Additionally, gestation periods tend to be long. Observes Vishnu Varshney, 50, the CEO of Gujarat Venture Finance (GVF): "Seed financing is all about patience. We have now begun questioning the wisdom of investing in start-ups." In 1990, all the 11 projects financed by GVF's first fund were start-ups; only one was based on a non-original technology. But GVF's second fund, which boasts of a Rs 60-crore corpus, will have a markedly-different investment profile, with upto 90 per cent being invested in private equity.

In part, this migration, away from the high-risk, high-return world of start-ups, reflects a global trend. Venture capital as an organised industry has evolved to a high degree of sophistication and maturity in the US. Yet, an informal network of high net worth individuals, popularly known as angels, constitutes the single-largest source of seed capital. And the bulk of institutional capital is targeted at expansion-stage financing since it is much less risky. Clearly, start-up financing will remain a somewhat-fragmented and individualised activity.

Institutional funds will be forthcoming only if the business mission dovetails neatly with policy-identified thrust areas, and the proposed project is a modest one. Technopreneurs like P.C. Jain, 40, the managing director of the Vadodara-based Ankur Scientific Energy Technologies, will fit the profile. His solar laser and instrumentation project finally got off the ground thanks to the assistance provided by Indian Renewable Energy Development Agency (IREDA), and a Rs 14-lakh grant from PACER. "In a lot of ways, I was lucky," says Jain.

The Finance Need:
Obtaining Equity Funding For The Initial Years Of Operation

Early-stage financing does not just end with the provision of seed finance. Until the project breaks even, a continuous stream of funds is required for working capital and expansion expenses. Relying on a conventional loan to meet these requirements is certainly not an optimal strategy as regular servicing would take a large bite out of still-inadequate cash-flows. Conditional loans may minimise the initial cash outgo, but outflows climb steeply once operations are on stream.

Consequently, in the developed countries, financial packages for fledgling companies tend to be tilted in favour of equity. In India, however, debt financing looms large. Partly blame the promoters' fears of dilution of control. Also responsible is the abysmal track-record of bought-out deals. Ideally, a bought-out deal fuses together, for mutual benefit, investment bankers and companies that are moving towards an ipo. An expanding enterprise obtains an improved cost of capital for a number of reasons: lower issue costs, quicker access to funds, and complete underwriting support from the investment bank-cum-sponsor.

In return for taking a stake in the company which it will offload later, the sponsor is banking on a rise in the market value of the company, and the possibility of a fee income. For instance, to drum up future fees, merchant banks in the UK have played a large role in extending finance to small and growing firms.

In the Indian context, there has been precious little difference between a bought-out deal and a direct placement in the market. Essentially, the investors sought to make a quick buck, and the lifespan of most bought-outs did not exceed a year. This was hardly conducive for the development of the enduring association that is at the heart of a successful bought-out deal. Indeed, after a brief boom, the bought-out phenomenon fizzled out as the offloaded shares invariably traded below their offer prices.

The Structured Solutions: The boom in private equity could bring investors back. Between 1993 and 1996, the equity component of venture capital investment swelled from 67 per cent to 95 per cent. Private equity is the new venture capital animal. Agrees P.D. Shedde, 48, president, Allianz Venture Capital Advisors: "The perception that venture capital means technologies, small investments, and first-generation entrepreneurs is fast changing. The focus is now on growth-oriented, return-driven projects."

Leading the equity surge has been an influx of foreign funds. At last count, there were 17 foreign private equity funds queuing up, with a combined corpus of $600 million (Rs 2,160 crore). These funds have been launched by investment bankers like Jardine Fleming and Peregrine Capital although there are exceptions--notably the Pathfinder Fund with a $140 million corpus, and the pioneering Indocean Venture Capital Fund with a $59 million corpus.

Most of these funds are sector-specific, which is sensible because it will provide the company with knowledgeable sponsors, and will prevent investments from being tarred by the bought-out brush. With the switch to private equity, expect the greater use of innovative quasi-equity instruments. A convertible debenture or a cumulative convertible preference share would be an ideal financing tool for a fast-growing firm. The initial interest payments or dividends can be kept low, and the voting rights should be deferred till conversion.

Equity participation can be grafted on to lease deals as well. Leasing is a flexible tool since the rentals can be tailored to suit virtually any cash-flow profile. To keep these rentals low in the initial years of operations, the lessor can pick an equity stake in the company that can be offloaded at a premium in the future. Says Aneish Kumar, 39, vice-president (leasing and hire purchase), Lloyds Finance: "Venture leasing can be done on a profit-sharing basis."

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