Venture capital refers to investments made in startup companies and small businesses with growth potential. Venture capitalists provide funding to companies in exchange for equity and play an active role in monitoring and advising the companies. The document discusses various aspects of venture capital including the types of investors, stages of financing, activities of venture capitalists like investing, monitoring and exiting investments, and key terms in a term sheet like liquidation preferences and founders' shareholding. It provides an overview of how venture capital works and the roles and considerations of venture capitalists and the companies they fund.

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What is Venture Capitalist/Private Equity?
 Venture capital is a subset of private equity and refers to equity
investments made for the launch, early development, or
expansion of a business
 Among different countries, there are variations in what is meant
by venture capital and private equity
 In Europe, these terms are generally used interchangeably and
venture capital thus includes management buy-outs and buy-ins
(MBO/MBIs).
 This is in contrast to the US, where MBO/MBIs are not classified
as venture capital.

3. Why companies need financing?
For start-ups or growing companies, as well as those facing a major
change, financing is one of the key business issues. New capital is
needed e.g. for
 Financing of product development
 Financing of market penetration
 Financing of investments
 Working capital financing to secure operative continuity
 Maintaining liquidity to be able to cover daily payments

4. Company Life Cycle and Investment Requirements
Incubator
Family Capital/ Bootstrap
R&D
Venture Capital
Start-up Funds
Business Angels
Expansion Capital
MBO/LBO/Expansion
Start-Up Take-off Development Maturity & Sale
Company Life Cycle
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Growth/financing requirements

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Type of Investors
Business Angels
Definition: An angel investor (also known as business angel or informal investor) is
an affluent individual who provides capital for a business start-up. The capital they
provide can be a one-time injection of seed money or ongoing support to carry the
company through difficult times.
Motivations: Dramatic return on investment via exit or liquidity event, • Initial
Public Offering (IPO) of company • Subsequent financing rounds, Interest in
technology and industry
Financial Instrument: Convertible debt & ownership equity.
Risk : Investments are characterized by high level of risk and a potentially large
return on investment
Venture
Capitalists
Definition: An investor/financial institutions which either provides capital to start up
ventures or supports small companies that wish to expand but do not have access
to public funding.
Financial Instrument: equity or quasi –equity instruments, and some times debt
Risk: It typically entails high risk for the investor, but it has the potential for above-average
returns.

6. Types of Venture Capitals
Investment is made by venture capital firms to finance the founding or early
growth of new companies that do not yet have access to the public securities
market or to institutional lenders such as banks or insurance companies
Type of Companies
where investment
is made
Type of Financing
May include equity or quasi –equity instruments, and some times debt—normal
or conditional in exchange for ownership for a predetermined time period. In
particular, the purchase of convertible securities (preferred shares or convertible
debt) by the venture capitalist is the predominant form of investments in many
countries.
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7. Venture Capitalist Overview
Venture Capital is the term applied to investments in new and untried
enterprises that are lacking a stable record growth.
Investment is made by venture capital firms to finance the founding or early
growth of new companies that do not yet have access to the public securities
market or to institutional lenders such as banks or insurance companies
Venture Capitalist
Type of Companies
where investment
is made
Type of Financing
May include equity or quasi –equity instruments, and some times debt—normal
or conditional in exchange for ownership for a predetermined time period. In
particular, the purchase of convertible securities (preferred shares or convertible
debt) by the venture capitalist is the predominant form of investments in many
countries.
Exits
Once any venture reaches the stage of profitability the venture capitalist divests
it investment through available exit routes (buy back, stake sale or an initial
public stock offering) and redeploys the resources in new ventures.
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8. Role of a Venture Capitalist
The Venture capitalists plays the role of a resource manager for business
development. Venture capital business demands skills, attitudes and systems
very different from those of traditional financial intermediaries such as banks
Role
 Funds: Venture capital funds the fill the gap between an entrepreneur's personal resources and
funds that may eventually be raised from traditional credit institutions or public stock offerings.
 Stake: Entrepreneurs give up a percentage of the ownership of their new company, often not more
than 50% , in exchange for acquiring capital. As a result, entrepreneurs avoid interest payments and
can more quickly achieve profitability,
 Co-Promoter: Venture capitalist joins entrepreneur as a co-promoter in projects and share the risks
and rewards of the enterprise with the objective of long-term capital appreciation.
 Fee: The common form of compensation is an annual management fee based on capital committed
and a portion of carried interest.
 Skills Set: Venture capital is not solely an injection of funds into a new firm, it is also an input of the
skills needed to set the firm up, design its marketing strategy, organize and manage its
 Specialized venture capitalists can better understand the industry in which the firm operates and its
technology, through this they can better control the business risk associated with early stage
investing by remaining in close contact with the venture. Further, such specialization aids in the
monitoring process.
 Investment Range: Venture capital invest between 5 lakhs ( for example - Seed funds) to 50 crore
(or larger). This is due to the fact that the characteristics of the venture vary by stage of development
and thus the degree of involvement also differs.
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9. Role of a Venture Capitalist
 Governance : Venture capitalists take an active role in the governance of their portfolio companies
by contributing their business experience and industry knowledge gained from helping other young
companies
 Specific Industry Expertise: Venture Capitalists are typically well connected in the specific industry,
they help to recruit key personnel, they negotiate with suppliers and customers, they advise the
entrepreneur on strategic decisions, play a major role in structuring mergers, acquisitions and initial
public offerings and sometimes are even engaged in the day to day operations of the firm.
 Board Members : Also serves on the Board of the company.
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10. Stages of Financing
Seed Financing
Early Stage Financing
Usually involves a small amount of capital provided to an investor or
entrepreneur to prove a concept
Startup
Financing
Provides funds to companies for use in product development and initial
marketing.
Other Early
stage Financing
Provides funds to companies that have exhausted their initial capital and need
funds to initiate commercial manufacturing and sales
Mezzanine/
Expansion
Financing
Later Stage Financing
Includes working capital for the initial expansion of a company or for manor
growth expansion and financing for a company expecting to go public within six
months to a year.
Management
/Leverage Buyout
Financing
Includes funds to acquire a product line or business from either a public or
private company, utilizing a significant amount of debt and little or no equity
Acquisition
Financing
Provides financing to obtain control , possession or ownership of a private
portfolio company.
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11. Venture Capitalist Activities
Investing – Prospecting for New Opportunities
Stage 1 --- Screening - For every investment made, a VC may screen hundreds of possibilities.
Out of these hundreds, perhaps a few dozen will be worthy of detailed attention, and fewer still
will merit a preliminary offer.
Stage 2 --- Preliminary offers are made with a term sheet, which outlines the proposed valuation,
type of security, and proposed control rights for the investors.
Stage 3 --- Due Diligence - If this term sheet is accepted by the company, then the VC performs
extensive due diligence by analysing every aspect of the company.
Stage 4 --- Final Closing - If the VC is satisfied, then all parties negotiate the final set of terms to
be included in the formal set of contracts to be signed in the final closing.
Investment Stages Selected Proposal at Each
Stage
Screening 100 -1,000
Preliminary Due Diligence 10
Term Sheet 3
Final Due Diligence 2
Closing 1
Key Questions
Does this venture have a large and addressable market? (Market test)
Does the current management have the capabilities to make this business work? (Management
test)
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12. Venture Capitalist Activities
Monitoring
Once an investment is made, the VC begins working with the company through board meetings,
recruiting, and regular advice.
Exiting
VCs are financial intermediaries with a contractual obligation to return capital to their investors.
However, the exit process itself requires knowledge and skills that are somewhat distinct from the
earlier investment and monitoring activities. VCs plan their exit strategies carefully, usually in
consultation with investment bankers.
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13. Flow of funds in the venture capital cycle
Portfolio
companies
Exits: IPO or
sale of portfolio
companies
VC funds
managed by
general
Partners (VCs
or GPs)
Limited partners
(investors or
LPs)
 VC firms are small organizations, averaging
about 10 professionals, who serve as the
general partner (GP) for VC funds.
 A VC fund is a limited partnership with a finite
lifetime (usually 10 years plus optional
extensions of a few years).
 The limited partners (LPs) of VC funds are
mostly institutional investors, such as pension
funds, university endowments, and large
corporations.
 When a fund is first raised, the LPs promise to provide a certain amount of capital,
which will be provided either on a set schedule or at the discretion of the GP.
These periodic capital provisions are known as capital calls, drawdowns, or
takedowns.
 The total amount of capital promised by the LPs over the lifetime of the fund is
called the committed capital of the fund.
 Once the GP has raised the full amount of committed capital and is ready to start
investing, we say that the fund has been closed.
 The typical fund will invest in portfolio companies and draw down capital over its
first five years.
 A successful VC firm will raise a new fund every few years so that there is always
at least one fund in the investment period at all times.
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14. VC Partnership Agreement
 The VC firm serves as the GP of the partnership and is compensated by
management fees .
 This compensation structure creates some differences between the
incentives of the GP and the LPs, and many partnership agreements include
several restrictive covenants to mitigate these differences.
 The expenses of VC investing start immediately: salaries must be paid, the
lights must stay on, and due diligence must be performed.
 The typical arrangement is for limited partners to start paying a set
percentage of committed capital every year, most commonly 2.0 percent.
Sometimes this fee remains constant or the full 10-year life of the fund, but in
most cases the fee drops somewhat after the five-year investment period is
over
Management
Fee
Carried Interest
 The other form of VC compensation is the carried interest, often referred to
simply as the carry. Carried interest enables GPs to participate in the profits
of the fund, and historically it has provided the largest portion of GP
compensation.
Restrictive
Covenants
 LPs tie up capital with no promise of a return and little control over the
investment activities of the GP. They divide covenants into three broad
categories: (1) restrictions on management of the fund, (2) restrictions on the
activities of the GP, and (3) restrictions on the types of investment.
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15. Valuations Methods
 Relative Valuations
 DCF Analysis
 Net Assest
 Option Pricing
 Real Options
 Valuation of Preferred Stock
 R&D Valuation
 Game Theory
 Monte Carlo Simulation
 Later Stage Investment
 Biomial Trees - The Black-scholes Equation
Startups are valued differently before they receive funding and after the money comes
in. The premoney valuation is a monetary estimate of various factors ranging from the
strength of the founding team, competitive landscape, intellectual property and the size
of the market. Once an investment is made, the final value of a startup is derived by
adding the amount invested to the pre-money valuation. Experts said the percentage of
stake that a founder cedes must be based on the post money valuation.
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16. VC Trends in India
2010 2011 2012
Invested capital (US$b) 0.9 1.7 1.4
Invested rounds* 109 175 205
Median round size (US$m) 7.25 5.45 3.61
Number of VC-backed IPOs 6 2 2
IPO capital raised (US$b) Median time to IPO (years) 0.5 0.05 0.02
Median time to IPO (years) 4.3 N/S N/S
Number of VC-backed M&As 17 5 15
Median M&A Valuation (US$m) 63.0 N/S 18.4
Median time to M&A (years) 3.5 4.0 3.8
Investment rounds increase in India
 India bucked the declining global trend in VC investment activity in 2012. The number of investment
rounds increased by 17% to 205, the third successive year of increasing activity
 Levels of reported VC investment also probably understate the true level of activity because of
unreported deals not captured in the data
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17. Economic Development is supporting growth
 The growing wealth of the Indian economy and the accompanying increase in
consumerization is underpinning the growth of the VC industry.
 The two predominant themes from a demand perspective are:
 Competition addressing changing consumer behavior patterns – the largest proportion of
the total pool of VC backed companies is in consumer services (170 companies out of a
pool of 528)
 The introduction of new technology, particularly internet based applications such as
cloud and mobile.
 From a supply perspective, rising economic prosperity has increased the pool of
entrepreneurs willing to take a risk on VC investment. Some of the high-net-worth
individuals have already made money as successful entrepreneurs prior to becoming VC
or angel Investors.
 The entrepreneurial ecosystem is becoming more developed as the availability of higher
education has spread to third and fourth tier cities, with a corresponding increase in the
number of engineering and medical schools.
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18. VC Trends
Late –Stage Investment Dominates
 The Indian VC industry is heavily weighted towards later-stage investment . The proportion of deals
in the revenue generating stages was 87% in 2012 up from 83% in 2011 and 81% in 2010.
 The reason for the predominance of later-stage investment is that compared with silicon valley.
 Indian companies are focused less on innovation and more on application development and efficient
delivery models, which take less time to develop into the revenue generating phase.
More Deals but smaller in sizes
 Median round size decreased from US$5.5m in 2011 to US$ 3.6 m in 2012.
 The decrease in part reflects the influence of the growing network of angel investors on the VC
market, with a preference for lower investment sizes.
M&A is more likely than IPO at exit
 Strategic buyers are a more likely exit route for Indian VC backed companies than IPOS. The very low
level of IPO exists (two in both 2011 and 2012) reflects the absence of a junior stock market such as
London, AIM
 Exits are a combination of fresh investment by new VC funds and strategic M&A, with a bias towards
the latter because strategic deals tend to command higher valuations.
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19. Key Aspects of Term Sheet
1.Liquidation Preference
This is the amount of money that holders of preference shares or the
investors get when a company is sold partly or fully. For instance an
investor puts in Rs 11 crore into a startup and asks for a two-fold
liquidation preference. Subsequently if the company is sold for Rs 25
crore, the investor would get Rs 22 crore as his returns. This would
leave the entrepreneur with just Rs 3 crore despite holding a majority
share in his company.
2.ESOP Pool
Investors typically bet on the jockey or the entrepreneur rather than
the horse, which is the company. To ensure that the jockey has a
support team backing him, investors push for stock option pools to be
set aside.
But this allocation is normally made from out of the share held by the
founder. However this ESOP pool may never be fully utilised, leaving a
hole in the stake of a founder. Experts are of the view that it is best for
startups to have a hiring plan for a period of about 18 months with a
smaller ESOP plan.
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20. Key Aspects of Term Sheet
3.. Founders' Shareholding
A term sheet provides the investor with a tool to ensure founders do not
leave prematurely. This is done by ensuring that only a portion of the
shares owned by the founders can be diluted immediately, the balance
is normally locked up.
Experts said this clause in a term sheet must be scrutinised by an
entrepreneur to ensure that he gets at least half his shares immediately
with the balance being vested within four years.
4.Shareholder Agreement
A contract made between shareholders of a company regarding their
stake in the company and the rights they hold on the board of the firm.
It also contains clauses which protect interests of investors in case of
a stake sale or a dispute.
5.Founders‘ Employment Agreement
Investors are wary of letting the founders go for fear they will start up
once more or join a rival. This document defines the mandatory length
or term of a founder's employment, compensation, shareholding,
ownership of intellectual property held by a founder as well as non-compete
provisions in case of an exit.
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21. Key Aspects of Term Sheet
6.. Double Dip
An investor who asks for a two-fold return on investment while stating
his liquidation preference can also slip in a clause on double dip. For
instance, if a company is sold for Rs 25 crore and the investor gets Rs
22 crore, in a double-dip clause the founder may have to part with even
a share of the Rs 3 crore that he is left with.
7.DRAG -ALONG CLAUSE
In case an investor wants to sell his stake in a company he can force a founder
and other investors to follow suit.
8.EARN-OUT MODEL
An investor's stake in a startup automatically increases in case it fails to reach
specific milestones.
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22. Key Aspects of Term Sheet
9.TRANCHING
Money is released in tranches based on targets making equity a form of
structured financing.
10.PAY TO PLAY
In this clause an existing investor must invest in follow-on rounds to retain his
rights.
11.RIGHT OF FIRST REFUSAL
The right to invest in subsequent rounds of funding rests with the first investor.
12.ANTI-DILUTION PROTECTION
This allows an entrepreneur to maintain his stake even after subsequent rounds
of funding
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23. Definitions: Types of Investments
A management buyout (MBO) involves the purchase of an independent business or
subsidiary from the owners in which the incumbent management purchase a share
of the equity (anything from as little as 2 percent or 3 per cent to 100 per cent to
the size of the deal) and contribute to management the business post-acquisition.
Venture capitalist and other investors would purchase the rest of the equity. In
large deals, it is also likely that the funding is highly leveraged
Management Buy
Out ( MBO)
Leveraged Buyout
- LBO
The acquisition of another company using a significant amount of borrowed money
(bonds or loans) to meet the cost of acquisition. Often, the assets of the company
being acquired are used as collateral for the loans in addition to the assets of
the acquiring company. The purpose of leveraged buyouts is to allow companies to
make large acquisitions without having to commit a lot of capital.
In an LBO, there is usually a ratio of 90% debt to 10% equity. Because of this high
debt/equity ratio, the bonds usually are not investment grade and are referred to as
junk bonds.
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24. Thank You
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