
2
Allied Motors (P.) Ltd. vs. Commissioner of Income Tax, Delhi MANU/SC/0317/1997
 CHAPTER-2

Critical factors for success of venture capital industry: While making the
recommendations the Committee felt that the following factors are critical for the success of the
VC industry in India:

(A) The regulatory, tax and legal environment should play an enabling role. Internationally,
venture funds have evolved in an atmosphere of structural flexibility, fiscal neutrality and
operational adaptability.

(B) Resource raising, investment, management and exit should be as simple and flexible as
needed and driven by global trends

(C) Venture capital should become an institutionalized industry that protects investors and
investee firms, operating in an environment suitable for raising the large amounts of risk capital
needed and for spurring innovation through startup firms in a wide range of high growth areas.

(D) In view of increasing global integration and mobility of capital it is important that Indian
venture capital funds as well as venture finance enterprises are able to have global exposure and
investment opportunities.

(E) Infrastructure in the form of incubators and R&D need to be promoted using Government
support and private management as has successfully been done by countries such as the US,
Israel and Taiwan. This is necessary for faster conversion of R & D and technological innovation
into commercial products.3

Presently there are three set of Regulations dealing with venture capital activity i.e. SEBI (Venture
Capital Regulations) 1996, Guidelines for Overseas Venture Capital Investments issued by
Department of Economic Affairs in the MOF in the year 1995 and CBDT Guidelines for Venture
Capital Companies in 1995 which was modified in 1999. The need is to consolidate and substitute
all these with one single regulation of SEBI to provide for uniformity, hassle free single window
clearance. There is already a pattern available in this regard; the mutual funds have only one set of
regulations and once a mutual fund is registered with SEBI, the tax exemption by CBDT and inflow

3
Kerala State Industrial Development Corpn. Ltd. vs. Commissioner of Income Tax MANU/SC/1244/2002
of funds from abroad is available automatically. Similarly, in the case of FIIs, tax benefits and
foreign inflows/outflows are automatically available once these entities are registered with SEBI.
Therefore, SEBI should be the nodal regulator for VCFs to provide uniform, hassle free, single
window regulatory framework. On the pattern of FIIs, Foreign Ventue Capital Investors (FVCIs)
also need to be registered with SEBI.

In the absence of an organised venture capital industry, individual investors and development
financial institutions have hitherto played the role of venture capitalists in India. Entrepreneurs have
largely depended upon private placements, public offerings and lending by the financial institutions.
In 1973 a committee on Development of Small and Medium Enterprises highlighted the need to
foster venture capital as a source of funding new entrepreneurs and technology. Thereafter some
public sector funds were set-up but the activity of venture capital did not gather momentum as the
thrust was on high-technology projects funded on a purely financial rather than a holistic basis.
Later, a study was undertaken by the World Bank to examine the possibility of developing venture
capital in the private sector, based on which the Government of India took a policy initiative and
announced guidelines for venture capital funds (VCFs) in India in 1988.4 However, these guidelines
restricted setting up of VCFs by the banks or the financial institutions only. Internationally, the
trend favoured venture capital being supplied by smaller-scale, entrepreneurial venture financiers
willing to take high risk in the expectation of high returns, a trend that has continued in this decade.

SEBI initiated interaction with industry participants and experts in early 1999 to identify the key
areas critical for the development of this industry in India. The Finance Minister, in his 1999 budget
speech had announced that “for boosting high-tech sectors and supporting first generation
entrepreneurs, there is an acute need for higher investment in venture capital activities.” He also
announced that the guidelines for registration of venture capital activity with the Central Board of
Direct Taxes would be harmonized with those for registration with the Securities and Exchange
Board of India. SEBI, decided to set up a committee on Venture Capital to identify the impediments
and suggest suitable measures to facilitate the growth of venture capital activity in India. Keeping in
view the need for a global perspective it was decided to associate Indian entrepreneurs from Silicon
Valley in the committee.

4
Soorajmull Nagarmull vs. Commissioner of Income Tax MANU/WB/0213/1991
 CHAPTER-3

FEATURES AND VISION FOR VENTURE CAPITAL IN INDIA

Venture Capital funding is different from traditional sources of financing. Venture capitalists finance
innovation and ideas which have potential for high growth but with inherent uncertainties. This
makes it a high-risk, high return investment. Apart from finance, venture capitalists provide
networking, management and marketing support as well. In the broadest sense, therefore, venture
capital connotes risk finance as well as managerial support. In the global venture capital industry,
investors and investee firms work together closely in an enabling environment that allows
entrepreneurs to focus on value creating ideas and venture capitalists to drive the industry through
ownership of the levers of control in return for the provision of capital, skills, information and
complementary resources. This very blend of risk financing and hand holding of entrepreneurs by
venture capitalists creates an environment particularly suitable for knowledge and technology based
enterprises.5

Scientific, technology and knowledge based ideas properly supported by venture capital can be
propelled into a powerful engine of economic growth and wealth creation in a sustainable manner.
In various developed and developing economies venture capital has played a significant
developmental role. India, along with Israel, Taiwan and the United States, is recognized for its
globally competitive high technology and human capital. The success India has achieved
particularly in software and information technology of success against several odds such as
inadequate infrastructure, expensive hardware, restricted access to foreign resources and limited
domestic demand, is a pointer to the hidden potential it has in the field of knowledge and
technology based industry. India has the second largest English speaking scientific and technical
manpower in the world. Some of the management (IIMs) and technology institutes (IITs) are
globally known as centres of excellence. Every year over 200,000 engineers graduate from
Government and private-run engineering colleges. Many also specialise through diploma courses in
computers and other technical areas. Management institutes produce 40000 management graduates
annually. Given this quality and magnitude of human capital India’s potential to create enterprises
is unlimited.

5
Commissioner of Income Tax vs. M.K. Vaidya MANU/KA/0157/1992
In Silicon Valley, these very Indians have proved their potential and have carved out a prominent
place in terms of wealth creation as well as credibility. There are success stories that are well known.
They were backed by a venture capital environment in Silicon Valley and elsewhere in US which
supports innovation and invention. This also has a powerful grip over the nation’s collective
imagination. At least 30% of the start-up enterprises in Silicon Valley are started/backed by Indians.
Back home also, as per NASSCOM data, the turnover of software sector in India has crossed Rs 100
billion mark during 1998. The sector grew 58% on a year to year basis and exports accounted for Rs
65.3 billion while the domestic market accounted for Rs 35.1 billion. Exports grew by 67% in rupee
terms and 55% in US dollar terms. The strength of software professionals grew by 14% in 1997 and
has crossed 160000. The global software sector is expected to grow at 12% to 15% per annum for
the next 5 to 7 years. With the inherent skills and manpower that India has, software exports will
thrive with an estimated 50% growth per annum. The market capitalisation of the listed software
companies is approximately 25% of the total market capitalisation of around US$ 200 billion as of
December,1999. There is also greater visibility of the Indian companies globally. Given such vast
potential which is not only confined to IT and software but also in several other sectors like
biotechnology, telecommunications, media and entertainment, medical and health etc., venture
capital industry can play a catalyst role in industrial development.6

Thus, venture capital is valuable not just because it makes risk capital available at the early stages of
a project but also because of the expertise of venture capitalist that leads to superior product
development. The big focus of venture capital worldwide is, technology. Thus, in 1999, around $30
bn of venture capital has been invested in the U.S. of which technology firms reportedly got around
75%. Besides this huge supply from organised venture funds there is an even larger pool of “angel”
funds provided by private investors. In 1999, it was expected that angel investment would be of the
order of $90 bn, thus making the total “at-risk” investment in high technology ventures in a single
year of $120 bn. By contrast, in India, cumulative disbursements to date are not more than $500m,
of which technology firms have received only 36%.

India certainly needs a large pool of risk capital both from home and abroad. Examples of US,
Taiwan and Israel clearly show that this can happen provided there is right regulatory, legal, tax and
institutional environment. It is also necessary that start-up’s have access to R&D flowing out of
laboratories and universities with infrastructure support such as telecom, technology parks etc. Steps

6
Cinestaan Entertainment (P) Ltd. vs. Income Tax Officer (27.05.2019 - ITAT Delhi) : MANU/ID/0888/2019
are being taken at the level of Government, Ministry of Information and Technology, and CSIR for
improvement in infrastructure and R&D. Certain NRI organisations are taking initiatives to create a
corpus of US$500m to strengthen the infrastructure of IITs. More focused attempts will be required
in all these directions.

The net FII investment in Indian markets is around US $10 billion and the flows for the last few
years have generally been positive. With enhanced interest in India as compared to some of the
other emerging and Asian markets, given the right environment good amount of money would flow
as venture capital investment. This is more so because India has already acquired credibility
particularly in the area of information technology and sectors like media, pharmaceuticals etc.
While the proportion of offshore to local capital which is around 80% foreign and 20% domestic,
may remain same for the first few years, the recycling of entrepreneurial wealth and skills within the
industry will gradually lead to greater presence of domestic venture capital industry.

With this background India is rightly poised for a big leap. This can happen by creating the right
environment and the mind set to understand global forces and when that happens we would have
created not “Silicon Valley” but the “Ind Valley” a phenomena for the world to watch and reckon
with.

Venture capital provides value addition by managerial support, monitoring and follow up assistance.
It monitors physical and financial progress as well as market development initiative. It helps by
identifying key resource person. They want one seat on the company’s board of directors and
involvement, for better or worse, in the major decision affecting the direction of company. This is a
unique philosophy of “hand on management” where Venture capitalist acts as complementary to the
entrepreneurs. Based upon the experience other companies, a venture capitalist advice the promoters
on project planning, monitoring, financial management, including working capital and public issue.

Venture capital was started as early stage financing of relatively small but rapidly growing
companies. However various reasons forced venture capitalists to be more and more involved in
expansion financing to support the development of existing portfolio companies. With increasing
demand of capital from newer business, venture capitalists began to operate across a broader
spectrum of investment interest. This diversity of opportunities enabled venture capitalists to balance
their activities in term of time involvement, risk acceptance and reward potential, while providing
ongoing assistance to developing business.
 CHAPTER-4

CRITICAL FACTORS FOR SUCCESS OF VENTURE CAPITAL INDUSTRY

Getting it right is what this report is concerned about. The endeavor of the Committee has been
to make recommendations that will facilitate, through an enabling regulatory, legal, tax and
institutional environment, the creation of a pool of risk capital to finance start-up enterprises
with the underlying objective of helping India achieve: a) rapid economic growth and b)
integration with the global economy from a position of strength.

While making the recommendations, the Committee felt that the following factors are critical for
the success of the VC industry in India:

 The regulatory, tax and legal environment should play an enabling role. This also underscores
the facilitating and promotional role of regulation. Internationally, venture funds have evolved
in an atmosphere of structural flexibility, fiscal neutrality and operational adaptability. We need
to provide regulatory simplicity and structural flexibility on the same lines. There is also the
need for a level playing field between domestic and offshore venture capital investors. This has
already been done for the mutual fund industry in India.

 Investment, management and exit should provide flexibility to suit the business requirements
and should also be driven by global trends. Venture capital investments have typically come
from high net worth individuals who have risk taking capacity. Since high risk is involved in
venture financing, venture investors globally seek investment and exit on very flexible terms
which provides them with certain levels of protection. Such exit should be possible through
IPOs and mergers/acquisitions on a global basis and not just within India.

 There is also the need for identifying and increasing the domestic pool of funds for venture
capital investment. In US, apart from high net worth individuals and angel investors, pension
funds, insurance funds, mutual funds etc provide a very big source of money. The share of
corporate funding is also increasing and it was as high as 25.9% in the year 1998 as compared
to 2% in 1995. Corporations are also setting up their own venture capital funds. Similar
avenues need to be identified in India also.
 CHAPTER- 5

FLEXIBILITY IN INVESTMENT AND EXIT

The venture capital fund is a high risk and reward activity. The investments are made by high
networth individuals and institutions to reap high returns. The investor in venture capital funds
does not involve himself in day-to-day management of the fund and the activities of the funds are
managed by professionals. The investor therefore likes to keep their liability limited to the
contribution committed by them to the fund and are not willing to take on any other liability. The
venture capital funds are set up for a limited life and on maturity, the returns are distributed
amongst the investors. The structure of venture capital funds should therefore protect the interest of
investors and the liquidation process should be simple. Limited Partnership (LP), Limited Liability
Partnership (LLP) and the Limited Liability Company (LLC) are commonly used and widely
accepted structures internationally especially in USA which has an active venture capital industry.
These structures limit the liability of investors to the extent of funds committed, at the same time
they can be structured to become pass through vehicles for the purpose of income tax. The legal
structure of LP, LLP and LLC is enclosed as Annexure to the Report.
For venture capital funds which deal in high risk investments structuring flexibility is very important
to meet their business strategies. In India, such structures like LP, LLP and LLC are not recognised
under the Indian Partnership Act and the Indian Companies Act. For development of VC industry in
India on global lines and also to facilitate and attract the foreign investment in venture capital
industry, such alternative structures need to be provided by bringing appropriate changes in
legislation.
SEBI Regulations should be amended to include the eligibility for registration of other entities such
as LP, LLP, LLC, etc. as and when permitted to be incorporated under the respective statutes.
 CHAPTER- 6

CONCLUSION:

Venture capital investment process is different from normal project financing. In order to
understand the investment process a review of the available literature on venture capital finance is
carried out. Tyebjee and Bruno in 1984 gave model of venture capital investment activity with
some variations is commonly used presently.

In generating a deal flow, the VC investor creates a pipeline of deals or investment opportunities
that he would consider for investing in. deal may originate in various ways. Referral system, active
search system, and intermediaries. Referral system is an important source of deals. Deals may be
referred to VCFs by their parent organizations, trade partners, industry associations, friends etc.
Another deal flow is active search through networks, trade fairs, conferences, seminars, foreign
visits etc. intermediaries is used by venture capitalists in developed countries like USA, is certain
intermediaries who match VCFs and the potential entrepreneurs.
Due diligence is the industry jargon for all the activities that are associated with evaluating an
investment proposal. The Venture capitalists evaluate the quality of entrepreneur before appraising
the characteristics of the product, market or technology. Most venture capitalists ask for a business
plan to make an assessment of the possible risk and return on the venture. Business plan contains
detailed information about the proposed venture.
Detailed evaluation: once the preliminary evaluation is over, the proposal is evaluated in greater
detail. VCFs in India expect the entrepreneur to have: - integrity, long-term vision, urge to grow,
managerial skills, commercial orientation. VCFs in India also make the risk analysis of the proposed
projects which includes: product risk, market risk, technological risk and entrepreneurial risk. The
final decision is taken in terms of the expected risk-return trade-off as shown in figure.7
In this process, the venture capitalist and the venture company negotiate the terms of the deals, that
are the amount form and price of the investment. This process is termed as deal structuring. The
agreement also include the venture capitalists right to control the venture company and to change its
management if needed, buyback arrangement specify the entrepreneurs equity share and the
objectives share and the objectives to be achieved.

7
www.thehindubusinessline.com
 CHAPTER-7

BIBLIOGRAPHIES

BOOKS

 Investment Law by Dr. Peter Johnson

 Law of Investment & Securities, 3rd Edition, by Dr. S. R. Myeni

 Singhal’s Investment and Competition Law, by Krishnan Keshav

WEBSITES

 www.Ipblogleader.com
 www.legalserviceindia.com
 www.manupatra.com
 www.caclubindia.com
 www.thehindubusinessline.com