What is Venture Capital?What is a Venture Capital Company?
What is a Venture Capital Fund?How are VC Funds structured?
What is a VC Portfolio?What is a Portfolio Company?
Who are Business Angels?What is Seed Capital?
What is Corporate VC?How are Venture Capital BR calculated?
What is Carried Interest?How is a VC Fund Liquidated?
What makes a good Venture Capitalist?Why invest in Venture Capital?
What is the Tax Status for VC Investments? 
What is Venture Capital?

Venture Capital (VC) is illiquid investing in high potential, high-risk business opportunities. More specifically, venture investments are classically minority equity interests in young, rapidly growing companies with the potential to become large companies. However, they are not yet credit-worthy, and thus are not eligible for traditional bank financing. Often lacking many of the resources required for success, immature companies call on the know-how as well as the capital of the investor.

What is a Venture Capital Company?

Securities and Exchange Commission of Pakistan under it Venture Capital Companies and Funds Rules 2001 defines a Venture Capital Company as “A company which is engaged in financing any Venture project, through equity or other instruments whether convertible into equity or not and provides managerial or technical expertise to venture projects, or acts as a management company for management of venture capital funds”.

What is a Venture Capital Fund?

SECP defines a VC Fund as “A company which is managed by a venture capital company and raises funds through private placement of equity and other securities, as specified under these rules and invests its resources in venture projects”.

The fund is managed by a venture capital company (the Management Company). For example, TMT-PKIC Incubation Fund is a VC fund managed by TMT Ventures.

How are VC Funds structured?

In the US, venture funds are usually organized as limited partnerships where the investors are limited partners
(LPs), and the managers are the general partners (GPs).

In Pakistan, the concept is somewhat different whereby the roles of LPs and GPs are performed by two separate companies. Investors have shareholding in a fund proportionate to their investments – similar to the role of LPs in the US. A venture capital management company is responsible for the fund’s operations; its role is similar to that of a GP in the US VC model.

What is a VC Portfolio?

A VC firm invests in several companies, each of which is known as a portfolio company. The spread of investments into the various target companies is referred to as the portfolio.

What is a Portfolio Company?

This is one of the companies backed by a venture capital or private equity firm.

Who are Business Angels?

Individuals who provide seed or start-up finance to entrepreneurs in return for equity. Angels usually contribute a lot more than pure cash – they often have industry knowledge and contacts that they can pass on to entrepreneurs. Angels sometimes have non-executive directorships in the companies they invest in.

What is Seed Capital?

The provision of very early stage finance to a company with a business venture or idea that has not yet been established. Capital is often provided before venture capitalists become involved. However, a small number of venture capitalists do provide seed capital.

What is Corporate VC?

This is the process by which large companies invest in smaller companies. They usually do this for strategic reasons. For example, a large corporate such as Intel may invest in smaller technology companies that are developing new products that can be assimilated into the Intel product range.

How are Venture Capital Returns calculated?

There are two complementary measures of investment performance for venture capital funds – internal rate of return (IRR) and multiples of invested capital returned (Realization Ratio). Both approaches take into account cash inflows from and outflows to investors after payment of fees and performance profits, called “carried interest”, to the management company (or general partners in the US). The IRR approach also considers the time value of money and assumes periodic reinvestment of “earnings” calculated over the investment period. Both methods have their shortcomings and are best viewed in comparison with one another. IRR is generally the more popular approach. However, for taxable investors, the ability to keep money invested over a significant period of time, building values equivalent to multiples of the original investment, is preferable to a series of short-term investments producing comparable, composite IRRs. This is why the Realization Ratio is a worthwhile measure.

What is Carried Interest?

The share of profits that a fund manager is due once he/she has returned the cost of investment to investors. Carried interest is normally expressed as a percentage of the total profits of the fund. The industry norm in the US is 20%. The fund manager will normally therefore receive 20% of the profits generated by the fund and distribute the remaining 80% of the profits to investors.

How is a VC Fund liquidated?

A VC fund is typically for a fixed period of time, usually 8 to 10 years. After the initial years when investments are made liquidation starts from the 4th or 5th year and majority of companies are typically sold out before the stipulated period. Upon the expiry of this period the fund is liquidated by selling out the remaining companies and the proceeds in the form of cash and/or securities are distributed pro-rata among the investors in the fund.

When a company in a fund’s portfolio is sold or taken public, the management company receives compensation in the form of cash, stock or both. The management company typically distributes any cash proceeds to the fund’s investors immediately and distributes securities when they are free of trading restrictions, if any, in case of an IPO and have reached a reasonable and stable valuation in the management company’s opinion.

What makes a good Venture Capitalist?

Management backgrounds and networks in specific industries, financial skills, people skills and negotiating skills are needed prerequisites of a good venture capitalist.

It takes years of mentoring to learn how to assess investment opportunities, set pricing and strategy, build and motivate management teams, deal with unpredictable threats to the businesses, source additional capital and strategic partners, and, finally, exit these investments.

Why invest in Venture Capital?

When properly executed, venture capital investing can provide substantially enhanced long-term returns to a diversified investment portfolio. It operates in a more imperfect market than most public investments, and consequently there is significant potential for super-normal return. The associated risks are significant, however, and each investor must undertake his/her own due diligence before making any VC investment.

What is the Tax Status for VC Investments?

Under clause 101 of part I of second schedule of Income Tax Ordinance, 2001 the profits and gains derived by a venture capital company and venture capital fund registered under Venture Capital Companies and Fund Management Rules are  exempt from income tax up to 30 June 2014.