Can a Karnataka Fund of Funds open new possibilities for startups from the state?

A state-wise fund of funds has been one of the proposals in a recently released report. According to stakeholders in the industry, start-ups and SMEs in Karnataka stand to gain a lot from it

September 29, 2023 09:00 am | Updated 09:00 am IST - Bengaluru

As per news reports, earlier this year Small Industries Development Bank of India (SIDBI) proposed a Fund of Funds for early-stage start-ups with a special focus on deep-tech start-ups.

As per news reports, earlier this year Small Industries Development Bank of India (SIDBI) proposed a Fund of Funds for early-stage start-ups with a special focus on deep-tech start-ups. | Photo Credit: cueapi

It was in 2016 that the Government of India announced a Fund of Fund for Startups (FFS) with a corpus of ₹10,000 Crore in line with the Startup India action plan. The idea was to provide a boost to the Indian start-up ecosystem and enable access to domestic capital.

Several start-ups seem to have benefited from the FFS, and ever since there has been a demand from various quarters for more focused sector-specific and region-specific Fund of Funds.

As per news reports, earlier this year Small Industries Development Bank of India (SIDBI) proposed a Fund of Funds for early-stage start-ups with a special focus on deep-tech start-ups. SIDBI operates the existing FFS.

A ₹5,000 Crore Fund of Funds for startups in Karnataka was part of BJP’s manifesto before the Karnataka elections in 2023.

A state-wise ₹5,000 Crore fund of funds (FoF) has also been one of the proposals in the recently released report titled ‘Karnataka’s Decade: Roadmap to $1 Trillion Economy.’ The report was released last week by the Planning, Programme Monitoring, and Statistics Department and the Federation of Indian Chamber of Commerce and Industry.

According to stakeholders in the industry, start-ups and SMEs in the state stand to gain a lot from a state-wise fund of funds (FoF).

Bringing in more local capital

“The idea behind the national fund of funds run by SIDBI was to grow the ecosystem of local capital and support local fund managers. That has worked largely,’ says Pranav Pai, founding partner and chief investment officer at 3one4 Capital.

SIDBI acts as a Limited Partner (LP) and invests in Alternate Investment Funds (AIFs) registered with SEBI. These AIFs will then invest in Indian startups through equity and equity-linked instruments.

Also called daughter funds, AIFs are required to deploy in startups at least double the amount they received. According to data available on the SIDBI website, ₹16,636 Crore have been invested in start-ups by AIFs under FFS and 888 start-ups supported as of August 16, 2023.

Limited Partner (LP)
Limited Partners are entities like institutions, family offices or individuals who invest in the corpuses of Venture Capital funds with the expectation of returns from the VC’s investments in startups and other high-growth companies.

“Now the share of Indian capital in the whole alternative investments space including equity, debt, and other products has gone up significantly, which is strong progress. Big institutions like HDFC, Nippon, and Kotak are also launching their fund of funds. That means there is growing demand for a product like it,” Mr. Pai points out.

According to him while states announcing incentives to start-ups from the region has been helpful, replicating the FFS model at a state level would help them set priorities to focus on sectors that are important to each state.

“The national fund of funds will define very broad priorities, whereas a state FoF can focus on specific local production and SMEs,” he notes.

Alternative Investment Funds (AIF)
AIFs are privately pooled investment funds which collects funds from Indian or foreign investors. Category-1 AIFs invest in startups, SMEs and other new economically viable businesses with high growth potential. A fund of fund is a category-2 AIF which does not have an investment portfolio but invests in other AIFs.

Beyond start-ups

By now a vibrant funding ecosystem exists for start-ups in Bengaluru. But the same is not the case for SMEs or start-ups from other parts of the state. Industry players feel that a state-wise FoF, to an extent, could bridge this gap.

“When we think of funds, we mostly think of start-ups. But start-ups are a very small corner of the overall SME market. Unfortunately, VCs and tech funds do not always invest in companies in domains such as contract manufacturing or logistics,” Mr. Pai points out.

Pranav Pai

Pranav Pai

Given venture capital firms look for a major tech or IP component in companies and, therefore, not a great source of equity capital for good SMEs in the state, it is important to have non-tech funds, he notes.

“Hopefully, the state fund of funds can focus more on them (SMEs) and help them grow.

Beyond Bengaluru

Madan Padaki, serial entrepreneur and president of The Indus Entrepreneurs (TiE) Bangalore chapter, is of the opinion that the state-wise Fund of Funds must focus largely on start-ups from beyond Bengaluru. According to him, a dearth of funding for start-ups in places like Mysuru, Hubbali, and Mangaluru forces entrepreneurs to relocate to Bengaluru.

In 2022, The Government of Karnataka sanctioned the establishment of a ₹75 Crore ‘Beyond Bengaluru cluster seed fund’ for start-ups from Mysuru, Hubbali-Dharwad and Mangaluru clusters in association with Karnataka Digital Economy Mission (KDEM), Karnataka Trustee Company Pvt Ltd (KAMCO) and Karnataka Asset Management Company Pct Ltd (KATCO).

A seed fund of ₹25 Crore was announced for the Mysuru cluster in August.

Madan Padaki

Madan Padaki

“The state-wise FoF proposal dovetails well into the cluster seed fund initiative,” says Mr. Padaki.

“If 80 per cent of a ₹5,000 crore fund is diverted to five cities or clusters in Karnataka, each cluster gets Rs 200 Crore.  It is a huge amount of money and can really unlock the ecosystem there. For the money that is being poured into Bengaluru, it is a small amount. But it can be really significant if it moves to non-Bengaluru startups,” he adds.

Sector and demographic focus

On top of geography, the FoF should also have domain and demographic dimensions according to Mr. Padaki. While in terms of domain, it could be deployed in sectors such as tourism, local art, local manufacturing and so on that could drive the local economy, in terms of demographics it could also be explored whether a part of the fund could be earmarked for women entrepreneurs, ventures by persons with disabilities and so on, he notes.

Dr. Taslimarif Saiyed, CEO and director of the Centre for Cellular and Molecular Platforms (C-CAMP) feels a state-wise FoF and the government’s participation as an LP would augment private risk funding in the region.

Taslimarif Saiyed.

Taslimarif Saiyed.

“That is important because it is all the more needed in life sciences or the big science segments. Classical funding has focused much more on tech than on deep science,” he says.

“With FoF there will be an opportunity for the government to identify, select and attract investors and funds geared more towards deep science. With state-wise FoF you are not only supporting local startups but are also building an ecosystem of local capital funds.”

Democratising access

While the start-up funding ecosystem in India has been thriving, it is also to be noted that most of the capital flowing in has been foreign. Only a mere 10 per cent of the inbound capital is domestic.

Mr. Padaki believes one of the reasons could simply be that the larger LPs around the world - the kinds of Ontario Teachers’ Pension Fund - are sitting on tons of money and even a small percentage of it would mean a lot of capital.

“In India, we don’t have that kind of capital,” he notes.

Some of the largest pools of capital in the country include banks, insurance companies and mutual funds. Strict regulations govern investments by such institutions in AIFs.

“We need stable regulations and simple boundary definitions for Indian capital spanning 10-20 years to invest in this asset class,” says Mr. Pai.

According to him domestic capital has been catching up in India with institutional capital from insurance companies, banks, mutual funds, family offices and large corporations flowing into in VC funds.

“But India needs more capital for sure. There can be other types of funds such as debt funds, and sector-specific funds that government schemes can invest in and encourage. Fund of funds is more to democratise access and to support the launch of a wider variety of funds,” he notes.

A state-wise FoF may also help deepen the government’s relationship with start-ups and give way to several follow-on effects. Mr. Pai notes that under the FoF, the government could look at giving grants for patent filing which is an expensive affair, or give money to university accelerators and incubators.

Building an ecosystem

As per reports SIDBI has been seeing impressive initial returns with the national fund of funds. While that’s encouraging, experts note that the focus of a FoF should be more on creating enabling environments for investments than getting into the ‘returns’ aspect of it.

“When you are a portfolio manager, you look at the internal rate of return (IRR). But when there is public money coming in, we should also look at the social benefits that the fund will unlock,” says Mr. Padaki.

He notes that the objective of the government is to not make money from investing in startups and if the government starts behaving like any other LP, then it becomes meaningless.

“Can the fund of funds generate an ecosystem in 10 other districts? Can this fund give rise to 10 unicorns from beyond Bengaluru in, say, five years? Or can it unlock, say, 400,000 jobs? It is important to look into what is the unique angle that deployment of money by the government has opened up for the welfare of the state.”

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