Empirical Study of Venture Capital and Innovation in India

Abstract

The study exhorts to ascertain the general perception that Venture Capitalists fund innovative technology projects in the Indian context using primary and secondary data. A structured questionnaire was used to elicit response from 101 (sample) out of 134 (Population) SEBI registered and active Venture Capital firms in the recent past.

The study analyses the mode of funding by Venture Capital firms and their geographical dispersion. The study ascertains whether Venture Capital firms have enabled innovation in the Indian context during the recent past or not. Finally, the study concludes that Venture Capital Investments have not been very enabling for innovative technologies in the Indian context, which is contrary to the relevant literature available in the context of USA and other developed nations.

KEY WORDS: Venture Capital, Innovation, Technology, Start-up, Investments.

1. Research Context

According to Samuel and Josh (2000), the start-ups backed by Venture Capital would be more innovative than the others; considered to be a promising mechanism to support innovation and growth (Gompers & Lerner, 2001); a specific type of finance, well-suited to the equity needs of firms based on innovation; risk capital, different from the conventional sources of finance in terms of return and risk. However, as Venture Capital activities grew they became more formalized and started managing large pools of capital. Over the years, the more generic term of ‘private equity’ was coined to encompass a variety of transactions relating to venture capital investments in companies providing high return opportunities.

It is supposed to address the “equity gap” by providing financing and tools to innovative start-ups during the first stages of innovation (Florida et. al Kenney, 1988 and leading companies would then invest in corporate venture to develop their innovative capabilities (Engel, 2011) (Birkinshaw et al., 2002). It has also become a means for public policy to foster some technological or environmental transitions, for example, Cleantech (Hargadon et Kenney, 2012).

However, recent research (Mason and Harrison, 2002) reveals that the profitability of venture capital funds is rather low and that their impact on innovation is more uncertain than expected, thus putting the model of venture capital itself into question. This raises the opportunity to review the canonical model of venture capital as presented by the economic and management literature, to exhibit its major assumptions and to assess whether these assumptions have been verified in practice for the past decades. As a mechanism to foster innovation for young firms in highly technological and capital-intensive sectors, authors also think that it is of interest to question whether this model takes recent advances in innovation management into account, or whether it is a mostly finance-based model that does not try to couple with a representation of innovation processes or not?

India, the second most populated country in the world with more than 1.24 billion people (Census, 2011), has emerged as one of the fastest growing economies in the recent years. With the projected compounded annual growth rate of 9%, India’s GDP is likely to be US$3.26 trillion by 2020 (Statista, Source: Statista, https://www.statista.com/statistics/263771/gross-domestic-product-gdp-in-india/). India has been doing well in IT/ITES industry; it is still a low-cost developer and service provider. As India continues its rapid growth path, several sectors of the economy such as telecom, FMCG, infrastructure and education are growing rapidly and offer significant opportunities for venture capital.

IT & ITES companies accounted for 45% of the venture capital financing led by Flipkart, Paytm and GlobalLogic- attracting US$10.7 billion across 325 deals. The prominent sectors are BFSI, Telecom, Energy, Healthcare, etc. It was reported that by the end of November 2018 the Venture Capital funding for start-ups had raised close to $11 billion in equity funding. By the end of December 2018, the figures had increased to $12.68 billion in equity funding, plus $1.14 billion in debt funding, taking the total to $13.88 billion. That’s a shade over the $13.7 billion raised in equity and debt combined in 2017. (https://yourstory.com/2019/01/2018-india-startups-funding-roundup-unicorns).

For the purpose of this study, innovation/innovative technology is defined as a new technology for commercial use or an existing technology with some modifications/ improvements resulting in new products/new services/new applications for commercial use. The study attempts to ascertain whether the recent (during the last three years, 2016-18) venture capital investments had supported innovation in the Indian context as per the “innovation” or not? The reason for choosing this time frame is because of surge in venture capital financing and IT/ITES sector, which accounted for 45% of the venture capital financing during the year 2018. Also, India has introduced Make in India and Start up India campaigns in the years 2014 and 2016 respectively. The Make in India campaign is an attempt to make India a global manufacturing hub, while the Start-up India campaign is designed to encourage entrepreneurial talent.

2. Literature Review

Richard & Martin (1988) find that venture capital transformed the innovation process in the USA. Venture capital financed innovation is a new model of innovation catalysing technological change.

Paul & Josh (2001) find that the manners in which venture capital funds are raised and structured, the capital is invested in young firms, and these investments are concluded are now much better managed.

Samuel & Josh (2002) examine the influence of venture capital on patented inventions in the United States across twenty industries over three decades and address concerns of causality in several ways.

Colin & Richard (2002) analyse the returns of venture capital investment, and find that the distribution of returns is skewed, with 34% of exits with negative returns, 13% at a partial loss or break even, but with 23% showing an IRR of 50% and above.

Bowonder & Mani (2004) trace the evolution of venture capital support for innovation in India, particularly the government supported schemes and suggest that Venture Capital has strong linkages with innovation-based Clusters.

Masayuki & Masaka (2008) conclude that venture capital investments stimulate innovation.

Roberta & Nina (2010) study the impact of venture capital on innovation as evident by the number of patents filed at the industry level. Further, they argue that a dollar of venture capital appears to stimulate innovation, three to four times than a dollar of traditional corporate research finance.

Eduards (2011) brings to light that revenues of venture-backed companies accounted for 21 percent of U.S. GDP and in 2008 employed more than 12 million people. Job and revenue growth within this private equity market significantly outperformed the overall economy for years.

Andrew & Martin (2012) argue that three key conditions are necessary for venture capital to successfully open new economic spaces and the study concludes that large loan guarantees are unlikely to be effective.

Juanita (2013) delves into the relation between venture capital and innovation by comparing the number of paten filings, and the quality of innovations, before and after companies are financed by venture capital investor.

Kevin, Blanche and Armand (2014) find venture capital to be a key link in the complex chain of financing for young innovative firms. By helping them at critical stages of innovation development, it helps an economy to leverage its public research and sustain growth.

Cheng et. al (2019) estimate the impact of venture capital on innovation, employment, and payroll in Chinese metropolitan area. Results show that VC is significantly contributing to the metropolitan economy as a whole by supporting innovation, creating jobs, and generating wealth in local cities.

3. Objectives of the study

1. To analyse the geographical dispersion of venture capital funding for innovation in India.
2. To analyse the mode of venture capital financing by venture capital organisations (Seed funding/Angel funding/Debt funding/Private Equity).
3. To study the perception of Venture Capital Organisations towards financing of innovative technologies in the Indian context.
4. To ascertain whether venture capital investments have supported (enabled) innovation in India during the period of study.

3. Research Methodology

In order to achieve the four objectives as detailed above, the following methodology has been adopted:

Objective (i): To analyse geographical dispersion of venture capital funding (VCF) projects in India.

Analysis of Secondary data of their geographical dispersion of VCF (available at: https://trak.in)

Objective (ii): To analyse the mode of venture capital funding (VCF) by venture capital organisations (Seed funding/Angel funding/Debt funding/Private Equity).

Analysis of Secondary data of their mode of VCF (available at: https://trak.in)

Objective (iii): A structured Questionnaire consisting of 10 questions was developed. The study is based on primary data based on a structured Questionnaire as per the details given below:

Population: There are 191 SEBI (Securities Exchange Board of India) registered Venture Capital Organisations (VCO) in India, out of which 134 are active which is considered as population for this study. A pilot testing of questionnaire was made from the point of comprehensibility, logical sequencing etc. and appropriate amendments were made to make the questionnaire understandable.

Questionnaire had been sent to 134 VCOs through e-mails and follow up was done through calling and messaging. 109 responses were received, out of which 101 responses were found complete in all respect. The sample size is 101 (at 95% Confidence level and the Margin of Error (MOE) is 5%).

Qualitative analysis of the responses (question wise) has been presented, (Source: https://trak.in)

Objective (iv): To ascertain whether venture capital investments have supported (enabled) innovation in India during the period of study or not.

Data Variables (Dependent):

• (a) No. of Venture Capital financed deals
• (b) Total amount of Venture Capital financing (US Dollars)
• (c) No. of Venture Capital financed deals (Innovative technologies)
• (d) Total amount of Venture Capital financing of Innovative technologies (in US Dollars)

4. Analysis

(a) Objective (i)

Table 1: Geographical dispersion of Venture Capital Funding

Cities

No. of Deals

Total

2016

2017

2018

Ahmedabad

18

8

6

32

Bengaluru

294

226

100

620

Chennai

31

24

16

71

Delhi NCR

335

198

82

615

Mumbai

188

141

61

390

Other Areas

152

90

43

285

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Total

1018

687

204

1909

It is seen from the above Table that Bengaluru and Delhi NCR have emerged as the major venture capital financing cities in India.

(b) Objective (ii)

Table 1: Mode of VCF for Innovative Technologies

Year

Mode of Funding

Total funding

(US$ billion)

Seed

PE

Angel

Debt

2016

3.08%

96.92%

Nil

Nil

3.90

2017

0.07%

98.85%

0.04%

1.04%

10.42

2018

5.00%

79.60%

15.00%

Nil

3.70

From the above Table, it is seen that the preferred mode of Venture Capital Financing for innovative technologies is PE (Private Equity).

(c) Analysis of the Questionnaire (Objective (iii))

1. 48% of the VCOs (VCOs) prefer High Risk-High Return while 42% of the VCOs indicated that their Risk-Return profile depends on the innovativeness of the project.
2. Most (95%) of the VCOs indicate that their expected rate of return is 20% and above, while 57% prefer a return of 25 to 30 percentage and above.
3. 62% of the VCOs prefer considerably higher rate of return than the prevalent market rate for innovative technologies, while 14% of the VCOs prefer initially high return but gradually stabilizing around market return in the later years.
4. 48% of the VCOs perceive a technology to be innovative, if it is ground breaking technology, while 33% perceive an innovative technology to be of a game changer in the industry.
5. 33% of the VCOs state their objective to promote innovative technologies is for diversifying their portfolio of investment, while 33% indicate their objective for such investments is for creating greater value for their asset portfolio.
6. A majority (67%) of the VCOs prefer Angel/Seed financing mode for innovative technology based firms, while 33% of the VCOs prefer private equity mode.
7. 57% of the VCOs prefer initial high risk but gradually would like the risk to stabilize around market risk for innovative technology firms.
8. 33% of the VCOs perceive innovative technologies to be of Quantum Computing and Machine Learning that would have potential of generating better return in future, while another 33% of the VCOs perceive Artificial Intelligence and 3-D printing to be innovative technologies and have the potential for better returns in near future.
9. 52% of the VCOs fund the innovative technology firms due to the excitement of breaking into new Technological frontiers, while 43% of the VCOs fund the innovative technologies for very high return and corporate branding.
10. 43% of the VCOs indicate that if innovative projects do not perform as expected, they would review the project plans and invest more funds in the medium term with better monitoring, while 43% of the VCOs indicate that they will invest more funds on a long term basis and get involved more actively in strategic and operational matters.

(d) Objective (iv) To ascertain whether venture capital investments have supported (enabled) innovation in India during the period of study.

Data Variables (Dependent):

• (a) No. of Venture Capital financed deals
• (b) Total amount of Venture Capital financing (US Dollars):
• (c) No. of Venture Capital financed deals (Innovative technologies)
• (d) Total amount of Venture Capital financing of Innovative technologies (in US Dollars):

Table 3: Financing of Innovative Technologies

Variable

2016

2017

2018

No. of Venture Capital financed deals

1018

687

308

Total amount of Venture Capital financing (US Dollars Billion):

3.9050

10.4290

3.6971

No. of Venture Capital financed deals (Innovative technologies)

77

66

34

Total amount of Venture Capital financing of Innovative technologies (in US Dollars billion)

0.4567

0.2618

0.1428

Innovative Deals to Total Deals (percentage)

7.56

9.61

11.04

Innovative Financing to Total Venture Capital Financing (percentage)

11.70

2.51

3.86

From the above Table, it is seen that the percentage of Innovative financing to Total Venture Capital Financing is quite low over the past three years pointing towards low support for innovative technologies in the Indian context.

Conclusion

The study researches the general perceptions and beliefs about funding of innovative technologies by Venture Capital Organisations (VCOs) in the Indian context based on primary and secondary sources of information over the past three years. The responses through the questionnaire highlight that VCOs are more inclined to fund innovative technologies if the returns are high and commensurate with the high risk involved with such projects and the expected returns are above 25% plus Return on Investment (ROI). The VCOs consider technologies to be innovative if they are Ground breaking/Game changer technology in the industry. The other important findings of the study have been that VCOs prefer Private Equity (PE) mode of financing and only a small percentage of the total funding goes towards financing innovative technologies. The Survey results are in contrast to the evidence available in the literature particularly in the context of US and other developed countries.

References

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