Venture Capital: Meaning, Features and Restrictions

After reading this article you will learn about:- 1. Meaning of Venture Capital 2. Features of Venture Capital 3. Restrictions on Investment.

Meaning of Venture Capital:

The term ‘venture capital’ represents financial investment in a highly risky project with the objective of earning a high rate of return. While the concept of venture capital is very old, the recent liberalisation policy of the government appears to have given a filip to the venture capital movement in India. In the real sense, venture capital financing is one of the most recent entrants in the Indian capital market.

There is a significant scope for venture capital companies in our country because of increasing emergence of technocrat entrepreneurs who lack capital to be risked.

These venture capital companies provide the necessary risk capital to the entrepreneurs so as to meet the promoters’ contribution as required by the financial institutions. In addition to providing capital, these VCFs (venture capital firms) take an active interest in guiding the assisted firms.

A young, high tech company that is in the early stage of financing and is not yet ready to make a public offer of securities may seek venture capital. Such a high risk capital is provided by venture capital funds in the form of long-term equity finance with the hope of earning a high rate of return primarily in the form of capital gain. In fact, the venture capitalist acts as a partner with the entrepreneur.

Features of Venture Capital:

The main features of venture capital can be summarised as follows:

(i) High Degrees of Risk:

Venture capital represents financial investment in a highly risk project with the objective of earning a high rate of return.

(ii) Equity Participation:

Venture capital financing is, invariably, an actual or potential equity participation wherein the objective of venture capitalist is to make capital gain by selling the shares once the firm becomes profitable.

(iii) Long Term Investment:

Venture capital financing is a long term investment. It generally takes a long period to encash the investment in securities made by the venture capitalists.

(iv) Participation in Management:

In addition to providing capital, venture capital funds take an active interest in the management of the assisted firms. Thus, the approach of venture capital firms is different from that of a traditional lender of banker.

It is also different from that of a ordinary stock market investor who merely trades in the shares of a company without participating in their management. It has been rightly said, “venture capital combines the qualities of banker, stock market investor and entrepreneur in one.”

Restrictions on Investment by a Venture Capital Fund:

All investments made or to be made by a venture capital funds shall be subject to the following restrictions as laid down by SEBI (Venture Capital Fund) Regulations, 1996:

(a) The venture capital fund shall not invest in the equity shares of the company or institutions providing financial services;

(b) At least 80 per cent of funds raised by a venture capital fund shall be invested in;

(i) The equity shares or equity related securities issued by a company whose securities are not listed on any recognised stock exchange:

Provided that a venture capital fund may invest in equity shares or equity related securities of a company whose securities are to be listed or are listed where the venture capital fund has made these investments through private placements prior to the listing of the securities.

(ii) The equity shares or equity related securities of a financially weak company or a sick industrial company, whose securities may or may not be listed or any recognised stock exchange:

Explanation:

For the purpose of this regulation, a ‘financially weak company’ means a company, which has at the end of the previous financial year accumulated losses, which has resulted in erosion of more than 50% but less than 100% of its net-worth as at the beginning of the previous financial year.

(iii) Providing financial assistance in any other manner to companies in whose equity shares the venture capital fund has invested under sub-clause (i) or sub-clause (ii) as the case may be;

Explanation:

For the purpose of this regulation, ‘funds raised’ means the actual monies raised from investors for subscribing to the securities of the venture capital fund and includes monies raised from the author of the trust in case the venture capital fund has been established as a trust but shall not include th6 paid lip capital of the trustee company, if any.

Venture capital financing involves a high degree of risk. Moreover, the guidelines issued by the government for the setting up of venture capital companies are too restrictive and unrealistic and have come in the way of their growth.

In addition to the venture capital companies, the government of India has been instrumental in setting up a number of new financial agencies to serve the increasing needs of the entrepreneurs in the area of venture capital.

These include:

(i) Venture Capital Scheme of IDBI.

(ii) Venture Capital Scheme of ICICI.

(iii) Risk Capital and Technology Corporation Ltd. (RCTC)

(iv) Infrastructure Leasing and Financial Services Ltd.

(v) Stock Holding Corporation of India Ltd. (SHCIL) to provide help in the transfer of shares and debentures.

(vi) The Credit Rating Information Services of India Ltd. (CRISIL) to undertake the rating of fixed deposit scheme, debentures/bonds and provides credit assessment of companies.

(vii) The National Venture Fund for Software and IT industry (NVFSIT) launched in the year 1999-2000.

The SEBI Committee on Venture Capital headed by Sh. K.B. Chandrasekhar set up in July, 1999, examined the impediments to the growth of VCF and suggested several measures to facilitate the growth of venture capital activity in India. The Finance Bill 2000-2001 has also proposed special provisions relating to tax on income distributed by venture capital companies and venture capital funds.