Quoting Reid Hoffman, LinkedIn’s founder, running a startup is much like jumping off a cliff and assembling an airplane on the way down. The journey from an idea to a fledgling company, if everything goes well, takes laborious efforts in market testing, product development, sales & marketing, hiring, scaling, fundraising and realizing exits for investors. With lean budgets and limited resources, the founding teams must navigate fog of uncertainties.
Those in India face additional challenges arising from the environment they operate in. Some of the issues tie back to factors that contribute to the country’s poor standing in Ease of Doing Business rankings – registration times, complicated tax codes and costs associated, inordinate regulatory scrutiny, bankruptcy procedures and so on. Yet others are more specific to startups, such as lack of domestic sources of venture funding, adversarial attitudes in regulatory catch up to newer business models and less than ideal market conditions for exits.
A fresh and well-intentioned initiative, Modi’s Startup India campaign was meant to stimulate creation of and smoothen the pathway for young and innovative enterprises. The four pillars of the campaign are relaxation from compliance burden, tax incentives to startup and founder, infrastructure support at seeding stage and, lastly, a Fund of Funds for Startups.
To its credit, the campaign has brought technology and startups into the popular culture, reflecting a new shift in attitudes of the masses and governments, because of which the youth are more willing than ever to jump off the proverbial cliff, families find it acceptable that their young ones pursue unconventional careers and government machinery has become sympathetic towards the needs of risk-takers. The uptick in startup registrations in 2016 speaks to it. The entrepreneurial enthusiasm even transcends beyond conventional tech hubs with saplings sprouting in tier-II cities. State governments started to view technology and startups as policy tools for economic development.
Although, the program touches upon the pain points at ideation, commercialization, seed and early stages it stops short afterwards. Its scope is narrow – the policies support a defined set of startups with a specific set of useful measures. As a result, the program is available only to a select few for limited things, prompting many startups to move their legal domicile to other jurisdictions. To maximize impact, the program needs to expand the scope of its policies.
Currently, about 90% of venture funding in India ultimately comes from foreign investors, mainly the US. This doesn’t only make incoming capital highly susceptible to American venture market gyrations as well as macroeconomic factors, but also leads Venture Capitalists to invest in sectors and business models that make their Limited Partners most comfortable – hyper-scalable, asset-light consumer internet variants – while everything else gets overlooked. India lacks a deep domestic investor base, the root cause of which is that Venture Capital is not available as a viable and attractive asset class to Indian institutional investors.
Indian pension funds and insurance companies, institutions which collectively manage more than Rs. 25 lakh Crore and have long time horizon as that of VCs, have venture funds virtually omitted from their metaphorical handbooks. Startup India’s fourth pillar – DIPP’s Rs. 10,000 Crore Fund of Funds for Startups (FFS) – was meant to be the filler. However, even despite DIPP’s recent efforts to correct certain restrictions that made FFS, originally, a somewhat undesirable fundraising option for most VC funds (e.g.,, relaxing the rule preventing fund managers from making follow-on investments in portfolio companies that are more than five years old or have surpassed Rs.25 Crore in topline revenues), FFS alone will likely fail to bring long lasting changes.
Policymakers could take ideas and best practices from policies or programs from elsewhere in the world. The United States IRA’s 1979 ‘Prudent Man Rule’ opened floodgates of Pension Funds capital to venture funds, with new commitments exceeding $5 Bn compared to $1 Bn a year ago. In India, it was only in 2016 that pension funds were allowed to allocate a meagre 2% in alternative assets, of which venture capital is a small part, and similarly, insurance companies were allowed a paltry 3% to alternative assets in 2013.
Another idea worth exploring is alternative uses of FFS. Instead of being a restrictive Limited Partner, FFS could play an enabler to attract private matching funds more effectively. The 2010 Venture Capital program within the US Dept. of Treasury’s Small Scale Credit Business Initiative (SSBCI) allowed US states to design their own venture capital programs that “are designed to stimulate and support private investment over time, rather than fill a capital markets gap with public funding alone.” New York State, for instance, chose to offer preference rights to the private co-investor in the Fund of Funds in order to incentivize participation, effectively multiplying many times over the total private matching capital deployed in startups.
Similarly, Singapore National Research Foundation’s (NRF) Early Stage Venture Fund, a Fund of Funds, incentivizes corporate VCs to pool capital by giving them the option to buy out NRF’s share of the fund within five years by returning NRF’s capital with interest, thereby enhancing returns potential and the risk-taking abilities of the latter.
Unlocking capital for the venture industry domestically will ensure a wide variety of industry sectors – many of which can’t naturally produce hyper scalable unicorns – get access to risk capital. Beneficiaries will also include the nascent venture ecosystems of tier-II cities, which currently fall out of the comfort zones of VCs and their investors.
In a large country such as India, no policy could be perfect in either design or implementation. Intentions and fresh thinking must not be discounted and, therefore, neither should those around Startup India. There remain serious structural challenges, which need to be addressed head-on, lest the vision of Modi’s campaign will never be fully realized. India needs to ease up as its young companies, otherwise, stand at a disadvantage compared to global peers.
(By – Tanmay Bhargava is Managing Partners at Gazelle Ventures)
Source: BW Disrupt
