2.0 OBJECTIVES AND VISION FOR VENTURE CAPITAL IN INDIA

2.1 Venture Capital funding is different from traditional sources of financing. Venture capitalists finance innovation and ideas which have potential for high growth but with inherent uncertainties. This makes it a high-risk, high return investment. Apart from finance, venture capitalists provide networking, management and marketing support as well. In the broadest sense, therefore, venture capital connotes risk finance as well as managerial support. In the global venture capital industry, investors and investee firms work together closely in an enabling environment that allows entrepreneurs to focus on value creating ideas and venture capitalists to drive the industry through ownership of the levers of control in return for the provision of capital, skills, information and complementary resources. This very blend of risk financing and hand holding of entrepreneurs by venture capitalists creates an environment particularly suitable for knowledge and technology based enterprises.

2.2 Scientific, technology and knowledge based ideas properly supported by venture capital can be propelled into a powerful engine of economic growth and wealth creation in a sustainable manner. In various developed and developing economies venture capital has played a significant developmental role. India, along with Israel, Taiwan and the United States, is recognized for its globally competitive high technology and human capital. The success India has achieved particularly in software and information technology of success against several odds such as inadequate infrastructure, expensive hardware, restricted access to foreign resources and limited domestic demand, is a pointer to the hidden potential it has in the field of knowledge and technology based industry. India has the second largest English speaking scientific and technical manpower in the world. Some of the management (IIMs) and technology institutes (IITs) are globally known as centres of excellence. Every year over 200,000 engineers graduate from Government and private-run engineering colleges. Many also specialise through diploma courses in computers and other technical areas. Management institutes produce 40000 management graduates annually. Given this quality and magnitude of human capital India�s potential to create enterprises is unlimited.

2.3 In Silicon Valley, these very Indians have proved their potential and have carved out a prominent place in terms of wealth creation as well as credibility. There are success stories that are well known. They were backed by a venture capital environment in Silicon Valley and elsewhere in US which supports innovation and invention. This also has a powerful grip over the nation�s collective imagination. At least 30% of the start-up enterprises in Silicon Valley are started/backed by Indians. Back home also, as per NASSCOM data, the turnover of software sector in India has crossed Rs 100 billion mark during 1998. The sector grew 58% on a year to year basis and exports accounted for Rs 65.3 billion while the domestic market accounted for Rs 35.1 billion. Exports grew by 67% in rupee terms and 55% in US dollar terms. The strength of software professionals grew by 14% in 1997 and has crossed 160000. The global software sector is expected to grow at 12% to 15% per annum for the next 5 to 7 years. With the inherent skills and manpower that India has, software exports will thrive with an estimated 50% growth per annum. The market capitalisation of the listed software companies is approximately 25% of the total market capitalisation of around US$ 200 billion as of December,1999.There is also greater visibility of the Indian companies globally. Given such vast potential which is not only confined to IT and software but also in several other sectors like biotechnology, telecommunications, media and entertainment, medical and health etc., venture capital industry can play a catalyst role in industrial development.

2.4 It is important to recognise that while India is doing well in IT and software, it is still a low cost developer and service provider. Though it has the advantage of English-speaking, skilled manpower and cheap labour, its leadership is on a slipping edge as other countries such as Philippines, China and Vietnam are moving to occupy India�s position as the premier supplier of low end software and support services. Many such countries have superior supplies of power, telecom and internet connections compared with India. As the US did in the semiconductor industry in the eighties, it is time for India to move to a higher level in the value chain. This will not happen automatically. The sequence of steps in the high technology value chain is information, knowledge, ideas, innovation, product development and marketing. Basically, India is still at the level of �knowledge�. Given the limited infrastructure, low foreign investment and other transitional problems, it certainly needs policy support to move to the third stage i.e. ideas and towards innovation and product development. This is very crucial for sustainable growth and for maintaining India�s competitive edge. This will need capital and other support which can be provided by venture capitalists.

2.5 India has a vast pool of scientific and technical research carried out in research laboratories, defense laboratories as well as in universities and technical institutes. A conducive environment including incubation facilities can help a great deal in identifying and actualizing some of this research into commercial production.

2.6 Development of a proper venture capital industry particularly in the Indian context is important for bringing to market high quality public offerings (IPOs). In the present situation, an individual investor becomes a venture capitalist of a sort by financing new enterprises and undertaking unknown risk. Investors also get enticed into public offerings of unproven and at times dubious quality. This situation can be corrected by venture capital backed successful enterprises accessing the capital market. This will also protect smaller investors. A study of US markets during the period 1972 through 1992 showed that venture-backed IPOs earned 44.6% over a typical five year holding period after listing compared with 22.5% for non-venture backed IPOs. The success of venture capital is partly reflected by these numbers since 80% of firms that receive venture capital are sold to acquiring companies rather than coming out with IPOs, in which the return multiple vis-�-vis non-venture funded companies is much higher. This potential can also be seen in sales growth figures for the U.S. where, from 1992 to 1998, venture capital funded companies sales have grown by 66.5% per annum on average versus 5% for Fortune 500 firms. The export growth by venture funded companies was 165%. All the top 10 sectors measured by asset and sales growth in USA were technology related.

2.7 Thus, venture capital is valuable not just because it makes risk capital available at the early stages of a project but also because of the expertise of venture capitalist that leads to superior product development. The big focus of venture capital worldwide is, technology. Thus, in 1999, around $30 bn of venture capital has been invested in the U.S. of which technology firms reportedly got around 75%. Besides this huge supply from organised venture funds there is an even larger pool of "angel" funds provided by private investors. In 1999, it was expected that angel investment would be of the order of $90 bn, thus making the total "at-risk" investment in high technology ventures in a single year of $120 bn. By contrast, in India, cumulative disbursements to date are not more than $500m, of which technology firms have received only 36%.

2.8 The other successful experience is that of Taiwan: Hsinchu Science-based Industrial Park is the showpiece of Taiwan�s success. Forty percent of the firms established in this government promoted park, which currently accommodate 3,000 expatriates, were begun by entrepreneurs from the United States. The revenue of firms located at Hsinchu Park alone was $14 billion in 1998. Facilities at Hsinchu include English language teaching for the children of its expatriate entrepreneurs. The Hsinchu experiment has benefited from the generally high quality of education in Taiwan, whose institutes produce 50,000 engineers annually. Taiwan has 74 technical schools, 36 colleges and 24 universities, two of which are located near Hsinchu Park. The venture capital environment has also been a favorable factor. There are 110 venture capital firms in Taiwan, including 38 begun in 1998. By the end of 1997, these firms had invested $1.32 billion in 1,839 ventures, mostly in high technology.

2.9 Taiwan�s government has been particularly successful in promoting its hardware industry through tax incentives, low tariff barriers, credit at cheap rates, good infrastructure facilities and establishment of research institutes. The Industrial Research Institute, owned by the government, started with semiconductor technology purchased from RCA Records. The technology subsequently developed at the Institute led to two very successful integrated chip firms. United Microland Corporation (UMC) and Taiwan Semiconductor Manufacturing Corporation (TSMC), which were initially promoted by the government and ultimately privatized.

2.10. Taiwan has benefited from close ties with Silicon Valley. A transnational community of Taiwanese venture capitalists has fostered a two-way flow of capital, skills and information between Silicon Valley and Taiwan. There is also an emerging trend of grouping of Taiwanese and Indian high technology talents in Silicon Valley. India can learn important lessons from the Taiwanese government�s focus on education and encouragement of small enterprises, via facilities such as Hsinchu Park, as well as a U.S. � style legal, regulatory, tax, and institutional environment.

2.11 Similarly the venture capital industry in Israel has grown from one firm with a corpus of $30 million in 1991, to eighty firms with a corpus of $3 billion by 1998. Further, Israel�s IT speciality is developing technology rather than software or products. This focus has meant that new Israeli ventures are most typically acquired by larger technology firms, and IPO route in the U.S. markets has also been succeesful. In fact, Israeli companies are the second largest group of companies listed on the Nasdaq markets after American companies, a remarkable achievement for a country of 6 million persons.

2.12 Like Taiwan, Israel is another country in which government policy fostered a successful, highly diversified, self-reliant industry. In the early 1990s, Israel restructured its legal, accounting and regulatory framework to mimic that of the United States. The new Israeli framework guarantees U.S. investors parity with U.S. tax rates. In 1984, the Israeli government passed a law to encourage industrial research and development (R&D) and created the Office of the Chief Scientist to implement government policy related to this area. The law�s strategy is to encourage private companies to invest in R&D projects with the government sharing the business risk. Under the law, a Research Committee appointed by the Chief Scientist approves proposals for anywhere from 30 to 66 percent of given projects� funding (up to $250,000). These proposals, when funded, also receive tax exemptions for up to ten years. As an additional incentive to entrepreneurship, the Israeli government has created twenty six technology incubators designed to allow start-ups to convert their ideas into commercially viable products.

2.13 Israel�s government participates in international cooperation, seeking to match the nation�s technical skills with global markets, and to share start-up risks up front with later-stage activities such a marketing. The most successful of these ventures has been the Bilateral Industrial Research and Development Foundation (BIRD), a joint venture with the U.S. government. The Israeli high technology industry enjoys the same kinds of transnational ties that has helped Taiwan. Similarly, the Israeli venture capital industry has strong U.S. connections. Several of Israel�s experiences have relevance for India. Government policy on incubators, the funding of R&D projects, and the BIRD project provide useful object lessons for the Indian government and business alike.

2.14 Venture capital has played a very important role in U.K., Australia and Hong Kong also in development of technology growth of exports and employment.

2.15 India certainly needs a large pool of risk capital both from home and abroad. Examples of US, Taiwan and Israel clearly show that this can happen provided there is right regulatory, legal, tax and institutional environment. It is also necessary that start-up�s have access to R&D flowing out of laboratories and universities with infrastructure support such as telecom, technology parks etc. Steps are being taken at the level of Government, Ministry of Information and Technology, and CSIR for improvement in infrastructure and R&D. Certain NRI organisations are taking initiatives to create a corpus of US$500m to strengthen the infrastructure of IITs. More focused attempts will be required in all these directions.

2.16 Recent phenomena, partly ignited by success stories of Indians in US and other places abroad, provide the indications of a growing number of young, technically qualified entrepreneurs in India. There are success stories within India also. At the same time increasing number of internationally savvy, senior managers have been leaving established multinationals and Indian companies to start new ventures. The quality of enterprise in India is on an ascending curve. The atmosphere thus is ripe for creating the right regulatory and policy environment for sustaining the momentum for high-technology entrepreneurship. The Indians abroad have leapfrogged the value chain of technology to its highest levels. By bringing venture capital and other supporting infrastructure this can certainly happen at home also.

2.17 Another important area is the need for multi country integration. Information Technology and Internet have brought about the trend of what can be called the "death of distance" and operation across the countries can be seamlessly integrated. In the Indian context with developing IT and internet technology coupled with close linkages of Indian technocrats and entrepreneurs located in India and abroad, there are interesting possibilities. This will of course need further regulatory and policy support to provide operational flexibility, easy entry-exit and ownership patterns to suit global needs. It is also to be noted that the quality and quantity of research conceptualized in startups competes favorably with research undertaken by big firms. This phenomenon is seen even in India.

2.18 What could all this mean in terms of employment generation within India? There is probably no industry as employment intensive in productivity and numbers as high technology. In US venture funded companies have grown jobs by 40% per annum since 1992. Conversely Fortune 500 jobs shrank by 2.5% per annum during the same period. 60% of the jobs created by venture funded companies were engineers/skilled jobs. Further in 62% of the venture funded companies, stock options covered 100% of the employees. India today produces over 60000 new computer science graduates annually and over 2 lakh more enroll annually in computer training institutes. Besides, about 200,000 engineering graduates come out from engineering colleges in addition to the substantial number of persons doing diploma and certificate courses in technology related areas. By contrast, in Taiwan, the total number of engineering graduates is around 50000 and in US it is 30000 per annum. According to available estimates there are about 3,50,000 unfilled jobs of computer scientists in the US with the growth rate of 100,000 job requirement each year. Achieving even a reasonable fraction of US scale of development in information technology and other knowledge based areas, there is going to be a big employment generation in India. Additionally, given India�s lower labour cost, the potential for employment is even larger than what appears from these estimates.

2.19 It also needs to be noted that with other areas of business and industry getting more and more technology oriented, there will be requirement of jobs all around. Indications are already emerging, as firms in India which are being outsourced by foreign organisations to provide services are recruiting hundreds of employees within one year of their existence. Several such firms are getting located around Delhi, Bangalore and Hyderabad. With proper venture capital support, there can be a phenomenal increase in start-up enterprises which would generate further employment potential.

2.20 Given the right environment, large flows of risk finance and venture capital can flow into the country. Apart from the foreign investment, substantial venture capital is likely to come from overseas Indian community in Silicon Valley. This is particularly so as some of the Indian technocrat entrepreneurs in Silicon Valley have strong Indian linkages at professional level and are enthused to invest in India. There are at least 300 such entrepreneurs with individual wealth exceeding $5 million and total wealth of about $25 US billion. Another 1000 are believed to have wealth in the range of $ 1-5 million. Currently, about 20% of their wealth is reinvested in new ventures which will rise as vesting schedules mature. The risk capital with Indian entrepreneurs is around $6 billion and even if 15% to 20% comes to India annually, there is a ready pool of around $1 billion available for annual venture capital investment in India. Further, larger venture capital firms in the United States with a combined corpus of around US$ 35 billion have reportedly set aside upto 20% of their funds for investment offshore. India along with Ireland and Taiwan, is a favoured destination for investments by these offshore venture funds.

2.21 The net FII investment in Indian markets is around US $10 billion and the flows for the last few years have generally been positive. With enhanced interest in India as compared to some of the other emerging and Asian markets, given the right environment good amount of money would flow as venture capital investment. This is more so because India has already acquired credibility particularly in the area of information technology and sectors like media, pharmaceuticals etc. While the proportion of offshore to local capital which is around 80% foreign and 20% domestic, may remain same for the first few years, the recycling of entrepreneurial wealth and skills within the industry will gradually lead to greater presence of domestic venture capital industry .

2.22 With this background India is rightly poised for a big leap. This can happen by creating the right environment and the mind set to understand global forces and when that happens we would have created not "Silicon Valley" but the "Ind Valley" a phenomena for the world to watch and reckon with .