CHAPTER 2

LITERATURE REVIEW

Developments in the field of Venture Capital Financing

This chapter provides an introduction of the topic by detailing the phenomenon of venture capital
financing. In the first section, a general discussion has been provided about the role of venture
capital financing in growth and development further details about the impacts of venture capital
in different sectors of Indian economy. In the remainder of the chapter, the assessment of venture
capital financing has been detailed in growth and development of Indian economy. Further the
implications of this research endeavor to both research and practice shall be presented.

2. Literature Review

The theoretical research on venture finance has only been recently emerged. Venture capital is a
type of private equity finance involving investments in unquoted companies with growth
potential. It is generally medium to long term in nature and made in exchange for a stake in a
company. The term venture capital is likely to be accepted as the generic term for business
angels, mezzanine equity, institutional or any other similar investments in early stages of
business. In summary, it is “a professionally managed pool of equity capital” (Hisrich and Peters,
1998).

According to Berlin (1998), venture capitalists take an active role in the management of the firm.
They fund the new company and work in close collaboration with the stock market to take the
firm public. Therefore they place emphasis on the support to the company. They offer start-ups
the controls, they might be granted as well as the exit strategy available. In all, they foster growth
in companies through hands-on involvement in financing, management, and technical support.

In most of the venture capitalists firm, the ventures take a very active role in the working of the
firm.

Burgyl (2000) described venture capital as the intermediary between institutional investor (such
as pension funds, banks, insurance companies) and portfolio companies.

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Investment screenings, negotiation, making agreements, controlling investments and assisting to
management team are the most common functions of venture capital.

Mason and Harrison (2000) stated that after bubble of internet hype got busted, most of the
venture capital companies had started funding only at maturity level because they did not want to
take any risk while funding the ventures. Because these companies had invested heavily into
venture so they had wanted only safer option while investing.
Smith (2001) has explained about the venture capital firm that these companies had given
valuable support in terms of product development, production, marketing and other areas of
business function. A venture capital firm had searched and had invested into those companies
which were already research oriented and had shown a growth curve. Selection of venture by
venture capital firm
1. Production capacity and past performance
2. Production planning of the venture
3. Results of the last few years
Lerner (2001) argued that venture capital had impacted on four factors: firms, economy,
innovation and geographical regions. Firms had benefited from additional capital that was
necessarily required for research and development, meanwhile economy was growing because of
more new jobs, and bigger value addition of new venture capital backed firms as well as
particular industry was flourishing because of bigger investment.

Amit, Glosten and Muller (1993) had suggested that venture capitalists should be regarded as
financial intermediaries. The basic aspect of financial intermediaries was to provide a link
between the entrepreneur and investor. This work had been done by venture capitalists in
particular as they had provided fund to the new ventures.

Lerner (2001) contended that venture capital backed companies were more innovative than their
counterparts. And the last, but not the least geographical regions had benefitted because of
growing investment in R&D due to closer relationship between science and business sectors.

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F.C.C. & Koh W.T.H. (2002) argued that thoughtful policies and support of the venture capital
industry could create the right climate for innovation and entrepreneurship, which in turn would
pay dividends in terms of job and wealth creation.

Ueda (2004) had offered an explanation for why venture capitalists and banks had coexisted in
an economy. The key trade-off between the two choices was that while venture capitals‟
evaluations of the project quality were more accurate, they had also used the threat of
expropriation to extract rent from the entrepreneurs. The model had explained why projects
financed by venture capitals been less collateral, high growth, high risk, and high profitability,
and why venture capital markets were more active in markets where intellectual property was
better protected.

Wonglimpiyarat (2007) argued that venture capital had improved the nation's innovative capacity
by making investments in early stage businesses that had offered both high potential and high
risk.
Engel and Keilbach (2007) have used firm data to examine the influence of venture capital
financing on innovation behaviour, specifically on the number of patent registrations at the
German patent office.
According to Dapkus and Kriaucioniene (2008) “Research and developments in business were
seen as a key tool for economy upgrade and national competitiveness achieved through the
development of high value added”. Meanwhile venture capital; with the financing such ventures
had triggered the development of particular industry and at the same time of the overall economy
(Snieska Vytautas & Venckuviene Vitalija 2009).
Florida and Kenney (1988) contended that venture capital in each region had boosted economical
development by attracting entrepreneurs and technical personnel. Venture capitalists had not
only helped to organize the process of innovation but also functioned to a large extent as
technological „gatekeepers‟ for the United States‟ economy and its fastest growing regions
(Florida & Kenney, 1988).
In the study conducted by Hart and Moore (1994) had been explained that the option of the
entrepreneur to repudiate her financial obligations had limited the feasible amount of outsider
claims. Neher (1994) had extended their approach to stage financing as an instrument to
implement the optimal investment path. Admati and Pfleiderer (1994) had shown that a fixed

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fraction equity contract might give robust optimal incentives if it was efficient to allocate the
control rights to the venture capitalist. Bergdorf (1994) had considered convertible debt in a
framework of incomplete contracts to transfer control rights to the value-maximizing party.
Chan, Siegel and Thakor (1990) had explained the optimal transition of control between
entrepreneur and venture capitalist in a model with initial uncertainty about the skill of the
entrepreneur. Hellmann (1996) had explained the willingness of the entrepreneur to relinquish
control rights by a trade-off between equity and debt induced incentives. Trester (1997) had
argued that the problem of an entrepreneur dissipating the firm‟s assets could be mitigated if the
investor had no option to declare default and seize the assets.
Cornelli and Yosha (1997) had analysed the problem of an entrepreneur, manipulating short-term
results for purposes of “window-dressing”.
Venture capital funds are not the only financial intermediaries that bridge gap between the
investors and small businesses; banks also provide the intermediary function for small
businesses.
Ueda (2004) had focused on the ex-ante screening ability differential between venture capitalists
and banks. Winton and Yerramilli (2008) model followed-on financing decisions, thus
incorporating ex-post (costly) monitoring into their analysis. In addition to the standard continue-
or-liquidate decision, the model allowed for an aggressive or a conservative continuation choice,
which made continuation strategy risky in the sense of cash flow volatility between the two
choices. Venture capitalists had better ability to monitor, but had demanded higher returns
because they had imposed illiquidity on their investors; In contrast, banks were less skilled at
monitoring, but had demanded lower returns from entrepreneurs because they themselves had
faced lower funding cost by exposing themselves to liquidity shocks. Venture capitalists were
optimal only if firms had faced highly risky and positively skewed project cash flows, with low
probability of success, low liquidation value, and high returns if successful, and if they had faced
highly volatile cash flows across two continuation strategies.
The number of companies which venture capitalists had monitored seems to have changed little
since 1984. Metrick and Yasuda (2010) had reported that, for a sample of funds raised between

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1993 and 2006, a mean (median) venture capital fund had invested in 24 (20) companies and had
5 (4) partners, suggesting that a partner at a typical venture capital firm running two funds on
average would monitor close to 10 firms at a given point in time. Kaplan et al. (2009) had
examined fifty venture capital backed companies that eventually went public, and had found that
business lines remained stable from early business plan to IPOs, while management was
frequently replaced. Therefore, the results had suggested that the business (idea) rather than the
management team should be the key screening criteria for investments in start-ups. The evidence
of frequent management turnover was in line with Hellmann (1998), which had explained that in
equilibrium, founders voluntarily had relinquished control of the firm so that venture capitalists
had incentives to search for a superior management team without fear of holdup.

In an empirical study of a large, comprehensive small business dataset, Puri and Zarutskie (2010)
have found that venture capital backed companies had tended to be younger, faster-growing, and
larger compared to non-venture capital backed companies. Thus, scalability was an important
criterion that venture capitalists used to screen prospective investments‟ market potential, while
profitability was not. The tendency for faster growth of venture capital backed firms had also
contributed to the higher CEOs turnover rate: rare are individuals who had the talent and skill
sets of founder- CEOs of start-ups as well as those of professional managers running multi-
billion dollar companies. First, venture capitalists had intervened very actively in the
management of the firms that they funded: they used their experience, contacts, and reputation in
order to provide advice to the entrepreneurs, especially with regard to issues such as the selection
of qualified personnel or the dealing with suppliers and customers. Second, the infusion of
capital had occurred in stages, matching investment decisions based on information that had
arrived over time. Third, it had relied on equity-like and convertible securities instead of the
senior secured debt that characterized most bank finance.

(Chan 1983) had done his research about venture capital investment and had found that imperfect
information about investment and ill-informed entrepreneur did not make wise decision to make
investment and in this way they had earned low return. While, if they had proper information
about investment into new ideas and new ventures, they could earn huge amount.

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(Campello and Da Matta 2010) had made an equilibrium analysis about limited partners‟
demand and services of the general partners, quality of general partners and their investment
patterns in venture capital fund. They had evolved that except venture capitalist, there were large
number of financial intermediaries who had worked as an active agent such as bank and these
intermediaries had bridged the gap between investors and small businesses. These banks had
worked for both venture capital and small businesses as well.

Veda (2004) has explained why venture capitalist and banks had equal importance in an
economy. This model has explained that venture capital financing has been less collateral, given
higher growth, higher risk and higher profitability and why venture capitalist market was more
active and provided better protection for intellectual property.

Winton and Yerramilli (2008) have presented a paper and in this paper, they had compared
venture capital financing and bank financing. While Veda (2004) mainly focused on screening
abilities of bank and venture capital funding, Winton and Yeramilli (2008) have mainly focused
on financing decision so they could analyzed about post financing scenario as well.

When they had seen notability into these two choices, venture capital companies were having
better techniques and mechanism to monitor financing but they had wanted better returns
because they had been pressured from their investors. But on the other hand, bank had lower
monitoring rate because they had wanted lower returns from entrepreneurs. Bank had low cost of
funding or fund raising activities. Venture capital firm might opt for high risk but they had
needed high margin because their main objective was to earn better returns on their investments.
2.1 The Economic Rational for Professional Buyout Investors
Professional buyout investors‟ literature had always focused on public to private deals. But
before public listed companies were purchased and delisted by buyout investors. In the literature
review below, there are two aspects. In first aspect conflict between shareholders and managers
are discussed and leveraged buyouts are proposed as a solution and in another solution liquidity
is emphasized as main point for the firm going to privates.

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Jensen and Meckling (1976) and Jensen (1986, 1989, 2007) had developed a hypothesis and
implied about free cash flow. They had shown that free cash flow public firm always had created
an agency problem and leveraged buyout had solved these problems between shareholders and
managers. A public firm manager could misuse the firm‟s free cash flow for their own self-
interest and shareholders were not satisfied because of these strategies. Leveraged buyouts were
the good tools because of high debt agency. Managers had the responsibility to spare the debt as
early as possible. These types of firms did better and had shown better financial results without
any problem.

Lehn and Poulsen (1983) have studied the sample of 263 private transactions between 1980 and
1987 and have got empirical results for Jansen‟s free-cash-flow hypothesis. Cash flows which
were not distributed were the main factors for the firm to go private and stake holders to get their
due premium out of this undistributed cash flow.

Mehran and Peristians (2010) conducted a study about the companies which had become private
between 1990 and 2007 and had argued that main reason of the companies to go private was
their failure to attract investor‟s interest. Firms which were having low stock turnover, they
would prefer to go public as early as possible.

Bharath and Ditmar (2010) had also got the similar results; they had studied a sample of the
firms which went private from 1980 to 2004. Both studies compared the firms, taken over by BO
fund and acquired by other investors. They found that they had become private for the same
reason. If firm had higher free cash flow it was likely that firm would be non-LBO going.
2.2 Economic Rational of Private to Private buyouts
All the largest buyout which was taking place in the entire business world, they were private to
private buyouts.
Stomberg (2007) had conducted a study and he had taken sample of 21,397 buyouts transactions
between 1970 and 2007. In these buyouts 97 per cent were private to private buyouts.

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Ching (2009) had studied and had told that these buyouts had always been worked for better and
had gone into fruitful and successful results.
Unlike most other financial intermediaries, such as pension funds and banks, venture capitalists
were active investors. They had many mechanisms to mitigate these principal-agent conflicts
suggested by Jensen and Meckling (1976). First, venture capitalists had engaged in a screening
process (Chan 1983). They had carefully screened projects and firms with great potential to
succeed.
They had collected information before deciding whether to invest and had tried to identify ex-
ante, unprofitable projects and bad entrepreneurs (Kaplan and Stromberg 2004). They had
carried out formal studies of the technology and market strategy, and informal assessments of the
management team. Second, venture capitalists could design financial contracts to reduce
investment risks, for example, convertible securities, allocation of control rights and cash flows
(Berglof 1994, Hellmann 1998, Hellmann 2001, Cornelli and Yosha 2003, Kaplan and
Stromberg 2003, Schmidt 2003).
Sahlman (1990) had suggested that three control mechanisms were common to nearly all venture
capital financing: the use of convertible securities (Trester 1998), syndication of investment
(Lerner 1994b), and the staging of capital infusions (Gompers 1995).
Kaplan and Stromberg (2003) had shown how venture capitalists had allocated various control
and ownership rights contingent on observable measures of financial and non-financial
performance. After studying 213 investments in 119 portfolio companies by 14 venture capital
firms, they found that if a portfolio company had performed poorly, venture capitalists would
obtain full control. As the performance would improve, the entrepreneurs again would obtain
more control rights over the company.
2.3 What Venture Capitalist and buyouts Investors do
Private equity investors are very active because they work on behalf of their limited partners.
These limited partners gives money to the venture capital firm and venture capital firm further
invest money into an idea or new venture with a view to get good returns. Now the literature is
focusing on three main activities of venture capital firm:
1. Pre-investment screening activities
2. Monitoring while holding period
3. Activities which are associated with the existing process.

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2.4 Venture capitalist and their economical activities
Venture capitalist firm works as a general partner. These firms get fund only for a finite period of
time. Generally this time period is ten years. A firm generally raises fund after every three to five
years and invest into more than one venture, which it manages consecutively two funds at a time.
If fund is invested for five years or less than five years, general partner has to work very hard and
invest more time, energy and effort to manage the fund. General partners have to screen a
number of prospective start ups before investing its fund into it.
Funds which are invested for more than five years, they are called growth and harvesting stage
fund and for these fund venture capitalist has to just monitor the fund and in this stage venture
capital fund companies assist the portfolio companies.

And at last they help the companies for exiting. In this process, initial public offer and
acquisition techniques is sought. When venture capital firm sees that venture is not going to give
any profitable results, they shut down the business in that non-profitable business.

Gooman and Sahlman (1989) had conducted a study regarding the process of venture capital
companies. They had taken a sample of hundred venture capital firms in 1984. They had
concluded how a venture capital firm had invested its time into various operations. They had got
the following results:
a) Venture capital firms had spent their half time in monitoring their investment in the nine
portfolio companies.
b) They had sat on the board of the companies and its numbers were five.
c) As board member, they had spent so many hours with the companies and on telephone;
they had spent thirty hours, while they were having contact with companies.
d) They were engaged in fund raising analysis and recruitment of the management staff.

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Metrick and yasunda (2010) had conducted a study and for this study, they had collected some
sample for fund raised between 1993 and 2006. This study had shown that each venture capital
firm was managing ten companies at a given period of time.
Kaplan (2009) had examined fifty venture capital backed companies and had found that their
business had started quietly from early stages to initial public offer, while management had seen
a lot of changes. This result had depicted that business idea was more important rather than
management. While screening, the start up idea had shown to be the main criteria rather than
quality of management.
Hellmann (1998) had conducted a study and found that equal-partners had left the companies and
venture capital firms were having fair chances to search for better management.
Puri and Zarat skie (2010) had done an empirical study and found that venture capital backed
companies were fast growing and larger as compared to non-venture capital backed companies.
So scalability was the main point while selecting a company for investment. Profitability was not
the main criteria. Faster growth of the companies had seen changes in the number of CEOs.
There are few chances that CEOs continue for a long time.
2.5 Do venture capital companies make funding in high-growth companies or those
companies which are funded by venture capital companies grow fast?
Facing with valuation uncertainty, Sahlman (1990) had suggested that the coping mechanism
was to either design investment contracts which materially would skew the distribution of the
payoffs from the project to the venture capital investors or would involve the active participation
of the venture capital investors to assure that the project had the professional managerial
expertise to succeed.
Sahlman (1990) had identified the three key factors of the investment contract that skewed
payoffs in favour of the venture capital investor: (1) the staging of the commitment of capital, (2)
the use of convertible securities instead of straight common shares and the associated senior
claims on the assets of the firm in case of failure and (3) anti-dilution provisions to secure the
venture capital investors equity position in the new firm. Of these mechanisms, he had concluded
that staged capital infusions were the most important control mechanism that a venture capitalist
could employ.

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Cossin, Leleux & Saliasi (2002) had examined the economic value of these legal features in a
real option context.
Inderst and Muller (2009) had conducted a study which had concluded that both the conditions
might be applicable. Their paper had shown if a Venture was financed by a venture capital firm,
this venture would take the advantage of this funding. The products of this venture might take
lead on its rivals because over-investing had always supported these types of products. Their
paper had shown that venture capital firm was very useful for emerging market because it would
encourage higher growth and large scale. Venture capital firm had made target of this type of
ideas and would put its hard effort to make these ideas successful and that was in a very short
period of time. They had found that how venture capital fund monitored and made investment.
This monitoring was stage wise. Funding was also conditional. Some payment was made in
advance and rest of the payment was made phase wise and according to the performance of the
venture. If venture capital firm had seen that venture was not going according to the terms and
conditions specified in the agreement, they had abandoned the project in the mid way.
Gompers (1995) analysed venture capital funded companies. He had taken a sample of seven
hundred and thirty four companies. He found that a firm which had higher cost in performing the
various task, was being monitored frequently. Venture capital companies had given active advice
to run the company and had told them how to manage the staff.
Hellmann and Puri (2002) conducted a research and found that venture capital backed companies
had more professionalism. They had good human resource policies and had better marketing
strategies. They had used a sample of European venture capital deals.
Bottazzi (2008) found that those venture capital companies which had more experience had
helped their portfolio companies for better management and fund raising activities. They had
helped the portfolio companies for recruiting the staff for running the entire show.
Both Baker and Gompers (2003) and Hochberg (2003) conducted a research and found that
venture capital companies made a change in the board of directors. Boards of directors of these
companies were more independent.

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Lerner (1995) found that venture capital backed companies had witnessed more turnover rate in
CEOs of the companies and those companies which were not backed by venture capital, they had
stake CEOs.
Cornell (2010) had made a survey for European venture capital investment data and found that
after IPO, those companies which were backed by venture capital companies, showed low
earning rate and those companies which were not supported by venture capital firm showed
better results.
Kortum and Lerner (2000) had made a research about the venture capital companies and their
patenting strategies. They found that venture capital companies‟ patents were more valuable.

Hellman and puri (2000) found that venture capital companies had taken less time to bring
product into the market and especially those products which were innovative and new to the
market. This had shown that a venture capital firm invested into innovative ideas and even when
a venture capital firm exiting from the venture, this innovative process continuous. Sometimes a
venture capital firm and its portfolio companies compete with each other.

Lindsey (2008) had made a research and found that those companies which were having the
same venture capital company as their financing partner, were having better strategic alliance.
2.6 Economic activities of buyout investors
Both venture capital and buyout fund which were making investments in ventures, these
investments were illiquid. The final returns for venture capital companies were reported as
internal rate of return.
2.7 Deal-level performance: venture capital
Brave and Gompers (1997) had conducted a study about venture capital backed companies and
non-venture capital backed companies. They had studied the data between 1972 and 1992 and
found the venture capital backed companies‟ initial public offers were better than non venture
capital backed companies. They found that the venture capital backed companies were never
formed under pressure. They found that the reason of better performance was that ventures
always had a pressure from the venture capital companies to perform.

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Cochrane (2005) had used mean, standard deviation and beta of venture companies to measures
the risk and return with the help of vitality. He found these measures with respect to NASDAQ
and calculated volatility and concluded how a venture capital firm might invest into a venture
where investment was not risky and return was also higher.
Sorensen (2010) had developed a model which studied that beta value should be between two to
three. This had clearly shown that individual security of the company was highly volatile as
compared to stock exchange where this security was listed.
2.8 Performance Persistence and Sources of Performance
Kaplan and schoar (2005) had conducted a study and found that venture capital was more
persistence than BO. BO fund managers increased the size of fund, when they increased in
numbers. But a venture capital fund manager did not increase the size of fund. When talking
about making investment by venture capital, following points were reviewed:
2.8.1 Industry
This was the main point when venture capital firm had invested into a company. Generally
venture capital companies had wanted those companies which could provide better results.
A venture capital, as name suggests try to invest where more risk is involved with innovative
ideas and more return as compare to investment into other types of companies. Amit, James and
Zott (1998) had conducted a study and they found that a venture capital firm should be vigilant
and should make a place into a segment so that people could know more about the performance
of the company. In their study, they had found the securities/companies in which venture capital
firm had invested the money. They had to spend less money on the monitoring point. So they had
preferred companies like biotechnology, computer, and software etc. They had not preferred the
companies like retail sector or fast food or food chains because these companies had required
more monitoring and more cost was involved in these types of businesses.

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2.8.2 Syndication
Bygrane, (1987); Brander et al (1999), had conducted a study about syndication. They had
collected total sample of five hundred companies and had found that syndication add value to the
portfolio companies because companies had required large fund to connect the innovative ideas
into reality. Only one venture capital firm was not sufficient to finance the project alone, there
was the need of other venture capital firms too with similar interest to come together and to
construct syndication, so that large funding could be done for the ongoing project and each stage
must have sufficient fund to invest. There should be smooth conduct of the activities.
Chemmanor and Tian (2009) had also conducted a study and had found that syndication was
always better than a single venture capital company because at the time of exit, syndication did
better than as individual firm. Those companies which were successful in syndication, they had
further made a prowl of companies and they had invested the money into the future projects.
Wilson (1968) had conducted a study and had found that decision making process by a group of
companies (Syndication), had delayed a process rather than investing by the single venture
capital firm, even though decision making was done jointly to give better result as compared to
single company.
2.8.3 Investment Duration
Cunnin and Macintosh (2001) had conducted a study about venture capital companies to find that
investment into various stages was very important because it could give investors a very clear
picture about the duration of the investment and its success rate. They had also collected data to
find out the stage in which a project was funded by the venture capital and to know the duration
of the investment.
Cumming and Johan (2010) had developed a theory of venture capital investment duration and
had found that total duration of the investment was based on the marginal benefit which should
be less than the expected cost for managing the portfolio.
2.8.4 Staging
Sahlman (1990) had conducted a research for staging decision. He had found that these decisions
had played an important role while making the investment decisions.

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It matters a lot when a venture capital firm was going to invest into a portfolio company. If it had
invested at early stage it would have got benefits because it had engaged from the right of the
beginning. If it had invested into more advanced stages, it would have got fewer benefits because
portfolio firm was quite mature and it had taken most of the benefits from the market.
Li (2002) had also conducted a research for staging decision and had found that many options
could be used for this type of decision. He had augmented that if a person was taking the option
to invest into a venture capital firm, which was far better than investing immediately because in
due course of time, market conditions could be judged correctly.
2.8.5 Exits
Wang and Sim (2001) had conducted a research for the data between 1990 and 1998. They had
found that family owned and high technology industries would exit generally through initial
public offer. This initial public offer would be depended on total amount financed by the venture
capital firm and total sale of the company.
Giot and Schwiebacher (2007) had conducted a research around six thousand venture capital
backed firm, covering around twenty thousand rounds. They had found that with the passing of
great time, there were many changes in companies‟ existing policy via initial public offer.
Bienz and Leite (2008) had conducted a research and had found that those companies which had
made good profit, they would have opt for going public through initial public offer. On the other
hand, those companies which had earned less profit, they would have gone for trade sales. They
had also found that if product was more innovative, going public would be more profitable as
compared to trade sales.
Arif and Abdul khadir (2005) had conducted a research and had found that those firm which had
low investment, they would have exited through initial public offer.
Initial public offer route is also related to total amount which is financed by venture capital firm,
total rounds done by venture capital companies and total funds which have participated in the
whole process.
2.8.6 Dot-Com effect
M.B. Green (2004) had conducted a research for pre-bubble, bubble and post-bubble period and
he had analyzed the investment patterns for stage financing of various industries.

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He had found the bubble period industries. He had found that the bubble period had attracted
larger fund and more deals as compared to pre-bubble and post-bubble period.
2.9 Indian Venture Capital and Private Equity Industry
Prof. I.M. Pandey had conducted a research in the year 1998. This research was based on the
process of developing venture capital in India from the in-depth case study of the Technology
Development and Information Company of India (TDICI). Initially TDICI had focused on high-
tech industries but after that they had shifted to more profitable industries.
A. Thillai Rajan (2010) had conducted a research on the efficiency of venture capital and its
portfolio companies. He had collected a sample between the year 2004 and 2008. He had found
that in round I, there were larger investment and later on, it had decreased dramatically. Mostly
these investments were in later stage and with short duration. He had concluded that these factors
had not focused on good growth of venture capital industry in India.

Ljungquist and Richardson (2003) had conducted a research and had made an analysis of venture
capital returns based on the cash flows of the ventures and buyout capital funds. Their study was
mainly emphasized on timing and magnitude of decisions. They had calculated the time period in
which capital was returned to the investors and for the overall functions of the venture capital.
They had also found that most of the firms had taken three years to invest 56.9 per cent and six
years to invest 90.5 per cent of the total capital agreed to invest. These companies had taken
eight years to convert internal rate of return into positive and ten years to exceed public equity
returns. Further, they had found that the private equity was much better than public equity return.
This return was five per cent to eight per cent higher in public equity. Under syndication, internal
rate of return was higher than return in single company. They had produced good results when
legal environment was in better situation.
Weidig and Mathoned (2004) had conducted a research on the risk and return pattern of the
various investment alternatives. They had calculated the risk-return of the various private equity
investment alternatives such as direct investment. They had studied that calculation of risk was
volatile in the market price as compared to various investment vehicles which had majorly
impacted adversely because of lack of efficient market for price and product.

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Therefore risk was measured only in standard deviation with the help of average return. The
return was measured as internal rate of return. This research had clearly shown that
diversification had played an important role for direct investment and for various other funds.
They had also found that around thirty per cent of the diversification was complete failure and
investors had lost their capital.

Katz (2005) analyzed how venture capital backed and non-venture capital backed companies
were affected in their performances and returns before and after initial public offers. In other
words, he had tried to know that strong monitoring system would affect the earning of the
management and performance after initial public offers as compared to non-venture capital
backed companies. They had found that venture capital backed companies had performed better
and had given better return as compared to management owned companies. If the size of the
venture capital invested was large, in that case the financial performance of the companies after
initial public offer would be better as compared to small investment by the venture capital firms.

Some studies have also emphasized that economy of scale played an important role. Metric and
Yasuda (2008) conducted a research and they had reached on the conclusion that a manager who
had managed venture capital, his skills would be better suited to small firm and a manager who
had managed buyout fund, his skills would be better suited to large firms. When a large firm
with investment of US$ 1000 million was managed by a manager efficiently, if he had to manage
a firm of US$ 10 million, he could do it quite successfully because he had earlier some
experience.

So we can say that buyout firm can be managed by one person in two different situations. But on
the other hand, when we talk about a venture capital firm, a manager who is handing the
company, when it is in is start-up stage, he can do it successfully. When this company matures, it
is difficult for the same person to handle the entire affairs. So a venture capital needs another
person to manage the company in more advanced stage. This is the basic difference while
managing a buyout firm and venture capital firm. It is difficult to manage a venture capital
backed firm as compared to buyout firm.

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Cumming and Johan had conducted a study in 2007 about the rules and regulatory environment
how a private equity firm did, when there was a perfect regulatory environment. When there was
a scarcity of regulatory environment how these companies were affected. They had found that
when there were low discloser standards for the companies, in that case, the cost for screening,
governance and monitoring was increased because a venture firm did not have much information
from the regulatory environment and sources. These firms had to evolve its own sources to
collect the various type of information for its new venture because without screening it would be
difficult to fund the new venture. After funding, proper governance and monitoring was required.
But this process had increased the entire cost of the venture capital firm. So these companies
were very particular, when they had wanted to invest into the venture as private equity. This
study had shown that private equity would attract less investment. Again this study had shown
that these companies had invested into the various companies not as a private equity but by other
various means to avoid these rules and regulations.
Cumming and Walz (2007) also had done analysis of the venture capital firms and found that
there were number of drivers for institutional investment in private equity. They had found that
institutional investment had preferred to invest in those private equity firms, where there was a
lot of disclosure of the standards.
Venture capitalists are one important category of investors that specializes in financing
innovation (Amit, Brander, & Zott, 1998). The structure of venture capital arrangements had
allowed these organizations to overcome many of the information asymmetry problems that
plague external financing of the innovation.
Thus, it is to be proposed that access to venture capital, which varies across environments and
over time, makes new firms more innovative.
As far as India is concerned, Chokshi had conducted a research in 2007. He had analyzed the
various factors which were responsible for stopping the process of leveraged buyout in India.
These factors were: there were a lot of restrictions of the foreign investment in India, limited
availability of professional management, under development of debt market, lot of restrictions of
the bank lending.

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From the above restriction, it is clear that there were a lot of difficulties in investing into Indian
corporate market.
Banga Rashmi (2006) had done a research on the growth of service sector in an atmosphere
where this sector had helped in removing poverty and unemployment. Due to growth of service
sector, a huge opportunity in job marked was created. So a lot of unemployed person got the job
and this led to remove the poverty from India.
So we can say that growth in service sector had improved the overall economy of India. In this
paper author had described about innovative investment means searching new avenues for
investment.
Dr. Alok Agarwal (2006) had done a study on venture capital. He had compared summer of India
with venture capital, means it was very hot.
Nirvikar Singh (2006) had also conducted a study about rapid growth of service sector. He had
emphasized that this sector had large potential for growth. If we had paid attention on this sector,
Indian economy would increase rapidly. He had also told that service sector should be
industrialized. Industrialized means government should bring clear cut policy for this sector and
make a conducive atmosphere for the development of this sector.
Mani Sunil (2006) had done a study about service sector and manufacturing sector. He had
explained the role of government of India and its policy for venture capital investment in India.
This study had shown that chemical and pharmaceutics industry had attracted venture capital and
capital was invested into research and development activities in this sector. This sector had
created a number of patents. This process was responsible for the growth of service sector based
on manufacturing sector.
D. Nagayya (2005) conducted a study about venture capital and found how the development of
this capital had impacted the growth of Indian economy. He had talked about pattern of venture
capital fund and how it had grown. He explained that venture capital had developed in phased
manner and after 1991, liberalization took place in India. Number of foreign companies came to
India and set up their business. It had spurred the growth of Indian economy. As these companies
came to India, they brought new ideas. When these new ideas were converted into reality, it
needed a large amount of fund and thus this process had created a large pot of venture capital
fund in Indian start-ups.

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B. Bowonder and Sunil Mani had conducted a research in 2003 and they explained how
innovation was responsible for the growth of venture capital in India. As the new ideas were
innovated, it needed a large fund to convert this idea into reality. This study explained that
government of India had supported these schemes. Mainly these scheme were responsible for
innovative IT and IT enabled services, government of India formulated various conducive
policies for the development of this sector. This led to smooth flow of venture capital into India.
The innovative ideas had attracted a number of venture capital companies to invest in India.
Jim Gordon and Poonam Gupta (2002) had done a study which was mainly pointing towards the
growth of service sector and its impact on GDP growth. This study clearly showed that in the
nineties, there was growth in GDP, due to a very fast growth in communication sector,
development of the financial sector and growth of information technology sector. The main
reason for the development of the GDP was because of development into the venture capital
sector. More and more venture capital companies came forward and invested heavily into Indian
start-ups.
Dossani and Martin (2001) had conducted a research work for the development of venture capital
firm in India. They emphasized on various patterns which were responsible for the growth or
failure of the venture capital investment in many countries. These patterns were taken as a model
in India. These models were implemented in India.
2.10 Summary
The literature review discussed above yields summarized findings as following:
1. Venture capitalists play an active role in corporate governance of their portfolio firms, by
designing contract to allocate control rights, influencing the board of directors, and monitoring
managers directly.
2. They emphasize various patterns which are responsible for the growth or failure of the venture
capital investment in many countries. These patterns are taken as a model in India. These models
were implemented in India.
3. Venture capitalists carefully structure exit strategies for their investments. They normally do
not sell any shares during the IPO, but they divest their interests in a portfolio firm within several
years following the IPO.

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4. Independence of the board and/or audit committee is negatively associated with earnings
management and the likelihood of financial statement restatement.
5. Insider selling is positively associated with opportunistic behavior in financial disclosure such
as earnings management and accounting fraud. There is mixed evidence on whether earnings
management is used before insider trading or after insider trading. Share distribution can exempt
VCs from securities regulation on insider trading, which makes the exit of venture capital out of
the notice to other investors.
6. There are positive discretionary accruals (a proxy for earnings management) in the IPO year.
Venture capital backing is significantly associated with lower discretionary accruals in the IPO
year.
7. There are a lot of restrictions of the foreign investment in India, limited availability of
professional management, under development of debt market, lot of restrictions of the bank
lending. From the above restriction, it is clear that there are a lot of difficulties in investing into
Indian corporate market.

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