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  • Barsha Singh

How India's Venture Capital Market Works



With more than $20.82 billion in capital raised in the first eight months of 2022, Indian entrepreneurs have had a tremendous year. The number of deals in the first eight months rose from 948 to 1129, despite the European conflict and the global trend toward ever-rising inflation. Due to the startup ecosystem growth, India has historically not been a market for venture capital, but it is now an essential component of the overall process. In India, venture capital financing is accepting an investor's faith, money, and experience in exchange for funding prospective development with the expectation that the investment would pay off as the company grows. When it comes to VC investment in India, it's not only about the money; it's also about promoting new ventures, innovations, and ideas that have a significant impact on society and address pressing problems.


There has been a name change for the game. VCs in India are no longer searching for sure bets; instead, they are engaging in high-risk, high-reward investments. Today, the majority of VCs in India are searching for a tiny player that will provide them with significant growth and earnings. A startup hasn't yet proved itself, and investing in one carries a significant amount of risk since it is more dependent on market circumstances than an established company is.

Private institutional venture capital is a kind of investment that includes funding start-up businesses with a short operational history but significant growth and value-creation potential. A startup's equity ownership is often used as collateral for VC investments, which are typically high-risk, high-reward investments. The majority of the time, venture capitalists who are considering investing in a startup company seek for some kind of validation and/or new goods or services. Venture investing's tendency to incorporate mentorship and company strategy development is one of its key distinguishing features.


Institutional investors, financial institutions, insurance companies, pension funds, and HNIs contribute money to privately pooled investment vehicles known as venture capital. Investment companies with specific knowledge run and manage these fund pools. A VC firm operates in line with its predetermined investment thesis or philosophy, which incorporates different aspects they take into account before investing in a company. After taking into account a variety of variables and methods that the business has specified as a part of its thesis, VC firm investors make their investments.

Venture capital companies are categorised as Alternative Investment Funds in India and are subject to SEBI's 2012 (AIF) Regulations.


Finance in general, including venture capital finance, operates similarly. Businesses with development potential present their proposals to venture capital companies. In line with its investment thesis, the company checks and assesses several areas of the business. When a company meets the VC firm's criteria for investment, a contract is crafted.


Following are typical activities throughout each round of VC funding:

  • Startups address the venture capital company with their pitch or business proposal (s). Startups should do due diligence to make sure the objectives and tactics of the VC match their company's and sector's needs. Investors may now choose to approve the company, reject it, or ask for additional details.

  • Deep dive: If the VC likes the startup pitch, it will often proceed to this level. The investment company may delve further into the companies they find intriguing or investible.

  • Negotiation: If and when a venture capital firm chooses to invest in a company, they would arrange an agreement and share the term sheet/memorandum with the startup. In addition to the amount of investment and company value, this document includes the Terms & Conditions.

  • Verify authenticity- using due care Following the adoption of the term sheet, the venture capital companies conduct an extensive due diligence investigation to verify the deal's correctness and authenticity and to guarantee good governance.

  • Indisputable proof: Following an effective and satisfying due diligence process, the VC firm draughts and distributes final documents. Subject to any precedent or follow-up requirements that may be established throughout the due-diligence process, this is the last stage before the business receives a financial injection.


Investment in venture capital phases:

Startups would experience several phases or rounds of fundraising throughout the venture capital process, beginning with:

Entrepreneurs that are just starting out and require funding for R&D often participate in a seed round. This round has increased participation from angel investors.


Early-Stage Round: The company model may raise the first round of investment, also known as Series A capital, after it is ready and scalable. They may then pursue series B and C after that.


Late Stage: As the company develops and is ready for an IPO or an M&A, it may seek more funds later to provide ideal market circumstances for its initial investors.

A VC firm usually takes part in every important round of funding in order to gain additional equity shares and raise the legitimacy of a fledgling company. It aids in reducing risk and job distribution for enterprises.

In addition to other industries including direct-to-consumer (D2C), India in 2022 has witnessed significant investment in blockchain, Web 3.0, robots, and the Internet of Things (IoT). According to a recent Tracxnreport, early-stage VC investments in India (up to Series A rounds) increased by over 28% to $1.50 billion from $1.17 billion a year earlier.

Global venture investors have been vying for a piece of the rising Indian company for the last three years. Thus, it is a good moment for Indian entrepreneurs to polish their business ideas and expand their reach with maturity, speed, and profitability in the relevant current market issues, as well as a wider market definition.



What is the business model for venture capital funds?

Venture capital firms are specialised investment vehicles that invest in early-stage companies with strong growth potentials and innovation at their core. They do this by pooling money from smart investors.

A percentage of the profits earned by the company via its investment procedures is exchanged for the money that venture funds pool from their investors or limited partners (LPs). When a startup successfully exits the venture capitalists' investment, not when the investment is being made. In order to prepare a profitable exit and maximise profits, a typical VC company assesses a startup's growth at the time of investment. They often set a price at which they will sell, whether for a profit or a loss.

Although the ideal time for venture capitalists to depart a firm is when it is at its zenith, they sometimes improvise exit plans for the companies they have invested in. As a strategy to realise their rewards, venture capitalists may leave a firm in a number of ways.


IPO

Shares of a firm are offered to institutional investors in an initial public offering, also known as a stock launch, as well as typically to individual investors. A number of investment banks often underwrite it and make arrangements for the shares to be listed on a number of stock exchanges. In order to ensure they get the highest potential return, investors wait for the appropriate moment to launch an IPO.


The Secondary market

The secondary market approach is when a venture capitalist sells their stake in a secondary market—where investors buy securities or other assets from other investors—to a third party, often other venture capitalists. The key point in this scenario is that if the venture investor is eager to leave or take returns, the third party would acquire the shares at a reduced cost.


Stock repurchases

According to this plan, the company's founders will purchase the shares back from venture capital firms. In addition to facilitating an investor's speedy withdrawal from a company, this strategy benefits the latter by raising profits per share.


Acquisition

When a business purchases something from you, they make you give up ownership of it. In this scenario, the purchasing business issues a tender offer to all stockholders to buy their shares, often in cash at a premium above what the investors paid.

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