VC impact: The picture beyond the pixels

My professional pursuits give me numerous opportunities to interact with venture investors. Invariably, most of these discussions steer towards the returns that the venture capital firms have been able to generate from their investments. While most venture investors proudly display their successes on the sleeve, they have been also frank in admitting that the venture industry in India as a whole has disappointed investors in terms of returns.

The quantum of investment involved has been significant – during 2011-16, the total estimated investment by PE and VC investors in India has exceeded ₹4 lakh crore. If the performance on returns has been ambivalent, what has been the contribution of venture capital investments in India? A recent joint study with Venture Intelligence provided interesting perspectives.

The first is size. In the Indian context, smaller companies face numerous barriers to access external or public capital and equity markets. Many of the start-up, technology firms have several years of negative earnings, making access to debt funding also difficult. Our analysis showed that the biggest contribution of PE and VC investors has been to provide capital to smaller companies. While this finding is consistent with expectation, our results give an indication of scale. VC-PE funded companies are just one-sixth of the revenues or asset size of all listed companies.

The second is growth. Revenue growth of VC and PE companies has been more than twice that of other benchmarks that we analysed, indicating that PE-VC firms invest in those companies that have high potential for growth. While smaller companies are likely to clock higher growth rates as compared to the larger firms, the growth spread between PE-VC funded companies and benchmarks is considerable, indicating that all of it could not be attributed to the size effect. A significant characteristic of PE-VC funding is their willingness to provide capital not just for organic growth, but also for inorganic route such as acquisitions.

The third is sustainability. PE-VC investment is associated not just with top line growth but also with growth in asset creation. Revenue growth achieved through various forms of promotional measures can only provide short-term benefits and cannot be sustainable. Our results show that PE funded firms have higher growth rates in asset creation. The asset growth rate of VC-PE funded companies was over 2.5 times the corresponding growth rates of other benchmarks we analysed. The growth in assets indicates that the higher revenue growth of PE funded companies is supported by tangible investment in assets, thereby ensuring that the revenue growth rates can be sustainable in the long term. Investment in asset creation provides benefits over many years, as compared to “cash-burn” in operational expenses.

The fourth is outlook. The profit growth and return on assets for VC-PE funded companies are negative. Our inference is that VC-PE investors look beyond the short term in their investment decision making. Being in the growth phase, VC-PE funded firms need to make significant investments in assets the benefits of which can be realised only in the future years. The biggest contribution of PE-VC investors is thus to seek out companies that have strong prospects in the long term, despite short-term weak performance. Such companies would find it difficult to access investment from other sources, and if not for the support of PE-VC investors would have found it difficult to survive.

Ships are safer in the harbour. But that is not where they are supposed to be. The objective of venture firms is to provide risk capital and not indulge in safe investments. Our results show that VC firms have not significantly deviated from their raison d'être.

While the critics could point to the poor returns, to quote Theodore Roosevelt, “The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds…and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.”

(The writer is Professor, Department of Management Studies, IIT-Madras and International Research Affiliate, Coller Institute of Venture, Tel Aviv University, Israel. He is also a co-founder of YNOS Venture Engine. This research was done in partnership with Venture Intelligence.)

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