Indian venture capital is at a take-off stage in India, according to this report from NASSCOM. Changes to the regulatory environment look set to encourage the flow of investment to the Indian high-tech sector.
In the absence of an organised venture capital industry until almost 1998 in India, individual investors and development financial institutions have played the role of venture capitalists. Entrepreneurs have largely depended upon private placements, public offerings and lending by financial institutions.
In 1973, a committee on the development of small and medium-sized enterprises highlighted the need to foster venture capital as a source of funding for new entrepreneurs and technology. Thereafter, some public sector funds were established but the activity of venture capital did not gather momentum as the thrust was on high-technology projects funded on a purely financial rather than a holistic basis. Later, a study was undertaken by the World Bank to examine the possibility of developing venture capital in the private sector, based on which the Indian government took a policy initiative and announced guidelines for venture capital funds (VCFs) in 1988. However, these guidelines restricted the setting up of VCFs to the banks or the financial institutions only. Internationally, the trend favoured venture capital being supplied by smaller-scale, entrepreneurial venture financiers willing to take a high risk in the expectation of high returns, a trend that has continued in this decade.
In September 1995 the Indian government issued guidelines for overseas investments in venture capital in India. For tax exemption purposes, the Central Board of Direct Taxes (CBDT)issued guidelines. The flow of investments and foreign currency in and out of India has been governed by the Reserve Bank of India's (RBI) requirements. Furthermore, as part of its mandate to regulate and to develop the Indian capital markets, the Securities and Exchange Board of India (SEBI) framed the SEBI (Venture Capital Funds) Regulations, 1996.
Pursuant to this regulatory framework some domestic VCFs were registered with SEBI. Some overseas investment also came through the Mauritius route. However, the venture capital industry - understood globally as ‘independently managed, dedicated pools of capital that focus on equity or equity-linked investments in privately held, high-growth companies' (Venture Capital Cycle, Gompers and Lerner, 1999) - is still in a nascent stage in India. Figures from the Indian Venture Capital Association (IVCA) show that until 1998, around Rs30bn had been committed by domestic VCFs and off-shore funds, which are members of IVCA. Figures available from private sources indicate that the overall funds committed are around US$1.3bn.
The funds available for investment are less than 50 per cent of the committed funds and actual investments are lower still. At the same time, due to economic liberalisation and an increasingly global outlook in India, there is an increased awareness and interest of domestic as well as foreign investors in venture capital. While only eight domestic VCFs were registered with SEBI during 1996-1998, 14 funds have already been registered in 1999-2000. Institutional interest is growing and foreign venture investments are also on the rise. Given the proper environment and policy support, there is undoubtedly a tremendous potential for venture capital activity in India.
In his 2000 budget speech, India's finance minister announced that a key ingredient for future success lay in venture capital finance. Young Indian entrepreneurs, whether in Silicon Valley, Bangalore or Hyderabad have shown how ideas, knowledge, entrepreneurship and technology can combine to yield unprecedented growth of incomes, employment and wealth. To promote this flowering of knowledge-based enterprise and job creation, he announced a major liberalisation of the tax treatment for venture capital funds. SEBI was granted the responsibility for the registration and regulation of both domestic and overseas venture capital funds. This liberalisation and simplification of procedures is expected to encourage non-resident Indians (NRIs) in Silicon Valley and elsewhere to invest some of their capital, knowledge and enterprise in Indian ventures.
Objective and vision for venture capital in India
Venture capital is very different from traditional sources of financing. Venture capitalists finance innovation and ideas, which have a potential for high growth but with inherent uncertainties. This makes it a high-risk, high-return investment. Apart from finance, venture capitalists provide networking, management and marketing support as well. In the broadest sense, therefore, venture capital connotes human as well as financial capital. In the global venture capital industry, investors and investee firms work together closely in an enabling environment that allows entrepreneurs to focus on value creating ideas. Venture capitalists, meanwhile, drive the industry through ownership of the levers of control in return for the provision of capital, skills, information and complementary resources. This very blend of risk financing and handholding of entrepreneurs by venture capitalists creates an environment particularly suitable for knowledge and technology-based enterprises.
Scientific, technological and knowledge-based ideas - properly supported by venture capital - can be propelled into a powerful engine of economic growth and wealth creation in a sustainable manner. In various developed and developing economies, venture capital has played a significant developmental role. India, along with Israel, Taiwan and the US, is recognised for its globally competitive high technology and human capital. India's recent success story in software and IT is almost a fairy tale when considering obstacles such as inadequate infrastructure, expensive hardware, restricted access to foreign skills and capital, and limited domestic demand. It also indicates the potential India has in terms of knowledge and technology-based industry.
India has the second largest English speaking scientific and technical manpower in the world. Some of its management (IIMs) and technology institutes (IITs) are known globally as centres of excellence. Every year, over 115,000 engineers graduate from government-run and private engineering colleges. Many also graduate with diploma courses in computers and other technical areas. Management institutes produce 40,000 management graduates annually. All of these candidates are potential entrepreneurs.
It is also important to recognise that while India is doing very well in IT and software, it is still behind in terms of product and packaged development. Many experts believe that just as the US did in the semiconductor industry in the eighties, it is time for India to move to a higher level in the value chain.
This is not expected to happen automatically. The sequence of steps in the high technology value chain is information, knowledge, ideas, innovation, product development and marketing. Basically, India is still at the level of ‘knowledge'. Given the limited infrastructure, low foreign investment and other transitional problems, it certainly needs policy support to move to the third stage - ie, ideas - and beyond, towards innovation and product development. This is crucial for sustainable growth and for maintaining India's competitive edge. This will take capital and other support, which can be provided by venture capitalists.
India also has a vast pool of existing and on-going scientific and technical research carried out by a large number of research laboratories, including defence laboratories as well as universities and technical institutes. A suitable venture capital environment - which includes incubation facilities - can help a great deal in identifying and actualising some of this research into commercial production.
The development of a proper venture capital industry, particularly in the Indian context, is needed if high quality public offerings (IPOs) are to be achieved. In the present situation, an individual investor becomes a venture capitalist of a sort by financing new enterprises and undertaking unknown risks. Investors also get enticed into public offerings of unproven and at times dubious quality. This situation can be corrected by venture-backed successful enterprises accessing the capital market. This will also protect smaller investors.
Experience of US market
The potential of venture capital is tremendous when looking at the experience of other countries. A study of the US market between 1972 and 1992 showed that venture-backed IPOs earned 44.6 per cent over a typical five year post-listing holding period, compared with 22.5 per cent for non-venture backed IPOs. The success of venture capital is only partly reflected by these numbers, since 80 per cent of the firms that receive venture capital are sold to other companies rather than achieving an IPO. In such cases, the return multiple vis-à-vis non-venture funded companies is much higher.
This potential can also be seen in the growth of sales figures for the US. From 1992 to 1998, venture-backed companies saw their sales grow, on average, by 66.5 per cent per annum as against five per cent for Fortune 500 firms. The export growth by venture-funded companies was 165 per cent. The top ten US sectors, measured by asset and sales growth, were technology-related.
Thus, venture capital is valuable not just because it makes risk capital available in the early stages of a project, but also because a venture capitalist brings expertise that leads to superior product development. The big focus of venture capital worldwide is, of course, technology. Thus, in 1999, of $30bn of venture capital invested in the US, technology firms received approximately 80 per cent. Additional to this huge supply of venture funds from formally organised venture capital firms, is an even larger pool of angel or seed/start-up funds provided by private investors. In 1999, according to estimates, approximately US$90bn of angel investment was available, thus making the total ‘at-risk' investment in high-technology ventures in a single year worth around US$120bn. By contrast, in India, cumulative disbursements to date are less than US$500m, of which technology firms have received only 36 per cent.
India is attractive for risk capital
India certainly needs a large pool of risk capital both from home and abroad. Examples of the US, Taiwan and Israel clearly show that this can happen. But this is dependent on the right regulatory, legal, tax and institutional environment; the risk-taking capacities among the budding entrepreneurs; start-up access to R&D flowing out of national and state level laboratories; support from universities; and infrastructure support, such as telecoms, technology parks, etc.
Steps are being taken at governmental level to improve infrastructure and R&D. Certain NRI organisations are taking initiatives to create a corpus of US$150m to strengthen the infrastructure of IITs. More focused attempts will be required in all these directions.
Recent phenomena, partly ignited by success stories of Indians in the US and other places abroad, provide the indications of a growing number of young, technically-qualified entrepreneurs in India. Already there are success stories in India. At the same time, an increasing number of savvy, senior management personnel have been leaving established multinationals and Indian companies to start new ventures. The quality of enterprise in human capital in India is on an ascending curve.
The environment is ripe for creating the right regulatory and policy environment for sustaining the momentum for high-technology entrepreneurship. Indians abroad have leapfrogged the value chain of technology to reach higher levels. At home in India, this is still to happen. By bringing venture capital and other supporting infrastructure, this can certainly become a reality in India as well.
India is rightly poised for a big leap. What is needed is a vibrant venture capital sector, which can leverage innovation, promote technology and harness the ongoing knowledge explosion. This can happen by creating the right environment and the mindset needed to understand global forces. When that happens we would have created not ‘Silicon Valley' but the ‘Ind Valley' - a phenomenon for the world to watch and reckon with.
Venture capital at a take-off stage in India
Lately, in India, the demand for software and dot.com-driven IT stocks on the stock exchanges has been growing steadily. Most of the companies have recorded substantial increases in their market capitalisation during the last year. On 2 May 2000, the info-tech industry's market capitalisation reached in excess of US$59bn, showing the highest increase in absolute valuation compared to any other industry during the last year.
The IPOs achieved by software companies in India in 1999 have attracted record investor subscriptions. The demand for Indian IT stocks is very high, even on Nasdaq, as is evident from the listing of ADRs of Infosys Technologies and Satyam Infoway. Investors have lapped up the offerings of these two companies and their shares have appreciated tremendously since their IPOs on Nasdaq.
A similar investor preference for start-up IT companies is being seen, though not of the same magnitude. Yet, it is apparent that investors are willing to take higher risks for a potentially higher reward by investing in start-up companies.
Until 1998, the venture creation phenomenon for the IT sector in India had been quite unsatisfactory. Some experts believe that India lacks strong anchor companies like HP and Fairchild, which funded the start-ups of early Silicon Valley entrepreneurs. Others believe that Indian entrepreneurs are not yet globally connected and are often unwilling to share equity with a quality risk capital investor. There was also a perception that start-ups in India do not typically attract the right managerial talent to enable rapid growth. Finally, exit options were considered to be few, with the general feeling that entrepreneurs were unwilling to sell their start-ups even if it was feasible. As a result, much of the risk capital available was not quickly deployed. However, since March 1999, things have been changing dramatically for the better.
The venture capital phenomenon has now reached a take-off stage in India. Risk capital in all forms is becoming available more freely. As against the earlier trend, where it was easy to raise only growth capital, even financing of ideas or seed capital is available now. The number of players offering growth capital and the number of investors is rising rapidly. The successful IPOs of entrepreneur-driven Indian IT companies have had a very positive effect in attracting investors. The Indian government initiatives in formulating policies regarding sweat equity, stock options, tax breaks for venture capital along with overseas listings have all contributed to the enthusiasm among investors and entrepreneurs, as has the creation of the dot.com phenomenon.
In India, the venture capital creation process has started taking off. All the four stages - including idea generation, start-up, growth ramp-up and exit processes - are being encouraged. However, much needs to be done in all of these areas, especially on the exit side.
The Indian government sets up a venture capital fund
The Indian government has reiterated its commitment to the Indian software-driven IT industry by creating a National Venture Capital Fund for the Software and IT Industry (NFSIT). NFSIT, set up in association with various financial institutions and the industry, operates under the umbrella of the Small Industries Development Bank of India (SIDBI). The objective of the fund is to encourage entrepreneurship in the areas of software, services, dot.com and other IT related sectors in which India has inherent as well as acquired competency. The fund was launched by prime minister Atal Behari Vajpayee, who has emerged as a strong proponent of India's software-driven IT industry. The fund is expected to be a key component in addressing the rapidly growing demand for venture capital in India. The fund will be looking at supporting entrepreneurship in high growth sectors.
Many state governments have already set up venture capital funds for the IT sector in partnership with local state financial institutions and SIDBI. These include Andhra Pradesh, Karnataka, Delhi, Kerala and Tamil Nadu.
NASSCOM is India's national association of software and service companies, the apex body and umbrella organisation of IT, software and service industries in India. NASSCOM is a Chamber of Commerce member and a single reference point for any information on IT, services and industry in India. Its primary objective is to act as a catalyst for the growth of the software, IT, services and e-commerce industries in India. It was specifically set up to facilitate business and trade in software and services and to encourage the advancement of research in software technology. It is a not-for-profit organisation.
19th February 2007 From India, Pune