Venture Capital

In plain language

How it works

A worked example

6 companies fail          6 × Rs 0           = Rs 0
3 companies return money  3 × Rs 5 crore     = Rs 15 crore
1 company returns 20×     1 × 20 × Rs 5 crore = Rs 100 crore
Total value                                  = Rs 115 crore
Multiple on Rs 50 crore                      = 115 ÷ 50 = 2.3×

Why NISM asks about it

Common exam traps

Check yourself

1. 1.What is the relationship between venture capital and private equity?

   1. a)They are entirely separate categories with no overlap
   2. b)Venture capital is a type of private equity used for early stage businesses
   3. c)Private equity is a type of venture capital used for listed companies
   4. d)Venture capital invests in debt while private equity invests in equity
   Show the answer

   Answer: (b) Venture capital is a type of private equity used for early stage businesses

   "But the term PRIVATE EQUITY IS PREDOMINANTLY USED TO DENOTE INVESTMENT IN COMPANIES WITH ESTABLISHED BUSINESS MODEL AND TRACK RECORD (known as LATER STAGE COMPANIES)."

   So the relationship is genus and species, not two parallel families. What separates them is the stage of the company, not the type of transaction — and both share the defining feature of being unlisted.

   Option (c) inverts the hierarchy and contradicts the core fact: private equity is by definition investment in companies not listed on a stock exchange.

   Option (d) is wrong in a more interesting way. It is true that private equity has "EXTENDED TO PROVIDING DEBT CAPITAL THROUGH PRIVATE DEBT" — but so has the broader category. The word "equity" in private equity "REFERS TO THE TOTAL CAPITAL RAISED FROM PRIVATE INVESTORS EVEN THOUGH THE INSTRUMENT USED MAY NOT ALWAYS BE AN EQUITY SHARE" — it may be "EQUITY, PREFERENCE, DEBT OR MEZZANINE CAPITAL." The instrument does not distinguish VC from PE.

   Beyond growth capital, PE also does control transactions: "BUYOUT" and "LEVERAGED BUY OUTS (LBOs)", where investors "typically look to acquire CONTROLLING INTERESTS OF EITHER 51% OR MORE."

2. 2.Alternative investment funds provide risk capital to businesses that have a very high probability of failure due to their complex technologies. True or false?

   1. a)True
   2. b)False
   Show the answer

   Answer: (b) False

   (This is a sample question from the NISM workbook.)

   FALSE, and the statement is wrong in three separate ways.

   First, on the degree of risk. The workbook says venture-backed businesses are "SUSCEPTIBLE TO HIGH MORTALITY RATE" — susceptible to, not carrying a very high probability of failure. That is a real difference in strength of claim.

   Second, on the cause. The reason given is not complex technology but size and assessability: "Since these businesses are SMALL, THEY ARE SUSCEPTIBLE TO HIGH MORTALITY RATE. ASSESSING THEIR FUTURE POTENTIAL IS ALSO A DIFFICULT AND COMPLEX TASK."

   Third, and most fundamentally, on scope. The statement describes venture capital only — one avenue among many. Alternative investments also include private equity in later stage companies with established track records, infrastructure funds investing in "OPERATIONAL PROJECTS THAT PROVIDE STEADY INCOME STREAMS", private debt, real estate, commodities used as "HEDGE AGAINST INFLATION", and REITs and InvITs preferred by "LOW RISK-TAKING LONG-TERM INVESTORS SUCH AS PENSION FUNDS AND INSURANCE COMPANIES."

   An infrastructure fund holding operational toll roads on long-term contracts is an alternative investment, and nothing about it resembles a start-up with a high probability of failure.

   What IS true of venture capital: it is "CONSIDERED HIGHLY RISKY AND RANKS AS SUCH AMONG ALTERNATIVE INVESTMENTS", with the rationale of "HIGHER RETURNS BASED ON EARLY INVESTMENT IN THE BUSINESS GROWTH POTENTIAL."

3. 3.Under the DPIIT definition, a start-up must satisfy which of the following?

   1. a)Not more than 5 years old with turnover under Rs 25 crore
   2. b)Not more than 10 years old, turnover never more than Rs 100 crore in any financial year, and engaged in innovation or a scalable business model
   3. c)Not more than 10 years old with any level of turnover, provided it is unlisted
   4. d)Any unlisted company engaged in technology, regardless of age or turnover
   Show the answer

   Answer: (b) Not more than 10 years old, turnover never more than Rs 100 crore in any financial year, and engaged in innovation or a scalable business model

   Three conditions, all of which must hold:

   Test	⚠️ Threshold
   Age	⚠️ Not more than 10 years
   Turnover	⚠️ Never more than Rs 100 crore IN ANY FINANCIAL YEAR
   Character	⚠️ Innovation, development or improvement of products, OR a scalable business model with high employment/wealth generation potential

   The turnover wording repays attention. It is "in any financial year", not "in the last financial year" — so a company that crossed Rs 100 crore once and then shrank has permanently lost the status. Options (c) and (d) each drop one or more of the three tests, which is how this question is usually constructed.

   Why the definition exists at all: "In order to GIVE IMPETUS TO START-UP FINANCING IN INDIA." It is a gateway to government benefits, not an academic classification — which is why the tests are bright-line rather than judgemental.

   Note also how it connects to the AIF Regulations' own description of venture capital targets: businesses "concerned with NEW PRODUCTS, NEW SERVICES, TECHNOLOGY OR INTELLECTUAL PROPERTY-BASED ACTIVITIES OR A NEW BUSINESS MODEL."

Where this is taught

• Series XIX-B · Chapter 1: Overview of Alternative Investmentsintroduced here
• Series XIX-A · Chapter 1: Overview of Alternative Investmentsintroduced here
• Series XIX-D · Chapter 2: Types of Investmentsintroduced here

Related terms

• Alternative InvestmentA financial asset outside the conventional categories of stocks, bonds and cash — defined by what it is not, and marked above all by illiquidity.
• Angel FundA sub-category of Category I AIF, registered with SEBI specifically as an angel fund, which raises money from angel investors and invests it in start-ups deal by deal rather than through schemes.
• Venture Capital FundA Category I AIF that invests primarily in unlisted securities of start-ups, emerging or early-stage venture capital undertakings, and includes migrated venture capital funds.
• Private EquityEquity capital raised by companies from external investors without going to the public markets — direct investment in businesses that are not listed on a stock exchange.
• Venture Capital UndertakingA domestic company that is not listed on a recognised stock exchange at the time the investment is made — the defined target that a venture capital fund must put at least 75% of its investable funds into.
• DPIIT start-up definitionThe Government of India's test for a "start-up": a business not more than 10 years old, with turnover not exceeding Rs 100 crore in any financial year, engaged in innovation.
• Viral CoefficientHow many new paid users one existing user brings in through referrals — referrals sent per user multiplied by the conversion rate of those referrals.
• Product Market FitThe point at which customers repeatedly buy and re-buy a start-up's product — the signal that lets an AIF manager stop betting on an idea and start betting on demand.