Category: Venture Capital

The paper attempts to empirically study the monitoring and value added activities practiced by Indian Venture Capitalists. A brief literature review of the monitoring activities in the context of developed countries has been presented leading to the development of a conceptual framework. Data on the monitoring and value addition activities of the venture capitalists was gathered through

A questionnaire consisting of 30 statements using Likert Scale of 1 to 5 was developed to gather information on the monitoring and value addition activities of the Indian venture capitalists. The statements attempt to elicit the perceptions of the Chief Executives of 82 Indian Venture Capital firms on many critical issues such as strategic role, over monitoring, knowledge sharing and mentoring etc. An analysis of the perception based information led to the conclusion that the monitoring and value added activities in the Indian context are more or less similar to that of developed countries as evidenced in the literature review despite dissimilarities in content and scale. The paper concludes with a few suggestions and for further research in venture capital financing domain.

1. Introduction

Venture capital is a very distinguished form of financing as compared to all other traditional modes of finance. All the other financial intermediaries eg., banks, institutional or stock market investors assume a passive role while making the financial contribution in the different ventures, whereas the venture capitalists as a financial intermediaries take for granted the active role they play in the management of the enterprise. They may show a little reticence while interfering in decision making but hawkish monitoring of the performance of the enterprise is considered norm of the day. This is a given due to the huge business and financial risks venture capitalists assume on one hand and inexperience of the nascent, young, growth oriented ventures (bereft of tangible assets but having deeply invested intangibles) need on the other. Venture capital firms possess a very keen competence in selecting potentially promising ventures and once invested get very actively and skillfully involved in the ventures. The post investment process has been well researched and documented in the context of developed countries like USA and European countries.

1.1 Venture Capital Financing: Indian Scenario

India, currently a USD 3.3 trillion economy, has witnessed significant growth in venture capital financing during the past decade in terms of number of venture capital firms (both domestic and overseas VCFs), total venture capital fund size and geographical dispersion of the venture capital firms across the metro cities of the country and sectors – information technology, e-commerce business, healthcare and biotechnology firms etc.

The growth in venture capital finance (CAGR of 8% approximately) is also due to a number of factors such as increasing costs of traditional finance (institutional finance, stock market options and Public policy initiatives of the Government of India (Make in India, Start-up India etc.).

Further, it is observed that 90 to 95 percent of the venture capital financing has been in the form of preference equity with voting rights (Seema and Javaid, 2019). There exists an industry association of Venture Capitalists in the form of “Indian Private Equity & Venture Capital Association”. India is pursuing ambitious economic growth plans and aims to achieve USD 5 trillion by the 2025 and the venture capital financing activity is likely to grow further in the next couple of years.

Abundant literature is available on venture capital finance including its monitoring methods in the form of research studies, articles and books in print and digital mode. Much of the available literature is in the context of developed countries, but not much literature in the domain of venture capital is available in the Indian context, though it is witnessing an increasing trend of venture capital financing in recent years and hence this study.

The present paper, focuses on the post-investment, but pre-exit phase practices of Indian Venture Capital Firms (VCFs), particularly on the interaction between VCFs and their entrepreneurs (portfolio companies). The primary focus is on the content and processes of the interaction and how these two emerge in the context of interactive dimensions.

1.2 Objectives of the Study

The study has the following objectives:

• (a) To review some of the existing literature on venture capital financing and monitoring methods.
• (b) To empirically study the venture capital financing and monitoring practices employed by Indian Venture Capital Firms:

2. Literature review

The existing literature into research shows a very distinct categorization in the aspects of VCs’ involvement in monitoring activities and VCs’ potential to add value to the portfolio companies. However, research focused on exploring the actions of VCs (Tyebjee and Bruno, 1984; MacMillan et al., 1988; Rosenstein, 1988), what roles do they play and what contribution do they make in these roles. The existing literature exhibits a kaleidoscopic variety on both counts: i.e., what actually the VCs do (i.e. content related) and actually how do they do it (i.e. process related) (Gorman and Sahlman, 1989; MacMillan et al., 1988). Of late, the body of the research work concedes that the contribution of VCs’ monitoring and the extent and impact of value addition by them seems to be two dimensional. It is driven by both, the characteristics of ventures undertaken as well as that of Venture Capital firms itself.

Whereas the earlier researches laid more emphasis on the contribution made by VCFs towards the ventures and how this contribution maximizes the returns on investments, the precise dimension of how the value addition is created in the process of interaction between the two parties remained under-studied, both with respect to what type of information is exchanged (i.e., content-related issues), and how the parties interact with one another (i.e., process-related issues).

Michael (1989) in his study of 100 venture capitalist firms reported that they use up almost fifty percent of their time monitoring nine portfolio firms; of these, in five firms they (VCs) represent themselves on boards. In the remaining four, they devote 80 hours of on-site time and 30 hours of phone time per year to keep in direct touch with these firms. The three most frequent services carried out by the VCs were raising additional financial resources, carrying out strategic analysis and recruiting the management. The survey also revealed that Venture Capitalists replaced an average of three CEOs during their careers and they very often considered the weak senior management to be the principal reason of venture failure.

Harry (1992) posits that larger the degree of innovation involved in the venture, the higher the frequency of contact between the lead Venture Capitalist and the entrepreneur, and the increased openness in the communication, the lesser the degree of divergence of viewpoints among the duo, the greater was the value derived from the involvement. Subsequently the value of venture capitalists’ involvement was also found to be strongly positively correlated with performance of ventures.

The inferences from the dynamics of the VCs involvement are as follows: (1) value derived from involvement may differ with varying circumstances; (2) the effectiveness of VCs’ is high for those who maintain frequent, open communications while minimizing conflict; (3) opportunities value addition subsist in all ventures. Thomas and Manju (2000) examine the representation of venture capitalists on the boards of private firms in their portfolios. If venture capitalists are intensive monitors of managers, their involvement as directors should be more intense when the need for oversight is greater.

Andy et.al (2003) suggested a framework for portfolio management in terms of monitoring and value addition activities by Venture Capital Firms. Erik (2008) analyzes how an entrepreneur and an external investor allocate revenues and control among themselves and finds the predominance of preferred stock and convertible instruments in a venture capital relationship. Josh (2010) examines the representation of venture capitalists on the Boards of private firms in their portfolios companies.

Max et.al (2016) discuss the utilization of an internal control prediction market in the process of monitoring of venture capital financing. Arguably, venture capitalists (VCs) contribute immensely in the promotion of innovation and growth of portfolio firms. Shaiet.al (2016) confirm that venture capitalists’ (VCs) in-situ association with their portfolio firms leads to better understanding of companies’ activities, thus enabling increased innovation and the probability of a successful exit.

Dirk and Sophie (2017) highlight the existence of goal incongruence in conjugation with information asymmetry between the two parties, VCs and entrepreneurs, which may impact the periodicity, quality and the outcomes of interaction between them.

3. Methodology

Following the brief literature review presented above, a conceptual framework has been developed and the same is presented below in Figure 1:

Figure 1: Conceptual Framework of Venture Capitalist Monitoring and Value Added Activities

Currently (end of 2019), 195 Venture Capital Firms registered with Securities Exchange Board of India (SEBI -, the regulator of Venture Capital Finance in India), out of which 135 are active and the rest are dormant.

Consistent with the objectives of the study and the conceptual framework presented in Figure1, the following methodology has been followed:

A Questionnaire consisting of 30 statements related to strategic role, information related to monitoring and value addition activities of venture capitalists. The statements are rated on Likert Scale of 1 to 5 (1, being Least likely to Agree and 5, being Most likely to Agree). The Questionnaire was emailed to the Chief Executives of all the 135 active venture capital firms (considered as Population for the study). Out of the 135 Questionnaires emailed 89 filled in Questionnaires were received back. However, only 82 Questionnaires were filled in completely and the 7 Questionnaires which were incompletely filled in were not considered for the study and hence the effective sample for the study is 82, which corresponds to 7% Margin of Error and 95% Confidence Level.

The respondents (CEOs of Venture Capital Firms) are required to rate each statement on the Likert Scale of 1 to 5 with the following rated values:

Most Likely Not Agree (MLNA, Value 1)

Not Agree (NA, Value 2)

Neutral (N, Value 3)

Likely to Agree (LA, Value 4)

Most Likely to Agree (MLA, Value 5)

The study being explorative in nature, no Hypotheses are formulated. The study aims at understanding the managerial practices followed by venture capital firms in India and compare with that of international practices documented in the literature. The study concludes with suggestions for further research.

4. Analysis and Discussion

The analysis of the Statements and Responses is presented in Table 1, given below:

Table 1: Responses Statement wise

No Statements No. of Responses

1

MLNA 2

NA 3

N 4

LA 5

MLA

1. Venture Capitalist (VC)–entrepreneur relationship IS about VC monitoring the entrepreneur’s activities to keep track of VC investment and value added services provided by VC. 4 6 8 28 36
2. Representation on the Board empowers VC to ensure that the Portfolio firm carries out its business in a manner that serves the best interests of all its stakeholders. 6 12 7 25 32
3. As Board members, VCs get updates on business performance and strategic issues regularly. 2 3 12 27 38
4. As Board Members, VCs are empowered to seek all information including that of confidential (financial, technical and competitors etc.). 3 7 6 30 36
5. The provisions of the Contract/MOU entitles VCs to receive annual budgets, business forecasts, interim financial reports and audited financial statements. 6 8 8 30 30
6. In order to keep track of the performance vis- a- vis the pre-determined goals, VCs request additional information along with the interim financial statements. 6 6 6 22 42
7. VCs frequently call, send emails and visit their portfolio firms in order to gain additional management insights. 4 8 6 27 37
8. Informal communication by VCs with portfolio firms leads to useful information about business progress. 11 15 14 26 16
9. Periodic (Quarterly, Half yearly and Annual) Portfolio review sessions are conducted to assess portfolio firm’s prospects, progress and current value. 6 10 6 27 33
10. Based on evaluation of performance and future prospects, a VC may alter the portfolio firm’s strategy, initiatethe changes in the management team and search for a strategic partner. 4 7 23 28 20
11. If a VC perceives that a particular sector is showing more potential as compared to others, the VC may supplement more investment in the firm 16 19 10 18 19
12. The type of information sought by Venture Capitalists depends upon the stage and sector of a portfolio firm. 2 8 18 26 28
13. Generally, besides financial assistance, to add value to the portfolio company, VCs provide for networking with outside managerial talent, outsourcing agencies and important customers. 29 16 10 17 10
14. A learning relationship between VC and entrepreneur facilitates exchange of knowledge and expertise which will lead to value addition to the partnership. 14 12 18 22 16
15. The information needs of VCs varies/depends on the implementation stage of the venture – pre-revenue generation, revenue generation and Break-even stages. 21 17 12 21 11
16. VCs opt for diversification in order to reduce financial risk. 8 4 10 28 32
17. VCs are inclined to develop competence in a particular vertical or a particular development stage. 4 7 5 26 40
18. VCs’ specialization has a positive effect on their (VCs) overall portfolio performance. 8 12 14 20 28
19. VCs’ competence in a particular vertical makes it difficult for portfolio firms to suppress the strategic information regarding company performance 10 11 16 22 23
20. Entrepreneurs (Portfolio Companies) accept significantly lower valuations and higher dilution, if the VC has a better reputation and is expected to contribute more to the development of their venture. 9 13 12 28 20
21. Over monitoring reduces agency problems (conflicts between VC and entrepreneur). 2 4 4 32 40
22. Over monitoring increases costs due to greater involvement and governance 12 7 10 21 32
23. Intensive monitoring by VCs can be avoided by having detailed contracts or equity control as agreed upon prior to the investment decision. 9 13 8 28 24
24. Portfolio companies are not comfortable with over monitoring by VCs due to increased costs of information reporting. 24 16 12 12 18
25. VC monitoring has positive outcomes and leads to effective corporate governance resulting in quality reporting in financial statements from the perspective of external stakeholders. 18 22 8 15 19
26. Effective communication between the VC and entrepreneur will lead to understanding of information needs of each party and thus will lead to Goal congruence. 16 12 9 18 27
27. VCs opt to stagger their investments stage-wise in order to reduce the investment risk. 8 4 5 28 37
28. For the Portfolio firms, value adding services compensate for the high cost of Venture Capital. 18 14 9 15 26
29. It is commonly understood that there are two approaches to monitoring portfolio companies — Project based (or Content based) and Process related. The monitoring approach depends upon the type of venture, 11 17 12 26 16
30. The trust between VC and Portfolio Company is important for success of the venture. The monitoring methods and value added services of VCs will help to build the trust between both the parties. 10 12 8 28 24

Responses Most Likely Not Agree (MLNA) and Not Agree (NA) are bunched together and are considered as Unfavorable (UF) Category, Neutral Responses are considered as Neutral Category. Responses Likely to Agree (LA) and Most Likely to Agree (MLA) are bunched together and are considered as Favourable (F) Category and the same is presented in Table 2 given below. The percentages indicate the endorsement of the respondents for a particular statement.

Introduction

In 2009, after tumultuous times, economic activities increased once again and small and medium enterprises (SME’s) claimed their place as the backbone of the economy (European Commission, 2018). In order to understand how SME’s enabled the economy to climb we must first define SME’s. A SME employs less than 250 persons and have an annual turn no larger than €50 million and/or a balance sheet not exceeding €43 million (European Commission, 2003). Within the term SME fall the micro, small and medium enterprises. Small with a limit of 50 persons and €10 million annual turnover and small with a limit of 10 persons and €2 million annual turnover (European Commission, 2003). In this paper I will be researching the how venture capital can stimulate the growth of innovative small- and medium enterprises (SME’s).

SME’s represent 99% of all businesses in the EU and provide over 66% of the private sector jobs (European Commission, 2019). One could say that the SME’s form the backbone of the entire economy, thus it is of crucial importance that these businesses are able to grow and fulfil their potential (Lee, Sameen & Cowling, 2015). However, many SME’s face troubles in growing. Accessing financial funds can be troublesome, Freel (2007) found that the economy’s most important enterprises, being the innovative firms, often have the hardest time obtaining finance.

SME’s can experience growth through various roads, one of them is by using funding from venture capital firms to finance their growth. Venture capital is defined as equity financing (Wang, & Zhou, 2014). Investments are made into SME’s in exchange for a portion of the ownership, shares, of the firm. This entails that the SME does not acquire debt and this will decrease the impact on the liquidity of the firm (Wang, & Zhou, 2014). Most countries’ banks can solely provide debt financing, simply because they are not allowed to partake in equity financing, (Marx, 1998). According to Cassar (2004) firms the strive to achieve significant growth are more likely to use bank/debt financing. However, Cressy and Olofsson (1997) found that SME’s using debt financing on average have a lower growth rate. They add that the preferred type of financing depends on the size of the firm. Asset rich companies are more likely to request venture capital since they are more capable of carrying the debt (Cressy, & Olofsson, 1997)

Innovative and technological SME’s seeking to achieve (rapid) growth often lack the resources to finance their own growth, therefore they turn to external sources of financing that are of utter importance for, not exclusively, their growth, but also for the continuous existence of the SME (Beck & Demirguc-Kunt, 2006; Schneider, & Veugelers, 2010). Venture capital can provide the solution. SME’s that obtain venture capital are more likely to experience employee and revenue growth (Davila, Foster & Gupta, 2003). Davila et al. (2003) controlled their own findings by researching if growing SME’s attract venture capitalist or that venture capital leads to SME growth, concluding that venture capital indeed leads more growth. Therefore, this research poses the following research question: Is venture capital effective in stimulating growth in innovative SME’s, evident from Dutch technological SME’s?

This paper will contribute to the academic research by filling the research gap that is the effect on specifically innovative technological SME’s provided with the entrepreneur’s perspective. The research will achieve this by interviewing Dutch entrepreneurs, venture capital consultants and venture capitalists. Research focusses in this field focusses mainly on venture capital contribution to start-up companies, this research however, will focus on the expansion of existing SME’s.

Previous papers by multiple authors discussed that innovative SME’s struggle in obtaining financial funds, since innovation is hard to valuate and thus difficult to secure a loan against (Lee et al., 2015). Moreover, innovative firms offer no guarantee to success, a great number of innovative SME’s fail and make funder reluctant to provide funding (Lee et al., 2015). For this paper I will combine previous research done into growth of innovative technologically SME’s and 12 interviews conducted with entrepreneurs, venture capital advisors and a venture capitalist.

The research hypothesizes that venture capital will be effective in stimulating growth for technologically innovative SME’s. The stimulating effect will have multiple cause for the SME, however it is hypothesized that the growth will be stimulated by all aspects of the venture capitalists, being the new connections and network, the additional funding and the recruitment of new talent.

Literature review

Venture Capital can be best defined by separating the two terms; Venture is defined as “an activity that involves risk or uncertainty” (Cambridge Dictionary, 2019). Capital is defined as “a large amount of money used for producing more wealth or for starting a new business” (Cambridge Dictionary, 2019). Combining these to term explains that venture capitalists partake in activities that involve risk with money in order to capture more wealth. Venture capital carries different definitions in Europe and the United States. In Europe venture capital and private equity are similar terms. Unlike regular passive investors that solely invest money, the active private equity investors invest both money and time. The investors frequently join the board of directors or the advisory board in order to practice control over their investments. It is not rare that the active investors deliver a new CEO and other managers in the company (Jeng, & Wells, 2000). In the United states private equity is an overarching term that can also include leveraged buy-outs, the purchase of a company with borrowed money, uncommon finance methods in Europe and venture capital focusses on start-up firms (Jeng & Wells, 2000). Venture capital exists because of the cooperation of 2 types of partners, the passive and the active partners. The passive partners provide the funds from which the investments are made. These are among others insurance firms, pension funds or highly affluent individuals. Large funds are prohibited by law from being active investors and holding large equity stakes in companies, in the United States (Roe, 1990). The active partners are the venture capitalists, they manage the fund by investing in promising opportunities. Venture capital investments are done in high-potential companies and the venture capitalist will advise or control the company to secure adequate growth rates. The investors receive, in addition to their salary, a proportion of the profits made, which stimulates them to carefully nourish the investments (Samila, & Sorenson, 2011).

The importance of agreements between entrepreneurs and venture capitalist is increasing. These agreements often consist of 4 standard agreement. Firstly, monitoring frequency. Secondly, the frequency of internal process checks, the compensation schemes for the entrepreneurs to increase the motivation. Often the compensations are based on equity to stimulate the focus on growth (Jeng, & Wells, 2000). Thirdly, the activity of the venture capitalists in the board. Lerner (1995) shows that their presence is higher when the need for oversight is larger, however entrepreneurs are very reluctant with requesting venture capitalists in the board (Jeng, & Wells, 2000). Lastly, the presence of securities in the deal. A potential buy-out scheme for both parties in case the one decides to alter its ideas about the cooperation.

Alternatives. When entrepreneurs are seeking capital to fund their business or new branches of the business, they have many funding opportunities available, however not all are suitable due to the inherent entrepreneurial risk attached of entrepreneurship (Hellman, & Puri, 2000). Bank loans are the more traditional option for funding, yet for entrepreneurial funding, loans are given only sporadic. Often the amount of funding that startups need is not aligned with what traditional bank loans can offer. Adverse selection and moral hazard play significant roles moreover, the rules and regulations do not allow banks to invest when the firm’s hard assets are not enough to secure the potential losses (Jeng, & Wells, 2000). Startups often compensate the lack of hard assets with information, however this does not suffice in convincing traditional investors. Furthermore, in some countries, like the United States, banks are not allowed to hold equity, but in countries where bank are allowed to hold equity, Germany and Japan, bank are still not eager to use equity funding (Zider, 1998, Jeng, & Wells, 2000).

Self-funding is the first considered option for most entrepreneurs. This implies raising money from friends and family or from the entrepreneur’s own funds. The risk involved makes most entrepreneurs reluctant from requesting funds from friends and family (Fluck, Hotlz, & Rosen, 1998). Angels are wealthy individuals managing their own fund. Often angels are active in funding startup company, however the opportunity for receiving large sums of money is low (Gompers, 1994). Corporations offer loans as well by investing from their own investment fund in order to diversify their wealth (Hellman, Puri, 2000). The possibility of conflict of interest and increased bureaucracy is what might prevent entrepreneurs from using this type of funding (Block, & Milan, 1993). Venture capital is the only type of funding willing to take relatively high risks and therefore they operate in a special niche of investments, high risk entrepreneurial companies (Sawers, Pretorius, & Oerlemans, 2008).

It is important for entrepreneurs to be reminded that venture capitalists are often not interested in the firm and its capability itself. Their interest comes from the potential value of the firm. Many venture capitalists are not investing for the long-run (Zider, 1998). The aim of Venture Capital money is to facilitate an environment in which rapid growth can be achieved. To capture the rapid growth venture capitalists generally enter the firm when it takes the next step as a company, exploiting innovation. Estimates shows that approximately 80% of the VC investments made are into creating the infrastructure and environment for the exploitation of the innovation (Zider, 1998). The infrastructure and environment exist among others of bringing forth working capital and funds for manufacturing, marketing and sales.

When significant growth has been realized the venture capital firm wishes to re-sell (it’s stakes in) the company in order to translate their investment into profit. The reselling happens either by going public or be reselling to another corporation. Initial public offering (IPO) refers to when a private company starts selling its shares to the public for the first time in order to gain capital for the firm and/or for its shareholders (Ritter, & Welsch, 2002).

Investment stages. Venture Capital can be received in multiple stages of the SME finds itself in, these are called seed, startup and expansion investments. Seed investment entails that SME’s are seeking funds that are willing to help their ‘seed’ grow. The SME still finds itself in the idea stage, the received funds in this stage will be utilized for development and research of the product. In the startup phase, meaning that the firm is ready to produce, however that SME is still experiencing a negative cashflow and thus need funding. Since investments are done in the early phases these type of investments are simply called early stage investments (Jeng, & Wells, 2000). Furthermore, when an SME has grown passed the early stages, funding can be employed to finance further growth. Manufacturing and R&D operations can be expanded. This paper will focus not on early stages investment but on expansions stage investments.

VC management advice. The possibility to create technological advances is ever present, however to commercialize new technological techniques or products is different from developing it. Not all engineers have the required commercial techniques (Stam, Bosma, Van Witteloostuijn, De Jong, Bogaert, Edwards, & Jaspers, 2012). Many people are able to start a business, however not all are able to manage it properly, all project require the right entrepreneurial ability. Another opportunity for venture capital arises, they can offer passive and active advice or provide the SME with a matching manager to oversee and escort the project and to train the right people (Jeng, & Wells, 2000).

Venture capital risk factors. According to Jeng and Wells (2000) venture capitalists judge their investments by using main pillars, labor market rigidity, macroeconomic variables, fund providers and IPO’s. These are the four main determinants on which venture capitalist decide to invest and thus use to measure the rate to which the risk can be covered.

Firstly, labor market rigidities can form hurdles for the growth of an SME. Rigidities are different throughout cultures and reflect the geographic culture in which SME is based. Several factors can affect these hurdles such as working spirit and entrepreneurial acceptance. For example, returning to a previous job is frowned upon in Japan and often not even an option due to the perceived unloyalty of the employee, however in the United States employees are often encouraged to return to their previous employers (Lu, & Beamish, 2006). Labor market rigidities are often used to explain the difference in presence of venture capital in the United States and Europe.

Secondly, macroeconomics can affect the growth of the SME and thus the return on the investment (Lerner, & Tåg, 2013). Fluctuating macroeconomic circumstances influence the activity of start-ups (Acs, & Audretsch, 1994). Positive changes in the macroeconomic environment result in an increase of startup activity, this in turn results in an increase of venture capital activity (Jeng, & Wells, 2000).

Lastly, we will discuss the option of initial public offering. The main risk for venture capitalist is losing money, a realistic option that is frequently used is an “exit”. The exit mechanism provides the venture capitalist with the opportunity of exit the firm after a set amount of time (Hellmann, 2006). The exit only works when the SME has grown significantly so that the venture capitalists reach the required return rates of their investment. The exit strategy provides the entrepreneur with incentives as well for two reasons (Black, & Gilson, 1998). First, the entrepreneurs still own a certain percentage of the firm, with the exit their value can be determined and equity-based compensation will be paid out. Secondly, the entrepreneurs are offered the chance to buy back the control over the firm from the venture capitalists (Jeng, & Wells, 2000). An IPO is not only a way in which investments can be turned into cash, however a study conducted by Venture Economics (1998) shows that within a similar time frame an IPO on average yields a more than 4 times higher return. Moreover, deciding on an IPO is found more attractive by the entrepreneur, since he is able to regain control over the firm (Jeng, & Wells, 2000).

Abstract

This paper presents an overview of the German Corporate Venture Capital (CVC) market. As such, it can be considered as an industry report of the CVC-industry in Germany including vehicles of DAX companies and major players from Munich and the Ruhr area. The goal is, to give an overview of the CVC-market in 2019 and to describe characteristics of different vehicles. Based on a dataset and a qualitative analysis of ten interviews, the focus lays on how established corporations can benefit from their engagement with startups. The analysis includes dimensions like strategic goals, organizational and fund structures, investment criteria as well as targeted industries. The results show how diversely corporations engage with startups but that the vast majority prioritizes strategic collaboration over financial returns.

Introduction

Corporations constantly seek innovation in order to obtain a sustainable competitive advantage. As Segerstrom already discussed in 1991, especially quality leaders must be at the forefront of innovation to defend their position and offer state-of-the-art products and services in a market economy (Innovation, Imitation, and Economic Growth). The vast majority of German companies aim to be such quality leaders. Famous examples are the four automotive manufacturers from southern Germany Mercedes-Benz, BMW, Audi, and Porsche that offer premium cars at high prices in medium quantities and earn high margins (Curtin, 2015). But also German corporations in the B2B business focus on quality leadership like Siemens that aims to stand for “engineering excellence, innovation, quality, [and] reliability” (Siemens & mendix, 2018). Hence, German corporations must particularly focus on fostering innovation in their business. Currently, the global pace of innovation is increasing in all three sectors: University, government, and industry (Etzkowitz & Zhou, 2017). This trend is expected to increase further as induced by neoclassical theory (Grossmann & Helpman, 1994). Thus, established companies need to increase their innovativeness to stay competitive.

Since the “Dotcom Boom” especially innovation from agile startups has increased substantially and raised significant attention. Famous examples for start-ups disrupting established industries are Amazon in retail and Spotify in music and entertainment. Additionally, startups often create a culture that is more likely to foster innovation and agility. Currently, companies of all industries undergo substantial efforts to integrate parts of such collaboration (Ries, 2017).

After the financial crisis in 2008, interest rates for established companies in Germany were remarkably low while the DAX and cash reserves reached records which eases acquiring other companies that can bring supplementary innovation. In fact, mergers & acquisition (M&A) activity was boosted to a constant high level. So, it is no surprise that corporates are the most relevant exit channel for startups (Prüver & Weber, 2018). Unfortunately, standard M&A does not help established companies to use their excess capital in order to gain access to startups in their development phase (Institute for Mergers, Acquisitions and Alliances, 2019).

Hence, corporations are searching for possibilities to benefit from startups. A format that has become increasingly popular is Corporate Venture Capital (CVC). This paper will analyze how established corporations in Germany use such corporate venturing to sustain a “window on technology”, foster internal cultural change, increase efficiency in research and development, and exploit growth opportunities.

Although Corporate Venture Capital has just reached its preliminary peak in Germany, there have already been some remarkable investments made and financing rounds led by Corporate Venturing vehicle.

For example, Tengelmann Ventures led Zalando’s Series A and the seed round of Delivery Hero. It still is invested in one of the most valuable startups worldwide: Uber. Allianz X is a shareholder of N26, Daimler is the majority owner of mytaxi, and Henkel is still invested in ZipJet. This peak preview already shows the significance Corporate Venturing has obtained in startup financing. However, many corporations are not well known for their venturing activities to the public because they focus on B2B businesses where most of the investments are made.

The goal of this thesis is to describe the difference between Corporate Venture Capital units in Germany and traditional Venture Capital. Furthermore, successful case examples will be assessed to determine the factors that contribute to fruitful Corporate Venturing activities. This paper also takes a look at what motivates established corporations to engage with startups in their particular form.

The last comprehensive report about the German Corporate Venture Capital landscape in Germany was published by Christina Weber in 2005. Additionally, Weber examined Corporate Venture Capital activities in Germany over time while this paper will focus on the status quo and include an additional qualitative analysis using semi-structured interviews. Findings of this thesis will be compared with the conclusions of Weber’s report when applicable.

This paper does not comprise all Corporate Venture Capital firms of German firms but includes two clusters. Firstly, it analyses all Dax companies since they are the most valuable and impactful firms in Germany. Hence, they can potentially have the most impact on the market. Secondly, venturing vehicles of major companies from the industrial hubs of Munich and the Ruhr area are included due to their economic importance.

Introduction to Corporate Venture Capital

Venture Capital

Before Corporate Venture Capital in Germany will be analyzed, it is crucial to understand the basic principles of the investment type corporates are adopting. Traditional Venture Capital is “financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential. […]. [It] does not always take a monetary form; it can also be provided in the form of technical or managerial expertise” (Chen, 2019). In practice, Venture Capital firms support ventures along with their way until their exit or an IPO with financial and strategic support.

Venture Capital firms already invest in very young firms and are often the prime provider of substantial financial resources because startups do not have enough assets or history to be granted a loan from a bank. Hence, investments are made as equity contributions which means there is no repayment liability. At the same time, the VC is strongly incentivized to support the venture in its development to increase the equity value. On the other side, VCs can achieve umpteen returns on their investments when the enterprise value rises.

Traditional VC funds follow a business model dealing with great uncertainty. They commit to a large number of investments but only expect that a fraction of those will generate actual returns. Co-founder of the ambitious early-stage investor BECO Capital expects two out of ten carefully considered investments to provide positive returns. Very successful VC funds still manage to yield an internal rates of return[footnoteRef:1] (IRR) in excess of 50% because the potential value increase of a successful placement is enough to cover the losses of the others (Farha, 2016). To achieve such internal rates of return[footnoteRef:2] IRRs, venture capital firms usually seek to sell their stake of an investment at the maturity of the fund at the latest instead of developing the venture further. [1: The IRR is is “used in capital budgeting to estimate the profitability of potential investments. The internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero” (Hayes, 2019). A project with an higher IRR is more profitable relative to invested amount of money.] [2: ]

The venture financing market in Germany has been defined by two trends lately. Firstly, quarterly deal volumes have stagnated around $1bn and secondly, the number of deals has decreased to 80 in the fourth quarter of 2018 (Lavender, Hughes, & Speier, 2019).

It might be helpful to understand how traditional VC firms are structured to assess special characteristics of Corporate Venture Capital later on.

Venture Capital firms are usually formed as limited partnerships (Figure XX). The managers of the fund serve as General Partners and are active in the day-to-day business. Mere investors provide funding as Limited Partners and are prohibited from management and control (Zhang, 2017). Directly applied to Corporate Venture Capital, the parent could be the corporation acting as Limited Partner and the management of the Corporate Venture Capital vehicle as General Partners, but this would significantly restrict the immediate influence the parent company has on management of the fund.

Corporate Engagement with Startups

There are more opportunities for corporations to leverage their knowledge and network than Corporate Venturing. Weiblen and Chesbrough (Engaging with Startups to Enhance Corporate Innovation, 2015) categorize corporate engagement with startups and its respective goal in a matrix (fig XX).

The horizontal axis differentiates between inside-out and outside-in approaches. Inside-out approaches do not aim at increasing innovation in the firm but to leverage existing innovation of the firm outside of the company. The vertical axis differentiates between methods that involve equity investments and those that do not.

This paper focuses on corporate venturing which is used to participate in external innovation by the use of equity. Still, this paper will discuss two cases where a Corporate Venture Capital unit also works as an incubator where innovation takes the opposite direction, but the same competencies are required. Additionally, many Corporate Venture Capital units can include Startup Programs in their service portfolio since they build connections to the startup system anyway. Corporate Venture Capital is of such high importance to leaders of corporations because it includes the two most important criteria. Firstly, it involves substantial cash investments and has a direct impact on the financial performance of the firm. Secondly, it serves to bring in innovation and thus, impacts the strategy of the parent company significantly. In fact, all investment committees of the corporations examined in this thesis include at least one member of the board proving the significance of Corporate Venture Capital to corporations.

Corporate Venture Capital

In this thesis, Corporate Venture Capital is defined as “an alternative to traditional methods for growing a company in which a company invests in new products or technologies by funding businesses that have a reasonably autonomous management team and separate humans resource policies. The goals can be to develop products to expand the core business, enter new industries or markets, or develop ‘breakthrough technologies’” (Bain & Company). “New products or technologies” in the context of ventures are interpreted as startups that are not publicly traded and provide either a new business model or substantial product innovation. This definition requires strategic cooperation. As laid out in Strategies of German Corporate Venture Capital Units, no Corporate Venture Capital unit has only financial goals. This restriction is applied to exclude vehicles that solely focus on investing access cash or capital reserves like the “Global Growth” pension fund of Siemens. Such vehicles are opportunistic financial investors and not corporation specific.

Nevertheless, it will be discussed to what extent this international, standardized definition is applicable to the German market.

Furthermore, this definition is rather generic because companies interpret their venturing activities very differently. Also, it does not include any definition of the form of funding.

The significant difference compared to traditional Venture Capital is the goal definition. While the prominent goal of those firms is maximizing fund returns, Corporate Venture Capital units aim to achieve strategic goals for the parent company which can be very diverse (Renz, 2019). Usually, Corporate Venture Capital firms do not primarily focus on direct financial success since their investment focus is too restricted for a balanced portfolio. Instead, ventures mostly are used as opportunity for new revenue alongside base business growth, internal R&D, technology licensing, and acquisitions (Winters & Murfin, 1998). Furthermore, Corporate Venture Capital firms are mostly exclusively funded by one parent company (Witzler, 2001). This also contributes to a difference in motivation and operating principles. While General Partners of traditional Venture Capital firms exert significant demand to achieve excess financial returns, corporations as main to sole sponsor are closer connected to their venturing vehicle. Thus, they can actually enforce their strategic venturing plans.

The corporate venture capital market in Germany is growing in size and also its share of venture transactions. The reasons for the latter will be discussed in this thesis. Because the European Venture Capital market is very closely interconnected, reports for size of transactions focus on Europe instead of national submarkets. By the end of 2018, Corporate Venture Capital participation in venture deals was up to 25% growing with a CAGR of 9.6% over the last eight years (Lavender, Hughes, & Speier, 2019). (graphic)

Companies define various, individual goals for their Venture Capital Funds. Firstly, there can be financial goals. A focus on such results can lead to agency problems and moral hazard.

Additionally, there are manifold possible strategic objectives for corporations to fund a Corporate Venture Capital unit, such as:

• Growth Enhancement (Access to new technologies, preparation of acquisitions, safeguarding sources of components/resources, increase demand for (own) core products, extension of product range, observing new markets) Comment by Janka, Niklas: Quelle Inno
• Technology Observation[footnoteRef:3] (Antenna function, exploitation of strategic window, access to carriers of relevant technological knowledge) [3: Often referred to as „window on technology“ which offers “earlier and better access to innovations” (Financial Times, 2019)]
• Efficiency Enhancement (Access to efficient forms of R&D, synergy creation from complementary capabilities, limitation of technological development risk)
• Entrepreneurial Spirit Problem (Promoting entrepreneurial spirit via access to spin-offs, training and networking for managers)

Furthermore, companies might invest in start-ups for reputational reasons.

Tobias Weiblen and Henry W. Chesbrough (2015) claimed in their widely discussed paper Engaging with Startups to Enhance Corporate Innovation that Corporate Venturing has the opportunity to connect two different ecosystems. Hence, their unique value proposition for the company must be to grant access to entrepreneurial activities.

Advantages of Corporate Venture Capital for Startups

From the viewpoint of a startup, there are four main advantages in taking a Corporate Venture Capital unit as an investor compared to a traditional Venture Capital firm or also a business angel (Winters & Murfin, 1998).

Firstly, established corporations have substantial cash reserves and, more importantly, can commit capital in the long term because they do not have to raise money per fund but invest cash that already is earned.

Additionally, corporations have significant know-how in their respective field. Hence, they can support the startup intellectually. Some traditional Venture Capital firms operate as “company builder” which means they provide not only funding but also contribute significant operational assistance. More precisely, such firms support their ventures by deploying their executing employees directly in the startups. Corporations have a considerable advantage to support startups operationally since they have multiple times the workforce of any company builder and often include operational collaboration. Hence, no traditional Venture Capital firm can match the broad knowledge base of an established, multinational company.

Thirdly, the corporate name and the connected image is an asset. For the start-up, a highly respected shareholder can signal credibility to other investors and ease subsequent financing.

Finally, small firms cannot possess comparable marketing and distribution networks due to limited time, capital, and human resources. Thus, utilizing the system of an established player can accelerate growth and traction significantly.

Currently, there is a liquidity surplus on capital markets and, hence, Corporate Venture Capital firms differentiate by solving the most important challenge of start-ups to scale fast. Potential investors cannot stand out by their liquidity alone. (Brigl, et al., 2018).

Methods

To assess the landscape of Corporate Venture Capital in Germany, all Venture Capital vehicles of DAX 30 companies were assessed. Additionally, Tengelmann Ventures, Vorwerk Selling Ventures, Check24 Ventures and Holtzbrinck Ventures as representatives of the economic centers Ruhr area and Munich are included in the analysis.

In the first part, a comprehensive list (fig XX) was created comprising relevant information along the definition of Corporate Venture Capital by Bain & Company.

This thesis focuses on corporations that established vehicles that are responsible for equity investments in startups[footnoteRef:4] in order to create a common ground for comparability and develop recommendations for operating such vehicles. Overall, the following Corporate Venture Capital units were included: Hydra Ventures, Allianz X, BASF Venture Capital, Leaps, BMW i Ventures, Tech Invest, DB1 Ventures, Lufthansa Innovation Hub, Deutsche Telekom Capital Partners, E.ON Ventures, Fresenius Medical Care Ventures, Henkel-Ventures, M Ventures, innogy ventures, Sapphire Ventures, Next47, Tengelmann Ventures[footnoteRef:5], Evonik Venture Capital, Vorwerk Selling Ventures, Check 24 Ventures, Holtzbrinck Digital. [4: According to Stanford professor Steve Blank, a startup is “an organization formed to search for a repeatable and scalable business model” (Ready, 2012). This definition is applied in this thesis.] [5: Tengelmann Ventures is included in this analysis despite its dissociation from Kaiser’s Tengelmann during the takeover by REWE and EDEKA in 2016/17 (Mehringer, 2017). By the definition used in this thesis, it is not a Corporate Venture Capital anymore because it is not operating for a corporation. Hence, it is not included in the quantitative analysis but used for case examples.]

An exhaustive table of German corporations and their Corporate Venture Capital units included in this thesis can be found in German Corporate Venture Capital Units and Their Investments.

Some corporations engage with startups using other types of vehicles. Software giant SAP created the SAP Startup Accelerator that also enables young firms to connect with the company and provides similar advantages for SAP as a Corporate Venture Capital do. For instance, they collaborate with digital freight-forwarder Instafreight and are integrating its platform for booking shipments into the market-leading SAP enterprise resource planning (ERP) product. Thus, SAP can offer an increased service level. However, while goals are similar there is no equity investment and hence, it is no Venture Capital.

The key factors of Bain & Company’s definition of Corporate Venture Capital are the parent company’s growth objective, the innovativeness of the targets, the financial funding aspect and a to some extent autonomous management and team. Firstly, Corporate Venture Capital units of DAX companies and additional significant German Corporate Venture Capital units was be categorized along with these levers. Additionally, their fund and investment size[footnoteRef:6], target industry, and the extent of cooperation with ventures will be compiled. [6: When necessary, USD where converted to EUR at the rate of 1.12 USD/EUR on April, 1.]

The data were gathered on the respective fund’s website. Additionally, the Bloomberg Profiles and primary interview research was used to collect data.

Secondly, interviews were conducted with employees and General Partners of those funds in order to develop a deeper understanding. A rather qualitative than quantitative approach was selected for several reasons. Firstly, there is a limited sample size of less than 40 venturing units which means a very high response quota is needed to generate significant results. Secondly, the goal of this thesis is to assess what defines Corporate Venture Capital in Germany and what are its success factors. Therefore, Weber’s approach to categorize influencing factors on subjective scales did not seem to fit for these questions. For this research paper, subjective scales were used because the relevant issues were mostly qualitative.

The interviews contained but were not limited to the following questions:

1. Does the focus of your fund in the selection and development process lay rather on integration or financial success?
2. How does your fund collaborate with ventures? How close is the supervision? Do you collaborate operationally? Are other business units engaged in the collaboration?
3. What is the position of the investment vehicle in the organizational diagram of the corporation? Does the parent company individually permit investments or is there a distinguished fund? Which accountabilities are in place?
4. When have you experienced advantages as a Corporate Venture Capital Fund in comparison to a traditional Venture Capital Fund?
5. Which challenges do you face in collaboration with the parent company and ventures?

The interview was extended to cover additional questions or experiences the interviewee brought up. Hence, the format was semi-structured to cover relevant information but was flexible to adjust for additional insights. The planned duration of an interview was between 15 and 30 minutes.

The interviews were conducted via phone, video call or face-to-face and audio recorded. For Holtzbrinck Ventures and Vorwerk Selling Ventures, single questions were answered via electronic communication. A detailed overview of all interviews conducted can be found in the appendix.

Results

German Corporations with Venture Capital Units

15 of 30 Dax companies have at least one vehicle that matches the definition of Corporate Venture Capital in this thesis. Interestingly, there is no apparent correlation between the industry of the parent company and activity in the field of Corporate Venture Capital. The average fund size of the selected Corporate Venture Capital units is €530m. However, few Corporate Venture Capital units have distinct funds but often invest firm money as they see fit. In these cases, money actually invested was considered as fund size. Hence, in comparison to traditional VCs, funds are underestimated for the vast majority of the vehicles that do not have a fund since only money actually invested was considered as funding.

However, €530m of average fund size is a remarkable number and again shows the importance corporations attribute to their venturing activities. This also enables corporations to make an impact on capital markets for startups.

Strategies of German Corporate Venture Capital Units

Traditional Venture Capital firms focus their strategy on achieving an IRR on funds that justifies the risky investments. Corporate Venturing can pursue either financial, strategic or a mixture of both goals since their funding is provided by one principal that has a distinctive strategy. Hence, a corporation can use its Corporate Venture Capital unit as part of its strategy.

Interestingly, there is a significant correlation* (fig XX) of 0.72[footnoteRef:7] between the development of the EuroStoxx and the total amount of Corporate Venture Capital invested in Europe[footnoteRef:8]. Both indices peak in the economic boom of 2017. While the amount of money invested decreased slightly afterwards, Corporate Venture Capital still increased its share of the deal count showing the growing importance of this type of funding for startups. This suggests corporations either see Corporate Venturing as an attractive option for financial returns in times of excess cash or they could not utilize strategic investment opportunities when cash was short. The graph also visualizes that the relative change of invested money is a multiple of stock price development showing investments into ventures is rather a bonus than a necessity to many corporations. Because stock price is only one of many influencing factors, linear, polynomial, logarithmical, and exponential regressions result in R2 below 0.6. [7: n=36; t=2.1; p

Abstract

The study exhorts to ascertain the general perception that Venture Capitalists fund innovative technology projects in the Indian context using primary and secondary data. A structured questionnaire was used to elicit response from 101 (sample) out of 134 (Population) SEBI registered and active Venture Capital firms in the recent past.

The study analyses the mode of funding by Venture Capital firms and their geographical dispersion. The study ascertains whether Venture Capital firms have enabled innovation in the Indian context during the recent past or not. Finally, the study concludes that Venture Capital Investments have not been very enabling for innovative technologies in the Indian context, which is contrary to the relevant literature available in the context of USA and other developed nations.

KEY WORDS: Venture Capital, Innovation, Technology, Start-up, Investments.

1. Research Context

According to Samuel and Josh (2000), the start-ups backed by Venture Capital would be more innovative than the others; considered to be a promising mechanism to support innovation and growth (Gompers & Lerner, 2001); a specific type of finance, well-suited to the equity needs of firms based on innovation; risk capital, different from the conventional sources of finance in terms of return and risk. However, as Venture Capital activities grew they became more formalized and started managing large pools of capital. Over the years, the more generic term of ‘private equity’ was coined to encompass a variety of transactions relating to venture capital investments in companies providing high return opportunities.

It is supposed to address the “equity gap” by providing financing and tools to innovative start-ups during the first stages of innovation (Florida et. al Kenney, 1988 and leading companies would then invest in corporate venture to develop their innovative capabilities (Engel, 2011) (Birkinshaw et al., 2002). It has also become a means for public policy to foster some technological or environmental transitions, for example, Cleantech (Hargadon et Kenney, 2012).

However, recent research (Mason and Harrison, 2002) reveals that the profitability of venture capital funds is rather low and that their impact on innovation is more uncertain than expected, thus putting the model of venture capital itself into question. This raises the opportunity to review the canonical model of venture capital as presented by the economic and management literature, to exhibit its major assumptions and to assess whether these assumptions have been verified in practice for the past decades. As a mechanism to foster innovation for young firms in highly technological and capital-intensive sectors, authors also think that it is of interest to question whether this model takes recent advances in innovation management into account, or whether it is a mostly finance-based model that does not try to couple with a representation of innovation processes or not?

India, the second most populated country in the world with more than 1.24 billion people (Census, 2011), has emerged as one of the fastest growing economies in the recent years. With the projected compounded annual growth rate of 9%, India’s GDP is likely to be US$3.26 trillion by 2020 (Statista, Source: Statista, https://www.statista.com/statistics/263771/gross-domestic-product-gdp-in-india/). India has been doing well in IT/ITES industry; it is still a low-cost developer and service provider. As India continues its rapid growth path, several sectors of the economy such as telecom, FMCG, infrastructure and education are growing rapidly and offer significant opportunities for venture capital.

IT & ITES companies accounted for 45% of the venture capital financing led by Flipkart, Paytm and GlobalLogic- attracting US$10.7 billion across 325 deals. The prominent sectors are BFSI, Telecom, Energy, Healthcare, etc. It was reported that by the end of November 2018 the Venture Capital funding for start-ups had raised close to $11 billion in equity funding. By the end of December 2018, the figures had increased to $12.68 billion in equity funding, plus $1.14 billion in debt funding, taking the total to $13.88 billion. That’s a shade over the $13.7 billion raised in equity and debt combined in 2017. (https://yourstory.com/2019/01/2018-india-startups-funding-roundup-unicorns).

For the purpose of this study, innovation/innovative technology is defined as a new technology for commercial use or an existing technology with some modifications/ improvements resulting in new products/new services/new applications for commercial use. The study attempts to ascertain whether the recent (during the last three years, 2016-18) venture capital investments had supported innovation in the Indian context as per the “innovation” or not? The reason for choosing this time frame is because of surge in venture capital financing and IT/ITES sector, which accounted for 45% of the venture capital financing during the year 2018. Also, India has introduced Make in India and Start up India campaigns in the years 2014 and 2016 respectively. The Make in India campaign is an attempt to make India a global manufacturing hub, while the Start-up India campaign is designed to encourage entrepreneurial talent.

2. Literature Review

Richard & Martin (1988) find that venture capital transformed the innovation process in the USA. Venture capital financed innovation is a new model of innovation catalysing technological change.

Paul & Josh (2001) find that the manners in which venture capital funds are raised and structured, the capital is invested in young firms, and these investments are concluded are now much better managed.

Samuel & Josh (2002) examine the influence of venture capital on patented inventions in the United States across twenty industries over three decades and address concerns of causality in several ways.

Colin & Richard (2002) analyse the returns of venture capital investment, and find that the distribution of returns is skewed, with 34% of exits with negative returns, 13% at a partial loss or break even, but with 23% showing an IRR of 50% and above.

Bowonder & Mani (2004) trace the evolution of venture capital support for innovation in India, particularly the government supported schemes and suggest that Venture Capital has strong linkages with innovation-based Clusters.

Masayuki & Masaka (2008) conclude that venture capital investments stimulate innovation.

Roberta & Nina (2010) study the impact of venture capital on innovation as evident by the number of patents filed at the industry level. Further, they argue that a dollar of venture capital appears to stimulate innovation, three to four times than a dollar of traditional corporate research finance.

Eduards (2011) brings to light that revenues of venture-backed companies accounted for 21 percent of U.S. GDP and in 2008 employed more than 12 million people. Job and revenue growth within this private equity market significantly outperformed the overall economy for years.

Andrew & Martin (2012) argue that three key conditions are necessary for venture capital to successfully open new economic spaces and the study concludes that large loan guarantees are unlikely to be effective.

Juanita (2013) delves into the relation between venture capital and innovation by comparing the number of paten filings, and the quality of innovations, before and after companies are financed by venture capital investor.

Kevin, Blanche and Armand (2014) find venture capital to be a key link in the complex chain of financing for young innovative firms. By helping them at critical stages of innovation development, it helps an economy to leverage its public research and sustain growth.

Cheng et. al (2019) estimate the impact of venture capital on innovation, employment, and payroll in Chinese metropolitan area. Results show that VC is significantly contributing to the metropolitan economy as a whole by supporting innovation, creating jobs, and generating wealth in local cities.

3. Objectives of the study

1. To analyse the geographical dispersion of venture capital funding for innovation in India.
2. To analyse the mode of venture capital financing by venture capital organisations (Seed funding/Angel funding/Debt funding/Private Equity).
3. To study the perception of Venture Capital Organisations towards financing of innovative technologies in the Indian context.
4. To ascertain whether venture capital investments have supported (enabled) innovation in India during the period of study.

3. Research Methodology

In order to achieve the four objectives as detailed above, the following methodology has been adopted:

Objective (i): To analyse geographical dispersion of venture capital funding (VCF) projects in India.

Analysis of Secondary data of their geographical dispersion of VCF (available at: https://trak.in)

Objective (ii): To analyse the mode of venture capital funding (VCF) by venture capital organisations (Seed funding/Angel funding/Debt funding/Private Equity).

Analysis of Secondary data of their mode of VCF (available at: https://trak.in)

Objective (iii): A structured Questionnaire consisting of 10 questions was developed. The study is based on primary data based on a structured Questionnaire as per the details given below:

Population: There are 191 SEBI (Securities Exchange Board of India) registered Venture Capital Organisations (VCO) in India, out of which 134 are active which is considered as population for this study. A pilot testing of questionnaire was made from the point of comprehensibility, logical sequencing etc. and appropriate amendments were made to make the questionnaire understandable.

Questionnaire had been sent to 134 VCOs through e-mails and follow up was done through calling and messaging. 109 responses were received, out of which 101 responses were found complete in all respect. The sample size is 101 (at 95% Confidence level and the Margin of Error (MOE) is 5%).

Qualitative analysis of the responses (question wise) has been presented, (Source: https://trak.in)

Objective (iv): To ascertain whether venture capital investments have supported (enabled) innovation in India during the period of study or not.

Data Variables (Dependent):

• (a) No. of Venture Capital financed deals
• (b) Total amount of Venture Capital financing (US Dollars)
• (c) No. of Venture Capital financed deals (Innovative technologies)
• (d) Total amount of Venture Capital financing of Innovative technologies (in US Dollars)

4. Analysis

(a) Objective (i)

Table 1: Geographical dispersion of Venture Capital Funding

Cities

No. of Deals

Total

2016

2017

2018

Ahmedabad

18

8

6

32

Bengaluru

294

226

100

620

Chennai

31

24

16

71

Delhi NCR

335

198

82

615

Mumbai

188

141

61

390

Other Areas

152

90

43

285

Total

1018

687

204

1909

It is seen from the above Table that Bengaluru and Delhi NCR have emerged as the major venture capital financing cities in India.

(b) Objective (ii)

Table 1: Mode of VCF for Innovative Technologies

Year

Mode of Funding

Total funding

(US$ billion)

Seed

PE

Angel

Debt

2016

3.08%

96.92%

Nil

Nil

3.90

2017

0.07%

98.85%

0.04%

1.04%

10.42

2018

5.00%

79.60%

15.00%

Nil

3.70

From the above Table, it is seen that the preferred mode of Venture Capital Financing for innovative technologies is PE (Private Equity).

(c) Analysis of the Questionnaire (Objective (iii))

1. 48% of the VCOs (VCOs) prefer High Risk-High Return while 42% of the VCOs indicated that their Risk-Return profile depends on the innovativeness of the project.
2. Most (95%) of the VCOs indicate that their expected rate of return is 20% and above, while 57% prefer a return of 25 to 30 percentage and above.
3. 62% of the VCOs prefer considerably higher rate of return than the prevalent market rate for innovative technologies, while 14% of the VCOs prefer initially high return but gradually stabilizing around market return in the later years.
4. 48% of the VCOs perceive a technology to be innovative, if it is ground breaking technology, while 33% perceive an innovative technology to be of a game changer in the industry.
5. 33% of the VCOs state their objective to promote innovative technologies is for diversifying their portfolio of investment, while 33% indicate their objective for such investments is for creating greater value for their asset portfolio.
6. A majority (67%) of the VCOs prefer Angel/Seed financing mode for innovative technology based firms, while 33% of the VCOs prefer private equity mode.
7. 57% of the VCOs prefer initial high risk but gradually would like the risk to stabilize around market risk for innovative technology firms.
8. 33% of the VCOs perceive innovative technologies to be of Quantum Computing and Machine Learning that would have potential of generating better return in future, while another 33% of the VCOs perceive Artificial Intelligence and 3-D printing to be innovative technologies and have the potential for better returns in near future.
9. 52% of the VCOs fund the innovative technology firms due to the excitement of breaking into new Technological frontiers, while 43% of the VCOs fund the innovative technologies for very high return and corporate branding.
10. 43% of the VCOs indicate that if innovative projects do not perform as expected, they would review the project plans and invest more funds in the medium term with better monitoring, while 43% of the VCOs indicate that they will invest more funds on a long term basis and get involved more actively in strategic and operational matters.

(d) Objective (iv) To ascertain whether venture capital investments have supported (enabled) innovation in India during the period of study.

Data Variables (Dependent):

• (a) No. of Venture Capital financed deals
• (b) Total amount of Venture Capital financing (US Dollars):
• (c) No. of Venture Capital financed deals (Innovative technologies)
• (d) Total amount of Venture Capital financing of Innovative technologies (in US Dollars):

Table 3: Financing of Innovative Technologies

Variable

2016

2017

2018

No. of Venture Capital financed deals

1018

687

308

Total amount of Venture Capital financing (US Dollars Billion):

3.9050

10.4290

3.6971

No. of Venture Capital financed deals (Innovative technologies)

77

66

34

Total amount of Venture Capital financing of Innovative technologies (in US Dollars billion)

0.4567

0.2618

0.1428

Innovative Deals to Total Deals (percentage)

7.56

9.61

11.04

Innovative Financing to Total Venture Capital Financing (percentage)

11.70

2.51

3.86

From the above Table, it is seen that the percentage of Innovative financing to Total Venture Capital Financing is quite low over the past three years pointing towards low support for innovative technologies in the Indian context.

Conclusion

The study researches the general perceptions and beliefs about funding of innovative technologies by Venture Capital Organisations (VCOs) in the Indian context based on primary and secondary sources of information over the past three years. The responses through the questionnaire highlight that VCOs are more inclined to fund innovative technologies if the returns are high and commensurate with the high risk involved with such projects and the expected returns are above 25% plus Return on Investment (ROI). The VCOs consider technologies to be innovative if they are Ground breaking/Game changer technology in the industry. The other important findings of the study have been that VCOs prefer Private Equity (PE) mode of financing and only a small percentage of the total funding goes towards financing innovative technologies. The Survey results are in contrast to the evidence available in the literature particularly in the context of US and other developed countries.

References

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