Despite the Rocky Terrain, an Entrepreneurial ‘Ecosystem’ Takes Root in India

Anyone looking for a sign of India’s entrepreneurial promise need only consider the recent growth in venture capital investing in the country. At the recent TiE Entrepreneurship Summit in New Delhi, Deepak Kamra, general partner of U.S.-based venture capital firm Canaan Partners, quoted some statistics: “In 2006, $150 million was invested by VCs in India,” he said. In the first nine months of 2007, VC investment totaled $750 million. “Early-stage investments accounted for 63% of this amount.”

Despite the optimism generated by such figures, the challenges are ample. Fuel and commodity prices are near all-time highs, and wage inflation is running at 12% to 15% a year. These factors can put huge pressure on small firms’ bottom lines. Good exit options still don’t exist, Kamra noted: “Just five or six VC-backed companies, out of 60 funded ones, [went] public last year. This needs to improve.”

Improve it will, suggested Raman Roy, widely regarded as the father of India’s business process outsourcing industry. India’s market has not yet matured for acquisitions to provide an exit route for VCs, he acknowledged, but when it does, investors will have more than one meaningful exit option. He offered as evidence his own experience in starting his current firm, Quatrro BPO Solutions, in January 2006. “When I was [starting as an] entrepreneur, the opportunity to get funding was limited, mentorship did not exist and angel investment did not exist,” he said. Today, funding is available for good projects, mentorship is facilitated by organizations such as TiE, and a group of 60 people have come together to form an Indian angel network to fill in the gap. “The infotech and BPO industries came about in India because [abundant] money was available” from investors, Roy observed.

Other conference speakers agreed that the elements of an enabling “ecosystem” for small and medium enterprises (SMEs) were now in place. Many called on the government to support such an ecosystem: They proposed that Indian universities’ intellectual capital be freed to partner with industry, and they pointed out the need for legislation facilitating a domestic pool of savings for investing in SMEs, whereas now it is practically impossible for pension funds and insurers to back high-risk entrepreneurial projects. “We need to place faith in our entrepreneurs as a country,” said Saurabh Srivastava, president of TiE New Delhi.

The ‘Rowdiest Democracy’

Responding to such remarks, Commerce and Industry Minister Kamal Nath noted that since the government’s first comprehensive trade policy was drafted in 2004, foreign direct investment has increased sevenfold and foreign trade has doubled. “If there is a place for entrepreneurs to meet, it’s India — the rowdiest democracy that produces the most entrepreneurs in the world,” Nath said. Enormous growth is occurring in B-class cities, he added. “In an uncertain global atmosphere, new opportunities are being thrown up for entrepreneurs as the centers of economic activity shift.”

Nath highlighted the “enormous” challenges facing the government. “India has 300 million people living on less than $1 a day. We also have 650 million engaged in agriculture that’s not commerce but subsistence.” That keeps disposable incomes meager and reinforces a vicious poverty cycle, he said.

The driver of growth in India has shifted from the state to the entrepreneur, Nath said, and this growth has enabled India to move forward. He drew the attention of budding entrepreneurs to the enormous opportunities that rising consumption would produce in rural and semi-rural India. “We need rural entrepreneurship to move 200 million people into industry and services. The rural sector is the new challenge for entrepreneurs.” If entrepreneurs can succeed, he said, India’s growth would be in the double digits, rather than the current 9% real growth in gross domestic product.

“The government of India is alive to these challenges,” Nath told the summit attendees. “We need to breed and motivate entrepreneurs by responding to [them].”

Nath added that Prime Minister Manmohan Singh was looking into the hurdles facing exporters, who remain hampered by taxes totaling almost 7% of export values. “India is getting a double hit from the depreciation of the U.S. dollar and huge foreign currency inflows,” he said, alluding to the problems of having a market-linked exchange rate for the Indian rupee while one of India’s biggest competitors, China, has a managed exchange rate.

Credit Guarantees

R.M. Malla, chairman and managing director of the Small Industries Development Bank of India, told the summit attendees that the current list of the top 10 Indian industrialists would likely change, much like the 1980s-era list bears little resemblance to today’s. Malla said the development bank was willing to offer credit guarantees up to 75% of the value of eligible collateral-free loans made by other banks to small and medium enterprises. Already, the bank has offered credit guarantees for loans extended to 85,000 SME units in India and has urged such businesses to avail themselves of these guarantees either directly or through the development bank’s network of 65,000 partner bank branches. Malla recommended that eligible firms seek an SME credit rating so that funding becomes available early and easily.

Alongside the discussions about enablers for entrepreneurial growth, conference attendees heard words of caution. Rahul Bhasin, managing partner of Baring Private Equity Partners, warned entrepreneurs to choose their sector well if they are considering a manufacturing set-up, particularly for export markets. “The average productivity growth in India in the recent past in the manufacturing sector has been 1% per annum vs. 6% per annum in China,” Bhasin said. “Even this 1% productivity growth is skewed toward large companies who own captive infrastructure rather than the smaller companies which VCs typically invest in.” He advised entrepreneurs to consider manufacturing only if it was based on niche proprietary technology, which would ensure a defensible market position.

Bhasin said the government could, through deliberate policy acts, help shape an entrepreneurial ecosystem. “Countries such as Taiwan have proven that by focusing resources on one area, such as semiconductors, this can be done,” Bhasin said. In Taiwan, the government captured the best information worldwide on the semiconductor value chain and disseminated it widely, through academic and other settings. The Taiwanese government also helped budding entrepreneurs set up companies that leveraged the talent pools that had grown as a result of the government effort, he added.

Sandeep Ghosh, head of global commercial banking at Citigroup India, noted that “entrepreneurs are dependent on rental premises, and these prices are quite high right now in India.” He warned that sectors that relied on U.S. markets were beginning to see a slowdown.

Still, entrepreneurs who steer clear of the traps when preparing their business plans have more help at hand, according to Ghosh. “The good news is that VCs are back in India,” he said. Citigroup itself offers venture debt to firms that have received proof of concept funding from VCs but that aren’t yet profitable. Essentially, such funding is an interest-bearing loan where a portion of the principal converts into shares at a future date. Companies that would not normally qualify for loans under conventional banking norms can raise debt this way to fund their business plans. Conversion of part of the debt into equity frees up cash to invest for further growth, instead of its being used for repayment of loans. A lower debt burden when the company has turned profitable also allows the business to seek conventional, lower-cost loans from commercial banks. Citigroup has provided such venture debt to 12 companies in India, Ghosh said.

Four Building Blocks

In a separate speech at the summit, India’s finance minister, P. Chidambaram, outlined what he called the four building blocks for the country’s progress: human resources, education, basic infrastructure and entrepreneurship. India takes pride in its abundant human resources, he said, “but we must also chastise ourselves for the inequality. Not all children in this country are born equal even though the Constitution of India says so.” He outlined government plans to offer scholarships and incentives, particularly for girls to go to and remain in school.

Similar to Nath, Chidambaram stressed that it was essential that India’s villagers be included in national growth. “We are building basic infrastructure which is available to any Indian citizen even if they are resident in any of India’s 600,000 villages. We need to connect them with roads, provide electricity, water and schooling facilities,” he said. “Today the aspiring young person in a village wants to skip the area altogether. We therefore need to ensure that villages are connected to the rest of the country and not cut off from the means to prosperity.”

Chidambaram admitted that the federal government had many claims on its finite resources but said that it understood the need for an ambitious program to provide basic infrastructure, improve the quality of cities and build new towns and cities. “We need to have at least 100 towns to 200 towns built from scratch each capable of housing one million to two million people,” he said.

Similarly, Chidambaram spoke of entrepreneurship in terms of enabling youngsters with little education and limited resources to start a business. “Small and medium enterprises provide employment, and entrepreneurs who can build these small enterprises are required most especially in some of our southern and eastern states,” he said. He pointed out that India had states whose economies were growing at 12% annually and others whose economies were growing at far below the approximate national average of 9% a year.

“The slower-growing states lack both entrepreneurs and good governance,” he said. “We need to find ways to motivate entrepreneurs to build enterprises in places which have fallen behind.”

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