Let’s talk about Venture Capital Funds

A venture capital fund is a scheme of pooled investment

The investment is made into a small and mid-sized start-up

The venture capital funds (VCFs), as the term suggests, means the funds that invest money in new ventures. It is regulated by the guidelines of the Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996 and managed by venture capital firms.

What is Venture Capital Fund?

A venture capital fund is a scheme of pooled investment that primarily invests the financial capital of third-party investors who seek private equity stakes in enterprises that are very risky for the standard capital markets or bank loans.

The investment is made into a small and mid-sized start-up, early-stage, and emerging companies that have huge growth potential. Venture capital funds are private equity investment vehicles that invest in firms with high-risk/high-return profiles as per the company’s assets, size, and stage of product development.

Registration of Venture Capital Funds

Any company or trust or a body corporate proposing to be established as a venture capital fund on or after the commencement of the Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996 shall make an application to the Board for registration along with a fee of Rs 25,000.

Any company or trust or a body corporate that is carrying any activity as a venture capital fund without registration on the date of commencement of these regulations shall make an application to the Board for registration within a period of three months or six months in exceptional cases from the date of such commencement.

Any company or trust or a body corporate that had worked as a venture capital fund before these regulations commenced, shall cease to work as a venture capital fund, failing to make an application for registration within the period specified therein.

The memorandum of association of the company shall have the main objective to carry on the activity of a venture capital fund, and the same applies to trust.

How are Venture Capital Funds managed and operated?

In the beginning, venture capital funds have to raise money like any other fund. Money can be raised from any investor, whether an Indian, foreign, or non-resident Indian. Potential investors are given a prospectus of the fund. The investors who commit are called by the fund’s operators to finalize the individual investment amounts.

The investment managers of the fund who manage the capital review hundreds of business plans and search out potentially high-growth companies. They make investment decisions according to the investor’s expectations and ensure delivering a risk-adjusted return to them.

The venture capital fund invests in exchange for equity or an ownership stake in early-stage companies.

Conditions and restrictions regarding investments

The regulation has conferred conditions and restrictions on investment to be made in and by the venture capital fund in India. As per the regulation, the venture capital fund shall not accept any investment from any investor less than five lakhs rupees. However, this does not apply to the investment made by the principal officers or the employees or fund’s directors or directors of the trustee company or the trustees where the venture capital fund is a trust.

A venture capital fund shall have a firm commitment from the investors to contribute an amount of at least rupees five crores for each scheme launched or fund set up, before starting of operations by the venture capital fund. The fund shall not issue any document or advertisement inviting public offers for the subscription or purchase of any of its units.

At the time of application for registration, the investment strategy shall be disclosed by the venture capital fund and also the duration of its life cycle.

No investment of more than 25% of the fund shall be made in a single venture capital undertaking. At least 66.67% of the funds shall be invested in unlisted equity shares or equity-linked instruments. Fund less than 33.33% may be financed by subscription to IPO of a VC undertaking with shares proposed to be listed, debt or debt instrument of a VC undertaking in which fund invested by way of equity, preferential allotment of equity shares of a listed company with one year lock-in period, the equity shares or equity-linked instruments of a financially ailing company or a sick industrial company with listed shares.

Investment types of Venture Capital Fund

The venture capital is classified as per their utilization at various stages of a business. These are mainly categorized into three types- i) early-stage financing, ii) expansion financing, and iii) acquisition/buyout financing. Early-stage funding is further subdivided into three categories, and they are seed financing, start-up financing, and first-stage financing. Expansion financing may be classified into three types of funding like second-stage financing, bridge financing, and third stage financing or mezzanine financing.

How do Venture Capital Funds make money?

A venture capital fund investors make returns when a portfolio company exits, either in an IPO or a merger and acquisition or promoter buyback or sale to another strategic investor. Venture capital funds typically aim for a gross internal rate of return of around 30%, though it varies based on industry and risk profile.

Venture Capital funds make money in two folds, like management fees and carry (carried interest) if a profit is made off the exit. Management fees usually calculated on a percentage of the capital committed to the fund, or about 2 to 2.5 percent. Carried interest or carry is share of the profits when an investment is fruitful, and that is paid to the investment manager over the amount manager contributes to the partnership. It is usually 20 to 25 percent.

Lastly, SEBI may order an investigation on receiving a complaint from the investors. The investigation carried out is regarding the maintenance of fund’s books of accounts, compliance of the regulation, and its affairs. In case any venture capital fund that fails to comply with the regulations, or furnish reports of its issues or doesn’t cooperate in any inquiry instituted by SEBI or fails to give a satisfactory answer in this regard to SEBI, shall be treated in the manner provided in SEBI Regulations, 2008.

That’s why Comparte Investment team asks do you have “Nivesh Ki Aadat”.

With this one can say “Mutual Fund Sahi hai”,  so let me do Nivesh