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January 16, 2006

What’s holding back the Indian Venture Capital Market?

In this guest post, Abrar Hussain, points out that India’s venture capital ecosystem has “some ripening to do” before it can be equated to the original Silicon Valley.

"Opportunity is missed by most people because it is dressed in overalls and looks like work."

- Thomas Edison

They heyday for Silicon Valley’s monopoly over the technology industry is long gone. Nowadays, Bangalore is often included in the same breath when there is a reference to Silicon Valley. But, is this really a realistic comparison? Although everyone seems to equate the two, if we poke around this comparison it’s easy to see that there are some big differences. I won’t pretend to have a monopoly on the items listed--I think lots of people are thinking the same thing. India is still maturing and, although there seems to be some recent evidence that the Indian VC industry is beginning to "fill in the gaps" within its offerings, there are still some significant parts of Indian venture capital ecosystem that have some ripening to do.

1) Innovation
– Early in Japan's development a common criticism they faced was that they could copy and make lots of things better but they couldn't create something new. It's much the same for Indian companies. While the offerings by many service companies seems to get better, cheaper and faster, none of these companies seem to be the next Google, or Genentech or eBay--companies which actually created new markets and fundamentally change the way that people look at an industry. This might be changing. There are some early startups that truly look innovative. But, why is it that Indians in the Valley can innovate and create something new and when you put them back in India they can’t seem to do the same thing?

2) Visibility – It takes a lot of trust to give someone money. Venture capital is all about trust; trust in the entrepreneur, trust in his team and trust in the idea. This goes hand in hand with visibility. An investor must be able to see what's going on inside a company even if he isn't there every day. Yet, in India, companies are often an extension of the founder. (This seems true of startups as well as large companies.) Until there is a clear separation of the person from the company and a more visibility into the operations to an outsider, early round investment will take a lot more work in India than it does in Silicon Valley. That may be fine for the likes of you and me (although I can't say that I have a few million lying around to invest in a company), but it does mean that the opportunities are not available to the broader investing market.

3) Pervasive Understanding of Venture Investment
– Any serious investor (and many not so serious investors) in Silicon Valley can tell you about the basics of an early round investment in Silicon Valley. How does a debt financing round work? How does a preferred round work? What sort of rights should an early round investor ask for as opposed to a later round investor? Because there is this implicit understanding of the basics, it easier for deals to get done quickly and efficiently. When I was COO at a startup (I still have flashbacks about the crazy time. What the heck was that startup thinking putting a 28 year old as COO?), there was one instance where we were able to get the details of a debt financing with an investor completed in one evening and get the legal documents done the next day.

4) Exit Strategy – Most Indian technology companies are focused on services. The problem is that it's hard to create a big exit for a services company. This is a mature space. As I look at some of the investments being made, it's not clear what the exit strategy is. It almost reminds me of the Internet boom in Silicon Valley when investors were investing because they didn't want to be "left behind". Some trends are meant to be left behind.

India's Big Advantages

While there are lots of things that the Indian investing community can learn from other dynamic ecosystems (like Silicon Valley, Boston, and Israel), the mistake is to conclude that there is only one way to create this vibrant ecosystem. Not all of the things that worked in Silicon Valley will work in India. But, there is one deep, fundamental advantage that sets India apart.

Ever since I was a kid, I've been going back and forth to visit my family in India. But, in the past five or six years, something changed. My relatives, instead of asking me about all the things going on in America, started talking about all the things that were going on in India. There was a shine in their eyes talking about the progress that has already happened and that will come. It’s this hope and confidence that fundamentally changes the equation. People are now willing to take risks and entrepreneurship is starting from a grass-roots level. Indian companies are becoming confident enough to go shopping on a global scale and many are not afraid to grow aggressively. As the IPO and M&A markets become broader, it will provide more opportunities for small companies and, most crucially, the investors that put money into them.

This confidence also allows the freedom to do something that is crucial to an entrepreneurial ecosystem--the ability to fail. Silicon Valley’s most fundamental advantage is that it allows companies to fail. An entrepreneur can fail and still get a job at another company. Failure is a wonderful teacher. Fail enough times, and learn from it, and you’re bound to succeed. Indian companies are starting to operate in this Darwinian ecosystem. Out of the hundreds of startups that emerge, only a handful will succeed. And that's the way it should be. The companies with better technology, better teams, better execution or some mix of these elements succeed and the others fail. In the startups that I've personally participated in, I've learned more from the failures than from the successes. This, at its most fundamental, is what makes Silicon Valley work. It's also what's emerging in India--a dynamic ecosystem where companies can fail and people can start over again to get it right.

Abrar Hussain is a specialist in cross-border transactions at leading US-based law firm Greenberg Traurig LLP. He can be reached at abrarh@gmail.com