REPORT OF K B CHANDRASEKHAR COMMITTEE

ON VENTURE CAPITAL

1.0 PREFACE

1.1 Technology and knowledge based ideas will drive the global economy in the 21^st century. India�s recent success story in the area of information technology has shown that there is a tremendous potential for the growth of knowledge based industries. This potential is not only confined to information technology but is equally relevant in several areas such as bio-technology, pharmaceuticals, media and entertainment, agriculture and food processing, telecommunication and other services. Given the inherent strength by way of its human capital, technical skills, cost competitive manpower, research and entrepreneurship, India can unleash a revolution of wealth creation leading to employment generation and rapid economic growth in a sustainable manner. What is needed is risk finance and venture capital environment which can leverage innovation, promote technology and harness knowledge based ideas.

1.2 In the absence of an organised venture capital industry, individual investors and development financial institutions have hitherto played the role of venture capitalists in India. Entrepreneurs have largely depended upon private placements, public offerings and lending by the financial institutions. In 1973 a committee on Development of Small and Medium Enterprises highlighted the need to foster venture capital as a source of funding new entrepreneurs and technology. Thereafter some public sector funds were set-up but the activity of venture capital did not gather momentum as the thrust was on high-technology projects funded on a purely financial rather than a holistic basis. Later, a study was undertaken by the World Bank to examine the possibility of developing venture capital in the private sector, based on which the Government of India took a policy initiative and announced guidelines for venture capital funds (VCFs) in India in 1988. However, these guidelines restricted setting up of VCFs by the banks or the financial institutions only. Internationally, the trend favoured venture capital being supplied by smaller-scale, entrepreneurial venture financiers willing to take high risk in the expectation of high returns, a trend that has continued in this decade.

1.3 Thereafter, the Government of India issued guidelines in September 1995 for overseas venture capital investment in India. For tax-exemption purposes, guidelines were issued by the Central Board of Direct Taxes (CBDT) and the investments and flow of foreign currency into and out of India is governed by the Reserve Bank of India (RBI). Further, as a part of its mandate to regulate and to develop the Indian capital markets, Securities and Exchange Board of India (SEBI) framed SEBI (Venture Capital Funds) Regulations, 1996.

1.4 Pursuant to the regulatory framework mentioned above, some domestic VCFs were registered with SEBI. Some overseas investment has also come through the Mauritius route. However, the venture capital industry understood globally as "independently managed, dedicated pools of capital that focus on equity or equity-linked investments in privately held, high-growth companies" ("The Venture Capital Cycle", Gompers and Lerner, 1999) is relatively in a nascent stage in India. Figures from the Indian Venture Capital Association (IVCA) show that, till 1998, around Rs.30 billion had been committed by domestic VCFs and offshore funds which are members of IVCA [Not all overseas venture investors and domestic funds are members of the IVCA.] Figures available from private sources indicate that overall funds committed are around US$ 1.3 billion. Investible funds are less than 50% of the committed funds and actual investments are lower still. At the same time, due to economic liberalization and increasing global outlook in India, there is increased awareness and interest of domestic as well as foreign investors in venture capital. While only 8 domestic VCFs were registered with SEBI during 1996-1998, an additional 13 funds have already been registered in 1999. Institutional interest is growing and foreign venture investments are also on the increase. Given the proper environment and policy support, there is tremendous potential for venture capital activity in India.

1.5 SEBI initiated interaction with industry participants and experts in early 1999 to identify the key areas critical for the development of this industry in India. The Finance Minister, in his 1999 budget speech had announced that "for boosting high-tech sectors and supporting first generation entrepreneurs, there is an acute need for higher investment in venture capital activities." He also announced that the guidelines for registration of venture capital activity with the Central Board of Direct Taxes would be harmonized with those for registration with the Securities and Exchange Board of India. SEBI, decided to set up a committee on Venture Capital to identify the impediments and suggest suitable measures to facilitate the growth of venture capital activity in India. Keeping in view the need for a global perspective it was decided to associate Indian entrepreneurs from Silicon Valley in the committee. The committee is headed by K.B. Chandrasekhar, Chairman, Exodus Communications Inc., California, USA and consist of industry participants, professionals and the representatives from financial institutions and RBI. The list of the committee members is given in the Annexure �I.

1.6 The setting up of this committee was primarily motivated by the need to play a facilitating role in tune with the mandate of SEBI, to regulate as well as develop the market. The first meeting of the Committee took place on August 5, 1999 and followed by further deliberations by the Working Groups formed by the committee to examine the issues related to Structure and Fund Raising, Investment Process, Exit and Vision for the Venture Capital Industry in India. The draft recommendations of the committee were formulated in the meeting of the committee held on December 8, 1999. The draft recommendations were released for public comments and after considering the feed back, the report was finalised in the meeting of the Committee held on January 8, 2000.