Minimum Govt, Maximum Governance? Modi's Start-up India Sticks To Just That

The government’s role ends with the policy allocation of capital; execution is left to a financial institution and governance and decision-making is through independent investment committees. So what is the criticism about?

On 16 January, the Prime Minister announced the Government’s policy on start-ups. The Department of Industrial Policy and Promotion (DIPP) had prepared a comprehensive 40-pager on the policy. It was the ‘Start-up India Action Plan’. Undoubtedly, much thought has gone into it.

The policy elicited both positive and negative reactions. Broadly, three criticisms were commonly made:

i. We already have a thriving VC (Venture Capitalist) industry, so there is no need to use taxpayers’ money to provide any impetus.

ii. It is a wasteful and risky mis-allocation of public funds, especially when there are other pressing issues that need public funding

iii.  Such a plan goes against the promise of “minimum government”.

Let us look at each of these in turn. First, the conclusion that we have a thriving VC industry is rather premature. Yes, a phenomenal volume of capital is flowing from a rapidly growing list of VC funds, predominantly foreign, into Indian start-ups – nearly US$5.2 billion in 2015, according to VCEdge. But, the industry is still in its infancy and is seeing a boom due to concentrated investments in a couple of sectors.

The annual investment value was less than US$1.0 billion until as recently as 2012 and 80 percent of VC investments in recent years has been in the ‘superhot’ mobile and consumer internet space.  There have only been a handful of hyper-successful ventures and most remain unproven in terms of returns. Unicorns and their slightly smaller cousins account for two-third of recent VC flows and majority of the VC funds are yet to record meaningful exits. Unless as an industry VC funds generate sustained high returns, it is too early to be complacent about India’s long-term ability to attract VC funds.

In addition, VC funds have thus far shown limited risk-appetite for disruptive innovations in key sectors such as healthcare, agriculture, cleantech and manufacturing and even in the domain of digital tech products. The Start-up India Action Plan specifically seeks to address this limitation – its definition of start-ups eligible for government schemes such as the VC FoF, clearly emphasises the criteria of innovation.

Two examples of funds launched by CIIE at IIM-Ahmedabad demonstrate the catalytic role that the government can play to foster innovation-driven entrepreneurship in important sectors:

The Rs.125 crore Infuse Ventures, India’s first cleantech and sustainability focussed ‘Incubation and VC fund’ was made possible by a Rs. 24 crore first-loss protection grant from the Ministry of New and Renewable Energy (MNRE) in 2012-13.

Similarly, anchor funding from the government (the Department of Biotech has committed Rs.50 crore; DIPP and MNRE have pledged support) will be the foundation for the recently launched Bharat Innovation Fund. It is a proposed Rs.1000 crore VC fund with a mission to strengthen the innovation ecosystem in the country by evangelizing a culture of venture creation to take technologies and science from our labs to the market, in sectors such as healthcare, life sciences and sustainability.

The investment thesis of Infuse Ventures and Bharat Innovation are not the current fad nor are they the low-hanging fruit opportunities of today. That naturally limits their appeal to private sector investors. But the government’s support, financial and otherwise, changes the risk-profile of these funds and attracts the right quality of private sector investors who are interested in participating in pioneering innovations in these areas, just as the ‘Tata Trusts’ and Google have pledged support for Bharat Innovation.

The second criticism, that a government VC FoF is wasteful and risky splurging of taxpayers’ money on VC funds is a flawed and narrow view. The reality is that governments in poor countries cannot direct all their public expenditure only towards poverty alleviation or traditional development projects. Government intervention in other areas, if they create successful enterprises and employment, could go a long way to address poverty than social welfare expenditure.

Cumulative annual grant funding of projects by innovators at our publicly funded national labs under various central science agencies is estimated to be over Rs.25,000 crore. Is that wasteful splurging of taxpayers’ money? Certainly not.

The annual investment target of Rs.2500 crore from the proposed VC FoF is just 10 percent of the central science and technology grant budget. If these funds serve to encourage innovators from our labs to create new ventures around the technologies they are developing, we would have a vibrant ecosystem not only for innovation but also for economic prosperity.

Is the VC FoF model an unacceptably risky use of taxpayers’ money? Of course, by its very nature early-stage investing is a risky proposition. That is undeniable. But two points to note here. First, the government is creating a Fund of VC Funds (FoF). Thus, there are two layers of diversification. A VC fund invests in many ventures across sectors. Hence, a VC fund is diversified, to start with. Money from the government’s VC FoF will be invested across many VC funds. That is the second layer of diversification.

Secondly, borrowing from the facts stated in the earlier cited critical opinions, the India Aspiration Fund (IAF, the Rs.2,000 crore VC FoF already set up by the government) has co-invested in a VC fund alongside Iconiq Capital, which manages funds from some of the most storied entrepreneurs of our times, such as Mark Zuckerberg, Jack Dorsey and Reid Hoffman. Investing in sought-after VC funds is a competitive arena. IAF’s managers are doing a good job if they have obtained a seat at the same table as these iconic entrepreneurs. From the standpoint of risk-return trade-off, it appears we are as well covered as possible within the VC asset class.

This brings us to the third line of criticism that the start-up policy is a travesty of claims of “minimum government”. Considering the facts, this line of argument is entirely misplaced. The IAF, the predecessor to the newly announced Rs.10,000 crore VC FoF, is managed by SIDBI, with an independent Investment Committee (IC) comprising experts from the world of technology, VC, academia, entrepreneurship  and just one member from the government.

In our opinion, this is a fine example of “minimum government” – the government’s role ends with the policy allocation of capital; execution is left to a financial institution and governance and decision-making is through the independent IC comprising predominantly of experts from the private sector.

The Baretalkcolumn of 30 November in MINT made an important point about the law of unintended consequences and the role that serendipity plays in the effectiveness of public policy – quoting the example of US defence R&D programs of long ago in the West Coast laying the foundations of today’s Silicon Valley. Who knows, serendipity may turn out to be our friend too.

For instance, the process of self-certification for labour and environmental laws and the exemptions from prior experience granted to start-up companies could turn out to be so successful that the government might be emboldened to extend it to other businesses. Inadvertently, the Start-up India Action Plan might end up making a big contribution to the campaign to make India an easier place to do businesses in.

The same Baretalk column, while highlighting the case for government intervention and a proactive start-up policy, also offered the counterview that market forces were better equipped to fuel entrepreneurship as well as new venture creation provided the government took care of the enabling conditions. However, the world never stands still; it is in a constant state of flux. That was 30 November.

What a difference two months have made! Stock markets around the world are crashing and economies are sliding into recession. India’s exports are contracting and our economic growth rate looks tepid, at best. Indeed, the government has recently marginally revised down the growth estimate 2014-15 to 7.2 percent.

Further, India is not immune to the domino effects of a Chinese slowdown, plunging commodity prices and currency wars. Suddenly, a policy that has a fiscal spending component, howsoever modest, looks sagacious. If anything, consistent with the wisdom of a looser fiscal policy, the government now has greater justification for a targeted start-up and VC funding programme.