Revving economy with startups

Growth incubator: Present infrastructure and govt interface needs radical change for revolution to kick in

The startup revolution is billed as something similar to the ushering of economic liberalisation of the early 1990s. It is too early to say if this “revolution” will take our economy to a new level like the opening up of the economy did or will it end up like the dot.com bust of the ‘90s. Still, the slew of schemes announced by the Centre should give a huge boost to the startups, including their investors.

The “Startup India” initiative has received a mixed response from analysts. While some like Vinod Dham, the Pentium chip inventor-turned venture capitalist, have hailed the initiative, other analysts, including some representatives of existing Indian Venture Capital funds, have been, to put it mildly, somewhat critical. An attempt is made here to place the initiative in perspective.

New business formation is vital for growth of an economy. In the US, it has been estimated that new businesses, defined as firms in existence for five years or under, account for over 20 per cent of gross employment and almost the entire “net” annual job creation. All new businesses are not popularly termed as startups. Only businesses which can grow or scale up rapidly are defined as startups.

This ability to scale up rapidly usually requires a technology oriented focus but not necessarily sectoral limitation. In their inception and early growth phase, they are able to access finance mainly through promoter or related party savings. Some are, however, often supported by Angel Investors, at the start phase, and subsequently by Venture Capital (VC) funds, in the early growth phase.

In the US, there are over 3,00,000 Angel Investors, mostly high net worth individuals, but also some corporates, and their annual investments are around $23 billion to $25 billion. After the business model of the startup demonstrates scalability or growth potential, VC firms step in, often, but not always, with the Angel Investors exiting at a premium. About 600 VC firms function there, managing a corpus of about $200 billion.

China warmed up to encouraging startups post announcements by then President Hu Jintao, for the need to establish a harmonious society and an innovation-based economy way back in 2007-08. This was further strengthened by a large multi-billion dollar package announced by the current team of President Xi Jinping and Premier Li Keqiang. The new company formation has boomed and reportedly over 10,000 new entities are being registered there every day. They also have very active Angel Investor networks with several crowdsourcing platforms.

India, too, has been experiencing a startup boom which is very vigorous compared to historical trends, but on a considerably lower trajectory if compared with the US and China, but much higher than most other countries.

In 2014, about 80,000 new companies got registered. We also have a very active Angel Investor network. But for India and China, statistics of actual Angel investments are hard to access.

The VC funding is well reported. In China, annual investments by recognised Venture Capital Funds are reported to be around $18 billion. In India, the cumulative aggregate of recognised VC firm investments stood at Rs 71,327 crore (about $12 billion) as on September 2015 as per Securities and Exchange Board of India (Sebi) database, of which Rs 38,661 crore came from foreign registered VC funds. Annual increase of VC funding is currently about Rs 6,000 crore or a little less than $ 1 billion.

Though the Chinese economy is five times and the US economy 10 times larger, the Indian startup activity, is disproportionately   lower. The current government initiative, therefore, needs to be applauded in this backdrop. The components include a financial package, focus on ecosystem enhancement and regulatory burden simplification. The question is, will the initiative work?          

The following aspects need to be highlighted:

  As a financial package, tax rebates and seed capital assistance has been included. A very carefully worded, elaborate, definition of “eligibility” has been crafted. An inter-ministerial board is proposed to evaluate case-specific eligibility. This could well result in unintentional back door re-introduction of red tape and prove to be a deal breaker.

  It is rare for startups to make significantly large enough profits in the first three years, which is the notified tax holiday period, to make the availability/non-availability of tax holiday a decision influencing criteria.

  The same applies to the as yet undefined customs duty exemptions. While undoubtedly, in case of technical manufacturing startups, import of modern equipment could get involved. It is unlikely that the amounts will be so significant given the pre-restriction of less than Rs 25 crore annual turnover concurrently specified. The cost-benefit analysis may not be in favour of future entrepreneurs.

  It is to be further noted that while the planned governmental seed money corpus is Rs 10,000 crore over four years is quite large, it is proposed to be infused through the intermediation of Sebi-registered venture capital funds. There are 200 such funds. The probable share of each fund would thus usually be in mid-double or low three digits. The decision of entrepreneur eligibility could thus well have been left to wisdom of these fund managers. Since this governmental seed money will be only one of the sources of funds for these fund managers, the restrictive, yet ambiguous, definitions creating future possibilities of heavy-handed mannerisms of various state regulatory institutions could well result in disrupting even the existing flow channels of risk capital into the startups. The cost-benefit analysis may not favour new entrepreneurial ventures, startups or otherwise.

  The intent to improve the startup ecosystem via upgradation/establishment of over 100 incubators/research parks etc., is commendable. However, the monetary ceilings at Rs 10 crore per centre is somewhat modest. Buildings and equipment costs can be significantly higher if large facilities are planned. While undoubtedly the Central government is only planning to part-subsidise the effort, nonetheless, the Indian story would have got a greater push if the Rs 10,000 crore seed money had instead been used for further augmenting the ecosystem capabilities through the same part-subsidy route. If additionally these centres are given entitlement to access corporate social responsibility funds, even larger and internationally competitive centres would get created. It would also have eliminated definitional issues.     
   
Risk capital flow

While undoubtedly, access to seed capital is important for startups, it is also equally true that a larger number of Indian “good” stories are equally important to augment risk capital flow.

India, all said and done, is currently an attractive growth pole. The main constraint it experiences is the extremely heterogeneous quality of its infrastructure and governmental interfaces. Effort needs to be focused on enhancing one and simultaneously reducing the other. Both are equally important. Focussing or ignoring only one could render waste the entire effort.

Cricket fans are currently rueing the fact that in the ongoing Australian tour, our team, despite consistently scoring 300-plus in their ODIs, which is a first for our overseas tours, have equally consistently been losing their matches! Is there a lesson to be learnt?

(The writer is former chairman, Exim Bank of India)