Trouble for Indian start-ups

A study by Stanford University and TiE shows India is drastically falling behind its counterparts when it comes to early-stage VC funding, and the study’s author warns this could have dire consequences for the quality of later-stage companies down the road. Dave Keating reports.

With the flow of venture capital in India having increased significantly since 2000, aided by targeted reforms by the government since 1999, one might expect early-stage companies in India to have seen a notable increase in investor interest in the past six years. But a new study unveiled recently in Mumbai shows that despite the increase in VC cash in India, Indian start-ups are actually receiving far less investment than their counterparts in other countries.

Asawari Desai

The study, conducted by Stanford University and Talent Ideas and Enterprise (TiE), shows that only 12 percent of the venture capital invested in India goes to early-stage innovative start-up firms. This compares to 29 percent in the European Union, 50 percent in Israel and, most interestingly, 41 percent in China.

Nearly 90 percent of VC investment in India is going to late-stage initiatives by mature firms, according to the study.

“A lot of government funding is there, but there are some other challenges,” says Asawari Desai, director of TiE Global and an author of the study. “People don’t have the knowledge about where to go to find the money.”

Desai says that the fault for the low level of investment lies both with the entrepreneurs and with the VCs. Domestic VCs, she says, lack the technical skills and market awareness necessary for identifying promising start-ups. This makes them hesitant and risk-averse. She adds that early-stage entrepreneurs, though skilled at cost control and technology, lack market awareness and product development skills. She also says one of the bigger problems is that Indian entrepreneurs often rely on a few personal connections and brokers rather than a wider network of “weak ties” like professional associates and financiers, as exists in Silicon Valley.

The study, which was conducted with 175 capital providers between October 2005 and March 2006, was unveiled at the TiE Entrepeneurial Summit 2006 in Mumbai.

The study suggests several measures to help rectify the problem, including the removal of the 25 percent limit on corpus investable in a single firm by Domestic Ventures Capital Fund (DVCF) and increasing the tenure of convertible securities of listed companies beyond 18 months. Desai also suggests more risk-taking by Indian VCs, and says firms need to establish more early-stage exclusive funds.

“One of the challenges now is the number of successes that you are seeing are limited,” says Desai. “Investors are wary in terms of taking risks in new ventures,. But there are a couple of investors who actually have a good appetite for this, and if investors could actually pull it together, then domestic investors could tie up with a couple of overseas investors.”

The study warns that failure to turn around the low numbers could negatively effect the quality of late-stage opportunities in years to come. However Desai says there are promising signs, and there are a select number of Indian VCs increasingly taking risks on more early-stage companies.