By Sudhir Sethi, Founder, Chairman IDG Ventures India
The Indian risk capital industry had investments of $9.3 billion in 2011. But it is feared the taxation proposals in Budget 2012 will create roadblocks to future growth. In this exclusive piece for The Economic Times, IDG Ventures India's founder and Chairman Sudhir Sethi explains why the right policy framework can boost risk capital inflow to $ 200 billion by 2020.
China and India are the cynosure of all eyes as the two fastest-growing major emerging economies with extremely large domestic markets across sectors. While China has emerged as the global epicentre of entrepreneurship, venture capital and private equity investing, India is significantly behind on all metrics. Between 2006 and 2011, there were over 5,600 venture capital and private equity transactions in China involving investment of nearly $107 billion ( 5.5 lakh crore). India saw investments of only $54 billion in 2,400 transactions during the same period.
In the early-to-mid-2000s, China instituted several policy amendments to promote entrepreneurship and renminbi-denominated investments. While foreign capital helped to launch the venture capital and private equity industry in China, in recent years, it is renminbi capital that has enabled the industry to grow exponentially. In 2011, more than $20 billion of renminbi-denominated venture capital was raised compared to less than $8 billion in foreign currency.
In India, while rupee funds launched the risk capital industry in the mid-1990s, today, over 95% of investments are from foreign capital. In order to meet the benchmark set by China, specific policy measures are needed to encourage more rupee risk capital.
In Budget 2012, there has been a positive step in the form of an announcement to establish a Sidbi-managed $1 billion India Opportunities Venture Fund to increase availability of equity to micro, small and medium enterprises. This entity should be structured as a fund of funds, with Sidbi as an advisor. It can invest as a Limited Partner in existing venture capital and private equity firms, utilising the expertise of General Partners at these firms.
The fund can also utilise leverage as an option by mandating these General Partners to raise a multiple of the amount committed by it from other LPs. With a potential leverage of 2-3 times, IOVF could effectively end up with $3-4 billion of combined equity risk capital. Furthermore, this capital should be made available to experienced private fund managers and not just state-run funds.
Second, well-capitalised family office funds that manage the personal wealth of entrepreneurs like Narayana Murthy of Infosys and Wipro’s Azim Premji should be incentivised to invest directly in privately-held companies and as Limited Partners in venture capital and private equity funds. These offices tend to mostly invest in the public markets since gains from shares held for more than 12 months (and subsequently sold on a recognised stock exchange) are exempted from capital gains tax while it is not so for privately-held companies. Tax treatment of investments in venture capital and private equity should be brought on a par with public market investments, especially since the former is much more illiquid.
Third, banks should be incentivised to invest in private equity and venture capital funds by treating these investments as priority sector funding instead of the present regulation that ranks it on a par with equity, and therefore subject to strict capital market exposure ceilings. Pension and insurance funds should also be permitted to invest a small portion of their corpus in this asset class. They, too, should be offered tax exemptions for illiquid private equity and venture capital investment.
It is a matter of concern that Budget 2012 proposes to tax the part of any angel and early stage equity consideration received by a startup which is more than the fair market value. This is a regressive step that could potentially disable the angel investing and entrepreneurial ecosystem in India. This proposal should be scrapped. Instead, ultra high net-worth individuals/ households should be incentivized to invest both directly in ventures and as Limited Partners in venture capital and private equity funds. An effective way to achieve this would be to provide ultra HNIs with a tax break at the personal income tax level.
International capital requires a long-term predictable governance and tax regime and it is high time such surprises are not thrown at an industry which has improved governance in private companies, given rise to employment and filled up the government tax kitty.
Given that private equity and venture capital are inherently risky, financial investors in this space need long-term clarity and predictability. Steps such as the retrospective amendment on taxing cross-border M&As, as proposed in the Budget 2012, will only increase uncertainty.
It is encouraging that the government has taken some positive steps in the Budget to boost the venture capital-private equity ecosystem, including introducing the IOVF and the proposal to remove restrictions on the sectors in which venture capital funds can invest. However, encouraging more rupee capital and having a predictable, long-term tax regime is the only way to further strengthen the Indian entrepreneurship and risk capital landscape.
The measures suggested above will ensure that India can attract $150-200 billion in venture capital and private equity investments between now and 2020. If such measures are not introduced, we have only ourselves to blame and investments may not even cross $50 billion in the same timeframe.
(Research by Soumitra Sharma, Senior Analyst, IDG Ventures India)