CHAPTER 4 PATTERNS OF VENTURE CAPITAL FINANCING IN INDIA

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1 CHAPTER 4 PATTERNS OF VENTURE CAPITAL FINANCING IN INDIA 4.1 Patterns of venture capital financing In the year 2012, the patterns of venture capital financing in India, were very volatile. Europe struggled to get a good growth because of the dwindling future of the Euro capital market. Spain s economy was also not showing good sign and it wanted a $125 billion for its rescue of its economy from financial meltdown. Greek was also creating problem & its economy demanded financial packages. There was news that Greek might exit the Euro Zone. However end of the year had seen a lot of changes and autistics were also going down. At the end of this year, Europe has started sign of improving. In Asia, economic growth was still far away from good growth, earlier years showed good sign of growth. China s GDP was increasing from seven per cent and India s GDP was decreasing below five per cent. This was a matter of great concern for India but Asia s stock market was still good and showing good sign of improvement. Shanghai market saw a growth by five per cent from January to December. India s NIFTY also grew twenty four per cent. In the western stock standard and poor s was going by ten per cent. NASDAQ was growing by eleven per cent and German s Dax was growing by thirty one per cent. Several leading private equity firms had recently cashed out of their investments, booking substantial losses in the process. Few years ago, New Silk s investment in high-profile 9X media group had crashed and burned. The most recent instances were the exits of Warburg Pincus and ChrysCapital from auto components manufacturer Amtek India. Warburg Pincus recently sold over half of its 7.45 per cent stake in the company taking an estimated 63 per cent hit on its portfolio. This was followed closely by the exit of ChrysCapital from its entire 8.17 per cent stake in the company, which is estimated to have put it in the red by up to 20 per cent. Another private equity firm, Citigroup Venture Capital International, carved out an 11 per cent loss when it cashed almost 7 per cent of its per cent stake in Jindal Drilling recently. After this scenario in venture capital market, there were many fluctuations in the Indian stock market indices. The following figure 4.1 shows the healthy growth in world stock market. 65

2 Figure 4.1 Healthy growth in world stock markets Source: IVCA Database, 2012 Despite good and positive growth, private equity investment in entire world economy showed no better increase. Rather it was showing flat growth rate as it was in North America had shown an increase in the private equity investment (Figure 4.2). Asia-Pacific had seen a decline by around 20 per cent and in this region only South Korea showed an increase in private equity (Figure 4.3). India and China had seen decreasing deal value and that caused the decline in private equity. India had seen a lot of mourning trends in this regard. One of the main causes of these falling trends in investment in private equity was due to disinterest of limited partner and they were very cautious while finalizing the deal. In 2012 only 55 funds were finalized to be invested into India, but the total fund value was around $ 3 Billion. 66

3 It was $7 billion in Limited partners were becoming very selective when they selected a particular fund. When we saw private equity investment in 2012, we found that it was a very uncertain year economically. This year saw a number of events in economic sector, there was a scandal in Maharashtra agriculture sector and foreign direct investment in retail and aviation sector. Some problem was due to Vodafone retrospective case in tax management. So investors were having concerns for their safe investment. Investors were not sure enough about the definite policy of the government about industries that created Indian market less attractive. Throughout the year the value of fund invested in Indian industries through venture capital route declined by thirty per cent. Number of deals increased from 531 deals in 2011 to 511 deals in If the deal size was smaller, it means the value of the fund had decreased. Figure 4.2 shows the global investment patterns. Many US and other foreign investors were evaluating alternatives for investments into software development, business process outsourcing, drug discovery and other services companies based in India. In the IT, life sciences and related sectors, both U.S. and India venture capitalists still tended to make early stage investments into a U.S. company which had a subsidiary in India for fulfillment. This structure was likely to change at least for services companies if the Bombay Stock Exchange continued to perform well. Because services companies usually had higher valuations in India than the U.S. private equity investments. Investments in infrastructure and business segments other than IT and biotech services companies tended to be direct investments into India. U.S. venture capitalists were more willing to directly invest into later stage Indian companies regardless of the business segment because there was less risk. A number of mezzanine stage investments had been made directly into India when the IPO was near. 67

4 Figure 4.2 Global Investment Patterns Source: IVCA Data base ( ) Global investment pattern in 2012 was not very well with growth only in North America. In North America, 2010 was a remarkable year for fund-raising for private equity and venture capital, with $85.9 billion raised in 2009, an increase of 70 per cent from Furthermore, this trend continued into the first half of 2011, when an additional $50.0 billion was raised, an increase of 100 per cent over the same period a year ago. Fund-raising appeared to have recovered from the lower levels of and approached 2002 levels. Some of 2012 s fund-raising may represent recycling of proceeds from realisations available to be invested again. By contrast with fund-raising activity, it was a quieter time for investment with the exception of technology. In 2004, $45.0 billion was invested in North America, down 25 per cent from This was equivalent to 0.38 per cent of North American GDP, although in the US investment was 0.4 per cent of GDP, while in Canada it was 0.14 per cent. Technology investment increased 11 per cent in 2004 to $22.7 billion, the same level as in By stage, buyouts dropped sharply, the $22.9 billion invested representing a decrease of 44 per cent from This was despite the fact that, as in the rest of the world, buyout had increased in 68

5 importance as a sector. Expansion investment was down 4 per cent to $10.0 billion in Looking at the total profile of 2004 investment by stage, 51 per cent was invested in buyout, 16 per cent in other late stage, 22 per cent in expansion and 11 per cent in early stage. For the first half of 2005, investment appeared to have dropped slightly to $21.1 billion. Of this, $9.8 billion was invested in buyouts, with $2.5 billion invested in start-up and early stage companies. While in the US almost twice as much was raised as invested in 2004, in Canada marginally more was invested ($1.2billion) than raised ($1.1 billion). Figure 4.3 APAC Deal Values Source: IVCA data base In Asia-Pacific there was a decline of 21 per cent to $48 billion; entire region saw a decline, except South Korea. When talking about exits 2012 proud to be a good year. There were good exits. In year 2011, it was 115 and valued $7 billion and in year 2012 it was 88 exits and valued at $4.1 billion. Financial services had largely been affected because there was five-fold growth in this value from $390 million to $2 billion from 2011 to year

6 This exit saw high profile changes: Carlyle $1.1 billion had seen exits from HDFC. Temasek s had seen exit with $299 million and warbug had exit with $460 million. Overall 2012 was a year which we could say that it was a caution for India s venture capital and private equity. In 2011, there was increase in demand for investment. New ventures were looking towards venture capital with more hopes to invest into their companies. Regulatory framework was increasing into India. Venture capital was becoming the source of investment into the new ventures and this pattern had seen good growth and better year to come with a growth in venture capital market in India. 4.2 Venture capital and private equity landscape in India In 2012 venture capital and private equity companies were working very cautiously and had been making their selection for investment. They were not very willing to fund outsized valuations. Now investors had tried to see a safe path for exit from the starting and they had wanted more money from the early stage investments. In 2012, there was an economic slowdown in India; this slowdown had increased concerns for general partners. There were following five issues for deal flow: 1) There was a great instability in political system which had worried investors. 2) High inflation started in 2011 and had continued for But it became a hit low at the end of 2012 due to tighten policies of Government of India. 3) Industrial production was very low. It was one per cent in April and two per cent in July. This was the negative growth in venture capital market. 4) Weakening of rupees with respect to US dollar. 5) In State, regulatory atmosphere was a major concern for the investors. Retrospective tax on a number of foreign companies created a lot of debate. Further government had also imposed capital gains on venture capital and private equity. This was the major concerns for the investors which had created negative sentiments in the investors and in the whole industry. Even after this situation, venture capital and private equity had been an important source for capital in India. 70

7 India had lost its number one position of venture capital and private equity market in Asia. It had declined with thirty per cent. In 2011, it was eight per cent of GDP and in 2012 it had again declined to five per cent. It was worse than China (26%) and Brazil (26%). 4.3 Major trends of private equity and venture capital in India Financial and political setbacks were the main reason for the decline of venture capital in India. Government could not bring the good capital expansion plan for the development of this sector. Many big sectors like telecommunication and infrastructure could not be developed by the government of India. So it could not attract good venture capital and private equity. Regulatory system had also worsened this issue. Figure 4.4 Annual Venture Capital Investment in India Source: - Bain PE deals database 71

8 Venture capital and private equity deal value had come down by thirty per cent from $20.11 billion to $10.2 billion in Now deal volume was good enough. Fund raising activities had seen a slow growth rate. Limited partners were doing hard work before counting their fund into a venture. In 2012 the total fund invested in deals was $3.5 billion. In year 2011, it was $6.9 billion. Venture capital was playing a main role in deal making. There were around 125 deals in 2011 and 2012 it became 244. Investment had been rising in consumer sector. Healthcare sector had attracted good investment. It had increased by $1.3 billion in 2012 from $.46 in 2011 and had 44 deals in year Exit route had seen a lot of pressure. Figure 4.5 Problem in exiting and in valuation of venture capital and private equity industry Source: IVCA data base ( ) a. Concern for return: All the investment could not generate the return which was expected from them, particularly between 2004 and Now they were at maturity stage and it had been creating a lot of problem for the limited partners. 72

9 b. Mismatch between expectation and valuation: General partners had always thought that good quality deal would be very costly. c. Robust pressure on exit: In 2012 there was a lot of pressure which general partners had faced. Those who had invested in 2006 and 2007, their holding period had been increased for more than five years. d. Creation of value: Many entrepreneurs were not fully ready to accept venture capital and private equity. e. Macroeconomic environment: India s GDP and Inflation had been frustrating the business environment. Policy of government had started a lot of reforms for the development of the market. 4.4 An in-depth pattern on Indian venture capital now and over the intermediate term In fund raising, last fiscal year had seen a lot of activities. Flow of investment and number of exits had been decreased. We could see growing impatience on limited partners because venture capital and private equity funds wanted profitable exits and the effect of this condition was that India, as an investment destination, had been losing its prime position. In the entire world economy in 2012, 672 funds were raised and total value of these funds was $320 billion. India had attracted only $3 billion whereas in 2011 it was $7 billion. This pattern had shown a declining attitude of entire world for investment in India. Now general partners had been holding back funds and they had been watching the Indian market. Now Indian market was quite mature and limited partners had been becoming very selective in investment. Figure 4.6 shows the total decrease in fund allocation process by venture capital firms in India. 73

10 Figure 4.6 Decrease in fund allocation to India Source IVCA data base ( ) Fund allocation to India had decreased. Limited Partners wanted a profitable exit and had kept tracks of General Partners. When we see balance in domestic and foreign funding, we see that economic reforms in 2012 did not change its stance. Rules and regulations had been same for venture capital investment. So domestic investors, who were very rich, they had been coming forward and investing into various ventures. But researcher had conducted various rounds of Interview and had found that in the coming year outside India and foreign venture capital investment would be a powerful source for ventures in India. 74

11 Figure 4.7 Decrease in share of domestic investment Source- Venture Intelligence database ( ) 4.5 Deal making In 2012, there were interesting trends in deal making. There were 180 investment deals in year 2012, whereas in 2011 it was only 100 deals. But value of fund invested had decreased by 30 per cent from $14.8 billion in 2011 to $10.2 billion in Average deal size had decreased from $28 million in 2011 and it was $18 million in When we observed closely, we had found that early-stage growth and venture capital had played a greater role in deal making in Average deal size was significant after 2011 onwards. 75

12 Figure 4.8 Size of average deals Source Global private equity report Size of Average deal had gone down in 2012 due to increased volume of venture capital deals. But general partners had predicted that the deal size would be same or increased in the next two years. In the next year average private equity deal size would increase and there were many reasons for that increase. Economic growth would be continued with a good growth rate. Although in 2012, it had seen a slowdown, investment in follow on deal size would grow and it would push up the average deal size. But environment was very unpredictable so investors were likely to invest in bigger firms where risk was very less. There were many megadeals which could not be materialized so it had resulted in decline in average deal size by $10 million. Top 25 deals in 2012 had attracted only $4.3 billion. In 2011 this figure was $5.9 billion. Number of mega deals was not more than $200 million. Only there were two deals which were more than $200 million. First one was Bain capital s 76

13 $1 billion deal which had invested in Genpact and other was Vornado Trust s $500 million which had been invested in Jawal Real Estate. But there were some other deals which were less than $1 million; they had been increased from 260 deals to 357 deals in year Investment of less than $10 million was made mainly in health care sector, IT and IT- Enabled sectors. Half of the numbers of deals were in information technology and ITCS. Some companies had invested in online portals and e-commerce activities. Figure 4.9 Decline in Average deal size for 2012 Source EMPEA, March 2012 From the above figure it is quite clear that there had been decline in average deal size for the past few years. The top twenty five deals of different ventures had represented only 46% of total deal value in the last five years. The average deal size had also dropped back to the year 2010 which was about 174 US$ (million). 77

14 Deal making had witnessed an increase in healthcare. Information Technology and entertainment sector and these volumes had better performance than 2011 results. The following figure 4.10 explains this very clearly. Figure 4.10 Number of deals and active funds ( ) Source- Thomson Reuters Database ( ) Deals those were less than $10 million were done in e-commerce and new start-ups such as mobile value added services. Number of deals had been double from year 2011 to It had increased from 12 per cent to 23 per cent. In the last year e-commerce was a very important sector and had attracted venture capital. Around eight deals were done in e-commerce out of total 225 in IT and ITES. The largest deal was done by Softbank of $200 million and it was in InMobi, a mobile advertising company. In 2012 flipkart had been attracted by a joint deal of Tiger global and Accel India. Sequoa Capital and SAP venture had invested around $60 million in Just dial. 78

15 Deal-size had been decreased in size in e-commerce companies. In this sector, around 86 per cent deals were less than $10 million. In 2011 it was 75 per cent. In 2012 early-stage had attracted 80 per cent deals as compared to 70 per cent deals in Health care sector had attracted around forty deals. It had been increased from the last year because it was not much affected by recession. As financial services were concerned, they had seen a bit decline from $1.1 billion in 2011 to $.9 billion in But Reality sector had seen a drastic decline from $3.4 billion in 2011 to $1.18 billion in Manufacturing and infrastructure sector had seen a decline from $2.4 billion and $3.4 billion in They had collapsed to $.06 billion and $.8 billion respectively in year This situation had created major problems in Indian infrastructure sector because Government of India could not award contracts due to paucity of fund with the companies. Government had also been failed in improving the policy decision of venture capital. In the last year, venture capital firm Accel India had invested $20 million in online companies like Book My Show and Myntra. A venture capital firm Sezuoia had made a consortium and had invested more than $10 million. It had invested in Manappuram Finance and Leasing and July system. Figure 4.11 Increase in number of active fund in 2012 Source IVCA, Indian Venture capital activity report database ( ) 79

16 Valuation of fund had been dropped after But this condition would not be continuing because capital market had shown signs of improvement and it had expected high return in the prevailing economic conditions. Figure 4.12 Average Investment Horizon of deals Source Global private equity report 2012 From the above figure, we can analyze that there were not much possibilities of change in investment horizons. Most of the people had rated current valuation as high but many people had not expected a decline in Valuation. Researcher had collected data and analyzed that twenty -five per cent of general partners had expected valuations to be steady; however seventy five per cent had expectation that current valuations had been inflated. The lack of quality assets had shown no sign of changing and would be maintaining the current level. Lack of deals which had involved quality assets, would be continuing and would made those assets priceless. 80

17 Figure 4.13 Future trends of valuation Source - Global private equity report 2012 When there was a matter of holding period, half of the general partners expect that current holding period from three to five years will continue. A third of them expect holding period to increase slightly. The majority of venture capital deals continue to involve minority stake holders. This reflects that India s venture capital is at nascent stage. The eighty per cent of deals which have minority stake had a shape face from ninety five per cent in 2011 to eighty six per cent in Researcher found that those venture capital firms are likely to increase, where they will get a controlling stake. This indicates that there is a change in the relationship between investors and entrepreneurs. 81

18 Later stage deals continued to be declined. It was thirty per cent in 2009 to 2010 and fifteen per cent in 2012 and it is expected that this trend will continue. Knock-on effect has caused a big drop in pre-ipo deals and many entrepreneurs are deferring their initial public offers. The number of buyouts has been decreased. It was twenty five transactions in 2011 and in 2012 it was just fifteen transactions, but researcher has analysis that there would be an increase in This is because there is a change in attitudes of promoters and slow growth of economy. In India many buyouts are not genuine, because they still run business even handing over the controlling stake. Although this trend is going to change, many big companies like Ranbaxy are ready to leave the control. General partners think that this trend will also be applied to small business. Figure 4.14 Stake in portfolio companies Source- IVCA data base ( ) 82

19 Most of the deals were for minority stake, although majority stakes are predicted to be popular in the coming years. In the survey it was found that twenty to fifty per cent respondents were of the view that there will be only percent minority stakes will continue in portfolio companies. Early stage deals are more popular; while buyouts will increase in the future. The share of earlystage deals had been increased from 2011 to The numbers of venture capital deals in India were more than forty per cent in early-stage, comparing to other stages in venture capital process. Many venture capital firms provide more growth capital to the new established firms. They do not provide much fund in the seed stage which is quite necessary for the growth stage. This trend has been reducing slowly compared to last two or three years. Figure 4.15 shows the share of early-stage deals and types of investment made in the last two years. Figure 4.15 Increase in early stage deals and buyouts Source IVCA Data Base ( ) 83

20 Deal activity in 2013 will remain cautions. The Interviews form the corporate had been taken and forty five per cent respondents had expected that there would be moderate growth in the entire industry. Law makers had also taken initiative to improve the overall atmosphere of the business in India. General partners think that more deals will be closed in coming years. Figure 4.16 shows the growth rate in venture capital and private equity firms. These firms are likely to grow at a very slow pace. These companies are planning to increase investment in different sectors as per the current market situation. There were forty per cent to eighty per cent respondents who believe the moderate growth in the next few years. Figure 4.16 Moderate growths in venture capital and private equity firms Source: Thomson Reuters Database,

21 Venture Capital and PE firms will be growing moderately in 2013 as more funds are expected to be invested in India It can be predicted that growth will be in healthcare and consumer care business. Health care has no effect of recession and its growth is predicted as fifteen per cent because infrastructure and insurance penetration will be improving. Consumer products do not show good business in troubled economic times. Investments have increased in food and beverages over the last two to four years. However, there would not be much investment in telecom and real estate sector. Banks will be playing a major role in deal sourcing. Now most of the venture capital companies have planned to make cordial relationship with many Indian companies. Figure 4.17 Attraction of investor in retail & consumer sector and healthcare sector Source: Bygrave W. D., Hay M. and J. B. Peeters (1999) In the above figure the different sectors have been shown which have attracted the investor for making further investment. Consumer and retail was one of the attractive sector among all 85

22 sectors selected for the survey. Healthcare sector also saw a good response from the potential investors. The rating was done on a scale of 1 to 5, where 5 stand for very important and 1 stands for least important. Figure 4.18 Deal closing duration Source: IVCA Database ( ) Banks and Fund networks are main deal Venture Capitalist are investing into innovative ways, they are different from the entrepreneurs In the coming future, there would be more time to be taken for closing the deal. Thirty per cent of deals took time three to six months and fifty per cent deals took more than six months of time. Researcher has conducted a number of interviews and found that there would be decrease in competition in the coming years because most of the general partners are having shortage of fund. Boom has started for deals in and continued till There is a lack of quality in deals in the coming years. 86

23 Figure 4.19 Change in competitive intensity Source: Global Private Equity Report, 2012 Competitive intensity has led to decision in general partners, but entrepreneurs are more interested in valuations and brands. 4.6 Portfolio management Indian investors of venture capital are different from developed market. In India, venture capital investors play a crucial role of advising, monitoring their investments for that they participate in board activities, MIS and take updated from senior management. Venture capitalist lay that they improve corporate governance and financial decision making process. Sometimes in recent years these venture capitalist are advising for expansion and tapping the overseas market. Now both the sides have better understanding for their mutual co-operation. 87

24 Still there is a lot of gap between the expectations of both of sides investors and entrepreneurs as well. Figure 4.20 Areas where promoters seek help actively Source: Venture Intelligence India, division of TSJ Media Private Limited, 2013 Promoters require venture capital private equity with corporate governance, strategic planning and decisions. New funds are invested after a thorough examination and number of investments is very limited. Present fund is also managed very intelligently and managers of venture capital are continuously monitoring it. Now investors are taking very active role while finalizing the deal or managing the deal. 88

25 In the coming years promoters will be more aware about the advantages of the venture capital investment. Now there would be more clarity on both the parts. First, venture capital and second promoters. Figure 4.21 General Partners view Source: Global Private Equity Report 2013 General Partners are hoping that venture capitalist/private equity funding will be more advantageous. Venture capitalists are using intelligent funding. Now venture capital companies want more valuation for their fund investment. Now venture capital companies want that they should get immediate return from their investment so the trust should be developed right from the beginning. 89

26 4.7 Exits There are a large number of exits in year In the earlier years, numbers of exits were less but in 2011 it was eighty eight and in year 2012 it was one hundred fifteen. In 2011 total value was $4.1 billion but in 2012 it increased to $6.8 billion. Figure 4.22 Increases in Exits Source: Venture Intelligence India, division of TSJ Media Private Limited (Report 2012) There was an increase in Exits by thirty per cent in year The most liked exit route for venture capital in India was through public market sales, Initial public offers were most important. Number of deals through this exit was forty per cent and all most same in year But deal value because doubled from twenty five per cent to forty eight per cent in There are many IPO s whose value had differed from year 2011 to year It was one of the reasons for this increase. After public market sales, promoter buybacks and secondary sales were also exits route. Secondary and buyback made thirty five per cent of exit value. 90

27 Financial service sector was most valued sector in exit route. It has seen fine time surge in total value from thirty nine billion in 2011 to $2.1 billion in Figure 4.23 sees the increase in strategic and secondary sales in Figure 4.23 Increase in strategic and secondary sales in 2012 Source: Almeida Capital research 2013 As per the above figure, it can be seen that there has been increase in strategic sale and secondary sale compared to public market sale and buyback process of companies. In the year 2007, there was around 44 per cent increase in strategic sale of funds. This increase was slightly decreased in the year 2008 and decreased as on till the year In the year 2010, public market sale also arose due to some market fluctuations. There may be an increase in exits but some fund which was invested between 2003 and 2007 still stock in market. Indian market has returned $30 billion out of $85 billion which was invested. Figure 4.24 reveals the total returns by Indian venture capital market. Here the total of private equity investments in Indian market and the number of exits have been recorded from the year 2004 to

28 Figure 4.24 Return by Indian Market ($30 billion since 2000) Source: Venture Intelligence India, division of TSJ Media Private Limited 2013 From the above figure, we can analyse that the there is US$ 30 billion more return from the year There were 84.7 per cent of total investments in various sectors. About US$46 billion of capital was deployed in the period of 2006 to 2008 and it approached for exits within the next one or two years. Figure 4.25 shows the increase in different exit modes which have been preferred by most of the venture capital firms on successfully completion of the project. Secondary sales and IPOs were the most attractive avenues for exit mode by the most ventures. 92

29 Figure 4.25 Increases in Different Exit Modes Source: accessed on 25 th May, 2012 As initial public offers was the favored mode of exit so exits increased significantly. From the above descriptions it can be concluded that the venture capital industry is booming in the current scenario since its inception. The patterns of venture capital investment in India are different from sector to sector. Most of the venture capital firms invest in the growth stage of the firm compared to seed/startup stage. Private equity firms and venture capital firms manage their portfolio and try to explore more market through different investment avenues in Indian stock market. Unlike U.S. where the largest single source of funds for US venture capital funds since the 1980s had been public and private sector pension funds, in India there are large pension funds but they are prohibited from investing in either equity or venture capital vehicles. This means they cannot be a source of capital. For any venture idea to succeed there should be a product that has a growing market with a scalable business model. The IT industry being one of the most suited industries in India for venture capital funding, till recently had a service centric business model. 93

30 Products developed for Indian markets lack scale. With the slump in the new economy sectors and collapse of the dotcoms, venture capital firms are presently following a highly selective approach in financing. The selective financing has also arisen due to problem. Venture capital funds are facing in making an exit from their venture capital investments which is by way of equity/equity type instruments. Also, there was absence of proper environment and policy support. The result of these various impediments was a micro management of investment, complicating the activities of the venture capital firms without either increasing effectiveness or reducing risk to any appreciable extent. Impediments to the development of venture capital also can be traced to India s corporate and currency laws. Earlier days of licensing raj and the IPO boom also resulted in venture capital activity not on an upswing in India. The investment horizon for a venture capital fund is for a longer duration Life of minimum seven years is kept because investment is made in unlisted companies and they take time to scale up and give an exit to the venture capital fund. Typically, the venture capital fund invests in the first three years and divests from its investment from fourth year onwards which may go up to ten years from the date of the setting up of the fund. 94