How Venture Capitalist Can Be Best Investment for a Startups?: An Indian Policy Analysis.

In a Globalized economy as well as Domestic economy a startup comes up with a unique idea and some enthusiastic team of entrepreneur loaded with skills that could develop and capture can be a multi-million dollar turnover company. To achieve such a heightened aspiration, the newly developed company has a lack of resources for which it requires funding. The Venture Capitals are one that does the support, which can maneuver the growth of the company by providing resources to the new venture. This often comes into the category of a very risky venture which can also be a great success. So, then why does a VC’s dives into such a risky Investment and what do the Policies that are framed for the better regulations and functions of the VC’s performing their task, which has been discussed in here. 

Who are the Venture Capitalists?

In the year of 2018, VC’s has invested billions of dollars into Indian startups, some of the well known VC’s in the market are Sequoia Capital which participated in 34 deals worth $1.81 billion, then Accel’s investments which bagged up three large deals worth of $100 million, then theChiratae Ventures (formerly IDG Ventures India) and the Blue Ventures which also bagged numerous deals in the startup arena. Thus, it consequently shows the impact the startup can get from the VC funds.[1]

In India, both Domestic and Foreign VC’s can have their own method of diversification and investment in a different startup. They both have their advantage and disadvantages, the domestic VC would be limited by their funds and expertise but with little interference by the Government and its regulators whereas the Foreign VC will have large funds and wider expertise but have larger interference from the Government and its Regulators.

The VC’s can be described as ‘Venture Capital Fund’, or as provided under SEBI (Venture Capital Funds) Regulations, 1996 as :

A fund established in the form of a trust or a company including a body corporate and registered under the SEBI regulation which—

  1. has a dedicated pool of capital;
  2. raised in a manner specified in the regulations, and
  3. invests in accordance with the regulations;

The VC’s as per the Regulations are impound to invest known as “Venture Capital Undertaking”. These VC Undertakings means a domestic company which is categorized as :

  1. whose shares are not listed on a recognized stock exchange in India or unlisted entities;
  2. which is engaged in the business for providing services, production or manufacture of an article or things or does not include such activities or sectors which are specified in the negative list by the SEBI Board with the approval of the Central Government by notification in the Official Gazette in this behalf.

For a Foreign VC it has to bind by further regulation in case of VC Undertakings it must be engaged in the business for providing services, production or manufacture of article or things and does not include following activities or sectors:

  1. non-banking financial companies, other than Core Investment Companies (CICs) in the infrastructure sector, Asset Finance Companies (AFCs), and Infrastructure Finance Companies (IFCs) registered with Reserve Bank of India;
  2. gold financing
  3. activities not permitted under the industrial policy of Government of India
  4. any other activity which may be specified by the Board in consultation with Government of India from time to time

The Foreign VCs has been specified into which kind of kinds of the companies it can invest which has been later discussed.

The Indian Policy for Startup

There are two kinds of VC’s as per the policies framed by the Regulators namely a Domestic Venture Capitalist and a Foreign Venture Capitalist. The Domestic Venture Capitalist has this regulation namely:

  • SEBI (Venture Capitalist) Regulations, 1996 framed by the SEBI

The Foreign Venture Capitalist has these Regulations namely:

  • SEBI (Foreign Venture Capitalist) Regulations, 2014
  • RBI’s FEMA (Transfer or Issue of Security by a Person Resident Outside India) Regulations,2017

The Regulators as per the above laws will have following kinds of Regulations upon the functions of a VC

  1. Registration: All Venture Capital Funds whether Domestic or Foreign has to be Registered with the SEBI Board and a certificate of registration has to be acquired by them.

The Domestic VC can be a company or a trust for doing the activities for the function in this regard. The registration of the VC fund will be accepted on the basis of the intent of the business of the VC, the financial health of it if its directors are not convicted of any offense of any moral turpitude or economic offense. In case of Foreign VC the, it must have professional competence, financial soundness, experience, general reputation of fairness and integrity, it must also disclose the nature of its incorporation, its approval from RBI to make foreign Investment.

  • Types of Instruments & Consideration: The VC funds can buy equity or equity-linked instruments only of unlisted entities by both Domestic and Foreign VC, it can only Invest up to 66.67% of its capital into these kinds of Instruments.

They can also invest up to 33.33% of its capital into other Instruments like, debt or debentures of companies where it investment in equity has already been made, preferential allotment of shares for listed companies for a period of lock-in of one year, or subscription to IPOs of VC undertaking whose shares are proposed to be listed.

  • Industry Limitations: The Domestic VC Investor has no industrial limitation in the category of unlisted companies in which they can invest.

Whereas a Foreign VC has been limited by RBI guidelines as per FEMA (Transfer or Issue of Security by a Person Resident Outside of India) Regulation, 2017, the following are the companies in which an FVCI can invest :

  1. Biotechnology
  2. IT related to hardware and software development
  3. Nanotechnology
  4. Seed research and development
  5. Research and development of new chemical entities in the pharmaceutical sector
  6. Dairy industry
  7. Poultry industry
  8. Production of biofuels
  9. Hotel-cum-convention centers with a seating capacity of more than three thousand.
  10. Infrastructure sector. The term ‘Infrastructure Sector’ has the same meaning as given in the Harmonized Master List of Infrastructure sub-sectors approved by Government of India vide Notification F. No. 13/06/2009-INF dated March 27, 2012, as amended/ updated.

Usually, a Share Purchase Agreement and a Share Subscription Agreement is used in the acquisition or investment in the startup.

  • Disclosures: The VC has to maintain books and records of the investment activities for a period of 8 years with them, it is not mandatorily for the VC to file a regular report but it can at anytime call upon the VC fund to file such report with regard to the activities before the Board.       

When & How the VC’s make an exit

After Investment in a startup next is the exit of the VC fund from the company. There are generally three ways for a VC to make an Exit from a startup :

  1. When VC makes a profit: VC funds invest with a profit margin when they invest in a venture. They have an investment period of 5 to 6 years in a company and then they decide to make an exit or to Invest further in a company. This is so because VC also has to pay to its Investors which pooled money into the fund. The startup can also make a buyback to their investor and get full control of the company they have created.
  2. Selling through IPO: The VC when mounting for higher profits they tend to open up the company to the stock markets. This makes the startup for the Big player to buy the shares of the startup if they can create hype in the market to the extent. The VC funds profit heavily by opening up the shares, large institutional investors make their bet in acquiring the company.
  3. In case of a loss by the startup: The startup in case of no growth, require further investment from the VC’s or can go for another round of funding from the market. In that case, the VC can be avoiding the loss can convert its part of shares to other instruments like debt where it can get a regular return as interest. The conversion will be according to the method discussed by the startup and the VC fund manager. In case of foreign VC, it has to obtain regulatory approvals from RBI for the conversion of to debt or debt related instruments.

How Startups are Benefited?

The VCs are a huge advantage for the startups because they hold they provide the most valuable thing that the Founders of the Startup really lack in starting a venture business. So from this aspect some of the advantages to the startup will be :

  1. Ventures Capitalists are specialist in making investments. They are employed with master specialist in making Investment decision that can study the market, look at the revenue and the future growth aspect of the idea on which the startup is built and the team management build by the founders of the startup they can leverage the prospects of the founders and become very helpful for the startup in gaining market expertise from them.
  2. If there is Foreign VC then the startup can have a better capital infusion as compared to other Domestic VC investors. The Investment capital will be hit by the conversion rate and would provide a large infusion of capital for the startup to work with. The Startup will also get recognition in the domestic market for raising funds to form a  Foreign fund and can have better penetration into the market against the other players in the market, it could also capture clients from the other players.

Conclusion

The Indian markets have a boom in the startup industry wherein the metropolitan cities like New Delhi, Mumbai and Bengaluru an average of 1,200 startups are incorporated in the year 2018[2]. The founders of the startup are built on an idea and their active participation in their idea, the VC provides the resource (cash) to immobilize with their idea more efficiently. Though the VC’s have their own expectation of profit from the startup the real prize of growth is benefited to the Startups and the new competitive economic climate they build.


[1] https://yourstory.com/2018/12/investors-sequoia-accel-blume-active

[2] https://economictimes.indiatimes.com/small-biz/startups/newsbuzz/startups-in-india-see-108-growth-in-funding-in-2018-nasscom/articleshow/66365422.cms?from=mdr

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