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Should government act as venture capitalist for Startups
- Rajasthan government recently announced its Startup policy (Innovation and Technology Startup Policy 2015).
- Karnataka and West Bengal governments followed suit and announced their own startup policy.
- Prime Minister is expected to announce centers startup policy by the year end. [Competitive federalism]
- Center’s policy will complement PM’s “Start-up India, Stand up India” slogan.
Startup Business Culture in India
- Startup culture began in India some 15-20 years back.
- It is only recently that the startup culture is picking up well in the country.
- More than 90% of this funding in start-ups is by foreign venture capital funds.
- Forty percent of these start-ups are in Bengaluru.
- Eight out of the 107 unicorns in the world are India-originated or domiciled. [Start-ups that are valued at more than $1 billion are called unicorns.]
- These start-ups range from food technology in idli (ID Fresh Food (India) Pvt. Ltd) to space technology (Lunar X).
- Some of these new innovative companies have made an impact on job creation in the economy.
- Start-ups using technology to aggregate taxi services to food delivery generate hundreds of thousands of “gigs”, if not full-time jobs.
- This “gig economy”, as popularized in the US, can be substantially more vital in economies such as India, where net new job creation is abysmal.
Steps required to boost startup environment
- To create a thriving startup industry, there is need for Special economic zones with robust digital and physical infrastructure. The government must lay special emphasis on the creation of such infrastructure.
- Governments need to play a proactive role in attracting investors by improving the ease of doing business in the country (GST: Uniform tax structure, unambiguous laws; clear laws on land acquisition; elimination of red tapeism; minimum government interference; facilitator rather than a regulator; transparent procedures; etc.).
- Enriching human capital: Create a robust higher education system to supply necessary and affordable human capital (Improve employability of Engineering Graduates).
Government Funding
- Governments are willing to offer funding for such risky businesses and innovations.
- The Rajasthan start-up policy proposes using taxpayer funds to invest in early-stage venture capital funds to finance start-ups domiciled in the state.
- Rs.2,000-crore India Aspiration Fund model was launched by the Union ministry of finance recently.
- This public venturing idea has been tried in various countries over many decades with limited success.
Problems with government funding
- Squandering of taxpayers money is the biggest risk with the inevitable frauds and scams that accompany government programmes (In India its worse).
- In India, there is a thriving private venture capital industry that has kicked off an innovation industry already. Direct government funding (won’t last long) might discourage such industry.
- Instead of funding, the state can provide indirect financing in terms of tax exemptions to start-ups domiciled in its territory.
- Long term solution will be improving ease of doing business and investor confidence.
Venture Capital
- To start a new business, you need money.
- There are several places where you can get this money:
- Personal wealth -- you can fund the business yourself (you need to be pretty rich for this).
- Bootstrapping -- With a very small investment, you can get the business going and then use the profits from each sale to grow the business. [This approach works well when capital required and competition are negligible (such businesses practically don’t exist)]
- Bank loan -- You can borrow money from a bank (not everyone gets a bank loan. Only suitable for people like Vijay Mallya).
- A fourth way to get money to start a business is called Venture Capital (comes from Venture Capital Funds or Angel Investors). (This is for people with less money but loads of ideas). This is a quick way to grow business.
Venture Capital Firms and Funds
- Venture capital firm will open a fund. A fund is a pool of money that the VC firm will invest in startups.
- The firm gathers money from wealthy individuals, companies, pension funds, etc.
- The firm will raise a fixed amount of money in the fund -- for example, $100 million.
- The VC firm will then invest the $100 million fund in some number of companies -- for example, 10 to 20 companies. (Not all these companies succeed. But one or two successful ones are enough to fetch enough returns on the investment made by the VC firm)
- The VC firm will choose only such companies which are highly promising (High probability of returns on investment).
- In many cases, a VC firm offers more than just money. For example, it might have good contacts in the industry or it might have a lot of experience it can provide to the company.
- The Venture Capital firm will invest the entire fund hoping to liquidate its investment in few years.
- VC firm expects each of the companies it invested in to either "go public" (meaning that the company sells shares on a stock exchange) or to be bought (acquired) by another company.
- In either case, a certain percentage of the cash that flows in is acquired by the VC firm (X times greater than its investment, i.e. $200 million or $300 million or even greater).
- When the whole process is done, the goal is to have made more money than the $100 million originally invested.
- The fund is then distributed back to the investors based on the amount each one originally contributed.
- In some cases, instead of money, the company (previously startup) gives the VCs stock in the company as well as some control over the decisions the company makes.
- The company, for example, might give the VC firm a seat on its board of directors (VC firm will have considerable influence on company’s affairs).
- Dot Coms (website based business; Amazon, Flipkart etc. Almost all these companies were created with the help of VC firms) typically use Venture Capital to start up because they need lots of cash for advertising, equipment, and employees. (Many of the eCommerce Dot Coms typically consume $50 million to $100 million to get to the point where they can go public. Up to half of that money can be spent on advertising!)
Angel investors
- If a business is high-tech or something very innovative, and if it requires large amounts of capital, then such companies will knock the door of angel investors and venture capitalists (VCs).
- Angel investors are simply wealthy people (Jeff Bezos, Warren Buffet) who operate in a similar manner as VCs, but independently rather than with a firm.
- They usually invest less than VC forms and stick to new businesses within their own geographical region.
- They are called "angels" because they usually aren't interested in controlling your company, but simply acting as a mentor.
- It is speculated that angels account for the largest source of start-up capital for new business, but their ventures are more informal and private.
Watch this video: http://www.investopedia.com/video/play/who-are-venture-capitalists/
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