Features of Indian Capital Market Securities Market Security Prices Participants Financial Intermediaries like Insurance companies, Investment companies, Pension funds etc. Non – financial business enterprises Households and goverments Mutual fund companies Location
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Capital Market Meaning The term “Capital Market” refers to the institutional arrangement for facilitating the borrowing and lending of long-term funds. It is the organized mechanism for effective and efficient transfer of capital or financial resources from the investing parties. Definition “This is not a market for capital goods, rather it is a market for raising and advancing capital for investment” - P.K. Dhar “It is a market for long-term funds. Its focus is on financing of fixed investments in
Transcript
Capital MarketMeaning
The term “Capital Market” refers to the institutional arrangement for facilitating the borrowing and lending of long-term funds.
It is the organized mechanism for effective and efficient transfer of capital or financial resources from the investing parties.Definition
“This is not a market for capital goods, rather it is a market for raising and advancing capital for investment” - P.K. Dhar
“It is a market for long-term funds. Its focus is on financing of fixed investments in contrast to money market which is the institutional source of working capital finance” - M.Y. Khan
Features of Indian Capital Market
Securities Market
Security Prices
Participants
Financial Intermediaries like Insurance
companies, Investment companies, Pension
funds etc.
Non – financial business enterprises
Households and goverments
Mutual fund companies
Location
1. The Indian capital market consists of Organized and Unorganized Sector
2. The demand for funds comes mostly from corporate enterprises, government and semi – government institutions.
3. The demand for funds in the organized sector is mostly for productive investment.
4. The supply of funds comes from Households savings and Institutional investors, like banks, investment trusts,
insurance companies, finance corporations, government and international financing agencies.
Nature of Indian Capital Market
Functions of Capital Market
Allocation Function
Liquidity Function
Other Functions
Indicative Function
Savings and Investment
Function
Transfer Function
Merger Function
Constituents of Capital Market in India
In both cases the capital market intermediaries like merchant banker, brokers, play an important role.
Constituents of Indian Capital
Market
New Issue Market or
Primary Market
Public Issue
Right Issue
Private Placement
Preferential Allotment
Stock Market or Secondary
Market
Primary Capital Market in IndiaIn the primary market the companies issue new securities to
raise funds. Hence it is referred as “New Issue Market”. primary market is a conduct for the sale of new securities. New or listed companies may make the public issue of securities by the new companies for the first time.
Private corporate sector did not show much enthusiasm to offer capital to the public till 1980, because of the following factors:ÞSmall size of operationÞAvailability of loan capital on easy termsÞFear of losing control over the companyÞHighly regulated environment.
Financial instrumentEquity and debt are the two basic instruments of raising capital from the primary markets. Equity was more important source of capital till 1995-96.
The instruments are:ÞOrdinary shares or Equity sharesÞPreference sharesÞDebentureÞWarrantsÞDerivative securitiesÞBorrowing funds from financial institution
Functions of primary market 1. Origination2. Underwriting3. Distribution
Operations in primary market 1. Public Issue: By far the most important method of issuing securities, a public
issue, involves a sale of securities to the public at large, public issues in India are governed by the provisions of the companies act, 1956, SEBI guidelines on investor protection, and the listing agreement between the issuing company and the stock exchanges. SEBI impose certain conditions on the issue besides specifying the additional information to be disclosed to the investors.
2. Right issue: It involves selling securities in the primary market by issuing rights to the existing share holders. This is required under section 81 of the companies Act 1956.
3. Private placement: It involve sale of securities to a limited number of sophisticated investors such as financial institutions, mutual funds, venture capital funds, banks and so on.
4. Preferential allotment: A n issue of equity by a listed companies to selected investors at a price which may or may not prevailing market price. It is not related to public issue. In India it mainly given to promoters or friendly investors to ward off the threat of take over.
Secondary MarketIt deals with the second-hand securities , securities that have already been issued by companies that are listed in a stock exchange. It also called as the “Stock Market”. It also include the “Over-the-counter” (OTC) and the “Derivatives Market”.
Features of Secondary Market1. It deals in previously issued securities.2. This is not place of the margin of the security.3. Here the instruments are not directly issued by the companies to the
investors.4. The intending buyer and seller can buy and sell securities through brokers.5. It merely facilitate the ownership of the security.6. It does not directly contribute to capital formation.
Functions of Secondary Market1. Ensure liquidity of capital2. Continuous market for securities.3. Evaluation of securities.4. Mobilizing surplus savings5. Helpful in raising new capital6. Safety in dealing7. Listing of securities8. Platform for public debt.9. Clearing house of business information.
Limitations of Secondary Market1. Rampant speculation2. Insider trading3. Oligopolistic4. Limited forward trading5. Outdated share trading system6. Lack of single market7. Problem of interface between the primary and secondary market8. Inadequacy of investor service
Long Term Finance
Equity Shares
Preference shares
Debentures
Term loans
Lease Financing
Venture capital
Investing
Private Equity
Ordinary SharesIt represent the ownership position in a company. The share holders of
ordinary shares are called, “Share Holders”, are the legal owners of the company. Ordinary shares are the source of permanent capital since they do not have a maturity date. For the capital contributed by share holders by purchasing ordinary shares, they are entitled for dividends.
The amount or rate of dividend is not fixed, the company’s board of directors decides it. An ordinary share is, therefore, known as variable income security.
Being the owners of the company, share holders bear the risk of ownership, they are entitled to dividends after the income claims of others have been satisfied. Similarly, when the company is wound up, they can exercise their claims on assets after the claims of other suppliers of capital have been met.
Reporting of Ordinary SharesThe capital represented by ordinary shares is called “share capita” or “equity capital”. It appears on the left-hand side of a firm’s account- form balance sheet on the top sources of capital in the step-from balance sheet.
Capital structure1. Authorized capital: It represent the maximum amount of capital, which a
company can rise from share holders. 2. Issued share capital: the portion of Authorized capital which has been offered
to share holders is called, Issued share capital3. Subscribed share capital: represent that part of the issued share capital,
which has been accepted by share holders.4. Paid-up share capital: the amount subscribed share capital actually paid up by
share holders to the company is called paid-up share capital.
Net WorthBook value per share = Number of Ordinary shares.
Features of ordinary shares:1. Claim on Income
These share have a residual ownership claim. They have a claim to the residual income, which is earning available for ordinary share holders, after paying expenses, interest charges, taxes and preference dividend, if any. This income may be split in to two parts: dividends and retained earnings.2. Claim on assets
These share holders have a residual claim on the company’s assets in the case of liquidation.3. Right to control
Control in the context of company means the power to determine its policies. The board of directors approves the company’s major policies and decisions while managers appointed by the board to carry out day-to-day operations. These share holders have a legal power to elect directors on the board. If the board fails to protect their interest, they can replace directors.
4. Voting rightsOrdinary share holders are required to vote on a number of important matters. The most significant proposals include: election of directors and change in memorandum of association. Each ordinary shares carry one vote. Thus, an Ordinary share holder has vote to equal number shares held by him. Share holders may vote in person or by “Proxy”. A proxy gives a designated person right to vote on behalf of a share holder at the company’s annual general meeting.5. Pre-emptive RightsThis entitles a share holder to maintain his proportionate share of ownership in the company. The law grants share holder the right to purchase new shares in the same proportion as their current ownership.6. Limited LiabilityOrdinary share holder are the true owners of the company, but their liability is limited to the amount of their investment in shares. If a share holder has already fully paid the issue price shares purchased, he has nothing more to contribute in the event of a financial distress or liquidation.
Pros of equity financing1. Permanent capitalSince ordinary shares are not redeemable the company has no liability for cash outflow associated with its redemption. It is a permanent capital, and is available for use as the company goes.2. Borrowing baseThe equity capital increases the company’s financial base, and thus its borrowing limit.3. Dividend payment discretionA company is not legally obliged to pay dividend. In times of financial difficulties, it can reduce or suspend payment of dividend. Thus, it can avoid cash outflow associated with ordinary shares.
Cons of equity capital1. CostShares have a higher cost at least for two reasons: dividends are not deductable and flotation cost on ordinary shares are higher than those on debt.2. RiskOrdinary shares are riskier from investors point of views there is uncertainty regarding dividend and capital gain.3. Earnings dilutionThe issue of new ordinary shares dilutes the existing share holder’s earnings per share if the profits do not increase immediately in proportion to the increase in the number of ordinary shares.4. Ownership dilutionThe issuance of new ordinary shares may dilute the ownership and control of the existing shareholders. The issuance of ordinary shares can change the ownership.
Public issue of EquityIt means raising of share capital directly from the public.
Underwriting of issuesIt is legally obligatory to underwrite a public and a right issue. to an
underwriting, the underwriters- generally banks, financial institution, brokers, etc.,- guarantee to buy the shares if the issue is not fully subscribed by the public. The company has to pay an underwriting commission to the underwriter for their service.
Private placementIt involves sale of shares by a company to few selected investors,
particularly the institutional investors like the Unit Trust of India(UTI), LIC, IDBI, etc.,
Right issue of equity sharesIt involve selling of ordinary shares to the existing share holders of the company. Obviously this will dilute the ownership.Pros of right issueÞThe existing share holders control is maintained through the pro rata issue of shares.ÞRaising funds through the sale of right issue rather than the public issue involves less flotation costs as the company can avoid underwriting commission.ÞIn case of profitable companies , the issue is more likely to be successful since the subscription price is set much below the current market price.Cons of right issueÞThe shareholders who fail to exercise their rights. They lose in terms of decline in their wealth.
Preference SharesIt is often considered to be a “Hybrid Security”.
It is similar to ordinary shares in thatÞThe non-payment of dividend does not force the company to insolvencyÞDividends are not deductable for tax purposesÞNo fixed maturity dateIt is similar to debenture in thatÞDividend rate is fixedÞPreference shareholders do not share in residual earningsÞ Preference shareholders have claim on income and assets prior to ordinary shareholdersÞThey usually do not have the voting rights
Features of Preference Shares1. Claims on income and assets
Preference share is a senior security as compared to ordinary shares. It has a prior claim on the company’s income in the sense that the company must first pay preference dividend before paying ordinary dividend. It also has a prior claim on the company’s assets in the event of liquidation.2. Fixed dividend
The dividend rate is fixed in the case of preference share, and preference dividends are not tax deductable.3. Cumulative dividends
Most preference shares in India carry a cumulative dividend feature, requiring that all past unpaid preference dividend be paid before any ordinary dividend are paid.4.Redemption
Both redeemable and perpetual preference shares can be issued5. Sinking fund
Like in case of debenture, a sinking fund provisions may be created to redeem preference share.
6. Call featureIt permits the company to buy back preference shares at a stipulated buy-
back or call price. Call price may be higher than the par value.7. Participation feature
Preference shares may in some cases have participation feature which entitles preference shareholder to participate in extra ordinary profit earned by the company.8. Voting rights
preference shareholders ordinarily do not have any voting rights. They may be entitled to “contingent” or “conditional voting rights”.9. Convertibility
A convertible preference share allows preference share holders to convert their preference shares, fully or partly in to ordinary shares at a specified price during a given period of time.
Advantages of preference shares1. Dividend postponability2. Fixed dividend3. Limited voting rights
Limitations of preference shares4. Non-deductibility of dividend5. Commitment to pay dividend
DebenturesMeaningA debenture is a long-term promissory note for raising loan capital. The firm promises to pay interest and principal as stipulated.
Features1. Interest rateThe interest arte on a debenture is fixed and known. It is called contractual rate of interest2. MaturityIt are issued for a specified period of time. In India it is redeemed after 7 to 10 years in installment3. RedemptionRedemption of debentures can be accomplished either through a sinking fund or buy-back provision4.SecurityDebentures are either secured or unsecured. A secure debenture is secured by alien on the company’s specific assets.
5. YieldThe yield on a debenture is related to its market price. Therefore, it could be different from the coupon rate of interest. 6. Claims on assets and incomeDebenture holders have a claim on the company’s earnings prior to that of the share holders. In liquidation, the debenture holders have a claim on assets prior to that of share holders.
Types of debentures1.Non-convertible Dentures (NCDs)These are pure debentures without a feature of conversion. They are repayable on maturity.2. Fully convertible debentures ( FCDs)FCDs are converted into shares as per the terms of the issue with regard tp price and time of conversion. The pure FCDs carry interest rate, generally less than the interest rate on NCDs since they have the attraction feature of being converted into equity shares.3. Partly convertible debentures ( PCDs)The investor has the advantage of both convertible and non –convertible debentures blended in to one debenture.4. Zero interest debentureThese debentures are issued at a highly discounted issue price. The difference between the issue price and the maturity value is the implicit amount of interest. It otherwise called as “deep-discount debentures”.
Advantages of Debenture1. Less costly2. No ownership dilution3. Fixed payment of interest4. Reduced legal obligation
conveys to the lessee, in the return for rent, the right to use an asset for an agreed period of time.
- “Institute of Charted accountants of India” .Involved Persons:1. Lessor: He/she is a person who conveys to another
person the right to use an asset in consideration of a payment of periodical rental, under a lease agreement.
2. Lessee: He/she is a person who obtain from the lessor, the right to use the asset for a periodical rental payment for an agreed period of time.
Characteristics of Lease
• The parties – Lessor and lessee
• The Asset
• The Term- Lease Period
• Lease Rentals – Specified in Lease Transaction.(Repairs and Maintenance charges,Depreciation,Interest, Service charges)
Merchant Banking A bank that deals mostly in (but is not limited to)
international finance, long-term loans for companies and underwriting. Merchant banks do not provide regular banking services to the general public.
Definition: Merchant bank is an organization that underwrites
securities for corporations, advises such clients on mergers and involved in the ownership of commercial ventures. These organizations are sometimes banks which are not merchants and sometimes merchants who are not banks and sometimes houses which are neither merchants nor banks”
Random House Dictionary
Functions of MB:1. Corporate counseling => Offer guidelines to efficient
running of the corporations2. Project counseling 3. Pre-investment Studies => A detail study of feasibility
and evaluate alternatives4. Capital Restructuring 5. Credit Syndication and project finance => Procurement
of finance6. Issue management and underwriting7. Portfolio management 8. Working capital finance9. Acceptance credit and bill discounting
10. Mergers, amalgamation and Takeovers11. Venture capital12. Lease Financing13. Foreign currency finance14. Fixed deposit broking => rendering service to the in
order to bringing new investment.15. Mutual Funds16. Relief to sick industries17. Project Appraisal
TYPES OF LEASING
Financial Lease According to International Accounting standards (IAS),” a financial lease is a lease that transfers substantially all the risks and rewards incident to ownership of an asset. Title may or may not be transferred”.
It is usually for longer period and non-cancellable Contractual Agreement.
It is very popular in India also USA,UK,Japan.
At present , in India approximately a lease worth Rs.75 to Rs.100 crores is transacted as a tax planning device.
It also known as Capital lease, Long term lease, Net lease, Close lease.
The rate of lease would be fixed based on the Kind of lease, Period of lease, Periodicity of rent payment, Rate of depreciation, other tax benefits,.
High cost of equipments like office equipments, diesel generator, machine tools, textile machinery, Containers, etc are leased under Financial lease.
Variants of Financial Leasea. Full Payout Lease: Here the lessor recovers the full value of the leased
asset, within the period of the lease, by the way of lease rentals and the residual value.
b. True Lease: In this type of lease, the typical tax-related benefits,
such as investment tax credit, depreciation tax shields, etc are offered to the lessor.
Operating Leasing
• In this lease ,the contractual Period between lessor and lessee is less than the full expected economic life of equipment. This means limited period, month, six month, a year or few year.
• It does not transfer the risk and benefits of ownership to the lessee
• Basically an economic service.
• This is cancelable at short-notice by the lessee.• It is also known as Service Lease, Short term
lease , true lease.• Computers, Copy machines and other office
equipments ,Vehicles, Material handling equipments etc.
FINANCIAL LEASE Vs OPERATING LEASE
1.Financial lease: It is like an installment loan. Operating lease: It’s Rental agreement.
2. Financial lease excludes provisions for maintenance or taxes which are paid separately by the lessee.
Operating lease provides for maintenance expenses and taxes
of the lessor.
3. FL - Contract period ranges from medium to long. OL - short Contract period
4.FL - Contracts are non-cancellable. OL - Contracts are cancellable either by lessor
or lessee.
5. FL- Lessor is just financial institution, does not render any specialized service in connection with the lease.
OL- Lessor is specialized in handling and operating the particular asset and usually provides specialized services.
3. Conveyance-type Lease: => It is a very tenure lease applicable to immovable
properties. => The intention of the lease is to convey title in the property => It entered in to the period as long as 99 to 999 years4. Leveraged Lease: => When a part or whole of the financial requirement
involved in a lease are arranged with the help of financier, it takes the form of leveraged lease.
=> Value of leased assets is very high. => A lessor is also a financier.
5. Sale and Leaseback: => Under this the owner of an asset sells it to the lessor,
and gets the asset back under the lease agreement. => This paper exchange of title has the effect of providing
immediate free finance to the selling company. => This transaction also helps the release of funds tied up
in that particular assets.6. Partial pay-out Lease: => It is a type of lease where by the lessor obtains full
payment of the lease in several leases. This broadly falls under the category of operating lease.
7. Consumer Leasing: => Leasing of consumer durables such as television,
refrigerators, etc., is called consumer leasing.Þ It has got popularity due to rapid increase in quantum of
consumer credit.8. Balloon Lease: => Which has zero residual value at the end of the lease
period is called “balloon lease” => In this the lease rentals are low at the inception, high
during the mid years and low again during end of the lease.
9. Close end Leasing: => A leasing arranged where by the asset leased out is
reverted to the lessor is known as “close-end leasing” => It is also called “Walk-away Leasing”.10. Open-End Leasing: => It means lease agreement where the lessee
guarantees that the lessor will realize a minimum value from the sale of the asset at the end of the lease period.
=> Under this if the asset’s residual value fetches less price than agreed , the lessee pays the difference to the lessor.
=> If asset’s residual value fetches more than the value, agreed the lessor pays the excess to the lessee.
11. Swap Leasing: Here the lessee is allowed to exchange equipment leased out
whenever the original assets has to be sent to lessor for some repair and maintenance.
12.Wrap Leasing:When the lessee sub-lease the asset to the end-user, retaining a
fee and a share of the residual value, it is called Wrap lease.13. Import Leasing: The leasing of imported capital goods is known as “import
leasing”. It is beneficial to the lessee because arranging any other
source of funding may take a long time.
14. Cross-border leasing: A type of lease where the lessor in one country leases out
assets to a lessee to another country, is known as cross-border leasing.
15. Double-dip: In this it is possible to have a advantage of depreciation
tax benefits twice, depending on the prevalence of differing tax laws in two different countries.
16. Triple-dip: Where the benefits of depreciation tax allowances is
available in three different jurisdictions for single asset leased out, it is a case of triple-dip.
17. Japanese cross-border lease: a) Samurai Lease- Acquisition of large value items as
aircraft b) Shogun Lease - Allowed for Outside Japan to non-
residents. It use with amendment of foreign exchange and Trade laws of Japan.
c) Mushashi Lease - Leasing in Foreign Currency. Popular in Japan.
18. International Leasing: When a leasing company operates in different
countries through its branches, it is case of international leasing.
Legal Aspects of Leasing Implications:• The lessor has the duty to deliver the asset to
the lessee to legally authorize the lessee to use the asset during the currency of the agreement.
• The lessee has the obligation to pay the lease rentals as specified in the lease agreement to protect the lessor’s title to take reasonable care of the asset and to return the leased asset on the expiry of the lease period.
• Income Tax provisions Related to Leasing :1. The lessee can claim lease rentals as tax
deductable expenses.2. The lease Rentals received by the lessor are taxable
under the head of ‘ Profits and gains of business .3. The lessor can claim investment allowances and
depreciation on the investment made in the leased asset.
Tax Planning Aspects: Leasing helps both lessor and lessee and helps them plan and save taxes.
Implications For LessorLessor can use Depreciation allowance as tax shield.• Purpose• The Rates• Conditions• Lessor’s Ownership• Other allowances• Amount of Depreciation• Capital gain/loss• Lessor’s Income
Implications For Lessee
• Allowability of Lease Rentals
• Deduction of Incidental Expenses – Such as Repairs and Maintenance,Insurance,Finance Charges. Are allowed for deduction from Taxable income.
• Sales Tax Provision Relating to Leasing:
It is governed by Central Sales Tax Act, 1957 . Enacted by Government of India, Sales Tax
Acts of Various states.
The lessor is not entitled for the concessional rate of central sales tax because the asset purchased for leasing is meant neither for resale nor for use in manufacturer.
• Funding Aspects of Leasing: Most important Funding sources are public deposits,
bank borrowings and institutional borrowings from Public Financial Institutions.
1. Deposits- Governed by NBFCs ,Directed by RBI. Provision relating to acceptance and repayment of
Deposits, their maximum maturity periods, the rate of interest.
2.Bank Borrowings: Maximum Limit- From All Sources not exceed 10 times
of the asset. For Equipment Leasing-75% of Gross income is derived.
Not exceed three times of the asset.
Structure of Leasing Industry
• Private sector Leasing• Public sector Leasing
Private Sector Leasing includes: Pure Leasing Companies Hire Purchase and Financial CompaniesSubsidaries of Manufacturing group
Companies
• Public Sector Leasing: Financial Institutions –IFCI,ICICI, etc Subsidiaries of Banks-SBI(Strategic Business
Unit(SBU)Others-Bharat Electronics, Hindustan
Packaging ltd.
HIRE PURCHASEAccording to the Hire Purchase Act of 1972,the term ‘hire purchase’ is defined
as, “an agreement under which goods are let on hire and under which the hirer
has an option to purchase them in accordance with the terms of the agreement,
and includes an agreement under which:
Possession of goods is delivered by the owner thereof to a pays the agreed
amount in periodic payments
The property of the goods is to pass to such a person on the payment of the last of
such installment
Such a person has a right to terminate the agreement any time before the
property so passes.”
HIRE PURCHASINGA transaction of finance whereby goods are bought and sold
as per the terms and conditions specified below is known as Hire Purchase.
• Payment of periodic installment.• Immediate Possession of goods by the buyer.• Ownership of goods remaining with the vendor until the
payment of the last installment.• Vendors right to repossess the goods in the event of
default committed by the buyer.• Treatment of each installment as hire charge till the
payment of the last payment.
RIGHTS OF HIRER
• Right of Protection• Right of Notice- weekly, less period• Right of Repossession• Right of Statement• Right to Excess amount
Characteristics Lease Financing Hp Financing
Ownership Never transferred transferred
Depreciation Lessor claim Hirer claim
Capitalization Done in the books of lessor In the books of hirer
Payments Entire amount are eligible for tax payment
Hire interest eligible for tax computation
SalvageValue
Lessor have right to claim Hirer can claim
Magnitude Used as a source of finance, for acquire higher cost of items
Used as a source of finance, for acquire low cost of items
Characteristics Lease Financing Hp Financing
Down Payment It is not required It is required. 20-25%
Reporting Lessee books it made as a note
It is shown as a assets
Maintanance of Assets
Lessee-financial leaseLessor- operating lease
Hirer bare all the coat
Suitability Not suitable for low capital enterprise
Highly suitable for low capital enterprise
Nature of assets Fixed asset of lessor Vendor shown as a stock
Receipts Receipts from lessee will taken as lessor profit
Interest portion alone take as a profit in the books of vendor
Income Lessors income decline as the investment outstanding in the lease declines
Financial charges are spilted equally
Characteristics Lease Financing Hp Financing
Down Payment It is not required It is required. 20-25%
Reporting Lessee books it made as a note
It is shown as a assets
Maintenance of Assets
Lessee-financial leaseLessor- operating lease
Hirer bare all the cost
Suitability Not suitable for low capital enterprise
Highly suitable for low capital enterprise
Nature of assets Fixed asset of lessor Vendor shown as a stock
Receipts Receipts from lessee will taken as lessor profit
Interest portion alone take as a profit in the books of vendor
Income Lessors income decline as the investment outstanding in the lease declines
Financial charges are spilted equally
Venture Capital
Meaning: A form of equity financing designed especially for
funding high risk and high reward projects is known as “Venture Capital”.
Definition It is defined as an activity by which investors support
entrepreneurial talent with finance and business skills to exploit market opportunities and thus obtain long-term capital –gains.
- Bank of England quarterly Bulletin.
Feature (or) characteristics of Venture Capital:1. New Venture: It is generally made in new enterprises that use new
technology to produce new products , in expectation of high gains.
with the clients investments, either by providing loans or managerial skills or any other support.
3. Mode of Investment: The investment is being made in relatively new
companies when it is too early to go to the capital market to raise funds.
4. Objective: => Objective is to make a capital gain on equity
investment at the time of exit. => It is a long term capital that is injected to enable the
business to grow at a rapid pace, mostly from the start-up stage.
5. Hands-on approach: => V.C institution take active part in providing value
added services such as providing business skills, etc., => They do not interfere in the management of the
firms.
6. High Risk-Return Venture: => Venture capitalist finance is a high risky venture. => Some of the ventures yield very high return in order
to compensate for the heavy risks related to the venture.7. Nature of Firms: => Venture capitalist usually finance small and medium-
sized firms during the early stages of their development, until they are established and are able to raise finance from the conventional industrial finance market.
8. liquidity: => Liquidity of venture capital investment depends on
the success of the product.
=> accordingly there will be higher liquidity where the new ventures are highly successful.
Evolution Of Venture Capital => It originated first in USA and spread over the world. => it is a post-war phenomenon in the business world, it is a
sideline activity of developed countries. => In 1960s this concept breed in USA next to this it entered
into UK.Early beginnings => In 1972, a committee on Development of Small and
Medium Enterprises highlighted the need to foster venture capital as a source of funding new entrepreneurs and technology.
=> Risk Capital Foundation, sponsored by IFCI, was set-up in 1975 to promote and support new technologies and businesses.
=> Seed Capital Scheme and the National Equity Scheme was set up by IDBI in 1976.
=> Program for Advancement of Commercial Technology (PACT) Scheme was introduced by ICICI in 1985.
Setting-up of TDICI and Regional Funds: 1987-1994: => For all practical purposes, the organized venture capital
industry did not exist in India till almost 1986.
=> The idea of venture capital gained momentum after it found mention in the budget of 1986-87.
=> Government of India took a policy initiative and announced guidelines for venture capital funds (VCFs) in India in 1988.
Entry of Foreign Venture Capital Funds: 1995-1998: => Thereafter, the Government of India issued guidelines
in September 1995 for overseas investment in venture capital in India
=>These guidelines were further amended in April 2000 with the objective of fuelling the growth of venture capital activities in India.
Policy Support — 1999 Onwards:Þ SEBI should be the nodal regulator for VC funds in India
providing a smooth, single window, problem-free regulatory framework for quick and efficient flow of money.
Status and Trends in 2009: =>About 300 VC funds were active in India. => Unlike in the early stages of the industry’s growth (in
2000) when the investments were largely in the IT sector, by 2009 VC (including PE) investments were being made in all sectors
=> VCs also prefer to invest higher amounts reflecting a bias towards PE investments rather than classic venture capital-type deals.
Valuation of Portfolio.
Selection of Investment.
Stages of Financing
Financial AnalysisFinancial
Instrument
Investment Nurturing
Exit/Disinvestme
nt
Process of Venture Capital
Financing.
Process of Venture Capital Financing:I. Selection of Investment: => Evaluating the business plan of the VC. => Feasibility studies will be done by the financial
institution which are granting the loan. => Should review the following things: a) The project history b) Track the record of the entrepreneur c) Market potential study d) Projection of future turnover e) Profitability.
II. Stages of Financing: After having selected the investment, the next step is to
determine the different stages for finance is required.,1. Early Stages Finance: It includes the following things:a) Seed Capital finance: => The capital required by an entrepreneur for
conducting research at pre-commercialization stage. => This may be end in prototype which may or may not
lead to a business launch. => The next step is testing the product, in this stage the
involvement of market risk is relatively very high.
b) Start-up-Finance:c) Second-Round Financing2. Last stage financing: => It involve the following type of capital: a) Developmental Capital b) Bridge/Expansion capital. c) Management buy-outs. d) Management buy-ins e) Turn a rounds.
III. Financial Analysis: In order to decide the required venture capital
percentage ownership, the venture capital investments are to be valued. there are three methods which can be adopted.
a. Conventional venture capitalist valuation Method.b. First Chicago Methodc. Revenue multiplier method.
IV Financial Instrument: It is required to decide the type of financial instruments
through which the venture capital investment is to be made.
=> It may be in the form of equity finance or debt finance.
1. equity instruments.2. Debt instruments.a) Conditional Loanb) Government Loan.c) Income Notes.d) Partly convertible debentures
e) Zero coupons debentures.f) Deep discount bonds.V. Investment Nurturing /After care: => VC institution take more care in the working of the
concerns. => They take part in the management and take care of
the development of the concern. => Different styles are adopting to nurturing the
institutions that are: a) Hands-on-nurturingb) Hands-off- nurturingc) Hands-holding- nurturing.
=> The investors company has the right to make sure that the assistance provided by it is properly utilized. For this following techniques are used:
a) Personal Discussion.b) Plant visits.c) Feedback through nominee directors.d) Commissioned studies.
VI. Valuation of Portfolio. The investments by the venture capital institution in the
investee company have to be valued from time to time. The valuation is done in the following ways:
1. Equity investmentsa) Quoted market value method.b) Fair market value method2. Debt Instrumentc) Market value methodd) Fair value method.
VII. Exit /Disinvestment: => After having promoted the company and has reach
the working stage, the venture capital institution has to take a decision to exit and to realize the investment so as to make a profit or to minimize its losses.
=> For this following techniques are adopted:1. Disinvestment of equitya) Going Public.b) Sale of shares to entrepreneurs/employees.2. Trade sales3. Sale to new investor.4. Liquidation.
Stages of Venture Capital Financing:1. Seed Capital: =>This is an early stage financing. This involves primarily
R&D financing. => “The financing of the initial product development or
the capital provided to an entrepreneur to prove the feasibility of a project and qualify for start-up-capital”.
European V.C Association. => This stage involves serious risk, as there is no
guarantee for the success of the concept, idea, and process pertaining to high technology or innovation.
=> Chances of success in hi-tech projects are meager.The V.C funds considers the following points to safe guard its
own interest:a) Successful performance record, entrepreneurs previous
experience in similar products, technology and market.b) Qualities of business management and technical
innovation in the enterprise.
2. Start-up-Financing: => The term refers to the stage where a new activity is
launched. => Venture capitalist provides finance with a view to take
advantage of the capital gain arising from equity appreciation on completion of such projects and marketing of its product.
The entrepreneur should furnish the following information for the proposal:
a) Brief history of business.b) A synoptic note on career history of entrepreneur.c) Description of product.d) Description about market condition, competition, etc.,
e) Description of technical process involved and technology.f) Structure of funding.Appraisal factors of Projects:a) The track of recordb) Performance assumption.c) Market Potentiald) Cost structure.e) Time schedule.
3. Early-stage-financing: => Finance provide to companies that have completed
development stage and require further funds to initiate commercial manufacturing and sales they will not yet be generating profit.
4. Follow-up-financing: => The provision of capital to a firm which has previously
been in receipt of external capital but whose financial needs have subsequently expanded.
=> Last-stage in a project, implies that the project has passed the test of acceptability and has proved to be successful.
5. Expansion Financing: => “ The finance provided to fund the expansion or
growth of the company which is breaking even or trading at a small profit”
=> Expansion or developmental capital will be used to finance increased production capacity, market or product development and /or to provide additional working capital.
6. Replacement Financing: => A later-stage financing method, also known as
“Money-out deal”, where by venture capitalist extend financing for the purchase of the existing shares from an entrepreneur or their association in order to reduce their holdings in the unlisted company is known as “Replacement Financing”
Venture Capital In India => The V.C industry in India is still in an embryonic stage. => To promote scientific technology and knowledge –
based ideas in to commercial production, it is very important to promote venture capital in India.
=> India has a tremendous potential for growth of knowledge-based industries. This potential is in several areas such as IT, Bio-Technology, Drugs, Agriculture, Food Processing, Tele communication services, etc.,
=> In India the venture capital industry will fill the gap between the capital requirement of technology and funding available in traditional financial institutions
=> The gap exist because such start-ups are necessarily based on intangible assets such as human capital and technology enabled mission.
=> Very often, they use technology developed in university and government research laboratories that would otherwise not to be converted to commercial use.
=> The point of a traditional banker, they have neither physical assets nor a low-risk business plan.
=> Companies such as Apple, Exodus, Etc., This multinational companies initially started through venture capital funding.
=> In addition to finance, other services such as smart advice, hands-on management support and other skills that help the entrepreneurial vision to be converted to marketable products and also offered.
=> Given the inherent strength of its skilled and cost competitive manpower, technology, research and Entrepreneurship, and with the proper environment and policy support, India can achieve rapid and sustainable economic growth and competitive global strength.
PRIVATE EQUITYÞ Private equity funds have historically been a major source of funding for start-up
companies and for firms that are in financial distress.Þ These funds are investment companies that buy publically held companies and
convert them to private ownership- usually through a limited partnership.Þ Although the market for private equity started in the 1960s it expanded rapidly
in the mid 2000s. Þ This represent a significant change in the way corporations are owned.Þ Private equity firms avoid the disclosure regulations that publically related firms
face. They also avoid the accounting regulations put on publicly traded firms.
Principals of private equity1. Investing in private equity funds2. Outsourcing selection of private equity funds3. Direct investment in private companies.
Investors Funds of funds
PE Fund
PE Fund
PE Fund
Company
Company
Company
Company
Investing in PE Funds
Direct Investment
Advantages of Private Equity1. Absolute return2. Improvement in portfolio diversification3. Exposure to the smaller companies market4. Ability to back entrepreneurs5. Influence over management and flexibility of implementation.
