Venture Capital Market in India Probably Getting Overheated

Playing down overall ongoing euphoria in Indian Market over private equity and venture capital investments, Evalueserve, a global research and analytics firm, has predicted stormy days ahaed.

At present pink papers are filled with new PE deals which seems to be surpassing the haydays of dotcom days only this time everybody expects PE run to last for some time.

However Evalueserve seems to differ from pink papers on this. Evalueserve research shows that over 44 US-based VC firms are now seeking to make significant investments in start-ups and early-stage companies in India. These firms have raised, or are in the process of raising, an average of US $100 million each. Indeed, if these 40-plus firms are successful in raising money, they would garner approximately $4.4 billion to be invested during the next 4 to 5 years. Taking India’s Purchasing Power Parity (PPP) into consideration, this is equivalent to $22 billion worth of investment in the US. Since about $1.75 billion (or approximately 40% of $4.4 billion) has been already raised, even if only a total of half, or $2.2 billion, is raised by December 2006, there will be a glut of VC money for early-stage investments in India. “This will be especially true if the VCs continue to invest only in their currently favorite sectors such as IT, BPO, software and hardware products, telecom, and consumer Internet. For example, early stage VCs have already invested in six on-line travel sites in India, but this sector is likely to generate only around $75 million in revenue by 2010,” says Dr. Aggarwal, Chairman and co-founder of Evalueserve.
Given that a typical start-up in India requires around $9 million of external funding during the first three years (i.e., approximately $3 million per year), investing $2.2 billion during 2007-2010 would imply investing in at least 150 to 180 start-ups every year during this period, assuming the start-up is in fact around for three years. Consequently, VCs who wish to invest in early stage companies must broaden their investment thesis and diversify into other rapidly growing areas such as bio-technology and pharmaceuticals; healthcare and medical tourism; auto-components; travel and tourism; retail; textiles; real estate and infrastructure; entertainment and media; and gems and jewellery. It is interesting to observe that Private Equity (PE) firms have already started this diversification. During the first half of 2006, only 24 percent of PE investment went into the IT and BPO sectors, whereas 66 percent had gone into these sectors in 2000.
Since the sophistication and maturity of VC investments in India today is probably at the same level as it was in the US in the early 1970s, Evalueserve suggests that VCs provide close guidance to their Indian portfolio companies and not just show up for board meetings every two or three months or set goals in a vacuum.
“While Indian entrepreneurs are technically adept and almost at par with their US counterparts, they tend to lack experience in marketing, sales and business development,” says Dr. Aggarwal,

“and the demand for such skills is being further exacerbated by the Indian domestic and exports sectors for many products and services, which are growing at12%-14% a year.”
Finally, since India had socialistic economic policies during 1947-1992, which simultaneously constrained supply and taxed producers and sellers enormously, Indian start-ups also need substantial help in creating good internal processes and in achieving financial transparency. So, according to Dr. Aggarwal, “ VCs are advised to actually help the Indian entrepreneurs in putting these processes in place, because simply directing them to do so will be futile since many – if not most – entrepreneurs do not know how.”