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VCs not thrilled about removal of 40% cap

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CIOL Bureau
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By J.R. Bashyam





DQ Week News Bureau





CHENNAI: Finance Ministry's move to eliminate the regulation that the investment of a single venture capital fund should not exceed 40 per cent of a start-up company's equity base has failed to enthuse the venture capital industry in a big way. The reason: the latest policy change is neither seen as one that eases the stifling regulatory regime nor perceived as of any great help in furthering the flow of venture capital.

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"This particular decision to remove the curb on a venture capital fund's exposure in a start



up or any other investee company is not likely to evoke broad smiles among venture capitalists. With countless unimaginative regulatory norms still in place, scrapping the exposure limit alone would not result in larger flow of funds. Nevertheless, it is a step in the right direction, small though," said Sankaran P. Raghunathan, Chairman, Blueshift Internet Ventures, a subsidiary of Blueshift India Private Limited.

While the government has chosen not to fix a ceiling on the extent of investment a VC fund



could make vis-à-vis the paid-up capital of a start-up, another norm which restricts the VC funds to invest only 25 per cent of their fund base in a company still exists. However, according to finance ministry sources, doing away with the 40 per cent limit would be of much help to the VC industry, as such a move paves the way for venture capitalists to take 100 per cent equity in a new company.

This optimism on the part of the regulators is not shared by the VC industry players. In the information technology sector, the average size of a VC deal today being in the region of Rs 2.5 crore and with many VC funds operating with a corpus of around 50 crore, few fund operators would have the inclination or the resources to take the entire equity of a start-up, VC industry sources say.

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Said Raghunathan, "A venture capitalist, like any other investor, looks for returns. Though



VC funding carries a higher risk, it is minimized by taking the co-funding route. In the US, for instance, the venture capitalist who first identifies the high-growth prospects of a start-up plays the role of the lead venture capitalist. Typically, he brings in a host of other VC funds. Co-funding reduces the individual exposure and, in turn, the risk is shared by more than one VC player."

Recently, a committee appointed by the Securities and Exchange Board of India (SEBI) and



headed by V. Chandrashekar of US-based Exodus Communications came out with a set of recommendations. The committee with Hotmail founder Sabeer Bhatia and Stanford Professor Rafique Dossani, among others, as its members, called for far-reaching changes in the current regulatory framework for VC funds. While making a strong case for a single window clearance under SEBI, the committee has also suggested that VC funds be treated on par with investments made by foreign institutional investors (FIIs).

It also felt that the requirement of a three-year track record for accessing the capital market through an initial public offer (IPO) may place the VC funded companies at a disadvantage. And the committee expressed itself in favor of allowing 30 per cent of a VC fund's total corpus to be invested in IPOs or preferential allotments or even debt instruments. "All too often, the multiple regulatory regime for VC funding works in cross-purposes. From registering a name of a company to issuing an initial public offer to making an exit from a venture, the road is full of procedural hurdles for both entrepreneurs and venture capitalists. Instead of attempting piece-meal changes, the policy makers could come out with a comprehensive set of rules modeled on the Securities Exchange Commission of the US," said Raghunathan.

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