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Over the past few posts, we’ve looked at various startup situations from an entrepreneur’s perspective. In this and the next few posts, we’ll look at how the people on the other side of the table, namely venture capitalists, operate. Getting a perspective of how the other party thinks and operates is crucial if you want to build a mutually beneficial relationship.
It is important to recognize that entrepreneurs and VCs are on the same team and have a commonality of goals – namely building a successful company. Everything happens before investment. As in all partnerships, if the relationship between VC and entrepreneur is viewed with suspicion and in an adversarial manner, a VC-entrepreneur tussle in the board-room will kill the company. Having said that, let’s take a look behind the scenes at how VC firms operate. In this post, let us understand the overall situation of VCs.
VC firms collect money from investors and then invest the money in carefully selected fast-growing businesses. In the US, VC firms are usually partnership firms. In India, VC firms follow a structure in common with a mutual fund structure (for legal and tax reasons, VC partnership firms are not viable in India.
The VC industry in India has been clamoring for a US-style structure for some time now, but that’s another story). That is, there is a VC fund in which various investors invest and an investment management company (commonly referred to as an asset management company or AMC) that manages the fund’s investments.
In the US, typical investors in VC firms are pension funds, university endowments, insurance companies, corporations, wealthy individuals, etc. Typical investors in India are wealthy individuals, developmental and financial institutions and some corporations. The laws do not allow investment of pension money or insurance money.
Universities in India have no real money or endowments, even if they are allowed to invest! Hence it is quite difficult to raise funds in India for Venture Capital purposes. The tax treatment of Indian VC firms also acts as a disincentive. This is why a large number of VC funds operating in India are actually offshore funds – based in places like Mauritius – with foreign investors thereby ensuring operational flexibility, tax benefits and speed.
Contrast this with VC activities in a small country like Singapore: A small country like Singapore, for example, invests huge amounts of money (more than $100 billion in funds) all over the world in various VC activities. These government-controlled investments are made keeping in mind the economic development of Singapore, strategic reasons (eg new technology, entry into new markets) etc. Singapore is also a source of capital for many of Silicon Valley’s marquee VC firms. There is a lesson for India somewhere!
In India, the traditional investors in VC firms have been development and financial institutions like ICICI, IDBI, SIDBI and so on. These VC firms have had to deal with various operational constraints and have had difficulty dealing with high-risk investments due to the nature of the structure within which they had to operate. Indian VC firms must be registered with SEBI (Securities and Exchange Board of India).
Over the past few years, India has seen the advent of several Silicon Valley-style independent private VC firms such as Draper (which pioneered this movement in 1995), Walden, Chrysalis and Infinity Capital. Many more are in the pipeline and will bring international-level VC investment styles and standards with a deep understanding of technology, finance and strategy. India is expected to attract around $10 billion in VC funds by 2008. In 1999 it attracted nearly $300 million.
With this background on the VC situation, we’ll look at how VC funds/firms operate in our next post.
This article was originally published in Venture Catalyst, India’s first e-zine started by Sanjay Anandram.
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