Business Finance from Venture Capital

 1   4542 times read   9 min 21 sec to read
 Business Finance from Venture Capital

The new alternative financing carries potential to promote startups with its collateral free and flexible nature.

--BY NIKEETA GAUTAM

Nepalis have come to a stage where many no more believe that entrepreneurship and business are only for the ones born in a well off families. Many creative young minds thinking of changing the scenario in economically potential areas are coming up with new business ideas.  Nonetheless, most of those entrepreneurial minds are not able to materialise their ideas due to the constraints in access to finance. While it is difficult for most aspiring people to take loans from banks for the seed and growth capital for their business initiatives that requires collateral and other guarantees, Venture Capital (VC) can be a feasible option for collateral free capital. VC basically is a business financing where investors provide to startups and SMEs money that have long-term growth potential. Such money from VC is as equity, not loan.

In Nepal, the growing number of startup companies in the recent years has led to the increase in venture funding activities. Currently, Biruwa Advisors, iCapital, True North Associates, Business Oxygen, Beed Management, Dolma Impact Fund, Gazzab Social Ventures and Udhyami Impact Fund are some organisations trying to create a space of venture capital in the country and providing startups with much needed investments. 

Aspects of VC funding
Venture funding is a new concept of business finance in Nepal. Organised venture capital activities started here only around 7-8 years ago. To get a VC funding, startups need to submit their business plans to the venture capital firm. After receiving the proposals, VC firm assesses some critical components including the business ideas and market potential of the products or services for investing. “No matter how good the idea is, when it goes to execution, we don’t know which direction it will take. So, Biruwa invests on the basis of the potential, passion and vision of the startup teams who apply for investments,” says Vidhan Rana, Founder and Managing Partner of Biruwa Advisors, a private enterprise that focuses on providing business services to entrepreneurs and businesses to help them grow their ventures. Earlier the firm was known as Biruwa Ventures. 

Looking at the international practices, VC firms after investing seed money in startups provide the growth capital in various rounds. They make sure that the venture is meeting the goals before adding another round of capital in case of need.  

“The early stage funding is quite risky compared to investing in an established company and the failure rate is 97 per cent. However, if the company earns targeted profit, the investment will be multiplied 100 to 1,000 per cent,” mentions Ajay Shrestha, Chairman and Managing Director of investment and holding company iCapital and Partner of private equity and venture capital firm True North Associates. 

Benefits
"VC funding not only benefits the startups by providing collateral free investment, but help the startups for networking as VC firms and the investors who provide them the money as equity are well connected in the business community,” opines Rana. According to him, the investors also bring business expertise which helps the startups and SMEs to take better decisions compared to the BFI loans that do not include such important business aspects.

Meanwhile, Shrestha says that active VC investors usually take responsibilities of specific functions of the startup companies that the young and relatively inexperienced founders find difficult to handle. “Such investors can provide active support in some critical business processes including the management, legal issues and human resource which helps the startups to grow efficiently,” he mentions.  

Raising the VC awareness
While young Nepali entrepreneurs are likely to have heard about VC funding, it is relatively a new investment terminology here. Experts stress on the need of raising the level of awareness about Venture Capital in order to foster the overall startup ecosystem. "Being a country where people are more societal in nature compared to the western countries, there is a culture of getting investments from family and friends to start business,” opines Rana. “The only difference is that VC funding and Angel Investment are foreign and new terms in our context and the methodologies are different from the conventional ways of investments.” Firms like Biruwa Advisors, iCapital, Business Oxyzen, True North Associates and Dolma Impact Fund are usually seen conducting various programmes targeting to fill the gap of understanding about Venture Capital among the youth entrepreneurs.

"Though entrepreneurship has become a buzzword over the past few years, many Nepalis who wish to become entrepreneurs have no proper understanding about entrepreneurship,” thinks Rana. He shares that many youths approach the VC firms without any general market research and even ask for an investment without any proper ideas. 

Need of legal framework 
 Despite the immense investment possibilities, absence of legal framework is holding back VC initiatives in Nepal. The legal provisions related to venture capital are mentioned in article 8 of the Bill to Amend and Integrate Laws Related to Foreign Direct Investment. According to the provision, the foreign investors can start venture capital firms in the country and invest in Nepali startups. “However, no such provision related to VC is mentioned in the Companies Act, 2063," says Abhay Paudel who is a Chartered Accountant and has been raising VC issues. 

Experts suggest the government and policy makers to first have clarity on the concept of VC before formulating rules and regulations.  “Authorities themselves have no proper understanding about the VC funding concept.  It is very important to study this subject in order to bring proper regulations and implement them effectively," stresses iCapital Managing Director Shrestha. 

Similarly, Poudel suggests some provisions to include in the amendment of the Companies Act, 2063, while creating the legal framework for venture capital in order to spur VC funding. According to him, the Act should make clear the status of institutionally registered VC firms whether they are financial institutions or investment institutions. “Similarly, formation of regulatory and governing bodies needs to be clearly stated so as to regulate and monitor the capital market developed through VC investments,” he says. Meanwhile, Poudel notes that it is important to have clarity about the areas open and restricted for VC firms to invest. "Also, the Act should clearly mention what per cent of venture funding can one entrepreneur receive from the total fund of the VC firms," he says. 

In the meantime, experts also see absence of legal provisions regarding the exit of investors from startup as major bottleneck. “We do not have laws for exit of investors which has been limiting the capital for startups from local as well as foreign investors. VC firms and their investors should be allowed to exit after certain years of investing in a startup,” says Shrestha.  

Global Scenario
Started in advanced western economies in the late 1970s, venture capital market gathered significant momentum and prominence in the late 1990s and early 2000s across the world. Nevertheless, the history of the initial attempt to organise and institutionalise VC activities can be traced back to 1950s in the United States with the introduction of Small Business Investment Act of 1958. The Act for the first time allowed the US authorities to issue licenses to investment companies to finance small businesses.   "The concept of organised venture capital investment came into existence in 1950s in US. But it progressed after 1979 when US government allowed corporate pension funds to invest in VC up to 10 per cent of the total fund and this rule was named as ‘Prudent Man Rule’," shares Poudel.  

According to him, venture capitalists specialise in investing in innovative companies with a huge potential for growth. Since investing in startsup is a risky proposition, venture funds usually refrain from investing large sum of money in a single company. He says that venture funds generally partner with other VC funds with each taking certain percentage of investment rounds to limit risks. “The current global trend shows that more than 70 per cent of VC funds have invested on IT-based companies," he observes. VC funds are attributed to the staggering growth of the Silicon Valley companies in the late 90s and thereafter.  Highly successful companies such as Facebook, Apple, Uber, and Google are some of the noteworthy projects developed through venture capital. Accel Partners, Clarium Capital, Bench Mark Capital, Helion Venture Partners, Fidelity Growth Partners, Early Bird, DN Capital, Index Ventures are some the active VC firms across the world.

In Europe, the venture capital is growing rapidly with the introduction of liberal regulations in many nations of the region.  After 1990, many European countries allowed pension funds to invest in VC.  As per Poudel, sources of money in VCs in Europe are similar to US including insurance companies, endowments, sovereign wealth funds and individuals. VCs accumulate funds from various sources in close-ended mechanism where funds are collected for a limited time, usually for 10 years. 

Meanwhile, in India, the first VC financing initiative started in 1988 with the establishment of Technology Development and Information Company of India promoted by ICICI Bank and UTI Mutual Fund. The Securities and Exchange Board of India (SEBI) regulates VC financing in the country with the SEBI (Venture Capital Funds) Regulations, 1996. As per the regulation, VCs are required to have a minimum of Rs 50 million from the investors to legally incorporate. It allows VC firms to invest less than 25 per cent of their total fund in one company. The legal framework permits 66.67 per cent of the investable funds to unlisted equity shares, whereas 33.33 per cent of investable funds can be invested in listed companies. 

Experts stress that with the rapid technological developments, it is high time for Nepal to introduce rules and regulation for alternative financing so that the entrepreneurs and would be entrepreneurs with innovative ideas can contribute their part in the growing economy.  Besides that, they also view that corporate venture funding can be another effective way to foster venture capital in the country. "Big corporate houses should invest in startups which can create a good business ecosystem," opines Biruwa Advisors founder Rana.

Gautam Kumud

Well-researched write up. Fast-paced technological evolution requires every organization (either established or a startup) to constantly innovate and come up with creative strategies to maintain the growth momentum, embrace latest technologies, keep pace with the competition, and woo the ever-demanding consumer base in today's age. Today, every organization is a technology organization as none can sustain without a strong technological backbone. Funding companies (either VC or PE) will only risk their capital for a product/idea/prototype that is fresh, unique, out-of-the-box, future focused, and promising in terms of Return on Investment. One advantage for us (India/Nepal) is we already have the list of success stories/case studies/modus operandi to refer to from the successful startups in the West (US/Europe), which can act as a guiding light. Thanks

"