Larger Domestic Capital Pool & Future Of Society
The decade spanning the years 2011-2020 saw the Indian private investing sector (PE & VC funds) grow to over $232 billion (cumulative investments in the decade) ‒ a number that’s twice the value recorded in the preceding decade. The sector grew at a CAGR of 19 per cent from around $8.5 billion in 2010 to over $47 billion in 2020, across various investment classes. The sector also witnessed structural changes, including changes in the investor mix, deal size and investment sectors. In the first half of the current calendar year, India-focused VC (venture capital) funds have raised over $14.1 billion, to be deployed in startups. This is thrice the number raised in the previous full year. The net average annual foreign direct investment (FDI) inflows into India was $38 billion between 2016 and 2020 ‒ cementing India as the fourth preferred FDI destination globally.
As a perspective, a large proportion of private capital deployed into Indian businesses used to originate from global investors ‒ sovereign funds, pension funds, buyout funds, etc. over the past few years, the trend of Indian domestic investors (HNIs, Family Offices) investing into private investing space has increased. Is this the sector’s growing-up moment?
Before and now
A few years ago, the usual excuse ‒ or rather criticism ‒ of global investors about the Indian investment space had been the lack of predictable investment exits. This was usually due to the absence of secondary deals and strategic deals in the market. In addition, the issues of governance worries, complicated and multi-tiered regulatory compliance and local compliance, gaps in and slowness of contractual laws reduced investor appetite.
Of late, the Indian market has seen entry of India-focussed investors, and even specialised themed-funds and strategic investors looking to invest into growth. This helps in exiting the early investors and allows for growth capital in aiding for scale and size of the companies.
Also credit should be given to the GoI’s developmental-oriented policies in encouraging entrepreneurship, digital infrastructure and in building consumption-led businesses. Some of these policies have been innovative and bold ‒ be it in building the Aadhar ecosystem, UPI-led payments framework, India Digital stack or encouraging low-cost data access across the country. These encouraged startups to build sustainable and scalable businesses, probably not yet churning profits. The past few years also saw exists in businesses where investor capital had been stuck for long. These in turn created a momentum of positivity in investor confidence.
The pandemic and the consumers’ adoption of digital in daily life and lifestyle, helped businesses across sectors and of various size and scale, move into the digital arena. Sectors like EdTech, healthcare, pharmaceuticals, tech, ecommerce, FinTech found traction and could showcase higher deal flow in the coming years and whether business momentum could be kept pace with, and the proven path to profitability.
Policies, the sustainable engine
The Indian government’s investment in physical and digital infrastructure and its initiatives in simplifying business regulations and removing onerous outdated compliances has been in progress. This is a positive move in enabling the business growth engine, when the younger demographics, rise of the middle class and its intent to become entrepreneurs, instead of being employees and increasing urbanisation contribute further to newer startups of all forms (digital, non-digital and Phygital).
The Indian private investing space is showcasing signs of maturity. In the past five years, the market has shown that new investments accounted for half of VC transactions. The VC-to-PE (venture capital to private equity) pipeline has also been robust and consistent.
The regulatory updates over the past few years have kept up with their encouragement to the private investment ecosystem. These regulatory upgrades have pushed larger impetus to the Alternative Investment Funds (AIF) sector. The successful domestic capital fund raise by the AIFs showcases the investment appetite and the available capital pool locally. With time, one can expect a larger number of investors to start using this asset class and expand the domestic capital pool to a larger proportion.
Since the market regulator SEBI brought in the AIF regulations in 2012, the AIF pool has grown 20 per cent annually. The AIF Category I covers early-stage funding, and comprises venture capital, social ventures, apart from small and medium enterprises (SMEs). Category II covers Private Equity, and is over 75 per cent of industry’s AUM (assets under management). Category III ‒ the hedge funds account for 13 per cent of the industry AUM. In the alternative investment space, the market has evolved from investors asking for downward protection initially, to guaranteeing upside participation as the startups scale.
The Indian market has also seen the emergence and stable growth of the venture debt funds. This investment category offers the investors an exposure to India’s startup ecosystem, as well as the funding route for the startups to grow their business without losing control or diluting too much equity.
Structural stability & domestic investors
The World Bank estimates India’s economy at around $3 trillion, with its forecast crossing the $5 trillion mark in the next few years. Plenty of research forecasts, and opinions are available in the public domain that showcase the global investors’ confidence in the Indian economic potential. The growth journey has come with efforts across polity and the policy spectrum, with encouragement to the various stakeholders. The theme of being a self-reliant nation #Atmanirbharta has been ingrained in the efforts to tap the entrepreneurial potential available in the nation. It is also important to note that as a populous younger demographics filled the nation and being a potentially a large consumption market, self - reliance is a vital need for social economic stability, and national security.
When the ‘Digital India’ initiative was launched a few years ago, it was initially met with scepticism. The programme intended to transform India into a “digitally empowered society and knowledge economy." The success of this programme is for all of us to see. Many of the digitally enabled startups and even the traditional businesses are using this framework effectively to their benefit. Citizenry services are being delivered with this large scale digital transformation.
But from the economic perspective of the last two to three years, there have been unintended drivers that have aided private investing in India. Surplus liquidity in the banking system, the declining interest rates, lowered returns from fixed income instruments, highly volatile capital markets, have helped some of these capital pool move to private investing. The outcome of this has shaped the diversification of domestic capital into various investable categories, apart from the traditional public markets or other financial instruments. It is also worthwhile to track India’s comparatively higher domestic savings rate ‒ another indicator that the domestic capital pool can grow multifold from the current levels.
What do private investors want
The private investing community is usually aware of the risks that they take. They seek policy continuum and regulatory guidance regularly. They are aware of additional delta possibilities in investment returns in markets that are transitioning into the next phase of regulatory clarity. Global investors, including VCs, PEs and sovereign funds, face an additional challenge ‒ that of deploying their capital or surplus corpus to generate extra returns for their investors. This is becoming tougher considering the global economic turmoil, political uncertainties, supply chain rejigging post the pandemic, nationalist policies that many nations started adopting to protect their domestic constituents, and importantly, increasing investor expectations for higher returns.
Hence the pressure on fund managers to look at deals more carefully, including tactical opportunities. Many investors, who had not done so in the past, now look at funding segmental consolidations that can create higher value, buyout of management teams, helping the promoter consolidate equity position and improve business margins, acquiring newer technologies and associated teams. The investors are now keen on operational excellence and hence, are more involved in the regular business reviewers, including having a say in many management decisions.
Challenges, caution, curbs, culture
Early stage investments do have local impact ‒ socially and economically. They create benefits for consumers, which, in turn, lead to societal benefits including employment generation, improved standard of living and overall social economic development. These investments provide funding for early-stage ventures that may be seen as risky bets for larger investors. Such early stage funding looks to generating returns on potentially risky investments through exit strategies that depend on a business developing over a few years’ time.
In this endeavour and pressures of time to manage the risks and to generate valuations gains, does fund-culture make any impact on the ethos of the market? Indeed yes. This is why it is critical to balance foreign capital with the domestic pool of investments. In a bad economic cycle, foreign capital is at risk of exiting the market. Also as larger investments get concentrated from specific global economic blocs, will we be vulnerable to trade discounts or policy push by other nations? How do we balance such policy pressures versus seeking global influx of capital? After all, there is a cost attached to every capital ‒ it can be more than just financial one.
Also the cultural style of performance oriented at cost of human capital Values and organisation building culture is markedly different between domestic investors and foreign.
For example, will the ‘hire and fire’ style pervade? Will talent be seen as ‘use and throw’ until the investment exit? Will the investors grow the organisation with resilient culture and people oriented style? Will they nurture inclusiveness? Will there be space and time for ‘mentoring’ talent? Will there be space for bringing local native intelligence as part of knowledge management of the platform? Will the influx of global monies create a sense of losing our cultural identity in the way we have dealt with businesses?
The road ahead
As more capital becomes available, the competition increases, and the lessons from previous mistakes help in bettering performance, private investors will have to up-their-capabilities and long-term presence in and for India. Private capital could become a large source of entrepreneurial risk and growth capital for the Indian economy to scale. This would need continued policy focus, and stable markets in offering exit options for investors. This also would need the businesses to start delivering on their potential and promises. Else valuations led businesses would find their investors moving away. The conversations about changing consumer behaviour and consumer needs have to be monetised by these new-age businesses. For capital is to make returns on capital and not just the return of capital. In this simple journey, we also need to balance how the nature of our entrepreneurial behaviour and societal benefits would shape. We cannot allow distractions of other global markets that would force an exit from Indian investments. We need to tap more into the domestic capital pool.
Instead of just looking at RoI (rate of return), is it possible to measure Ro4Cs ‒ Return on Capital, Culture, Competence, Core Values? That would be true Atmanirbharta, for a stable social economy in the long term. This is the reason why we need more domestic capital shaping our economic engine. For the investors would need patience to shape the culturally relevant business ecosystem, and not be pressurised by the urgency of returns ‒ but also look at societal impact, and inclusive developmental agenda.
Dr. Srinath Sridharan, Corporate Advisor
@ssmumbai
