Attracting Risk Capital - Here's What India Needs To Do

In the coming years, Innovation is the watchword for India. Our success with homegrown innovation will decide if and how we move from a society of scarcity and deprivation to a nation of abundance and empowered citizens.

As an economy matures, it needs to be directed up the value chain. We have seen this occur across small and large countries where economies have moved from trading to manufacturing to services and then on to value added manufacturing/services. Economies that increasingly leverage knowledge to create and sustain comparative advantage are able to demonstrate rapid growth in productivity that in turn leads to jumps in per capita wealth.

Coming off a lost decade and at a time when many emerging countries are looking weak, there is a clear and present opportunity for India to leapfrog. To its credit, our new government has already articulated its aspirations and has begun demonstrating its commitment to put the nation on a sustainable trajectory of high-value growth.

The key is high-value growth. This requires the capacity to lead and to innovate.

Leadership and developing a culture of leading rather than serving and following is the subject of another article. The country is still deeply feudal and changing this culture requires both imagination and perseverance at several levels.

Innovation requires risk capital and an environment that nurtures ideas and markets. While we have ideas aplenty and are maturing in terms of our understanding of markets and marketing, there is a serious lack of risk capital. First, let us examine the key characteristics of risk capital.

1. Risk capital seeks outsized returns for taking extraordinary risks.

2. Risk capital does not like uncertainty in the rules of the game i.e. Regulation.

3. Risk capital is willing to accept genuine business losses, not promoter malfeasance.

4. Risk capital likes alignment of incentives among stakeholders.

5. Risk capital thrives on protection and enforcement of Intellectual property (IP) rights.

6. Risk capital feeds on exits to create a virtuous innovation cycle.

7. Risk capital likes significant Impact – Environmental, Social, and Governance.

8. Risk capital will pursue scalable innovation, not ‘Jugaad’ workarounds.

The common view is that Venture Capital (VC), currently flowing freely, represents risk capital. On the contrary, the recent flood of VC investments represents relatively short term capital chasing `momentum’ opportunities. It is crucial not to confuse this with the patient, smart capital that fuels innovation.

So where do we stand as a country with respect to the ability to attract risk capital? Sadly, we fall short on all the key parameters, except on the opportunity for Impact. While some aspects will evolve organically under the sunshine of good governance, a sustained investment cycle, and beneficial market behavior, others need triggers. While the government is committed to changing the scenario, it needs to think further and go farther. Some key action points that will catalyse the right environment:

1. The GoI should seed investments in `Innovation funds’ (IFs), under a Sovereign Wealth fund or Fund of funds structure.

2. IFs must invest in ventures within specified sectors and segments that are meaningful to the nation building agenda and where India can be a credible source of innovation.

3. Investments must flow to both early stage and growth capital stage ventures.

4. Investments must allow for acquisition of patents and IP that help investees build solutions that can be differentiated and marketed successfully. Often, individual patents and IP don’t have the ability to represent a product that can be marketed.

5. A simpler approach to the tax treatment of investment structures. There should be no need to invest through offshore/Double Taxation Avoidance Agreement (DTAA) regimes. Allow investors to come in directly into IFs. All gains, income, and dividends should be subject to zero tax withholding.

6. Seek 1-1 match of patient risk capital from institutional investors and family offices to the seed provided by the GoI. Expecting follow on capital commitments in excess of a 1-1 ratio may be difficult at this stage of Innovation maturity.

7. Allow banks to provide debt products once a venture is over the survival risk. These products can focus on funding working capital that is crucial for marketing.

8. Encourage dynamic commercial structures that can utilize IP and patents within academia or Government research institutions. This will automatically drive deeper collaboration across players.

9. Taper off real estate and infrastructure support for enterprises and ventures. The government should focus on providing essential infrastructure to all. Let the ventures pay market rate for rents. This excessive focus on real estate and rent subsidy through incubators and zones creates `rent seeking’ behaviors and distorts incentives.

10. Demonstrate that our legal system works. Let a few promoters who have clearly violated our laws get their just desserts. This alone will send a powerful signal that India means business, Good business.

Where does the GoI get the capital to seed innovation? For a start, liberate money that is lost to the exchequer from subsidies no longer needed for mature industries, say IT services.

In the coming years, Innovation is the watchword for India. Our success with homegrown innovation will decide if and how we move from a society of scarcity and deprivation to a nation of abundance and empowered citizens.

Views are personal.