Splurging taxpayer funds in venture capital to boost start-ups is illogical and a travesty of the ‘minimum government’ promise
Driving me to work on Monday morning, my driver asked me, “Sir, yeh start-up kya hota hai?” (What is this start-up?). Clearly, he had watched television and/or read the newspapers about Prime Minister Narendra Modi’s Start-up India event. That my otherwise reticent driver felt compelled to enquire about this thing called “start-up” is a tremendous tribute to the prime minister’s signature style of governance, i.e. to communicate incessantly with the common man.
I explained to my driver how Ola Cabs, a four-year-old upstart that raised a billion dollars to provide jobs or “gigs” to more than 200,000 drivers across 300 cities and towns, all made possible through the clever use of technology is what the prime minister meant by Start-up India. Nearly 4,000 new start-ups, $100 billion in risk financing with perhaps at least half a million new jobs created has been the untold story of venture capital activity in India over the past decade. Prime Minister Modi has now ensured that this is no longer one of India’s best-kept secrets.
Start-up India is a rightful recognition of the inordinately important role of the venture capital and private equity asset classes in India’s economy. It is also a rightful recognition of the unique needs of these classes of companies that thrive on technology, innovation and scale. Yet, the elephant in Vigyan Bhavan (the venue of the Start-up India event) on Saturday was this lingering question: can the government really do much to foster start-ups?
For starters, the government now has a precise 125-word answer to my driver’s question—a definition of a start-up. Those companies that fit into this 125-word definition will now be eligible for a set of 11 incentives. This, in a nutshell, is the Start-up India policy.
Incentives range from ease of registering a business, shutting it down, a three-year tax holiday on profits that normally elude these start-ups for at least a decade, and discounts on registering intellectual property, something that usually costs a fraction of what it does to develop an intellectual property in the first place. The policy also provides for incubation infrastructure (land, in start-up jargon), a dire need for most start-ups. Perhaps, there could have been some actions to make it easier for start-ups to hire and retrench workers, given the intensity of scale of hiring for some of these start-ups. However, the most controversial policy action was the announcement of a Rs.10,000 crore fund of funds to spur start-ups.
The government had announced an India Aspiration Fund of Rs.2,500 crore in August. This model was further expanded to Rs.10,000 crore at the Start-up India event. Essentially, the government will take taxpayer funds to invest in other venture capital funds, which will then fund start-ups. Thus, you and I will be indirect investors in venture capital funds and thus start-ups. Would we have done the same with our money, i.e. invest them in VC funds? I doubt it. Because they are at the extreme high end of the risk-reward category of investments. When there is clearly a thriving venture capital industry that funds start-ups, what is the rationale for the government to risk taxpayer funds in this? The arguments posited by the perpetrators and supporters of this initiative are:
(1) Israel, the US and Canada have done it.
All these countries invested tax dollars into government venture funds to kick-start their innovation economy, not when there was one already thriving. There was no external risk capital in their economy, which necessitated the government to step in with funds. India does not have this problem today.
(2) There is a lack of seed-stage risk financing in India.
According to the government’s own reports, India today has the third largest number of start-ups in the world. India is also home to eight of the world’s “unicorns”—start-ups valued at more than $1 billion. I am reasonably certain that every one of these successful start-ups were seed-financed with risk capital before foreign venture capital institutions provided further capital. Surely, there can always be more risk capital available to spur more start-ups. But to argue taxpayers need to provide seed-stage risk capital to start-ups is illogical, when clearly India has spawned so many new start-ups with seed-stage financing over the past decade.
(3) India is over-reliant on foreign venture capital and the government needs to offset this imbalance.
It is true that close to 90% of venture financing over the past decade has been through foreign capital. Foreign capital inevitably supports business models that are proven in the Western world and can potentially skew the balance. But it is a futile chase to try to throw matching taxpayer funds to foreign flows in order to correct this imbalance. India needs its scarce tax resources to provide for healthcare and education to a vast majority of her citizens, not chase foreign risk capital as matching grants. If India needs to incentivize domestic risk capital pools, it is best done through tax incentives for private investors. It is also true that foreign flows into India’s equity markets are 10 times more than domestic flows and hence stock market movements are subject to foreign investors. Surely, this government is not going to address that issue by starting a taxpayer-funded mutual fund, is it?
It is undeniable that India’s start-ups need to be saluted, encouraged and fostered. The Modi government deserves to be lauded for recognizing this and accomplishing it in its characteristic pomp and splendour. However, the temptation to translate that into policy actions by splurging taxpayer funds in venture capital is illogical and a travesty of the “minimum government” promise.
Published on 19 January, 2016 in Mint