Venture capital funds (VCFs) invest in emerging businesses and start-ups with strong growth potential. Unlike mutual funds, which mainly invest in established listed companies, a VCF invests in many early stage promising businesses. At the time of the launch, VCFs may specify sectors that it will target.
Venture capital is a type of equity financing where the VCF provides funds to companies in exchange for equity stake in the firm. In addition, venture capitalists also participate in company operations to help them grow. These funds generate returns when they sell off their stake in the companies.
Features:
A high risk-high return investment
Low liquidity
Long investment horizon
A chance to invest in innovative companies
Returns
As this is equity financing, there are no promised returns. If a start-up bet pays off, returns can be very high. Typically, these funds charge a management fee of around 2%. In addition, if the returns cross a minimum rate called the hurdle rate, as disclosed in the prospectus, the VCF may take a share of those profits.
Structure and regulation
Under SEBI guidelines, VCFs come under AIF (alternative investment fund) Category 1. Angel funds are a sub-category of VCFs, which provide seed capital to businesses. While earlier VCFs came under a separate guideline (Venture Capital Guideline 1996), post 2012 all new VCFs need to be launched under AIF 1 as per SEBI guidelines. Here are some key features of VCFs.
- They are close-ended funds and come with a minimum tenure of 3 years (can be extended by additional 2 years, subject to approval of unit holders of AIF)
- Can be listed in stock exchanges with a minimum tradable lot of Rs.1 crore
- Cannot invest more than 25% in one company
- Can invest in their own sub categories (venture capital, SME, infrastructure, social venture) but cannot invest in fund of funds.
- They are not allowed to borrow funds directly or indirectly to run their operations.
Commissions
AIFs typically offer an upfront commission in the range of 2% to 3% to distributors depending on the type of AIF. However, the structure and quantum may vary from fund to fund.
Current markets
Blume Ventures, Chiratae (foremerly IDG Ventures India) and Venture Catalyst are a few big VCF players in India. Blume Ventures mobilised investments of over US$ 40 million in 2018 through its VCF.
Generally, HNIs, UHNIs, corporates and the government (SIDBI) invest in VCFs. A news report in 2018 stated that HNIs and UHNIs are increasingly participating in VCFs. In 2017, of the Rs.177.45 crore raised by venture capitalists, Rs.110 crore came through HNIs and ultra HNIs.
Attractive upfront commission and growing appetite for VCFs among wealthy investors make them an interesting business opportunity for advisors.