Ventures get a bigger bang from the domestic buck

The buzz is in the air. Youth of all ages in India is keener than ever to pursue an entrepreneurial career. However, the entrepreneurial journey is strewn with hurdles, and success often requires an amalgamation of personal traits such as passion, hard work, determination, persistence, and more importantly, luck.

Presence of these factors, however, does not automatically grant success as business ventures need a lot more than just persona. An important reason for the failure of ventures is non-availability of risk capital in the early and growth phases of the business.

With limited collateral to support debt funding, private equity remains the common form of funding for most first generation entrepreneurs.

The growth in Venture Capital and Private Equity (VCPE) investments has significantly contributed to the development of the entrepreneurial ecosystem in the country. Annual VCPE investments have reached a level of $8–10 billion in recent years.

During 2000-13, VCPE capital funded over 4,000 businesses. Similar to the trend seen in stock markets and corporate investments, a substantial part of the VCPE capital that gets invested in India is from foreign sources. Our analysis showed that foreign capital accounted for close to 94 per cent of VCPE investment in the country. Fund managers also prefer to approach overseas investors when raising funds for a variety of reasons: their ability to make larger commitments and their understanding of the VCPE asset class.

While there are several advantages with foreign capital, there are several limitations as well. For example, foreign capital flow would be highly sensitive to global developments, resulting in wide swings in capital flows. It could also be sensitive to macroeconomic factors such as currency depreciation. For example, PE fundraising from overseas investors, which was $7.8 billion in 2008, fell to $1.4 billion in 2013. Such dramatic fluctuations can act as a choke for capital seeking entrepreneurs.

On the other hand, domestic investors in general are more consistent. For example, when we classified capital providers into quartiles based on the draw-downs they participated, the proportion of domestic investors in the top quartile was 42.74 per cent whereas it was only 26.51 per cent in the bottom quartile. Therefore, in recent years, there has been a concerted effort to develop domestic capital pools for VCPE investment.

On ground, the impact of domestic capital can be far higher. The 2014 India Venture Capital and Private Equity report released recently by the Department of Management Studies, IIT – Madras, highlights some of these. First, domestic capital seeks to invest more in early-stage deals compared with foreign capital.

A bottleneck in the Indian start-up funding environment is the availability of early-stage capital. VC funds invest in early-stage companies, whereas large PE funds make more of growth and late stage investments. Our analysis shows that, domestic sources have a higher share of their commitments to venture funds as compared to foreign sources (Fig 1).

Mobilising more domestic capital for ventures would thus address the bugbear of inadequate early-stage funding. Second, domestic capital can fund ventures in those sectors that can have a strong relevance to India.

A case in point is the investment in IT and ITeS sector. The contribution of IT and ITeS to export growth and employment generation is well known. Our results indicate that the proportion of IT & ITeS investments by VCPE funds that have domestic capital providers is substantially higher as compared to funds that have foreign investors (Fig 2). A similar trend can be seen in healthcare as well, another sector of national priority.

More importantly, domestic investors investing in VCPE funds would serve to make a statement. This was well summarised by Vikram Gandhi, the well-known investment banker, when he released the 2014 report. Said he, “Foreign investors frequently ask why should we invest in Indian entrepreneurs, when the domestic investors don't?” Rather than crowding out, increase in domestic capital, can, ipso facto , also lead to an increase in foreign capital thus making it a double bonanza for entrepreneurs.

(The writer is Associate Professor, Department of Management Studies, IIT-Madras)

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