Page 54 - DMGT207_MANAGEMENT_OF_FINANCES

Unit 3: Sources of Finance

Self Assessment Notes

Fill in the blanks:
8. ………………. refers to loans taken by a company normally from commercial banks for a
short period, pending disbursement of loans sanctioned by financial institutions.

9. Commercial paper represents a short-term ………………. promissory note issued by firms
that have a fairly high credit rating.

3.5 Venture Capital Financing

The venture capital financing refers to financing of new high risky venture promoted by qualified
entrepreneurs who lack experience and funds to give shape to their ideas. In a broad sense,
under venture capital financing, venture capitalists make investments to purchase equity or
debt securities from inexperienced entrepreneurs, who undertake highly risky ventures with a
potential of success.

Methods of Venture Capital Financing

The venture capital industry in India is just a decade old. The venture capitalist generally finance
ventures, which are in national priority areas such as energy conservation, quality upgradation,
etc. In November 1988, the Government of India issued the first set of guidelines for venture
capital companies' funds and made them eligible for capital gain concessions. In 1995, certain
new clauses and amendments were made in the guidelines. These guidelines require the venture
capitalists to meet the requirements of different statutory bodies and this makes it difficult for
them to operate as they do not have much flexibility in structuring investments. In 1999, the
existing guidelines were relaxed for increasing the attractiveness of the venture schemes and
induce high net worth investors to commit their funds to 'sunrise' sectors particularly the
information technology sector.

Initially, the contribution to the funds available for venture capital investment in the country
was from the all-India development financial institutions, state development financial
institutions, commercial banks and companies in private sector. In the last couple of years,
many offshore funds have been started in country and the maximum contribution is from
foreign institutional investors. A few venture capital companies operate as both investment and
fund management companies, while other set up funds and function as asset management
companies.
It is hoped that the changes in the guidelines for the implementation of venture capital schemes
in the country would encourage more funds to be set up to provide the required momentum for
venture capital investment in India.

Some common methods of venture capital financing are as follows:
1. Equity financing: The venture capital undertakings generally require funds for a longer
period but may not be able to provide returns to the investors during the initial stages.
Therefore, the venture capital finance is generally provided by way of equity share capital.
The equity contribution of venture capital firm does not exceed 49% of the total equity
capital of venture capital undertakings so that the effective control and ownership remain
with the entrepreneur.
2. Conditional loan: A conditional loan is repayable in the form of a royalty after the
venture is able to generate sales. No interest is paid on such loans. In India venture capital
financiers charge royalty ranging between 2 and 15 per cent; actual rate depends on other
factors of the venture such as gestation period, cash flow patterns, riskiness and other

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