Venture capital and Private Equity in India
Index Sr No 1. Table of contents Structure of the Indian Venture Capital and Private Equity industry Milestones VC & PE – The Indian Experience
- Presentation on VC & PE – The Indian Experience, 2006 by G N Bajpai - Presentation on Indian Investment Funds, 2006, by Andrew Kurth LLC - Presentation on State of Venture Capital in India, 2004, IVCA - Presentation on Regulatory Reforms in Venture Capital, 2007, India Juris - Presentation on India‟s Evolving VC Regulatory Climate, 2001, L K Singhvi
Page Nos 1-3 3–5 5-6
4. 5. 6.
Impact of VC & PE on the Indian Economy Listing on Alternative Investment Markets by Indian Entities Deficiencies and Recommendations for improvements
- Summary of Accessing Early-Stage Risk Capital in India, 2006, Rafiq Dossani - Summary of the Committee Report on Technology Innovation and Venture Capital, 2006, Indian Planning Commission - Is the Venture Capital Market in India getting overheated?, 2006, Alok Aggarwal - Summaries of Lahiri committee and Chandrashekhar committee report
6–7 7 8
Global VC & PE surveys – Where India stands as an investment destination
- Brief on Global Trends in Venture Capital 2006 Survey by Deloitte & Touche USA LLP - Brief on Global Venture Capital Insights Report 2006, Ernst & Young
1. 2. 3.
Appendices Key Regulations Phases of growth in Risk Capital in India India Risk capital investment by Stage, 2003-2005
9 – 12
1. Structure of the Indian Venture capital and Private Equity industry
Registered Funds [link] Registered Venture Capital Funds - 90 Registered Foreign Venture Capital Investors (FVCI) – 80 Unregistered Funds A substantial part of the flow of money for venture undertakings comes from abroad and much of this is channeled through the FIPB route, bye-passing SEBI regulation. In fact venture investing is difficult to distinguish from private equity funds whose activities have been expanding rapidly in recent years. Hence the data on the flow of funds for venture investing vary from source to source. According to the Indian Venture Capital Association Yearbook (2003), investments of $881 million were injected into 80 companies in 2002, and investments of $470 million were injected into 56 companies in 2003 by venture capital funds. (Data to be updated) The firms, which received these investments, were drawn from a wide range of industries, including finance, consumer goods and health. Corporate Structure of Venture Capital Fund (VCF) and Venture Capital Fund Management (VCFM) A Domestic Venture Capital Fund (DVCF) can be organized either as a trust or as a company. There is no restriction on how the FVCI may be organized. A DVCF with overseas and domestic investors is more complex to organize. First, a trust or a company is organized in India. The domestic investors contribute directly to the trust. Overseas investors pool their investments in an offshore vehicle and this offshore vehicle invests in the domestic trust. The offshore vehicle may have its own offshore manager or advisor. This structure enables the domestic manager to draw its share of carry directly from the trust. An alternative structure is for parallel DVCFs and FVCIs to be organized, with the domestic fund manager of the DVCF acting as the investment advisor to the FVCI.
Alternative routes for foreign risk capital providers It is not necessary for foreign investors to register with SEBI. Many prefer not to do so in order to avoid the restrictions discussed above and to retain the corporate structure of the parent firm overseas (typically a limited liability corporation or limited liability partnership, neither of which are permitted in India). Tax pass-through is then achieved by registering the fund in a tax-favored jurisdiction, typically Mauritius. In order to enable the fund to manage investment and divestment over different funds and investee companies (for example, if a portfolio company is listed overseas), most funds create an intermediary holding company in Mauritius. However in order to enjoy capital gains tax exemption under the tax treaty, the Mauritius entity cannot have a permanent establishment (PE) in India. Consequently, usually the investor sets up an advisory company in India to source deals and advise on structuring transactions and monitoring the portfolio. The costs of such a set-up are significant. These include a minimum capitalization of the Indian Advisory entity of US$ 500,000 and the administrative and legal costs of the Mauritius presence. Differences between domestic and foreign funds a. The primary difference is that DVCFs may not hold foreign securities, even shares that it acquires when a domestic portfolio company is acquired by an overseas company and compensation is through an allocation of shares. It is also possible that the domestic company may issue an ADR and GDR before getting itself listed on a domestic stock exchange (although recent RBI guidelines prohibit this). Under these circumstances, the DVCF cannot take advantage of this listing and exit from its investment. To rectify this, the Lahiri Committee on VC Industry had recommended that DVCFs be permitted to 2
invest in foreign securities. SEBI has formulated the regulations for this, which await RBI approval. b. DVCFs cannot invest more than 25% of their corpus of the fund in one VCU, whereas this restriction has been removed from FVCIs. c. DVCFs cannot list their units on any recognized stock exchange for 3 years from the date of the issuance of units. d. DVCFs cannot invest in associate companies. e. The FVCI has to appoint a domestic custodian and open a special non-resident Indian rupee or foreign currency account with a designated bank. SEBI is the nodal agency for all necessary approvals including RBI‟s permission for opening the bank account.
2. Milestones: Private Equity & Venture Capital in India
While the first formal Private Equity and Venture Capital vehicle in India can be traced back to the setting up of the Risk Capital Foundation in 1975, the history of the industry in India is entwined with the liberalization of the country‟s economy – a process which began hesitantly in the 1980s and gained significant momentum in 1991. Pre-1995 Until the mid-1990s, the need for Private Equity was met largely by development finance institutions like IDBI, ICICI and IFCI. 1984: The Industrial Credit and Investment Corporation of India (ICICI) decides to allocate funds for venture capital type activity. 1986: ICICI launches a venture capital scheme to encourage start-up ventures in the private sector in emerging technology sectors. 1988: Technology Development and Information Company of India Ltd. (TDICI) is set up to encourage private sector ventures in emerging technology sectors. (TDICI has since been renamed ICICI Venture Funds). With strong encouragement and financial support from the World Bank, the Government of India announces guidelines for venture capital funds. IFCI-sponsored RCF is converted into the Risk Capital and Technology Finance Corporation of India Ltd. (RCTC). 1989: Regional venture capital fund APIDC Venture Capital (APIDC VCL) is set up in Andhra Pradesh, followed by Gujarat Venture Finance Ltd. (GVFL) in Gujarat. Canbank Venture Capital, sponsored by Canara Bank, is also set up. The first private sector funds come into being. Credit Capital Venture Fund (India) Ltd. is set up by Lazard Credit Capital in association with Asian Development Bank and the
Commonwealth Development Corporation. (ANZ Grindlays – now part of Standard Chartered – had earlier set up India Investment Fund using funds from overseas Indians.) 1995-2000 During this period, several foreign PE/VC firms like Baring Private Equity Partners, CDC Capital, Draper International, HSBC Private Equity and Warburg Pincus enter the country. Firms like ChrysCapital and WestBridge Capital, set up by managers of Indian origin with foreign capital, also make their entry. The venture capital arms of companies like Intel and GE become active in India. The main focus is on Information Technology and Internet related investments. 1995: Overseas investment in venture capital is permitted, along with tax incentives for such investments. VC funds can be floated by firms other than Banks and Financial Institutions. 1996: The Securities and Exchange Board of India (SEBI) issues the SEBI (Venture Capital Funds) Regulations, 1996. Infrastructure Leasing & Financial Services Limited (IL&FS) acquires Credit Capital Venture Fund leading to the creation of what is now IL&FS Investment Managers Limited (IIML). 1999: Small Industries Development Bank of India (SIDBI) sets up SIDBI Venture Capital 2000: Based on the recommendations of the K. B. Chandrasekhar Committee, SEBI amends the 1996 regulations to help fuel the growth of the industry. Mutual fund house Unit Trust of India (UTI) sets up its private equity arm, UTI Venture Funds. 2000-2005 An economic recession in the US and a slowdown in the technology sector result in some foreign PE investors quitting India during 2001-2003. The remaining funds focus largely on later stage and PIPE investments. 2002: Infrastructure Development Finance Company (IDFC) sets up IDFC Private Equity. While successful exits – especially in the Business Process Outsourcing (BPO) sector – bring some cheer, investors clearly prefer late stage companies. 2003: Funds like ICICI Ventures and Actis become active in buyouts. 2004: Investment activity picks up. Six PE-backed companies – including Patni Computer Systems and Biocon - go public successfully.
2005: Investors increasingly focus on non-IT investments including in industries like manufacturing, healthcare and those dependent on domestic consumption. Early stage investments re-emerge on investors‟ radar screens with several Silicon Valley VCs beginning to make direct investments in Indian companies. SEBI allows PE/VC investments in Real Estate. Warburg Pincus‟ $1 billion plus gains from its investment in telecom services firm Bharti Airtel makes the global Private Equity industry sit up and take notice. Highly successful IPOs of PE-backed companies – including that of wind energy firm Suzlon Energy and print media firm HT Media – reinforce India‟s attractiveness as a destination for Private Equity investing.
3. VC & PE – The Indian Experience
Presentation on Venture Capital and Private Equity – Indian Experience, 2006,G N
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Presentation on India Investment Funds, 2006 by Andrew Kurth LLC
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Presentation on State of Venture Capital in India, 2004, IVCA Presentation on Regulatory Reforms in
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Venture Capital, 2007, India
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Presentation on India‟s Evolving VC Regulatory Climate, 2001, L K Singhvi
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Lack of Strong Domestic and Global Networks of Entrepreneurs, Financiers, Large Firms and Research Institutes The academic literature on social networks identifies „social capital‟ as a key requirement for startups to innovate and grow. Such social networks offer information and risk 5
mitigation that is often crucial for startups. In Silicon Valley, for example, it is argued that social capital supports a tolerance for experimentation (and possible failure), provides a network of angel and other risk-tolerant investors, a network of research ideas through linkages with Stanford University and University of California, Berkeley, and opportunities to find the complementary members of a founding team. Silicon Valley‟s success has been attributed to a vibrant network of „weak ties‟, i.e., opportunities for would-be entrepreneurs to interact with financiers, potential co-founders and fellow employees in settings such as meetings of professional associations. On the other hand, strong ties, such as close business associates and friends, have been found to be less useful for entrepreneurship than weak ties because of their overlapping domains of information. India does not have social networks as useful as Silicon Valley‟s or even China‟s. While the India-US (particularly Silicon Valley) corridor is growing, it does not yet match the China-US corridor, thanks in large part to the mediation provided by Taiwanese engineers and capital, which is of longer standing and is even an important source of capital for Silicon Valley startups. China‟s location has made it a focal point for investment by firms in Japan and Korea, apart from Taiwan and Singapore. China‟s dense social networks and manufacturing relationships with engineers, entrepreneurs and risk capital providers in Taiwan, Korea and Japan induces early-stage investment for onward supply to intermediate and final goods producers in East Asia. India, by contrast, does not have multi-country supply-chain relationships with the rest of Asia. As a result, spin-offs from large firms and university research, for example, are rare.
4. Impact of VC & PE on the Indian Economy
Study and Survey by Venture intelligence along with Prof Bubna of ISB on the impact of private equity and venture capital on the Indian Economy, 2006 [link] Summary - The period under study was 2000-2005 and covered 75 publicly listed Private Equitybacked companies - Over the 5 year period considered in the study, on average PE-backed companies grew at a significantly higher rate compared to Non-PE backed companies - Majority of the executives of PE-backed companies interviewed in the survey believed that without Private Equity capital their company would not have existed or would have developed slower. - PE firms are willing to back companies that are focused on larger returns in the long term - Majority of the PE-backed companies surveyed said they utilized the financing to invest in capital expenditure or R&D. - PE backed companies utilize capital to expand their operations internationally and improve their sales in exports markets, thereby generating foreign exchange earnings - Wages at PE backed companies grew at a significantly higher rate compared to their peers which were not PE-backed
- Private Equity catalyses innovation in the economy through investment in R&D. PE backed companies invest more in R&D activities compared to their non-PE backed counterparts - PE-backed companies felt that their private equity investors made far greater contributions than just provision of capital i.e. in the form of strategic direction, financial advice, top management recruitment and marketing - PE reinforces India‟s entrepreneurial spirit. Most PE backed entrepreneurs surveyed said that they self funded or borrowed from family / friends to finance their business before raising PE capital - Concerns raised by PE backed companies on challenges they face in PE funding is Valuations, Excessive due-diligence, Timing of capital availability
5. Listing on Alternative Investment Market (AIM)– London, by Indian entities
Presentation on Listing on AIM by Indian Entities – Legal Considerations, 2006, Luthra
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and Luthra lawyers
In 2006, 10 India-related companies/investment funds raised about $2.6 billion, accounting for 10 per cent of the total $26 billion of capital raised from AIM in that year. Indian Small and medium enterprises (SME) are likely to maintain the tempo on raising of growth capital through the Alternative Investments Market (AIM) in the current year too, a top London Stock Exchange (LSE) official has said. The amount of capital raised by Indian companies ranked second to the UK companies, which together raised the highest in 2006 in value terms. As many as 16 India-related entities have over the last two years listed at the AIM, which is a sub-market of the London Stock Exchange (LSE) and adopts a flexible regulatory approach for smaller growing companies to raise growth capital. Indian companies are keen to list on alternative global stock exchanges such as London's Alternative Investment Market as they seek to boost valuations, sidestep India's regulatory hurdles and avoid stringent US rules. Interest is especially keen among Indian companies from sectors such as real estate, infrastructure, information technology, pharmaceuticals and energy.
6. Deficiencies in the Indian VC and PE industry and Recommendations for improvements
Recent reports 1. Summary of Accessing Early-Stage Risk Capital in India, 2006, Rafiq Dossani
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2. Summary of the Committee Report on Technology Innovation and Venture Capital,
2006, Indian Planning Commission
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3. Is the Venture Capital Market in India getting overheated?, 2006, Alok Aggarwal [link] Summaries of previous committees reports 1. Summary of the Committee Report on Technology Innovation and Venture Capital, 2006, Indian Planning Commission (same as above)
2. Summary of the Lahiri committee report, 2003-04
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3. Summary of the Chandrashekhar committee report, 1999
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7. Global VC surveys – Where India stands as an investment destination
1. Brief on Global Trends in Venture Capital 2006 Survey by Deloitte & Touche USA
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2. Brief on Global Venture Capital Insights Report 2006, Ernst & Young
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Appendices 1. Key Regulations SEBI regulations on Venture capital and Private Equity
The Securities and Exchange Board of India (SEBI) regulates venture capital by both domestic venture capital funds (DVCF) and foreign venture capital investors (FVCIs). SEBI-registration offers benefits subject to certain restrictions. Income is passed through to investors without tax in the case of Trusts registered under the Indian Trusts Act and Venture Capital Companies FVCIs can freely remit funds to India for investments in Indian venture capital undertakings (“VCUs”) and SEBI registered DVCFs. FVCIs are exempt from both the entry and exit pricing regulations that otherwise apply to foreign investors, such as market-related pricing on divestment. The sale of shares by VCFs to company insiders post-listing is exempt from the SEBI takeover code. VCFs automatically obtain Qualified Institutional Buyer (“QIB”) status, which is useful for participating in new security placements. Exemption from one-year lock-in for divestment post-IPO for shares purchased prior to the IPO. VCFs do not get treated as promoters for purposes of IPO.
Sectoral caps for industries as prescribed in the FDI regulations are applicable to FVCIs. The other restrictions common to all VCFs include: at least 66.67% of the investible funds shall be invested in unlisted equity shares or equity linked instruments of VCUs Not more than 33.33% of the investible funds may be invested by way of: subscription to IPO of a VCU whose shares are proposed to be listed or in debt or debt instrument of a VCU in which the VCF has already made an investment by way of equity or in preferential allotment of equity shares of a listed company subject to lock in period of one year SPVs (Special Purpose Vehicles) created for facilitating investments in accordance with SEBI guidelines Minimum capitalization requirement. While there is no minimum corpus requirement for FVCIs, DVCFs require a minimum capital commitment from its investors of INR 5 crore with a minimum of INR 500,000 from individual investors contributing to the VCF. The domestic branches of FVCIs, if established, need to be capitalized with a minimum of $500,000.
2) Phases of Growth of Indian Risk Capital
Phase I Pre-1995 Funds: 30 Phase II 1995-97 125 Phase III 1998-2001 2847 Phase IV 2002-2005 5239 75 Growth Maturity Diversified Overseas Institutional 250 58 3107 288 1882 100 446 11.75
Total ($m) Number of Funds 8 20 50 Primary stages Seed, Early- DevelopmentEarly-stage and and sectors stage and Diversified DevelopmentDevelopment Telecom & IT - Diversified Primary sources World Bank, Government Overseas of Funds Government Institutional Seed / early-stage 5 15 657 ($m) Number of 10 20 273 transactions Development 25 110 2168.1 ($m) Number of 20 45 273 transactions Growth / maturity 21.9 ($m) Number of 2 Transactions Total Number of 30 65 548 Transactions Average 1 2 5.20 Investment ($ m) Source: Accessing early-stage risk capital in India by Rafiq Dossani
The table above shows the decline in early stage funding after the Internet bubble burst in 2001. The few startups that succeeded were „me-too‟ firms that replicated proven business models, thus creating the strategy for funding that predominates to this day. The strategy favors two types of entrepreneurs: i) Those who were earlier executives in successful firms and need capital to replicate the products or services and business models of their previous employers. ii) Those who run closely, profitable firms which need capital to expand or prepare for a public listing.
Risk Capital Investment by Stage, 2003-2005