The dot-com bubble burst has forced a change in focus of Venture Capital (VC) funds in India. During FY00, the dot-com boom had attracted US $ 0.4 bn (Rs 20 bn) by way of VC funding to the Indian shores. Now two years after the melt down of the net economy VC funds have matured and shifted their attention from dot-coms that promised fantastic sales of products and services using the Internet to software companies in emerging technologies.
In spite of the disappointment of the dot-com boom, the VC funds are still bullish about Indian startups. In fact, India was the second largest market for VC funding during the year FY02 (US $ 1.2 bn) after Japan, which saw investments to the tune of $ 1.9 bn. Compared to this, China, projected to be an emerging threat to Indian software capability, attracted only $ 39 m funding. In this article we look at the prospects of the VC industry in India. We also look at the regulatory problems faced by VC funds, which has impaired the growth of this industry.
But before we delve deeper we must first understand what makes this industry click. VC funds would be successful only as long as there is an environment of entrepreneurship within the economy. This is the main reason why the US economy attracts more VC funding than any other country in the world. In the Indian context VCs are still bullish about their prospects in spite of the fact that Indians are not encouraged enough to become entrepreneurs.
As in the US, technology enterprises and especially Internet related companies have attracted the predominant share of VC funding in India. Nearly 68% of the VC investments in India have been directed into IT and IT related products like business to consumer (B2C) solutions, electronic commerce (e-commerce) services and Internet related products. Other major sectors that have attracted VC funding include industrial products, biotechnology, food & food processing and pharmaceuticals.
In FY03, the flow of VC funds into India is expected to double. This is due to the funds investing in IT enabled services (ITES) companies. The ITES segment grew by a phenomenal 70% in FY02 and is expected to clock a similar growth (64%) in FY03, according to NASSCOM. Other growth areas that could see VC investments are Internet communications infrastructure and the media sector. VC funding directed towards food processing and, the longer-gestating pharmaceutical and biotechnology sectors (where there are always more ideas than funding available for research) is also expected to grow.
Domestic VCs are regulated by three government bodies the Securities and Exchange Board of India (SEBI), the Ministry of Finance, and the CBDT (Central Board of Direct Taxes). Foreign VC firms are under greater regulation in the form of the Foreign Investment Promotion Board (FIPB), which approves every investment, and the RBI, which approves every disinvestment. The large numbers of regulatory bodies have created numerous regulatory roadblocks in the way of the development of this industry in India. Just as the currency regime inhibits international venture capital firms from investing in India, domestic venture capital firms are not allowed to invest offshore. All these factors have led to a stunted growth of this industry.
Currently there are restrictions on the quantum of investments that the VC can make in a particular venture. There are also restrictions on the industries that can be VC funded. Only six industries have been approved for VC investment: software, information technology, pharmaceuticals, biotechnology, agriculture and industries allied to the first five. VC funds also do not have the freedom to choose the kind of set up they are comfortable with for the new venture.
While larger amount of foreign investment is good for the country, its flow must be regulated in order to prevent scenarios like the economic melt down of the Southeast Asian economy in 1998. The government with its strict rules had ensured that India was considerably insulated form the Southeast Asian crisis. Having said that it while checks are important adequate steps must be taken in order to facilitate VC funding.