A lifecycle analysis of VC-PE investments in India: Half full or half empty?

The growth and vibrancy in the Indian VC-PE industry has been acclaimed by various industry players. Although the high-growth rates are definitely noteworthy achievements, this article highlights some areas of concern that need to addressed for the industry to see long-term growth in the country. First, an ecosystem that encourages early-stage investments must be developed. It is such early-stage investments that will spur innovation and provide the pipeline for growth- and late-stage investments. In the absence of early-stage investments, many PE funds will find it difficult to find new opportunities for follow-on investments. The result would be a funneling of investments to established companies with increasing valuations. In the long run, the industry would fall apart under the burden of such high va luations lead ing to an exit of investors from India. To prevent this from happening, it is important to ensure that there is adequate early-stage investing. Second, the short duration of VC-PE investment does not bode well. A recent World Economic Forum report indicates that PE investors have a long-term ownership bias and 58% of PE investments are exited more than five years after the initial transaction. So-called "quick flips" (i.e., exits within two years of investment by private equity fund) account for 12% of deals and have decreased in the last few years (Lerner and Gurung [2008]). From this perspective, most of India's VC-PE investments would be labeled "quick flips." This trend, if it continues, would be a cause for real concern. It is expected that VC-PE investors would do a lot of hand holding and participate in value-adding activities in their portfolio companies. However, contributing to the investment th rough such ways willh appen only if the investors remain invested for a long term. Short-term investments deny the portfolio companies the opportunity to leverage the management expertise of the VC-PE investors. Third, the time intervals between successive funding rounds should increase. Frequently approaching investors means that top management attention is diverted f rom business operations. It would be beneficial if entrepreneurs and companies raise capital that can sustain operations for at least two years. While companies might feel that raising a large round may deprive them of the benefits of valuation increases from raising funding in multiple rounds, less frequent rounds would definitely help to keep transaction costs lower. The issue of valuation increases can be addressed by incorporating suitable incentive structures in the shareholders' agreement. The investors too should support the idea of a larger funding round for the companies and engage in co-investing with other VC-PE investors if required.