Insights into Editorial: Fine Print of India’s Start-up Policy
22 January 2016
As part of a bunch of measures that constitute the action plan for government’s start-up initiative, the centre will shortly be setting up a Fund of Funds that would invest in private venture capital funds.
- The fund will be set up with the initial corpus of 10,000 crore (about $1.5 billion). However, it will be deployed in tranches of Rs.2,500 crore over a period of four years. India’s venture capitalists are very happy with this announcement.
- Please note that the idea of a fund of funds isn’t new. Finance minister Arun Jaitley had earmarked Rs.10,000 crore for a fund of funds nearly 18 months ago in the Union Budget 2014-2015. The fund of funds announced as part of start-up action plan is a reiteration, rather a repackaging of the July 2014 budget proposal with some clarity on how it will be structured and managed.
Who can use this fund?
The fund of funds will invest in venture capital funds registered with markets regulator Securities and Exchange Board of India (Sebi).
Why we need this fund?
Presently, the domestic venture capital industry is practically non-existent in the country. The country’s venture capital industry, consisting mostly of foreign firms, currently raise more than 90% of their capital from foreign institutional investors, commonly known as limited partners. Thus, it is necessary to stimulate the growth of the domestic venture capital industry.
Why is it important to encourage the growth of a domestic venture capital industry that is not overwhelmingly dependent on foreign capital?
It is because of the following reasons-
- Firms backed by foreign capital tend to jump towards start-ups that replicate business models that have been successful in the US, or in other developing markets. Their limited partners are understandably more comfortable with that strategy.
- The dependence on foreign capital makes firms in India vulnerable to the ups and downs of those markets. While the Indian venture capital market is not currently strapped for capital and India remains an attractive investment destination for global limited partners, even a tremor in the US economy or venture capital market could trigger a major upset here.
The fund of funds aims to address the above mentioned concerns by specifically investing in funds that will, in turn, invest in sectors such as health, education, manufacturing and agriculture.
Challenges before the venture capital industry:
- According to data compiled by Chennai-based Venture Intelligence, in 2015, venture capital investments in India stood at about $1.8 billion. Therefore, Rs.10,000 crore is not sufficient to spur the growth of this industry.
- The government has announced that it intends to contribute up to 50% of the stated corpus of a Sebi-registered venture capital fund. However, the problem here is that it is quite difficult for these funds to raise the rest 50%. Added to it, the government contributes 50% only after the Sebi-registered fund has already raised commitments from other investors for the balance 50%.
- These venture capital funds do not have access to a large pool of domestic institutional capital. Even the banks and insurance companies cannot help them as their investment limits are capped at 10% of the overall corpus of a Sebi-registered venture capital fund.
- Hence, the only sources of domestic capital currently available to venture capital funds are HNIs (high net-worth individuals) and family offices. However, neither is incentivised enough, through tax concessions, to put meaningful money into play in venture capital funds.
- This leaves domestic venture capital funds with no option but to raise but to raise capital from overseas investors. Even that is not easy because of a complex regulatory framework.
- As a result, most domestic venture capital funds have to adopt a dual fund structure (in which capital raised from foreign investors is parked in a separate offshore fund).
Why some people are not happy with the formation of this fund?
Critics argue that it is not prudent, even proper, on the part of the government to invest taxpayers’ money in venture capital funds, which will in turn invest in enterprises that carry a high risk of failure.
An advisory panel set up by Sebi and led by Infosys founder N.R. Narayana Murthy has just submitted a report suggesting reforms to make the fund-raising environment for venture capital funds more conducive. The government has assured that it will soon address their concerns.
While it remains unclear whether tech start-ups have anywhere near the potential to create the kind of employment that India needs, the government on its part has done well to give these start-ups the necessary ammunition to get on with value creation with the minimum of government interface. Overall, while the intent is praiseworthy and there are many laudable ideas in the policy, much in the fine print needs attention if its goal is to be realised. However, on the other hand it appears that the launch of the fund of funds at this juncture is more a case of putting the cart before the horse. And, it certainly isn’t the most efficient use of taxpayers’ money.