Venture capital opens up a new business horizon

The much-awaited Alternative Investment Rule was approved by the Bangladesh Securities and Exchange Commission (BSEC) in June 2015. It will create opportunities to undertake business by venture capital and private equity in the country. Venture capital (VC) and private equity (PE) are a mode of financing which is widely practised in different developed countries.
Financing can be done in two modes - debt and equity. All banks and non-bank financial institutions provide debt or loan. Bangladesh's financial market is debt-driven, be it loan or bond, or lease. Equity is limited in capital market - raised through IPO (initial public offering) right share. Stock exchange is the marketplace for shares of the company issued to members of the public. This marketability provides liquidity to those who invest in equity. The transaction happens every day in the stock exchange. That money does not flow to the company whose share an investor is buying.
Venture capital and private equity are the financial instruments of primary market or non-listed equity instruments. More importantly, venture capital finances enterprises at a stage when no other financial institutions will do so. The type of enterprises venture capital selects is seldom in the positive list of formal financial institutions such as software, apps  or game making, etc. Both types of business and stages of the enterprise (such as seed, or product prototype) are customer non grata for bank and NBFI (non-banking financial institution).
Venture capital law was passed in India in 1996. Last year, they invested US$ 5.2 billion from VC fund in  business enterprises. In the US, venture capital law was promulgated in 1948. The Dot.Com Revolution in Silicon Valley was possible due to venture capital. In 2014, all venture capital firms in the US together invested US$ 49.3 billion in 4,361 enterprises of which 41 per cent was invested in software and 12 in bio-technology. This was the highest amount in 15 years and a big leap from 2013 when US $29 billion was invested in 3,382 companies through 4,041 deals. In 2000, venture capital investment reached its peak with US$ 105 billion invested through 8,083 deals (Year Book for 2015 of National Venture capital Association, USA). Among the reputed companies, Facebook, Ebay, Starbucks, Microsoft, Intel, Google and Apple started business by receiving venture capital fund. These are high-growth businesses which are reflected in increase in the number of employees of these companies from the time of IPO to the present day. Facebook's staff rose from 3,200 to 9,199, Starbuck from 2,521 to 191,000, Ebay's from 138 to 34,400, Microsoft from 1,153 to 128,000, Intel from 460 to 101,700, Google from 3,021 to 53,861 and Apple from 1,015 to 76,100.  Such an astonishing growth has happened due to the fact that venture capital invests in enterprises which work with disruptive technologies or processes. There is a high risk that these companies may not succeed. But if they succeed, they grow exponentially.    
The recent passage of Alternative Investment Rule (AIR) will open the doors of venture capital firms in Bangladesh. Venture capital and private equity firms have to get registered with the BSEC as Fund Manager after fulfilling certain terms and conditions. A firm has to be a company or a statutory body whose minimum capital will be Tk 50 million and will have the capability to be a fund manager. Neither the director nor the company was a defaulter or violated security laws, etc. Fund Managers are general partners (GP). They raise venture capital fund after getting proper approval from the BSEC. Eligible investors invest in venture capital fund. Unlike other equity or debt instruments, anybody is not allowed to invest in VC fund. Moreover, venture capital fund can't raise money through public offering. This bar is to keep general public, who are not aware about the risk nature of VC fund, away. Venture capital is a risky instrument. Moreover, its term is long such as 10 years. Many investors may have patience for such a long period.  
'Eligible investors' are defined as "participants eligible and competent to understand the risk and return potentials to invest and commit capital to any alternative investment fund and be either a registered local of foreign fund manager or a company incorporated in Bangladesh or abroad or a statutory body or a local government authority or a bank or a financial institution or an insurance company or a merchant banker or a stock dealer or an asset manager or an alternative investment fund managed by another fund manager or a registered pension fund or a registered provident fund or a registered trust fund or a registered super annuation fund or a foreign fund or a foreign individual or a high net worth resident or non-resident Bangladeshi individual".
These eligible investors, who invest but do not participate in management of fund, is called LP. GP manages the fund. They receive management fee to maintain their administrative expenses. GP raises the fund, select enterprises to invest in, perform due diligence, make disbursement, monitor the company, exit from the company and harvest capital gain along with the principal. This capital gain is distributed among GP and LP at 20:80 ratio after ensuring hurdle rate (minimum rate committed at constitutive document) to LP. The fund has a separate entity, which is registered under Trust Act and governed by trustees. Bank or insurance companies are eligible to be Trustees if they meet criteria set by and registered with the BSEC. Neither the Trustee, nor any of its affiliates or directors has any relation with the fund manager nor act as arranger or advisor of fund.
Fund Manager invests the fund in innovative businesses. Innovation may not necessarily happen in technology; it may occur in business process or in new product or market. There should be something disruptive to the status quo. This has chance to fail. But if it succeeds, returns will be manifold. Fund Manager sells its share and earn good amount through capital gain.
Alternative Investment Fund is to be invested mainly (at least 75 per cent of the fund corpus) in non-listed securities of portfolio companies and maximum 25 per cent of the fund corpus in listed securities and units of alternative investment funds managed by other fund managers, of which maximum 10 per cent of the fund corpus may be invested in money market instruments. Investment in single listed securities shall not exceed 5.0 per cent of the fund corpus. No alternative investment fund shall invest more than 25 per cent of the fund corpus in a single non-listed portfolio company.
Venture capital and private equity are totally different from debt financing. Debt is less risky than equity financing. A good enterprise normally makes more money than its cost of borrowing, which is interest rate. So return for equity is expected to be higher than the interest on loan. Secondly, venture capitalist is much more involved in the invested business. They 'closely monitor the activities of portfolio companies and if necessary, participate in the management and represent in the board of directors of such companies with approval of the Trustee'. The objective is to enhance the value of the company as much as possible so that its stake in the company increases.
In order to make the venture capital business start in full swing, the government has to provide tax pass-over effect for venture capital and private equity fund. Since private equity or venture capital fund is a new entity, tax status has to be decided. If an investor finds that s/he has to pay double tax for passing through his investment to an enterprise through PE/VC fund instead of making the investment directly to that enterprise, s/he will be least interested to invest in PE/VC Fund. Therefore, the government has to waive income tax on PE/VC fund.
The writer is Managing Director of BD Venture Limited and Fellow of Cost & Management Accountants.
shawkat_h@yahoo.com