Rise of risk capital

Private funding is bridging a crucial gap

India’s unicorn club is expanding rapidly, with 10 start-ups crossing the $1-billion valuation mark in just four months of this year. According to one estimate, India now has 47 start-ups with a $1 billion-plus valuation and the number is expected to cross 150 by 2025. It is likely that all businesses getting funding and headline-grabbing valuations would not succeed, but the developments in the start-up universe can potentially make a meaningful difference in the Indian economy. According to a recent study by the Indian Private Equity & Venture Capital Association and Ernst & Young, private equity (PE) and venture capital (VC) investment in India registered a compound annual growth rate (CAGR) of 19 per cent between 2011 and 2020 — a total investment of over $230 billion. Notably, the bulk of the investment came over the last four years at a CAGR of over 30 per cent.

It is highly likely that the momentum will continue in the coming years as the economy recovers from the pandemic-induced disruption. PE/VC activity has increased globally due to a variety of reasons. For one, interest rates in advanced economies have come down structurally over the years and a large amount of surplus savings is looking for higher yields. This has led to a fundamental change in the way businesses raise capital. As Credit Suisse has highlighted, the number of listed companies globally has remained largely unchanged since 2006. Most of the fundraising is happening privately and it’s also convenient for firms. The pool of capital in this category has increased with the participation of large investors such as global pension and sovereign wealth funds. India is attracting investment because of its relative longer-term growth potential. Its ability to adapt to digital technology is also an advantage.

Private fundraising is estimated to have exceeded public transactions in every single year over the last decade. The flow of PE/VC funding is bridging the crucial risk capital gap in India, which has allowed some of the firms to grow rapidly. It is also the biggest source of foreign direct investment. Savings in India are not sufficient to fund the investment needs of the economy. Besides, the allocation of household financial savings towards equity is negligible. Many of the new businesses would not have grown the way they have without the support of foreign risk capital. Thus, it is important for policymakers to constantly assess the business environment and improve the ease of doing business.

It is worth noting that financial services and infrastructure sectors are among the top preferred areas for funding. These are also sectors where India needs a large amount of investment. India is also planning to privatise most of its public sector firms, including banks. Large PE players backed by stable funding could emerge as potential buyers for such assets. PE/VC focus on e-commerce also has the potential to transform the retail trade in India. Additionally, higher efficiency in the system and investment in logistics will improve India’s external competitiveness. Hundreds of billions of dollars worth of capital is waiting on the sidelines looking for opportunities. India should aim to provide such opportunities with increased ease of doing business. Not every deal will create lasting assets and that’s why the flow of risk capital is so critical.