Report on

Venture Capital

Date: 20th August, 2016

Course: Financial Institutions

Submitted to: Sir Sharique Ayubi
Submitted by: Muhammad Moeenuddin (15632)
WHAT IS VENTURE CAPITAL?
Venture capital is money provided by an outside investor to finance a new, growing, or troubled
business. The venture capitalist provides the funding knowing that theres a significant risk
associated with the companys future profits and cash flow. Capital is invested in exchange for an
equity stake in the business rather than given as a loan, and the investor hopes the investment
will yield a better-than-average return.

Venture capital is an important source of funding for start-up and other companies that have a
limited operating history and dont have access to capital markets. A venture capital firm (VC)
typically looks for new and small businesses with a perceived long-term growth potential that
will result in a large payout for investors.

A venture capitalist is not necessarily just one wealthy financier. Most VCs are limited
partnerships that have a fund of pooled investment capital with which to invest in a number of
companies. They vary in size from firms that manage just a few million dollars worth of
investments to much larger VCs that may have billions of dollars invested in companies all over
the world. VCs may be a small group of investors or an affiliate or subsidiary of a large
commercial bank, investment bank, or insurance company that makes investments on behalf
clients of the parent company or outside investors. In any case, the VC aims to use its business
knowledge, experience and expertise to fund and nurture companies that will yield a substantial
return on the VCs investment, generally within three to seven years.

Not all VC investments pay off. The failure rate can be quite high, and in fact, anywhere from 20
percent to 90 percent of portfolio companies may fail to return on the VCs investment. On the
other hand, if a VC does well, a fund can offer returns of 300 to 1,000 percent.

THE FUNDING PROCESS

Step 1: Business Plan Submission The first step in approaching a VC is to submit a business
plan. At minimum, your plan should include:

1. A description of the opportunity and market size;

2. Resumes of your management team;
3. A review of the competitive landscape and solutions;
4. Detailed financial projections
5. A capitalization table.
Once the VC has received your plan, it will discuss your opportunity internally and decide
whether or not to proceed. This part of the process can take up to three weeks, depending on the
number of business plans under review at any given time.Dont be passive about your
submission. Follow up with the VC to check the status of your proposal and to find out if theres
additional information you could be providing that might help the VC with its decision. If you
are asked for further information, respond quickly and effectively. If possible, always try to get a
face-to-face meeting with the VC.

Keep in mind that most VCs receive an average of 200 business plans each month. Of those, less
than five percent will be invited to meet with the VCs partners. Just two percent will reach the
due diligence phase, and less than one percent will be offered a term sheet. Some 0.3 percent of
those submitting a business plan will ultimately obtain VC funding.

Step 2:

Introductory Conversation/Meeting If your firm has the potential to fit with the VCs investment
preferences, you will be contacted in order to discuss your business in more depth. If, after this
phone conversation, a mutual fit is still seen, youll be asked to visit with the VC for a one- totwo
hour meeting to discuss the opportunity in more detail. After this meeting, the VC will determine
whether or not to move forward to the due diligence stage of the process.

Step 3:

Due Diligence The due diligence phase will vary depending upon the nature of your business
proposal. The process may last from three weeks to three months, and you should expect
multiple phone calls, emails, management interviews, customer references, product and business
strategy evaluations and other such exchanges of information during this time period.

Step 4:

Term Sheets and Funding If the due diligence phase is satisfactory, the VC will offer you a term
sheet. This is a non-binding document that spells out the basic terms and conditions of the
investment agreement. The term sheet is generally negotiable and must be agreed upon by all
parties, after which you should expect a wait of roughly three to four weeks for completion of
legal documents and legal due diligence before funds are made available.

TYPES OF FUNDING
The first professional investor to a deal at the start-up stage is referred to as the Series A investor.
This investment is followed by middle and later stage funding the Series B, C, and D rounds.
The final rounds include mezzanine, late stage and pre-IPO funding. A VC may specialize in
provide just one of these series of funding, or may offer funding for all stages of the business life
cycle. Its important to know the preferences of the VC youre approaching, and to clearly
articulate what type of funding youre seeking:

1. Seed Capital.
If youre just starting out and have no product or organized company yet, you would be
seeking seed capital. Few VCs fund at this stage and the amount invested would probably
be small. Investment capital may be used to create a sample product, fund market
research, or cover administrative set-up costs.

2. Startup Capital. At this stage, your company would have a sample product available
with at least one principal working full-time. Funding at this stage is also rare. It tends to
cover recruitment of other key management, additional market research, and finalizing of
the product or service for introduction to the marketplace.

3. Early Stage Capital. Two to three years into your venture, youve gotten your company
off the ground, a management team is in place, and sales are increasing. At this stage, VC
funding could help you increase sales to the break-even point, improve your productivity,
or increase your companys efficiency.

4. Expansion Capital. Your company is well established, and now you are looking to a VC
to help take your business to the next level of growth. Funding at this stage may help you
enter new markets or increase your marketing efforts. You should seek out VCs that
specialize in later stage investing.

5. Late Stage Capital. At this stage, your company has achieved impressive sales and
revenue and you have a second level of management in place. You may be looking for
funds to increase capacity, ramp up marketing, or increase working capital.

A key factor for the VC will be risk versus return. The earlier a VC invests, the greater are the
inherent risks and the longer is the time period until the VCs exit. It follows that the VC will
expect a higher return for investing at this early stage, typically a 10 times multiple return in
four to seven years. A later stage VC may be seeking a two to four times multiple return within
two years.

NON-DISCLOSURE AGREEMENTS (NDAs)

Its not advisable to ask a VC for a non-disclosure agreement, and may even risk stopping your
potential VC deal in its tracks. Venture capitalists may review hundreds or thousands of business
plans in any given year. Even if you think your ideas are proprietary, they may be just similar
enough to another entrepreneurs that the VC takes on the added risk of legal action against it
just by signing your NDA. Also, for the VC, accepting NDAs adds the administrative burden of
having to keep track of which NDA covers what entrepreneurs ideas.

TERM SHEET
A term sheet is a document that sets out the basic terms and conditions under which the VC will
invest in your company. Work completed in the due diligence phase of the funding process is
used to draft this document. The term sheet is generally non-binding and is used as a template,
along with further due diligence, to draw up more detailed legal documents.

You will, no doubt, be particularly concerned with the valuation of your company set forth in the
term sheet. To arrive at this figure, the VC takes into account your management team, your
companys market and competitive advantage in the marketplace, and your earning potential.
The various factors that go into a valuation are determined during the due diligence phase. Note
the difference between pre-money valuation the valuation of your company before a VC
invests in it, and post-money valuation the pre-money valuation plus the contemplated
investment amount.

In negotiating your term sheet, keep in mind that there are two central issues for the VC. The
first is the economics of the deal, i.e. the return on investment and the terms that dictate that
return. The second is control, meaning how the VC will be able to exercise control over your
companys decisions. The pertinent negotiations will revolve around these two issues.

WHAT DO VCs LOOK FOR?

Venture capitalists look for businesses that have the potential to grow quickly to a significant
size, yielding a significant return on the VCs investment in a relatively short period of time. VCs
are not just interested in start-ups. Your companys current size is less important than its future
aspirations and growth potential. A target company for a VC is one that may be capable of
becoming a large market leader in its industry due to some new industry opportunity and
competitive advantage. Theres no single 7 determinant for a successful portfolio company, but a
VC tends to focus on the following factors:

a) Commercially viable. Does the company have a product or service that can be reproduced
efficiently to generate revenue?

b) Identifiable market. Is there a clearly defined market for the companys product or
service? Does the companys product or service meet an identifiable need in that
industry? Does the company have a reasonable plan to meet the identified need in an
efficient, revenue-generating manner?
 c) Strong management. Does the companys leadership inspire confidence? Do they have
the vision, expertise, and the ability to propel a business to a significant level of growth?
Does the team consider best practices of those that have gone before them?

d) Sustainable competitive advantage. Has the company hit upon an idea thats truly unique
to the industry, one that has significant barriers to entry that will inhibit others from
encroaching upon its market? Has the company considered economic and technological
change that may affect the business model? Who are the companys potential
competitors, and what are those companies strengths and weaknesses?

Like a banker, a VC will also consider factors such as results of past operations, amount of funds
needed and their intended use, future earnings projections and conditions. But unlike a banker, a
VC is a part owner rather than a creditor, so its looking for potential long-term capital, rather
than interest income. A common rule of thumb is that a VC looks for a return of three to five
times its investment in a five- to seven-year time period. A lot may also depend on the
relationship between you and the VC. Often, the firm will have you meet with every one of its
individual partners to determine whether theres a consensus on how the company will be co-
managed. Dont underestimate the value of mutual respect, teamwork, and understanding.

How to approach?
Its important to do your homework before approaching a VC for funding, to make sure youre
targeting the right potential partner for your business needs. Not all VCs invest in start-ups.
While some may invest small amounts of seed capital for very early ventures, many focus on
early or expansion funding (see section III. Types of Funding), while still others may invest at
the end of the business cycle, specializing in buyouts, turnarounds, or recapitalizations.

VCs may be generalists that invest in a variety of industries and locations. More typically, they
specialize in a particular industry. Make sure your company falls within the VCs target industry
before you make your pitch a VC thats focused on biotechnology start-ups will not consider
your request for later-stage funding for expansion of your semiconductor firm. You can often
gain insight into a VCs investment preferences by reviewing its website.

In addition to industry preferences, VCs also typically have a geographic preference. Being in
the same general location as a portfolio company allows the VC to better assist with business
operations such as marketing, personnel, and financing. Keep in mind that venture capital is not
an option for all new businesses. In fact, VCs are very selective in choosing new companies to
invest in, so your company may not qualify. Theyre most interested in businesses with high
growth potential that will allow them to successfully exit with a higher than average return in a
time frame of roughly three to 10 years, depending on the type of investment. Given the rigorous
expectations, most venture funding goes to companies in rapidly expanding industries such as
technology, biotechnology, and life sciences.

There are some excellent alternatives to venture capital that you should also explore in your
search for funding sources. One such alternative is an angel investor a term for an investor that
takes you under its wing and lifts you up to the next level of growth. Angel investors typically do
not have deep pockets so the average investment tends to be smaller than that of a VC, typically
hundreds of thousands of dollars rather than millions. For that amount of capital, proceed with
caution if youre considering giving up some control over your company. For instance, it may
not be wise to give a Board position to an angel investor who does not necessarily have the time,
experience or expertise to make a significant contribution to your company.

You might also consider a strategic investor partner in place of a VC investment. This could be a
vendor, customer, or other business partner with whom youre currently working, who might be
interested in investing in your company. A strategic investor often has deeper pockets than an
angel investor, but typically has a specific reason for investing in your company make sure you
know the reason behind the investment.

VC EXIT STRATEGY
The exit strategy is the VCs way of cashing out on its investment in a portfolio company. A VC
often hopes to sell its equity (stock, warrants, options, convertibles, etc.) in a portfolio company
in three to seven years, ideally through an initial public offering (IPO) 8 of the company. The
company becomes liquid through the sale of its stock to the public and the VC sells its stock to
reap its return.

While an IPO may be the most visible and glamorous form of exit, its not the most common.
Most companies are sold through a merger or acquisition event before an IPO can occur. If the
portfolio company is bought out or merges with another company, the VC receives stock or cash
from the event.

Another alternative may be the reorganization of a portfolio companys debt and equity mixture,
called a recapitalization. The VC exchanges its equity for cash, the management team gains
equity incentives, and the company is positioned for future growth.

Pakistan Scenario
The growth in the economy of Pakistan in the last few years has created a new generation of
entrepreneurs. The younger generations who have taken over these businesses and who have
received best education from the local and foreign educational institutes have been able to
positively affect their businesses by changing the mindset and bringing latest business strategies.
Currently, services sector contribute 52% to the economy of Pakistan. Banking, leasing,
insurance, health services, education, telecom, IT, tourism and allied services, courier/cargo
services, travel operators, printing, consultancy and other sectors have contributed in the growth
of services sector. This growth has resulted in new class of entrepreneurs because many of these
business opportunities did not exist just a decade back.

SOURCE OF FUNDING FOR PRIVATE SECTOR IN PAKISTAN

One of the most important supporting elements for the economic development of any country is
the easy access to finance. There have been many channels and modes of finance available for
private sector in all sectors. In Pakistan, the main options of finance for starting or expanding
their business by private sector have been:

1. Personal equity: Inherited wealth or savings made during career is used to start business
2. Family and friends equity: Family and friends provide funding to start and expand the
business on interest free basis and/or profit sharing basis.
3. Bank loans: Banks provide project financing, term loans, working capital finance etc on
basis of client history, soundness of business and collateral requirement.
4. Angel investors: Investors providing capital for start-up or expansion and looking for
high returns.

VENTURE CAPITAL INDUSTRY IN PAKISTAN

Pakistani entrepreneurs are more inclined towards starting and investing in traditional businesses,
as they are risk averse. Consequently, they start businesses with relatively low risk and low
return but with sound cash flows. Currently, the venture capital/private equity industry is small.

Some of the local brokerage houses such as AKD Securities, BMA Capital, AMZ Group, and
Jehangir Siddiqui have set up venture capital firms. Jehangir Siddiqui has received financing
from International Finance Corporation (IFC), BMA Capital from UAEs Abraaj Capital (Cupola
Group), and AKD Securities from PakKuwait Investment Company. Some of these firms
specialize in one sector only, for example, BMA Capital is focusing on real estate; while Jehangir
Siddiqui and AMZ group are investing in IT projects.

SWOT analysis
Strengths:

Better economic growth in last 6 years

Growth and consolidation of banking sector
Better spending on higher education

Weaknesses:

Lack of entrepreneurship
Shortage of skilled human resource
Lack of innovation and R&D among enterprises
Limited knowledge based sectors
Risky investment and few exit opportunities

Opportunities:

Increase in foreign direct investment

Young entrepreneurs willing to share the success
Growth potential in many sectors of economy

Threats:

Law and order situation

Political Instability
Country Image Perception

STARTUP INCUBATORS AND ACCELERATORS

IN PAKISTAN

NO. INCUBATOR/ACCELERATOR CITY DESCRIPTION

1 Microsoft Innovation Center Lahore, Microsoft Innovation Center

Pakistan Startups Incubation is a unique
program designed to promote
innovation. The main idea behind
the program is to facilitate
transformation of high-potential
software startups into successful
NO. INCUBATOR/ACCELERATOR CITY DESCRIPTION

businesses.

2 Social Innovation Lab Lahore, The Social Innovation Lab's

Punjab incubator, 'The Hatchery' is
Pakistans only social enterprise
incubator geared to the needs of
passionate, social innovators, big
on ideas but lacking in the means
and experience necessary to
realize their vision. They use an
indigenized curriculum and 4-
month mentorship program,
which combines humanistic
perspectives on poverty
alleviation, rural development
and inclusive marketing with the
latest insights on sustainable
business practices.

3 The Founder Institute Islamabad, Founder Institute offers a four-

Karachi month part-time program for new
and early-stage entrepreneurs that
helps them develop their business
ideas and form a company.
Among the key requirements for
graduation is the creation of a
fully operational company by the
end of the four-month program.

4 Telenor Velocity Islamabad, Velocity is Telenor Pakistan's

Punjab initiative. The digital incubator
selects startups from their
network partners, who are usually
other incubators, and help the
selected startups get access to
market, distribution, payment
NO. INCUBATOR/ACCELERATOR CITY DESCRIPTION

gateways etc.

5 Revolt Peshawar, Revolt is an intensive 3-months

Khyber training program with a
Pakhtunkhwa curriculum specially designed for
up and coming startup founders
to help them take their ideas to
the next level. Peshawar2.0.org is
the parent organization of this
startup training program.

6 Plan9 Lahore, Plan9 is a government-backed

Punjab incubator that was started by the
Punjab Information Technology
Board. It is Pakistan's largest tech
incubator.

7 The Nest I/O Karachi, Sindh Represented by P@SHA and

supported by Google For
Entrepreneurs and Samsung, The
Nest I/O is a technology
incubator with a direct incubation
process of 4 months, after which
incubatees remain a part of NEST
I/O as "External Incubatees" for
up to 12 months.

8 Invest2Innovate Lahore, An accelerator with an annual

Islamabad and program, a strong community of
Karachi angel investors and a team of 35+
local mentors ready to provide
consultancy, training and
executive leadership
development.
NO. INCUBATOR/ACCELERATOR CITY DESCRIPTION

9 LUMS Center for Lahore, Describing itself as "the nations

Entrepreneurship
Punjab most comprehensive experiential
development platform for
entrepreneurs", LCE is an equity-
based incubator offering a co-
working space at LUMS, utilities,
monthly stipend and access to
investors.

10 PlanX Lahore, After the success of Plan9, the

Punjab PITB began Pakistan's largest
technology accelerator. It is
responsible for advancing mid-
stage startups.

11 Serendipity Islamabad, Serendipity is an accelerator

Punjab offering funding support,
networking and consultancy
services in Islamabad.

12 The Incubator Topi, Khyber Ghulam Ishaq Khan Institute's

Pakhtunkhwa "The Incubator" focuses on
providing office space, internet
and computer facilities along
with technical assistance and
mentoring for final year students
and fresh graduates.

13 Technology Incubation Center, Islamabad, An initiative of the National

NUST Punjab University of Sciences and
Technology, the TIC became the
first technology incubator of
Pakistan in 2005. It aims to
provide entrepreneurs and teams
the required office facilities for
maximizing their abilities and
NO. INCUBATOR/ACCELERATOR CITY DESCRIPTION

sustainability.

14 Arpatech Hatchery Lahore & Arpatech is one of the leading

Karachi technology services companies in
Pakistan and The Hatchery is
their internal incubator. Startups
benefit heavily from the Arpatech
Technology Venture group and
the strong associations the
company has with venture and
private equity groups in the US
and Europe.

15 CED IBA Karachi, Sindh The AMAN Center for

Entrepreneurial Development
(AMAN-CED) at IBA aims to
support in the creation of new
business, small and medium.
They provide education, on-the-
job training, advisory services
and seed money to entrepreneurs.

16 Peracha Organization Karachi, Sindh Peracha Organization provides a

three-month program to enable
startups to explore fundraising,
learn from mentors, and network
with and present their ideas to
angel investors.

17 SMEDA Lahore, Punjab The Small and Medium Enterprises

Development Authority is an institution of
the Government of Pakistan that provides
technical services, financial services and
training services to facilitate the
development of small and medium
NO. INCUBATOR/ACCELERATOR CITY DESCRIPTION

businesses in over 10 cities.

18 SEED Incubation Center Karachi, Sindh Social, Entrepreneurship and

Equity Development (SEED) is
an enterprise development
organization and the SEED
Incubation Centre facilitates
innovative individuals with
reasonably priced office space,
mentoring, training, start-up
capital and also introduces them
to potential investors.

19 BIC COMSATS Islamabad, A project of COMSATS Institute

Punjab of Information Technology, the
Business Incubation Centre was
established to provide help with
legal, marketing and financial
issues, along with incubation
facilities, logistics, meeting
rooms, office space, internet
connectivity and consultancy.

20 NSPIRE Lahore, A fairly new incubator started by

Punjab one of Pakistan's leading
technology companies NetSol
Technologies, NSPIRE has a 5-
month incubation period.
Incubatees gain access to
NetSol's latest IT facilities, legal
advice, mentorship from highly
credible mentors and dedicated
working space of maximum 4
persons (per team).
CONCLUSION
Before you approach a VC for funding, examine your goals. How much capital do you need? Do
you want passive or active investors? Are you looking to ramp up your marketing efforts? Grow
your management team? Does your Board of Directors need more seasoned expertise?
Answering these questions for yourself will help you decide whom to approach for investment
capital, whether that be a VC, angel investor, strategic investor, or other.

If you choose the VC path, make your best effort to get an entre into your target VCs through a
trusted referral. And always do your homework, both on the VCs youre targeting and on your
own business needs. Do the math, come to the table prepared, and keep your presentation brief
and to the point. Know your ultimate business objectives, and be honest about those goals with
your prospective investors.

The main factors for success of venture capital industry in any economy are: better physical and
telecom infrastructure, easy registration and operating regulatory framework, tax incentives for
VC companies as well as investors, entrepreneurship culture, availability of business and
technology incubators, strong R&D facilities, better supply of qualified and experienced human
resource in IT and other technologies related sectors, mature financial sector, easy exit options
and human resource to understand the dynamics of business operations and attitude of the
companies. Currently, the economy of Pakistan is much better compared with 6-7 years back and
there are many positive factors, which can help in growing the current infancy stage venture
capital industry. There are similarities on many issues between current venture capital industry in
Pakistan and venture capital industry of India in mid 1990s. This is the requirement of the time
for both public and private sector to learn from the mistakes and successes of Indian venture
capital industry.

Venture capital companies should also make efforts to understand the cultural attitude of
Pakistani entrepreneurs and SMEs; and also the business dynamics of the country, which govern
these companies. There is tendency of business secrecy and wish of control over the company
among the Pakistani entrepreneurs, unlike U.S or other developed countries, where companies
are built to sell for better returns.

There is certainly room for venture capital because access to formal credit is linked with
collateral, documentation and business history. So, new wave of young, educated entrepreneurs
with different attitude will accept venture capital. Converting dreams into reality will also require
political stability; better law and order situation along with direct and indirect support from
government; and active involvement of private sector to timely identify right kind of
opportunities.

RECOMMENDATIONS
 Government needs to create more technology innovation centers and business incubators
and create linkages of these centers with industry, financial institutions and other support
services organizations.
Banks and other financial institutions should be encouraged to invest in venture capital
companies by providing tax related incentives. In the long term, this will be beneficial for
banking sector in the shape of more credit requirement and other banking services.
Government needs to launch special programs to attract Pakistani expatriates particularly
working in IT related sectors of U.S and other countries to invest in technology related
projects. These expatriates Pakistanis should be given incentive like easy and low cost
provision of office space, better telecom infrastructure, tax incentives and other support
services.
Regulations for registration and operation of venture capital companies should be
simplified, like allowing limited partnership firms for establishing venture capital firms.
Research facilities and research culture should be strengthened in education institutes,
particularly engineering universities.
Entrepreneurship culture should be promoted among the young graduates and
entrepreneurship subjects to be introduced in professional colleges and engineering
universities.