Financial Daily from THE HINDU group of publications
Thursday, Oct 10, 2002
Financial Daily from THE HINDU group of publications Thursday, Oct 10, 2002 |
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Opinion
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Venture Capital Venture capital: Time to reflect? G. Sabarinathan
THE Indian venture capital (VC) industry has witnessed considerable turmoil in the last two years. Consider this: At least seven VC funds (VCFs) shut shop. Many others simply ran out of funds. A few set up high-cost Indian operations, with no funds raised or allocated for investment. The rest of the industry appears to be busy, `restructuring' their investment focus, making very few new investments. After a period of hectic investing, from 1998 to 2000, the Indian VC industry appears to be going through difficult times. This is a time for the industry to engage in some serious reflection. Managers in the industry may possibly disagree with me. They might argue that the developments in the Indian industry are a mere reflection of a larger global phenomenon. After all, have the American and European VC industries not slowed down? That comparison though, is inappropriate. The slow down and the poor performance of many funds in the Western world are part of a cyclical phenomenon. The Indian industry, on the contrary, faces issues of a fundamental nature. Let us examine four issues of concern. First, there is a serious mismatch between the kind of venture capital available in India and what the market demands. Almost all VCFs in India have been targeting their capital at companies in the information technology, pharmaceuticals and some services industries, looking for expansion financing of Rs 15 crore or more. Now, this is a limited market segment. Most of the industries mentioned above are relatively young. There are very few firms in these sectors, seeking large amounts of capital for expansion financing. At the same time, a large number of aspiring entrepreneurs, start-ups, early- stage companies and Old Economy firms, which are fundamentally sound businesses, are unable to attract the VC financing that they badly need in order to grow. Apart from the relatively smaller amounts of funding that they seek, on average start-ups require considerable post-funding support from the investor to grow their businesses. That is painstaking work, for which Indian VCF managers have demonstrated neither experience nor training nor temperament. Old Economy firms do not provide the quick or glamorous exits that VCFs often desire. Second, most VCFs in India are an extended arm or a division of global investment institutions. International funds represent more than 95 per cent of the VC invested in India. Two consequences follow from this near-total dependence on foreign capital. One, the investment mandates of these VCFs are often driven by the parent institutions' global world view, which often ignores local market needs. The homogenous investment preferences of VCFs outlined earlier follow from the parent institutions' global investment strategies. Two, at a portfolio level, every international VC investor in India has been a victim of the depreciation of the rupee against the dollar. The returns produced by Indian VCFs, measured in US dollars or other Western currencies, turn out to be considerably less attractive than that measured in Indian currency. Many nations such as the Netherlands, Portugal, Finland, Norway and Israel recognised the limitations of depending on foreign funds at the time of evolving a policy for developing a local VC industry. Their first step was to kickstart VCFs in the private sector with funds from domestic institutions. Over a decade, or even less, they succeeded in creating a local VC industry that depended less and less on government support and international investors. The third issue is the poor quality of corporate governance and lack of sensitivity among entrepreneurs and investors, to each other's legitimate business aspirations. This is a universal problem and not unique to India. What is however unique to India is the hopeless system of legal redress of grievances when partners renege on contractual obligations. Often, aggrieved parties in India agree to settlements that are unfair to them, apprehending that litigation in Indian courts could be dysfunctional. This situation may not change in the foreseeable future. The alternative to litigation and unfair bad investments would be to invest more effort in better identification and selection of investments and supervision of the portfolio. Indian VCF managers need to ask themselves if they are prepared to put in that extra effort to minimise prospects for litigation in the first place. Last, but not the least, the industry lacks a broad-based and effective trade association. The Indian Venture Capital Association (IVCA) does not represent a large proportion of the VCFs who are active in India. I am not sure of the IVCA's contributions to the VC industry either, in the ten years since it was formed. For some years initially, the IVCA used to produce a delightfully uninformative annual report, many months after the end of the year. For the past four years even those reports do not appear to have been published! Venture capital has been a remarkable catalyst of entrepreneurial activity, after the Second World War, in many developed countries. It has led to significant growth in industry and innovation. The prospects for the Indian VC industry are no less humongous. It is up to the industry to reflect on its current predicament and evolve a strategy to seize the opportunity. (The author teaches at IIM Bangalore. The views expressed are personal.)
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